oversight

Federal Supervision of State and National Banks [Vol. II: Main Body of Report]

Published by the Government Accountability Office on 1977-01-31.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                            DOCUMENT '$SUME
 00278 - [A0751124]

 Federal Supervision of State and National Banks
 Body of Report]. OCG-77-1; B-114831; B-118535; [Vol. II: Eain
                                                 B-168904# January
 31, 1977. 1 vol. (various pagings).
 Report to the Congress; by Elmer B. Staats, Ccmptroller
                                                            General.
 Issue Area: Federal Regulatory Activities (30C0);
                                                     Accounting and
      Financial Reporting (2800).
 Contact: Office of the Comptroller General.
 Budget Function: Miscellaneous: Financial Management
                                                        and
      Information Systems (1002); General Government:
      Fiscal Operations (803).                         Central
 Organization Concerned: Federal Deposit Insurance
                                                     Corp.; Federal
      Reserve System; Department of the Treasu-y; Cffice
      Ccoptroller of the Currency.                        of the
 Actnlority: National Banking Act (12 U.S.C. 21-27).
     Depeosit Insurance Act (12 U.S.i. 1816).         Federal

           Several congressional committees requested
 evaluation of the effectiveness of the supervisory the
 the three Federal agencies involved in monitoring efforts of
 operations, because of the increasing instability banking
 study objectives were to evaluate the agencies'      of banks. The
                                                   efforts to
 identify unso'nd conditions ard violations of laws
 cause bank management to take corrective actions. in banks, and
 reports and correspondence files on more than 900 Examination
 superviad by FDIC, Office of the Comptroller of banks
                                                    the Currency,
 and the Federal Reserve Boards were examined,, including
 banks that had failed, 294 of 787 problem barks,            30 of 42
                                                    and a general
 sample of 600 of the banks in the United States.
 Findings/Conclusions: Adverse economic conditions
                                                     contributed to
 some bank failures, but generally embezzlement
                                                 and
management ot loans were the causes. Problems were poor
because: (1) the regulatory agencies were reluctant not corrected
lega' .uthority to force the banks to change, (2)       to use their
                                                     the agencies
did not consult with bank boards, (3) examinations
on a time basis rather than a problem solving basis,were set up
recommendations were not generally made as to how        and (4)
problems. Examiners have enforcement tools they      to  solve
informal and formal: (1) informally request that may use, both
changes, (2) formal written agreements to ccnfirt banks make the
                                                     :orrection
plans, (3) cease and desist orders, (4) remcval
                                                  of
 (5) financial assistance, (6) cancellation of depositmanagement,
(7) cancellation of Federal Reserve membership,           insurance,
                                                  and   (8)
revocation of charter. Federal Reserve Board surveillance
bank holding companies is not adequate. Training               of
                                                   of
not adequate. Major imsrovements of bank supervision    examiners  is
organizational changes, closer bank surveillance,        include
                                                     self-dealing
and insider transaction monitoring, consumer protection
enforcement, new examination procedures, closer             law
bank bcards, problem solving monitoring, more usecontact    with
                                                    of formal
poweers, experiemeuts on relying on state examinations, and
better training of examiners. The agencies involved are not
working as closely as they shculd. Recorfendaticns: The
agencies should revise their examination practices and
frequencies to better identify problems. Bxamination reports and
Featings with bank boards should follow all examinations. More
aggressive policies should be developed for the use of formal
actions against problem banks. Better training and screening or
potential examiners should be implemented. The three agencies,
either through their own initiative or legislaticn, should
coordinate their efforts more closely. bore strigent procedures
for handling charter applications should be devised. (SS)
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                COMPTROLLER GENERAL OF THE UNITED STATES
                           WA.HINGTON. D.C. 2t051




B-114831
B-118535
B-168904




To the President of the Senate and the
Speaker of the House of Representatives

     This report is the :esult of our unprecedented study of
the effectiveness of State and national bank supervision
by the Federal Deposit Insurance Corporation; the Federal
Reserve System; and the Office of the Comptroller of the
Currency, Department of the Treasury.

     This study was made at the request of several congres-
sional committees concerned ove: large bank failures in
recent years and public disclosure that supervisory agencies'
lists of "problem banks" had lengthened.

     Our Office does not have legislative authority to audit
the operations of the Federal Reserve System or the Comptroller
of t e Currency. Also, our access to the bank examination
reports of the Federal DeposeL Insurance Corporation has long
been a matter of dispute.

      In light of the heavy congressional interest in the
area, the agencies allowed us to make the study. They agreed,
ill April 1976, to give us unlimited access to their bank
examination reports and other related records,  provided
we would not disclose any information about specific banks,
bank officers, or bank customers.

     The focus of this report is on evaluating the agencies'
bank examination functions and their efforts to get banks to
correct problems identified. Several recommendations for
improvements are made.
B-114831
B-118535
B-168904



     The three agencies have reviewed and commented on a
draft of the report. Their comments are presented, in
full, as appendixes to the report. In view of the time
constraints placed on us for completing and releasing
the study, we have not been able to fully evaluate their
comments.

     In the past we have supported proposals before the
Congress to give this Office continuing legislative
authority to review the operations of the bank regulatory
agencies and report to the Congress. With such authority,
we could be more helpful to the Congress in carrying
out its legislative and oversight responsibilities for
bank insurance and regulation. In view of the very important
part that the three agencies play in the Nation's system
of money and credit, we feel that the Congress should
provide for GAO audits of the agencies.

     We are sending copies of this report to the Secretary
of the Treasury; the Comptroller of the Currency; the
Chairman, Board of Governors of the Federal Reserve System;
and the Chairman, Board of Directors of the Federal Deposit
Insurance Corporation.




                                   Comptroller General
                                   of the United States




                           - 2 -
                             Contents


CHAPTER                                                   Page

   i       INTRODUCTION                                     1-1

   2       ENTRY INTO THE NATIONAL BANKING SYSTEM           2-1

   3       CONVERSIONS OF CHARTERS--CHANGES IN
             SUPERVISORY AGENCIES                           3-1

   4       BANF EXAMINATIONS: 1971-75                       4-1

   5       BANK PROBLEMS IDENTIFIED BY EXAMINATIONS         5-1

   6       REPORTING PRACTICES: 1971-75                     6-1

   7       EFFORTS TO IMPROVE BANK EXAMINATION              7-1

   8       EFFECTIVENESS OF AGENCIES IN RESOLVING
             PROBLEMS                                       8-1

   9       AN ANALYSIS OF BANKS THAT FAILED I1N THE
             LAST 5 YEARS                                   9-1

  10       EXAMINER CAPABILITY AND INDEPENDENCE           10-1

  11       POTENTIAL FOR BETTER INTERAGENCY COOPERATION   li-1

  12       SCOPE AND APPROACH OF GAO STUDY                 12-1


APPENDIX

       I   Letter dated January 14, 1977, from the
           Comptroller of the Currency, to the
           General Accounting Office                        I-1

   II      Letter dated January 16, 1977, from the
           Chairman, Federal Reserve Board, to the
           General Accounting Office                       II-1

  III      Letter dated January 17, 1977, from the
           Chairman, Federal Deposit Insurance Cor-
           poration, to the General Accounting Office     III-1
  IV      Survey of commercial bankers                   IV-1

      V   Principal officials responsible for adminis-
            tering activities discussed in this report   V-1


                          ABBREVIATIONS

CSC       Civil Service Commission

EDP       Electronic data processing

FDIC      Federal Deposit Insurance Corporation

FRB       Federal Reserve bank

FRS       Federal Reserve System

GAO       General Accounting Office

NBSS      National Bank Surveillance System

OCC       Office of the Comptroller of the Currency
                         CHAPTER 1
                        INTRODUCTION

                                                  Pagq
Purpose of this study                             1- 1
The banking industry                              1- 3
    Changes in th, banking industry: 1971-75      1- 3
Government involvement in banking--a
  historical perspective                          1- 8
    Initial Federal and State involvement         1- 8
    State involvement only                        1-. 8
    Reemergence of Federal. involvement           1- 9
    The bankers' view of Faderal supervision      1-10
Regulation and supervision of banks today         1-11
    The agencies' responsibilities and finances   1-13
      Federal Deposit Insurance Corporation       1-13
      Federal Reserve System                      1-14
      Office of the Comptroller of the Currency   1-15
    The cost of Federal bank supervision          1-16
                          CHAPTER 1
                        INTRODUCTION

PURPOSE OF THIS STUDY

     The Congress is concerned with the soundness of the
commercial banking system. In the past 3 years, several
large U.S. banks have failed. The public has become aware
that a number of major banks are on supervisoryr agencies'
lists of problem banks 1/. The supervisory agencies' power,
capability. and independence to pLoperly supervise the
banks are being questioned.
     In early 1976, several cor7ressional committees asked
us to evaluate the effectiveness of the supervisory efforts
of the three Federal agencies involved:  Federal Deposit
Insurance Corporation (FDIC); Federal Reserve System (FRS);
and Office of the Comptroller of the Currency (OCC), Depart-
ment of tne Treasury. Specifically, the study was requested
by the Chairmen of
     -- the House Committee on Banking, Currency
        and Housing;

     -- the Domestic Monetary Policy Subcommittee, House
        Committee on Banking, Currency and Housing;
     -- the Financial Institutions Supervision, Regulation
        and Insurance Subcommittee, House Committee
        on Banking, Currency and Housing;
     -- the Commerce, Consumer, and Monetary Affairs Sub-
        committee, House Committee on Government Operations;
        and

     -- the Senate Committee on Banking, Housing and Urban
        Affairs.



I/In the context of this report we use the term "problem
  banks" to refer to banks requiring special supervisory
  attention. FDIC and FRS also commonly refer to them as
  problem banks, but OCC considers problem banks as a i:or-
  tion of banks requiring special supervisory attention.



                             1-1
     Our study was possible because the agencies granted us
access to their bank examination reports and related records.
We do not have statutory audit authority at FRS or OCC, and
our right of access to bank examination records at FDIC has
long been contested. The agencies supported out efforts and
provided the cooperation essential to completing the study.

     The objective of our study was to evaluate the agencies'
efforts to (1) identify unsound conditions and violations cf
laws and regulations in banks and (21 cause bank management
to take corrective actions. Our effort was directed to de-
termining whether:

     --OCC considers applications for national bank charters
       on a fair and consistent basis.
     -- Bank examinations are of sufficienit scope to identify
        banks which are likely to run into serious managerial
        or financial difficulties.
     -- Supervisory agencies' efforts to improve their opera-
        tions are satisfactory.
     -- Supervisory agencies can and do follow through on
        their findings of problems in banks to see that cor-
        rective actions are taken by bank managers.
     -- Examiners are qualified and trained to counduct reli-
        able bank examinations.
     We reviewed examination reports and correspondence
files on over 900 banKs supervised by the 3 agencies. These
included three sample groups:

     -- 30 of the 42 banks which failed from 1971 to mid-1976.

     -- 294 of 7R7 "proble. " banks (those identified by the
        agencies as needing special supervision) as of Decem-
        ber 31, 1970, and December 31, 1975.
     --A general sample of 600 of the over 14,030 banks in
       the United States.

     The scope of our study is described more fully in
chapter 12.




                             1-2
THE BANKING INDUSTRY

     About 14,700 commercial banks are chartered to do
business in the United States and its possessions. Of these,
about two-thirds are chartered by the 50 States and one-third
by the Comptroller of the Currency.
     Banks range in size from a general-store-post-office
bank in the mountains of Colorado to a multibillion dollar
institution with over 1,000 domestic and foreign branches.
Half of the industry's assets are teld by less than
2%0 banks.

     Banking in its simplest form is a straightforward busi-
ness. Funds received as deposits are invested primarily as
loans to commercial and individual enterprises, and to Fed-
eral, State, and local gover.nuits. Bank profits result
from investing funds at interest rates greater than the
rates paid to depositors.
       Banking entails risk, and these risks become greater
in periods of general economic decline. To lessen the
effects of possible economic declines, banks have engendered
a host of strategies to reduce risks while still assuring
reasonable profits. Diversifying loan and security port-
folios and balancing demand and time deposits are perhaps
the most basic strategies for dealing with risk.
     The changing needs of consumers have also influenced
the marketing strategies of banks. Today commercial banks
must serve the needs of governments, multinational corpora-
tions, small businesses, farmers, and individual consumers.
Changes in the bankin g indutry: _1971-75
     During 1971-75, the commercial banking industry under-
went significant change. Much of the change is reflected in
the following comparative statistics for December 31, 1971
and 1975.




                              1-3
                     General Statistics
                                                         Percent
                                     1971        1975    increase

Number of commercial banks          13,804      14,657       6
Number of large banks (assets
  over $100 million)                      640      920      44
Number of small banks (assets
  under $10 million)                 7,367       5,661    -23
Number of domestic branches         23,370      30,262     29
Number of bank holding companies     1,567       1,821     16
Number of multibank holding com-
  panies                                  177      311      76
Number of banks controlled by
  holding companies                  2,420       3,674      52
Assets of banks controlled by
  holding companies (billions)        $362        $661      83
Number of foreign branches of
  U.S. member banks                       577      762      32
Assets of foreign branches of
  U.S. member banks (billions)        $ 61        $176     189
Foreign loans of U.S. domestic
  banks (billions)                    $ 27        $ 60    122


     Several trends are apparent from the preceding statis-
tical data:

     -- The number of banks with assets over $100 million
        increased 44 percent, while banks with under
        $10 million in assets decreased 23 percent.

     -- The number of banks controlled by holding companies
        increased 52 percent and their assets increased 83
        percent.

     -- Assets of foreign branches of FRS member banks in-
        creased 189 percent. (Nonmember banks hold less than
        1 percent of foreign branch assets.)
       Foreign loans of domestic banks and branches increased
     ·--
       122 percent.

     The following tatles describe all commercial banks, ex-
cluding their foreign operations.


                             1-4
                       Balance Sheet Data
                                                          Percent
                                                          increase
                                            1971   1975   (note a)

                                            (billions)
Cash                                        $100   $135      35
Securities:
     Federal, State, and local
       government                            166    222      34
     Other                                     4      9     108
Federal funds sold                            20     39      97
Loans:
     Residential real estate                  57     92      62
     Automobile                               25     34      36
     Other personal                           41     59      42
     Comntercial and industrial              120    181      51
     Banking and financial                    22     42      96
     Agricultural                             17     26      59
     Other real estate                        30     53      75
     All other                                19     25      29
Bank premises and equipment                   10     16      52
Other assets                                  15     42     185

        Total assets                        $646   $975      51


Demand deposits                             $264   $326      23
Time deposits                                279    467      68
Federal funds purchased                       24     54     122
Other liabilities                             25     49      96
Reserves for losses on loans and
  securities                                   7      9      41
Capital notes and debentures                   3      5      50
Capital stock and surplus                     32     43      33
Undivided profits and reserves                12     22      80

        Total liabilities
          and capital                       $646   $975      51


a/Based on amounts before rounding.




                                  1-5
                 Income and Ex2ense Data


                       1971   1972    1973     1974     1975
                      ------------- (billions)-------
Income:
    Interest           $32    $35     $47      $61      $58
    Other                5      5       6        7        9
Expenses:
    Interest            14     16      25       35       30
    Compensation         8      9      10       12       13
    Provision for
      losses            1       1          1     2        4
    Other               7       7          8    10       11
    Income taxes        2       2          2     2        2
        Net income    $ 5     $ 5     $ 7      $ 7      $ 7


Dividends paid       $2.23    $2.20   $2.43    $2.77    $3.03




Losses charged
  to reserves        $1.41    $1.26   $1.55    $2.42    $3.80
RecoveLies
  credited to
 reserves             -. 32    -.37    -. 39    -. 46    -. 55
        Net loan and
          securities
          losses     $1.09    $0.89   $1.16    $1.S6    $3.25




                              1-6
     From our analysis of the financial data, the following
observations can be made about the banking industry:

     -- Total assets of the commercial banking industry grew
        by over 50 percent. The number of banks increased
        only 6 percent.

     -- Less than 19 percent of the asset growth was financed
        by demand deposits (checking accounts), while
        74 percent came from more costly time deposits (such
        as savings certificates) and borrowings.   (The remain-
        ing 7 percent came from an increase in capital.)

     -- Loans secured by residential and other real estate
        increased over 66 percent.
     -- Other assets increased 185 percent.  Included were
        real estate holdings resulting from foreclosures,
        or taken in lieu of foreclosure, which increased
        380 percent, (from $0.4 billion in 1971 to
        $1.9 billion in 1975).

     -- Reserves for potential losses on loans and securities
        increased 41 percent, 7 percentage points less than
        the overall growth in loans and securities.

     -- Total capital increased 46 percent. Approximately
        half of the growth was the result of profits being
        retained; half, the result of new capital being
        added.

     -- Capital declined slightly in proportion to assets,
        from 8.36 percent in 1971 to 8.10 percent in 1975.

     -- The relationship of profits to assets also declined
        slightly (from 0.77 to 0.72 percent).

     -- Income and expenses for 1975 were about 82 percent
        greater than for 1971, due mostly to the rise in
        interest rates.

     -- Net losses from loans and securities for 1975 were
        approximately 200 percent greater than for 1971.




                              1-7
GOVERNMENT INVOLVEMENT IN BANKING--
A HISTORICAL PERSPECTIVE

     Government involvement in the American banking industry
has consisted of recurring attempts to balance the need for
healthy competition among banks with the need for a sound
banking system. As history shows, these objectives are not
easily reconcilable. Attempts to balance them have led to a
banking system which is unique in the contemporary world;
Government involvement in the Nation's 14,700 commercial
banks is dispersed among 50 States and 3 Federal agencies.

     The historical path to the present system followed three
stages of governmental supervision:   involvement initially
by both Federal and State governments, then by State govern-
ments alone, and again by both levels of government,

Initial Federal and State involvement
     The first bank in the United States--the Bank of
Pennsylvania--was chartered in 1781 by the Continental Con-
gress. Until 1790 there were only three commercial banks in
the country--the Bank of North America (successor to Bank of
Pennsylvania), which held both Federal and State charters,
and two other State-chartered institutions.

     In chartering the first "Bank of the United States" in
1791 and the second "Bank of the United States' in 1816, the
Congress attempted to establish a "central" bank to regulate
the money supply in the economy. Both banks were chartered
for a specific time period and, although both banks were
considered successful, their charters were not renewed for
political reasons.

     President Jackson's veto of its application for charter
renewal in 1836 closed the second Bank of the United States
and temporarily resolved two controversies--should the Fed-
eral Government charter banks, and should it regulate the
money supply?
State involvement only

     From the demise of the second Bank of the United States
until 1863, State governments chartered banks. The Federal
Government made no attempt to regulate the supply of State-
bank-issued promissory notes. The Federal Government from
1836 to 1863 was out of the banking business.



                             1-8
     With the demise of the second Bank of the United States,
the era of "wild cat" banking began, under State banking laws
which were often rather lax. The number of State banks grew
from only 88 in 1811, to 713 in 1836, to 1,466 in 1863.

     The price of increased competition was the disruptive
effect of numerous bank failures. The resulting instability
in the banking system led for a time to a complete ban on
banking in some of the States.

     During that period, entry into banking was regulated by
charters granted by State legislatures. To get a charter,
one needed a majority vote in the legislature.

     Such "political" chartering was opposed by proponents
of "free" chartering; they favored entry for anyone who could
meet certain objective criteria specified by statute. The
New York "Free Bank Act" of 1838 was the pioneer; it speci-
fied less subjective requirements for acquiring a bank
charter.  Similar free-banking laws were enacted by other
States.

Reemergence of Federal involvement

     The return of the Federal Government to banking super-
vision came in three major steps:  the National Currency Act
of 1863 (superseded by the National Bank Act of 1864) which
created OCC; the Federal Reserve Act of 1913 which created
FRS; and the Banking Act of 1933 whic. created FDIC.

     Under the 1863 act, the Federal Government again became
involved in bank chartering.  The act created a new type of
bank--a national bank.  This bank could issue its own bank
notes secured by Federal bonds.  The act also created a
"Comptroller of the Currency," with authority to charter and
supervise national banks.

     In many respects, the act extended the basic concepts
of the various State free-banking acts to a national scale.
National banks offer an additional avenue of entry for per-
sons unable to secure State charters.  The effect of the act
was to increase competition.

     While some may have intended that national banks would
supplant State banks, the actual result was a dual Federal-
State banking system. Attempts to force State banks to con-
vert to national banks by taxing State bank notes reduced



                             1-9
the number of State banks from 1,089 in 1864 to 325 in 1870.
Eventually, however, the tax caused the elimination of State
bank notes, but not State banks.

     The advent of deposit banking (use of checking accounts)
and the realization that less stringent State laws gave State
banks a competitive advantage over national banks stimulated
State banking. By 1892 State banks had increased to 3,773--
outnumbering national banks, which they have continued to
do, although for many years after 1892 and consistently since
the bank moratorium of 1933, total assets of national banks
have exceeded those of State chartered banks.

     With the Federal Reserve Act of 1913, the balance
between competition and soundness was struck differently.
Central banking powers of the Federal Government were recon-
stituted, but dispersed in a system of 12 Federal Reserve
banks administered by a 7-member Federal Reserve Board
While national banks automatically became members of the new
Reserve System, State banks had to apply for membership.
Supervision of State member banks by the Board presumably
increased State bank soundness through reserve and other
requirements.

     The Banking Act of 1933 which established FDIC, in-
creased Federal involvement in banking. Bank soundness was
promoted because the Federal Government would now supervise
those State banks which were not in the Reserve System and
which subscribed to the Federal insurance program.

     Except for 286 State banks not covered by Federal De-
posit Insurance, all commercial banks were supervised by one
of the three Federal agencies at the end of 1976.

The bankers' view of Federal supervision

     As the historical record shows, banks in the United
States have always been regulated by some level of govern-
ment. At a minimum, establishing a bank has always depended
on a government "blessing" in the form of a charter.  The
power to grant a charter carries with it the inherent power
to revoke it.  Further, the authority to charter establishes,
ipso facto, a government interest in the soundness cf the
chartered entity. Protection of this interest has led, his-
torically, to bank supervision.

     Chartering, examination, and followup actions are
central aspects of the State and Federal Government relation-
ship to commercial banks.

                             1-10
     Bankers, responding to our survey 1/, endorsed
government intervention in the banking Industry. Almost
90 percent indicated that "elimination of bank regulation
entirely" would be, to some degree, "detrimental." Other
aspects of Government intervention received similar endorse-
ments. For example

     --70 percent felt elimination of Federal chartering
       would be detrimental,

     -- 72 percent felt elimination of State chartering
        would be detrimental, and

     -- 88 percent felt elimination of bank examinations
        would be detrimental.

     Approximately 80 percent of bankers responding to our
questionnaire opposed any bank regulatory arrangement which
did not include States. Bankers clearly favored the dual
banking system over a solely Federal system.
REGULATION AND SUPERVISION OF BANKS TODAY

     Government regulation is one of the strongest influ-
ences on the banking industry today. The primary regulators
are the States and the three Federal agencies--FDIC, FRS,
and OCC.
       The Federal agencies, as well as agencies in
50 States, all have some responsibility for bank regulation
(the process of interpreting banking legislation and issuing
rules and regulations for the ban.gs) and bank supervision
(the process of monitoring, examining, and advising individ-
ual banks).
     The Federal agencies influence the .. ructure and opera-
tion of commercial banks by granting national bank charters,
FRS membership, and FDIC insurance and by approving bank
holding companies, foreign branches, and other bank struc-
tural changes.


1/Our survey of commercial bankers is described on page 12-6,
  and the results of the survey are summarized in appendix IV.




                             1-11
     All banks--both State and national--are also influenced
to some extent by State law. Most noteworthy are State
laws which govern trust operations and branching. Twenty
States permit statewide branching; 18 States permit limited
forms of branch banking; and 12 States require unit banking.

      Individual State laws on the formation of bank holding
companies also influence the structure of the banking indus-
try. In 8 of the 12 unit-banking States, holding companies
may own more than one bank. The result is that very few
States can be considered true unit-banking States. Only
Illinois, Kansas, Nebraska, and Oklahoma are fairly consist-
ent in prohibiting branches (except auxiliary teller facili-
ties) as well as multibank holding companies.

     Some of the important regulations issued and adminis-
tered by the Federal agencies are in the following areas:

     -- Equal credit opportunity.

     -- Standards for security devices and procedures.
     -- Interest on deposits.

     -- Securities issuance.

     -- Bank holding companies.

     -- Interlocking relationships.
     -- Truth in lending.

     --Fair credit reporting.

     -- Home mortgage disclosure.
     The process of promulgating a regulation is much the
same at each agency. Briefly, it entails determining the
need for a regulation, drafting it, publicizing it, receiv-
ing comments on it, revising it, and issuing it. Need may
be determined as the result of new legislation, or it may
arise from changing circumstances or the desire to correct
an abuse which has surfaced during bank examination. Regu-
lations are proposed and issued in the Federal Register.




                                1-12
          re resnsibilities and finances
Theaencies'
     FDIC, FRS and OCC have similar supervisory responsibil-
ities. Their structure is also similar, however, FRS is
less centralized. The agencies receive no congressional
appropriations, but rely essentially on the banks they super-
vise and their investments in U.S. Government securities for
operating funds.
     Federal Deposit Insurance Cor£oration

     The Federal Deposit In"lrance Corporation was created
June 16 1933, under the authori;   -ontained in the Banking
Act of 1933 (48 SLat. 168; 12 I1.    1811). The act estab-
lished FDIC, as an independent ,,  inment corporation. to
insure small depositors against losses resulting from bank
failures. FDIC is authorized to:
     -- Approve or deny a bank's eFplication for deposit
        insurance currently of up to $40,000 for each private
        depositor and up to $100,000 for savings and time
        deposit accounts of Federal, State, and local govern-
        ments. National banks and State banks that belong to
        FRS receive FDIC insurance with their charters and do
        not require FDIC approval.

     -- Approve or deny applications for structural and other
        changes, such as branches, mergers, and relocation of
        State nonmember insured banks.

     -- Act as receiver for closed insured banks.

     -- Operate special "deposit insurance national banks'
        for up to 2 years to provide limited banking services
        to communities where banks have closed.
     -- Purchase assets from, make deposits in, or extend
        loans to, insured banks which have closed or are in
        danger of closing.
     -- Administer securities registration requirements
        (under the Securities Exchange Act of 1934) that
        apply to St -e banks not belonging to FRS.
     -- Supervise State nonmember insured banks and their
        affiliates by surveillance, examination, and enforce-
        ment activities.


                              1-13
     In 1975, 40 percent of FDIC's revenue came from premium
assessments; the remaining 60 percent came from investments
of the Deposit Insurance Fund in U.S. Government securities.
Net income amounted to $592 million in 1975. The fund com-
prises FDIC's accumulated net income since inception. As of
December 31, 1975, it amounted to $6.7 billion, or
1.18 percent of the insured deposits at 14,714 banks. In
the event the fund should prove inadequate, FDIC can borrow
an additional $3 billion from the U.S. Treasury.

     Federal Reserve System
     The Federal Reserve System was created on December 23,
1913, by the Federal Reserve Act (38 Stat. 251; 12 U.S.C.
221). The act established Federal Reserve banks, supervised
by a Board of Governors to carry out monetary policy and
improve the supervision of banking in the United States, as
well as provide various central banking services for banks
and the U.S. Government. FRS has been entrusted with many
supervisory and regulatory functions:

    -- Approving or denying various applications, such as
       for branches, mergers, bank holding companies,
       capital stock or debenture issues, and membership
       in FRS.

    -- Determining margin requirements, i.e., the amount
       of credit that may be extended to purchase or hold
       equity securities.

    -- Establishing maximum interest rates that member banks
       may pay on savings and time deposits.

    -- Regulating the foreign activities of all member banks.

    -- Regulating the activity of bank holding companies.

    -- Administering securities registration requirements
       (under the Securities Exchange Act of 1934) that
       apply to State member banks.

    -- Establishing rules for all lenders of consumer credit
       to disclose interest cn loans and terms of repayment
       ("truth in lending").
    -- Examining State member banks, bank holding companies
       and their nonbank subsidiaries, and Edge Act and
       agreement corporations.

                              1-14
     FRS is financed mainly by in'erest on its holdings of
U.S. Government securities, which it acquires in the process
of creating bank reserves.   After FRS operations have been
financed, interest left over  is returned to the Treasury.
FRS does not exercise its authority to charge banks -or
examinations.

    Office of the Comptroller of the Currency

     The Office of the Comptroller of the Currency was estab-
lished by the National Bank Act of 1864 (12 Stat. 665 (1863),
as superceded by 13 Stat. 99 (1864)).  The act provides that
national banks be chartered which will operate soundly and
fulfill the public need for commercial banking services.

     As the administrator of the national banking system,
the Comptroller:

     -- Approves or disapproves structural changes in the
        system, including applications to (1) organize new
        national banks, (2) establish branches of existing
        national banks, (3) merge or consolidate banks into
        national banks, and (4) relocate national bank
        offices.

     -- Determines when national banks become insolvent
        and appoints FDIC as the receiver for closed banks.

     -- Issues rules and regulations governing the corpor-
        ate structure of national banks and their lending
        and investment practices.

     -- Administers securities registration requirements
        (under the Securities Exchange Act of 1934) that
        apply to national banks.

     -- Examines each national bank periodically to ascer-
        tain if it is being operated soundly and in accor-
        dance with Federal statutes.   Each bank is required
        by statute to be  examined twice each calendar year.
        except that one  examination may be waived every
        2 years.

     About 88 percent of OCC's $59 million income in 1975
came from semiannual assessments against national banks;
7 percent from charges for special examinations and investi-
gations; and 5 percent from investments and other sources.



                              1-15
The co~ ' of Federal bank supervision

     Salaries and travel account for most of thR agencies'
bank supervision costs.  Their 1975 c )sts follow:

                                 FDIC       FRS      OCC

Number of bank examiners         1,700      700     2,00C

1975 cost   (millions)              $68a/   $22b/   $69

a/Includes supervision of mutual savings banks which
  accounts for approximately 8-10 percent of FDIC's bank
  supervision costs.  (FDIC is the only Federal supervisor
  of mutual savings banks.)

b/Estimated cost of bank supervision and regulation, exclu-
  sive of occupancy and other indirect costs not allocated
  by the district banks.  These functions account for about
  3 percent of FRS tctal operating costs.




                             1-16
                         CHAPTER 2
           ENTRY INTO THE NATIONAL BANKING SYSTEM


                                                    Page

Overview                                             2- 1

The survival pattern of national banks               2- 4

OCC's chartering criteria and procedures             2- 6

Chartering by State banking authorities              2- 9
Adequacy of OCC's chartering criteria
  and procedures                                     2-10
    How did the Comptroller decide?                  2-14
    Haskins & Sells study noted
      similar weaknesses                             2-18

Time required for processing applications            2-19
Conclusions                                          2-20
Recommendations                                      2-21
Agency comments                                      2-21
                          CHAPTER 2

           ENTRY INTO THE NATIONAL BANKING SYSTEM
OVERVIEW

     The Comptroller of the Currency must approve the forma-
tion of all national banks and, thus, entry into the national
banking system. This chartering responsibility is one of
the Comptroller's major functions. The chartering process
is intended to provide a sound national banking system
without unduly restricting entry into that system. Thus,
under present law, the Comptroller is vested with a great
public trust. Through his decisions on chartering, he plays
a vital role in structuring banking markets.

     To instill the fullest public confidence in the char-
tering of national banks, the Comptroller needs to develop
more definitive criteria and provide better documentation
for his decisions to approve or disapprove applications
for bank charters.
     National charters may be granted to groups of organizers
seeking to form new banking associations or to operating
State banks seeking to convert to national banks.   (See ch.
3.) OCC's goal, as stated in its recent policy statements,
is to insure a healthy, competitive banking system that
offers the public maximum convenience and choice and stimu-
lates economic growth and efficiency. It is OCC's policy
to charter only banks which cakn be economically supported
and profitably operated.
     From .January 1, 1970, to April 30, 1976, OCC considered
865 applications for establishing new banks. As shown below,
the Comptroller approved 57 percent of the applications.




                             2-1
          Decisions on New Bank Applications
            Approved             Rejected
Year     Number Percent      Number Percent      Total

1970       42       48         46       52         88
1971       55       50         54       50        109
1972       84       58         60       42        144
1973      134       66         68       34        202
1974       92       57         70       43        162
1975       70       53         61       47        131
1976       13       45         16       55         29

          490       57        375       43        865

     In evaluating a charter application, OCC primarily
considers the proposed bank's capital structure, future
earnings and management, and the convenience and needs of
persons in the area to be served. State banking authorities
consider similar factors.

     Under OCC's application review process, five individuals
independently review applications and make recommendations
to the Comptroller, who decides whether to approve or reject
an application.
     The agency, however, has few definitive criteria for
evaluating applications. The policies established on
November 1, 1976, prescribe essentially general criteria.
Definitive criteria were provided to measure only one factor
that the agency considers--capital structure. Considerations
of charter applications are highly judgmental, and OCC re-
viewers often had different opinions of the action that
should be taken on individual applications.

     Furthermore, OCC reviewers about half the time did not
clearly indicate which factors they considered favorable
and which unfavorable. The Comptroller himself rarely
stated why he approved or disapproved a charter application.
Under new policies established in November 1976, OCC will
in the future furnish disapproved applicants a written
statement of the reason.; for disapprovals.




                             2-2
     In ruling on the applications we reviewed, the
Comptroller apparently relied on what the majority of his
five reviewers recommended. The lack of definitive criteria
and complete documentation for the decisionmaking process
prevents us from evaluating whether OCC has considered ap-
plications fairly and consistently.

     On the basis of a 1975 study conducted under its aus-
pices, the Administrative Conference of the United States
proposed that OCC state its policy objectives and decision
standards so that cases could be understood and evaluated
on their merits. The Conference recommended that OCC (1)
fully state its objectives in approving or denying applica-
tions and (2) concretely define the standards to be applied.
     The Conference said its recommendations for policiej
and standards did not result from any trend of public dis-
satisfaction, but rather from a general distrust of decision-
making based on undefined discretion. In its March 1976
report, the Conference stated:

     --The statutes governing approval of entry into
       banking contain sketchy or no standards defin-
       ing how the agencies should exercise judgment.
     -- The agency has not filled this statutory
        void with comprehensive policy statements or
        meaningful rules of general applicability.
     OCC has recently taken several actions to improve the
processing of applications and to make charter decisions
more consistent. Even with these changes, however, we be-
lieve that more definitive criteria and documentation are
still needed.




                            2-3
THE SURVIVAL PATTERN OF NATIONAL BANKS

     On the premise that banks which continue to operate
for several years after chartering are evidence of the
effectiveness of the chartering process, we collected data
on:
     -- How many new national banks were chartered during
        the 15-year period, January 1958 through December
        1972?

     -- How many of these banks were no longer operating
        as national banks on April 30, 1976?
     -- What happened to the banks which were no longer
        national banks?

        indicated in the following table, most national
banks Lhartered over this 15-year period are still ope,-
ating as individual national banks.




                              2-4
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     Of the 813 new banks chartered during 1958-72, 172, or
21 percent, were no longer operating as individual national
banks at the end of April 1976. However, about 76 percent
of these operated for 3 or more years before ceasing to op-
erate as national banks. Thus, of the 813 newly chartered
banks, only 5 percent did not survive as national banks for
at least 3 years.

     Of the 172 which were no longer operating at April 30,
1976, 80 had merged with other banks, 57 had converted to a
State charter, 30 were voluntarily liquidated, and 5 were
declared insolvent. Thus, of the 813 banks chartered during
the 15-year period, less than 1 percent ceased operations
because they were declared insolvent.
     The survival rate of national banks in this period is
almost the same as the rate noted in a similar analysis of
a sample of national and State banks chartered between 1948
and 1966.1/
     Exits from the national banking system cannot always
be considered a sign of weak operations or poor chartering
decisions. For example, many banks converting to a State
charter may still be operating as sound State banks. On the
other hand, the mergers and voluntary liquidations may have
occurred because of normal market changes in local banking
structure or because of banks' i capability of continuing to
operate. For the 14 percent that merge- or were liquidated,
we did not attempt to determine whether exits were actually
voluntary or forced by financial difficulty.
     Nevertheless, national banks' high rate of survival
indicates that OCC has at least tended to charter banks
that can be economically supported.

OCC'S CHARTERING CRITERIA AND PROCEDURES
     The National Bank Act (12 U.S.C. 21-27) provides OCC's
chartering authority and requires the Comptroller to base
his charter decision on facts reported in the application
and




1/ Alhadeff, David A. and Charlotte P. "Growth and
   Survival Patterns of New Banks, 1948-70," Journal
   of Money, Banking and Credit, May 1976.

                            2-6
    "any other facts which may come to [his] knowledge
    * * * whether by means of a special commission ap-
    pointed by him for the purpose of inquiring into
    the condition of such association, or otherwise."

     The act specifies the minimum number of persons needed
to organize a national bank (five) and the minimum amount
of initial capital required in a city of a given population.
The Comptroller, however, requires substantially more capital
than the legal minimum. OCC will normally not approve an
application to organize a national bank with less than
$1 million initial capital.   The National Bank Act provides
no other criteria for the  Comptrolier  to consider in acting
on charter applications.   According to  OCC regulations, the
Comptroller may conduct  investigations  of applicants as he
deems necessary or proper.

     The Federal Deposit Insurance Act (12 U.S.C. 1816)
gives OCC additional chartering guidance. Because national
banks are rcquired to have deposit insurance, before grant-
ing a charter the Comptroller must certify to FDIC that he
has considered the following factors:   (1) the bank's finan-
cial history and condition, (2) its capital  structure, (3)
its future earnings prospects, (4) the general character of
its management, (5) the convenience and needs of the commu-
nity it is to serve, and (6) whether its corporate powers
are consistent with the purpose of the act.

     OCC has assigned to its regional offices the primary
responsibility for reviewing and processing charter appli-
cations.  Potential applicants usually discuss their pro-
posal with a regional administrator.  After the regional
office accepts an application and the information the appli-
cant supplied to support the proposal, the applicants publish
a notice of filing in a newspaper of general circulation.
The regional administrator advises area banks and other bank
regulatory agencies of the filing and assigns an examiner
to conduct a field investigation.

     The examiner visits the proposed bank site and inter-
views the applicants, who are called organizers.  Also, the
examiner usually confers with opponents to the application
and local business and professional persons.  With the in-
formation developed, the examiner evaluates the data fur-
nished by the organizers and prepares a report of the
investigation.



                            2-7
     The examiner's report provides the essential infor-
mation for evaluating a charter application. The examiner
answers questions such as:

     -- Is the strength of management adequate?

     -- Is the proposed capital structure adequate
        for the estimated volume and character of
        operations?

    -- Is there a public need for the proposed bank,
       or do existing banks and branches serve the
       area reasonably well?

    -- Is it reasonable to expect that the available
       banking business will be adequate to support
       the proposed bank, together with existing
       competitive banks and branches, or will an
       "overbanked" situation be created?

    -- Are the applicant's 3-year estimates of income
       and expenses reasonable?

     In the report the examiner summarizes his or her find-
ings in an unstructured narrative format and recommends
approval or disapproval of the application.   The regional
administrator also writes in narrative  form his or her
conclusions and makes a recommendation.

     The information gathered at the regional level, plus
the two staff recommendations, are forwarded to OCC head-
quarters. At the time of our review, the director of the
Bank Organization Division and a senior economist also eval-
uated the application, wrote brief remarks, and recommernded
approval or disapproval.  The deputy comptroller responsible
for new charters usually wrote a memorandum setting forth
his comments on capital, management, convenience and needs,
and competitive factors.  Finally, the Comptroller reviewed
the file and approved or rejeczed the application, usually
without written comment.

     If the application was approved, the organizers were
usually allowed 1 year (now 18 months) to incorporate the
bank; that is, complete the sale of stock, acquire a build-
ing, and hire officers acceptable to OCC. Wnen the bank
is ready to open, the Comptroller issues a charter certi-
ficate authorizing the bank to begin business.



                             2-8
CHARTERI., BY STATE BANKING AUTHORITIES

     The 50 States also have authority to charter new banks.
The States have vested their chartering authority in a State
supervisor (29 States), a banking board (14), or a combin-
ation of the two (4); a commission (2); or a board of
trust (1).

     To gather information on State chartering criteria,
policies, and procedures, we contacted all State bank
supervisors in July 1976.  Of the 24 State bank supervisors
responding, 15 said that they investigate the same factors
as OCC: the proposed bank's capital structure, its earnings
prospects, the convenience and needs of its community, and
the general character and the banking ability of its organ-
izers and prospective directors.  The remaining nine State
supervisors who responded investigate at least three of the
same factors.

     The majority of the States responding also said that
State statutes set forth the factors used to evaluate char-
ter applications.  Some indicated that to receive a charter,
applicants must satisfy all criteria.

     Unlike OCC, however, most States require, either by
statute or as a matter of practice, a public hearing before
they take final action on charter applications.  The Comp-
troller conducts public hearings for national bank appli-
cations only if he considers it necessary or an opponent
to the application requests it.

     Of the 24 States responding, 14 also provided
information on the standards used to evaluate the factors
they consider.  For the most part, the information provided
translates into general criteria similar to that OCC uses.




                           2-9
ADEQUACY OF OCC'S CHARTERING
CRITERIA AND PROCEDURES

     To assess OCC's fairness and consistency in evaluating
applications for new bank charters, we randomly selected
50 of the applications approved and 25 of the applications
rejected by the Comptroller from January 1, 1974, through
April 30, 1976. 1/  More than half of the 75 applications
were received from applicants in 3 States--Florida (20),
Texas (14), and Illinois (5).  The.e three are "unit-
banking" States which prohibit branch banking; therefore,
new banking offices require new bank charters.

     tle could not judge OCC's fairness and consistency,
because:

     -- OCC has few definitive criteria for   its staff
        to use in evaluating applications.

     -- Considerations of charter applications are
        highly judgmental, and there were differences
        of opinion by OCC reviewers regarding the
        action that should be taken on individual
        applications.

     -- OCC reviewers about half the time did not
        clearly indicate which factors were considered
        favorable and which unfavorable.

     -- The Comptroller rarely documented the basis
        for his final decision on charter applications.

     The professional judgment of the examiner and the
other four reviewers was a key factor in considering charter
applications. But the reviewers generally did not (1) docu-
ment in the files the degree to which the various factors
were considered or (2) clearly indicate whether they con-
sidered individual factors favorable or unfavorable.   The
form used by the three headquarters reviewers provided  for
each to state whether capital, earnings, management, and


1/Of the 75 applications, 12 were reconsiderations, that
  is, applications considered and acted on by the Comp-
  troller more than once.  Reconsiderations are initiated
  by previously rejected applicants.   The Comptroller ruled
  twice on 11 cases and thrice  on 1 case.  Therefore, our
  review actually included 88  charter decisions for 75
  banks.

                               2-10
"convenience and needs" were adequate or inadequate. The
reviewers did not, for the most part, provide this infor-
mation. When an application reached the Comptroller for
his final decision, he usually hid a recommendation from
each of the five reviewers. He documented the reasons for
his decisions in only 7 of the 88 cases we reviewed.

     Selected cases shown below illustrate the diversity
of reviewers' opinions on specific applications. Through-
out this report black borders have been put around case
studies to distinguish them from the text of the report.



                         Case 1
     Examiner--Recommended disapproval because of the lack
of demonstrated need and the potential to damage existing
banks in the area.
      Regional administrator--Recommended disapproval
because there was little reason to believe that the banking
needs of the public were not being met fully, effectively,
and on a strongly competitive basis. The prospects for the
proposed bank, in this atmosphere and under the guidance of
an inexperienced board of directors, would be uncertain at
best.

     Director, Bank Organization Division--Recommended
disapproval because he thought that there was no real
public need for another bank in this market.

     Economist--Recommended approval because the proposed
bank would probably be a marginally successful entry into
a highly competitive market. However, the bank would not
be a serious competitor for some time, and thiz new entry
through the addition of competition could accentuate the
problems of three local banks.

     Deputy Comptroller--Recommended disapproval
even though the new bank would bring competition because
                                                 of a cer-
tain type to this market and provide another choice of
banking for the public, the application was marginal insofar
as the directorate's net worth and business representation
were concerned.

     The Comptroller approved the application, stating that
the new bank could be Justi-led on competitive grounds.


                             2-11
                        Case 2

     Examiner--Recommended aEproval because even though
there did not appear to be a strong need for a new bank, it
was believed that applicant's loan and deposit projections
were attainable and that profitable and successful oper-
ations could be achieved without providing detrimental
competition to any existing banks.

     Regional Administrator--Recommended apEproval because
"* * *applicant does not contend that existing banking
office3 are not adequately serving the banking needs
of the public." Rather the applicant intended to provide
the service area with a new competitive banking unit.
Further, a sampling of local public opinion indicated
moderate support for the bank, and it should not have
a serious adverse affect on existing banks.

     Director, Bank Organization Division--Recommended
disapprova  because sufficient banking alternatives
already provided adequate service. Also, there was no
strong public support and the record showed no need.

     Economist--Recommended appropval because the area,
                                -would
while served by established anks,         probably support
the proposed bank and the bank would  provide modest compet-
itive benefits.

     Deputy Comptroller--Recommended disapproval because,
although from the competitive standpoint it was possible
this group could inject healthy competition in this market,
there were a number of alternative banking offices and the
convenience factor was minimal. He concluded that, on
balance, a strong case was not made for this bank.

     The Comptroller disapproved this application.   He did
not document the basis for his decision.



                           Case 3

     Examiner--Recommended approval because it would appear
that the needs of the community might be better served by
a bank based on the concept of concentrating on new or
growing small or medium-sized business. He commented that
it would be difficult to visualize this group of organizers
falling short of any goal they set for themselves.


                             2-12
     Regional Administrator--Recommended disapproval
because, although he agreed with the examiner that the
proposed bank would ultimately achieve satisfactory oper-
ations, he was unable to conclude that there was a distinct
unfulfilled public interest or need. Also, he thought that
the banking record of about half of the proposeC director-
ate, plus the competition in the area, suggested that the
ultimate future of the bank would be a sale to a bank hold
ing company. The application was predicated on this specu-
lation, and it would not serve any particular public
interest.
     Director, Bank Organization Division--Recommerlded
approval because (1) the proposed directorate was strong,
(Tt2area banks were well established and had performed
well, and (3) no real arm would be done to existing
banks.
     Economist--Recommended approval because he thought (1)
there was room for another bink, (2) it would provide con-
venience to the public, and (3) the proposed directorate
appeared strong enough to ensure success.

     Deputy Comptroller--Recommended aeeroval because he
thought that the business and professiona--market was
sufficient to provide a profit, and it would provide
healthy competition in the area.

        The Comptroller apiroved the application without com-
ment.



                             Case 4
     Examiner--Recommended disapproval . He stated that,
although the area was experiencing economic growth aad the
population was increasing, relatively little development
had actually begun, and the application was premature. He
said'also that there was no real need for a new bank at that
time, as the other area banks serviced the community well.
     Regional Administrator--Recommended approval because
there was a reasonable public need for the bank in the
future, even though he thought the application might
be slightly premature. The new bank would provide healthy
competition; public opinion slightly favored the need
for another bank; and a fair degree of usage was indicated.


                              2-13
     Director, Bank Organization Division--Recommended
disapproval because (1) during the last year the existing
local bank recorded no asset growth, (2) public reaction
was mixed, and (3) no strong case had been made for
added competition or service.

     Economist--Recommended approval because, although the
community offered a limited opportunity at that time, its
proximity to the city had produced modest growth which
was likely to continue.  Further, there was considerable
evidence that the local bank was not meeting the needs of
the community. The comapetitive factors, convenience and
needs, and holding company affiliation were favorable.

     Deputy Comptroller--Recommended approval because the
new bank would bring healthy competitio-nand there appeared
to be an adequate base to support this new entry.

     The Comptroller approved the application without
written comments.




     As can be seen, the staff members based their recom-
mendations on whatever factors they thought relevant.   The
application review process lacked uniformity, and  differ-
ences in reviewers' opinions were left unresolved.

How did the Comptroller decide?

     Judging from written comments by the five staff
reviewers, approval of applications appeared to have been
mainly related to the "convenience and needs" factor,
broadly interpreted to include need for competition, new
or better services, or service to a special clientele.
Rejections included in our sample seemed to be based
largely on lack of need for a new bank or on expectations
of newly approved State banks opening in the community.

     As previously mentioned, the Comptroller rarely
documented why he approved or disapproved a charter appli-
cation. He apparently relied on what the majority of his
five reviewers recommended. OCC officials told us, however,
that the Comptroller considers staff recommendations on
charter applications as advisory because he alone has the
legal power to approve or reject a charter application.



                             2-14
      The following table shows that the Comptroller
 agreed with all five staff members in 44 percent of
 the cases we reviewed and with the majority of his
 staif in 91 percent of the cases.

               Extent of Staff Agreement With the
                 Comtrolier-s Charter Decisions

 Staff recommendations
 against Comptroller's
   eventual decision                   Total               Percent
       None                              39                  44
       One                               28                  32
       Two                               13                  15
       Three                              3                   4
       Four                               4                   4
       Five                               1                   1



     The Comptroller disagreed with his regional office
staff--the examiners and regional administrators--more often
than with his headquarters staff. The table below notes the
frequency with which ::.e Comptroller disagreed with the
recommendations of each of the reviewers.

           Staff Pecommendations Compared to the
               ComptrolieL'_   Charter Decision

                                      Recommendations
                    Number of          contrary to       Percent of
Staff member     recohmendations      final decision    disagreement
Examiner               85                   25              29
Region.J. a'mi,i-      88                   21              24
   ins'rator
Director, Balk
  Organizaticn
  Division             85                   10             12
Economist              85                   16             19
Deputy comptroller     86                   12             14




                               2-15
     In some cases there was considerable disagreement
among reviewers. The Comptroller, as shown above, dis-
agreed with the examiner's recommendations in 25 cases
and the regional administrator's in 21. However, only
8 of the regional administrator's cases of disagreement
with the Comptroller are included in the examiner's 25.
Likewise, when the Director of the Bank Organization
Division, the economist, and the deputy comptroller
disagreed with the Comptroller, those cases were not
complete subsets of the examiner disagreements. The
following tables illustrate the extent of staff dis-
agreement on cases where the Comptroller disagreed
with more than one staff member. The tables further
illustrate that for the 12 applications which the
Comptroller approved, he tended to agree with th3
majority of the reviewers more so than he did when
he rejected applications.




                            2-16
                                      Extent of Staff DiLantreent n Approved Applicatione
                                                          (note a)
                                                     Director, Bank
 Care                              Regional           Organization                         Deputy
number            Examiner       administrator          Division         IEconist        comptroller    Comntrollor
     1             Re iect          Reiect              Re iect           Re iect            Reject        Approve
     2             Reiect           Reject              Reiect            Re ect             Approve      Approve
     3             Reject           Reject              Re iect          Approve             Re ect       Approve
     4             Reject           Reject              Approve          Approve             Approve      Approve
     5             Reject           Approve             Reject           Approve             Approve      Approve
     6             Reject           Approve             Aptrove          Approve             Reject       Approve

     7             Reiect           Arprove             Approve          Approve             Reject       Approve
     8             Approve          Reject              Reject           Reject              Approve      Approve
     9             Approve          Approve             Reject           R   ect             Approve      Approve

 10                Approve          Approve             Reiect           Reject              Approve      Appi ve
 11                Approve          Approve             Approve          Reject              Reject       Approve
 12                Approve          Approve              pprove          Rejet               Reject       Approve




a/       For 18 applications only 1 staff member made a reccomendation uoyitrary to the Comptroller'e
         charter decision. The examiner accounted for 8 of them; the ,e3io.,nal administratcr, 6;
         the economist, 2; end the deputy comptrolle;, 2.

                                      Extent of Staff Diaeereement on Relected Applictions
                                                         (note a)

                                                    Director, Bank
 Case                              Regional          Organization                           Deputy
number            Examiner       achniniutrator        Division         Econi            colptroller    Crqtrollor
     1             Approve          Approve             Reject           Approve          Approve         Reject
     2            Approve          Approve              Approve          Reject           Reject          Reject

     3            Approve           Approve             Reject           Approve          Reject          Re ject
     4            Approve          Approve              Reject           Reject           Reject          Reject

     5            Appgrce           Reject              Approve          Reject           Reject          Reject

     6             Reject          Appro'e              Reject           Approve          Reject          Reject

     7             Reject          Approve              Reject           Approve          Reject          Reject

     8             Reject          Approve              Reject           Approve          Reject          Reject

     9            Reject           Approve              Aprove           Approve          Approve         Reject



.        For 10 applications only 1 staff member made a recomaendation contrary to the Comptroller's
         charter decision. The examiner accounted for 5 of 'hem; the regional administretor, 2; the
         economist, 1; and the deputy comptroller, 2.




                                                       2-17
Haskins & Sells study noted
       w
sTim-ia7r ea-nesses

     A May 1975 Haskins & Sells report noted that OCC
lacked formal guidelines for processing applications and
making decisions. The report states:

     "Past practice, precedent, and policies of
     the present Comptroller as interpreted by
     key staff provide the informal guidelines
     on which the OCC functions. The result is
     considerable flexibility in the making of
     decisions on specific applications   * *.
     Policy thus tends to be formulated on an
     ad hoc basis and the decisionmaking process
     is affected by some uncertainty about the
     factors on whicha decision wli   turn."
     (Underscoring suppTie.T

      The public accounting firm recommended that OCC write
(1) policy statements setting forth the conditions under
which applications will be received and considered and
(2) decision guidelines setting forth the specific fac-
tors to be considered in the decision process.   Haskins &
Sells  proposed that the pertinent factors be grouped
into three categories: (1) major factors for which
a negative finding on any one factor would ordinarily
result in rejecting the application, (2) factors for
which a negative finding on one or more factors would
not necessarily result in rejection but which would
need to be weighed in the aggregate, and (3) factors
which may significantly benefit the public.

     In response to the Haskins & Sells recommendations,
OCC issued policy statements on November 1, 1976. The
statements include decision guidelines, but no grouping
of factors as recommended. OCC officials said groups
of pertinent factors would not be applicable to every
possible market situation and hence to every application
considered. OCC's policy statements do provide, however,
that when a charter application is rejected, the applicant
will be furnished a written statement of the reasons
for rejection.

     In response to other Haskins & Sells recommendations,
OCC took further actions which should help standardize
the review process and provide a better documented record:


                              2-18
     -- In February 1976, OCC reorganized the headquarters
        division responsible for reviewing charter applica-
        tions. To supplement the regional offices' evalu-
        ation of applications, staff reviewers of the
        newly organized Bank Organization and Structure
        Division are required to comment on capital,
        management, competition, and the market area.

     -- A new investigation report form was instituted in
        November 1976 for regional office reviewers. The
        comments, conclusions, and recommendations
        section provides space for specific comments
        by the examiner and regional administrator on
        the factors involved in arriving at their recom-
        mendations for approval or disapproval of
        the application.
TIME REQUIRED FOR PROCESSING APPLICATIONS

     The time OCC took to process applications seems
excessive. The processing time for the sampled appli-
cations is shown below.

                                    Months in process
                          Average         Medi an     Range
Approved applications       10.8           10.0    5.5 to 26.8
Rejected applications       10.2            8.8    4.0 to 25.5
     OCC took an average of 10-1/2 months to initially
decide on the applications. The headquarters office
accounted for 5-1/2 months, and 4-1/2 of these were
taken for reviews by the deputy comptroller and the
Comptroller. The headquarters review time appears
to be excessive, since the examiner's field investigation
and any necessary public hearings are conducted by
the regional office.
     Of the 24 States responding to our information
request on chartering, 7 said that their statutes
require them to approve or reject charter applications
within a certain time frame. The required time frames
for the sever. States are as follows:




                            2-19
              Number of States          Months

                     2                    2
                     1                    3
                     1                    5
                     2                    6
                     1                   12

We do not know whether   the States were meeting these
limits.

      In response to a Haskins & Sells questionnaire,
31 percent of 180 recently chartered national banks indi-
cated that the processing time for their applications
was excessive.   The accounting firm made several recom-
mendations which should help diminish the processing
time.   These included revised application forms, stream-
lined information requirements, and a manual on proce-
dural guidelines for processing applications.   OCC imple-
mented these recommendations  on November 1, 1976.

CONCLUSIONS

     The high survival rate for national banks indicates
that OCC's chartering process has at least tended to
charter banks that prove to be economically supported--
thus contributing to a sound national banking system.

     However, there is no practical way to determine
whether OCC has been fair and consistent in approving
or disapproving new banks because the agency lacks
(1) definitive criteria for its staff to use in evalua-
ting applications and (2) an Adequately documented
decisionmaking process.

     The differing opinions of the staff reviewers
suggest that more definitive criteria are needed to
provide for uniformity in the application review process
and to insure that all factors are considered and resolved
either favorably or unfavorably. Although definitive
criteria that would apply to every application may be
difficult to develop, we believe the matter warrants
further study by OCC.




                                 2-20
     The Comptroller has considerable latitude in decid-
ing whether to approve or reject an application, and
for the most part, gives no reason for ruling a parti-
cular way. While he is not legally required to make
a determination on each of the factors considered, he
must certify to FDIC that he has considered the six
required factors. We believe reviewers' conclusions
on these factors should be completely documented during
the application review process.

RECOMMENDATIONS
     Accordingly, we recommend that the Comptroller of
the Currency (1) develop more definitive criteria for
evaluating charter applications and (2) thoroughly
document the decisionmaking process, including an identi-
fication by reviewers of each factor as either favorable or
unfavorable.
AGENCY COMMENTS

    OCC in its letter dated January 14, 1977, stated:

    "The OCC is the only federal agency with the
    responsibility for chartering banks. It charters
    banks in all of the 50 states and in Puerto Rico
    and the Virgin Islands. The widely differing
    banking environments found in the U.S. make it
    almost impossible to develop definitive criteria
    which can be universally applied such as in
    states like Arizona, which has 6 National Banks,
    and in Illinois which has over 400 National Banks.
    The diversity of criteria therefore, is a function
    primarily of the differing political, social
    and economic environments in which the OCC must
    operate. The OCC's chartering criteria, of
    necessity, must be somewhat flexible. That is
    only to be expected since the OCC does not
    charter in one environment. Also, under the terms
    of the McFadd,:n Act, the OCC's actions are
    often affected by applicable state law.
    "The new corporate guidelines, development of which
    began in September 1975 and which became effective
    on November 1, 1976, answer many of the criticisms
    of the GAO. Written opinions containing reasons
    are now sent to applicants receiving denials.


                            2-21
As examples, we quote from three recent letters
sent to applicants denying their charters. One
letter in part, states:
     'Based upon the population and the median
     income per household, it would appear
     difficult for many individuals in the
     priv!ary service area to qualify for a
     loan. Furthermore, income levels are in-
     adequate to provide a sufficient deposit
     base for the proposed bank to become a
     viable institution.'

     'In another case, we quote in part:   In
     view of the Supreme Court decision  in
     Whitney and the Federal Reserve Board's
     decision in InterMountain Bank Shares,
     it would be an exercise in adminstrative
     futility for this Office to approve the
     present charter application...Should West
     Virginia change its statutes or should the
     statute be successfully challenged, then
     this Office could consider a new appli-
     cation in light of these changed citcum-
     stances.'

     'In still another case, the denial letter
     to the applicants stated: The new guide-
     lines state that a new banking office will
     not be approved, if its establishment would
     threaten the viability of a newly chartered
     independent bank. Such protection will
     typically not exceed one year. As you are
     aware, the new bank opened on September 27,
     1976.  It is the opinion of this Office
     that this newly chartered independent state
     bank is entitled to the protection set forth
     in the Comptroller's policy statement.'

"Every attempt is now made to document thoroughly
the decision-making process. Further efforts will
be made by our Office to identify each factor as
favorable or unfavorable.

"Our decisions have been suject to judicial review
for many years. In the long series of court cases
covering our chartering process, the Comptroller's


                        2-22
decision on a charter application has never been
finally overturned by a reviewing court. See
annotations to 12 U.S.C. 21 et seq.
"Our Department of Research & Economic Analysis
has undertaken a market study of 35 national
banks chartered between 1969 and 1971. The
economic study attempts to identify, statistically,
those factors which can be identified with the
growth or lack of growth of these new banks.
The results of that study, if positive, will
be incorporated into our decision-making pro-
cess. We are hopeful that quantification of a
sufficient number of pertinent factors appli-
cable to a majority of cases will result."




                       2-23
                          CHAPTER 3
               CONVERSIONS OF CHARTERS--CHANGES
                    IN SUPERVISORY AGENCIES




Overview                                             3-1

Criteria and procedures                              3-3

State-to-national conversions                        3-3
    Many State banks convert to change supervisors   3-4
    Condition of banks applying to convert           3-6
    General OCC agreement on applications            3-7

Recent changes to OCC's conversion process           3-7

National-to-State conversions                        3--8
    State conversion policies                        3--8
    National banks convert to withdraw from FRS      3-9

Conclusions                                          3-10
                          CHAPTER- 3

               CONVERSION-OF-CHARTERS--CHANGES

                  IN SUPERVISORY AGENCIES


OVERVIEW

     With the Comptroller of the Currency's approval,
State-chartered banks are allowed to convert to national
banks.  By changing charters in this way, banks become
subject to supervision by the Comptroller, instead of
by a State authority and either by the Federal Deposit
Insurance Corporation or by the Federal Reserve System.

     Because such banks are already in operation and
usually subject to Federal supervision, the impact on
the total banking industry of whether to approve requests
to change charters is not as important as initial charter
decisions.   From OCC's viewpoint, however, approval
means entry into the national banking system; therefore,
decisions to change charters are equally as important to
it as initial charter decisions.

     In November i976, OCC began requiring an applicant
to give reasons for wanting to convert to a national
bank. It also established policy statements which say
that it will ordinarily approve conversions that are
consistent with maintaining a sound national banking
system but that conversions should not be motivated
by supervisory pressures from other bank regulators.
     We reviewed the 71 State-to-national conversion
applications OCC acted on from January 1972 through
April 1976.  Sixty-four were approved, four were rejected,
and three were withdrawn.
     Many banks applied for conversion either to receive
favorable decisions on corporate structural changes, such
as branches and mergers, or to change their image or
obtain the prestige of national banks. According to OCC
files, few banks applied to avoid supervisory action
from another banking agency.

     Before deciding on the conversion applications, OCC
either examined the bank itself or reviewed earlier
Federal or State bank examination reports. Most banks


                            3-1
converting to national banks were judged by OCC or their
previous supervisors as sound in every respect. Only one
bank was receiving special supervisory attention when it
converted.

     With the approval of its State agency, a nationally
chartered bank may also convert to a State charter (12
U.S.C. 214-214c).  OCC has no authority over a national-to-
State conversion, except to require a percentage of stock-
holder approval and to protect the rights of dissenting
minority shareholders.  From January 1972 through April
1976, 79 national banks switched to State banks.  According
to FRS, the major reason national banks convert their
charters is to avoid maintaining assets in the non-
interest-bearing reserves required for FRS membership.
All national banks are required by law to be members
of the Federal Reserve System; State banks are not.




                            3-2
CRITERIA AND PROCEDURES

     The National Bank Act (12 U.S.C. 35) permits any
State-chartered bank to become a national bank, if it
has sufficient capital and the approval of OCC, unless
conversion is prohibited by State law. The application
for conversion must be authorized by owners of at least
51 percent of the bank's capital stock.

     The law does not provide specific criteria for
evaluating applications for charter conversions. The
agency has established regulations allowing it to conduct
any examination or investigation necessary, but until
November 1, 1976, it had no written regulations or policy
statements of criteria for approving or rejecting such
ccnversions.
     Applications include information on the bank's present
and proposed capital structure and number of branches,
whether it is a member of FDIC or FRS, proposed names for
the converted bank, and names and addresses of bank
directors. The applications are processed in generally
the same way as new bdnv charter requests. An examiner
at the regional office usually examines or visits t.e
bank and prepares a written report recommending approval
or disapproval. Reviews and recommendations are also
made by the regional administrator and various OCC
headquarters personnel. The Comptroller makes the final
decision.

     If OCC grants anproval, the bank completes certain
corporate documents (equired by statute and OCC issues
a charter certificate authorizing it to commence business
as a national bank on a specific date.
STAME-TO-NATIONAL CONVERSIONS

      From January 1972 through April 1976, OCC considered
71 conversion applications. Of these, 64 were approved,
4 were rejected, and 3 were withdrawn. Of the 71 State
banks and financial institutions applying for conversion,
23 were members of FRS, 45 were nonmember banks insured
by FDIC, and 3 (a savings and loan association, a credit
union, and a trust company) were not commercial banks.
As shown in the table below, most of the applicants
were small in terms of deposits.



                            3-3
    Deposits                                Number of banks

(000,000 omitted)

Under      $100                                    62
$100 to    $500                                     6
$500  to $1,000                                     2
Over     $1,000                                     1
                                                   71


Many State banks convert
to cha!Me supervlsors
     During the period covered by our review, OCC did not
require applicants tD disclose their reasons for wanting
a national charter. Nevertheless, files for 53 of the 71
cases contained either stated or implied reasons for
the requests. Reasons were given by some applicants; in
other cases motives were discussed by the OCC reviewers.
                     Summary of Reasons for
                  Conversions-to Natlonal-Banks

Reasons related to supervisory agencies:
   Seeking to avoid supervisory pressure
     fur corrective actions                             4
   Seeking favorable decisions on desired
     structural changes                             22
   Generally dissatisfied with former
     regulator                                          5
                                                    31

Reasons unrelated to regulatory disagreements:
   Seeking same type of charter as
     affiliated banks                                   7
   Changing image or obtaining
     prestige of national bank                      10
   Miscellaneous                                     5
                                                    22
                                                    53




                              3-4
     F)r the four banks which applied for conversion
to avoid supervisory action, OCC

     -- rejected one application, knowing the bank's prob-
        lems and its desire for a structural change which
        probably would be rejected even if the conver-
        sion were approved,
     -- approved one conversion but required the bank to
        correct the problem identified by the previous
        supervisor,
     -- approved a second conversion, was aware of the
        problems identified by the previous supervisor,
        but took its own actions to correct the problems,
        and
     -- approved the other application but did not
        take the same action as the previous supervisory
        agencies.
      In the last case, the bank obtained a more
decision from OCC than it had from FDIC and the favorable
                                                 State
supervisory agency1 which had told the bank to increase
its capital. In a letter to OCC, the applicant explained
its disagreement with the amount of the directed increase.
After examining the bank, OCC required additional capital
as a condition of approval, but less than FDIC and the
State agency had asked for. Except for undercapitalization,
the OCC examination disclosed that the Lank was in sound
condition.

     For tne 22 conversion applications which were related
to a bank's desire for structural changes, OCC

    -- rejected 2 applications,
    --approved 15 and later approved branches. mergers,
      and other structural changes, and
    -- approved 5 others, but either has not acted on or
       has not received their requests for structural
       changes.




                           3-5
     Of the 15 requests for structural changes approved
by OCC, 4 had been rejected by the previous supervisory
agency.  In the rev: ining 11 cases, the banks implied that
structural change r 'uests were the reasons for conversions
but did not indicate whether they had actually been turned
down by another agency. Since this information was
readily available in the files we reviewed, OCC apparently
was aware of the banks' motives for conversion. OCC investi-
gated the merits of applications submitted by the converted
banks for branches, mergers, and other structural changes.
These investigations apparently satisfied OCC that the
corporate structure requests should be approved.

Condition of banks applying to convert

     An OCC examination or investigation was performed for
54 of the 70 conversion applications we reviewed. 1/
Fifty-one had deposits under $100 million and three had
deposits over $100 million. OCC reviewed earlier bank
examination reports or contacted the applicant's previous
Federal or State agency for about half of the 70 banks,
including the 16 which OCC did not examine firsthand. Thus,
in all 70 cases, before deciding on the conversion applica-
tions, OCC either did its own examination or investigation,
or reviewed previous examination reports.

   Although several banks accepted for conversion had some
weaknesses, most were rated by OCC or their previous agen-
cies as sound in every respect. Two banks with weaknesses
were approved because they were affiliated with bank holding
companies which OCC believed would improve their condition.

     A third bank had been designated a problem bank by
FDIC, which was considering issuing a cease and desist
order to prevent the diversion of profits through a manage-
ment service contract.  After examining the bank, OCC gave
preliminary approval for conversion, without knowing about
FDIC's proposed action. OCC believed the bank had no
serious problem and had been assured by its president that
the contract's objectionable provisions would be rescinded.
Before OCC gave final approval for conversion, FDIC noti-
fied OCC of its proposed action, and OCC granted final
approval with the understanding that the bank agree to
correct problems in the management contract.  Because


1/ One applicant withdrew before any OCC evaluation.


                             3-6
the problems were not fully corrected after conversions
OCC entered into a formal written agreement with the
bank about 7 months later to confirm the bank's planned
actions to correct the problems.

     Another bank with known problems was also accepted
for conversion. Memos in the files indicate that OCC was
aware of this bank's problems, had met with FRS before
approving the application, and took its own actions to
encourage the bank to correct the problems identified by
that agency.
      All four apDnpiCrts £Lur 6tate-to-national charter
coizversions that OCC rejected from January 1972 through
April 1976 were very small banks with deposits ranging
from $800,000 to $3.6 million. One bank was turned down
because OCC's examination revealed a poor overall condi-
tion. Two other banks had sought a relocation which OCC
believed should not be approved; one of these also had
not obtained the additional capital recently recommended
by its State and Federal supervisors. The final applica-
tion was disapproved because the bank appeared more in-
terested in expanding through branching than in correct-
ing operating weaknesses.
General OC_agreement on applications

     OCC reviewers at the regional office and headquar-
ters generally agreed with one another on conversion
applications. The Comptroller disagreed with more than
one staff member on only 1 of the 68 conversions from
January 1972 through April 1976. Single recommendations
were contrary to the final decision on only two other
applications. Reviewers thus agreed much more often on
conversions than on new charter applications.
RECENT CHANGES TO OCC'S CONVERSION PROCESS

     The Haskins & Sells study addressed OCC charter con-
version policies and procedures. The public accounting
firm said OCC should (1) require an applicant for con-
version to a national charter to give reasons for the
conversion and (2) assure itself the conversion is not
the result of supervisory pressure from other bank regu-
lators because of illegalities or unsatisfactory banking
practices. Several of the study's general recommendations




                           3-7
about OCC's handling of applications for new banks and
structural changes also apply to the conversion process.
These include (1) policy statements and decision guidelines,
(2) better application forms, and (3) better guidelines
for receiving, verifying, and reviewing applications.
     OCC addressed the recommendations about conversions
with a set of policy statements and revised application
forms and procedures. OCC began using the policy state-
ments and forms on November 1, 1976.
     According to OCC's policy statements, it will ordin-
arily approve conversions which are consistent with a
sound national banking system. Conversions should not be
motivated by supervisory pressures from other supervisory
agencies. The bank's general condition should be satisfac-
tory and managers should have demonstrated ability to
supervise a sound bank. Serious problems will normally
preclude approval. Disapproved applicants will be told
the reasons for rejection.
     OCC's new procedures do not, however, define the method
of obtaining information on the factors to be considered.
Certain procedures should be part of the process; for example,
contacting the applicant's current Federal and State regu-
latory agencies. By reviewing recent bank examination
reports and talking with the appropriate regulators, OCC
will have all current supervisory information and will be
better able to evaluate a bank's condition and its motives
for conversion. OCC officials intend to closely monitor the
implementation of the new procedures and, as they gain
experience in using them, make changes to insure their
effectiveness.
      The new conversion application now requests a bank's
reasons for applying for conversion. The new procedures
require an examination of the applicant unless specifically
waived by a regional administrator. If the examination
is waived, the region must provide a written justification
to be reviewed by the Comptroller.
NATIONAL- 20-STATE CONVERSIONS

State conversion policies

     Of the 24 State agencies responding to our survey,
15 provided information on their policies, criteria, or


                             3-8
procedures for reviewing national-to-State charter conver-
sion applications. Several respondents stressed they have
had little or no experience with bank charter conversions.

     Five states indicated they use the same or similar
procedures and criteria as for new bank charter applica-
tions. Nine States fully examine a bank before deciding.
Of these nine, two also apply the same criteria applied
to new bank charters. The remaining State explained that
statutes require an investigation to assure that depositors
are protected and legal requirements are satisfied. Cali-
fornia, Michigan, and New York review OCC examinations
of applicants as part of their conversion review process.
Only California indicated it would waive its own examina-
tion if satisfied with a recent OCC examination.

     Few States presented their policies regarding
acceptance of national-to-State conversions.  Michigan
and Georgia stated conversion requests should not be the
rcult of supervisory pressure and, along with Oklahoma,
specifically indicated that converting banks should be
in sound condition.

National banks convert to withdraw from FRS

     National-to-State charter conversion applications
are not evaluated by OCC, and the agency's files do not
contain information on banks' motives for such changes.
However, according to FRS, the major reason that banks
have given up national charters is to avoid maintaining
assets in the non-interest-bearing reserves required
for FRS membership.

     National banks are required by law to be members of
FRS, but State banks are not.  According to FRS, only 2
of the 73 national banks converting to State charters
from 1972 to 1975 retained membership. Also, stockholder
proxy statements available for 11 converting banks
indicated that 10 gave up national charters to withdraw
from FRS.  The other bank converted to a State charter
to prepare for a planned merger with a State bank,

     Even though some national banks have convected
apparently to avoid FRS reserve requirements, other
factors have influenced national banks not to convert
and State member banks to maintain FRS membership.




                            3-9
     State reserve requirements for nonmember banks off-
set some of the disadvantages of the FRS requirements.
Forty-nine States have asset reserve requirements, and
over half of these States specify that the reserves are
to be maintained as vault cash or non-interest-bearing
demand deposits at other banks. These balances can
also be used to compensate for various correspondent
banking services. Only 3 States allow all the reserves
to be maintained Ln selected interest-bearing assets,
and 18 other States permit part of the reserves to be
invested in certain short-term assets.

     Member banks also receive advantages such as access
to the FRS discount window, free shipment of coin and
currency, and use of FRS safekeeping facilities. In
addition, FRS membership helps banks attract interest-
free demand deposits from banks that are seeking corre-
spondent bank services.

     A recent study by the Conference of State Bank Super-
visors quantified the benefits and drawbacks of FRS mem-
bership, concluding that some banks profit more from mem-
bership and some from nonmembership. Apparently, most of
the banks which converted from national-to-State charters
had determined that they were not receiving net benefits
from their membership.
CONCLUSIONS
     Before OCC had policies governing conversion requests,
several banks appear to have converted to national charters
to avoid supervisory action by another regulatory agency.
Supervision was usually consistent because OCC addressed
the problems identified by the previous regulators.
     Other banks converted to obtain more favorable consid-
eration of requests for branches, mergers, or other struc-
tural changes. OCC approved many of these requests after
separately considering their merits.

    State banks also converted for reasons unrelated to
supervisory disagreements, such as to have the same type of
charter as affiliated banks or to obtain the prestige and
Federal Reserve-related banking powers of national banks.

    OCC's recently established policies and its require-
ments that State banks explain their reasons for wanting
a national charter should help it make better informed
                            3-10
decisions about whether a bank should be allowed to change
supervisors. More importantly, they should help OCC to
accomplish its basic objective--maintaining a sourd national
banking system.




                            3-11
                       CHAPTER 4
             BANK EXAMINATIONS:    1971-75




Overview                                            4-1

Objectives of examination                           4-4

Examination responsibilities                        4-4

Types of examination                                4-5

Scheduling and planning of commercial
  examinations                                      4-6
    Examination patterns                            4-6
        Conclusion                                  4-7
        Recommendation                              4-7
        Agency comments                             4-7
    How often are banks examined?                   4-8
        Conclusion                                  4-9
        Recommendations                             4-9
        Agency comments                             4-9
    How are Federal examinations coordinated
      with State examinations?                      4-11
        Conclusion                                  4-13
        Recommendation                              4-13
        Agency comments                             4-14
    Planning and preparing for examinations         4-15
    Determining examination scope                   4-15
        Conclusion                                  4-16
        Recommendation                              4-17
        Agency comments                             4-17
    Procedural guidelines                           4-18
    Documentation standards                         4-18
        Conclusion                                  4-18
         Recommendation                             4-19
        Agency comments                             4-19

How examinations were performed                     4-20

Specific areas covered by commercial examinations   4-21
    Classification of assets                        4-21
    Review of loans                                 4-21
    Evaluation of securities                        4-23
    Real estate                                     4-23
    Deposits                                        4-24
    Borrowing by banks                              4-24
    Adequacy of capital                                4-25
    Income and dividends                               4-26
    Liquidity                                          4-26
    Compliance with banking laws
      and regulations                                  4-27
    Management, management practices,
      and internal controls                            4-27
Bankers' views on examination coverage                 4-28
International operations examinations                  4-30
    Evaluation of foreign credit                       4-31
        Conclusion                                     4-32
        Recommendation                                 4-33
        Agency comments                                4-33
    Onsite versus home office examinations
      of foreign branches and subsidiaries             4-34
        Conclusion                                     4-35
        Recommendations                                4-35
        Agency comments                                4-35
Electronic data processing examinations                4-38
    Conclusion                                         4-39
    Recommendation                                     4-39
    Agency comments                                    4-39
Trust department examinations                          4-40
Compliance with consumer protection laws               4-40
    How violations are discovered                      4-41
    Unaggressive examinations                          4-41
    Action on violations                               4-43
    Conclusions                                        4-43
Bank affiliation with holding companies                4-43
    Snme holding companies caused problems for
       subsidiary banks                                4-44
    Unsound holding companies' expansion
      applications approved                            4-44
    FRS surveillance and inspection policies           4-45
    Review of financial data                           4-45
    Onsite inspection                                  4-46
    Time spent on inspections                          4-47
    Holding company inspections did not discover
      weaknesses                                       4-47
    Reserve Board oversight of FRBs' holding company
      surveillance and inspection activities           4-49
    Interagency coordination                           4-50
    Conclusions                                        4-50
    Recommendation                                     4-51
    Agency comments                                    4-51
                         CHAPTER 4

                BANK EXAMINATIONS:   1971-75

OVERVIEW

      Bank examinations have placed great emphasis on ana-
lyzing the bank's condition at the time of the examina-
tion.   This approach has been reasonably effective in
identifying problems in banks.   However, in many cases
examiners do not address the underlying causes which
have existed for some time, such as the bank's basic
management practices, operations, and controls.   The
examination approaches have also emphasized financial
ratios and comparisons.   The agencies had not established
absolute agency-or industry-wide criteria or levels of
acceptability for these ratios and comparisons.   Their
views of the condition of banks depended largely on
individual judgment.

     The Federal agencies do not examine the same banks.
The Office of the Comptroller of the Currency examines
national banks, the Federal Reserve banks (FRBs) examine
State banks which are members of the System, the Federal
Deposit Insurance Corporation examines insured State banks
which are not members of FRS.  State banking authorities
also examine State banks.

     The agencies examine banks' commercial departments,
trust departments, electronic data processing operations
or service bureaus, and international operations.

     The National Bank Act requires that each national
bank be examined twice each calendar year, but allows the
Comptroller of the Currency to waive one examination for
each bank in each 2-year period.  During the 1974-75 cycle,
OCC examined 75 percent of the national banks the required
3 times.  FRS policy is to examine each State member bank
at least once a year.  In 1975 it examined 97.5 percent
of its banks.  FDIC, in practice, attempted to examine
each of its banks once every 12 months.  In 1975 it
examined 88 percent of its banks.

     In our view, the number of times a bank is examined
should not be based upon a rigid frequency requirement.
Rather, the agencies, using the results of the previous
examination and information from reports by the bank,
should schedule examinations based on an evaluation
of the bank's soundness and the quality of its policies,
procedures, practices, controls, audit, and management.


                           4-1
    under this approach, banks in poor condition would
be examined more often than those in good condition.
Each agency should have policies to allow it to con-
sider such factors and exercise discretion in determining
when to examine banks.

     FDIC and FRS sometimes conducted their examina-
tions at the same time as the State banking agencies.
Both agencies have started very limited experimental
programs to rely more on the work of State examiners
instead of examining banks in those States. We believe
that the agencies should expand these efforts to as many
States as possible; of course, the quality of the State
examinations must be considered in such programs.

     The examination procedures followed by the agencies
were much alike. They looked at the same things and did
essentially the same types of analyses and evaluations.
The major emphasis of the agencies' examinations efforts
was on evaluating asset quality, adequacy of capital,
and quality of management. The examiner-in-charge set
the scope of each examination within general guideline-
provided by agency manuals, standard report formats, anr
agency training and tradition.
     Of the several factors which influenced the scope
of an examination, the primary one was the bank's asset
size. To some extent, the scope was also influenced by
the condition of the bank and the quality of its internal
controls and audit. However, we found no evidence that
the examiners first evaluate the bank's internal controls,
its internal audit, or its policies and procedures, co
determine what the examination's scope should be. They
did not attempt to identify areas of operational strength
or weakness before beginning the detailed examination
steps. Thus, the same things were usually looked at
from bank to bank.

     In our opinion, examiners should identify and then
concentrate on weak bank operations which could cause
serious problems. Also, the examiners should forego
certain steps that have been done satisfactorily by the
bank's internal auditors, an independent accounting firm,
or State examiners.




                           4-2
    FRS and OCC are the primary examiners of international
operations because few FDIC-examined banks are interna-
tionally involved.  International examinations are similar
to commercial examinations, in that loan quality, controls,
and management are evaluated. However, these examinations
are complicated because special risks are involved in
foreign loans and foreign currency trading and because
the operations are conducted in foreign countries.

     The different approaches used by FRS and OCC to eval-
uate certain loans to foreign businesses or countries may
have resulted in inconsistent treatment of U.S. banks.
Also, we believe that the agencies have not conducted
onsite examinations of foreign branches and subsidiaries
frequently enough.

     While the agencies reported some violations of con-
sumer protection laws and regulations, they acknowledged
that they have not aggressively monitored consumer protec-
tion law compliance, and they have begun revising their
approaches.  (See ch. 7.)

     According to the examiners, affiliation with a hold-
ing company caused problems for 22 of the 344 sampled
banks so affiliated. 1/ With 15 of these 22, the bank
examination was the first indication of such problems,
although the FRBs had inspected 7 of the controlling
holding companies within the previous 2 years.  Had
these inspections been adequate and had the other eight
been inspected, the problems might have been resolved before
they affected the banks.


17As   agre-ed-with the Board of Governors of the FRS, we
    confined our evaluation of holding companies to
    FRS actions with regard to holding comipanies affiliated
    with banks in our samples.




                           4-3
OBJECTIVES OF EXAMINATION

     Bank examination is the agencies' primary tool for
bank supervision. An examination is intended to provide
the supervisory agency and the bank with an evaluation
of the bank's soundness. It also discloses problems
which the bank must rectify with advice and sometimes
pressure from the supervisory agency.

     Unlike auditors, examiners are not expected to
evaluate banks' ac.(unting practices or systems, nor
do they attest to tbe accuracy and fairness of financial
statements. Howe-    , examiners are expected to check
the accuracy of t.ie various financial reports which the
banks are required to file with the agencies.

     The disclosure of fraud is not a primary objective
of an examination, although some examination procedures
uncover defalcations in banks. Examiners, however, do
evaluate the banks' systems of internal control.


EXAMINATION RESPONSIBILTIES

     OCC and the State agencies have legal power to examine
the banks they charter. FRS has authority to examine
banks which are members of the System. FDIC has authority
to examine banks which subscribe to Federal deposit in-
surance. State banks are also examined by their State
banking supervisors. The result is a system of    ?rlapping
supervisory responsibilities. However, the thrL, Federal
agencies have agreed to allocate bank examination respon-
sibilities. Thus, national banks are subject to only one
examining agency (OCC); State banks, to two (FRS or FDIC
and their State agency).

     As the chart on the following page indicates, the
Federal agencies have different examination workloads.
FDIC examines about 60 percent of all commercial banks,
but these banks account for less than 23 percent of total
deposits and the majority are small or medium sized. OCC
and FRS examine most of the large banks in the Nation,
as well as many small and medium-sized banks; therefore,
their workloads are less homogeneous.




                              4-4
                            Number of banks examined by:
                           FDIC      FRS
                           and       and
Bank asset size           States    States   OCC    Total

(000,U00   omitted)

Over     $1,000               11          28       78      117
$500 to $1,000                15          18       64       97
$100 to     $500             259          97      468      824
Under       $100           8,309         903    4,134   13,346
      Total                8,594       1,046    4,74 a/1-4,384

     Percent of total       59.7         7.3    33.0    100.0


a/An additional 273 banks had no Fede al deposit insurance
and, therefore, were not federally supervised.
                         Percent of deposits of banks super-
                                vised by Federal_aqencies
                            FDIC        FRS
                            and         and
Bank asset size            States      States    OCC    Total
(000,000 omitted)

Over    $1,000               1.5        12.9    32.0     46.4
$500 to $1,000               1.2         1.4     4.8      7.4
$100 to   $500               5.0         2.3    10.1     17.4
Under     $100              14.8         2.4    11.6     28.C

   Total                    22.5        19.0    58.5    100.0

TYPES OF EXAMiNATION

     The agencies devoted most of their resources to
examining the commercial departments of banks. These
departments encompass the primary operations of most banks:
accepting deposits, making loans, investing in securities,
etc.
     The agencies have also developed examination
policies, procedures, reports, and sometimes staffs
for four other areas:




                          4-5
     --Trust departments.
     -- International departments.

     -- Electronic data processing services.
     -- Ccnsumer protection laws and regulations.
These areas have been given special attention because
they are complex and can greatly affect a bank's overall
condition.

SCHEDULING AND PLANNING
OF COMMERCIAL EXAMINATIONS

     All three agencies scheduled examinations at the
field office or regional level. The frequency with which
schedules were prepared varied. Because their banks were
also examined by State examiners, FDIC and FRS coordinated
their schedules with State agencies. The agencies' schedules
were based on

     -- agency policy on examination frequency,
     -- bank asset size,

     --the availability of examiners, and
     -- travel considerations.
Examination patterns

     Agency officials said they tried to preserve the
element of surprise in scheduling examinations so banks
would not hide adverse conditions or wrongdoing. Therefore,
as a matter of policy, they did not disclose examination
schedules to banks or outsiders (other than State examiners)
and they tried to avoid establishing predictable patterns.
However, to avoid delays once the examination started, the
agencies sometimes rsked for information from a large
bank's computer-based files juist before starting an
examination.

     Nearly all of the bankers responding to our question-
naire said they received no advance notice of an examina-
tion. However, in some cases the agencies had established
definite examination patterns. FRS examined 70, FDIC



                             4-6
examined 56, and OCC examined 78 of the banks in our samples
in the same month of 2 or 3 consecutive years. A 1976 OCC
internal review concluded that examinations of 16 banks in
8 regions were so regularly scheduled that they could
easily have been predicted by the banks.
     Upon entering the bank, the examiners were to take
control of assets such as cash, securities, loan port-
folios and collateral, etc. This procedure was int,,sded
to prevent employees from substituting assets to cover
shortages or misuse of assets. Thus. the agencies consid-
ered the element of surprise to be important to the examina-
tion process, especially when they examined banks with
poor internal controls or inadequate internal or external
audit programs.
     Conclusion

     Because the agencies view surprise as an important
element of an examination, they should be scheduling their
examinations to avoid obvious patterns.
     Recommendation

     Therefore, we recommend that the Board of Directors,
FDIC, the Board of Governors, FRS, and the Comptroller
of the Currency establish scheduling policies and proce-
dures which would avoid setting examination patterns.
     Agency comments

     FDIC in its letter dated January 17, 1977, stated:
     "We believe that our recently adopted General Memo-
     randum #1, which has been under consideration and
     extensively tested for several vears prior to adop-
     tion, largely satisfies this recommendation. For
     more extensive comments on our General Memorandum,
     please refer to our comments on the recommenda-
     tions contained on page 4-9 of the GAO Report."
     FRS in its letter dated January 16, 1977, stated:

     "This recommendation is based upon t'he premise that
     the agencies view surprise as an important element
     of an examination. The Board believes that, in
     many cases, there is serious doubt as to the


                            *i
      benefits to be gained aiid hence the desirability
      of surprise examinations. In those instances
      where surprise is considered important, it has
      been, and will continue to be, our practice
      to schedule examinations so that they cannot
      be predicted in advance."

     OCC in its letter dated January 14, 1977, stated:
     "Historically, the OCC has viewed surprise as an
     important element of an examination. However, a
     primary feature of our new examination approach
     entails the pre-examination analysis wherein the
     examiner will determine the adequacy of internal
     control and audit activity. The OCC feels the
     best deterrent for fraud is not periodic un-
     announced visits by examiners but rather the
     existence of sound bank policies, procedures,
     internal control and audit activity on a con-
     tinuing basis. The element of surprise is
     necessary only in those cases where such factors
     are suspect."
How often are banks examined?

     Although FDIC had no policy, in practice it examined
most of its banks at least once every 12 months.   In
1975, it did not examine 12 percent of its banks. All of
those banks, unless new, had been examined in 1974.

     FRS policy is to examine each State member bank at
least once a year. It did not examine 2.5 percent of its
banks in 1975. These banks had all joined FRS in 1975 or
had been examined in 1974.

     OCC is the only agency of the three subject to a
statutory examination frequency requirement.   The National
Bank Act requires that each national bank be examined at
least twice each calendar year but allows the Comptroller
to waive one examination at each bank once in 2 years.
According to its own reports, OCC has not examined national
banks as frequently as required by the National Bank Act.
During 1974-75 about 1,200 national banks were not examined
the required 3 times. Some banks with poor composite
ratings (see ch. 6) were examined only twice during those
years although some banks with better ratings were examined
three times.



                           4-8
     OCC, since early 1975, has been using a "bobtailed"
or abbreviated  examination for national banks in good
condition.  And  recently, FRS has adopted a "compacted"
examination (see  ch. 7) for State member banks in good
condition.  In  November 1976, FDIC established a policy
to schedule a  bank examination based upon the bank's
condition.  (See ch. 7.)

     Conclusion

     Although the agencies did not examine all of their
banks as frequently as their policies or the law required,
they may have been examining some banks more often than
necessary and others not often enough.

     Using the results of previous examinations and infor-
mation from reports by the banks, the agencies should
base the liumber of times a bank is examined on an
evaluation of the bank's soundness; policies, procedures,
and controls; and management quality. Thus, banks in
known poor condition or with major weaknesses in policies,
procedures, or controls would be examined more often than
banks with good policies thought to be in good condition.

     Recommendations

     We recommend that the Board of Directors, FDIC, and
the Board of Governors, FRS, adopt flexible policies for
examination frequency which would allow them to concen-
trate their efforts on banks with known serious problems.

     We recommend that the Congress amend the National Bank
Act to allow the Comptroller of the Currency to examine
national banks at his/her discretion. We would be glad to
assist the committees in drafting appropriate legislation.

     FDIenc   comments

     FDIC stated:

     "Although it was FDIC's long-standing policy to examine
     each bank once a year, it is inaccurate and misleading
     to suggest that that time-frame was the only guide-
     line used by the FDIC in scheduling examinations,
     or, to state it another way, that examinations were
     not scheduled and conducted by the FDIC based upon




                              4-9
the "bank's soundness; and the quality of
its policies, procedures, practices, controls,
audit, and management.

"During 1975, FDIC conducted 213 follow-up
examinations and a number of on-site visitations
at banks presenting either financial or super-
visory problems. Further, those banks which
were not examined in 1975 largely consisted of
banks which would not fall within the one-year
time-frame guideline under General Memorandum
#1. Although General Memorandum #1 was formally
adopted in November 1976 and implemented on
January 1, 1977, the concepts and practices em-
bodied in it are not of recent origin. Those
concepts and practices have been under con-
sideration at FDIC since early 1974. Further-
more, the concepts and practices have been experi-
mented with and tested in five of the FDIC's
14 Regional Offices prior to formal adoption of
General Memorandum #1. We might add parentheti-
cally that FDIC policy is to experiment on a
regional basis with major policy changes before
implementation for the entire Corporation.

"According-y, while the recently issued General
Memorandum #1 expresses more definitively that
scheduling of examinations is not based on time-
fralne priorities alone, nevertheless, we feel
that the criticism of past scheduling practices
expressed in the GAO recommendation is misplaced.
The FDIC has followed and continues to follow
a policy so aptly stated in the said General
Memorandum #1, namely:

     "The first priority has been and will
     continue to be, effective surveillance
     and supervision of the institutions which
     present either supervisory or financial
     problems."
FRS said:
"The Board already has established policies that
are flexible enough to allow us to concentrate our
efforts on banks with known serious problems.
Some years ago, the Board adopted the policy, which
was reaffirmed in 1975, that all banks considered
to be in a problem status be examined at a minimum

                       4-10
    of six-month intervals. However, we will continue
    to schedule periodic examinations of all banks
    under our supervision since a bank may deterior-
    ate with the passage of time. As pointed out in
    the GAO report, the Board recently approved the
    usage of Asset Quality and Management Performance
    Examinations in the case of banks thought to be
    relatively free of major problems. If this
    limited scope examination detects major changes
    or deterioration, a full scale examination is then
    commenced. These procedures give us flexibility
    while at the same time insuring that problems are
    not overlooked."
    OCC said:

    "We support the recommendation of legislation to
    permit OCC discretion in scheduling the frequency
    of examinations. The current method uf adapting
    the depth cf examinations to the needs of each
    bank, based on NBSS data and pre-examination
    analysis, fily complies with law. However,
    greater sti   tcry discretion would enhance our
    effectiveness in this regard."

How are Federal examinations
coordinated-wi-t State examinations?
     Since the banks examined by FDIC and FRS were also
examined by State banking authorities, both agencies
tried to coordinate and frequently combine their examina-
tions with those of the States. The arrangements between
the Federal supervisors and State authorities were of two
basic types:

     -- The Federal agencies and the States conducted
        independent examinations.

     ---The Federal agencies and the States conducted
        joint examinations and wrote either one or two
        examination reports.

The examination relationships between the Federal agencies
and the States varied from State to State, from bank to
bank, and sometimes from examination to examination.




                           4-11
     In joint FDIC-State examinations which resulted in
C Ingle report, examiners shared the work. In those joint
FvbC-State efforts which resulted in two reports (called
concurrent examinations), the examiners also sometimes
shared the workload. Similarly, FRS and State examiners
sometimes shared the work during j .nt examinations.

The following table summarizes the predominant examination
arrangements during 1375.

          Predominant
   examination arrangements         Number of States
                                    FDIC         FRS
In'dependent                      a/ 22           15
Joint--two reports ("concurrent")     8            8
Joinc--one report                    13            7
Mixed                                 7           12
Experimental (see p. 4-13)            -            1
     Total                           50        b/ 43

a/Special arrangements existed for some banks in 3 States,
  see page 4-13.

b/In seven States, no State banks belonged to the FRS.




                          4-12
     We asked bankers their opinions about the compet-
ence of State examiners as compared to Federal examiners.
As shown below, many of the bankers believed the State
examiners to be as competent as Federal examiners.
                          Percent of responding bankers
                        who said State examiner competence,
                   compared with that of Federal examiners, was
Type of bank           Better       The same            Wcrse
State nonmrember         8             64                28
State member             5             61                34

     FDIC and FRS were conducting experimental programs
with States which could improve efficiency. In Georgia,
Iowa, and Washington, FDIC was relying completely on State
examinations to replace its own.

     The FRB ot Chicago was conducting a similar experiment
in India.a. The State examined the bank with only one
Federal examiner present. The bank and the FPB received
a copy of the State report. For FRS use, the FRB examiner
wrote a report of examination based primarily on the work
of the State examiners.

     Conclusion

     In our opinion, these approaches are reasonable
attempts to eliminate needless duplication of work.   If
found acceptable, they should be expanded to enable  ?DIC
and FRS to concentrate their efforts more on banks with
serious problems.  By relying more on State examinations
FDIC and FRS could free their own examiners from relatively
routine examinations of "good" banks to examine, reexamine,
visit, or monitor banks with major problems.  The Federal
agencies, of course, should rely on the States' examinations
only if they are of acceptable quality.
     Recommendation

      We recommend that the Board of Directors, FDIC,
ari, the nBord of Governors, FRS,   -bend their current
etfforts to use State examinations and, if they do, we
also recommend that they
      -- develop minimum standards for State
         examiner training and examination proce-
         dures and

                               4-13
-- use only reports of State examinations meeting
   those standards.

Agency comments
FDIC said:
"The FDIC has determined that the Experimental
Withdrawal Program conducted in three states
during the past three years will not be con-
tinued in its present form. However, agreement
to examine nonproblem banks on an alternate-
year basis has already been consummantad with
one state and the possibility of entering into
similar arrangements with other states is being
explored.   Furthermore, termination of the Ex-
perimental Withdrawal Program should not be
construed as a decline on the part of the
FL)IC to cooperate to the fullest extent possible
with the various states or to place less reliance
on the efforts of the state supervisors. The
guidelines set forth in General Memorandum #!
provide a workable framework for increased
cooperation with the states. Thus, almost by
definition, if the program expressed in General
Memorandum #1 proves workable and if a state
banking department performs in an acceptable
manner, the frequency and scope of FDIC exam-
inations in that state will be reduced."

FRS said:

"The report recognizes our cuLrent extensive
efforts to eliminate unnecessary duplication by
utilizing State examiners and State examination
reports.   If experience with our existing pro-
gram in Indiana should indicate that expansion
of this program is desirable, GAO's recommenda-
tions regarding standards would be appropriate.
Indeed, the purpose of the existing experimental
program is to develop such standards. In this
connection, however, it should be recognized
that written standards alone will not insure
the success of any program."




                       4-14
Planning and preparing for examinations
     The examiner-in-charge typically prepared for an
examination by reviewing the previous report of
examination and related workpapers. Just before entering
the bank, the examiner-in-charge usually met with his/her
staff and assigned specific tasks. In many districts,
workload, geography, and travel difficulties precluded
extensive preparation. However, some FRBs gave
their examiners-in-charge a period of time, usually a
week, to study the report, workpapers, and related
correspondence from the previous examination.

Determining examination scope
     The scope of an examination is the extent to which
the examiner reviews and analyzes the bank's financial
condition, operations, and management. Included in scope
is the depth of the examiner's coverage; e.g., how many
loans and securities were analyzed.

     The areas of examination coverage were reasonably
well defined and about the same at each agency. Each

     -- evaluated assets,

     -- analyzed capital structure,
     -- analyzed income and changes in capital,

     -- evaluated loan policies,

     -- analyzed concentrations of credit,

     -- analyzed "insider" loans,

     -- evaluated investment policies,
     -- reviewed the bank's premises and other real
        estate owned,
     -- analyzed borrowing,
     -- evaluated management,

     -- evaluated internal contr.,ls, and

     --reviewed compliance with laws and
        regulations.

                              4-15
How thoroughly hese areas were reviewed and analyzed
varied, largely according to the examiner's judgment.

     The standari report of examination (see ch. 6)
established the basic scope of an examination. Proce-
dural manuals, whether agencywide or local, also provided
some scope guidance to the examiners. Beyond these guides,
examination scope was left to the discretion of regional
officials and the examiner-in-charge.

     Agency officials said problems in the bank's
internal controls or internal or external audit programs
discovered during the previous examination could have
influenced the extent to which certain records were veri-
fied or whether cash was counted.

     The examiner might have expanded or reduced
coverage of some areas because of the results of the
previous examination. However, we found no evidence
in examination reports that the examiner reviewed
the bank's internal controls, policies, or procedures
before setting the scope of the examination. Unless the
examination was a special, limited-scope reexamination,
it usually closely resembled the last examination.

     Conclusion
     When planning the examination and defining its
scope, the examiner-in-charge should pay close attention
to the bank's system of internal controls, its policies,
and the audit or verification work already done by internal
and external auditors. We believe that, by examining
electronic data processing operations and by reviewing
the system of controls and policies, the examiners
could identify areas of weakness upon which to focus their
commercial examinations.

     The first step of the examination should be a review
and evaluation of policies, procedures, controls, and audit
and the scope of the remaining work should be adjusted
accordingly. Thus, the examiners would not spend time
reviewing areas in which problems are unlikely. Explana-
tion for scope modifications should be included in the
workpapers or the report.




                          4-16
     New examination approaches and procedures being
implemented by the agencies are described in chapter 7.
OCC's new approaches and procedures should eliminate the
weakness discussed above.
     Recommendation

     We recommend that the Board of Directors, FDIC, and
the Board of Governors, FRS, establish procedures to base
the scope of each examination on the examiners' evaluation
of the quality of the bank's controls, policies, procedures,
and audit.

     Agency comments
     FDIC stated:

     "With respect to FDIC examinations, the findings
     and conclusions expressed by GAO are not accurate.
     The primary factor influencing the scope of
     the examination is not size, but the known his-
     tory of strengths and weaknesses of the parti-
     cular institution. Furthermore, FDIC examiners
     do pre-plan the scope of an examination, by
     studying applicable files and previous examina-
     tion reports, and noting any material changes
     in the management or style of operations since
     the last examination.
     "FDIC examiners have in recent years reviewed
     a bank's internal controls, policies and pro-
     cedures prior to actual commencement of the
     examination in order to establish the scope
     of the examination within the minimum standards
     prescribed. With respect to smaller banks,
     however, such a review tends to be less formal,
     hence harder for GAO to detect than with larger
     banks. Considerable leeway in this respect is
     provided for in the recently adopted General
     Memorandum #1, and we reiterate that these
     procedures were considered and extensively
     tested in five of the FDIC's 14 Regional Offices
     for several years prior to formal adoption."
     FRS said:

     "This recommendation encompasses what we are al-
     ready doing. We review the policies, procedures,


                           4-17
     and controls in connection with all bank
     examinations.  In most large banks, our ex-
     aminers currently perform a preexamination
     review specifically focusing on controls,
     nclicies, and procedures.  The results of
     such review are used to determine the
     amount of scrutiny given to each area.   In
     smaller banking institutions, a review of
     the controls, policies and procedures in
     effect at the last examination is used to
     develop the scope of the examination."

Procedural guidelines

     Each of the three agencies has a manual describing
the general procedures to be followed during an examination.
However, only the FDIC and OCC manuals were in use during
the period covered by our review.  The FRS manual was issued
in 1976.  Brfore the systemwide manual was issued, the FRBs
followed their own procedures.  Some had examination manuals;
others formally compiled procedural memorandums.  All three
agencies allowed their regional officials and examiners
considerable discretion in establishing examination proced-
dures.

     Beyond the manuals, procedural guidance came from agen-
cywide and regional schools and seminars. (See ch. 10.)
The reports of examination also dictated some procedures.

Documentation standards

     The agencies' reports of examination (se  ch. 6) were,
to a great extent, the workpapers for the examination.   The
agencies retained certain forms for recording details about
loans and securities in the files.  However, there were no
guides for what other material--schedules, records of inter-
views, etc.--should have been available or how it should
have been prepared and organized.

     Conclusion

    More complete and organized workpaper files would

    -- enable the examiner-in-charge to readily determine
       if all the required examination steps have been
       followed,

    -- provide organized and accessible support for
       the preparation of the examination report,


                           4-18
    -- i -ble the agencies to streamline their reports
       (see ch. 6) by transferring information now in
       the reports to the workpapers,

    -- enable agency reviewers to determine what work was
       done and what information and analyses support the
       examiners criticisms, and

    -- facilitate review of the workpaperz by the examiner
       in charge of the later examinations.

     The approaches and procedures being taken by OCC
(cee ch. 7) should result in better documentation
of bank examinations.

     Recommendation

     We recommend that the Board of Directors, FDIC, and
the Board of Governors, FRS, develop standards for the
preparation, maintenance, and use of examination work-
papers.

     Agenc _cormments

     FDIC stated:

     "The standards for the preparation, maintenance,
     use and importance of examination workpapers are
     included in the course of study at the various
     schools operated ¥,ythe Corporation and in our
     on-the-job traininr program.  The examination
     workpapers do, in fact, cover a number of items
     other than the details relating to specific
     loans and securities in support of comments
     contained in a Peport of Examination. We believe
     our e:  ination workpapers will permit a determin-
     ation that appropriate examination procedures have
     been followed, provide support for the preparation
     of the Report of Examination, and are utilized at
     the next examination."

     FRS said:

     "We believe that, in the vast majority of examations,
     the examination workpapers an   line sheets I spared
     are adequate to meet the Sysco.. : needs.  The
     manner in vhich examination workpapers should be
     prepared and maintained is extensively covered in
     connection with the training of our examiners."

                              '-19
HOW EXAMINATIONS WERE PERFORMED

     Examinations were not conducted very differently by
the three agencies. Those variations which existed resulted
from differences in workload and geographical dispersion
of banks.

     The examination team consisted of one or more examiners
(one of whom was the examiner-in-charge) and one or more
assistant examiners. Upon entering the banes, the examiners
would take control over assets and request certain informa-
tion from the banks' managers, usually through a standard
questionnaire.

     The actual steps followed during the examination were
established at th? discretion of the examiner-in-charge.
He/she concentrated on evaluating loan quality, while other
examiners or assistants counted cash, listed securities,
and administered policy and internal control questionnaries.
Sometimes the various listings and analyses were consoli-
dated by a senior assistant examiner, but the examiner-in-
charge checked his/her staff's work and drafted the report.

     The time taken for an examination depended on several
things: the bank's size, complexity, and condition; the
numb-r cf examiners available; the skill and experience of
the -xaminers; and the number of examinations to be conducted
during a given period. Specific examination times were fr£-
quently based on the time taken for the last examination of
the bank.
     As shown below, the supervisory agencies generally
spent more effort examining large banks than small banks.

                       Avera9eStaffdays for
                 Independent Fede 31 Ex.miinations

                              FDIC                   FRS                  oCC

                       Numter                Number                Number
                         of                    of                    of
                       examina-      Staff   examina-      Staff   examina-     Staff
Bank deos    size       tions        days     tions        days     tions       day

(000,000 omitted)

Over    $ ,000            1           444        -           -       62          932
$500 to $1,000            1           316        1          188      32          300
$101 to   $500           13           170        8          107      51          117
Under     $100           99            28       36           25      55           30



                                      4-20
SPECIFIC AREAS COVERED BY COMMERCIAL EXAMINATIONS

     The agencies' examinations concentrated on several
major areas, such as asset quality, deposits, capital ade-
quacy, compliance, and management. The agencies were doing
essentially the same things in considering each area.

Classification of assets
     An important factor in assessing a br-     s condition was
the quality of its investments and its  locins.   Part of an
examination was to judge the quality of  assets.    The agencies
used three classifications for poor assets--namely (from bad
to worst), "substandard," "doubtful," and "loss." of  These
classifications conform to the "uniform  Agreement      1949,"
signed by the Federal supervisory agencies   and  the National
Association of State Bank Supervisors. The classifications
were the examiner's judgement of the difficulty converting
assets to full cash value at maturity.
     The classifications were used to describe the quality
of the bank's loans, investment securities, real estate
other than bank premises, and other assets.
Review of loans
     The examiners looked for low-quality loans, concen-
trations of credit, insider transactions, and loans out-
side of the bank's normal trading area (this practice was
cf special concern in small banks).
     The     liners did not evaluate the quality of all the
            ..
loans in a bank's portfolio. Generally, the examiner-in-
charge was to review all past-due loans, all loans previous-
ly classified, and all loans of more than a specified amount.
This amount varied according to the size of the bank, total
loans, and the amount of classified loans found in the prev-
ious examination.
     Each loan reviewed was judged on risk, collateral,
character, and financial position of the borrower, and
likelihood of repayment. Loan evaluation depended upon the
examiner's knowledge, judgment, perception, and analytical
technique.

     Cutoff points and percent of loans reviewed varied
from agency to agency and from region to region. We
were told that FDIC examiners tried to review about 75

                               4-21
percent of the examined bank's loan volume. FRS examiners
were to establish a cutoff point based on a percent of
capital (each loan of over 1 to 2 percent was reviewed)
and, we were told, usually covered 75 to 90 percent of
the bank's loan dollar volume. OCC's suggested guide-
lines were:   (1) all loans of at least 0.75 percent of
gross capital were to be reviewed in banks with assets
of less than $25 million and (2) all loans of at least
either 0.5 percent of gross capital or $500,000, whichever
was less, were to be reviewed in banks with assets of
$25 million or more.

      In addition to the adverse classifications, the
agencies had a category for loans which required more
than ordinary management attention--"other loan, espec-
ially mentioned." FDIC also listed loans with which
examiner had found technical difficulties (inadequate the
documentation of collateral, insufficient credit infor-
mation).   PRS listed loans not supported by adequate
credit information. OCC used two exception categories:
(1) collateral exceptions and (2) loans not supported
by current and satisfactory credit information.

     Examiners were to check all loans and securities to
identify instances where the bank depended on the ability
of a single individual, entity, or industry to repay loans.
The examiners were to group together all large direct and
indirect loans to, and purchases of securities from,
(1) individuals and their families and related interests
(2) business entities and their affiliates, and (3) indus-
tries (e.g., agriculture, automobile, real estate). The
examiners were to -eview these concentrations whether or
not the loans or securities were classified or exceeded
the State lending limits.

     The examiners were to review and record all debts
(direct and indirect) owed to the bank by its directors,
officers, and employees, and their interests. Federal and
State laws restrict the amounts of such loans, and the exam-
iners were expected to comment on any loans which violated
these laws. Also, examiners were to criticize any such
loans which they considered large and unwarranted.

     The examiners were to look for and criticize large
amounts of loans to borrowers outside of the bank's normal
trading area.




                            4-22
Evaluation of securities

     The examiners were concerned about at least three fac-
tors affecting securities (stocks and bonds) the banks had
purchased: current value, quality, and maturity. Examiners
Examiners were usually expected to review all securities
using, as guides to quality, ratings provided by various
securities rating services.
     The examiners were to group the bank's securites into
special categories. FDIC used four; FRS used a different
four; OCC tsed seven. The examiners were expected to com-
pare the maLket values for all groups of securities to
their book values. If market value was less than book value,
the amount of the difference ("depreciation") would be
class&fied substandard, doubtful, or loss depending upon
the agency's standards for each group. Generally, the
agencies would not classify either U.S. Government bonds
or bonds which received one of the four highest ratings
of one of the securities rating services.
     The agencies' approach to New York City bonds shows how
different classes of securities were treated by examiners.
In October 1975 the agencies agreed not to classify certain
New York obligations even though a rating service had lowered
their rating. This was done because the agencies believed
that the "unsettled condition" of the market did not reflect
the truie value of the securities. Ordinarily, bonds with
that rating would have been classified as doubtful by the
examiners. In December 1975, FRS modified its position by
suggesting that New York City obligations of less than in-
vestment grade be classified as substandard. OCC similarly
modified its posiLion on New York City bonds in March 1976.
     The examiners were also to see whether the bank's in-
vestment securities would be redeemed at different times to
provide the bank with a steady flow of funds.
Real estat

     The examiners were to review each real estate
holding, other than the bank p.emises, to determine

     -- the reason the property was acquired and the
        plans for disposing of it,



                           4-23
     -- the book value (the cost to acquire the property)
        in relation to the appraised value,
     -- the length of time the property had been held
        and the reasons it had not been sold, and

     -- rental income and maintenance expense.
The examiners were to classify real estate as substandard,
doubtful, or loss if the bank was losing money by main-
taining the property or if the market value of the property
w s less than its book value.

Deposits
     Examiners were to analyze the bank's deposit trends
both in total and by account type--checking, regular savings,
or time (such as Christmas clubs or savings certificates);
public or private funds; individuals, partnerships, and cor-
porations; etc. The time spans covered differed among the
agencies (FDIC looked at a 5-year span, FRS looked at 4
years, OCC looked at 3 years), as did deposit categories,
but the agencies had similar objectives. The examiners
were to analyze deposit trends and distribution in order
to jude the bank's assets (short-versus long-term, low-
versus high-interest), identify changes in its operations,
and identify potential decreases in ready cash.

     The examiners were to look at the sizes of
deposit accounts to identify concentrations of deposits which
might be withdrawn quickly, thus decreasing ready cash. To
identify overreliance on public funds or an entrance into a
new field of operations, the examiners were to analyze the
amount of the bank's deposits which were secured by pledged
assets. It was ccnsidered undesirable for a bank to have an
inordinately high percentage of its assets pledged against a
similarly high percentage of its deposits.

     The examiners also were to analyze in detail the public
funds deposited in the bank. Particular attention was given
to the types of accounts, interest paid, and any special
terms or conditions, The examiner also compared the current
rates of interest paid to the types of accounts. The rates
could have indicated the bank's competitive position.

Borrowing by banks

     FDIC and OCC examiners prepared detailed listings of
loans made to the banks since the previous examination;

                           4-24
FRS examiners summarized the bank's borrowing in the re-
ports of examination. The examiners were interested in
the same things:  the amounts of borrowed funds compared
to the assets and condition of the bank, frequencies and
types of borrowings, borrowings which had not been approved
by the bank's board of directors or which exceeded legal
limits and the likelihood that the sources of loans would
continue to be available. The borrowing practices were
then evaluated in light of the bank's liquidity, capital,
and profits.
Adequacy of capital
     When analyzing the adequacy of a bank's capital,
the examiners calculated a figure for "adjusted capital"--
total capital minus (1) losses and estimated losses on
assets and (2) half of the assets classified as doubtful.
If the resulting figure was less than the amount of capital
stock, the bank's capital was considered impaired. If the
figure was negative, the bank could have been insolvent.

     When adjusted capital exceeded capita. stock, the
examiner was to determine if the bank's capital structure
was below an acceptable level. During the examination,
the examiner would calculate various capital ratios for
the bank. These would be compared to industry and/or
peer group ratios. The results of such comparisons would
indicate whether or not the bank required further analysis.
Other factors considered in the analysis of capital were
asset quality, liquidity, deposit trends and distribution,
borrowings, income, and management. The bank's capital
would not normally be criticized if, in the view of the
examiner or reviewing agency officials, it was sufficient
to support the bank's operations and protect the bank's
depositors. There was no level of capital, either ratio
or absolute amount, deemed minimally acceptable for all
banks or any particular class of banks.
     The agencies indicated that they were studying the con-
cept of industrywide standards for adequate capital. How-
ever, these efforts have not produced standards or more
definitive criteria.  (Case 5 in chapter 8 illustrates this
situation.)  The agencies emphasized that developing indus-
trywide capital standards is extremely difficult and might
even be impossible.




                           4-25
Income and dividends
     The examiners also were to analyze the bank's earn-
ings and dividends to determine whether:
     -- Earnings were sufficient to provide capital to
        accommodate future growth.
     -- Earnings were sufficient to cover current asset
        losses.
     -- Earnings were adequate in relation to the existing
        dividend rate.
     -- The bank was sufficiently managed and operated.
     -- Dividends were consistent with the bank's condition,

     -- Dividends were legal.

     The examiners were to analyze income and changes in
capital using data contained in the bank's annual reports
of income and other records. Specific practices for
neriods covered and sources of data varied among the
akencies.
Liquidity

      Many of the analyses performed by tIe examiners involved
information important for determining the bank's liquidity
position (its ability to fund probable and possible cash
needs without liquidating assets at substantial losses).
Information about such things as maturity and value of
securities, types oi loans, deposit concentrations, forward
commitments, contingent liabilities, and deposit trends
was considered by cte examiner. The examir'r decided
(subject to the review of agency officials) whether or
not the bank's liquidity was adequate based on the above
information and other factors, such as the economy, manage-
ment capability, access to money markets, ind asset quality.
The agencies also had liquidity formulas which they used
as screening devices to indicate which banks warrented
further analysis.




                          4-26
Compliance with banking   laws and regulations

     Examiners were instructed to inspect for violations
of Federal and State laws and regulations.  FDIC and FRS
examiners were to cite violations of State laws in the
reports of examination.

     The laws and regulations enforced through the exam-
ination process varied in importance and concerned lend-
ing practices, including: specific lending limits; secur-
ities and real estate investments; dividends; activities
of directors, officers, and employees; deposits and inter-
est rates; stock registration; affiliations; consumer
protection (see pp. 4-42 to 4-45); and bank security.

Management, management practices,
and internal controls
     Appraising a bank's management was an important part
of the exyami.ation. The examiners were to consider (1) the
bank's condition, (2) its policies and procedures, (3) the
adequacy and quality of its earnings, (4) the relat:on-
ships among individuals and management levels, and (5) pro-
visions for management succession.
     trhe examination was to include analyses of policies
and procedures for

     -- loans,

     -- credit card and credit-check plans,
     -   investments,

     -- internal controls,

     -- outside :nvolvement of the board of directors,
     -- insurance, and
     -- emergencies.




                              4-27
The examiners were to use a questionnaire approach in
identifying and analyzing these policies and procedures.
They were also to review the activities of the board of
directors.
BANKERS' VIEWS ON EXAMINATION COVERAGE

     We asked bankers to indicate (1) what they considered
the five most important objectives of bank examinations
and (2) which five objectives they thought were most impor-
tant to the agencies. (See app. I, pp. I-5 and I-6.) As
shown below, four objectives appear in both lists *of most
frequent answers, though in different order. The bankers
consider the safety of depositors' funds and the quality
of management more important than they thought the agencies
considered it. The agencies' examination policies emphasized
the importance of the evaluation of management, and each
agency's rating system (see ch. 6) included a rating of
management. Yet the bankers had not perceived an evaluation
of management as being one of the agencies' five most
important objectives.

                                                   Bankers'
                                                   view of
                                 Bankers'          agencies'
   Area of examination          priorities        priorities

Safety of depositors' funds          1                 4
Asset quality                        2                 2
Compliance with laws and
  regulations                        3                 1
Quality of management                4                 -
Adequacy of internal controls        5                 5
Adequacy of capital                                    3
     Less than 40 percent of the bankers believed evaluation
of capital adequacy and evaluation of liquidity to be among
the five most important.

     The following tabulation shows that the bankers gener-
ally believed that the examiners were paying enough attention
to the important aspects of examinations.




                            4-28
                              Percent of bankers who felt
                                examiners' attention was
        Area               Too much    Appropriate Too little

Loan assessment               20           77           3
Co..pliance with banking
  laws and regulations       22            74           4
Manaqement assessrelit        8            79          13
Internal control             12            79           9
Capital adequacy             16            81           3




                               4-29
 INTERNATIONAL OPERATIONS EXAMINATIONS

       The agencies' international examinations were
similar to their commercial examinations in objective and
scope. However, the special risks involved in international
loans and the risks and complexities of foreign exchange
transactions required specialized knowledge and procedures.
Thus, the agencies used specialists in international
examinations.

     Domestic banks may maintain branches in foreign coun-
tries or invest in foreign banks or financial institutions.
Today, foreign branches account for most of the inter-
national assets of domestic banks.  Investments in foreign
banks or financial institutions may be direct purchases
of foreign bank stock or "Edge Act" or "agreement" corpora-
tions--domestic corporations which are chartered solely
for foreign banking or financial activities. Most branches
of foreign banks operating in the U.S. are not subject to
FDIC, FRS, or OCC supervision. 1/

     Relatively few domestic banks are engaged in major
international operations. As of December 31, 1975, only
131 of the 5,790 national and State member banks had over-
seas branches and/or foreign subsidiaries. Foreign branches
of the 20 largest banks had almost 92 percent of total
foreign branch assets.

     While international assets as a percentage of total
assets amounted to approximately 15 percent of the banking
industry as a whole, 40 to 50 percent of the assets of
the largest banks were in international operations. For
example, the 30 largest banks in our samples had nearly
$167 billion of foreign assets at their most recent examina-
tions. Of this amount, nearly $81 billion was in loans to
foreign governments, businesses. and individuals. Also;
these banks' international operations are a major source of
income--up to 50 percent in some cases.

       The objectives of international examinations were to
determine the condition of the international departments
and to assess their management. Thus, the international

1/   See "International Banking--a Supplement to a
     Compendium of Papers Prepared for the FINE Study,"
     a staff report for the House Committee on Banking,
     Currency and Housing, May 1976.


                             4-30
examiners, like commercial examiners, evaluated asset
quality, internal controls, policies, and procedures.
     The foreign exchange activities of banks, becaus?
of their special risk, were of major concern to the examiners.
The examiners reviewed the bank's net currency positions and
future commitments to identify potential large losses, eval-
uated the risks involved should customers not fulfill their
parts of the transactions, evaluated the credit of the
bank's trading partners, and evaluated the bank's system
of audit and controls over foreign exchange dealings.

Evaluation   f tor.eign credit

     Foreign loans are more complicated to evaluate than
domestic loans because they are often made in different cur-
rencies and to foreign governments. A special risk (called
country risk) is taken with loans made in different cur-
rencies because the borrower must repay the loan in the
currency borrowed. The borrower's ability to obtain the
appropriate curren-, is affected by the political and
economic stabili7  of the borrower's country, including its
     -- balance of trade and of payments,
     -- Fxport-import trends,

     -- foreign exchange reserves,
     -- overall debt and debt-service rates,

     -- gross national product growth, and
     -- employment and inflation rates.
     FRS and OCC took different approaches to evaluating
loans subject to country risk. These different approaches
caused some banks' loans to be classified differently than
other banks' loans to the same country or foreign business.
     Within FRS, two approaches were taken. In 1976 an
ad hoc committee of senior examiners in the New York FRB
evaluated the country risks and assigned a general classi-
fication to loans to borrowers (including the government)
within some of those countries. All loans to those countries
and their businesses received the classification, unless
the borrower's ability to obtain the repayment currency
was independent of the country's stability or the loan
was made in the local currency. A loan in a local currency
was judged according to the borrower's financial condition.
                                 4-31
     At the other FRBs, foreign loans were evaluated
individually. This approach led to inconsistent classi-
fications within the FRS. For example, a loan to one
country was classified by San Francisco examiners, while
examiners from FPBs of New York, Philadelphia, and Rich-
mond did nct classify loans to the same country. Similarly,
examiners from the FRBs of Boston, Chicago, and San
Francisco criticized loans to another country, but New
York examiners did not. As a r:'sult, some State -member
banks may have received more supervisory attention than
others in different locations, even though they had similar
loans subject to the same risks.


     In 1974, OCC set up a committee for evaluating country
risk. Each quarter senior international examiners from
headquarters and the Chicago, New York, and San Francisco
offices met to evaluate the risk involved in, and assign
classifications to, certain loans to certain countries. The
loans classified were those for which repayment was as much
dependent on the borrower's ability to obtain the appropriate
repayment currency as on the borrower's financial condition.
The committee classified these loans by using information
from major banks' research dparments and Government sources
available to it. The classifications arrived at by tne
committee were then used throughout OCC for loans to these
countries.

      The New York FRB and OCC thus both used "committee"
systems; but with, different results. In July 1976 the
Reserve bank's committee and OCC's committee each developed
ratings for loans to foreign countries. While the OCC
   mmittLe concluded that certain loans to five countries
g..ould be classified as substandard, the New York FRB
assigned the substandard classification to loans of only
o,ie of them. Neither committee classified loans to any
other countries. As a result, one bank may have been
subject to more supervisory attention and pressure than
another even though their loans were similar.

     Conclusion

      Using three country risk evaluation methods has resulted
in different treatment of the banks that FRS and OCC super-
vise, Further, the method used by the FRBs depends on
 .ndividual examiners keeping abreast of economic conditions
 a many countries and being able to judge loans in many



                            4-32
countries. A te.m of experts who evaluate economic condi-
tions in each codntry should produce more accurate and
consistent results than numerous individuals who evalu-
ate loans case by case.
     Recommendation

     We recommend that the Board of Governors, FRS, and the
Comptroller of the Currency, using all available informatiot,
develop and use a single approach to classify loans subject
to country risk.
     Agency comments
     FRS said:

      'The evaluation of the country risk element in inter-
     national loans calls for difficult analysis and judg-
     ment a. the time lines of credit are established or
     loans extended since "country risk" involves an
     estimate of a country's political, economic, and
     social fortunes over the life of the loan as they
     may affect the collectability of such loans. There
     is serious question as to the validity of generalized
     characterizations of credits based on the country
     of residency of the borrower, particularly where
     the characteristics of the credit may well vary with
     the borrower - private or governmental - as well as
     the nature and extent of external resources avail-
     able to support the loan. For a number of months now,
     the Federal Reserve has had underway a review of
     country risk problems in international lending as
     well as appropriate supervisory treatment of the
     problem. This review has included an on-going ap-
     praisal of the system employed by th2 Comptroiler
     of the Currency. In this regard, we believe that,
     while there may be general agreement on the desir-
     ability of of uniform evaluation of the country
     risk element in individual interrational credits,
     there is a real question as to the desirability
     of rating individual countries. It might be noted,
     for instance, that the ComptrollerCs system focuses
     almost exclusively on credits to individual govern-
     ments. In any event, we believe that we should
     strive toward uniform treatment. Of course, as with
     respect to many of the recommendations, the Federal
     Bank Examination Council proposal would accomplish
     this."'


                           4-33
      OCC said:
      EThe OCC has a well established procedure using
      single approach to the classification of country a
      credits. This procedure makes use of information
      from many governmental and non-governmental sources
      and examiners in all fourteen national bank
      regions.
      "Copies of the minutes of our committee meetings
      any resulting classifications have always been   and
      provided to members of the staff of the Board
      of Governors.
      "The process of country risk evaluation is more
      precisely an art than a science. Most of the
      evaluation process is judgmental.  However, the
      interagency meetings held to date have been
      beneficial in determining basic differences in
      philosophies."
Onsite versus home office examinations
of foreign branches and subsidiar ie s
     FRS and OCC conducted international examinations
home affi.e of the bank or the Edge Act corporation    at the
                                                     and
at the foreign branch or subsidiary. The examiners
evaluated foreign loans from information at the      usually
of the parent bank or corporation.              home  office

     We reviewed examination reports on 18 national
                                                     banks
and 12 State member banks with substantial international
operations. A high percentage rf classified loans,
                                                     inadequate
controls over foreign exchlange operations, and inadequate
overall internal controls were the most prevblent
                                                   problems
found in those banks' international operations.

      FRS examiners stated that two of the State
banks were experiencing some problems which were member
                                                   related
to subsidiaries of the banks' Edge Act corporations.
banks' Edge Act corporations had been examined           Both
                                                by  FRS
before the problems were noted in the banks. However,
examiners of both had said the information available       the
their home offices was inadequate. The subsidiaries     at
                                                       were
not examined onsite until after the banks had begun
experiencing problems.




                            4-34
    Conclusion

     We believe that these subsidiaries should have been
examined onsite as soon as possible, once the home office
files were found inadequate. Early onsite examinations
of the subsidiaries might have disclosed their problems
before parent banks were injured.

     The supervisory agencies are sometimes prohibited or
restricted by foreign laws from making onsite examinations
of domestic banks' foreign branches and subsidiaries.
     Recommendations

     We recommend that the Board of Governors, FRS, and the
Comptroller of the Currency implement proced' .s to examine
(where permitted by the country involved) major foreign
branches and subsidiaries, including subsidiaries of
Edge Act corporations, onsite--periodically and whenever
adequate information about their activities is not available
at the home office.
     Also, we recommend that the Board of Governors, FRS,
and the Comptroller of the Currency utilize each others'
examiners to cut expenses when conducting examinations in
foreign countries.

     Agency comments

     FRS said:

     "The development of widespread networks of foreign
     branches and subsidiaries by the major banks has
     brought the question of the supervision of the
     banks' international operations to the forefront
     in recent years. We concur with the principle
     that examinations, wherever conducted, should
     be adequate to provide the necessary supervisory
     information. However, one constraint with which
     the Board has had to deal is, as noted in the
     report, that, in many cases examinations of foreign
     subsidiaries are not possible because of host
     country laws which preclude direct examinations
     by other governmental authorities of banks char-
     tered in those countries regardless of the owner-
     ship. The System has not only required that
     banks maintain records at the head office adequate
     to appraise the risk and exposure of the banks


                           4-35
 through their foreign operations, but the System
 has also provided for direct visitations of examiners
 to major foreign branches in those cases where
 visitations have been legally possible.        such

 "The Board believes that, on the whole, this system
 has worked well. The information available at
 head offices has, in general, been adequate to
 assure that the banks were not unduly exposed to
 loss or serious financial difficulties. At the
 same time, there has been a continual search for
 better and more efficient ways of satisfying the
 Federal Reserve's supervisory responsibilities
 in the international field.
 "Beginning in the fall of 1976, onsite examina-
 tions were made of foreign branches of State
 member banks where we had previously utilized on-
 site inspections by State examiners or informa-
 tion at the head office. Moreover, a number of
 foreign subsidiaries were directly examined for
the first time with the agreement of the host
government. A full evaluation of those examina-
tions has not yet been completed. One preliminary
result of that exercise Las been to provide assur-
ance that a large portion of the material needed
for proper supervision of foreign branches and
subsidiaries is in the management information
systems at head offices. In this connection,
it should be noted that consultations are con-
tinuing with foreign bank supervisory authorities
about the ways in which access to foreign sub-
sidiaries may be broadened to accommodate onsite
reviews. These consultations are part of a wider
effort of international cooperation in bank
supervision."

Regarding onsite examinations OCC said:
"National Banks are required by Regulations K &
                                                 M
to provide examiners with whatever credit and
financial information the examiner deems necessary
to evaluate the condition of the bank's foreign
branches and subsidiaries. Those regulations
                                               re-
quire such information be transmitted to and main-
tained at the baink's head office. The OCC has
f r practical purposes defined "head office" to
.zaclude any foreign or domestic office of the bank


                      4-36
which is readily accessible to its examiners.
For example, all international credits of one
large national bank are examined from two domestic
offices and four foreign offices located in
London, Caracas, Tokyo and Manila. All of
that bank's many branches and subsidiaries
located in E rope, the Middle East and Africa
are examined from duplicate records in London.
"Supplemental examinations to determine the
quality of the bank's operations are made onsite
overseas when necessary. For purposes of per-
forming asset and operational examinations,
the OCC established in 1972 a London office
permanently staffed by six examiners.    In ful-
filling its overseas examination obligations,
the OCC in 1976 examined 141 overseas branches
and subsidiaries of 25 banks located in 37
countries; 154 onsite examinations were per-
formned by 215 National Bank Examiners."

Regarding joint overseas examinations, OCC said:
"The GAO recommendation has merit. As a bare
minimum the physical support of the three agencies
could be jointly provided. F..rther arrangements
could be made so that any of the agencies could
jointly commission overseas examiners. In this
regard, the OCC is willing to seek a cooperative
solution with our sister agencies.

"Under present statutes, however, such a sharing
of examiner forces may be difficult. Section 481
of Title 12 (12 U.S.C. 481) directs the Comptroller
of the Currency to appoint examiners who shall
examine every national bank. That same section
empowers the Comptrolle .o make a thorough ex-
amination of all the affairs of the banks under
his jurisdiction including the affairs of all
affiliates of National banks 'other than member
banks',   in order to disclose fully the relations
between the bank and its affiliates and the
'effect of such relations upon the affairs of such
bank'.   (Emphasis added.)"




                      4-37
ELECTRONIC   DATA PROCESSING EXAMINATIONS
     Over 85 percent of the country's banks use computers
to process accounting and financial records. At some banks,
computers support every operation. The agencies devote
special attention to electronic data processing (EDP)
operations (whether carried out by the banks or contracted)
because

     -- the accuracy of management and accounting reports
        depends on EDP,

     -- the bank's ability to function might depend on
        the continued operation of EDP, and
     -- the bank could be vulnerable to large embezzlements
        through computer fraud.

     Banks are beginning to use more advanced computer
operations, such as computer audio response systems, online
account changes, automatic payment and deposit procedures,
and electronic funds transfer. To keep pace, the agencies
will hare to devote even more attention to EDP operations
and increase the expertise of their staffs.

      Many banks did not have enough data processing activity
to justify buying a computer. To meet their data processing
needs, these banks contracted with service centers, which
frequently specialize in standard programs that can be used
by similar customers. Examinations of such service centers
were generally the same in scope as examinations of
banks' in-house EDP departments.

     Although each agency had an "EDP handbook," or stand-
ardized examination procedures manual, prepared by its
Washington headquarters, the scope of each EDP examination
was determined at the regional level. Examination procedures
at the three agencies emphasized a questionnaire approach.


     The time and staff allotted to an EDP examination de-
pended on the size of the bank, its degree of automation,
and the availability of qualified examiners. The average
time spent on an examination varied from agency to agency
and region to region.

     TIe OCC and FDIC examination reports had various ques-
tioLnnaires on EDP and a comment section summarizing EDP


                             4-38
matters requiring management attention. The FRS examina-
tion report asked for similar information, but the
questions were to be answered in narrative, rather than by
l']es" or "no."
     The examination reports of all three agencies contained
more information than required to tell bank managers
of the need for corrective action. The banks received all
questionnaires answered during the examination, whether
a deficiency was disclosed or not.
Conclusion

     In our view the EDP examination report, like the com-
mercial examination report, should contain the deficiencies
noted by the examiner and any necessary supporting information.
     OCC is developing new procedures for EDP examinations
which should result in a streamlined examination report.
Recommendation
     We recommend that the Board of Directors, FDIC, and the
Board of Governors, FRS develop reports of examinations for
EDP operations which present the problems found, corrective
action needed and any necessary explanatory data in a clear
and concise manner.

Agency comments
     FDIC stated:
     "The summary comments page of the FDIC EDP question-
     naire provides clear and concise descriptions of the
     results of a data center evaluation.  In our judg-
     ment, a new evaluation report is not necessary at
     this time and our form, if effectively used, is
     comparable to the new one recently adopted by the
     OCC.  However, we view our questionnaire as a
     constantly evolving tool which will be revised
     frequently in order to stay abreast of industry
     developments and to meet the burgeoning needs of
     our field personnel. See also our comments re-
     garding EDP evaluation reports included with our
     general comments."




                           4-39
      FRS said:

     "The Board wishes to note that it believes its
     present EDP examination report adequately pre-
     sents the major problems found and corrective
     action needed. Furthermore, the System has
     already undertaken a review of EDP examination
     procedures to determine whether there are
     possible improvements, particularly in the
     review of internal controls, and, in con-
     nection with that review, is preparing a
     revised examination report."
TRUST DEPARTMENT EXAMINATIONS
      Banks operate trust departments to control or manage
clIstoaers' money or property at their request. The agencies
have developed special trust examination techniques to
focus on two issues:

     -- Is the trust department complying with laws and
        with individual trust agreements?
     -- Is the trust department managed so the bank does
        not incur any major liabilities?
     We reviewed (1) the agencies' trust examination policies
and procedures and (2) examination reports on 30 trust depart-
ments. We learned that:

     -- The agencies' policies and procedures were similar.

     -- Their examination reports differed only in format.
     -- They used different trust department rating systems,
        all of which emphasized the examiner's judgment.
COMPLIANCE WITH CONSUMER PROTECTION LAWS

     The Congress has enacted several laws to protect
consumers. Certain of these laws affect banks' lending
practices, efforts to attract depositors, and billing
discrepancies. The agencies are responsible for enforcing
these provisions.




                           4-40
How violations are discovered

     The agencies learn of violations through consumer com-
plaints and bank examinations. Each agency defines the handl-
ing of consumer complaints as a major function of its con-
sumer affairs effort. Both FDIC and OCC keep computerized
records of consumer complaints and their disposition. FRS
records consumer complaints on a card filing system, and
each FRB handles complaints in its district. Each agency
processes hundreds of complaints and inquiries each year.

     Until recently, all three agencies reviewed consumer
credit as part of their regular commercial examinations.
FDIC adopted separate compliance reports and consumer credit
reviews in September 1974. In the most recent examinations
of banks in our general sample, FDIC examiners cited viola-
tions of consumer credit and truth-in-lending regulations
more often than did FRS and OCC examiners.

                                   Percent of banks in which
                                   violations were found bv
       Law or regulation             FDIC     FRS      OCC
Credit discrimination (regulation B) 3         1        -
Truth-in-lending (regulation Z)     29        17       14

Unaggressive examinations

     Consumer advocates have frequently complained that
bank regulators have been deficient in their enforcement
of truth-in-lending provisions (regulation Z) and other
regulations. Although consumer credit compliance was
being reviewed, agency officials acknowledged that examin-
ations in this area had not been penetrating. Both
consumer protection organizations and the agencies agreed
that the consumer credit regulations are complex and,
therefore, difficult to comply with or enforce. Officials
of each agency stated that most complaints are technical
problems resulting from a lack of understanding of the
regulations by both banker and consumer.




                            4-41
     In addition, some agency representatives pointed out
the poteniL-al conflict between a bank's objective of finan-
cial soundness and strict compliance with consumer credit
laws. For example, the financial soundness of a bank may
depend upon its lending selectivity. This selectivity could
violate consumer credit laws if the criteria used discrimin-
ate illegally. Also, consumer credit violations disclosed
by examiners may stimulate consumer lawsuits which force
banks to pay large settlements.

     Since September 1974, FDIC has used consumer credit
compliance reports which contained questions concerning
consumer credit practices. The current report consists
of four pages entitled "Truth-in-Lending--Fair Credit
Billing," "Fair Credit Reportinc Act," "Advertising of
Interest or Dividends on Deposits," and "Equal Credit Oppor-
tunity." Each question required a yes or no response, and
each page allowed space for comments.

     FRS was reviewing consumer credit laws as part ot
the regular commercial examination. Several general ques-
tions in the regular report of examination referred to
consumer credit laws; however, there was no evidence of
the type or extent of testing done for consumer credit
compliance.
     The OCC review of consumer credit laws was also included
in the regular commercial examination. A truth-in-lending
disclosure checklist of 22 items for review was used; however,
forms were not provided for other consumer credit laws.

     The forms used by the agencies for reporting on banks'
consumer credit compliance:

    -- Did not require specific enough information as to
       the extent of noncompliance in cases of possible
       or probable violation.
    -- Did not ask about lawsuits, other civil claims,
       or pending prosecution.
    -- Left the real questions of compliance up to the
       individual examiner.
     Discovery of violation, depended on the examiner's
familiarity with the regulations and persistence in asking




                           4-42
questions. However, compliance training for examiners has
been limited and inconsistent. Examiner training in consumer
credit regulations, according to agency officials, has
varied from 2 hours at OCC to 10 hours at FDIC and 'RS.
Officials at all three agencies acknowledge that training
has not emphasized examining for consumer credit law com-
pliance other than with regulation Z.

Action on violations
     The agencies investigated each complaint.  If they
found it valid, they notified the complainant and the
offending bank. The agencies did not publicly disclose the
violation. When a violation was discovered during an examin-
ation, the agency informed bank managers in meetings and
in the examination report. The agencies have statutory
authority to issue cease and desist orders (see ch. 8)
for persistent violations of consumer protection laws and
regulations.
Coiiclusions

     The agencies were not devoting enough attention to
monitoring banks' compliance with consumer protection laws
and regulations.  Their procedures were not sufficiently
comprehensive or detailed. Thus, they relied heavily upon
the individual examiners to find violations; yet examiner
training was Insufficient. The agencies have started
new programs to improve their approaches, including more
comprehensive procedures, specialized training, and special-
ized examination staffs.  (See ch. 7.)
BANK AFFILIATION WITH HOLDING COMPANIES
     Bank holding companies are those which own or control
one or more banks. They are a major element in the American
banking system, owning or controlling one-fourth of all
commercial banks in America which control two-thirds of
all assets and deposits.
     A holding company may be a source of financial and mana-
gerial strength to its affiliated bank or banks, or it may
be a scurce of weakness. In 1956 the Congress passed the Bank
Holding C'ompany Act to control the concentration of financ,e.
resources, and preserve effective competiton. FRS was
assigned responsibility for supervising and regulating
bank holding companies.



                           4-43
Some holding companies caused
problems for subsidiary banks
     The agencies' examiners were expected to review banks'
relationships with their affiliates, including holding
companies, and to criticize any relationship which could
cause or was causing problems for the banks. Examiners said
that 72 of the 344 banks in our samples which were affiliated
with holding companies had problems resulting from that
affiliation. According to the examination reports for 50
of these banks, holding company management was not the
primary cause of the problems. However, for the remaining
22 banks, 20 holding companies' actions were causing the
problems.

     According to the examination reports for these 22 banks,
problems were caused by inept and ineffective holding
company management--particularly overexpansion4 unsound
operations of nonbank subsidiaries, and real estate loans
which were unpaid. Holding company actions which harmed
subsidiary banks were
      -- transferring loans between subsidiaries and charging
         excessive management fees and dividends to

            (1) offset weaknesses in nonbank subsidiaries.
                particularly mortgage subsidiaries with weak
                real estate loan portfolios (nine holding
                companies), or

            (2) repay loans for either expansion or additional
                subsidiary bank capital (seven companies);
      -- excessive investment in bank quarters (one company);

      -- insisting that a bank make real estate loans which
         were subsequently classified as risky (one company);
      -- self-dealing and engaging in various unsound
         banking practices (one company); and

      --fraud (one company).
Unsound holding companies'
2_xansion     applications approved
     Through December 1975, FRS approved applications by
15 of the 20 detrimental holding companies to acquire


                               4-44
additional banking and nonbanking subsidiaries. Such acqui-
sition contributed to problems in two subsidiary banks.  In
1972, FRS approved six of seven applications for purchases
by one holding company with inadequate capital. Serious
problems in the company's lead bank were noted 2 years
later. According to examiners, by the end of 1975 the hold-
ing company and its banks were in hazardous capital
positions.

     Another holding company's applications to acquire addi-
tional subsidiary banks were approved b-t FRS, despite serious
asset problems in one of its subsidiaries. Recently the hold-
ing company went bankrupt and its lead .Tank failed. (See
case on p. 4-41.)

FRS surveillance and inspection _clicies
     Bank holding companies are supervised by FRBs, with the
Division of Bank Supervision and Regulaeion providing general
policy guidance and oversight from FRS Headquarters.

     In 1972, FRS developed a surveillance system
to identify and monitor actual and potential problems
by gathering and analyzing information. The system consists
of

     -- reviews of examination reports on holding-company-
        affiliated banks, whether national, State member, or
        State nonmember,
     -- reviews of holding companies' registration state-
        ments, annual reports, applications, and other
        financial information, and
     -- visits to holding companies to review records and
        operations.
The aim of these activities is to insure that bank
holding companies are operated in a manner that does not
jeopardize subsidiary banks.
Review of financial data

     Reserve bank surveillance rctivity focuses on analyzing
information on each holding company and its banking and
nonbanking subsidiaries.




                           4-45
     All bank holding companies are required to report annu-
ally, and the larger companies must also file quarterly and
annual supplementary data. Annual reports are due nout later
than 3 months after the end of a holding company's fiscal
year, but the Reserve Board will grant an extension. FRB
personnel are supposed to study these reports in depth and
appraise the holdingcompanies' conditions in detail. Reserve
bank staff also review registration statements; applications
and related memorandums; bank examination reports by FRS,
OCC, FDIC, and State bank supervisors; Securities and Ex-
change Commission annual (10K) reports; and all correspon-
dence. Also, FRB officers frequently contact holding company
managers, who yield useful information.

     According to FRS officials, they monitor those holding
company activities that are most likely to place a bank in
a difficult financial position. such as loans and other
extensions of credit; capital adequacy, including debt equity,
liquidity, and cash flow; nonbank subsidiary earnings; and
intracompany transactions, including dividends and management
fees. They are specifically concerned with those holding
companies, subsidiaries, and affiliates which engage in
leveraging activities, such as mortgage banking, consumer
financing, and leasing.

     Reserve Board officials believe that the information
presently gathered, both oral and written, allows early
identification and monitoring of problems that otherwise
would come to FRS' attention only after they affected the
banks. We found only one instance where the review of finan-
cial data disclosed a problem before it was found by a bank
exmination.

Cnsite inspection
     FRS inspection guidelines state that the frequency
and scope of holding company inspections should depend not
only on the holding compary's size and complexity but also
on information gained from other sources, such as
registration statements, annual reports, and particularly
examination reports on the company's subsidiary banks.

     According to responsible officials, of the 12 Reserve
banks:
    -- 9 have no written guidelines detailing the scope
       of inspections;



                           4-46
    -- 5 do not evaluate nonbank subsidiaries' assets;

     --3 perform limited evaluations of nonbank subsidiaries;
     --4 do not meet with holding company boards of
       directors to discuss findings;
     --2 do not submit inspection reports to holding
       company managers or directors; and
     --7 restrict supervisory activities, including
       inspections, due to bucgetary restraints which pre-
       clude hiring additional personnel.

Time spent on inspections

     The average time for an inspection by each Reserve bank
ranged from about 4 staff-days to about 150 staff-days.
Some of the variance can be attributed to differences in
the average size of holding companies supervised by each
FRB.

     Many of the FRBs did not begin formal holding company
inspection programs until 1974. FRBs had made 527 inspec-
tions through Decembe. 1975, as follows:

                  Number of             Percent of all
     Year         inspections           holding companies

     1971             13                       1
     1972             69                       5
     1973             89                       6
     1974            128                       8
     1975            228                      13

     Three FRBs made approximately 55 percent of these in-
spections. Six others together accounted for only about
20 percent. One of these made only six inspections in this
5-year period.
Holdingcompany inspections
did not discover weaknesses

       FRS did not detect weaknesses in 15 of the 20 holding
cumpanies until after they had damaged subsidiary banks.
Problem in the 20 holding companies were first identified by



                              4-47
     -- examinations of subsidiary banks of 15 companies,

     -- the review of financial data of 1 company,

     -- 2 simultaneous bank examinations and holding company
        inspections, and
     -- inspection of 2 holding companies.

     Nine of the 20 holding companies had not been inspected
before problems appeared in their banking subsidiaries.
Seven holding companies had been inspected before problems
were found in the banks, but these inspections did not dis-
cover the potential for problems. Four of the seven had last
been inspected 1 to 2 years before the problems were identi-
fied in the banks. In one case the inspection was confined
to a review of the holding company's financial data. The
remaining two inspections occurred less than 3 months before
the bank examinations that identified the problems. The
fallowing case illustrates how FRS inspections failed to
disclose problems.

    The bank became a subsidiary of a multibank holding
    company in the late 1960's. The holding company oper-
    ated several banks and had other subsidiaries engaged
    in real estate, data processing, mortgage banking, life
    insurance, factoring, and loan servicing. The principal
    nonbank subsidiary was a mortgage corporation.

    The bank failed because of numerous deteriorating real
    estate loans associated with the mortgage company. The
    bank participated heavily in these loans, which were
    arranged by officials who controlled both the holding
    company and the bank. In fact, some decisions regarding
    the bank's operations were made by personnel who worked,
    not for the bank, but for the holding company.

    FRS inspected the holding company 4 years after it
    acquired the bank, but no problems were noted. In
    bank examination repcrts issued 1 month before and
    7 months after the holding company inspection OCC
    examiners criticized loan participaticrs purchased
    by the bank from the mortgage subsidiary. However,
    on both occasions, the exleminers considered the bank's
    financial condition and management good, and the bank
    received the highest composite rating possible (a "1"
    rating).



                          4-48
    Noting that the condition of the holding company and
    its subsidiaries was "generally satisfactory," FRS
    issued application approval orders the year follow-
    ing its inspection, authorizing the holding company
    to acquire other banks. A later FRS memorandum noted,
    "At the time of each of these Orders there was
    apparently no evidence available that problems were
    developing in [the] mortgage subsidiary."

    Thirteen months after the inspection, FRS conducted
    a special investigation of the holding uompany and
    its mortgage subsidiary. The investigation had been
    prompted by a large increase in short term borrowings
    by the holding company. The resulting report noted
    substantial asset problems in the mortgage subsidiary
    which were causing a highly leveraged position foL
    the holding company. The report stated,
          "of primary concern to the Reserve Bank is
           the increasing dependency of [the holding
           companyl on [the bank] for financial support
           to mset the demand of the mortgage corporation
           and the resulting financial strain placed
           on [the bank] by such demands."

    The report was provided to the OCC regional
    administrator.

    The OCC examination of the bank 2 months after the
    FRS investigation disclosed that mortgage loans had
    severely deteriorated. The examiners considered the
    condition of the bank and its management poor, and
    assigned the lowest composite rating possible, a "4."
    The bank never recovered.

Reserve Board oversight of FRBs' holding
company survillanceand Inspection activities
     The Division of Bank Supervision and Regulation re-
ceived data from the FRBs on specific holding companies,
and Division personnel were in frequent contact with FRB
employees. However, Division employees did not completely
monitor FRB supervisory activities. For instance, they had
no system, such as status reports, to keep track of the
number of holding companies inspected and to insure that
all holding companies with closely monitored subsidiary banks
cr leveraging nonbanking subsidiaries had been inspected.


                           4-49
Interagency coordination
     The agencies exchanged information on holding company
matters at both headquarters and regional levels. FDIC
and CCC provided the FRBs with copies of their examination
reports on banks affiliated with holding companies. The FRBs
gave their holding company inspection reports to FDIC and
OCC.
     A March 1975 bulletin requires OCC regional offices to
promptly notify, in writing, the appropriate FRB whenever
their examination reveals an unsatisfactory or deteriorating
condition in a bank affiliated with a holding company. FRB
officials said they usually received oral but not written
notices from OCC of significant bank problems.

     FDIC examiners can inspect parent holding companies
of State nonmember banks. Such inspections, however, are
not often made.

     Holding companies are also inspected by OCC personnel,
who arte authorized to review the operations and condition
of organizations connected with national banks. OCC examiners
can inspect parent holding companies and nonbank affiliates
in conjunction with bank examinations when they need to
consider the interaction which occurs. However, an OCC
official said such inspections are rare.
     T.le agencies did not normally conduct simul'aneous hold-
ing company inspections and bank examinations, even when the
main subsidiary of the holding company was a national or
State nonmember bank.

Conclusions

     For the cases we reviewed, the FRS holding company sur-
veillance by financial analysis and limited onsite inspec-
tion did not discover problems in the holding companies or
their nonbanking subsidiaries before those problems affected
the affiliate& banks. FRS should be attempting to identify
and correct holding company problems before the banks are
affected. And we believe that more frequent indepth inspec-
tions of holding companies would enable FRS to do so.




                           4-50
     Because it has provided no systematic procedural guide-
lines or standard inspection report and does not evaluate
holding company inspection units, the Reserve board cannot
be sure that holding companies are effectively and consis-
tently supervised.

      We consider the exchange of information among the
agencies especially important to the supervision of bank
holding companies. The problems encountered by holding
companies and their nonbank subsidiaries could threaten
the soundness of affiliated banks and vice versa; thus,
the appropriate supervisory agency should be aware of any
problems. We believe that the channels of communication
shiould be as formal as possible and that information should
be exchanged regularly. Also, we see some merit in the pos-
sibilities of simultaneously inspecting holding companies
and examining their subsidiaries--which would require
greater interagency coordination and cooperation than now
exists. (See ch. 11.)

Recommendation

     We recommend that the Board of Governors, FRS, implement
a system of supervision which is based on onsite inspections
of holding companies and their major nonbanking subsidiaries.
We also recommend that the Board strengthen its oversight
of Reserve banks' holding company supervision by establishing

     -- a systemwide manual of inspectior    procedures,
     --;   standard inspection report, and

     -- periodic onsite evaluations of Reserve bank supervi-
        sory activities.

Agency comments
     FRS said:
     "The System has for some time condjcted on-site in-
     spections of selected holding companies. Partly as
     a result of these inspections and problems which
     came to its attention, the Board in late 1974 re-
     quested and was granted 'egislative authority to
     impose the same supervisory remedies on holding com-
     panies that were applicable to banks under the Fin-
     ancial Institutions Supervisory Act of 1966. In
     early 1976, the Board directed that this inspection

                             4-51
program be significantly expanded with initial
efforts directed toward holding companies requiring
special supervisory attention.

"In addition, in 1975 the Board commenced work on
a computer based monitoring system in order to
identify those holding companies which might
require special attention. This program is parti-
ally operational at the present time and is expected
to be fully operable within the next few months.

"A manua&. of inspection procedures is currently
under development. However, completion of such
a manual has of necessity awaited experience
gained from the direct on-site inspections whi.h
have been caLried out. We believe that the
recommendations relating to a standardized inspec-
tion report as well as periodic on-site evaluations
of Reserve Banks supervisory activities warrant
further consideration. We might note that the
initial steps to set up such periodic evaluations
already have been commenced by the Board.

"While we see no difficulty with the thrust of the
recommendations, the Board is concerned that the
method used in the GAO report may lead to unwar-
rarted fears as to the general health of bank
holding companies. The sample chosen was one in
which problem banks were at least six time more
likely to occur than in the industry as a whole.
A sample biased toward problem banks is naturally
biased toward problem holding companies."




                      4-52
                         CHAPTER 5

           BANK PROBLEMS IDENTIFIED BY EXAMINATIONS

                                                      Page


Overview                                              5- 1

What problems did examinations disclose?              5- 3

What types of problems cause the agencies to put
  banks on the problem list?                          5- 3

Do examiners find the same problems in large and
  small banks?                                        5- 5

Do the agencies generally identify the same types
  of problems?                                        5- 6

Do examiners criticize the causes of problems?        5- 8

Are insider and out-of-territory loans signifi-
  cant problems in banks?                             5-10

What violations of laws and regulations are found
  by examiners?                                       5-10

What problems do holding companies cause in banks?    5-12

What problems were found in banks' international
  operations?                                         5-13
                         CHAPTER 5
           BANK PROBLEMS IDENTIFIED BY EXAMINATIONS


OVERVIEW

      Examiners found problems in nearly all of the
in our samples including those not on the agencies' banks
lists. The most frequently found problems were       problem
                                                 similar
among the banks in our general and problem samples.
degree of severity for problems related to loan      The
                                                 concentra-
tions, liquidity, loan policy, and capital adequacy
fered dramatically between problem banks and         dif-
                                              banks in
general. Also, banks with liquidity, loan collateral,
management or insider loan problems--whether
not--in addition to more common problems were severe or
                                               likely to
be problem banks.

     Banks of different sizes had different problems.
Large banks were more often criticiz(  for problems related
to the character of their busiress (classified
sive real estate holdings) whercas smaller banksloans, exces-
                                                  were most
often criticized for problems related to prccedures
operations (inadequate credit files, poor collection and
procedures).
     For banks in general and, to a lesser degree,
                                                   for
problem banks, FDIC examiners cited problems
                                             more often
than FRS or OCC examiners.

     Surprisingly, far fewer banks were
tive management than were criticized for cited for ineffec-
                                          the related pro-
blems of inadequate internal routines and controls
violations of laws and regulations:                 and

    -- Four percent of the banks in general were cited
       for ineffective management; 55 percent, for
       lations of lawis and regulations though some vio-
                                                    of
       these are of a technical nature and did not
       impair the soundness of the banks; and 44 percent,
       for inadequate rountines and controls.




                            5-1
    -- Sixteen percent of the problem banks were cited
       for ineffective management; 81 percent, for
       violations of laws and regulations; and 55
       percent, for inadequate routines and controls.

     The agencies rarely criticized a bank's loan poli-
cies until loan problems developed. For example, if a
bank's managers had not adequately diversified the bank's
risks, examiners did not criticize the inadequate diver-
silication policy until those lines of credit actually
became classified. Insider ani ^'mt-of-territory lending
were not frequently mentioned proble:;, for banks in our
samples,




                             5-2
WHAT PROBLEMS DID EXAMINATIONS DISCLOSE?

     Examiners found some type of problem in virtually
all banks in our samples. The types and severity of problems
varied from bank to bank and among various groups of banks.
In the most recent reports of examination for the 600 banks
in our general sample, examiners cited the problems listc-3
below for at least 10 percent of the banks.

                                              Percent of
                                             sample banks
Classified loans                                  70
Violations of laws and regulations                55
Inadequate routines and controls                  44
Overdue loans                                     35
Inadequate credit files                           32
Inadequate capital                                21
Concentration of credit                           21
Loan collection procedures                        15
Classified assets                                 14
Inadequate loan policy                            12
Excessive real estate holdings                    12
     Over half of the frequently cited problems involved
the banks' loan quality and credit procedures. Examiners
stated that 61 percent of the problems with overdue loans
and 49 percent of the problems with classified loans
were severe. They also stated that no more than 25 percent
of the other problems were severe in the cases in which
they were cited.

WHAT TYPES OF PROBLEMS CAUSE THE
AGENCIES TO PUT BANKS ON THE PROBLEM LIST?
     As shown by the following chart, the problems found in
10 percent or more of the problem banks closely resembled
those cited for banks in general.




                             5-3
                                             Percent of
                                            sample banks
                                              (note a)
Classified loans                                  96
Violations of laws and regulations                81
Overdue loans                                     65
Inadequate credit files                           57
Inadequate routines and controls                  55
Inadequate capital                                53
Inadequate loan policy                            53
Loan collection procedures                        40
Liquidity                                         40
Concentration of credit                           31
Classified assets                                 28
Inadequate collateral documentation               27
Excessive rezV estate holdings                    20
Management effectiveness                          16
Insider loans                                     11

a/Based on information in second earliest reports of examina-
  tion for those banks selected from lists of problem banks
  as of December 31, 1975.
     These problems were cited for a larger portion of
the problem banks than the banks in general. Seven prob-
lems were cited for over 50 percent of the problem banks;
whereas, two problems were cited for more than lalf the
general sample. Therefore, the number of problc J found
in a bank is related to whether it receives sr cial
supervisory attention.

     To a lesser extent, the type of problems found in
problem banks were different than those of banks in general.
In addition to the problems cited above, inadequate liquidity,
inadequate collateral documentation, ineffective management,
and excessive insider loans were criticized in at least
10 percent of the problem banks. No problems were cited
in at least 10 percent of general sample banks which were
not also cited for problem sample banks.

     Using the examiners' descriptions of the problems
in the examination reports, we ranked the apparent severity
of the problems. Except for violations of laws and regu-
lations, internal routines and controls, real estate holdings,
and collateral for loans, the examiners clearly cited problem


                             5-4
banks' problems as being severe more often than those of
banks in general. As shown below, the difference in severity
for certain problems between banks in general and problem
banks is quite dramatic.


                              Percent of banks with problem
                                   described as severe
                                     Banks
                                       in       Problem
                                   general       banks
                                  (nte    a)    (note b)
                                                (n
Concentration of credit              20            70
Loan collection procedures           25            51
Classified assets                    25            58
Inadequate loan policy               23            61
Liquidity                            16            61
Inadequate capital                   22            57

a/ Based on information in the most recent reports of
   examination for banks in our general sample.
b/ Based on information in the second earliest reports
   of examination for those banks selected from lists
   of problem banks as of December 31, 1975.

      Banks with severe problems in these areas were more
likely to be considered problem banks than banks cited
for other problems, such as violations of laws and regula-
tions.
DO EXAMINERS FIND THE SAME
PROBLEMS IN LARGE AND SMALL BANKS?

     Problems varied among banks of different sizes. As
shown below, problems related to the nature of the bank's
business, such as classified loans, classified assets,
and inadequate capital were more often cited 'or large banks
than small. The problems most often cited for small banks
were generally related to policies and procedures.




                             5-5
                                       Deposits (000,000 omitted)
                                    Over  500 to--- $100 to Under
                                    $1000   $1000    $500      $100
                                    Percent of general sample-anks
 Nature of business:
   Classified loans                   93      77          73    59
   Inadequate capital                 31      19          21    18
   Classified assets                  22      22          14     9
   Excessive real estate holdings     18      19          15     7
   Concentration of credit            17      23          17    23
   Overdue loans                      30      46          34    34
 Policies and procedures:
   Inadequate loan policy             10      13          10    14
   Violations of laws and
     regulations                      46      52          55    59
   Inadequate routines and
     controls                         28      35          41    54
   Loan collection procedures          7      14          14    1R
   Inadequate credit files             9      20          27    47



DO THE AGENCIES GENERALLY
IDENTIFY THE SAME TYPES OF PROBLEM?

     As shown below, FDIC examiners reported more problems
to the banks than FRS examiners, who reported rmore than OCC
examiners.

                                          Percent of general
                                      sample banks with problem

                                     FDIC           FRS          OCC

Classified loans                      82             68               60
Violations of laws and
  regulations                         70             49               46
Inadequate routines and
  controls                            65             47               20
Overdue loans                         39             39               27
Inadequate credit files               47             30               20
Inadequate capital                    24             25               14
Concentration of credit               37             17                8
Loan collection procedures            20             13               11
Classified assets                     18             13               11
Inadequate loan policy                21              8                8
Excessive real estate
  holdings                            18             10               10

                                5-6
     Some of the disparity between FDIC and the other two
is no doubt due to the fact that the problems most frequently
cited are most often found in small banks, which are mainly
examined by FDIC. But FDIC examiners also cited more often
the problems found usually in larger banks--classified
loans and classified assets. The only exception to this
is inadequate capital--FRS examiners cite this problem
slightly more often.

     The agencies often found problems which they disclosed
only in a report "confidential section" not given to the
banks. OCC examiners generally discussed problems more
often in the confidential sections than the examiner's
comments sections. This could explain the disparity between
OCC and the other agencies. However, a bank does not benefit
from a discussion of its problems in a report section it
does not see.  (See ch. 6.)
     The agencies identified problems in problem banks with
the same order of frequency, but the differences among agen-
cies were smaller.
     OCC cited some problems relatively more frequently,
like liquidity or inadequate credit files.

                                 Percent of problem
                              sample banks with problem
                            FDIC         FRS         OCC
Classified loans               98         98          92
Violations of laws and
  regulations                 91          68          80
CTerdue loans                 76          53          64
Inadequate credit riles       54          63          56
Inadequate routines and
  controls                    67          60          38
Inadequate capital            61          60          38
Inadequate loan policy        80          48          28
Loan collection proce-
  dures                       54          40          24
Liquidity                     37          30          50
Concentration of credit       46          15          26
Classified assets             37          28          18
Inadequate collateral
  documentation               41          18          20
Excessive real estate
  holdings                    31         18           10
Management effectiveness      26         10           10
Insider loans                 22          5            4

                            5-7
DO EXAMINERS CRITICIZE
THE CAUSES OF PROBLEM?
     While the examiners frequently cited banks for
problems in two areas of management--internal controls
and compliance with laws and regulations--they did
not often criticize management effectiveness. As
shown below, management was most often criticized
in problem banks with less than $500 million in deposits,
even though 51 percent of larger banks in the general
and problem samples were also criticized for violations
and 32 percent were criticized for inadequate internal
routines and controls.

                                Percent of sampled banks
                                with management problems
                         Banks in general       Problem banks
Bank deposit size        FDIC   FRS   OCC       FDIC FRS OCC
(000,000 omitted)
Over      $1,000          -      9    5         a/      -   -
$500   to $1,000          -      -    6         -       -   -
$100 to     $500           5     2    4         23   11     25
Under       $100           4     3    5         28   14     11

a/ No bank in our sample of problem banks at FDIC had
   deposits of over $1 billion.

     As we noted in our study of failed banks (see ch. 9)
poor management policies caused the problems that led to
the failures. These problems included concentration of
credit, inadequate credit information, and poor loan collec-
tion procedures. As shown on the previous page, similar
problems were found by examiners in problem banks. But
the examiners often did not criticize a banks' policies
until the problems had already developed. For example,
inadequate loan policies were not cited by examiners
unless the banks had classified loan problems, as shown
by data for banks cited for either problem in our general
and problem samples combined:




                               5-8
                                            Percent of banks cited for

                                                    Both
                                                   policy
                             Number    Only loan    and       Only loan
         Bank deposit          of       policy     quality     quality
Agency       size            banks      poblem_    p-oblem    _roblem

         (000,000 omitted)
  FDIC   Over    $1,000          3          --                     100
         $500 to $1,000         18          -        22             78
         $100 to   $500         53          -        40             60
         Under     $100        146          2        38             60




  FRS    Over    $1,000         28          -        11             89
         $500 to $1,000         18          -        17             83
         $100 to   $500         73          -        16             84
         Under     $100         57          2        28             70

 OCC     Over    $1,000         63          -        16             84
         $500 to $1,000         29          4        10             86
         $100 to   $500         34          -         9             91
         Under     $100         44          5        25             70



 ARE INSIDER AND OUT-OF-TERRITORY
 LOANS SIGNIFICANT PROB LEMS IN BANKS?

     Two kinds of bank problems--insider loans and out-of-
territory loans--are of particular concern because they
are commonly found in banks that failed.  (See ch. 9.)  An
insider loan may be described as direct or indirect credit
to a bank officer, director, major shareholder, or his
interests.  These loans are not necessarily improper or
detrimental to a bank, but they may be if abused. Out-of-
territory loans are those made to borrowers outside a
bank's normal trade area. This is a greater problem for
small banks because they cannot properly service loans to
such borrowers.

      The examiners criticized the banks for excessive
 "insider lending" in 3 percent of our general sample
 and 11 percent of our problem sample.




                                      5-9
     Loans were considered to be "out of territory" when
the borrower was located outside of the bank's normal
trading area. Many banks, especially medium-sized or
small ones, were unable to maintain adequate contact
with borrowers outside of their trading areas--which could
make collection difficult. Also, such loans could have
been riskier than most, since borrowers with good credit
could have obtained the loans from banks in their own
localities. When out-of-territory lending was cited
as a problem, it was usually for banks with deposits
under $100 million.
WHAT VIOLATIONS OF LAWS AND
REGULATIONS ARE FOUND BY EXAMINERS?

     Banking laws and regulations are an essential element
of the regulatory system. They protect depositors,
customers, investors, creditors, and the public by estab-
lishing th Boundaries of banking activities. Violations
of laws anu   gulations reflect management's capability.

     Some laws ard regulations are complex, and violating
some technical provisions of them does not affect the
soundness of a bank. Other types of violations, such as
exceeding a bank's legal lending limit could result in
lesses to the bank.
     The laws and regulations enforced through examinations
pertained to lending practices; investments in securities
and real estate; dividends; activities of directors,
officers, and employees; deposits and interest rates;
stock registration; affiliations; and bank security.

     The examiners cited violations as a problem for
60 percent of the banks in our samples. Reports most
frequently mentioned the violations of the laws and
regulations listed below.




                             5-10
                                         Percent of banks in which
                                          violations were cited _b
Area of violation                      FDIC         FRS          OCC
                                      G     P    G      P     G      P

                                  (General (G) and Problem (P) samples)

Extensions of credit:
    Excessive                         29    54    6     23   16      72
    To insiders                       16    28    6     10   11      18
    To affiliates                      8    22    7     10   10      28
Collateral:
    Loans                             18    39    4     10    4      10
    Securities                        16    26    3      5    3       4
Securities acquired                    7     7    5      5    5       4
Real estate acquired
  other than premises                  3     4    1      -   13       4
Amount of borrowings                   -     2    1      -    1       2
State laws:
    Lending                             4    6   20     23    -       -
    Others                            27    26    9     13    1       2
Interest rate ceiling                   3    4   15     23    4      20
Reporting requirements                 -     -    1      3    1       -
Bank premises                          1     2    8      8    2       8
Interlocking directorate               -     -    1      3    1       -
Dividends                              -     -    2      5    1       -
International operations               2     2    2      3    -       -
External crimes                       25     7    8      -    1       -
Consumer credit (regulation B)         3     4    1      -    -       -
Truth in lending (regulation Z)       29    24   17     23   14      16
Note:   National banks and State-chartered banks are not
        subject to all of the same laws 2nd regulations.




     For all three agencies, more problem banks were cited
for violations of laws or noncompliance with regulations
than were general sample banks. However, the more prevalent
violations were nearly the same for general and problem
sample banks in FDIC and OCC. For example, 4 of the 5
laws and regulations cited for 10 percent or more of
the general sample national banks were also cited for
10 percent or more of the problem national banks. Only
3 laws or regulations were violated by 10 percent or
more of the general sample State member banks--8
laws and regulations were cited for 10 percent or more
of the problem sample banks.



                               5-11
WHAT PROBLEMS DO HOLDING
COMPANIES CAUSE IN BANKS?

     Our sample of commercial banks included 344 that were
affiliated with 279 holding companies. Bank examiners noted
that 72 of these banks had problems resulting from their
affiliation. We reviewed the examination reports on these
banks. In 50 cases, holding company management was not the
primary cause of the problems but neither was it a source
of strength. Twenty holding companies had either caused
serious problems or had contributed to existing problems
in the remaining 22 banks. (See ch. 4.)

     Bank problems caused by their holding companies are
shown below:
                                               Banks affected
        Type of Problem                      Number     Percent

Impaired bank liquidity because of excess
  management fees or dividends paid to
  holding company                              14          64
High volume of low-quality loans made at
  insistence of holding companies              10          45
Bank profit decrease                            7          32
Improper control by holding company over
  operations or services of the bank            7          32
Overall negative effect on the bank             7          32
Violations of laws and regulations              6          27
Excessive purchase of assets at insistence
  of holding companies                          4          18




                             5-12
WHAT PROBLEMS WERE FOUND IN
BANKS' INTERNATIONAL OPERATIONS?

     We reviewed examination reports for 18 national banks
and 12 State member banks which had substantial interna-
tional operations. The examiners cited the following problems
related to international operations:


                                             Banks with problem
                                             Number     Percent

Loans:
    High percentage of classified
       international loans                      9           30
    Poor credit files                           3           10
    Large concentrations                        3           10
    Poor loan analysis                          1            3
    Inadequate information on affiliate
       investments                              1            3
    Inadequate information on branch credit     1            3
Foreign exchange operations:
    Poor internal controls                      5          17
    Lack or violation of net open position      2           7
    Lack of customer exposure limits            2           7
    Lack of well-defined policies               1           3
Management:
    Poor overall internal controls              6          20
    Violations of laws and regulations          4          13

     Also, in the latest reports of examination, these
banks were reported as having a total of $80.5 billion
in loans to foreign governments, businesses, and indivi-
duals. The examiners had classified 3.7 percent of these
loans as substandard, 0.4 percent as doubtful, and 0.1
percent as loss. Seven percent were "specially mentioned."




                            5-13
                    CHAPTER 6

           REPORTING PRACTICES: 1971-75
                                          Page
                                          6-1
Overview

Discussion of examination results         6-3
  with bank management                    6-4
    Conclusion
    Recommendation                        6-5
                                          6-5
    Agency comments
                                          6-8
Bank ratings
                                          6-10
The report of examination
    Conclusion                            6-12
    Recommendation                        6-13
    Agency comments                       6-13

                                          6-14
Report processing                         6-14
    Regional report review
    Headquarters review                   6-15
                                          6-15
Interagency report exchange
                             CHAPTER 6

                   REPORTING PRACTICES:   1971-75

OVERVIEW

     The success of the supervisory process depends heavily
on how examination results are disclosed to those respon-
sible for correcting problems--the bank's board of directors.
While the agencies' examiners discussed the results of their
work with bank managers during and after the examination,
the agencies generally did not meet with boards of directors.
Examiners or agency officials met with the boards of di-
rectors of less than 10 percent (FDIC 1 percent; FRS 9 per-
cent; OCC 6 percent) of the general sample banks after
examinations conducted in 1974 or 1975.   Even when the banks
had major problems, the examiners met with the boards of
directors in only dbout half of the cases. After the second
most recent examination we reviewed, FDIC representatives
met with the boards of directors of 30 percent of the banks
in our sample of problem banks; FRS representatives with
53 percent; and OCC representatives with 54 percent.   We
believe that the agencies should always discuss the results
of their examinations with the boards of directors or the
directors' audit or examining committees.

     The agencies :ated each bank after each examination.
Although the rating systems used were mechanically dif-
ferent, they considered the same basic factors and were
subjective.  Generally, these ratings were not disclosed
to the banks and were important only as internal shorthand
ways of referring to the condition of individual banks.

     The agencies prepared reports of examination which were
sent to the examined banks' boards of directors and to
agency headquarters.  The reports were organized differently
but contained the same basic information.  The problems
noted during the examination were presented in a summary
section which was given to the bank.  Detailed schedules,
analyses, and listing contained in the "body" of the report
were also given to the bank.  This section

    -- supported   the examiner's criticisms and con-
       clusions,

    -- documented some of their work,     and




                                6-1
     -- communicated some of the bank's financial data to
        agency officials.

     The examination reports also had a "confidential"
section which bank personnel did not see. Here, the examiner
expressed his or her opinions on the bank's financial
condition and management quality. This section was a major
medium for communications between the examiner and agency
management about a specific bank.

     The agencies' reports of examination were not effec-
tively communicating the examination results to the banks,
because:
     -- Many problems and criticisms were stated in the
        confidential sections but not disclosed in the
        sections given to the banks. For example    in
        three consecutive reports of examination for one
        bank, the examiner criticized the bank's capital
        position in the confidential sections only.
     --Much of the information reported originated from
       the banks and was included to document the
       examiners' work rather than to inform the banks.
       The reports provided the banks with their own
       balance sheets, income and expense data, deposit
       trends, and real estate holdings.
     -- The examiners generally did not recommend how the
        banks could correct the problems. For 63 percent
        of the problems noted in banks in our problem
        samples, the examiners did not recommend corrective
        actions. In some instances, the required corrective
        action would have been obvious to the bank.

     The reports of examination should tell the banks, in
a concise and straightforward fashion, the results of the
examination and recommendations for corrective action.




                            6-2
DISCUSSION OF EXAMINATION RESULTS WITH BANK MANAGEMENT

     During and after the examination, the examiners
were expected to discuss their findings with bank managers;
loan classifications, in particular, were to be discussed
in detail.  In a few instances, the banks were given prelim-
inary written report results. The FRB of Philadelphia exam-
iners, for example, gave large banks in their district a
"minireport," containing examiner's comments and 'oan write-
ups, when the examiner left the bank.

     Although specific duties, responsibilities, and lia-
bilities vary from State to State, generally bank directors
are required to be fully aware of the bank's policies,
operations, and condition. They are supposed to apply ordi-
nary care and prudence in administering the bank's affairs,
and they may be liable for any resulting losses if they do
not. Thus, the results of an examination should be important
to the board of directors, and the supervisory agencies
should be doing their utmost to communicate the examination
results to the directors.
     Another indication of the board of directors' ultimate
responsibility for the bank is that about half of the States
require some form of directors' audit or examination. While
the actual work might be done by an independent accounting
firm, many boards have established audit or examining
committees to insure that their examining responsibility
is met.
     The agencies routinely send copies of examination
reports to the oanks' boards of directors, but they did not
require their examiners or regional officials to meet with
each banks' board of directors after each examination. As
shown by the following chart, the agencies rarely met with
the boards of directors of banks in general and very often
did not meet with those of banks with major problems.
(Cases 1, 2, 3, 4, and 5 in ch. 8 illustrate the agencies'
practices with regard to meeting with directors.)




                            6-3
                          Percent of banks in which
                         agencies met with directors
Agency               Bagns in general      Problem banks
                           tnote
                            .                (note E--
FDIC                       1                       30
FRS                        9                       53
OCC                        6                       54
a/ Based on actions taken aftt-.     the earliest reports
of examination.
b/ Based on actions taken after the second most recent
examination for sample of problem banks as of December
311 1975.
     Both FDIC and FRS have a general policy of meeting
with boards of directors of all problem banks. Officials
of one FRB, however, had a policy of meeting with the board
of directors of each examined bank and believed that this
practice reduced the incidence of serious problems. In
January 1976, OCC instituted a policy of meeting with the
board of directors of every national bank each year.
Conclusion

     One factor common to many bank failures was the lack
of oversight exercised by the banks' boards of directors.
(See ch. 9.)  The agencies can at least insure that the
directors have the information needed for exercising the
proper degree of oversight by informing them of the results
of each examination.
     We believe that tne report of examination should not be
the only method by which examination results are disclosed
to the bank. The agencies should also meet with the banks'
boards of directors or audit or examining committees after
each examination irrespective of the nature of their find-
ings to

       -- emphasize to the bank the importance of the
          examination and the agency's concern for its
          well-being.

       --insure that the boards, which are ultimately
         responsible for the bank's operations, are fully
         aware of the examination results.


                               6-4
     -- discuss findings,

     -- establish closer working relationships with
        the boards, and

     -- enhance the stature of the examiners.

     Perhaps, it wo-ld be appropriate to provide the exami-
ners with some instruction on how to conduct the meetings.


Recommendation

     Therefore, we recommend that the Board of Directors,
FDIC, and the Board of Governors, FRS require their
examiners to meet with the bank's board of directors or
audit or examining committee after each examination.

Agencycomments
     FDIC said:

    "FDIC conducted approximately 7,900 examinations
    in 1975.  Senior officials from the various Regional
    Offices met with bank management on approximately
    1,750 occasions, representing 22% of all examinations.
    Throughout 1975, there was an average of 224 banks
    under our supervision which were formally designated
    as financial problems. FDIC policy is to meet with
    bank directors at least where problem situations
    exist.

    "FDIC staff has in the past year been considering
    the question of how often meetings with bank di.rec-
    tors should be held.  In consideration of this
    subject, the responsibilities of bank directors,
    the Corporation's responsibility to bank directors,
    and our past and present practices in holding
    board meetings were weighed.

    "In a broad sense, the board of directors of a
    bank is responsible for the formulation of sound
    policies and objectives of a bank. the effective
    supervision of its affairs, and promotion of its
    welfare.  In discharging these responsibilities,
    a director's duty is to exercise due care or be



                            6-5
exposed to a charge of negligent performance of his
duty. To insure that bank directors are aware of the
contents of examination reports the Corporation requires
that a receipt accompanying each report be signed by
the bank's executive officer stating that the report
"...was duly considered by the directors...and a record
of the action taken thereon by the Board has been enter-
ed in the minutes." Moreover, at each examination, the
examiner is charged with the responsibility of deter-
mining that the bank's board minutes reflect a thorough
consideration of examination reports and correspondence
received from supervisory authorities since the last
examination.

"To enable bank managements to begin work on problem
areas prior to receipt of the completed examination
report, a list of adversely classified assets and
other major criticisms is provided to, the executive
officer at the completion of each examination and most
of the FDIC Regional Offices have implemented deadlines
fox receipt of completed examination reports in the
Regional Office--usually 10 calendar days after the
close of the examination.

"The FDIC Manual of Examination Policies states, with
respect to examiners holding meetings with directors
(Section Q, page 3, paragraph I.E.):

     "Except in instances where authority has been
    delegated by the Regional Director, the Examiner
    should consult with the Regional Office before
    calling a board meeting. Ordinarily, meetings
    with the board of directors should be held at
    the conclusion of all examinations of problem
    banks. A meeting of the board may also be re-
    quired when experience and instinct tells the
    Examiner a likelihood exists that the bank will
    be added to the problem list or will be earmarked
    for other special supervision. Additionally,
    where there is a substantial volume of classified
    assets, low capit l or other areas of important
    criticism, a board meeting may be desirable. This
    is particularly true when the trend has been
    unfavorable and previous admonitions have
    gone unheeded."




                      6-6
"In keeping with this policy, it is in fact the
practice in most regions for the examiner to
hold a meeting with bank directors if problems
of consequence are found at the examination,
or if significant adverse trends are noted
since the last examination. In virtually all
instances involving problem banks, a repre-
sentative from the Regional Office will meet
with the directors, and in most cases an invi-
tation is extended to the state aut'ority to
participate in the meeting.
"The FDIC is cognizant of the benefits flowing
from more frequent meetings with the boards
of directors of banks under our direct super-
vision and anticipates holding such meetings
with increased frequency in the future. We
are also actively reviewing the posture of the
FDIC in this regard with a view of improving
upon the Limeliness and conduct of such meet-
ings."
FRI; stated:

"The System has for many years been concerned
that the board of directors be particularly
aware of the results of an examination. Thus,
the System has historizcilly required that the
examination report be considered and discussed
at a meetin- of the board of directors. To
insure that this is done, directors are required
to sign a statement attached to the report that
it has been so read and considered. Further,
examiners are instructed to review the minutes
of board of director meetings to insure that
the spirit of these requirements has been
fully carried out.
"With respect to meetings, the Board in 1975
directed that an earlier existing policy for
most of the System be expanded to all Reserve
Banks. This policy requires that Reserve Bank
staff meet with the board of directors
of all so-called problem banks. The Board
believes that such meetings are important
where significant problems are revealed."


                      6-7
BANK RATINGS

     The supervisory agencies developed systems to rate
banks on financial condition and management quality. The
ratings were used only by the agencies as a shorthand for
describing a bank's condition and were generally not dis-
closed to the banks. A rating was an indicator of the need
for supervisory attention, but not the sole determinant
of whether or not a bank was designated to receive special
supervision. (See ch. 8.)

     At FDIC the examiners-in-charge rated banks. At FRBs,
ratings were assigned by the examiners-in-charge or the
review examiners, the chief examiners or the vice presi-
dents, depending on the FRB. At OCC, the regional admini-
strators assigned the ratings.

     The ratings were based upon information developed dur-
ing the examinations and were combinations of specific
ratios and judgment.

     The agencies used different systems to rate banks, but
they considered the same basic factors:  asset quality,
capital adequacy, and management quality. FDIC also consi-
dered the adequacy of the bank's earnings.

    The FDIC rating   included the rdtios of

    -- adjusted capital and reserves to adjusted gross
       assets,
    -- net capital and reserves to adjusted gross assets,
       and
    -- net earnings to average gross assets.
The FDIC rating also included the examiner's judgment of the
bank's management as good, satisfactory, fair, unsatisfac-
tory, or poor.
    The rating system used by all FRBs had four elements:
    --a rating of capital position (1, I, 2, 3 or 4),

    --a rating of asset quality (A, B, C or D),
    -- a rating for management (S, F, or P), and



                            6-8
     -- a composite rating (1, 2, 3 or 4) of those three
        factors.

Although the rating system employed several ratios and
some thresholds, judgment was again e major component.

     OCC's rating system included an overall rating of the
bank, ranging from "1" to "4"--"1" being the best.  In addi-
tion, the bank was rated for capital position, quality of
assets, and management. The best rating indicated that the
bank was sound in every respect. A "2" rating was given to
banks with "relatively moderate to moderately severe" asset
weaknesses, which had insufficient capital, unsatisfactory
management, or a combination of problems and weaknesses.
A "3" rating was given to banks with "an immoderate volume
of asset weaknesses" which, when combined with other fac-
tors, could have developed into "a situation urgently
reguiring aid either from the shareholders or otherwise."
A 4" rating was given to banks whose failure, if aid was
not provided, appeared "probable." The ratings for capital
position and asset quality were based on specific ratios
coupled with the regional administrator's judgment. Manage-
ment ratings were based on the judgment of the regional
administrator rather than on established criteria.

     The following chart summarizes the composite ratings
received by the banks in our general sample as a result of
their most recent examinations.




                             6-9
                                  Percent of banks
                                 recelv-----in   rang- f
             Agency          1           2          3      4
            (note a)

             FRS            52           37         10     1
             OCC            46           34         19     1


a/ As explained on page 6-8, FDIC does not develop an over-
all rating for a bank. However, FDIC uses a problem designa-
tion system which designates banks as "other problem,"
"serious problem," and "serious problem potential payoff."
(See ch. 8.) Five percent of the FDIC banks in our general
sample were designated as one of these.

While about half of the banks received a rating of "1", our
analysis of ratings for these banks after previous examina-
tions shows a decrease in "1" rated banks and increases in
"2", "3", and "4" rated banks.

THE REPORT OF EXAMINATION

     The report of examination had three distinct parts:

     1.   The "examiner's comments" or "summary."

     2.   The "body."

     3.   The "confidential" section.

     The examiner's comments section presented the examin-
ation's results and was the primary written communication
from the examiner to the bank. The examiner cited problems
and sometimes suggested actions to resolve them.

     However, in the second earliest reports on our sample
of December 31, 1975, problem banks, the agencies' examiners
recommended corrective steps for an average of only 34 per-
cent of the problems they found. FDIC recommended actions
for 37 percent; FRS for 23 percent; and OCC for 39 percent.
In some instances, the required corrective action would have
been obvious to the bank.




                             6-10
     The body, which was the bulk of the examination report,
presented the facts and analyses on which the examiner's
comments were based. Tables, questionnaires, lists, and
some narrative comments were included. This section served
a number of functions:

     -- It detailed the results of some examiner analyses.

     -- It documented some of the steps followed by the
        examiner.
     -- It supplied some financial information to the super-
        vising agency.
     Although the body section was given to the bank, it
contained information such as the balance sheet and income
and expense data which the bank had furnished to the
examiners.
     The confidential section was not provided to the
examined bank.  In addition to some factual material, this
section contained the examiner's more explicit comments
and opinions on the bank's condition, management, ownership,
earnings, growth potential, and progress toward resolving
problems. It was intended as an internal communication from
the examiner to agency management.

     The confidential sections of reports we reviewed
contained criticisms which were not noted elsewhere in the
reports. The examiners were more critical of bank manage-
ment here than they were in the comments section as shown
by the following table, based upon information in the second
earliest reports of examination foL our sample of problem
banks as of December 31, 1975.


                                  Percent of reports
                          in which problems were noted in
                           Confidential     Examiner's com-
                              section       ments section
 Problem or criticism     FDIC FRS -OCC    -FDIC  FR-S -CC
Inadequate or incompe-
 tent management           63      45   60   26   10      10
Inadequate capital         43      63   68   61   60      38
Insufficient liquidity     19      35   54   37   30      50
Earnings                   11      25   26   17   18       8


                            6-11
     The following cases illustrate the types of problems
discussed in the confidential section which were not dis-
closed to the banks. (See also cases 2 and 4 in ch. 8.)

                         Case 1

     For three consecutive examinations, the FDIC examiner-
in-charge criticized the effectiveness of the bank's manage-
ment and indicated a severe problem with management dominia-!
tion in the confidential section but not in the examiner's
comments section. The examiner-in-charge criticized the
management's responsiveness to problems in only the confi-
dential section in the most recent report of examination.

                         Case 2

      The FRB examiner-in-charge criticized the bank's
unsatisfactory capital ratios in the confidential sections
of two consecutive reports and indicated that the bank's
capital was inadeguate in the confidential section of the
following report.   Also, in one year the examiner-
in-charge criticized excessive amounts of real-estate
holdings and a lack or top management in the conriaential
section. None of these criticisms were pointed out in the
examiners comments sections of the reports given to the
bank.

                         Case 3

     The OCC examiner-in-charge criticized the bank's loan
policies in the confidential sections of three consecutive
reports of examination but not in the examiner's comments
section. Also in the second and third reports, the confi-
dential sections contained criticism of costs and expenses,
internal routines and controls, and borrowing frequency
which were not disclosed in the examlner's comments section
of the report given to the bank.

Conclusion

     The report of examination was not serving its primary
function as effectively as possible.  We believe that the
report of examination should present clearly and concisely
the results of the examination, the agency's recommendations
for corrective action, and any information necessary to sup-
port the examiner's conclusions.  It need not go to great
length to provide information which the bank already h'as.



                            6-12
If the agency needs additional information for review or
statistical purposes, the report sent to headquarters should
be accompanied by a detailed, structured set of workpapers
and standard data collection forms. (See ch. 4.) Thus, the
bank would not be burdened by a report containing super-
fluous information, and the agencies would be better able
to review the examiners' work.

     OCC is implementing new examination procedures which
will result in a revised report of examination and standard
workpapers.  (See ch. 7.)

Recommendation

     We recommend that the Board of Directors, FDIC, and
the Board of Governors, FRS, develop and use reports of
examination which provide the banks with the results of the
examination and any necessary supporting information.

Agency comments

     FDIC said:

    "FDIC conducted an intensive study in 1965 to assess
    the impact of its examination report on banks. As a
    result in 1969, a new examination report format was
    put into use. We believe this report format, and the
    guidelines under which it is used, provides a clear,
    concise picture of problem areas to bank managements.
    Various FDIC staff members have attended familiari-
    zation sessions on the OCC's new examination report
    format.  The OCC has tested this new format in only
    ten banks and the impression of the FDIC staff members
    is that the report format is somewhat cumbersome,
    especially in problem situations.

    "There appears to be some misunderstanding with respect
    to the purpose and thrust of the confidential (super-
    visory) section of the report of examination.   The
    purpose and thrust of the confidential section are to
    allow the examiner to comment on matters uncovered dur-
    ing the course of the examination which may not lend
    the:nselves to complete substantiation, but which may
    serve to alert his superiors that further investigatory
    cr supervisory efforts may be necessary.   For obvious
    reasons, such material is not, and should not, be pro-
    vided to the management of the bank. However, a
    thorough study of the role and use of the confidential


                           6-13
    section was started some months ago and, when completed,
    will probably result in significant changes in its
    thrust, format and content, or in its elimination."

     FRS said:

    "We believe the bank examination report presently pro-
    vides the banks with the results of an examination and
    necef ary supporting information. We also believe it
     should provide the System with the information it needs
     to carry out its supervisory functions. The present
     examination report adequately carries out these needs.
     It should not be forgotten that the System also uses
     other methods of communicating its views to its member
     banks, such as correspondence, informal meetings, and
     consultations on applications. Of course, the System
     is continually exploring methods of improving
     communications."
REPORT PROCESSING

     The examiners-in-charge were responsible for drafting
and signing the reports of examination.  Where and when
they drafted the report varied among and within the agencies.

Regional report review

     In all three agencies the reports of examination were
reviewed in the regional offices before they were finalized
and sent to the banks and the agencies' headquarters.   In
general, the reports drafted by the examiners-in-charge  were
reviewed for arithmetic accuracy, grammar, logic, support
for statements, and internal consistency. Reviewer positions
were filled by senior field examiners either permanently
or on a rotating basis.




                            6-14
     FDIC stated that about 30 days elapsed from the
drafting of an examination report to its transmittal to
the bank and receipt by Corporation headquarters. The
FRBs attempted to send the reports to the banks within
30 days of completing the examination. OCC attempted to
send reports to the banks within 20 days of completing the
examination.
Headquarters review

     Each agency headquarters received a copy of each report
of examination. FDIC headquarters staff reviewed the re-
ports, designated certain banks for special attention, and
monitored the supervisory actions taken by the field offices.
At FRS, the headquarters staff reviewed each report but paid
special attention to those banks with composite ratings of 3
or 4 or those rated 2 which, in the reviewer's judgment,
required intensive monitoring. The FRS reviewers would
suggest supervisory action only in those cases where they
believed the FRB's action was inappropriate. OCC headquar-
ters staff primarily reviewed the reports to insure that
banks requiring increased supervision were identified, and
to validate the follow-up activity of the regional offices.
INTERAGENCY REPORT EXCHANGE

     Each agency could request any report of another agency.
In addition, FRS provided FDIC with all reports on banks
composite-rated 3 or 4, and OCC provided FRS with all re-
ports and FDIC with all reports on problem banks.

     State exchange arrangements varied from region to
region but FDIC and FRS generally provided their reports of
examination to the State banking agencies.




                           6-15
                          CHAPTER 7

              EFFORTS TO IMPROVE BANK EXAMINATION
                                                        Page

Overview                                                7-1

OCC's new examination approach                          7-1
     Monitoring systems                                 7-2
     Commercial examination procedures                  7-4
         Preexamination analysis and review             7-5
         Detailed examination                           7-6
         Revised examination report                     7-10
     Specialized and special supervisory examinations   7-11
     Evaluation of large shared loans                   7-13
     Revised trust examination procedures               7-14
     Revised EDP examination procedures                 7-14

Changes in FRS's examination approach                   7-15
     Revised examination procedures                     7-15
     Monitoring systems                                 7-16

Changes in FDIC's examination approach                  7-19
     Frequency of examination                           7-19
     Scope of examination                               7-20
     Monitoring systems                                 7-20
     Revised trust examination procedures               7-22

New approaches to consumer credit compliance
  examinations                                          7-22

Conclusions                                             7-23
Recommendations                                         7-25

Agency comments                                         7-26
                           CHAPTER 7
               EFFORTS TO IMPROVE BANK EXAMINATION
OVERVIEW

      The Federal Deposit Insurance Corporation and the
Federal Reserve System recently revised their examination
approaches to give greater priority to examining the weakest
banks and less emphasis to examining relatively trouble-free
banks.   To assist in identifying banks that may have prob-
lems, the agencies are expanding their systems to analyze
banks' performance by using financial data that agencies
periodically obtain from the banks.

     The Office of the Comptroller of the Currency initiated
development of a new examination approach in the fall of
1975 which also focuses more on banks with problems and less
on trouble-free banks; however, its changes are much more
extensive than those being made by FDIC and FRS. OCC has
developed examination procedures emphasizing early identifi-
cation of weaknesses in management policies and procedures.
If OCC can influence the banks to rectify these weaknesses
promptly, many of the problems now occurring can be cor-
rected before they seriously threaten the soundness of the
banks. This concept, in our opinion, offers significant ben-
efits over the traditional examination approach which has
been used by the three regulatory agencies.

     At the time of our study, the process had only recently
been developed and field tested at 10 banks. Neither we nor
the agency could fully evaluate the practical problems that
may be encountered in implementing the new procedures, such
as the resources needed and the applicability of the process
to all types of banks. Undoubtedly, many practical problems
will be encountered and futher refinement of the process
will be necessary. We believe, however, that these problems
can be worked out as OCC gains additional experience. The
basic concept of the process seems logical and, we believe,
should be pursued jointly by the three supervisory agencies.

OCC'S NEW EXAMINATION APPROACH

     In May 1974, Comptroller of the Currency, James E. Smith,
commissioned the public accounting firm of Haskins & Sells
to comprehensively review and evaluate OCC operations--the
first major outside study of the Office since its establish-
ment in 1863. On May 30, 1975, the firm reported to the

                            7-1
Comptroller numerous recommendations for modifying or
extending existing activities.  Regarding bank examinations,
Haskins & Sells recommended that OCC

     -- monitor the financial reports of national banks,

    -- require national banks to report financial data more
       promptly and in accordance with uniform principles
       of accounting and reporting, and

     -- modify the examination procedures.

Monitoring systems

     To monitor national banks, Haskins & Sells recommended
a system which they called the National Bank Surveillance
System (NBSS).  The system consists of four basic elements:

     -- A data-collection system.

     --A computer-based monitoring system to detect unusual
       or significantly changed circumstances within a bank
       and within the national banking system.

     -- An evaluation by experienced personnel of the impact
        of such changes on bank soundness.

     --A review procedure that would provide administrative
       controls over all proposed OCC remedial actions.

     To implement the recommendation, in September 1975 OCC
established a small staff of experienced OCC examiners and
Haskins & Sells employees.    Information for the NBSS data
base was derived  from  reports of condition (balance sheet
data) and reports  of  income which national banks are
required to periodically submit to OCC.    FDIC also processes
the same data from all banks.    (See ch. 11.)

     The staff, in implementing the system, generally
followed the concepts set out in Haskins & Sells' report,
and by mid-1976, a limited system, with a 5-year data base,
began operation with data reported for March 31, 1976.    By
October 1976,  the system was fully operational, although
OCC plans to add additional data to the system, including
data from its examination reports.

     NBSS supplements the new examination procedures by
detecting, each quarter, financial changes in national banks.

                             7-2
Data produced from the system is to be used to identify
those banks which need priority examination and to provide
statistical data in a usable form to assist the examiners in
evaluating the bank's financial condition.

      One computer program provides a statistical profile, or
performance report, of each national bank in comparison with
a profile of its peers.   Another computer program quarterly
summarizes key performance data, and ranks those banks which
are to receive priority review.   For those banks ranked by
the computer as being in greatest need of review, trained
specialists analyze the bank performance reports, looking
for high or low percentile rankings and for short term and
long term trends.   The performance reports contain ratios of
financial data for current and past periods for each bank,
as well as for its peers.   Certain key ratios provide, in
OCC's opinion, the best general measures of unusual or
changed circumstances in a bank that require further inves-
tigation.   For example, one ratio monitors changes in the
composition of the loan portfolio.   This ratio is used as an
indicator of changed management emphasis on types of loans
made.

     An NBSS specialist who detects unusual or significantly
changed circumstances within a bank, is to report them to
the regional administrator, who may direct any investiga-
tions considered necessary--ranging from a telephone call to
the bank to a full, priority examination--to analyze the
impact of the change on the bank's soundness.

     In planning bank examirntions, the examiner also uses
the bank performance report to develop an overview of
financial conditions and reslts of bank operations and to
to identify potential problem areas so staff and procedures
can be selected.

     NBSS also includes an action control system to monitor
the problems identified to see that they are resolved.
Banks designated for priority review are placed quarterly in
the action control system. Banks cannot be removed from the
system until all problems arc resolved.  For those banks
that remain in the system, reports will be made every
2 weeks showing the progress o- the lack of progress in
resolving their problems.

     According to OCC officials, the system will be expanded
to also monitor the actions taken by banks in response to
deficiencies disclosed in examination reports.  During the


                            7-3
period of our review, OCC should have been more aggressive
in requiring banks to correct problems noted during examina-
tions.  (See ch. 8.)   In this regard. the use of the action
control system to  monitor the progress that banks make in
correcting their  problems would be a useful tool to the
agency.
Commercial examination procedures
     During the fall of 1975, OCC formed a task force to
revise its commercial examination procedures. The task
force developed more sophisticated, formal, and uniform
procedures for examining banks, incorporating (1) the recom-
mendations of Haskins & Sells, (2) the informal practices of
many examiners ,n the past, and (3) other changes considered
necessary. In the spring of 1976 these procedures were
field-tested in two banks. The'procedures were revised as a
result of the field test, and during July 1976, 4 examiners
from each of the 14 OCC regional offices were instructed on
the revised procedures. These examiners then conducted
pilot examinations of eight banks. Beginning in September
1976, additional bank examinations commenced under the new
approach. The four trained examiners from each region began
in mid-1976 to gradually train other examiners. OCC expects
all its examiners to be using the new procedures by mid-1977.
     The new procedures provide for three types of examina-
tions:

       General examinations which are broad in scope and
       are to be performed once every 2 years at all banks.
       S2ecialized examinations which are limited in scope
       and are to be performed at all banks twice in each
       2-year period.

       Special supervisory examinations which are made only
       at those- ban- with severe problems necessitating
       close supervision.
     The limited testing of the new procedures indicates
that the general examinations, at least the initial examina-
tion at each bank, will be very time consuming in relation
to the traditional examination. During the 1976-77 cycle,
OCC may not have sufficient staff to make a general examina-
tion plus two specialized examinations of all national banks,
in addiuion to the special supervisory examinations of banks
requiring close supervision.

                             7-4
     During 1975, OCC made 6,000 regular commercial examina-
tions and 860 special examinations. The average time re-
quired to complete the examination of the test banks was
about three times the amount required to examine the banks
under the traditional method. OCC has not estimated the
resources required by the new procedures. Officials said
that, while some problems will be encountered in meeting
their 1976-77 examination goals, the required examinations
for the 1978-79 cycle can be mat with their existing statf.

     They also said that the time required to make the
general examination under the new procedures will decrease
as the examiners become more familiar with the procedures.
Officials pointed out that the second general examination of
a bank will consist largely of updating the workpapers of
the initial examination and will not require as much staff
time. They also stated that the two specialized examina-
tions to be made in each 2--year cycle will not require as
much staff time as the current traditional examination.

     The new general examination consists of two separate
phases--the preexamination analysis and review, and the
detailed examination.

     Preexamination analysis and review

     The preexamination analysis and review ordinarily is to
be performed by the examiner-in-charge and one or two assis-
tants, depending on the size and complexity of the bank, and
is expected to take from 1/2 day to 2 weeks to complete.
Where possible, the review is to be performed at the bank
several weeks in advance of the examination date.

     The principal purpose of the preexamination analysis
and review is to determine the scope and objectives of the
general examination. In other words, OCC expects to identify
areas where deficiencies exist and where it should put the
most emphasis. This analysis and review is also intended to

    -- familiarize the examiner with the bank's operations,

    -- determine staff requirements for the detailed
       examination,
    -- identify potential problems in applying the
       examination procedures,

    -- coordinate work schedules with bank management, and
                            7-5
     -- decide which affiliated companies to examine and
        how broadly to cover them.
     This phase of the e: mination process consists of
obtaining basic data about the bank's policies, procedures,
controls, and internal and external audit activities. The
data is evaluated and the scope of the general examination
is defined, including the extent of examination and verifi-
cation procedures to be performed during the detailed exam-
ination.  If the examiners find that the conclusions reached
during the preexamination analysis and review phases were
incorrect they may revise the scope during the general
examination.

     The work performed during the preexamination analysis
and review includes

     -- reviewing prior examination reports and applicable
        working papers,

     -- analyzing bank financial data as shown on the NBSS
        report, including any comments or analysis by NBSS
        specialists,

     -- completing an internal control questionnaire,
     -- reviewing the bank's audit functions,

     -- completing an examination planning and control
        questionnaire, and
     -- reviewing minutes of board of directors and
        committee meetings.

     This phase of the work is intended to tailor the work
programs for the general examination to the bank being
examined and at the same time to provide for consistent exam-
inations whose scope is dictated by the bank's condition and
not by the examiner's judgment alone.
     Detailed examination

     The basic task of the detailed examination is to com-
plete the work programs, with any adjustments that become
necessary during the course of the examilnation; to reach a
conclusion on the overall condition of the bank, present and
prospective; and to develop recommendations for correcting
deficiencies.

                              7-6
      In our view, the most important facet of the new exami-
nation procedures is that they will center more on the
underlying causes of problems rather than on the results of
operations. Poor results are visible in bad loans, concen-
trations of credits, excessive insider loans, risky in-est-
ments, inadequate capital, inadequate liquidity, violations
of laws, etc. The traditional examination has focused on
identifying these types of problems.   (See ch. 4.)
     The agencies have previously made little use of a
formal or structured approach to examining those elements of
bank activities that cause problems. The extent of examina-
tion ci bank policies, practices; procedures and controls
was largevly left to the discretion of the examiner, and
according to agency officials, time restrictions often
caused examination efforts in these areas to be minimal or
superficial. While the new procedures still provide for
examining the end results of operations, they place much
more emphasis on identifying conditions which, if not cor-
rected, could lead to poor results.

     OCC has developed a comprehensive handbook, a standard
internal control questionnaire, and sets of examination and
verification procedures for specific asset and liability ac-
counts and for particular banking and examining activities.

     According to OCC officials, many examiners had developed
their own informal examination procedures, which differed
from examiner to examiner and from bank to bank. To a large
extent, the new examination procedures represent a composite
of these informal procedures.

     The new approach provides greater assurance that indepth
analysis of policies, practices, procedures, and controls is
made during each examination. Additionally, it provides
documentation of examinatior pro cedures followed, tests per-
formed, information obtained, and conclusions reached. This
documentation can assist the examiner-in-charge in judging
the overall condition of the bank and in planning subsequent
examinations.
     In essence, OCC will be looking at how well banks are
managing themselves from day to day. Where weaknesses are
found in bank management, OCC will be recommending changes
in bank policies, practices, controls, and audit to a much
greater extent than previously. While the objective of the
new procedures is to identify weaknesses in bank management
which could lead to such problems as bad or risky loans and
investments, and liquidity and capital deficiencies, it can
                             7-.7
also help to reduce fraud--sometimes a cause of bank failure.
(See ch. 9.) Although fraud detection is not one of the
primary objectives of the new procedures, early correction
of weaknesses in policies, procedures, controls, and audit
activities may reduce the opportunity for fraud or allow it
to be discovered before the bank's condition is seriously
impaired.
     The contrast between the old and new approaches can be
seen by comparing the examination reports of the 10 banks
that were examined using the new procedures with prior
reports for the same banks that were prepared under the old
approach. Numerous weaknesses in managerial practices and
controls were discussed in the new reports which apparently
had existed for a long time but had not been identified in
the prior reports. The following examples, in our opinion,
illustrate the contrast in the examination approaches.

                         Case 1
     The new report on one of the test banks depicted the
condition of the bank as unsatisfactory because of the
amount of classified assets.  The report attributed this con-
dition to poor, unwritten, or nonexistent lending policies.
The report stated that

     "* * * the bulk of criticized items have orgina-
     tion [sic] dates in the 1972 to 1974 period and
     many reflected weaknesses at inception, particu-
     larly with respect to financial support, estab-
     lishment of valid repayment sources, documentation
     and collateral, and these deficiencies have become
     especially pronounced during this period of eco-
     nomic strain. Those granted in the 1975-forward
     period which are listed in this report often
     exhibit the same deficiencies which can be traced
     primarily to the absence of a sound lending policy,
     thus allowing for the continuing extension of
     credit without defined and approved guidelines."

     The report pointed out that a lending policy was being
drafted by the bank and suggested that the bank establish an
internal loan review department.

     The three prior examination reports on this bank, pre-
pared under the traditional approach, criticized the volume
of classified assets but did not criticize the bank's lend-
ing policies or controls. In the confidential section of

                            7-8
two prior reports the examiner concluded that the lending
policies were reasonably sound and conservative. The confi-
dential section of the other report did not express any
opinion on the bank's loan policy.
     Since the report is the product of the examination pro-
cedures used, one can understand why the traditional reports
were not critical of the bank's lending policies and con-
trols. The traditional approach is to examine a large por-
tion of the loans as of a certain date and to appraise and
classify them according to the degree of risk involved.
(See ch. 4.)
     In addition, the Comptroller's old handbook of examina-
tion procedures required the examiner to analyze the bank's
lending and collection policies and Practices; however, the
examiner had almost complete discretion in deciding the
specific procedures to be used and the workpapers to be
prepared.

     Under the new approach, l1ans are still examined in
detail, appraised, and classified. Increased emphasis, how-
ever, is placed on evaluating whether the bank's policies,
procedures, practices, internal controls, and internal and
external audit are adequate to assure compliance ,with laws,
regulations, and sound banking principles.
     To provide a basis for these evaluations, the examiner
completes an internal control questionnaire and a prescribed
schedule of detailed examination and verification procedures.



                          Case 2

     One of the test banks had no problems requiring atten-
tion, according to a January 26, 1976, report conducted under
the traditional approach. In a report prepared June 30,
1976, using the new approach, the examiner concluded that
the bank's overall condition was good, but he pointed out
numerous deficiencies in internal audit and controls and a
lack of written policies on accounting procedures and con-
centration of credit.




                             7-9
     The January report analyzed the bank's audit department
anJ the scope of its audits and found them adequate. The
analysis of the audit department and internal audit scope
was limited to a one-page, question and answer worksheet.
The new procedures provide for a more indepth review and
evaluation. In addition to a nine-page questionnaire, it
includes numerous examination procedures, such as reviewing
the internal audit reports and related workpapers.

     The same auditor was still employed by the bank in June
but OCC was very critical of the audit department. The June
report concluded:

     "The internal audit function is considered ineffec-
     tive. The audit program, scope of audits and
     documentation thereof are generally considered to
     be unacceptable.      * * *

     "The internal audit staff lacks * * * experience and
     professional    ckground to audit a bank the size and
     complexity of your bank.        * * *"

     The January report did not criticize any bank activity
or recommend improvements.  The confidential section of the
report, which did not go to the bank, considered internal
controls and audit procedures adequate.  Since the bank had
no changes in management or substantial growth in resources,
the numerous recommendations in the June report appear at-
tributable to the broadened scope of the new examination
procedures, rather than to a deterioration in bank opera-
tions.
     Revised examination report

     The examination report itself has been revised to com-
municate information more effectively both to OCC management
and to the banks.
     The traditional examination report contains numerous
pages of data, taken from the bank's records, that is
readily available to bank management. Many of the critical
comments are contained in the confidential section, which
the bank does not receive.  (See ch. 6.)
    The new report contains four major sections:

    -- Letter to the board of directors.
     -- Comment section.
                                   7-10
     -- Appendix.
     -- Confidential section.
     The letter to the board is to set forth the scope of
the examination and the examiners' evaluation of the condi-
tion of the bank--either positive or negative. Where prob-
lems exist, the letter is to describe the probable causes of
the problems and recommend corrective actions.

     The comment section is several pages of narrative in
which the examiner discusses the problems found and evalu-
ates such areas of bank activity as loan portfolio manage-
ment, investments and broker-dealer activities, earnings,
capital adequacy, and asset-liability management.

     Much of the appendix contains schedules supporting the
narrative in the comment section, such as a writeup of clas-
sified loans and a list of credit data and collateral excep-
tions.

     The confidential section of the report, which is not
furnished to the bank, is to relate matters requiring the
prompt attention of OCC senior staff, s, :h as

     -- suspected violations of law uncovered during the
        course of the examination,
     -- actions of senior bank officers which may require
        such official sanctions by OrC, as the threat of
        cease-and-desist orders or officers' removal, and
     -- subjective comments which have not been proven by
        the examiner but which nevertheless constitute
        areas of concern.
     The examination report also contains a form requiring
the signature of each board member attesting that he or she
has personally reviewed the content of the report.

Specialized and seecial supervisory examinations

     OCC decided that, with its new more extensive examina-
tions and with NBSS to identify changing situations in banks,
completely examining a bank three times every 2 years is
unnecessary. Therefore, during each 2-year cycle it will
normally examine each national bank completely once and per-
form two specialized examinations. For those banks which


                                7-11
are well managed, the specialized examinations will be
directed primarily at following up on changes that are dis-
closed by OCC's surveillance system. Fcr those banks which
show substantial weaknesses during the general examinations,
the specialized examinations will be directed largely at
following up on the actions taken to correct these weaknesses
as well as any changes detected by NBSS. In determining the
scope of specialized examinations, the examiners are to con-
sider the bank's changes in policy, procedures, or manage-
ment and any plans that could significantly affect future
operations.
     OCC has established minimum procedures to be used
during specialized examinations. The examiners may add pro-
cedures after considering such matters as
     -- the results of the most recent general examination,

     --the risk ascribable to the policies and practices
       employed by the bank,
     -- internal controls,
     -- the capability of managers and directors,

     -- the nature of and risk ascribed to transactions with
        and investments in related organizations,

     -- the internal audit function,
     -- the scope and results of the most recent examination
        by external auditors,
     -- the anticipated impact of local and national economic
        factors, and

     -- adverse changes in risk assets, earnings, or liquid-
        ity, or other matters coming to the examiners' atten-
        tion as a result of performing the minimium procedures.
     Other special supervisory examinations are to be per-
formed when a bank's condition necessitates an examination
or supervisory visit more than twice in one calendar year.
These examinations have no minimum scope requirements.
Rather, they are to consist of procedures selected to fit
the circumstances in each case.



                              7-12
     These specialized examinations will be scheduled primar-
ily in response to NBSS identification of a bank with severe
changes in its quarterly financial reports.

Evaluation of larde shared loans

     In 1975, OCC began a program of conducting special
examinations at certain banks which participate with other
banks in loans to large corporations. The purpose of the
program is to provide uniform treatment of the same loan
among participating banks. A loan qualifies for the program
(and is termed a shared national credit) if it totals
$20 million or more and two or more banks participate.

     A team of OCC bank examiners reviews a shared national
credit at the lead bank (or the national bank with the larg-
est dollar share when the lead bank is State-chartered) and
votes whether or not the loan will be classified (i.e.,
criticized). The shared national credit evaluation is then
incorporated into regular examination reports of all na-
tional banks which participate in the loan.

      In 1975, OCC reviewed 521 shared national credits at
14 lead national banks. The loans totaled $48 billion--
9 percent of the dollar value of all outstanding loans in
the commercial banking system.   In 1976, under
national credit program, OCC reviewed 704 loans the shared
                                                 at 16 lead
banks. These loans amounted to $63 billion, or 13 percent
of the value of all commercial bank loans.

     Many of the participating banks are State-chartered.
FDIC and FRS received limited data on OCC's 1975 shared
national credit evaluations and its 1976 consolidated report.
FDIC and FRS, however, did not use the OCC's evaluations
when their examiners reviewed the loans at the State-
chartered participating banks. On December 21, 1976, FDIC
headquarters advised its regional directors that their exam-
iners should begin utilizing the OCC's shared national
credit classifications when they examine a participating
State nonmember bank unless some change has occurred since
OCC's classification which would warrant a different clas-
sification.

     We traced 183 State bank participations in 53 loans
evaluated by OCC's shared national credit program, to com-
pare the evaluations of FRS and FDIC examiners to those of
OCC's team. In over half the cases for which the examina-
tion dates were comparable, the FRS or FDIC evaluation of
the loan differed from the OCC uniform rating.

                             7-13
     Loan eva'uations were inconsistent at both FDIC- and
FRS-superviseo banks.  At each of the 12 State member banks
we reviewed and at both of the State nonmember insured banks
which had participated in more than one shared national
credit, at least one loan evaluation differed.  In general,
many more State members than nonmembers participate in
shared national credits.  Of the 183 participations we
traced, only 19 were to State nonmember insured banks.

Revised trust examination erocedures

     OCC has also made extensive changes to its trust exami-
nation rrocess, as the Haskins & Sells study recommended.

     The new approach includes preprinted forms which are to
be completed for each trust departnme:t examined.  These
forms provide for more uniform examinations but still permit
the examiner-in-charge some leeway for dealing ;yith a partic-
ule- bank's situation.  The examiners may reduce their veri-
fication work if they find they can rely on the work done by
the bank's internal and external auditors.

     In March, April, and May 1976, the new procedures were
field tested in six banks: two in California, one in Iowa,
one in Kansas, and two in Pennsylvania.  Full implementation
began October 1, 1976.

Revised EDP examination
                      _rocedures

     Traditionally, examinations of electronic data process-
ing operations have been regionally administered with little
or no national coordination. They consisted of interviews
with bank personnel supplemented by limited reviews of
corroborating documents.  The EDP reports contained question-
naires requiring in some cases the examiners' overall assess-
ment of some EDP-related activity.  There were no agencywide
work plans or guidance to assist the examiners in these
assessments.  A headquarters official concluded that exami-
nations were not being conducted uniformly and in many
instances were of poor quality.  The Haskins & Sells report
made several recommendations for improving OCC's EDP exami-
nations.

     By November 1976, OCC was completing       improvements   in
numerous EDP related areas such as:

     -- Upgrading EDP examiners'   expertise.

     -- Developing a detailed examination handbook.

                              7-14
     -- Developing a comprehensive work program.
     -- Expanding the EDP field staff.

     -- Revising the EDP examination report.

     -- Increasing headquarters direction of EDP examinations.
    The new OCC handbook and work program should improve
and standardize examinations.

     In the traditional EDP examination report, question-
naires were filled out on various EDP activities whether or
not a deficiency was disclosed. (See ch. 4.) The revised
report eliminates the questionnaires and consists of narra-
tive comments on

     --the scope of the examination,
     -- any exceptions and deficiencies noted, and
     -- specific recommendations for improvement.

CHANGES IN FRS'S EXAMINATION APPROACH

     During 1975 the Federal Reserve Board's Committee on
Bank Regulation and Supervision undertook a number of studies
and projects to update and improve examination policies and
procedures.

Revised examination 2rocedures
     In Marcn 1976, the Board adopted a limited-scope
examination of historically sound banks, referred to as an
asset-management examination. These examinations are to be
alternated with regular examinations. Use of the new proce-
dure, however, is left to the discretion of the Reserve
banks.

     This examination is designed to increase efficiency by
shifting some examination resources from banks that are
prudently operated and relatively trouble-free to those
banks that are in more critical need of attention.

     The asset-management examination ±.- 4nt-,3ed to be
integrated with a surveillance program whicn, according to
FRB, need not be formal, but which should be sufficient to
highlight unusual shifts in a bank's position. The


                             7-15
surveillance results may influence whether an asset-
management examination or a regular examination will be made.
If substantial changes in senior management, ownership, or
local or general economic conditions have occurred or harmful
trends are developing, a regular examination may be war-
ranted.  This is, however, a subjective decision left to the
discretion of the Reserve bank.

     Techniques employed in this type of an examination may
differ from those employed in regular examinations.  The
principle thrust of the examination is to

      -- analyze assets (The examiner uses discretion in
         deciding how many to examine.),

      -- identify and analyze changes in overall financial
         condition and the caliber of management since the
         previous examination, and

      -- ascertain that policies and procedures are being
         followed that will insure compliance with relevant
         laws and regulations.

Monitor in_ system   s

     The Board has developed three major computer programs
that perform screening and monitoring functions on a variety
of data files for banks and bank holding companies.  The
main computer program generates a list of banks or bank
holding companies by specifying any set of financial ratios
for a peer group, which have actual or potential financial
problems, and monitors the progress of such companies over
time. The data sources for the main computer program are
the periodic reports of condition and income foc banks and
the bank holding company annual report and quartetly finan-
cial report (now under development).

     The consolidated bank holding companies shareholders'
report program uses published financial data to produce a
comparative ratio analysis of the 300 largest bank holding
companies.  The program produces six reports including
comparative percentage breakdowns of each holding company's
financial statements, year-to-year percentage changes in
various financial items and ratios, and rankings of bank
holding companies within peer groups by 24 financial ratios.
The data sources for this program are the annual and quar-
terly reports to shareholders published by large bank hold-
ing companies.


                               7-16
      The weekly bank monitoring program screens four weekly
 repcrting series which allow analysts and examiners to
 follow weekly and monthly changes of key balance sheet items
 of large banks and to derive monthly net income of reporting
 banks.

     The main computer program and the shareholders'
program became operational during September 1976, and the
weekly monitoring program will be operational during
January 1977.

     Additionally, FRS deve'oFwd in 1975 a report that
identifies transactions tha' cake place between the nonbank
portion of the holding company and the bank portion. Major
transactions are to be reported 10 days after they occur;
other transactions are to be reported quarterly. Informa-
tion from the report is computer processed at the Reserve
bank and sent to the Board. The report is reviewed at the
Reserve bank and the computer printout summary of the
report is reviewed at the Board to identify any large,
unusual, or improper transactions. A memorandum is prepared
quarterly for the Board that summarizes major transactions
and balances.
      In order to set up the surveillance system for bank
holding companies, the Board began developing in 1974 a
                                                          com-
puter supplement to the bank holding company annual report.
In 1975 the Board developed the intercompany transactions
and balances report that identifies major transactions be-
tween the bank and nonbank portion of the holding company
During 1976 the Board revised the bank holding company
annual report to add new information to aid monitoring, and
reformat the report to aid computer processing of the infor-
mation. The Board is now in the process of developing a
quarterly financial report for bank holding companies wnich
is intended to enhance the monitoring of the financial con-
dition of these companies.
      In addition to its computer programs, the Board moni-
tors banks and bank holding companies through manual sys-
tems. For example, the Board monitors on a daily basis
stock market prices and earnings reports that appear in
                                                         the
financial press. Formalized relationships have been set
                                                          up
with stock surveillance groups of the major stock e::changes
which alert the Board when a stock price breaks a price
                                                         or
volume parameter. Monitoring of earnings releases enables
the Board to obtain information before it would otherwise
available to the Board.                                     be


                             7-17
     In September 1976 the conference of presidents of the
Federal Reserve Banks completed plans for a minimum monitor-
ing system to be developed by each Reserve bank in addition
to any ot.er monitoring the bank considers necessary. Mean-
while, several Reserve banks have developed their own moni-
toring systems. The Board's surveillance group is to work
closely with the Reserve banks in developing a minimum
surveillance system so that the systems are compatible.
According to FRS the Reserve Banks' systems are directed
more to the district level and the Board's system is
directed towards monitoring large peer groups of banks and
bank holding companies that cross district boundaries.

     The Boston Federal Reserve bank began developing a
monitoring system about 4 years ago. The system started to
monitor banks about 2 years ago; the portion dealing with
bank holding companies is still under developme.t. The
system's purposes include monitoring individual banks as
well as the banking industry, providing a basis for sched-
uling examinations, and preparing an examiner for an exami-
nation.

      Data for the system comes from reports of condition
and income, weekly reports from certain banks, holding com-
pan', reports, and internally generated information. Banks
and holding companies are ranked in relation to each other,
..- the most extreme cases can be designated for additional
review.
     The Kansas City Federal Reserve bank monitors the
liquidity position of 36 large banks in its district to
identify banks whose liability management activities may
pose a threat to their financial stability. The Reserve
bank's staff developed several ratios which relate a bank's
confidence-sensitive si.ney (such as Federal funds and
$100,000-or-larger certificates of deposit) to that bank's
ability to refund this money to lenders on snort notice.
Such funds are not backed by Federal deposit insurance and
can be highly volatile. The Reserve bank uses rankings
rather than absolute criteria, and examines trends over time.
Data for this system comes from weekly reports filed by
certain large banks and from internally generated data on
borrowing from the Reserve bank. The Reserve bank began
developing the system in late 1974 and put it into operation
in early 1975.

     Of the 36 banks tracked, 33 are national banks moni-
tored largely for comparative purposes (although adverse

                              7-18
trends are brought to the attention of the OCC regional
administrator), and 3 are State member banks, over which
the Reserve bank has supervisory authority.

     The Kansas City Federal Reserve bank is also develop-
ing a comprehensive bank monitoring system, which it expects
to begin operating in early 1977.

     The San Francisco Federal Reserve bank is developing a
financial monitoring system to track the condition of banks
and bank holling companies in that district.   In addition to
monitoring, the system is expected to be useful in scheduling
examinations, preparing examiners to begin an examination,
and providing data for research, as well as in other areas.

     The system will use data from call and income reports,
weekly data on certain large banks, quarterly dat, 'n bank
holding companies, and examination data. The insc ation
will be analyzed on two levels: (1) all institutions will be
compared quarterly with approximately 18 relative or abso-
lute ratios relating to liquidity, leverage, capital ade-
quacy, profitability, and operating efficiency, and those
comparing unfavorably will be noted and (2) institutions so
noted will be subjected to detailed individual analysis.
The system is designed to give users flexibility in changing
the ratios used without reprogramming.

     The Reserve bank decided in mid-1975 to begin develop-
ing such a system and entered into a $76,000 contract for
its design. The system is expected to be operational in
early 1977 and is expected to have yearly operating costs of
about $23,000.
CHANGES IN FDIC'S EXAMINATION APPROACH
     On November 2, 1976, the Director, Division of Bank
Supervision, announced a new examination policy to become
effective January 1, 1977. The principal policy changes
relate to examination frequency and scope. FDIC is also
planning to make greater use ,f financial data that banks
prepare for it each quarter.

FrequencY   o f examination

     The new policy is to conduct, at least once every
12 months, a full-scope examination of each State nonmember
insured bank having supervisory or financial problems.
Additional examinations or visitations of such banks will be


                              7-19
made as considered necessary by the regional directors.
Banks not having supervisory or financial problems are to be
examined at least once every 18-month period, with no more
than 24 months between examinations.
      As stated in chapter 4, during the period of our review
FDIC did not have a policy on examination frequency.   In
practice, however, it examined most of its banks once each
year.

Sco2e of examination
     The scope of examination, as well as the report, may be
modified for banks with assets of less than $100 million
that have been operating for 3 full years and meet certain
prescribed standards with respect to management, capital,
earnings, fidelity coverage, controls, and audit.

     FDIC's new policy statement provides:
     "* * * Full use should be made of the bank's EDP
     and management reports, and sampling should be
     utilized wherever possible, and proof and veri-
     fication procedures may be eliminated or substan-
     tially limited unless circumstances indicate
     additioaal effort is needed in these areas.
     Additionally, the volume of loans subjected to
     analysis may be reduced, and less important
     branches need not be examined. Emphasis at these
     modified examinations should be placed on manage-
     ment policies and performance; the evaluation of
     asset quality, alignment and liquidity; capital
     adequacy; and, compliance with applicable laws
     and regulations.
     Where adverse trends or other justifications appear,
     appropriate revisions in the conduct of the examina-
     tion should be made and report schedules added."

     For banks with assets over $100 million which do not
have supervisory or financial problems, some curtailment is
permitted in the scope and reports of examination under cer-
tain conditions.

Monito ring systems
     FDIC has in operation and under development several
systems to moniitor bank performance for adverse trends and


                             7-20
identify banks which may have potential problems. Banks so
identified may be scheduled for priority examination or
other followup. These systems are based on data reported
periodically by banks on reports of condition and income.

     These systems were designed to utilize different method-
ologies and are, to some extent, competing. FDIC plans to
evaluate all of these systems over the next year or two to
determine which provide the most useful results. Thereafter,
FDIC plans to integrate the most effective systems into a
coordinated bank monitoring system.

    Three systems are currently in operation.

    -- Financial Trend Analysis. From this system a user
       can obtain a printout showing which banks in certain
       geographical areas meet certain levels for all or
       some of 83 variables.
    -- JAWS    (Just A Warning System).  This system identifies
       banks    whose financial ratios do not meet predeter-
       mined    levels in 13 critical areas. Headquarters
       staff    set a critical threshold for each ratio, but
       these    can be changed for individual regional offices.

    -- Early Warning System. Based on statistical analyses
       to identify the most critical differences between
       problem and non-problem banks, seven variables were
       selected and various weights, or importance, were
       assigned to each. This sytem produces a score for
       each bank which is designed to indicate the severity
       of its potential problems.

    Two other systems are under development:

    -- Monitoring System. On the basis of 11 variables,
       this sytem compares one bank against other banks of
       comparable size, and identifies those banks which are
       furthest above or below the group average.

    -- Regression Model. Based on balance sheet data, this
       system generates a model bank with an asset structure
       similar to the bank under study, and compares income
       and expense data of the bank under study with pro-
       jected data for the model to evaluate operating
       efficiency.




                               7-21
Revised trust examination Erocedures
     Changes in FDIC's trust examination process include
(1) a revised report format, more extensively covering
corporate activities and collective investment funds, and
(2) preprinted checklists, similar to the questionnaire and
checklists established by OCC but not as extensive.

     Of the three agencies, FDIC was the only one that did
not have specialized positions for trust examiners. FDIC
has now established 14 trust specialist positions which are
being filled.
NEW APPROACHES TO CONSUMER CREDIT
COMPLIANCE EXAMINATIONS
     The agencies have planned expanded efforts in consumer
credit regulation, following the enactment in 1975 of in-
creased legislative requirements.
     In testimony before the U.S. Senate Committee on Bank-
ing, Housing and Urban Affairs, the State Bank Commissioner
of Connecticut described a test based on a sample of 15 FDIC
examination reports. With only 2 exceptions, all 15
reported compliance. In contrast, 15 State reports revealed
961 offenses, including $35,180 in overcharges.
     FDIC, which has been using separate consumer credit
compliance reports nationally since September 1974, plaois to
adopt standard statistical sampling techniques and to in-
stall a specialist within each region, but not to change its
examination or reporting procedures.
     FRS, which plane to perform separate consumer credit
compliance examinations, found that the techniques needed to
examine bank policies and practices in the consumer credit
area are quite different from those used for determining the
safety and soundness of banks. The Federal Reserve Board
has developed new supplemental manuals for consumer credit
examinations. Additionally, several Federal Reserve banks
are developing their own procedural checklists foL the other
consumer credit regulations. FRS is also developing a
separate report of examination and procedures for consumer
credit compliance examinations. A committee of the Board of
Governors has been formed to study various approaches to
uniform enforcement of consumer credit laws.



                             7-22
     OCC conducted a test project during 1975 and 1976 in
one regional office.   It found that consumer credit protec-
tion laws were violated more frequently than was previously
thought. OCC officials, acknowledging that the national
banks have received only cursory reviews for compliance with
consumer credit laws, have begun a special crash program in
September 1976, with the target of examining all national
banks within 12 months. Key elements of the new examination
effort include

     --a revamped and greatly expanded examination question-
       naire which will enable the examiner to probe the
       policies, procedures, and practices of national banks,

     -- expanded programc to train assistant examiners in the
        new consumer-oriented examination procedures,

     -- coordinated followup procedures which will require
        the regional officer to secure early correction of
        banks' deficient practices,

     -- the help of the Comptroller's Enforcement and Compli-
        ance Division in getting banks to correct deficien-
        cies, and
     -- the use of standard statistical sampling techniques
        to provide examiners with a simplified yet accurate
        testing approach.
     All three agencies, as part of their increased efforts
in consumer credit regulation, have begun intensive examiner
training schools. Beginning in September 1976, the three
agencies started training experienced bank examiners to look
for consumer credit and fair housing violations. They expect
to eventually train all bank examiners in procedures for
consumer credit compliance examination. A separate staff of
compliance examiners will be developed to work independently
of other examiners or, in the case of FRS, to work concur-
rently with the commercial examiners.

CONCLUSIONS

     We support FDIC's and FRS's objective of giving greater
emphasis in the examination process tc the weaker banks and
less emphasis to the relatively trouble-free banks.  In our
view, however, the new approaches adopted by FDIC and FRS
will not provide the degree of assurance that OCC's new
approach will provide that examiners will systematically and


                             7-23
indepth examine banks' policies, practices, procedures, con-
trols, and audit to identify weaknesses in bank management
which could lead to serious problems.

     OCC's revised commercial examination procedures should
provide the agency with more meaningful information regard-
ing the banks it supervises and result in more complete and
consistent examinations.  More importantly, the new approach
should result in early detection of situations which could
cause banks difficulty. Examiners could thus help banks
avoid problems rather than point out problems after they
have occurred.

     To derive the full benefit of this approach OCC must
act more aggressively than in the past to influence banks to
remedy defects in operations disclosed by its new examina-
tions.   (See ch. 8.) While the new procedures do provide
better documentation for deficiencies noted and more effec-
tive communication between OCC and bank directors and senior
management, the new procedures will not guarantee that weak-
nesses noted will be corrected. We believe that a computer-
ized system for monitoring the actions taken to correct
deficiencies, such as   a NBSS action control system, is a
step in this direction.

     The new OCC procedures for examining trust departments
and EDP operations, in our view, would assure more uniform
and indepth examinations than do the traditional approaches
and could be used by all three agencies.

     More experience is needed with the new examination pro-
cesses before many practical aspects of the processes can be
fully assessed. However, we believe that the concepts are
logical and offer benefits which could also apply to FDIC
and FRS.  Because of the importance of the changes, we be-
lieve that OCC should invite FDIC and FRS to jointly compare
its new processes with the traditional processes, as well as
the modifications being made by the other two agencies, both
in terms of benefits derived and resources consumed.   Such
an assessment would provide a sounder  foundation for fully
implementing the new processes at. OCC, as well as at FDIC
and FRS. It could help resolve such issues as:

     -- Costs and staffing implications of new processes.

     -- Applicability of new processes to banks of all
        sizes.



                             7-24
     -- Whether the agency already has sufficient data about
        ceit-.n well-managed banks to waive some of the
        detaied review of policies, procedures, etc. at
        these banks.
     In our view, the responsibility to analyze all large
shared national credits should be centralized in one group
composed of examiners from all three agencies. This group
could produce classifications of these loans at the lead
banks which would be accepted by all three agencies when
they examine the participating banks--both national and
State banks. The three agencies operate under a uniform
agreement for classifying loans; thus examiners from the
three agencies should not encounter insurmountable difficul-
ties in arriving at uniform classifications.

     By different routes, the agencies are striving to find
the most meaningful system for monitoring banks and the most
effective approach to examine banks for compliance with con-
sumer protection laws. We believe they would benefit from
jointly evaluating the various systems and approaches being
developed. Each agency could modify its approach to incor-
porate strengths that other approaches may offer.

RECOMMENDATIONS

     We recommend that the Comptroller of the Currency
invite FDIC and FRS to jointly evaluate its new examination
approach. We further recommend that, in the event of a
favorable assessment of the new process, the Board of Direc-
tors, FDIC, and the Board of Governors, FRS, revise their
examination processes to incorporate the concepts of OCC's
approach.

     We recommend that the Board of Directors, FDIC, the
Board of Governors, FRS, and the Comptroller of the Currency
jointly staff a group to analyze shared national credits at
State and national lead banks under Federal supervision and
that the three agencies use the uniform classification of
these loans when they examine the participating banks.

      We recommend that the Board of Directors, FDIC, the
Board of Governors, FRS, and the Comptroller of the Currency
work together to refine their monitoring systems and their
approaches to examining for compliance with consumer credit
laws.




                             7-25
AGENCY COMMENTS
     With respect to our recommendation relating to OCC's
new examination approach,
     FDIC stated:

     "In light of the limited testing that has been
     conducted (10 banks) of the OCC's new process, we
     believe it is premature to consider that process
     a success either for large or small banks. Repre-
     sentatives of the OCC admitted that, while the new
     procedures are workable in banks with assets be-
     tween $50 million and $1 billion, they do not
     appear feasible for banks with assets of less than
     $25 million. We therefore question the logic and
     wisdom of GAO's recommendation that FDIC adopt
     such process, either for the large or small banks
     under our direct supervision, especially when it
     is recalled that 91% of the banks we directly
     supervise have assets of less than $50 million
     and 77% less than $25 million. Since the number
     of large banks directly supervised by the FDIC
     has and continues to increase, our examination
     process is necessarily designed to handle small,
     medium and large-sized banks. However, we shall
     follow closely OCC's experience with the new
     examination process as it undergoes further test-
     ing, and we remain receptive to further revision
     in our own examination approach which will be
     beneficial to and improve our supervisory capa-
     bilities.

     "In our judgment, the discussion of changes in
     FDIC's examination approach does not reflect
     sufficiently the impact and significance of those
     changes, especially with respect to our review of
     the management policies and internal controls of
     a bank under examination. We believe that the
     changes made by the FDIC represent, at the present
     time, the most logical, beneficial, and prudent
     improvements in the examination orocess. We have
     blended the proven techniques and practices with
     a new approach which we feel should enable FDIC
     to focus more directly on, and devote more time
     and effort to, problem and near-problem situa-
     tions, and concomitantly less on healthy banks.
     We refer to excerpts from our General Memoran-
     dum #1, included with our general comments."
                             7-26
     FRS stated:
      "The Comptroller's new procedures are based
     in large part on the Haskins & Sells report.
     At the time that report was prepared, the
     Comptroller furnished it to the other banking
     institutions in the belief that some of the
     recommendations might be jointly applicable.
     A task force at the Federal Reserve reviewed
     the report shortly after its issuance and
     concluded that, in most instances, the System
     had already implemented those recommendations
     involved which would have been applicable to
     the System. Subsequent to that time, the
     development of new examination procedures
     at the Comptroller's office has been substan-
     tially completed.   Recently, senior members
     of the Board's staff attended a briefing by
     the Comptroller's office on these new examina-
     tion procedures and the report form to be used
     by that agency. The Board believes that the
     Comptroller has been most cooperative in shar-
     ing his new systems with us and fully intends
     to use whatever benefits may be derived from
     the Comptroller's efforts in this area in our
     on-going review of our examination procedures."
     OCC stated:

    "On November 23, 1976, OCC staff members made
    a presentation to approximately 20 FRS and FDIC
    staff members on the revised examination proce-
    dures. Copies of our draft Handbook of Exami-
    nation Procedures were furnished. Their review
    and evaluation on an ongoing basis is welcomed.
    The Acting Comptroller has proposed to the
    Interagency Coordinating Committee that a per-
    manent staff group be set up for this purpose."
     With respect to our recommendation relating to joint
evaluation of shared national credits,
     FDIC stated:

    "Although--as the GAO report points out--of the
    183 participations in shared national credits
    traced by GAO only 19 were to state nonmember
    insured banks, the FDIC is now a participant
    in the Shared National Credits Program."

                            7-27
FRS stated:

"A joint approach to shared national credits is
clearly desirable. In fact, in June 1976 the
Board and the Office of the Comptroller of the
Currency entered into a preliminary agreement
which provides for a sharing by each agency of
examiners' classifications of a national credit."

OCC stated:

"In 1974, meetings were held with representatives
of the OCC, FRS and FDIC present to discuss the -
possibilities of using a uniform program for the
review of selected large shared loans. Both the
FRS and the FDIC found merit in the program but
they believed sufficient pitfalls existed to delay
their participation in the program. Also, in
March of 1974 this Office met with representatives
of the Conference of State Bank Supervisors to
discuss the proposed program. They indicated
interest and agreed to work out arrangements with
various bank supervisors.

"In 1975, the Office of the Comptroller of the
Currency conducted uniform reviews of shared
national credits in applicable Naticnal Banks.
The loan write-ups generated by these reviews
were made available to both the FRS and the
FDIC. In March, 1975 FRS expressed their con-
tinued interest in the program and hoped they
could participate if the "pitfalls" could be
overcome. In November, 1975 'RS revealed they
were instituting a test review program involv-
ing state member banks paralleling our methods
and procedures. In July, 1975 FDIC again ex-
pressed interest and a meeting was held in
September, 1975 with representatives Jf the
FDIC. This Office indicated FDIC involvement
would be welcomed in whatever way they deemed
appropriate.

"During May, 1976 the second uniform review was
conducted and again the data generated was made
available to the FRS and FDIC.

"In July, 1976 the Comptroller of the Currency
and the Vice Chairman of the Federal Reserve


                        7-28
     Board met to discuss the approaches of the two
     agencies to shared national credits. It was
     agreed that the 0; should continue to provide
     FRS with the information developed under its
     program and to explore at a staff level whether
     uniform procedures could be developed between
     the two agencies waich would be acceptable to
     all of the Federal Reserve Banks. It is our
     understanding that the New York Federal Reserve
     Bank is conducting a pilot project involving
     shared credits which may assist in resolving
     some of the anticipated problems associated
     with a combining of the approaches of the two
     agencies."
     With respect to our recommendation relating to monitor-
ing systems,

    OCC stated:
    "The OCC has met on several occasions with
    officials of the other two Federal supervisory
    agencies to present its NBSS system. Those
    orientations were given both orally and with
    complete submission of all relevant documents.
    Further, we have offered the other supervisory
    agencies computer programs and technical know-
    ledge to implement the programs."
    FDIC and FRS did not respond to this recommendation.

     With respect to our recommendation relating to consumer
credit compliance examinations,

    FDIC stated:

    "We are, of course, in favor of the three
    federal bank regulatory agencies sharing
    and working together in the important area
    of consumer credit compliance. However, in
    many instances healthy competition in the
    area of consumer credit compliance as well
    as in other areas of banking supervision
    between the three federal bank regulatory
    agencies can lead to a better system of
    supervision then complete uniformity. Thus,
    the development of an independent approach
    by one or more of the agencies may lead to a
    better end result."



                            7-29
FRS stated:

"The second portion of this recommendation
deals with the desirability of uniform re-
finement of consumer credit enforcement and
compliance policies.  In the report, the GAO
states that some agencies believe there is
a possible "conflict between a bank's objec-
tive of financial soundness and strict com-
pliance with consumer credit laws."  The
Board does not agree with this statement.
On the contrary, we believe that stringent
enforcement of consumer laws and regulations
will achieve compliance and thereby reduce
the likelihood that banks will incur sub-
stantial liability as a result of consumer
suits.

"The Federal Reserve has had the major
responsibility for drafting regulations to
implement the explosion of legislation that
has taken place in this area over the past
two years.  Ini this connection, the Board's
Division of Consumer Affairs has worked very
closely with the other agencies.   It has
formed a lederal Reserve task force to de-
velop approaches to the enforcement of newly
enacted consumer credit laws.   A cadre of
examination specialists who will concentrate
on inspection and compliance is being trained.
Two schools on consumer regulations were
conducted in 1976 and four have been planned
for 1977.

"Additionally, examination manuals that deal
with the full array of consumer regulations
have recently been prepared.  A new examina-
tion report form dealing exclusively with this
area has been prepared and is expected to be
in use in the near future."

OCC stated:

"With reference to consumer credit compliance
examinations the draft report does not fully
recognize that our new program is already
operational.  Over 6% of our field staff is
currently allocated to the consumer area.   We


                        7-30
have conducted three two week schools which
trained over 140 examiners in the new proce-
dures; a second series of three schools is
scheduled for March and April, and a third
series will take place in the Fall.   The
schools stress examination techniques and
feature heavy reliance on case studies to give
experience in examining for compliance.    The
procedures are tailored to spot problems most
likely to result in harm to consumers.    We
make use of sophisticated advanced financial
calculators, specially programmed for banking
applicatio.is, and sampling techniques designed
to increase our effectiveness.

 Eleven percent of the country's 4,700 national
banks have been examined under the new proce-
dures.  Prelim'nary analysis of these reports
indicates that our expanded efforts in this
area are both justified and effective.

"The draft report also does not reflect the
extent to which other agencies have cooperated
in developing our new program.  The Federal
Reserve Board and H.U.D. aided in reviewing
our procedures.  Speakers from the Federal
Reserve Board, H.U.D. and the Justice Depart-
ment participated in our schools.  Observers
from the Federal Reserve Board, FDIC, N.C.U.A.
ani H.U.D. attended the schoo.s to assess the
new procedures.  As a result many of our ex-
amination procedures and teaching materials
have been adopted by these .our agencies.
This experience has reinforced our awareness
of the benefits of such cooperative efforts."




                        7-31
                           CHAPTER 8

      EFFECTIVENESS OF AGENCIES IN RESOLVING PROBLEMS


                                                        Page
Overview                                                8-1
How the agencies deal with problems                     8-4
    Informal enforcement actions                        8-4
    Formal enforcement actions                          8-7
Frequency of enforcement actions taken by agencies      8-12
    Results of enforcement actions                      8-13
    What types of problems can formal actions be
      used to correct?                                  8-].4
    What happened when formal actions were used?        8-15
    Conclusions                                         8-18
    Recommendation                                      8-18
    Agency comments                                     8-19
Case studies--How agencies dealt with banks
  to resolve problems                                   8-23
    Conclusions                                         8-44
How the agencies decide which banks
  require special supervisory attention                 8-44
    FDIC problem classifications                        8-45
    FRS problem classifications                         8-46
    OCC problem classifications                         8-46
    Different criteria--different problem banks         8-47
    Conclusions                                         8-49
    Recommendation                                      8-49
    Agency comments                                     8-49
Dynamics of the prob'   n bank list: 1971-75            3-51
    Conclusions                                         8-53
Enforcement actions against bank holding companies      8-54
Do the supervisory agencies have appropriate powers?    8-55
    Conclusions                                         8-57
                           CHAPTER 8
        EFFECTIVENESS OF AGENCIES IN RESOLVING PROBLEMS

OVERVIEW

     Our analysis of enforcement actions taken by the
supervisory agencies for almost 900 banks included in
our samples showed that informal actions were used most
of the time and that formal actions were seldom used.

     The agencies dealt with problem and nonproblem banks
in basically the same way. Even though the same types of
problems existed from one examination to another, the agen-
cies did not always change or intensify the type of en-
forcement actions used to get the problems corrected. The
supervisory agencies should have used their formal enforce-
ment powers more often.

     Examiners find some type of problem in virtually all
banks; however, some banks have more serious problems and
require more supervisory attention than others. The agencies
cannot correct the banks' problems themselves but they
can use many enforcement tools to get banks to correct
their problt,.s. These tools include both informal and formal
enforcement actions.

     Informal enforcement actions are nothing more than an
agency's attempts to persuade bank management to take
corrective action. Formal enforcement actions are used as
a last resort for getting problems corrected. Some of the
formal enforcement actions do not help correct problems
or save banks, but result in closirg the bank to protect
depositors.

     After an examination, the agencies evaluate the effect
that the problems identified during the examination can
have on the bank's soundness. If the problems are serioL
tne bank is designated for special supervisory attent:on.
Such banks are sometimes referred to as "problem banks."
       'cause the agencies use different criteria to identify
problem Danks, they often do tlot agree on which banks
require special supervision. Of the 4,744 national banks
operating cn December 31, 1975, OCC considered 85 as re-
quirialg special supervision; FRS 267; and FDIC 52.



                             8-1
Among the 1,046 State member banks, FRS identified 65
problem banks and FDIC identified 17. Because the agen-
cies' interest in and responsibility for dealing with
the banks overlap, and because their interest should
intensify as serious problems arc identified, we
believe they should work towards a common definition of
banks requiring close supervisory attention.
     To assess the supervisory agencies' effectiveness in
getting banks to resolve their problems once they have been
designated for special supervisory attention, w -nialyzed
the agencies' "problem list" for the 5-year period ending
December 31, 1975. During that period 718 State nonmember
banks, 128 State member banks, and 686 national banks had
at some time been in the agencies' problem bank category.
Of those banks, 414 (58 percent) of the State nonmember
banks, 38 (30 percent) of the State member banks, and 392
(57 percent) of the national banks were returned to non-
problem status by December 31, 1975. Although most re-
turned to nonproblem status within 2 years, 19 percent
were problem banks from 2 to 5 years, and 5 percent were
problem banks for over 5 years.
     The supervisory agencies' success in getting bank
problems corrected depends heavily on cooperation from bank
management in changing the practices and policies which
caused the problems. Those banks which are receptive to
the agencies' identification of problems and suggestions
for solutions stand a better chance of correcting their
problems sooner.  Informal enforcement action works for
these banks.

     What conce      us are those banks which are problem banks
for long periods  of  time, for example the 201 banks that were
problem banks fur  over  2 years during 1971-75. We believe
that the supervisory agencies should have used formal en-
forcement actions more frequently when dealing with these
banks. During the entire 5-year period, the agencies made
limited use of written agreements and cease and desist or-
ders, probably their most effective tools. The use of
written agreements was FDIC 3, FRS 8, and OCC 48, and the use
of cease and desist orders was FDIC 38, FRS 5, and OCC 13.
During 1976, each agency increased its use of cease and
desist orders. FDIC used 29, FRS used 4, and OCC used 7.
Also, OCC increased its use of wsitten agreements in 1976,
when it used such acti 'n 23 times.

     The supervisory agencies have requested additional
statutory authority to remove a bank official whose acts

                             8-2
stem from either personal dishonesty or gross negligence
and to assess civil penalties against banks and individual
officials for specific violations. Our study of failed
and problem banks showed that the authority to remove in-
dividuals or to apply penalties could have been helpful in
dealing with the officials of these banks. We believe that
the authority to remove individuals or to apply civil
penalties could be useful to the agencies and we would
support such legislation.




                           8
HOW THE AGENCIES DEAL WITH PROBLEMS


     Once the supervisory agencies have identified problems
and communicated them to the bank, they have at their
disposal a number of enforcement tools which they can use to
get bank management to correct its problems. These tools
include both informal and formal actions.
     For purposes of analyzing agency files, we identified
10 kinds of informal enforcement actions and 7 kinds of for-
mal actions.
Informal enforcement actions
     Infor;nal enforcement actions, sometimes referred to as
mora. suasion, are simply the supervisory agencies' efforts
tc persuade bank managers to correct a problem.
     Discussion at time of examination

     The examiner-in-charge discusses problem situations
with the bank's executive officers as problems are discovered
or at the close of the examination. The purpose of such
meetings is to direct managers' attention Lo the problems
found and to possible resolutions. It the problems are
serious, regional or district officials may attend the
discussions. If the bank is State chartered, State officials
may also attend. The supervisory agencies may also discuss
the deficiencies with the bank's board of directors.
(See below.)
     Request for formal response
     to reported deficiencies
     The supervisory agencies frequently request that banks
respond formally to criticisms in examination reports. Such
a request is made in the transmittal letter to the bank.
The agency, aftt  reviewing the bank's response, may con-
clude that the bank is correcting or has corrected its prob-
lems. The agency would then followup no further until the
next scheduled examination. On the other hand, if the agency
is not satisfied that the problem is being dealt with, it
can take other followup actions.




                               8-4
     Request for 2eriodic _rogress reports
     The supervisory agencies often ask banks to report
periodically on progress in correcting deficiencies (e.g.,
the status of classified assets).  Such a request also is
made in the transmittal letter accompanying the bank
examination report. After reviewing progress reports, the
agency may decide the bank is correcting its problems and
may request no further progress reports. On the other hand,
the agency may decide that more frequent progress reports
are required or that some other type of enforcement action
is needed.

     Request for meeting with
     bank's board of directors

     The supervisory agencies can request a meeting with the
bank's board of directors to discuss examination results
and the bank's condition.

     Since January 1976, OCC's policy is to meet with each
board of directors annually, usually at the time of the
examination. FDIC and FRS do not routinely meet with the
bank's boards of directors.  (See ch. 6.)
     Written communications
     One method of informal followup, other than the
transmittal letter, is a letter from the supervisory agency
to the bank. Depending on the seriousness of the problems,
the letter may be signed by the examiiier-in-charge, a re-
gional or district official, or a headquarters official. If
a State agency is involved, a State official may sign the
letter.  The agencies can use written communications to make
followup requests for for mal responses to examination report
deficiencies and progress reports.

     Bank visits
     The supervisory agencies can visit banks to followup on
problems. Such a visit may be to meet with directors, ex-
ecutive officers, or other individuals in the bank.

     Special   examinations
     OCC and FRS use special examinations to monitor certain
bank problems. Such exi 'inations are limited in scope. For
example, the agency might visit the bank and review its


                              8-5
classified loans if the examiner cited them as a serious
problem during the last examination or if the agency notes
from the bank's progress reports that classified loans are
not improving.

     FDIC does not generally conduct special examinations
but prefers to increase examination frequency o0 problem
banks.  The frequencies of examinations for the 1970 and
1975 problem bank samples were as follows:

                          Months between examinations
                          FDIC         FRS        OCC

12/31/70 sample               6.5      8.0        5.3

12/31/75 sample               6.7      8.1        5.8

     The three agencies may also place examiners in banks
for long periods to monitor certain problem situations.

     Branch application rrejections

     The supervisory agencies may reject a bank's application
for a new branch as a way of inducing management to correct
its problems.  These actions can be effective in improving
the condition of banks suffering from managerial neglect.
FRS also may reject a bank holding company's application for
banking and nonbanking subsidiaries t) influence management
to correct problems.

     Public disclosure

     The supervisory agencies can disclose or threaten to
disclose a bank's problems publicly to force bank management
to correct its problems.  However, public disclosure of
problems requires advance notice to the bank and could
have undesirable effects, such as causing depositors to
withdraw their funds from the bank.

     Threat of le2al action

     One of the more effective informal actions that tiic
supervisory agencies can use is the threat of taking legal
or formal action if the bank does not correct itb problems
within a given period of time.




                               3-6
Formal enforcement actions

     Formal enforcement actions are used by the supervisory
agencies as a last resort to get bank managers to correct
their problems. Some formral actions do not help correct
problems, but result in closing the bank to protect
depositors.

       Written agreements
     The supervisory agencies use formal written agreements,
sometimes referred to as voluntary agreements or letter agree·-
ments, to confirm a bank's plans to correct problems. The
agency and the bank both sign the agreement. A violated
agreement can be the basis for issuing a cease and desist
order against the bank.

     The agencies'use of written agreements for the period
1971 through 1976 was as follows:

                               FRS
Year            FDIC         (note a)      OCC          Total
1971              1              1          3              5
1972              1              -          4              5
1973              1              3          6             10
1974              -              2         17             19
1975              -              2         18             20
1976              -              1         23             24
                  3              9         71             83
a/Does not include 12 agreements against bank holding
  companies.

       Cease and desist orders
     The supervisory agencies, under authority of the
Financial Institutions Supervisory Act of 1966 (12 U.S.C.
1818(b)), can issue cease and desist orders against banks to
get problems corrected. First, a notice of charges is
served upon a bank

       -- which has engaged or is engaging in unsafe or unsound
          practices,
       -- which has violated or is violating a law, a rule, a
          regulation, or a written agreement with the agencies,
          or any condition imposed in writing by the agencies
          in connection with the granting of any application or
          other request, or
                                8-7
    -- which is about to do either.

The notice of charges presents a        statement of facts con-
stituting the alleged violations        or unsound practices and
establishes a time and place for        a hearing to determine
whether a cease and desist order        should be issued.

     If bank representatives do not appear at the hearing or
if the hearing confirms the violation or the unsafe or un-
sound practices, the agencies may issue the cease and desist
order. A bank can consent to the cease and desist order,
thereby obviating a hearing. Once the order becomes effec-
tive, it remains in effect until it is stayed, modified,
terminated, or set aside by the agency or a reviewing court.

     The agencies'use of cease and desist orders for the
period 1971 through 1976 was as follows:
                                   FRS
  Year           FDiC            (note a)         OCC         Total

  1971            7                1               -            8
  1972           10                3               2           15
  1973            9                -               4           13
  1974            4                -               2            6
  1975            8                1               5           14
  1976           29                4               7           40

                  67                9             20           96

  a/Does not include 12 orders against bank holding
    companies.
         Removal of management

       Also under the Financial Institutions Supervisory Act
  of 1966 (12 U.S.C. 1818(e)), FDIC and FRS may order the
  removal of a director or off cer of a State bank which
  they supervise and OCC may recommend that FRS remove
  one from a national bank when
         -- the director or officer has violated a law,
           a rule, a regulation, or a final cease and
           desist order; has participated in any unsafe
           or unsound banking practice, or has committed
           or engaged in any act, omission, or practice
           which constitutes a breach of his fiduciary
           duty; and

                                 8-8
    -- as a result, the bank has suffered or will
       probably suffer substantial financial loss or
       other damage, or the interests of its depositors
       could be seriously prejudiced; and

     -- the violation, practice, or breach involved personal
        dishonesty on the part of the director or officer.
     The agency must first serve the director or officer
with a written notice of its intention to remove him/her
from cffice. The notice of intention states the grounds
for removal and establishes a time and a place for a hear-
ing. As with a cease and desist order, the agency can re-
move the director or officer if he fails to appear at the
hearing or if the charges specified in the notice of inten-
tion are substantiated. The removal order, too, remains
in effect until stayed, modified, terminated, or set aside
by the agency or a reviewing court.
     In addition, the agencies have the authority (12 U.S.C.
1818(g)(1)) to suspend any bank director or officer indicted
for a felony involving dishonesty or breach of trust. The
statute provides that such a suspension can be enforced
by written notice and remains in effect until the charges
are disposed of or the suspension is terminated by the
agency. In Feinberg v. Federal Deposit Insurance Company,
420 F. Supp. 109 (D.D.C.- 1976), a three-judge distrct court
declared the statute to bL "constitutionally infirm" inso-
far as it permits the issuance of a notice and order of
suspension without affording the individual an immediate
post-suspension hearing, preceded by notice of such a
right, and an opportunity to be represented by counsel, to
make written submissions, and to make oral argument. FDIC
officials said they are working with the other agencies to
prepare and issue regulations in an effort to comply with
the due process requirements.




                             8-9
     During the period 1971 through 1976, the agencies took
action to remove or suspend management as follows:

               FDIC             FRS        OCC
Year         (note a)         (note a)   (note a)          Total
1971
1572             3               1           3                7
1973             3               -           8               11
1974             4               -           3                7
1975             6               2           9               17
1976             3               1           3                7
                19               4          26               49


a/Includes 15 FDIC, 2 FRS, and 25 OCC suspensions.
       Financial assistance
     FDIC has the authority (12 U.S.C. 1823(c)(e)) to provide
funds to insured banks in danger of closing which are essen-
tial for providing banting services to the community or to
assist a merger, or sa.e of assets and assumption of liabili-
ties of A,failing or failed bank into or by another insured
bank. In providing financial assistance, FDIC can require
that bank managers correct theirc problems.

       Such assistance may include

       -- making deposits in the troubled bank,
       -- purchasing assets of the failing or failed bank,

       -- granting a loan secured by the assets of the failing
          or failed bank, or
       -- guaranteeing another insured banK against loss
          in assuming the assets and liabilities of the
          troubled bank.

     FRS has the authority (12 U.S.C. 347(a)) to extend credit
to member banks

       -- to increase their available funds because of
          developments such as a sudden withdrawal of
          deposits or seasonal requirements for credit
          which cannot reasonably be supplied from the
          banks' own resources or


                                 8-10
     --to assist them in meeting unusual situations
       which may result from national, regional, or
       local difficulties.

     Cancellation of deposit insurance
     FDIC has the authority (12 U.S.C. 1818(a)) to
terminate a bank's deposit insurance if

     -- its officers or directors are engaging in
        unsafe or unsound banking practices,
     -- it is in an unsafe or unsound condition, or
     -- it has violated an applicable law, rule,
        or regulation, or order; a condition imposed
        in writing; or a written agreement with FDIC.

     When FDIC initiates proceedings to terminate insurance,
it may give that bank a maximum of 120 days to correct its
problems. If the bank corrects all or some of its problems
within the t.me period allowed, FDIC may drop the termina-
tion proceedings altogether or take other action, for ex-
ample a cease and desist order. If the bank does not correct
its problems, FDIC's Board of Directors can terminate its
insurance.
     During the period 1971 through 1976, FDIC initiated
termination proceedings as follows:

                               Number of
                Year          proceedings
                1971               5
                1972               5
                1973               1
                1974               3
                1975               5
                1976               8
                                   27
Only 1 of the 27 proceedings, in 1976, resulted in termi-
nation of deposit insurance. Before 1371, FDIC terminated
the insurance of 13 banks. Canceling a bank's deposit in-
surance does not solve its problems.




                            8-11
     Cancellat rl of FRS memberh
     FRS has the authority (12 U.S.C. 327) to cancel a
bank's membership in the Federal Reserve. As far as we
could determine, FRS has used this authority only once as
a corrective tool. As with terminating deposit insurance,
this action does not solve a bank's problems.
     Revocation of charter
     OCC has the authority (12 U.S.C. 93,481) to revoke
national bank charters and States have the authority to
revoke State bank charters, although this too solves no
problems. In the last 2 decades, as far as we could deter-
mine, OCC has not revoked a bank's charter for not correct-
ing its problems.

FREQUENCY OF ENFORCEMENT
ACTIONS TAKEN BY AGENCIES

     The table below show- the percentage of sampled
banks for which the su ? Lvisory agencies took various in-
formal and formal enfoicement actions.

     Our tabulations are based on agency actions documented
in examination reports and correspondence files. In inter-
preting the tabulations, the reader should recognize that
the agencies would hardly ever need to use all types of ac-
tions with any one bank. We are not suggesting that the
figures should be 100 percent, even for problem banks.
     The tabulations show how differently the agencies
treated problem banks from banks in the general sample.
They also show differences between actions t)ward banks
considered problems in 1970 and actions toward banks con-
sidered problems in 1975.




                             8-12
                                           Dec. 1970 prob-              Dec. '975 prob-
                        General sample     lem sample banks             lem sample banks
                        banks_inote_a)        (note b)                     (note b)
                        FDIC FRS OCC       FDIC FR! OCC                 FDIC FRS OCC
Number of banks          161   192   201    53    37       54            54   40       50
Informal
  actions:              --------- (percent of sampled banks)-------------
     Request for
       formal
       response to
       reported
       deficiencies       30    61    43   17     57       35            44   65       34
     Request for
       periodic
       progress
       reports             6     5    12   32     46       56            41   48       62
     Request for
       meetings
       with bank's
       board of
       directors           1     9     6   36     57       50            30   53       54
     Written
       communications    22     35    30   34     27       43            54   50       58
     Bank visits          1      2     4    2     11       33             6   10       18
     Special
       examinations        -     2     3      2    3       19             -   18       32
     Branch appli-
       cation rejec-
       tions               -     -     1      -                           4    -        4
     Public dis-
       closure             -     -     -      -                          -             -
     Threat of
       legal action       -      -     -      2    -        -             4        -

Formal actions:

     Written
       greements          -     -      -      1                 -       - -    -       6
             vnd
       ]e.i ,t orders      1    -      -      2   -         -             4    -       2
          .1 of
       .nangqemcnt         -    -     -       -                                3       -
      inancial
       assistance                      -      -        -            -         -        -
     Cr.ncellation of
       deposit insur-
       ance               -     -      -
     Revocation of
       charter            -     -     -

a/   Since earliest report of examination.

b/   Since second most recent report of examination.




                                      8-12a
     As the above table shows, the frequently used enforce-
ment actions were requests for formal responses to reported
deficiencies, requests for periodic progress repnrts, re-
quests for board of directors meetings, and written com-
munications. For the mast part the above actions were used
more frequently on problem banks than on general banks.
     Compared with their treatment of 1970 problem banks, in
1975 the agencies requested more formal responses and peti-
odic progress reports and used more written communications.
FDIC's increase was the largest.
     As far as ti~. remaining enforcemert ?ctions, including
formal actions, are concerned, their use vas limited.
Results of enforcement actions
     We reviewed a sample of 149 banks which were on the
supervisory agencies' problem lists at Decem.br 31, 1970,
to determine how effective the agencies were in getting
bank management to correct problems. We used the 1970
sample of problem banks because the agencies had had 5 years
to get the banks to correct their problems. As of Decenm-
be£ 31, 1975, the status of the 149 banks was as follows:
                            FDIC            FRS            OCZ
                        Num- Per-       Num- Per-      Num- Per-
                        ber    cent     ber     cent   ber    cent

Removed from prohlem
  bank list (105)        44       80    15      38     46      84
Converted to a
  national or State
  charter (5)             -        -     1       3      4       7
Withdrawn from FRS
  membership (7)          -              7      18      -
Merged with another
         (7)              -        -     6      15      1       2
  bank
Failed (4)                2        4     1        3     1       2
Remained on problem
  list (21)               9       16     9      23      3       5

     Total               55      100    39     100     55     100




                                 8-13
     For the 105 banks which had beer taken off the problem
lists we determined the length of time spent in problem
status:


                          FDIC           FRS            OCC
                      Num- Per-      Num- Per-      Num- Per-
      Years           ber    cent    ber     cent   ber     cent
     Under 1             6      14     1       7     12      26
     1 to 2             13      30     1       7     18      39
     2 to 3              9      20     2      13      5      11
     3 to 4              7      16     4      26      2       4
     4 to 5              4       9     1       7      3       7
     5 to 10             5      11     6      40      6      13
       Total            44     100    15     100     46     100
     The supervisory agencies used primarily informal en-
forcement actions against the 149 banks. OCC and FDIC had
the greatest degree of success using informal action, return-
ing 84 and 80 percent respectively nf the problem banks to
nonproblcm status, while FRS was successful with only 38
percent of its problem banks.
     OCC hea the greatest success in getting problems
resolved quickly. About 65 percent of its banks which returned
to nk.nproolem status did so within 2 years. Only 44 percent
of the FDIC banks and 14 percent of the FRS banks which re-
turned to nonproblem status di- so within 2 years.
What tynes of proolensa can formal
actions be uced to correct?
     We analyzed the use of certain formal enforcement
actions to determine what types of problems they were in-
tended to correct and whether our sample of problem banks
exhibited these same types of problems. During 1971-75 the
agencies used cease and desist orders 56 times and written
agreements 57 times to obtain corrective action on problems
in banks. The agencies used these two actions to correct
many of the same types of problems identified in our sample
of problem banks. The following table shows the percentage
of cease and desist orders and written agreements that ,eere
used to deal with specific problems. The reader should note
that each formal action usually addresses more than one type
of problem.




                              8-14
                             Cease and            Written
     Problem               desist orders         agreements

Capital adequacy                   54                14
Violations of laws
  and regulations                  52                65
Loans--collections,
  policies, and proce-
  dures                            45                39
Loans--condition and
  classified                       43                42
Management--effective-
  ness                             41                35
Management--self-
  serving                          29                40
Liquidity/borrowings               20                 -
Internal controls/
  operating policies               20                26
Loans--concentrated,
  excessive, and out
  of territory                     16                12
Loans--extension of
  credit                            -                19
     As the above table shows, the agencies used cease and
desist o-ders and written agreements to correct many dif-
ferent types of problems. A high percentage of problem tanks
exhibited these same types of problems. For example, 92 pec-
cent of the problem banks which we reviewed had classified
loan problems; 81 percent had loan collection, policy and
procedures problems; and 78 percent had violated laws and
regulations. Yet each of these two formal actions was taken
against less than 4 percent of the banks on the problem list
during the 5-year period. We believe the agencies could have
used cease and desist orders and written agreements more
than they did to correct the problems noted in our sample
of problem banks.

What happened when formal actions were used?

     The supervisory agencies used cease and desist orders
and suspension of managers 18 times against 17 banks in our
problem sample. As of November 30, 1976, eight of these
banks were classified as nonproblems by the agencies. The
following tables show a chronology of events for the banks
which were returned to nonproblem status and for the banks
which were still problems as of November 30, 1976.



                            8-15
                       Banks Returned to Nonoroblem Status


                                   Type and                                Total
          Date    Months before    date of Montts before       Date       time on
       designated formal action     formal   problems        designated   problem
Bank    Epoblem      taken          action   resolved        nonproblem     list

  1     12/74           5         Suspension     12             5/76        17
                                     (5/75)
  2       2/74         16         Cease and      13             7/7F        29
                                  desist order
                                     (6/75)
  3       4/69         37         Cease and       4             9/72        41
                                  desist order
                                     (5/7,2)
  4       5/69         31         Cease and      12            12/72        43
                                  desist order
                                   (12/71)
  5      9/75          -          Suspension     13            10/76        13
                                     (9/75)
  6      2/67         45          Cease and      43            6/74        88
                                  desist order
                                   (11/70)
  7     11/67         59          Cease and      22            8/74        81
                                  desist order
                                   (10/72)
  8      5/70         20          Cease and      29            6/74        49
                                  desist order
                                    (1/72)

  Average months      27                         18                        -15




                                     8-16
             Banks in Problem Status at NovemDer 30, 1976

                                        Type and                Number of
           Date       Months before      date of                months in
        designated    formal action      formal      Months      problem
Bank     Problem         taken           action    since action   status

  1        3/55            196      Cease and          64          260
                                    desist order
                                       (7/71)
  2        8/75              7      Cease and            8          15
                                    desist order
                                       (3/76)
  3        5/68             27      Cease an]          75         102
                                    desist order
                                      (8/7J0
  4        9/73             30      Cease and           8           38
                                    desist order
                                      (3/76)
  5        2/66             76      Cease and          53         129
                                    desist order
                                      (6/72:)
                            90   a/ Suspension         39         129
                                      (8/73)
  6        6/71             39      Cease aid          26          65
                                    desist order
                                      (9/74)
  7        1/75              9      Cease and          13          22
                                    desist order
                                     (10/75)
  8        4/73             37      Cease and           6          43
                                    desist order
                                      (5/76)
  9        6/65             95      Suspension         42         137
                                      (5/73)




Average months              57                         33          90




  a/   Data for this action nct included in the averages.




                                 8-17
Conclusions
     The supervisory agencies can use a variety of informal
and formal enforcement tools to get bank management co cor-
rect problems. The agencies rely on informal tools much more
heavily than on formal tools.

     The agencies were somewhat successful in getting bank
management to correct the problems of the banks in our 1970
problem sample. Primarily through informal enforcement
actions, 70 percent of the banks had reached nonproblem sta-
tus as of December 31, 1975. What concerns us is the banks
that were in problem status for over 2 years and the remaining
banks which the agencies had been unable to return to non-
problem status as of December 31, 1975. We believe that
there is a need for the agencies to use stronger formal
actions against these banks.


     The agencies could have used their formal enforce-
ment powers more than they did to correct problems that
we identified in a sample of problem banks. On the average,
when the agencies did use formal action, the sooner the action
was taker the faster the problems got corrected.

     We recognize that every problem situation has to be
evaluated on a case by case basis and that formal enforce-
ment action would not always be applicable. However, we
believe that the agencies should use formal enforcement
action as much and as soon as possible to get problems
corrected, especially when the problems exist over long
periods of time.

Recommendation

     We recommend that the Board of Directors, FDIC, the Board
of Governors, FRS, and the Comptroller of the Currency estab-
lish more aggressive policies for using formal actions. Writ-
ten guidelines should be developed to identify the types and
magnitude of problems that formal actions could appropriately
correct.




                            8-18
Aienny comments
     FDIC stated:

     "Congress granted cease and desi,;t powers in 1966
     with the enactment of Section 8(b) of the Federal
     Deposit Insurance Act. For several years there-
     after, there was some reluctance to utilize Section
     8(b) powers due mainly to a general misunderstanding
     of its purpose and usefulness. Prior to enactment
     of Section 8(b), the FDIC's only experience with
     formal administrative corrective 'measures was the
     termination of insurance proceedings, a severe form
     of action which ~ould result in the removal of the
     deposit insurance coverage of a bank. Because of
     its severity, the Section 8(a) proceeding was used
     judiciously and only after all other means for
     accomplishing correction were exhausted. Apparently,
     albeit erroneously, that same rationale was largely
     applied to Section 8(b) proceedings. In addition,
     there was to a lesser extent an unwillingness to try
     something new. Commencing in 1970, a program to educate
     FDIC personnel as to the usefulness of Section 8(b)
     action was begun. The FDIC first used its cease and
     desist authority in 1971 and between 1971 and 1975
     issued 38 cease and desist orders and three formal
     written agreements. In contrast, in a recent renewed
     effort to foster the use and to test the effectiveness
     of cease and desist powers, in calendar year 1976
     alone FDIC issued 24 such orders and five emergency
     orders. In addition, at year-end 1976, 18 more
     cease and desist actions were in various stages of
     process.
     "While cease and desist action is in most cases
     effective as a corrective measure, there are some
     instances where it may be of little or no use and
     could perhaps be counterproductive. For example, the
     recently experienced worst economic period since the
     great depression caused severe problems to the
     banking industry, many of which did not lend them-
     selves to correction through use of the cease and
     desist powers. In short, it is not a panacea for
     the removal of all problems experienced by the
     banking community.




                         8-19
"The recommendation foz adoption of criteria for use
in formal actions, contained in the last sentence of
the recommendation, is troublesome. We would recom-
mend against adopting formal criteria for use of
Section 8, because the statutory criteria are adequate.
The facts and circumstances of bank problems seem
so varied, and the remedial actions can differ so much
according to the problem, it would he inhibiting to
Live to work within the confines of additional writ-
ten criteria. The adoption of such criteria could
give the banks additional bases for contesting
Section 8 actions."

FRS stated:

"In this section the report notes that each problem
situation has to be evaluated on a case-by-case basis
and formal action would not always be appropriate.
The report goes on to recommend that more aggressive
policies be used for formal actions and that written
guidelines be developed to identify the types and
magnitude of problems that formal actions could
appropriately correct.  In this regard, we note that
the report confirms that all of the agencies have
already markedly expanded their formal enforcement
activities. On November 3, 1975, the Board issued
a policy statement emphasizing its intention to take
formal action where appropriate in connection with
violations of the Bank Holding Company Act.

"Further, we do not believe that adequate weight has
been given in the report to existing hindrances to
formal action under the Financial Institutions Sup-
ervisory Act of 1966.  The chapter does, however,
support the Board's existing recommendations for
changes to the Financial Institutions Supervisory
Act which would enable the supervisory authorities
to remove bank officers for gross negligence and
to assess civil penalties for violations of laws
and regulations.  These legislative recommendations
were made in response to procedural and substantive
problems inherent in making effective use of the
present formal procedures set forth in the
Financial Institutions Supervisory Act.  In this
regard, the Board's letter of September 5, 1975, to
the banking committees of both Houses of Congress




                     8-20
setting forth the legisiative proposals made it clear
that there were a number of situations in which the
existing formal regulatory remedies would have little
or no value in preventing or ameliorating problem
bank situations. We believe that those recommendations,
embodied in H.R. 9743 and S. 23C4, would help to sub-
stantially reduce the incidence of problem banking
situations. Further, the Board has continued to
review areas in which it appears that changes may
be of substantial aid. The Board intends to submit
further legislative proposals to this erf in the very
near future, In this regard, Chairman Proxmire has
introduced legislation in the 95th Congress which
encompasses the earlier recommendations.

"The Board is further concerned that the discussion
in this chapter of the manner in which the agencies
are handling problem bank situations may not present
an accurate view in all respects. The major short-
coming in this regard stems from the fact that the
different agencies utilize problem bank lists for
varying purposes. Furthermore, even between agencies
with similar goals, different judgments may occur as
to the severity of an institution's problems and
the length of time monitoring is required. Meaningful
comparison between agencies' enforcement activities
in this area is therefore impossible. We would,
however, note that the report's conclusions relating
to the agencies' effectiveness in returning insti-
tutions to nonproblem status are not supported by the
tables since the percentages used excluded insti-
tutions withdrawing from membership and merging.
Presumably, the approving agency found in the case
of the mergers, as required by the Bank Merger Act,
that the financial and managerial condition of the
resulting bank was satisfactory and, in the case
of withdrawals from membership, supervisory pressure
may well have contributed to such withdrawals.
Further, as noted in the table, withdrawals anld mergers
are disproportionately high in the sample for the
Federal Reserve."

OCC stated:

"We believe that in supervising the vast majority
of national banks, our most effective remedy continues
to be the examination process and the meetings held


                     8-21
as part of that process between the board of directors
of the bank and OCC personnel. Since December 23, 1975,
the OCC has required meetings with boards of directors
of each national bank at least once every calendar
year and, in certain cases, fcllowing every examination.
We believe that the increased use of such meetings
together with our new examination procedures and early
warning system will ,,aKe our first-line, informal
supervisory techniques even more effective.
"As the GAO report elsewhere notes, our informal sup-
ervisory techniques even without the improvements noted
above, nave proven effective in rehabilitation of most
of the so-called problem bank situations. For example,
over the period reviewed by GAG informal procedures
utilized by OCC were successful 84% of the time.
Nonetheless, we agree that increased use of formal
agreements and cease and desist orders under the Fin -
ancial Institutions Supervisory Act may acceilrate
correction of problems in the nore recalcitrant insti-
tutions.

"OCC use of such formal agreements and orders has in-
creased tenfold from 1970 to 1975. The OCC has origi-
nated slightly more than half of the combined total (179)
formal agreements and cease and desist orders issued
by all three agencies during the last five years. The
OCC, however, supervises fewer than half the number of
banks supervised by the other two agencies combined.
When compared to the numbe: of banks supervised, the
OCC over the past five years has used the formal enforce-
ment tools of Financial Institutions Supervisory Act
about two and one half times as often as the oTher two
agenciesn
"It should also be noted that the three banking agencies
jointly requested Congress in 1975 to refine and increase
the agencies' formal enforcement powers. Congress
'ailed to pass the necessary legislation.

"The OCC has developed as part of its National Bank
Surveillance System a severity anomaly ranking system
which identifies every three months the national banks
most likely to require special supervisory attention. A
computerized action control system is designed to assure
that the OCC responds promptly anC appropriately to
these situations. The criteria built into these systems
identifies more systematically and promptly those cases
in which formal enforcement action is appropriate."


                        8-22
CASE STUDIES--HOW AGENCIES DEALT
WITH BANKS TO RESOLVE PROBLEMS

     The following six case studies illustrate how the su-
pervisory agencies dealt with specific banks. These cases
are reasonably typical of the agencies' efforts. The reader
should look for the problems which the examiner identified,
the enforcement actions which the agencies took to get the
problems corrected, any differences in enforcement action
for problem and nonproblem banks, and evidence of the ex-
istence of the same problems at subsequent examinations.
The reader should also look to see whether the agencies
intensified or varied their use of followup actions when
the same problems appeared from one examination to another.




                      Case 1--FDIC Problem Bank

      January 1974 examination

       The first examination report which we reviewed cited
the   following problems and recommendations:

       (1)   Inadequate capital---the board of directors
             should adopt their proposed $3.5 million capital
             enhancemer.t program.

      (2)    Classified loans totaling $1i.4 million, compared
             to adjusted capital and reserves of $5.1 million.

       (3)   Overdue loans had increased substantially and
             were 4.4 percent of gross loans--collection and
             renewal policies need to be reviewed.

       (4)   Concentrations of credit total $10.3 million,
             violating the sound principles of diversification

       (5)   Violation of various laws--early correction is
             warranted

FDIC rated management    "satisfactory" and classified   the
bank "nonproblem."




                                 8-23
The examiner-in-charge discussed the above problems with           1
 the bank's officers at the close of the examination.

     March 1974

     The transmittal letter forwarding the examination
report to the bank discussed asset problems, requested
a response to the reported problems, and requested plans
for corrective action.

     September 1974


     The examiner visited the bank to review 1nans made
to an individual.

    January 1975

     The examiner visited the banK a second time to review
several loans including the above-mentioned loans.
He noted a discrepancy between the bank's records and
the amount due for one of the loans.

    April 1975 examination

     The next examination report cited the following prob-
lems and recommendations:

     (1)   A capital to asset ratio of 5.6 percent--the
           board of directors should formulate a plan to
           raise from $3 to $5 million additional capital.

    (2)    Classified loans totaling $21 million compared
           to adjusted capital and reserves of $8 million--
           the bank should put; a moratorium on all future
           real estate  uQ,istruction loans and initiate a
           comprehensive loan policy.

    (3)    Overdue loans amounting   to 27 percent of the roan
           portfolio.

    (4)    Non-i.nterest earning loans totalinc' $8 million.

    (5)    Violations of laws and regulations.                 J




                              8-24
     FDIC rated management "unsatisfactory" and classified
the bank as a "serious problem."
      At the close of the examination, the examiner-in-
charge, an assistant regional director, a headquarters
official, and the chief examiner from the 3tate banking
agency met with the bank's board of directors to discuss
thesr problems.
    July 1975

     The transmittal letter to the bank expressed concern
about the deterioration in the loan portfolio and the
potential for a liquidity problem. The regional director
requested (1) a plan of action to correct the problems
noted and t2) progress rep¢,rts.
     Members of the board of directors met at the FDIC re-
gional office to discuss the April examination. They failed
to present specific plans to correct prc¢lems. The assist-
ant regional director prepared a letter of understanding
which required the board to meet and submit prcgress re-
ports twice monthly. The letter of understanding was later
signed by the board members.
    Auqust 1975

    The bank sent a progress report to FDIC.

    September 1975 examination

     i·
    T_     following problems and recommendations were cited:

     (1)   Inadequate capital and earnings as a result of
           loan losses--the infusion of capital is necessary
     (2)   Classified loans totaling $18.7 million, over
           twice the amount of adjusted capital and reserves.
     (3)   Twenty-three percent of total loans are overdue.

     (4)   Concentrations of credit totaling $8.4 million.

     (5)   Improperly recorded interest income accruals.

     (6)   Sxcessive cash dividends.



                               8-25
     FDIC again rated management "unsatisfactory" and clas-
sified tLe bank as a "serious problem."

     The examiner-in-charge discussed the abov.-, problems
with the bank's board of directors at the close of the
examination.
     November 1975

     The bank sent a progress report to FDIC.

     December 1975
     The transmittal letter to the bank discussed the above
problems, requested a meeting with the bank and State
banking officials, and requested that progress reports
be continued.
     January 1976

      Two meetings weit held with bank and State banking
officials to discuss the bank's request to make further
dividend payments. The request was denied.

     March 1976

    The bank sent a progress report to FDIC.
    April 1976 examination

     The fourth examination was conducted in April 1976;
however, FDIC was unable to locate the examination
report for our study. In a memorandum to the files,
the regional director had cited the following problems:

    -- Rapid growth has caused a serious capital
       deficiency. The capital assets ratio is a low
       5.4 percent and classified assets a-e 193 percent
       of the capital structure.
    -- Overdue and classified loans are excessive.
       representing 22.9 and 22.2 percent respectively,
       of total loans.
    -- Concentration of :redit among real estate specu-
       lators, developers and builders has resulted in a
       grossly unsatisfactory asset condition.


                             8-26
    -- Loans were hastily made without written lending
       policies. Lending deficiencies include a lack
       of equity in collateral, no repayment programs,
       undercapitalized and inexperienced borrowers, and
       poorly documented loans.
    -- Liquidity is a serious problem.
    -- The president is considered liberal and unimpres-
       sive. Lack of directorate involvement is one of the
       primary reasons for the bank's current condition.
    -- The parent holding company is regarded as a serious
       problem by FRS.
    FDIC rated management "unsatisfactory" and classified
the bank as a "serious problem."
    My_1976

    A meeting was held with bank officials to discuss
their proposed plan to raise capital.
    July1976
    A meeting was held with bank directors, parent company
directors, and the State banking commissioner to discuss
proposals to raise $3 million in capital.

    September 1976
    The Director, Division of Bank Supervision, requested
approval to seek the bank's coisent to a cease ant, desist
order. The bank's attorney wr' te FDIC tnat a cease and
desist order would be "counter productive" and that
cAditional time was needed to complete the capitalization
program.
    A meeting was held with bank officers and State bank-
ing officials to discuss cease and desist proceedings
against the bank. Afterwards, the bank agreed to
comply with the cease aitd desist order. The order
was issued to stop "hazardous lending and lax collection
practices."

    The bank sent a progress report to FDIC.




                            8-27
     October 1976

     The bank wrote to FDIC and said it was complying with
the consent cease and desist order.
 Our comments
     This bank has had the same basic problems since the
January 1974 examination. FDIC ased informal enforcement
actions for 32 months without success. In September 1976,
FDIC took formal action.
     This case illustrates that the agencies do not always
discuss the results of the examination with the banks'
boards of directors.  (See ch. 6.) FDIC officials did not
meet with the bank's directors until 15 months after con-
tinuing problems were found. The examiners did not criti-
cize the bank's loan policies until the amount of classi-
fied loans had increased substantially. (See ch. 5.)


                      Case 2--FRS Problem Bank
     July 1974 examination

     The first examination report which we reviewed cited
problems and rr commendations as follows:

     (1)   Overdue loans of 5.2 percer' o'- total loans.
     (2)   Classified assets totaled $125,000, with
           adjusted capital totaling $1.7 million.

     (3)   The bank should review its current lending
           procedures.
     (4)   Credit files should be updated.
     In the confidential section of the report, the exam-
iner-in-charge noted that the general condition of the
bank was satisfactory. He noted also that capital ratios
were well below generally acceptable levels and that
earnings showed a moderate decline from the previous year.

    At the conclusion of the examination, the examiner-in-
harge met with two of the bank's executive officers to
iscuss the above matters.


                              8-28
     FRS rated management "satisfactory" and classified thel
bank as a "nonproblem."

     August 1974

     The Federal Reserve Bank, in ito transmittal letter to
the bank, cited the various criticisms noted in the exam-
ination report and recommended that the bank increase
capital by $1 million.

     May_1975

     The bank responded to the above recommendation and in-
formed the FRB of its intention to raise $1.3 million of
additional capital.

     June 1975 examination

     In the report, the examiner-in-charge said that the
bank's condition had deteriorated since the last examina-
tion. He cited the following problems:

     -- Overdue loans of 3.4 percent of total loans.

     -- Classified assets totaling $1.7 million, with
        adjusted capital only $1.4 million.

     -- Inadequate capital.

     -- Violations of laws.

     The examiner-in-charge mentioned that the bank's
plans to increase capital might well prove inadequate
in the future.

     In the confidential section of the report, the exam-
iner-in-charge said two former executive officers were
primarily responsible for the "swift deterioration of
the quality of the bank's assets." He noted that the bulk
of the classified loans were of "poor quality at inception
or rapidly proved to be." He stated, "it was not known
why the two officers, whose previous records had not been
tne subject of criticism, quite obviously embarked on a
program of lending liberalism."  One officer had resigned
and the other had become inactive.

     According _o the examiner-in-charge, the present offi-
cers had yet to demonstrate the ability to deal with the
many problems presented. In addition, he said that earnings



                              8-29
were below the average of other banks of similar size in
that State.

     At the conclusion of the examination, the examiner-in-
charge met with the bank's active officers and available
board members to discuss the bank's asset problems.

     FRS rated management "fair" and classified the bank as
a "problem."
     August 1975

     The FRB's transmittal letter to the bank emphasized
the need for strict adherence to the bank's recently
strengthened lending procedures. It requested monthly
status reports and a meeting with senior managers.

     September 1975

     FRB officials met with the bank's board of direc rs
to discuss the loan situation. They noted minor improvement
in the bank's loan portfolio.

     February 196 examination

     In the report, the examiner noted a more favorable
condition but cited the following problems:
     --classified assets totalinu $1.4 million, with
        adjusted capital of $2.8 million.

    -- Violations of laws.
     -- Heavy loan losses.
    --Poor earnings.

     In the confidential section of the report, the exam-
iner-in-charge noted that the general condition of the bank
was "unsatisfactory" and that earnings were poor as a
result of heavy loan losses.

     An :internal FRB memorandum referring to the February
1976 examirition stated, "Management may be improved but
it is appa ently unimpressive and believed to lack adequate
depth to administer the improved policies."




                             8-30
     The FRh met with the board of directors at the close
of the examination to discuss the bank's problems.

     FRS rated management "fair" and classified the bank
as a "nonprobiem."

     April 1976
     The transmittal letter indicated that further effort
was needed to reduce classified loans and again requested
monthly status reports. The letter also mentioned that
capital ratios were low despite the addition of capital.

     As of April 1976, the bank had sent nine progress
reports to the FRB.
     August 1976

     Between April and August, the bank sent five more
progress reports to the FRB.
Our comments

     After the February 1976 examination, FRS removed the
bank from problem status, even though classified assets
had decreased only $300,000 since the last examination.
The ratio of classified assets to adjusted capital was
more favorable because over $1 million of capital had
been added.
      This case demonstrates that the examiners often make
important observations about the bank's condition without
including them in the portion of the report sent to the
bank.   (See ch. 6.)  In the confidential section of the
first examination report, the examiner noted that the
bank's capita] ratios were below acceptable levels.
Although the transmittal letter commented on the capital
deficiency, such comments were not included in the por-
tion of the examination report going to the bank until
the second examination report--ll months later. Also, the
agency did not attempt to discuss the problems with the
bank's directors until after the second examination.

     The same problems have been in evidence for almost
2 years yet FRS has had little success in using informal
enforcement action to get the problems corrected.




                             8-31
                  Case 3--OCC Problem Bank
     July 1974 examination
     The first examination report which we reviewed dis-
closed the following problems:

     -- Violations of laws.
     -- Increasing classified assets.
     -- Inadequate credit files.

     -- Low liquidity.
     -- Internal control deficiencies.

     Following the examination, OCC classified the bank as
a "nonproblem" and rated management "satisfactory."

     September 1974
     Regional officials wrote to the bank expressing con-
cern with the sharp increase in classified assets and the
violations of laws cited in the report. OCC requested the
bank to submit progress reports.

     The president of the bank and officials of its holding
company visited the OCC regional counsel to discuss a group
of loans criticized in the July report. As a result of the
meeting, the examiner-in-charge visited the bank's mortgage
loan department and found that classified loans had in-
creased since the July examination.

     Because of problems disclosed in the July exami-
nation and the visit, the bank's president and three
officials of the mortgage loan department resigned under
pressure from the bank's board of directors.

     November 1974 and January_1975
     The bank submitted a progress report to the regional
office.




                              8-32
    February 1975 examination

    The report cited:
    -- Violations of laws.

    -- Increasing classified assets.
    -- Inadequate credit files.

    -- Low liquidity.
    -- Overdue loans.


     OCC classified the bank as a "problem" and rated
management as "fair."
    AEril 1975

     At the close of the examination, the examiner-in-
charge and the deputy regional administrator met with
the bank's board of directors to discuss the deficiencies.
     May 1975

     The regional administrator sent the bank's board of
directors a letter reemphasizing the bank's violations
of laws, classified assets, poor credit information,
and low liquidity. He requested monthly progress reports
to the region and to headquarters.
     July 1975

     The bank submitted a progress report.
     August 1975
     Regional officials noted that liquidity had dropped
below acceptable levels and they held a meeting with bank
officials to discuss plans for improving liquidity.
     The bank submitted another progress report.
     September 1975 examination

     The report cited:



                             8-33
     -- Violations of laws.
     -- Classifi:' assets are decreasing but still are con-
        sidered high.
     -- Low liquidity.
     -- High volume of overdue loans.

     OCC classified the bank as a "problem" and rated
management "fair. "

     The barik submitted another progress report.

     October 1975
     The bank submitted a progress report.

     November 1975
     The regional administrator wrote to the bank's board
of directors, citing violations of laws. classified assets,
overdue loans, and low liquidity.  He a-.o asked that
progress reports be continued.

    December 1975, JanuarX and-February 1976
    The bank submitted progress reports.

    March 1976
     The bank's president and an official of the parent
holding company visited the regional office to discuss
problems experienced by the bank.

    The bank submitted progress reports.
    April 1976 examination

    The report cited:
    -- Violations of laws.

    -- Classified assets are decreasing but are still high.
    -- Inadequate credit files.

    -- Overdue loans.


                              8-34
     OCC classified the bank as a "problem" and rated
management "fair."

     The bank submitted a progress report.

     June 1976

     The regional administrator's transmittal letter to the
bank's board of directors referred to the problems cited
in the report and mentioned pending litigation.  He again
requested that progress reports be continued.

     Jul_   1976

     The deputy regional administrat-:       with the bank's
board of directors.

     The bank submitted a progress report.

     August 1976

     The bank submitted another progress report.

 Our comment

     For 2 years OCC has used mostly the same types of
informal enforcement actions to get the bank to correct
its problems, yet many of the problems continued.

     This case also shows that altnough the agencies find
problems, they sometimes do not address the basic causes.
(See ch. 5.)    For four consecutive examinations, the
examiners  cited  several problems with loans and yet,
the probable   causes--poor  loan policies and procedures--
were not  cited  as  problems. The agency did not meet with
the bank's  board   of directors until after the bank was
designated as   a problem,  even though similar problems
were found  10  months  earlier.  (See ch. 6.)




                   Case 4--FDIC Nonpoblem Bank

     April 1973 examination

     The first examination report which we reviewed cited
problems and recommendations as follows:



                               8-35
     (1)   Increase in classified loans due to weak
           lending policies, collection practices, and
           credit analyses--certain classified loans
           should be written off.
     (2)   Adjusted capital below State and national
           averages for comparable banks--capital should be
           increased.
     (3)   Internal control weaknesses--management's attei-
           tion is needed.
     In the confidential section of the report, the exam-
iner stated:
     -- The bank's lending policies were liberal.
     -- Management wa' unwilling to accept his recommenda-
        tions.
     -- The loan function was totally decentralized and
        working space was too limited.

     --The president was too preoccupied with texpansion
       plans.

      Following the examination, FDIC tated management as
"fair" and classified the bank as a "nonproblem."
     August 1973
     The State supervisory agency wrote to the bank and
recommended an increase in capital and better control and
supervision of lending and collection policies. The bank
responded to the State that it had increased its capital
as recommended.

     Se2tember 1973

     The bank wrote to FDIC regarding the deficiencies
mentioned in the examination report.
     March 1974 examination

     The report cited the following problems and recommend-
ations:

     (1)   Excessive classified assets; primarily loans.



                              8-36
     (2)   Weak credit supervision, loan portfolio manage-
           ment, and collection efforts--corrective action
           required.

     (3)   Adjusted capital well below State and national
           averages of comparable banks, despite the recent
           injection of capital.

     (4)   Internal control deficiencies.

     %5)   Violation of State banking   laws.

     Again in the confidential section of the report, the
examiner stated that the president was more concerned
with expansion than with daily banking activities.

      Following the examination, FDIC rated management as
"fair" and classified the bank as "nonproblem."

     August 1974

     FDIC wrote to the bank asking for its actions or plans
to increase capital and reduce the volume of classified
and delinquent loans.

     September 1974

     The bank reported to FDIC on   its planned actions.

     May_1975

     The bank submitted, for FDIC's approval, a proposed
circular for issuing capital notes.

     June 1975

     FDIC approved the circular.

     July 1975 examination
     The report cited problems and recommendations as follows:

     (1)   A 98 percent increase in classified assets, pri-
           marily loans, due mainly to ineffective supervi-
           sion and collection of loans.

     (2)   Losses in real estate and securities--bank
           managers should obtain additional capital.

     The examiner noted other deficiencies similar to those
of the two previous examinations and said the bank was having
problems issuing its capt..l notes.
                             8-37
     Again, the examiner cemarked in the confidential sec-
tion that the bank's president devoted 100 percent of
his time promoting his "bank's image" for growth, through
mergers and branching. The exa.,;iner stated that the bank's
financial condition was less than average as the quality
of its assets continued to depreciate.

      Following the examination, FDIC rated management
"fair" and classified the bank as "nonproblem."

      October 1975

     FDIC's transmittal letter    requested that the bank
report action taken or planned    to correct a!1 cited
problems.

      December 1975

      The bank responded to   the reported deficiencies and
[action taken on them.

Our comment

     The bank has had the same problems for 2-1/2 years,
yet FDIC has not varied or increased its followup acti-
vity. It could have used more informal enforcement action
or considered using formal action to coriect these
problems.

     The agencies rarelr met with the boards of directors
of banks unless the banks were considered to be problems.
(See ch. 6.)  In this case, despite an apparently
unresponsive management, FDIC representatives did not
meet with the bank's directors during 2-1/2 years.  The
examiners were highly critical of management in the
confidential sections of the reports but not in the por-
tions of the reports the bank received.




                  Case 5--FRS NonproblemBank

     October 1973 examination

     The first examination report which we reviewed    cited
two problems:

     -- Substantial decline in net     income.



                                8-38
    -- Substantial decline in net income.

    -- Low capital position.
    FRS rated management as "satisfactory" and classified
he bank as "nonproblem."
    March 1974

     FRS wrote to the bank and requested its formal response
to and its action taken on the examination deficiencies.

     2Eril 1974
     The bank informed FRS of the action it had taken to
correct the examination deficiencies.
    June 1974 examination

    The report cited four problems:

    (1)    Capital continues to be somewhat low.
     (2)   Increasing classified and specially mentioned
           loans.
     (3)   Violations of law.

    (4)    Serious internal control deficiencies--it is im-
           perative that immediate corrective action be taken
    FRS rated management as "fair" and classified the bank
s a "nonproblem."
    November 1974

     FRS wrote to the bank requesting that it formally state
what actions it would take to correct the examination
Deficiencies.

    December 1974

     The bank informed FRS of its efforts to strengthen
internal controls and gave its assurance that the other
Jeficiencies would be corrected.
    May 1975 examination

    The report cited four problems:

    -- Capital funds continue to be low.
                                8-39
    -- Classified loans have again increased.
    -- More violations of law were committed.

    -- Internal control weaknesses still existed.

     In the confidential section of the examination report,
the examiner stated that the bank's general condition was
satisfactory; however, he noted that the capital structure,
the classified assets including loans, and the violations
of law were unsatisfactory.
     The examiner discussed the examination deficiencies
with the bank's managers at the close of the examination.
     FRS rated management as "satisfactory" and classified
the bank as "nonproblemo"

     September 1975

     FRS sent the examination report to the bank and
requested response to its criticisms.
    October 1975

     The bank responded that it was acting to correct the
defic ienc ies.

Our comment

     Even though the same problem has existed for 2 years,
FRS has not increased its use of informal enforcement
action or considered using formal action.
     Although the reports of examination indicated that
the bank was not solving its problems, the FRS did
not discuss the examinations with the bank's board of
directors.  (See ch. 6.)




                             8-40
                Case 6--OCC Nonproblem Bank
 Auust 1973 examination

     The first examination report which we reviewed cited
the following problems and recommendations.

     (1)   Inadequate capital--the bank should secure
           additional capital.
     (2)   Poor liquidity--liquidity should be improved.


     In the confidential section of the examination report,
the examiner recommended that OCC headquarters formally
request that the bank secure additional capital.

     OCC rated management as "satisfactory" and classified
the bank as "nonproblem."

     Sj!ptember 1973
     The regional administrator wrote to the bank's board
of directors expressing concern over the capital position
and suggesting that the board (1) study ways to correct the
problem and (2) advise him of the results.

    November 1973

     The bank responded to OCC, agreeing that capital
should be strengthened and providing a plan for improvement

     After reviewing the bank's financial report, the
regional administrator wrote to request its plans for
improving its liquidity position.




                              8-41
    The regional administrator wrote to the bank stating
that OCC would not pursue the capital adequacy matter
until the next examination.
    December 1973

    The bank responded to OCC that it was aware of its
liquidity situation and was making every effort to keep it
within a satisfactory range.
July 1974 examination
    The report cited the following problems and recommend-
ations:
    (1) Inadequate capital--capital should be increased.
    (2) Poor liquidity--liquidity position should be
        improved.
    (3) Internal control deficiencies.
    For the second time the examiner recommended that OCC
headquarters request that the bank increase its capital.

    OCC rated management as "satisfactory" and classified
the bank as "nonproblem."
    October 1974

    The regional administrator wrote to the bank and sug-
gested that the bank adopt a program to increase capital
and inform him of its plans.
    November 1974
    After reviewing the bank's financial report, the re-
gional administrator wrote to the bank about its low liquid-
ity position and requested plans for improving liquidity.
    December 1974
    Bank officials agreed with the need to increase capital.
They said the increase could not come from external sources
due to market conditions and presented a plan for increasing
capital from internal sources.



                             8-42
    The regional administrator wrote to the bank stating
that OCC would not pursue the capita] adequacy matter
until the next examination.

July 1975 examination

    The report cited the following problems and recommenda-
tions:

    (1) Inadequate capital--capital should be increased.

    (2) Poor liquidity--liquidity should be improved.

    The examiner, for the third time, mentioned that the
bank would increase its capital if OCC headquarters would
make the recommendation.

    OCC rated management as "satisfactory" and classified
the bank as "nonproblem."

    Sep .     er 1975

    The regional administrator wrote to the bank about the
problems noted and the need for a program to add more
capital. He requested a formal response from the board
of directors.

    October 1975

    The bank's president responded that the hank was making
every effort to correct its problems.  The regional
administrator decided not to pursue the capital ade-
quacy matter until the next examination.

Our comment

    Even though the same problems have existed for over 2
years, OCC has not altered or intensified its use of
followup activity.  In addition, coordination is
apparently lacking between the regional office and head-
quarters in getting the bank to take corrective action.
OCC could have increased its use of informal enforcement
actions or considered using formal actions to correct
these problems.




                            8-43
     The agencies do not have definitive criteria for
assessing the adequacy of a bank's capital.  (See ch. 4.)
In this case, the examiner and regional administrator
seemingly did not agree on the seriousness of the bank's
capital problem.  Judging by actions it took, OCC's posi-
tion on the bank's capital was at best confusing.




Conclusions

      The supervisory agencies dealt with the above "prob-
blem" and "nonproblem" banks in basically the same way and
had little success in getting them to correct their prob-
lems.   Even though the same types of problems existed from
one examination to another, the agencies frequently did not
vary or intensify their use of enforcement action to get
the problems corrected.   We believe the agencies could have
made more use of their formal enforcement powers to correct
some of the problems, because formal powers had been used
in the past to correct some of these same types of problems.

     Problem banks presumably present a greater risk of
financial loss than do nonproblem banks.  We believe, there-
fore, that in order to fulfill their responsibility to main-
tain soundness in the banking system and to protect deposi-
tors, supervisory agencies should followup on problem banks
more aggressively than they do on nonproblem banks.  If the
supervisory agencies find that certain followup actions are
not working, they should try something else or at least
intensify their actions in order to get the problems
corrected.

HOW THE AGENCIES DECIDE WHICH BANKS
REQUIRE SPECIAL-SUPERVISORY ATTENTION

     After every examination, the supervisory agencies eval-
uate the effects of the problems identified on the soundness
of the bank.  If agency officials judge the bank's problems
as serious enough to affect its soundness, they designate
it as a problem bank or one requiring special supervisory
attention.

     A bank's rating is not always the determining factor
in deciding whether it is a problem bank.  Not all banks




                             8-44
with poor ratings are designated as problem banks, nor are
problem banks only those with poor ratings. The supervi-
sory agencies say they consider a bank's overall condi-
ditioi--capital adequacy, asset quality, earnings, liquidi-
ty, quality ;f management--and do not always rely on any
specific rating factor in determining whether a bank is a
problem bank.
     The regional offices and district banks have primary
responsibility for monitoring problem situations in banks,
whether or not they are designated problem binks.  If
the bank is designated as a problem bank, the supervisory
agencies' headquarters also become involved in the mon-
itoring process.
FDIC problem classifications
     FDIC classifies banks according to the severity of
their problems so its Board of Directors can assess the de-
gree and dollar volume of potential threat to the insurance
fund. The classifications follow:
     -- Serious problem, potential payoff:  FDIC has no
        specific guidelines for placing a bank in this
        category. It is reserved for serious problem banks
        (see below) which are in advanced deterioration
        that could result in failure and which present a 50-
        percent chance of requiring FDIC financial assist-
        ance in the near future.

     -- Serious problem: a bank that threatens to involve
        FDIC in a financial outlay unless drastic changes
        occur. These banks are usually those in which the
        nature, prevalence, and trends of weaknesses are
        such that correction is urgently needed. Their net
        capital and reserves position (the second element of
        the FDIC rating) is likely to be substantially nega-
        tive.   In addition, management (the fourth element
        of the FDIC rating) is usually rated unsatisfactory
        or poor.
    -- Other problem: a bank that has major weaknesses
       but a lesser degree of vulnerability and that re-
       quires more than ordinary concern and aggressive
       supervision. These banks' net capital and reserves
       position is generally low or negative. Banks also
       can be placed in this category because of excessive
       loan delinquencies, a rapid rate of asset deteriora-
       tion, significant violations of laws or regulations,
                               8-45
       an unusually low adjusted capital position (the
       first element of the FDTC rating), an undesirable
       liquidity posture, pronounced management deficien-
       cies, or other adverse factors. Usually, manage-
       ment is rated unsatisfactory, with a rating of
       fair or satisfactory the exception.
FRS problem classifications
     FRS classifies banks which have composite ratings of
"3" or "4" as problem banks. However, a bank which is
rated "2" can also be designated as a problem bank if FRS
judges that its problems could ultimately affect its sound-
ness. The composite rating is one of the four elements of
the FRS rating. A bank rated "3" requires special super-
vision and a bank rated "4" usually requires prompt and ex-
tensive attention to restore it to a satisfactory condition.
OCC problem classifications

     Since 1970, OCC criteria for problem banks have varied.
Until late 1974, problem banks were those banks whose clas-
sified assets totaled 40 percent or more of the bank's gross
capital. An OCC official said problem banks were probably
those with an overall rating of "3" or "4".

     In November 1974, OCC initiated the "Victor program."
Initially, the Vict)r program included all banks with a
composite rating of "3" or "4" and any other banks which
OCC believed warranted special attention. In December 1974,
OCC changed the criteria for including banks in the Victor
program. Examiners were reauired to include banks when
they judged that any condition existed which could lead
to ins-lvency or when criticized assets were 65 percent or
more of adjusted capital.
     In late 1975, OCC began a "special projects/bank
review program." The special projects group supervises
banks with total resources of $100 million or more and
the bank review group supervises banks with total
resources below $100 million. The criteria for selecting
banks for the program are as follows:

    -- Banks are designated by the regional administrators
       according to their judgment of the quality of assets,
       adequacy of earnings, quality of management, capital
       adequacy, and other factors.


                              8-46
        -- Banks having criticized assets totaling 65 percent
           or more of adjusted capital, as well as other de-
           ficiencies, are reviewed by the regional adminis-
           tors for possible inclusion.

        --All other banks with assets exceeding $100 million
          and criticized assets that total 65 percent or more
          of adjusted capital are reviewed by the special
          projects group for possible inclusion.

        -- Still other banks are designated by banking opera-
           tions, special projects, and the National BanK Sur-
           veillance System group using the above criteria.

        --All banks operating under a formal written
          agreement or a cease and desist order are included.

        OCC classifies banks included in the program as fol-
lows:

        -- Critical:  a bank which exhibits a combination of
           weaknesses and adverse financial trends which
           endanger its liquidity and solvency.   The probability
           of failure is high for such banks and they require
           the most intense supervision and m.nonitoring.

        -- Serious: a bank whose weaknesses and financial
           trends are not so severe as to immediately threaten
           the liquidity and solvency of the institution. The
           potential for failure is present but is not pro-
           nounced.  Such banks require continuous monitoring,
           supervision, and attention.

        -- Special levels of supervision:  a bank that may
           be experiencing a combination of adverse factors
           to the same or lesser degree than those banks in the
           serious category. However, banks in this category
           possess certain characteristics more favorable than
           banks in the critical and serious categories. They
           are less vulnerable; their strength ard financial
           capacity is such as to make a failure a remote
           possibility. OCC maintains that these banks are
           not problem banks but require more than ordinary
           supervisory concern and monitoring.




                                8-47
Different crif   ia--different problem banks

     As shown above, each supervisory agency uses its own
criteria to identify problem banks and the bank's rating
is not always The determining factor.

      OCC included 255 of the 4,744 national banks in the
"special projects/bank review program" as of December 31,
1975.   Of that number 85 were problem banks which required
more than ordinary supervisory concern and monitoring. OCC
said that while the remaining 170 banks were monitored un-
der the program, they did not receive the same degree of
monitoring as did the 85 banks or were monitored for reasons
other than the fact that they were problem banks.

     Of the 85 banks, 22 had composite ratings of "1" or
"2," 46 had composite ratings of "3," and 17 had composite
ratings of "4."  Since all national banks are members of
FRS, it also is interested in the condition of those banks.
FRS does not maintain a list of problem national banks,
but it would have so classified 267 national banks--those
which OCC rated as composite "3" or "4."  The banks so
classified would have included 63 banks identified by OCC.
All national banks are also insured by FDIC, so it, too,
is interested in their condition. FDIC, using its criteria,
classified 52 national banks as problem banks, including
32 of those identified by OCC.

     Of the 1,046 State member banks as of December 31,
1975, FRS classified 65 as problem banks.   Since
all State member banks are insured by FDIC, it is
concerned about the condition of those banks.   FDIC
classified only 17 of these State member banks as problem
banks. FDIC's rating of national and State member banks,
however, is based on financial risk to the insurance fund.
The difference in the number of designated problem banks
could also be partially due to a difference in judgment by
the ag' ncies in identifying problems in areas such as capi-
tal, liquidity, and management.

     We believe there should be some consistency among the
supervisory agencies in determining whether or not a bank
is a problem bank.  OCC included 22 national banks as prob-
lem banks which FRS did not include and 53 national banks
as problem banks which FDIC did not include. On the other
hand, FRS included 204 other national banks as problem
banks but OCC did not include them and FDIC included 20



                             8-48
national banks not included by OCC. The same holds true
for FRS and FDIC. FRS included 48 State member banks as
problem banks which FDIC did not include.

Conclusions

     Because the supervisory agencies are responsible
for maintaining soundness in the banking system and for
protecting depositors, they should agree on which banks
are problem banks needing extra attention.  The use of
different criteria to identify problem banks results in
some differences in the agencies' problem bank lists.
As a result, some banks may be receiving more attention
than they need and some less. The reader would have had
difficulty concluding which of our case studies were pro-
blem banks and which were not, if we had not labeled them
as such.  We believe that uniform criteria are necessary
to assure that the agencies are identifying and monitoring
the right problem banks.

Recommendation

     We recommend that the Board of Directors, FDIC, the
Board of Governors, FRS, and the Comptroller of the
Currency develop uniform criteria for identifying problem
banks.

Agency comments

     FDIC stated:

    "We believe our general comments clarify the posture
    of the three federal bank regulatory agencies with
    respect to problem banks,.including those which pose
    supervisory problems as well as those which present
    inordinate financial risk to the FDIC.  Moreover,
    we do not believe there is confusion or wide dis-
    agreement among the bank regulatory agencies as to
    which banks should be accorded close surveillance
    and supervision by the respective agencies and that,
    except in a failing bank, and to a limited extent
    in a bank holding company situation, there is
    virtually no overlap of regulatory jurisdiction
    at the federal level.  Furthermore, the need to
    develop common criteria for problem banks is not
    obvious and indeed may not be appropriate.




                             8-49
"It is, we believe appropriate and useful for the FD'C
as an insurer to view what constitutes a problem bank
from a somewhat different perspective than the other
two federal bank regulatory agencies.  In addition, the
extent to which the three federal bank regulatory agen-
cies use somewhat different approaches to the issue of
banks in need of increased and intensified supervision
could foster a greater degree of innovation in this
area of supervisory endeavor and could serve as a check
and balance in the promotion of the widest coverage of
such banks.  Finally, the objectives and detached
review process conducted by FDIC of all types of exami-
nations, in order to assess the degree of financial
exposure to the insurance fund, provides an overall
review of all banks without imposing across-the-board
guidelines which may not be suitable for the three
agencies on individual basis."

FRS stated:

"As previously noted in earlier responses, the rating
systems are utilized for different purposes within
different agencies.  However, we believe there is
certainly room for much common ground in this area.
The legislative proposals for a Federal Bank Exam-
ination Council referred to earlier would aid in
this development, though judgmental evaluation of
any common critieria will likely lead to some
diversity."

OCC stated:

"The term 'problem bank' is barking agency jargon
for many different fact patterns.  To an outsider,
it appears reasonable and logical to expect a uniform
definition of the term.  The agency staff person
recognizes the difficulty of reducing all the variables
to a single definition.  At the same time, he has
little difficulty in communicating with colleagues
in other banking agencies on particular bank situations.

"OCC's approach is to computerize to the greatest
extent possible the many variables which characterize a
bank's condition and management from time to time.
This results in a capability to rank all banks in rela-
tion to their peers.  The final selection of banks




                        8-50
    needing special supervision can only be done subjec-
    tively by trained personnel using all the tools avail-
    able and the results of our revised examinations.
    The dividing line on the spectrum between 'problem'
    and 'non-proDlem' status is hard to define but OCC
    is more than willing to consult and cooperate with
    the other agencies in seeking such dividing lines."

DYNAMICS OF THE PROBLEM BANK LIST:        1971-75

     In the early 1970's problem banks were decreasing,
however, by the end of 1975, they had increased substan-
tially. At the same time, more banks with deposits of
over $100 million began appearing on the supervisory
agencies' problem lists.  This is illustrated by the
following schedule:



                               Problem Lists
                 FDIC (note a)       FRS                  OCC --
            Totai no. Large    Total no. Large           no. Large
   Date     of banks   banks   of banks banks       of banks banks

 12/31/70     190        -           39        4     123       9
 12/31/71     183        2           48        6     119      10
 12/31/72     145        3           36        6      73       5
 12'31/73     124        1           29        5     109       7
 12/31/74     144        4           38        7     187      33
 12/31/75     275       14           65       18     267      58
  9/30/76     288       16           65       19     219      48

 a/FDIC includes national and State member banks on their
 problem lists, in addition to State nonmember banks--for
 which they have supervisory responsibility. However, these
 figures represent only the State nonmember banks on FDIC's
 problem list.

      We analyzed the number of problem banks at the super-
visory agencies for the 5-year period ended December 31,
1975.   OCC's criteria varied during the period, and it
could not identify for us all banks which had been con-
sidered problem banks.   An OCC official said that until
December 1974, problem banks were mostly those with com-
posite ratings of "3" or "4."   Therefore, we are showing
those national banks with composite ratings of "3" or "4"
as OCC problem banks.



                              8-51
                                FDIC            FRS              OCC
Number of problem banks.
  at 1.2/31/70                   190             39              123
Number added from
  1/1/71 thru 12/31/75           528             89              563
     Total number of problem
     banks during the 5-year
     period                      718   (100%) 128 (100%)         686      (100%)
Number returner to non-
  problem statut during
  the period                     414   ( 58%)    38 ( 30%)       392      ( 57%)
Number merged with another
  bank                            14 (    2%)     9 (    7%)       8      (   1%)
Number closed                     15 (    2%)     2 (    1%)      11      (   2%)
Number converted to a
  national/State charter          -               1 (    1%)          8   (   1%)
Number that withdrew
  from FRS membership             -              13 ( 10%)        -
Number removed from list         443   ( 62%)    63 (_49%)       419      ( 61%)
Number of problem banks
  at 12/31/75                    275 ( 38%)      65   ( 51%)     267      ( 39%)
Total number of
  banks at 12/31/75            8,594        1,046              4,747
Percentage of problem banks
  among total banks super-       3.2            6.2              5.6
  vised at 12/31/75




                               8-52
     The following analysis shows, for the 844 banks
returned to nonproblem status, the length of time they were
classified as problem banks.


                  Total             FDIC           FRS            OCC
              Num-    Per-   Num-     Per-     Num- Per-      Num- Per-
Years         ber     cent   ber      cent     ber     cent   ber     cent
Under 1       395       47   149        36      12      32    234     60
1 to 2        248       29   136        33       8      21    104     26
2 to 3         e8       11    59        14       6      16     23      6
3 to 4         45        5    26         6       4      10     15      4
4 to 5         21        3    14         3       2       5      5      1
5 to 10        45        5    28         7       6      16     11      3
10 or more      2       -      2           1            -      -      -


              844     100    414       100      38     100    392    100



     Of the 844 problem banks that returned to nonproblem
status, 76 percent were problem banks for 2 years or less.
Nineteen percent were problem banks from 2 tc 5 years;
5 percent, from 5 to 10 years; and 2 banks, for over 10
years.

     In addition, 15 banks were on the problem list during
the entire 5-year period of our study. As of December 31,
1975, these banks had been problem banks for an average
of 9.2 years. Of these, one State nonmember bank had been
on the problem list for 20 years; one State member bank,
for 26 years; and one national bank, for 10 years.

Conclusions

     The supervisory agencies' success in getting bank
problems corrected depends largely on how willing and
cooperative bank managers are to change those practices
and policies which caused the problems. Those banks
which are receptive to the agencies' identification of
problems and suggestions for soiling them stand a better
chance of correcting their problems sooner.  Therefore,
movement off the problem list results from the banks'
as well as the agencies' actions.




                                    8-53
     Most banks (55 percent, -sere returned to nonproblem
status during the 5-year period--most of them (76 percent)
within 2 years.  Informal enforcement action worked for
these banks. The banks remaining on the list (40 percent)
probably had come on the problem list near the end of the
5-year period, too late to have already had their problems
corrected. The problem list as of December 31, 1975, included
only 4 percent of all banks in the system.

     What concerns us are those banks which were problem
banks for long periods of time; e.g.. those that were
problem banks for over 2 years. We believe that the
agencies have to use more formal enforcement actions
when dealing with them.
     We also question whether banks which have been on the
agencies' problem lists for extended periods of time are
really problem banks. Obviously some banks were able to
remain in existence even though they were on the agencies'
problem lists for a long time.
ENFORCEMENT ACTIONS AGAINST
BANK   5LDIN dOMPANIE-
               -
     FRS deals with bank holding company problems the same
way the three agencies deal with problem banks. When
FRBs identify holding company problems. they use informal
enforcement methods. Formal methods can be used when
informal ones fail.
     We reviewed 20 holding companies and found that FRBs
used the following types of enforcement actions from
January 1. 1973. through September 30, 1976. to induce hold-
ing company management to correct its problems:




                              8-54
                                                  Number
          Enforcer   At action                  of actions
Informal:
     Phone calls and letters                          13
     Visits                                           11
     Special inspections or examinations               9
     Requests for progress reports                     8
     Analytical checks                                 4
     Threat of cease and desist orders                 2
     Disapproval of expansion applications             6
Formal:
     Cease and desist order (note a)                  1
a/Cease and desist order authority was not given to
  FRS until October 1974.

     As the above table shows, FRBs primarily used informal
enforcement actions when they dealt with bank holding com-
panies.
DO THE SUPERVISORY AGENCIES
HAVE APPROPRIATE POWERS?

     Earlier in this chapter we discussed the formal powers
available to the supervisory agencies. Closing a bank or
canceling its insurance does not save it or solve its
problems. although the threat of these actions can influence
managers to take corrective action.  Short of these
procedures, the agencies' formal powers that can be actually
used to influence a bank are removing officers and issuing
cease and desist orders.
     Officials at all three agencies said removing bank
officers is now too cumbersome to be useful. The agencies
must prove that the officers have committed acts of
personal dishonesty. and they say such proof is difficult.
In addition. OCC cannot proceed directly against a bank
officer.  it must present its evidence to FRS and rely
on that agency to take action. Consequently. the agencies
do not use their removal power as frequently as they would
like to.
     Agency officials said further that cease and desist orders
are not always a deterrent to bank mismanagement, since they
require a bank to stop performing an act or to take affirmative
action to correct the conditions resulting from any such
violation or practice.




                                 8-55
     Another problem pointed out by the agencies is
that available legal measures do not get at the individuals
causing banks problems. This is because the measures
are aimed at banks, not bank officials. except for the
unwieldy removal procedure.
     The supervisory agencies requested additional statutory
authority in a bill (S. 2304) which was considered
in the second sessicr of the 94th Congress. Among other
provisions, the bill would authorize the three agencies
to initiate removal proceedings against a bank official
whose acts stem from either personal dishonesty or gross
negligence. The bill would have also authorized civil
penalties against banks and officials who violate sections
22 and 23A of the Federal Reserve Act, or regulations
pursuant to them, These sections deal with (1) purchases
of securities from directors, (2) interest on deposits
of directors, officers, and employees. (3) loans to execu-
tive officers. and (4) loans to affiliates.
     The agencies made only limited studies of the need
for specific legal powers.   In response to the failure
of Franklin National Bank. FRS formed a task force to develop
requests for more statutory tools, but made no quantitative
analyses of bank problems. The agencies used their supervis-
ory experience to decide what. measures could aid them
in dealing with banks. Agency officials do not expect
to use the requested powers very often. but they feel
that the extended authority would be useful when needed.
     In our study of 30 banks that failed. we found that
the examiners often sta-ed that the failures were caused by
bank managers who followed self-serving loan practices or
who were incompetent. Also, among our sample of problem
banks on December 31. 1975. management effectiveness was
cited as a problem in 57 percent of the banks at the time
the banks were put on the problem list. Therefore, the
ability to apply penalties or to remove individuals could
have been helpful in dealing with these bank officials.
     As for the types of violations mentioned in section
22 and 23A of the Federal Reserve Act, we found that the
percentages of banks in our samples that had these violations
cited after the most recent reports of examination were
as follows:




                             8-56
                                         Sample
                       1vZ-rs-aT
                      Un                 Problem-l-_-    F
    Violation        --------        (percent---------

Purchase of
  securities              5                 4                4
Interest on
  deposits               6                  8                 4
Loans tc insiders       10                 10                22
Loans to af-
  filiates                8                10                 4

While relatively few banks committed these violations the
authority to levy penalties could be a deterrent.
Conclusions

     Although in the past the supervisory agencies have not
used their legal powers often enough. additional powers
could enhance their ability to deal with bank problems.
Specifically. the authority to remove bank officers for gross
negligence and to levy civil penalties for certain violations
could be useful. Therefore, we would support legislation
which would authorize the agencies to remove bank officials
for gross negligence and to assess civil penalties for viola-
tions of laws and regulations.
     We would also support legislation to allow OCC to present
evidence and argument at removal proceedings conducted by
FRS.




                              8-57
                         CHAPTER 9
              AN ANALYSIS OF BANKS THAT HAVE

                FAILED IN THE LAST 5 YEARS



Overview                                       9-1
What is a failed bank?                         9-4
What happens when a bank fails?                9-4
  How does FDIC handle closings?               9-4
    Deposit assumption                         9-4
    Statutory payoff                           9-5
    Deposit insurance national bank            9-5
  What are the effects of a bank failure?      9-6
_'hy did banks fail?                           9-9
How early did the agencies identify
  the causes of failures?                      9-13
How did the agencies try to resolve
  the banks' problems?                         9-14
Conclusions                                    9-16
                           CHAPTAk 9

                 AN ANALYSIS OF BANKS THAI HAVE

                   FAILED IN THE   LAST 5 YEARS

OVERVIEV

     For the first time since the massive Dank failures of
the 1930s, the public is concerned about the health of the
banking system. One direct result of tnose earlier failures
was the creation of the Federal Deposit Insurance Corpora-
tion in 1933, to protect depositors and prevent mass with-
drawals. Since 1933, banks have continued t-o fail, but
until 1966 these failures involved relatively small banks.
(The largest had deposits of $48.8 million.)
     However, several larger banks have failed since 1965.
The Public Bank of Detroit, with deposits of $93 million,
closed in 1966. In 1971 it was Sharpstown State Bank of
Houston with $66.8 million in deposits; in 1973, U.S,
National Bank of San Diego with $932 million; in 1974,
Franklin National Bank of New York with $1.4 billion; in
1Y75, American City Bank and Trust of Milwaukee with $99.5
million; and in 1976, Hamilton National Bank of Chattanooga
with $341 million.

     The graphs on the following page show the number of
failures and the total deposits of banks that closed between
January 1960 and December 1976. Although the number of
failures is still small, the total of failed banks' deoosits
has risen dramatically.

     Placing the figures in perspect ve, the largest number
of failures in any year shown was 16 during 1976. This re-
presents about 0.1 percent of the total number of banks. At
the end of 1975 the three supervisory agencies listed a
total of 607 different banks needing special attention;
and the number of failures during 1976 was only 2.6
percent of that figure.

     FDIC studies of 92 bank failures from 1960 through
September 1976 indicate self-serving and improper loans
caused 57.6 percent of the failures; defalcations, such as
embezzlement and fraud, 27.2 percent; and other management
weaknesses, 15.2 percent.




                            9-1
                                          NUMBER OF BANKS CLOSED 1960-1976
Number Of Closings
 16
150
14
13
12


10"




 9
1                               --

1960        61        62             63    64    65        66        67     68        69    70    71    72   73    74    75    76
                                                                          YEAR


Total Deposits (millions)                   TOTAL DEPOSITS OF CLOSED BANKS 1960-1976



 900-

 800

 700

 60

 500



 300

 200



     1960        61        62         63    64        65        66    67         68    69    70    71   72    73    74    75    76
                                                                          YEAR

                                                                           9-2
     we selected for detailed review 30 of the 42 banks that
were closed between January 1971 and June 30, 1976.     Of
these 30 banks, 19 were  supervised Dy  FDIC, 9 by OCC,  and 2
by FRS.  An additional  27 banks merged  with others to  avert
probable failure.

     Adverse economic conditions in the early 1970s contrib-
uted to some of the bank failures. However, the primary
cause of each failure was the practices followed by the
Dank's managers.  These practices left the banks more vul-
nerable to economic fluctations.

     Among the 30 cases we reviewed, 14 banks' problems
were related to self-serving loan policies, which had been
pointed out by examiners well before the banks failed.
Illegal acts such as embezzlements caused eight of the
failures and in seven of those cases examiners had criti-
cized the banks for poor internal controls. Examiners
actually discovered illegal acts at three of those banks.
The remaining eight failures were caused by general loan
mismanagement.

     Accoraing to FDIC, one factor common to banks that
failed was the lack of supervision by the banks' boards of
directors.  The directors did not fulfil' their responsi-
bilities to set and enforce bank policies.

     Faced with incompetent or dishonest managers and with
boards of directors that often did not become involved
enough in bank operations, bank supervisors used informal
persuasive techniques in vain.  Managers of banks that
eventually failed did not respond to the supervisory agen-
cies methods and did not correct their problems.

     Short of closing a bank the regulators have formal
legal methods available to them, such as terminating insur-
ance and issuing cease and desist orders. (See ch. 8.)
However, the supervisory agencies used their legal powers
in only 8 of the 30 cases we studied, and only after the
banks' problems had become critical.  Notwithstanding their
recent requests for additional powers, we believe the agen-
cies should have used the ones they have sooner and more
often.




                              9-3
WHAT IS A FAILED BANK?

     For purposes of our report, a failed bank is one which
closes due to financial or other problems. A bank can vol-'
untarily liquidate, or, if the Comptroller of the Currency
becomes satisfied that a national bank is insolvent, he may
appoint a receiver. Although State laws vary, State char-
tering authorities can similarly close State banks. Our
charts on page 9-2 include banks both voluntarily and invol-
untarily closed.
     Some banks in imminent dancer of failing are merged
with or are purchased by other banks. Each supervisoiy
agency can approve such mergers or purchases on an emergency
basis. OCC approved 14 such mergers during the period cover-
ed by our study, FDIC approved 10 and FRS 3. If a purchaser
cannot be found and the bank is considered vital to a com-
munity, the regulators may give direct financial aid to keep
it open.
WHAT HAPPENS WHEN A BANK FAILS?

     When a national bank closes, FDIC is appointed receiver
with power to liquidate assets of the closed bank, enforce
the liability of the stockholders and directors of the bank,
and wind up the bank's affairs. Usually FDIC is appointed
receiver for insured State banks that fail.
How does FDIC handle closings?

     FDIC can choose from three basic methods of handling
closings, depending on the potential cost to the Corporation
and the needs of the community.

     Deposit assumption
     FDIC can assist a sound bank to ansorb a failed bank,
when such action will reduce risk or avert a threatened loss
to the Corporation. It can do this by purchasing assets of
the failed bank, granting a loan to the assuming bank evid-
enced by a capital note, or indemnifying the assuming bank
against actual or potential losses.

    Often, the transaction works as follows:

     (1) FDIC, as receiver of a failed bank, solicits bids
         to assume deposit liabilities of the bank.


                           9-4
     (2) The winning bidder, which could be a newly
         chartered bank, assumes the failed bank's
         deposits and perhaps other specified
         liabilities. The assuming bank may also
         purchase assets of the failed bank from the
         receiver.
     (3) If liabilities assumed exceed the assets
         purchased and the premium paid, the failed
         bank's receiver pays the assuming bank the
         difference in cash with funds from FDIC for
         for its purchase of the remaining assets of
         the failed bank.
     Twenty of the thirty banks we studied were handled as
deposit assumptions. For example, the newly chartered First
Tennessee National Bank was the winning bidder for the de-
posit liabilities of the defunct Hamilton National Bank of
Chattanooga. First Tennessee tcok over $385 million in de-
posits and other liabilities. It paid a premium of over
$16 million, and accepted about $314 million in assets. To
complete the transaction, FDIC as receiver paid over $54
million. FDIC also purchased a capital note of $24 million.
     Statutory payoff (straight receivership)

     FDIC pays insured depositors out of the insurance fund.
It acts as receiver for the failed bank. The 30 cases we
reviewed included 8 statutory payoffs. One such case was
the Elm Creek State Bank of Nebraska. This bank had total
deposits of about $2.9 million, including those of 23
uninsured depositors. All insured depositors were paid,
and even the uninsured depositors had received 95 percent
of their money at the t .me we made our study.

     Deposit insurance national bank
      If FDIC finds that it is advisable and in the interest
of the depositors of the closed bank, OCC may charter a
Deposit Insurance National Bank (DINB). For a period of up
to 2 years the DINB services deposits and may, if its char-
ter allows, extend loans. The manager of the bank is ap-
pointed by FDIC and is under its direction. FDIC may make
a public offering of the DINB, but if a buyer cannot be
found within 2 years FDIC must wind up the affairs of the
DINB.



                            9-5
     DINb's were established in 2 of the 30 cases we studiea.
One was the Swope Parkway National Bank of Kansas City,
Missouri.  The DINB assumed all insured deposits us to
$40,000 and also assumed cash and "due irom banks" accounts,
along with certain investments.  As assets are liquidated,
uninsured deposits and other creditors are being paio off.
The stockholders have lost their investments, out they have
the first chance at buying into the DINB.  Insured deposits
were aoout $4.9 million, and FDIC nas established a loss
reserve of $1.5 million for this case.

What are the effects of a oank failure?

     The financial effects of a bank closing vary according
to the method used to handle it.

      A deposit assumption may offer the least inconvenience
to the bank's former customers.   Banking services often re-
remain uninterrupted for members of the community.   No de-
posits are lost, and at least some borrowers may continue to
have creidit available from the assuming oank.    Generally,
 'DIC acquires the unassumed loans and continues to collect
them.   Most creditors other than depositors must await the
outcome of FDIC liquidation proceedings before they know what
their losses are. They are left to any legal remedies they
might have against the receivership. The banK's stockholders
can lose their investments out may recoup something as a
result of liquidation by FDIC.

     In a statutory payoff, only insured depositors are paid
off quickly. Uninsured depositors, other creditors, and
stockholders must await the outcome of liquidation.  bank
customers, of course, mnust try to find services from another
bank.

     The full financial impact of a closing is not calcul-
aole until the liquidation process is completed. This pro-
cess may take several years after the closing, so we could
not determine tne tull effects of each failure we studied.
However, according to FDIC, tor banks that failed since
1934, over 99 percent of all depositors--insurea and unin-
sured--have been paid in full or nave had their funds made
available to them, as in a deposit assumption.




                             9-6
     FDIC's costs include the amount it pays to depositors
in a payoff, or the amount it pays to facilitate an assump-
tion; tne interest income lost on the money it pays out; and
the expenses of acting as receiver for the failed bank.
FDIC may recover money from the liquidated assets of the
bank; proceeds from fidelity bonds; and proceeds from direc-
tors' liability.
     When a Dank tails, FDIC estimates the potential losses
on liquidating the assets it assumes. As the bante's  assets
are liquidated, the reserve establishea for the losses is
aajusted semiannually. As of June 30, l75,
                                        7,'IC     had approved
the following reserves for banks that failed during the per-
iod we studied:


             FDIC Reserves for   Losses on Closed Banks


         t.aine of bank                              Reserve

                                                  (000 omitted)
     Payoffs:
          Sharpstown State Bank
            Houston, Tex.                            $1,050
          Farmers State Bank of
            Carlock, 111.                                 300
          First National Bank ot
            Cripple Creek, Colo.                          140
          Surety Bank & Trust Co.
            Wakefield, Mass.                          4,100
          Swope Parkway National Bank
            Kansas City, Mo.    1/                    1,500
          FranKlin Bank
            Houston, Tex.                             3,025
          Peoples Bank of the
            Virgin Islands   1/                       2,350
          Mt. Zion Deposit BanK
              1t. Zion, Ky.                               100
          Coronado NJational Bank
            Denver, Col.                                  200
          Citizens State Bank
            Carrizo Springs, Rex.                         300



1/     Deposit Insurance National   Bank


                                  9-7
       Name of bank                                 Reserve
                                               (000 omitted)
  Deposit assumptions:
       Skyline National Bank
          Denver, Col.                         $       130
       U.S. National Bank
          San Diego, Cal.                          350,o00
       First National Bank of
          Eldora, Iowa                                  85
       American Bank & Trust
         Orangeburg, S. C.                           2,700
       Tri-City Bank
         Warren, Mich.                              2,100
       Northern Ohio Bank
         Cleveland, Ohio                            5,725
       Algoma Bank
         Algoma, Wisc.                                825
       Bank of Chidester
         Chidester, Ark.                              620
       State Bank of Clearing
         Chicago, Ill.                              8,700
       Astro Bank
         Houston, Tex.                                440
       American City Bank & Trust Co., N.A.
         Milwaukee, Wis.                           13,530
       Peoples Bank
         Wilcox, Ariz.                                125
       Bank of
         Bloomfield, N. J.                            600
       Bank of Woodmoor
         Monument, Col.                               330
       South Texas Bank
         Houston, Tex.                                950
       Northeast Bank of
         Houston, Tex.                                680
       First State Bank of Hudson County
         Jersey City, N.-J.                           570


     Not all the banks that failed during the period we stu-
died are on the preceding list, because FDIC did not project
losses for them. For example, FDIC does not anticipate los-
ses on Franklin National Bank, so no reserve was established.




                            9-8
      FD1C derives most of its income from assessments (sim-
ilar to insurance premiums) paid by insured banks and from
investments in U.S. Government securities.   From
tne total assessments due each year FDIC subtracts its ex-
penses, insurance losses, and net increases in loss re-
serves.   Two-tnirus of the remainder is credited back to
insured DanKs to offset forthcoming assessments.    Therefore,
the more Danks that fail and the larger their assets,
the less is credited back to the banks still operating.
In tnis way, all insured oanks oear the costs of failures
-- the concept of risk-spreading through insurance.

     FDIC officials said failures, especially of small
oanks, have usually had little impact on the communities
involved.  Of concern to many is the effect of large bank
failures on the public's confidence in our banking system.
Although it is apparent that the economy can tolerate the
number of failures that have occurred in recent years, we
cannot determine at what point an intolerable situation
would develop.  For example, if the number of large bank
lailures were to increase, the economy coula be seriously
affected.

WHY DID BANKS FAIL?

     From 1934 to the early 1960s, illegal acts--such as
fraud and embezzlement--were the major cause of bank
failures. Some failures also resulted from extremely
oad management.

     The Chairman of FDIC I/ has pointed out that in the
late 1960s some banks began expanding their activities
into riskier areas, such as real estate, direct lease
financing, and foreign operations. These banks were primar-
ily concerned with rapid growth and high profits, and they
adopted more liber~e lending policies. With the relatively
stable growth and moderately stable prices of that period,
no noticeaole harm was caused by these new banking
philosophies.


1/Robert E. Barnett, in a speech before the 92nd annual
  convention of the Texas Bankers Association, El Paso,
  (May 3, 1Y76).




                             9-9
     But the early 197Cs provided a tougher economic cli-
mate. Bankers faced not only a major recession but also
tight credit and high borrowing costs. These economic con-
ditions contributed to the increase in bank failures.

     However, our study of examination records of failed
banks revealed that the failures were primarily caused
by the policies used by the banks' managers. Examiners
in 17 of the 30 cases we studied had criticized the
banks' managers for following self-serving loan practices.
In 26 cases examiners considered managers incompetent.
In 17 cases examiners had warned that the banks were
overconcentrating their loan risks in a single industry
or to a single borrower. And in 27 of 30 cases we
reviewed, examiners stated that the banks' loan records
were inadequate.

    In other words, management practices were unusually
risky even under good economic conditions, since poor
loans were often made. Therefore. the banks were more
vulnerable to economic fluctuations.

     A recent FDIC study of 92 bank failures between January
1960 and September 1976 showed that 57.6 percent were caused
by improper loans to officers, directors, or owners, or by
loans tc out-ot-territory borrowers; 27.2 percent resulted
from embezzlement or manipulation of funds; and 15.2 percent
were due to general loan management weaknesses. Compared
with an earlier FDIC study through 1974, this one showed
proportionately more failures caused by poor loan management
and fewer caused by embezzlement.

    The 30 banks we reviewed that failed from January
1971 to June 1976 followed a slightly different pattern.
Fourteen of the banks (46.7 percent) failed because the
management made improper or self-serving loans.  Eight
of the cases (26.7 percent) involved general loan management
weaknesses. Eight other cases involved embezzlement or other
crimes. The differences in our statistics reflect an in-
crease in mismanagement as a cause of failure, because our
study covered the most recent cases.



     Typical of the cases of self-serving or improper loans
is the following one, which we shall call State Bank.
State Bank opened in the i960s and shared ownership with


                             9-10
three other banks.  In the first examination we studied,
examiners criticized tl:- self-serving tendencies of the
bank's management. The (examiners stated the bank's direc-
tors had borrowed one-fourth of all the money loaned by the
bank, over twice the bank's adjusted capital and reserves.
Subsequent examinations divulged problems such as loans
secured by affiliated banks' stock, affiliated banks
financing each other, an overconcentration of large
speculative advances to real estate developers, and
unsecured credits to heavily indebted borrowers.
     When it closed State Bank had assets classified as
"loss" that exceeded its total capital and reserves.
Another bank owned by the same group failed a year later.


     A bank which we shall call Capital Bank illustrates
failures caused by the mismanagement of loans in general.
     Capital Bank was closed in the 1970s. Some years
earlier the State's capital city experienced a boom in
the real estate market, and developers started many new
housing projects. Some of these projects were aided
by a Federal program promotinr low-income housing.

     The bank's directors, according to Federal examiners,
were eager for the bank to grow. They approved large
loans to several developers, thereby overextending the
bank in the real estate area. Examiners believed that many
of these loans were made on the assumption that the real
estate market would continue to expand and that the bank's
officers paid too little attention to the creditworthiness
of the borrowers. Some of the construction projects did not
have s fficient fl,:ids to complete them.
     The Federal Government announced plans to phase out
its low Income housing subsidy, and the real estate mar-
ket in t;eneral also suffered a R.cline. Loans made by
Capital Bank became overdue, w..ik some borrowers unable
to meet their interest payments. Capital Bank made new
loans to some of these borrowers so they could make the
overdue payments on the previous loans. The bank accepted
insufficient collateral for these new loans, according
to examiners.


                            9-11
     Rumors of the bank's financial troubles caused many de-
positors to withdraw their funds, severely affecting the
bank's liquidity. In spite of a loan from FDIC and a line
of credit at ancter bank, Capital Bank had to close.



     The crimes that lead to failures are exemplified by a
bank we shall call Country Bank.

     Country, the only bank in a small town, suffered from
a variety of problems. Its management had been rated un-
satisfactory by the examiners over most of the last 5 years
of its existence. Examiners had been criticizing the bank
for classified loans, overdue payments, poor internal con-
trols, and violations of regulations. During that time a
new owner took over as president.

     As Country Bank was apparently beginning to improve,
its principal correspondent bank informed the State bank-
ing commission that Country Bank had been exposed to a
massive check kiting scheme. Federal and State examiners
determined that the scheme involved a substantial sum to
one of the bank's customers and that the same customer had
other unsecured credit at the bank.

     A kiting scheme is one in which a depositor with ac-
counts in two or more banks draws on nonexistent funds by
taking advantage of the time required for checks to clear
in order to obtain unauthorized credit. This scheme can
function only if depositors are allowed to draw against
checks which have not yet cleared--a commonly extended
courtesy.
     In this case the custcmer maintained checking accounts
at Country Bank and at severa. other banks. He wrote
checks on his Country Bank account and made deposits to
that account using checks of a corporation with an account
at one of the other banks. The cashier at Country told exam-
iners these checks were mailed to the bank at various times
so that enough would be on hand to keep the account
in the black. Once the other banks involved cut off the
kite, Country Bank was unable to recover from its losses.




                           9-12
     A bank's board of directors is responsible for setting
policies and overseeing bank operations. According to FDIC,
one factor common to many banks that failed was that their
boards of directors did not carry out their responsibilities
properly. Examiners had criticized the lack of director
involvement '   O20
                  of the 30 cases we reviewed.
HOW EARLY DID THE AGENCIES IDENTIFY
THE CAUSES OF FAILURES?

     The examiners identified the underlying problems which
led to most bank failures. In 21 of the 30 cases we re-
viewed, the agencies identified the banks' problems at least
2 years before they closed. Moreover, the examiners usually
commented to bank managers on the problems in reports or
meetings.
     Supervisors readily identified continued self-serving
tendencies and poor loan policies. The problems were usu-
ally cited in examination reports for several years before
banks failed. For example, OCC examiners criticized credit
practices of the Swope Parkway National Bank almost 4 years
before it closed. Although managers were replaced, losses
from the original loans so depleted the bank that it never
recovered.

     Even among the eight banks we studied which failed
because of frauds, examiners had noted problems with in-
ternal controls in seven long before they were forced to
close.



     OnCit
         example is a bank we shall call National Bank.
In the 5 years we studied, examiners had made 9 examin-
ations and 22 visits, and a public accounting firm had
audited the bank.

     In one report examiners disclosed that the salaries
of both the bank's vice president and its cashier were
"dangerously low"; however, both men indicated they had
"outside resources or assistance." The bank had a his-
tory of problems, including poor internal controls.
But the examiners stated they waived normal control re-
quirements since the bank had only a few employees.

     Following the discovery of a shortage by an em-
ployee of an affiliated bank, the vice president and
                             9-13
cashier were found dead in what was termed a mutual self-
destruction pact. Subsequently, the authorities found
substantial shortages and determined that irregularities
had existed for at least 3 years. According to examiners
the two employees had kept two sets of records to hide
the misapplications of funds from examiners. Unfortunately
for the bank, its bonding insurance had been canceled
earlier, and it could not recover from the loss.


HOW DID THE AGENCIES TRY
TO RESOLVE THE BANKS' PROBLEMS?

     Supervisory agencies could use both informal and
formal action when dealing with banks having problems.
(See ch. 8.) First they attempted to influence bank
managers and owners with informal techniques. For ex-
ample, in some of the cases we reviewed, the super-
visory agencies male periodic visits to the banks in
addition to regular examinations. Some of the banks
were required to report periodically on progress in
solving their problems.  In one case we studied, OCC
even placed examiners in the bank full time to monitor
its progress.



     A bank which we shall call Town Bank will help
illustrate agency actions.

     Town Bank served a rural community and was not highly
rated when it was purchased by a new owner.  After the
bank was closed it was alleged several persons used illegal
means to finance highly speculative real estate ventures.
This line of credit comprised almost half of Town Bank's
loan portfolio when it closed.
      Examiners had cited the concentrated loans and self-
serving tendencies in one of their examinations. Some
months later the bank was sold again, but examiners felt
the new owner was inexperienced. Both Federal and State
banking authorities stepped up their activity. Federal
regional officials met with bank officials, and they con-
ducted a special examination. Town Bank also agreed to
submit progress reports on its efforts to solve its prob-
lems.   Federal authorities considered issuing a cease and

                            9-14
desist order or terminating the bank's insurance, but the
State Commissioner of banking recommended against it,
reasoning that the offending individual had gone and the
offensive acts had ceased. In addition, the Commissioner
felt that such an action would discourage efforts to
resell the bank.

      The bank requested that FDIC grant it a loan to stay
open.   FDIC declined, suggesting the bank was not really
essential to the community, and began proceedings to term-
inate Town Bank's deposit insurance.   A hearing had been
scheduled when the bank finally closed.   In the last few
months both Federal and :icate authorities had tried to
help arrange a merger between Town Bank and another bank,
but their efforts proved futile.



      Agency field r rsonnel preferred to use informal
enforcement techniques and usually found them effective.
Regional officials stated they can even influence a
bank's directors to force an undesirable officer to re-
sign.   For example, one bank we reviewed changed mana-
gers at the insistence of OCC, but the bank still failed.

     When informal measures fail to elicit corrective
action, formal legal authority is available to the
supervisory agencies:

     -- FDIC may terminate a bank's insurance.

     -- FRS may expel member banks.

     -- Any of the agencies may remove offending managers
        (OCC must rely on FRS for action).

     -- Any of the three agencies may issue a cease and
        desist order.

      In 7 of the 30 cases we reviewed, the agencies threat-
ened to either close the banks or terminate deposit insur-
ance.   FDIC actually began to terminate the insurance of
four banks we reviewed.   The agency removed an officer of
one bank.   However, he owned a controlling interest in the
bank and so remained influential.

     Since 1966 the Federal regulators have had thie power
to issue cease and desist orders. Proceedings were

                             9-15
initiated in only 4 of the 30 cases we reviewed. Two
were begun 18 months or more after the problems had
first been identified. None of the proceedings went
to the hearing stage because all the banks involved
consented to the orders.
     In addition to the actions discussed above, FDIC and
FRS can each render financial assistance to banks in
trouble.  Under section 13(c) of the Federal Deposit In-
surance Act (12 U.S.C. 1823(c)), FDIC may make loans,
purchase assets, or make deposits to prevent the closing
of an insured bank which is essential to its community.

     Under section 13(e) of the Federal Deposit Insurance
Act (12 U.S.C. 1823(e)), to facilitate a merger, the FDIC
may make loans to the acquiring bank, purchase assets, or
guarantee any other insured bank against losses on pur-
chasing assets.  Such actions were taken to avert a
closing for the first time in 1975, when FDIC loaned $10
million to assist the merger of the failing Palmer First
National Bank and Trust Company.

     The Federal Reserve can also make cr.edit available
to banks in trouble. FRS loaned Franklin National al-
most $2 billion to keep it operating until a permanent
solution could be found to its problems. None was
found and Franklin ultimately closet
CONCLUSIONS

     Most bank failures we studied were caused by bad man-
oqement practices that were readily identified by the
supervisory agencies' examiners. Although economic con-
dit:ons worsened the banks' problem.s, the primary causes
of the failures were the management decisions that left
the banks inordinately vulnerable.

     The difficulty confronting the agencies in most of
the cases we studied was not in identifying the problems
but in influencing the banks to solve them.   Although
agency personnel said informal persuasive techniques are
usually sufficient to convince a bank's managers to solve
its problems, persuasion obviously did not work with the
banks that failed. This was usually because the bank
officials followed self-serving loan practices and were
incompetent, as stated in examination reports and corres-
pondence. In addition, the banks' boards of directors
did not meet their responsibilities.

                            9-16
     Faced with this situation, the agencies could have
turned to their legal powers. However, we noted a
tendency by each supervisory agency to delay formal
action until a bank's problems had become so severe as
to be difficult at best to correct. The regulators kept
waiting for the banks to take action they had promised,
and we found bank managers would break those promises
several times before the agencies began legal steps.
     Judging the appropriate time :o take formal measures
against a bank's management is dif,:icult. Nevertheless,
in the cases of failed banks we studied, supervisory
agencies did not use their cease and desist authority as
effectively as they might have.
     Since 1975, the agencies have begun to initiate more
cease and desist orders. Issuing cease and desist orders
early, when a bank's problems are still manageable, should
increase the supervisory agencies' effectiveness.




                            9-17
                        CHAPTER 10

           EXAMINER CAPABILITY AND INDEPENDENCE

                                                      Pae
Overview                                             10-1
Recruitment policies and practices                   10-4
     Sources of bank examiners                       10-4
     Standards for beginning examiners               10-4
Development of career examiners                      10-5
     Types of training                               10-5
       Conclusion                                    10-6
       Recommendation                                10-6
       Agency comments                               10-6
     Adequacy of training                            10-8
       Improvement needed in FRS training            10-9
       Conclusions                                   10-11
       Recommendations                               10-11
       Agency comments                               10-11
Performance evaluation                               10-13
     Qualifying for examiner-in-charge               10-14
       Conclusion                                    10-15
       Recommendation                                10-15
       Agency comments                               10-15
Advancement and compensation of examiners            10-15
Assuring examiner objectivity                        10-1d
     Restrictions on examiners' outside activities   10-19
     Financial disclosure requirements               10-19
     Rotation of examiners                           10-19
     Examiner turnover                               10-20
     Conclusion                                      10-21
                          CHAPTER 10

             EXAMINER CAPABILITY AND INDEPENDENCE
OVERVIEW

     The quality of bank supervision depends largely on the
competence and objectivity of the bank examiners.
     In responding to our questionnaire mailed to 1,678 banks,
commercial bank officials generally reported favorably on
the competency of examiners. Senior examiners' understand-
ing of the specialized examination areas of trust and inter-
national was rated adequate or more than adequate by 89 per-
cent of the bankers while 11 percent thought it was borderline
or less. Toward examinations of electronic data processing,
however, bankers were less favorable. Here, approximately
25 percent thought senior examiners' understanding was border-
line or inadequate. Opinions concerning each of the three
agencies were similar.
     An examiner's competence, or examining skill, is his/her
ability to analyze a commercial bank's operations and judge
its soundness. Competence is based on knowledge of banking
practices and of the supervisory agency's policies and regula-
tions. Examiners may acquire this knowledge from colleges,
from employment with banks, and from training and experience
provided by the agency. Agency training and experience
are probably the most important elements to help the examiner
understand and evaluate banking practices.
     TIi., agencies are not legally subject to Civil Service
Commission (CSC) rules and regulations governing Federal per-
sonnel practices; however, FDIC follows them in recruiting,
compensating, and promoting examiners. OCC uses CSC's Gen-
eral Schedule in paying its examiners. For the most part,
Federal Reserve district banks set their own personnel
policies.
     Although the agencies' personnel policies are similar
in many respects, there are important differences.  FDIC
and OCC are more centralized than FRS; therefore, they have
more uniform policies and practices.  Each Federal Reserve
district bank has primary responsibility for recruiting,
training, evaluating, and paying examiners, and, as might
be expected, policies and practices vary considerably.




                            10-1
     Most of the examiners hired by the three agencies have
undergraduate degrees in business-related subjects, and some
have worked in banks or as bank examiners. During 1971-75,
FDIC, FRS, and OCC hired 912, 594, and 1,147 examiners,
respectively, from the following sources:
                               FDIC       FRS      OCC
                               ------ (percent)--------

       College                    81      58        71
       Commercial Banks            2      12        12
       Other a/                   17      30        17
a/ Private sector, Federal agencies, intra-agency
   transfers, reemployed military.
     The agencies operate internal schools which instruct
examiners in various aspects of bank examination, such as
commercial banking, trusts, international banking, and
electronic data processing. Bank examiners we questioned
generally rated the internal courses as useful or very use-
ful; however, many thought they needed additional training,
particularly in law, EDP, and accounting.
     In the specialized areas of EDP and international bank-
ing operations, FRS has not provided much training in recent
years. Its EDP school was not held in 1975 or 1976 though
plans have been formulated for a school in 1977.  Its inter-
national school was held once in 1972, 1974 and 1976. FRS
officials note however, that the New York Federal Reserve
Bank provides continuing training in international topics.
     FDIC offers three EDP schools which are available to
examiners at various stages of their careers.  It does
not have an international school; officials said that the
banks supervised by FDIC tend to be small and are therefore
unlikely to be engaged in international banking.  FDIC uses
OCC's schools or instructors to provide international train-
ing when needed for its examiners. OCC annually operates
one EDP and three international schools for its examiners.
     In 1975, the three agencies spent the following amounts
for internal and external training of their examiners, includ-
ing tuition, books, fees, space rental, and GttCents' and
instructors' subsistence and travel:




                           10-2
                                                 Average
                Training                       expenditure
              expenditures   Examining staff   per examiner
FDIC            $946,450            1,712        $552
FRS              321,836              709         453
OCC              636,000            1,968         323

     All three agencies periodically evaluate the job per-
formance of their bank examiners. FDIC and OCC require
employees to complete a formal evaluation process before
they can take charge of bank examinations. The process
emphasizes the skills needed to analyze a bank's manage-
ment, assets, and soundness. FRS does not have such a
process.
     All three agencies have policies to guard against actual
or potential conflicts of interest among their examiners.
The policies generally prohibit examiners from owning stock
in banks or bank holding companies, from having loans or
credit cards with banks that they may be asked to examine,
and from examining banks where their relatives work.
    Each agency requires examiners to file statements of
financial and personal interests when they are hired but
only FRS requires annual updates. We have been requested
by the Chairman, Subcommittee on Commerce, Consumer and
Monetary Affairs of the House Committee on Government
Operations to examine, in a separate study, the financial
disclosure practices of the three agencies.




                             10-3
RECRUITMENT POLICIES AND PRACTICES

Sources of bank examiners

     The three bank supervisory agencies generally hire
college graduates with bachelor's degrees in business-
related subjects such as finance, accounting, and economics;
however, they also consider applicants without degrees who
have worked in banks. Most of the positions are filled at
the entry level, although the agencies hire some individuals
at higher levels who have prier work experience, usually
with banks or with other Fede al or State bank supervision
agencies.

     Methods of filling examiner positions vary among the
three agencies. OCC regional offices typically recruit at
local colleges and universities.   In addition, they accept
walk-in applicants and referrals from bankers and OCC employ-
ees. FDIC regional offices fill positions from CSC job
registers. Individual Federal Reserve district banks fill
their positions by various methods: recruiting at colleges,
accepting referrals from employees and bankers, contacting
employment bureaus, advertising in newspapers, etc.
Standards for beginninaexaminers

     Minimum qualification requirements for examiners hired
by the three agencies are generally an undergraduate degree
in a business-related major or at least 3 years work in
banking or bank examining.  In addition, FDIC requires mo
applicants to pass CSC's Professional Administrative Career
Examination 1/ and OCC requires its applicants to pass a
general abilities test. Each Federal Reserve district bank
sets its own qualification requirements for examiner posi-
tions. Some require an undergraduate degree as a minimum
while others accept bank experience in lieu of the degree.
Of the 325 examiners interviewed at the 3 agencies, 301 had
college degrees.




1/Thiose with experience who apply for higher than entry-
  level positions must pass CSC's mid of senior-level
  examination.



                            10-4
DEVELOPMENT OF CAREER EXAMINERS

     The three agencies' bank supervision duties are carried
out p. imarily by their field examining staffs. Examining
teams are composed of assistant examiners and those who have
reached the full examiner level. Typically, assistants are
apprentices who begin with the more mechanical tasks, such
as cash verification, and progress to more analytical ones,
such as loan evaluation. Those who have reached the full
examiner level are considered capable of conducting the
overall examinat'on and preparing the examination report.
Typically, it takes 4 to 5 years for an individual to
progress from entry level to full examiner.
Tyes of training
     Bank examiners are trained by three mel.aods. The pri-
mary one is on-the-job training. New examiners are gener-
ally considered to be in training for 1 or more years while
more experienced examiners help them learn examining
skills through assignments with increasing responsibility
and progressively more complex tasks.
     The second type of training is through formal schools
and seminars operated at agency headquarters or at regional
offices and Federal Reserve district banks. There examiners
receive training in the commercial, trust, international,
and EDP areas of bank operations. Examiners at each agency
learn fundamentals at commercial bank examining schools
during their first 6 months of employment. The agencies
also operate more advanced schools ir; the commercial area
to pepare assistant examiners to take charge of bank
examinations. These schools emphasize the more analytical
and evaluative aspects of examination--judging asset qual-
ity, management ef -ctiveness, and bank policies and prepar-
ing examination reports.
     Each agency also offers basic and advanced courses for
examiners who will be specializing in trust examining or who
will be examining commercial banks with small trust depart-
ments.
     In the international banking area, OCC operates three
schools for individuals who will be examining banks with
international departments or overseas branches or subsidi-
aries. FDIC does not have an international school because,
according to officials, the banks it supervises are typically


                            10-5
small ones which do not have international operations. FDIC
uses OCC schools or instructors to provide training in inter-
national examining for individuals who may need it. FRS
holds an international school every 2 to 2-1/2 years.

      FDIC and OCC each offer introductory and more advanced
schools in examining the computerized aspects of bank opera-
tions. FRS used to have a 3-week basic EDP school, designed
to cover EDP examinations and provide guidelines for prepar-
ing an examination report. This course was not held in 1975
or 1976 though plans have been formulated for a course ih
1977.
     Examiners in the three agencies may also receive job-
related training from external sources. According to agency
officials, examiners are encouraged to enroll in correspond-
ence courses offered by such firms as Dun and Bradstreet,
Inc., or by such industry groups as the American Institute
of Banking. Some examiners also enroll in industry-sponsored
banking schools such as the Stonier Graduate School of Bank-
ing at Rutgers University and the National Trust School at
Northwestern University.

     Conclusion
     Generally, the agencies operate examiner training
schools in the same areas of bank operations. Since their
schools cover generally the same topics, the agencies could
(1) realize economies by consolidating their schools and
(2) assure high quality instruction by exchanging information
and standardizing curriculums.

     Recommendation
     We recommend that where feasible the Board of Directors,
FDIC, the Board of Governors, FRS, and the Comptroller of
the Currency combine their examiner schools and standardize
their curriculums.

    Agency_comments
    FDIC stated:
    "Although we find the comments and recommendations con-
    tained in the report on examiner training provocative,




                           10-6
on balance we believe they did not afford sufficient
treatment or depth to the various examiner training
and educational programs offered by the FDIC.
"We are especially dismayed by the fact that the GAO
study largely ignores the operation of the FDIC Division
of Bank Supervision (DBS) Training Center. The FDIC
Training Center is undoubtedly the best bank examiner
training program in the country. Nevertheless, because
of our burgeoning training needs, the FDIC is consider-
ing constructing its own, larger facility with resident
dormitory quarters. The FDIC has approached the FRS
and the OCC to join with the Corporation in a cooperative
training facility. Both the FRS and the OCC have
evidenced interest in this project and discussions
on a cooperative training effort are going forward.
A brief summary of the operation of the FDIC DBS
Training Center is included with our general comments."
FRS stated:

"The examiner schools were a combined effort of the
three agencies when they were established in 1952 by
the Federal Reserve. However, in 1962 the Office of
the Comptroller of the Currency withdrew from the pro-
gram, believing it preferable to operate its own school.
In the early 1970's the number of FDIC students ne-
cessitated some sessions held for FDIC examiners only
and, when the FDIC enrollment needs continued at
this high level, it was decided that the only prac-
tical course of action for the FDIC and the Federal
Reserve System was to establish separate schools.
The Board believes that a joint effort in this area
would be appropriate and desirable. This is among
the reasons the Board supports the concept of a Federal
Bank Examination Council. Short of this proposal, the
Poard will explore with other agencies the feasibility
of conducting joint schools."
OCC stated:

"The OCC recognizes that a common training effort and
a combined examiners' school would be highly desirable
both in terms of expense and coordination of examina-
tion policy. Our Office stands ready to cooperate fully
with all such efforts.  Indeed, our Office is in re-
ceipt Or a letter from Chairman Barnett of the FDIC

                       10-7
     asking our cooperation and financial support for a
     combined training facility to be constructed at a
     Rosslyn, Virginia site. This matter is receiving
     serious attention.
     The practical difficulty is that our Office has im-
     plemented the Haskins and Sells Report which has
     created fundamental changes in our examination pro-
     cess. These changes are so basic to our examination
     process that it would be difficult to coordinate a
     curriculum. A combined examiners' school is viable
     only if the other agencies modernize their techniques
     in line with those being implemented at the OCC.   It
     would be possible, however, to offer jointly courses
     in more generalized subjects such as Economics and
     Accounting."

AdeguacFy_of training

     We asked 325 examiners' opinions on the usefulness of
their agencies' training schools in increasing their banking
skills and helping them meet requirements of their work.
Most answered that the training they received was useful;
however, they said that more training would be helpful in
certain areas. The areas most often cited were law, account-
ing, EDP, management, fiscal management, corporate taxation,
and foreign exchange transactions.

     The responses of commercial bank officials to our
questionnaire also support the need for additional training,
especially in EDP.

     -- In response to a question about examiners' knowledge
        of banking, approximately 92 percent of the bankers
        thought it was adequate or more than adequate.
    -- We also asked the bankers to rate the competence of
       examiners-in-charge in 11 analytical and evaluative
       areas, such as loans, inter-al controls, and bank
       liquidity. In each of these areas, although approxi-
       mately 85 percent or more rated the examiners' com-
       petence as adequate or more than adequate, up to
       15 percent rated it as borderline or inadequate.
    -- Regar]ing the specialized examination areas of trust,
       international, and EDP, the bankers' opinions about



                           10-8
       the competence of examiners-in-charge were mixed.
       In the trust and international areas, approximately
       89 percent of the bankers thought examiners' under-
       standing adequate or more than adequate while 11 per-
       cent thought it borderline or inadequate.   The
       bankers' opinions were less favorable on EDP examin-
       ing.  Here, approximately 25 percent thought examiners'
       understanding borderline or inadequate.   This
       pattern of bankers' opinions was consistent among the
       agencies.

     OCC is improving its training for bank examiners, as
recommended public accounting firm of Haskins & Sells.
Beginning in January 1977, OCC headquarters will implement
an agencywide personnel development program consisting of
a continuing education segment and a career development
segment.

     The education segment will consist of at least 80 hours
of formal, technical education annually in the first several
years of an examiner's career.  This training is intended to
assure that the examiners learn needed skills at appropriate
points in their careers.  Training programs for the first,
second, and fifth years of the examiner's career have so far
been developed.

     The career development segment will provide management
oriented and technical training later in the examiner's
career.

     OCC officials also believe that its on-the-job training
of examiners will be improved b 'the agency's adoption of a
new handbook of examination procedure " . ;,hieh describes the
various areas of banking operations and provic s instruc-
tions on the examining functions to be performed for each.
An official said that these procedures will provide new
employees with guidance about the examiner's role and
understanding of sound banking practices.

     Improvement needed in FRS training

     Federal Reserve examiner training also needs improve-
ment, according to the findings of a 1975 FRS study of
examiner recruiting, training, development, and compensa-
tion done for the Conference of Reserve Bank Presidents.


                            10-9
 Half of the district Reserve Banks considered
                                                examiner
 training inadequate, while most had reservations
 quacy or expressed the need for expansion,         about ade-
 specialized areas. The study stated that    generally  or in
                                            to
 rent problems and new developments, examiners cope  with cur-
                                                would need
 additional specialized skills in the areas
                                             of EDP, inter-
 national banking, bank holding company operations,
 sumer protection.                                    and con-

      The Board has offered little or no training
                                                     in these
 areas in recent years.   It has not offered its introductory
 EDP school at all in 1975 or 1976 (plans have
 for a school in 1977).                         been formulated
                         It only held its introductory inter-
 national school once in 1972, 1974, and 1976.
                                                  Officials note
 however, that the New York Federal Reserve
 continuing training in international topics.Bank  provides
                                                At  the time
 of the study, FRS offered no courses in bank
 examinaticns and only a few hours on examiningholding company
 with various laws affecting consumer credit.     for compliance

     The FRS study recommended that the Conference
Bank Presidents urge the Board of Governors         of Reserve
                                            to
its examiner training program and insure that   reevaluate
                                               examiners
learn to deal effectively with current banking
and developments. The study specifically        practices
                                          recommended
      -- a school for examiners who inspect bank
                                                 holding
         companies,
     -- a refresher program for full examiners,
                                                and
     --a reappraisal of district Reserve Bank budget
        planning policies which have limited examiner and
        ing programs.                                 train-

      In January 1976, the Board appointed a
education to study training needs. A result omm.itLee on
has been the estab ; 4 hnent of an FRS school of this study
                                               for bank holding
company examiners, the first cession of which
October 1976.                                    was held in
                Further, the Federal Reserve Board's Division
of Consumer Affairs has designed a school
                                            for examiners who
check on commercial banks' compliance with
                                             the various con-
sumer protection laws. This school began
Officials said these schools will be held in September 1976.
                                            regularly to build
up a cadre of examiners knowledgeable in these
areas. The FRS education committee is also        examining
                                              considering es-
tablishing a new EDP school and a seminar
examiners to inform them of new developmentsfor higher level
                                                in banking and
other subjects of interest.

                            10--]0
     According to the Board's staff, it has long been aware
of the need for a complete review of the curriculums for the
the examiner schools but the pressure of the work has not
permitted this. Similarly, the Board staff has recognized
a longstanding need for teaching experienced examiners about
new developments in banking. The officials responsible for
the Board's schools are in its Division of Banking Super-
vision and Regulation, where they have other duties.  In the
small portion of time they can devote to training, they
cannot do the planning needed to revise current schools.
     Conclusions
     FDIC's training program seems to be providing its
examiners with most of the skills needed to assure high-
quality supervision of banks. OCC has recognized problems
with its program and has acted to improve it. Although
the Federal Reserve Board has improved its program as a
result of a recent FRS study, we do not believe that train-
ing can receive enough attention as a part-time responsi-
bility of the Board's Division of Banking Supervision and
Regulation.
   Additional training   l subjects such as EDP, law, and
accounting would be useful for examiners in the three
agencies.

     Recommendations

     We recommend that the Board of Governors, FRS,
(1) establish a full-time training office to operate its
examiner training program and (2) carry out the revision
of examiner school curriculums which it has recognized
as needed for sometime.
     We also recommend that the Board of Directors, FDIC,
the Board of Governors, FRS, and the Comptroller of the
Currency increase their training in EDP, law, and accounting,
as desired by their examiners.
     Agency comments
     FDIC stated:

     "We plan to give further attention to this apparent
     need. It is worth pointing out in passing, however,




                             10-11
 that, at least with respect to EDP training, in addi-
 tion -- the regular basic EDP courses (Course in
 Examii..ng a Computerized Bank (CECB) I and II), and
 advanced eight-week technical EDP school, known as
 Field Examiner Advanced Automation Training (FEAAT),
 is presently offered to examiners who have a desire to
 become highly proficient technically in FDP matters."

 FRS stated:

 "One individual currently administers the various
Federal Reserve examination schools held in Washington.
 In addition, one full time staff
handle preparatory and procedural member is assigned to
                                   aspects such as regis-
traticn, printing and distribution of instructional
materials and day-to-day dealings with instructors and
students. Other responsibilities for the different
schools have been assigned to various members of the
Board's staff who are experts in each field of training.
For instance, the curriculum for the newly established
Holding Company School was devised by members of the
Federal Reserve staff expert in matters relating to
holding companies and the new Consumer Regulations
School is handled by individuals who have been actively
involved in implementing the recent consumer legislation.
The Board believes that this system has met its needs.

If the report's recommendation for a joint school
adopted, this would reduce the need to consider a is
                                                   sepa-
rate office at the Board.   However, if such arrange-
ments cannot be worked out, the Board will consider
establishing such an office.
We might note that the portion of this recommendation
relating to a revision of examination curricula had
been started prior to the report. At the direction
of the System Education Committee, the curricula for
the schools for assistant examiners and examiners were
updated and revised in the spring and summer of 1976
and the curriculum for the EDP school was revised in
the fall.  The Holding Company and the Consumer
lation School have been recently established and Regu-
                                                  there-
fore have new curricula.

With respect to that portion of the recommendation
relating to additional training in specific areas,
the Board has a previously scheduled session of the
EDP school set for 1977 which will use a recently


                       10-12
    updated curriculum. The laws relating to consumer
    affairs are extensively covered in schools developed
    by the Office of Consumer Affairs now conducted in
    Washington as part of the overall examination program.
    The Board will study the question whether additional
    training in the areas or law and accounting should be
    provided to examiners."
    OCC stated:

     "As part of our acknowledged need for specialized
     training, and consistent with the advice of our con-
     sultants, the Training Division of the Personnel Man-
     agement Department has identified a multitude of dif-
     ferent specialized courses which selected examiners
     will take; they include 7 different commerical exami-
     nation schools, 3 trust examination schools, an EDP
     school, an International school and a consumer exami-
     nation school. That program has now been implemented
     and is in full operation. The schools are programmed
     for examiners at different stages of their professional
     development. Among the many courses that will be
     offered by skilled personnel, both from within the OCC
     and, where necessary, from outside, are ones in EDP,
     Law and Accounting. Among the other areas that will
     be covered in that curriculum development will be spe-
     cialized work in Economics , Bank Marketirg, Finance,
     Auditing and similar topics."
PERFORMANCE EVALUATION

     Each agency has procedures to evaluate the performance
of its examiners. Generally, examiners are rated annually
on the promptness, quality, and quantity uf their work;
their ability to plan, organize, and lead; their interest,
attitude, and interpersonal relations; and their judgment.
Newer examiners are rated more frequently. Assistant exam-
iners in FDIC, for example, are evaluated every 6 months.
Agency officials said supervisors discuss performance
appraisals with examiners. They also said they emphasize
these performance evaluations when considering individuals
for annual salary increases and for promotion.




                           10-13
Qualifyinfor examiner-in-charge

      The examiner-in-charge is the key member of the bank
examination team, the agencies' front line of bank super-
vision. This individual's duties require the ability to
analyze. and appraise factors affecting a bank's condition,
such as quality of assets, degree of liquidity, competency
of management, and adequacy of internal controls. The judg-
ment of the examiner-in-charge is important in determining
the scope, depth, and results of the examination. The
examiner-in-charge also deals with bank managers and prepares
and signs the examination report.   FDIC examiners-in-charge
and those at some Federal  Reserve banks are responsible for
rating banks according  to their agencies' procedures.

     Examiners-in-charge are individuals who the agency
believes have acquired the experience and skill needed to
conduct bank examinations. These individuals may advance to
the higher examining positions and to management positions.
     One way the agencies determine if an assistant examiner
is skillful enough to conduct bank examinations is through
job performance ratings. FDIC and OCC also have formal
evaluation processes, lasting 3 to 4 days, which are admin-
istered by one or more full examiners. In these processes
¢:andidates

     -- answer oral and written questions on banking terms,
        regulations, arid examination procedures,
     -- analyze and evaluate bank loans from an actual exami-
        nation, and
     -- prepare the confidential section of an examination
        report, based on analysis of bank operational data
        from an actual report.

     Generally, an assistant examiner must pass the perfor-
mance evaluation to be promoted to full examiner status.




                            1C-14
     Federal Reserve district banks do not use such a formal
evaluation process. Assistant examiners are advanced to
full examiner status when their performance has demonstrated
that they are ready.
     Conclusion
     We believe that formally evaluating examiners, as FDIC
and OCC do, is a sound practice for assuring that examiners
have received the necessary training and experience to make
the appropriate decisions and judgments in the bank
examination process.

     Recommendation
     We recommend that the Board of Governors, FRS also estab-
lish a formal evaluation process to measure the competence
of persons seeking advancement to examiner status.

     Agency comments
     FRS stated:

     "We note that this recommendation is not based upon
     a conclusion that the examiners of any one agency
     are more or less competent than those of another
     agency. Standardized tests are merely one way of
     arriving at a formal evaluation, and we would not
     want to rely on them exclusively. However, there is
     something to be said in favor of formal tests as a
     supplementary evaluation device, and the Board in-
     tends to investigate their feasibility."
ADVANCEMENT AND COMPENSATION OF EXAMINERS

     Bank examiners are hired and employed at FDIC and OCC
regional offices and at district Reserve Ban- .  Generally,
examiners are not recruited and assigned 'o ~eadquarters for
active examining work. Individuals hireG . :.hout prior bank-
ing or bank examining experience start as 4ssistant examiner
trainees at salaries ranging from $9,685 to $11,544, depend-
ing on the agency or Federal Reserve district bank. Each of
the 12 district Reserve Banks sets its own salaries, titles,
and grades. The agencies report no difficulty in attracting
qualified applicants at their starting salaries.




                           10-15
     The career path fre a bank examiner is typically through
two or three levels as assistant examiner to the first full
examiner position in 4 to 5 years, at which point his/her
salary would be $17,056 at FDIC, $17,625 at OCC, and from
$14,000 to $18,980 at tne various Federal Reserve district
banks. Thereafter, individuals may advance to the higher
e- Iner positions depending on their job performance.
     At FDIC and OCC, qualified individuals may reach the
top examiner positions with a salary of $33,789, in 10 to
12 years after reaching the first full examiner position.
Time required to reach the top examiner positions is approxi-
mately 8 years in the Federal Reserve banks; however begin-
ning salaries for these position are lower than the other
two agencies, ranging from $17,407 to $24,500.
     The following chart compares the agencies' starting
salaries for entry-level positions, for the first full
examiner positions, and for top examiner positions.




                           1.0-16
                                                                      TOP EXAMINER POSITIONS

DOLLARS                                                                 33.789             33,789
30,000




               •g     RANGE




                                                                                 24,500



                                               FIRST FULL
                                            EXAMINER POSITIONS

20,000                         _                        case18.980

                                                             17.625
                                             17,056


                                                                                 1.7407




          ENTRY-LEVEL POSITIONS


                      11 544       11,413

             10,543


10,000
                      9,685




            FDIC      FRS          OCC      FDIC      FRS   O.C        FDIC      FRS      OCC




                                            10-17
     FDIC and OCC use a career ladder procedure to advance
thei. examiners from the entry level to the second full
examiner position (GS-12).   Individuals are generally
promoted annudlly if they perform satisfactorily.   FDIC
uses a formal competitive promotion system for advancement
to higher positions. This system requires advertisement
of vacancies, within a regional office for GS-13 examiner
positions and throughout the agency for uS-14 and GS-15
positions.  OCC has a less formal competitive promotion
procedure which does not advertise vacancies agencywide.
Federal Reserve banks d& not use career ladder or competi-
tive promotion riocedures   Instead, employees are promoted
when their job performance demonstrates they are ready to
assume the duties of the next position.

     In response to recommendations of the 1975 Haskins &
Sells study, OCC has developed a new compensation and
benefits program in ended to encourage high performance.
I includes:

     -- Comprehensive position descriptions listing specific
        qualifications.

     ---Results-oriented performance appraisals intended to
        strengthen the concept of ba-cng salary increases
        on merit instead of on time-in-grade.

     -- A new salary administration procedure to replace the
        GS system currently used.  An annual salary survey
        will be taken to establish compensation levels and
        ranges competitive with positions of comparabl  re-
        sponsibility in other government agencies and in the
        private sector.

OCC hopes to have the program in operation by early 1977.

ASSURING EXAMINER OBJECTIVITY

     A bank examination could be biased by an examiner's
financial or personal interests in the bank or his/her
over-familiarity with bank managers. Each agency therefore
restricts its examiners' outside financial and personal
interests, and limits the number of consecutive examinations
at a bank by the same examiner-in-charge.




                           10-18
Rest ictions on examiners' outside activities

     Various laws and agency policies restrict the outside
financial activities and personal relationships of bank exam-
iners. They may not engage in any outside employment. or
accept any fees, gifts. or payments of expenses, which could
cause actual or apparent conflicts of interest.

     The agencies generally prohibit the ownership by exam-
iners and their immediate families of stock in banks,
their affiliates, and bank holding companies. At FDIC.
the prohibition applies to banks insured by the agency.
Federal Reserve Board policy forbids ownership of stock
in any bank, affiliate, or holding company. OCC prohibits
its examiners from investing in national banks.

     Bank examiners are prohibited from accepting a loan
or gratuity from any bank which they examine or have authority
to examine. This prohibition applies also to credit
cards of banks or their affiliates.

     Each FDIC and OCC regional office and Fede-' Reserve
district bank sets its own restrictions on assigning exam-
iners to banks where their relatives work. In general.
examiners are not a.lowed to examine banks that employ
close relatives.
Financial disclosure requirements

     At the three agencies. er-)loyees in certain sensitive
positions must file statements, listing any outside work,
stock holdings. and indebtedness. Each agency requires
its examiners to file these statements when they are hired
and FRS requires examiners to file annual updated statements.

     In this study. ¥w did nct review the agencies' imple.
mentation of their , i.cies regarding outside financial
and personal interests; however. we have been requested to
do this as a separate study by the Chairman. Subcommittee
on Commerce. Consoimer. and Monetary Affairs of the House
Committee on Goverrnment Operations. We expect to complete
that study in mid-1977.
Rotation of examiners
   The agencies have policies intended to - ntain ar. "ar. s
length" relationship between examiners-in-cihargt and bank
officials by limiting the number of consecutive examinations
an examiner may make at the same bank. OCC has a genera'

                            10-i.
policy that examiners-in-charge may not make more than five
consecutive examinations at one bank. Each FDIC regional
office and each Federal Reserve district bank sets its own
policy. Four offices and district Reserve Banks where we
inquired limited consecutive examinations to two or three.

     We reviewed the last three examination reports on
200 banks supervised by each of the agencies and found that
the above policies are generally followed.

Examiner turnover

     During 1973-75, the turnover rate of examiners in each
of the agenciec was approximately 10 percent. Most examiners
who leave the Lhree agencies do so either to take jobs with
commercial banks, other private firms or organizations, or
other government agencies or to continue their education.
Most departures occur during the first 5 years of employment.
Examiners who left during 1973-75 numbered 506 at FDIC,
218 at FRS, and 603 at OCC.
     Examiners who left for commercial banks accounted for
29, 37, and 41 percent of total departures at FDIC, FRS, and
OCC, respectively. We checked at the agencies to determine
how many fuV- examiners--i.e., th se who can be in charge of
examination. -were hired by banks which they had examined
shortly before resigning.
     At FDIC during 1974 and 1975, 19 full examiners went to
work for banks which they had examined during the year pr. .ed-
ing resignation.  Eleven of these had assisted on the exami-
nation and eight had functioned as examiner-in-charge. At
two Federal Reservc district banks that we checked, no full
examiners left during these 2 years to join banks which they
had examined. During 1974 and 1975, 24.full examiners left
OCC to go to work for banks which they had examined in the
3 years preceding their resignation. Of these, 15 had as-
sisted in and 9 had been in charge of the examinations.

     The three agencies recognize that many of their exai,.-
iners leave to go with commercial banks. They consider this
to be beneficial because former examiners are a source of
aual.fied bank managers who understand the importance of




                            10-20
sound banking practices and the regqllaory function of the
agencies. Agency officials do not believe that the objec-
tivity of examinations is lessened by examiners going to
work for banks they examine.
     Conclusion

     Since few examiners left to work for banks they examined,
we see no threat to their objectivity as long a   ..ie agencies
continue rotating examiners-in-charge among banks examined
and reviewing examination reports at regional offices and
district banks.




                            10-21
                         CHAPTER 11

                    POTENTIAL FOR B~ETER

                  INTERAGENCY 1MOC PERATION


Overview                                         11-1

Problems in interagency - operation              11-4
     blew approaches to ).)nk ex:amination       11-4
     Examination for c.,.mpliane with consumer
        protection laws                          11-4
     Development of monitoring systems           11-5
     Examiner trainiag                           11-5
     Qualifying for examiner-in-charge           1.1-5
     Joint evaluation of foreign loans           11-6
     Joint examination of foreign branches       11-6
     Data processing                             11-6
     Supervision of bank holding companies       11-7
     Joint evaluation of shared loans to large
        corporations                             11-7
     Criteria for identifying problem banks      11-8
Conclusions                                      11-8

Recommendation                                   11-8

Agency comments                                  11-8
                           CHAPTER 11

         POTENTIAL FOR BETTERINTERAGENCY- COOPERATION

OVERVIEW

     The legislation establishing the three agencies created
several overlaps in authority.  The area with the greatest
potential for duplication of effort i.s bank examination.
FDIC has statutory authority to examine all insured banks
(including national banks and State-chartered FRS members);
FRS has statutory authority to examine all member banks
(including national banks and State-chartered member banks
that are insured by FDIC); and OCC has statutory authority
to examine all national banks. (See ch. 4.)
     m
       e three agencies have other      inter-related    :esponsi-
     Dllities:

     -- OCC is responsible for closing national banks
        which have become insolvent and FDIC is respon-
        sible foL liquidating these banks.

     --FRS has primary responsibility for inspecting bank
       holding companies, but FDIC may examine a nonmember
       insured State bank subsidiary and its parent holding
       company, and OCC may examine a national bank subsid-
       iary and its parent holding company.

     -- All banKs are required, under the Securities Ex-
        change Act of 1934, as amended (15 U.S.C. 78a et
        seq.), to report to FRS on extensions of credi-for
        the purchase of stock.  If any bank fails to fur-
        nish such information, FRS may inspect such bank
        in order to obtain the information.

     In addition   to   legislative overlaps,   the   three agencies
conduct many similir    dctivities,   and they coordinate their
activities to var-ing degrees. The three agencies have
operated under a unif¢orm agreement--signed in 1938 and
amended in 1949--for classifying bank assets and for
appraising certain secaLities during bank examinations.
According to a former OFRB Governor, the first interagency
coordination committee began in 1952 and fJnctioned until
about 1960.
     Formal mechanism Eor coordination was resumed in 1964,
when President Johnson expressed concern about the lack

                                114--
of coordination among the Federal bank regulatory agencies
and instructed the Secretary of the Treasury to establish
procedures to insure that they act in concert and resolve
their differences.  The Secretary established a procedure
for the exchange of information among the bank regulatory
agencies.

     The 1964 procedure was revised in 1965 to establish a
Coordinating Committee on Bank Regulation composed of the
Chairman of the FRS Board of Governors or a designated
Governor, the Comptroller of the Currency, the Chairman
of FDIC, and the Chairman of the Federal Home Loan Bank
Board. The Commihtee meets at the call of any member, but
not less than quarterly. Under the procedure, the Committee
chairman is to report to the Secretary of the Treasury any
instance where the Committee cannot agree on conflicting
rules, regulations, or policies.

     We were told that eight meetings were held during 1975
and six meetings were held from January 1, 1976, to October
31, 1976.  We were advised that the Committee does not
maintain minutes of its meetings.

     We ware fu-nished an agenda for all but two of the
Coordinating Committee meetings. Approaches and techniqucs
of bank examination were apparently discussed on several
occasions in connection with changes in call and other
reports, fair lending in housing, and classification of
certain bonds. Most of the topics, however, related to
various types of accounts a bank might nffer, such as
individual retirement accounts, corporate savings accounts,
telephone transfers to and from savings accounts, over-
draft protection for checking accounts, and experiments
with deposit rate ceilings in New England. According to
a Treasury official, no conflict among the Committee members
has ever been reported to the Secretary of the Treasury.

     Coordination also occurs through meetings and discus-
sions with senior management at the three agencies. In
addition, the Comptroller of the Currency is by law a member
of the FDIC Board of Directors and thus is directly involved
with that agency.

     Effective cooperation between the three Federal bank
regulatory agencies is important to:




                            11-2
     -- avoid duplication of effort,

     -- afford equal treatment to all classes of banks,
        and

     -- maximize economy and efficiency of operations.

     The agencies have to a large extent--through formal and
informal coordination efforts---avoided duplication of effort
and provided equal treatment of all classes of banks.   The
current framework for coordinating the activities of the
three regulatory agencies provides a forum for exchanging
information about possible conflicting rules, regulations,
or policies, but it does not provide a mechanism for the
three agencies to combine their forces in improving the bank
supervisory process or in resolving problems common to the
three agencies.

     We identified several areas where, in our opinion,
the agencies could benefit by working together, sharing
experiences about innovations in bank supervision, and
undertaking activities jointly or on a reciprocal basis.




                            11-3
PROBLEMS   IN INTERAGENCY COOPERATION

     In some areas similar activities were being carried
out differently by the three agencies and, as a result,
from an overall Federal viewpoint, did not provide for
efficient operation.  In some cases these differences
resulted in treating different classes of banks unequally
under similar conditions.

     The foliowing examples, which are generally discussed
in other sections of this report in greater detail, illus-
trate areas where greater cooperation could benefit the
agencies. The Coordinating Committee apparently did not
consider any of these areas during 1975 or 1976.

New approaches   to bank examination

     While all three agencies have recently made changes
in their examination approaches, OCC's changes are the most
extensive.   OCC's new examination approach, which places
more emphasis on bank policies, procedures, practices,
controls, and audit, resulted primarily from several rec-
ommendations in Haskins & Sells' May 1975 report.   The new
examinatior procedures were developed during the fall of
1975 and sptrng of 1976 and were field tested in mid-1976.
(See ch. 7.)

     OCC made a large investment in     a major step in bank
supervision. Y % there is no formal     mechanism for sharing
the results among the agencies. Not     until November 1976
did OCC present its r.ew approach in    detail to FDIC and
FRS.

     When one agency plans major changes in its activities
which may be applicable to the other agencies, early con-
sultation and exchange of views would benefit all agncies
concerned. We believe that the three agencies should
jointly participate in testing and evaluating the new
approach.

Examinations for compliance with
consumer protection laws

     The agencies have recognized      that their past approaches
for examining banks' compliance with consumer protection
laws needed improvement, and all three are modifying their
examination approaches. We believe, however, that they
should work together more closely in refining their approach
to consumer credit compliance examinations. (See ch. 7.)

                              11-4
Development of monitoring   systems
     Each of the three agency headquarters and several
Federal Reserve Banks, generally independently of each
other, have developed or are developing monitoring systems
to identify banks that may require close supervision.
(See ch. 7.) A cooperative effort among the agencies
might have reduced the developmental effort and--through
"cross fertilization" of concepts--speeded development.
The agencies are still working on these systems, and the
need for coordination continues.
Examiner trainin_

      The three agencies have generally provided forma'
training to its bank examiners through their own operated
sc'iools and seminars. Much of the training in the past has
covered the sameLtopics at each agency. (See ch. 10.) While
we recognize that OCC is implementing new examination ap-
proaches tha: are conceptually different than those of the
other two agencies and thus, some of their current train-
ing needs may be somewhat different, we are also suggestiin.
(see ch. 7) that the agencies jointly evaluate the OCC's
new approaches and determine whether they should be
adopted by all three agencies.

     We believe, therefore, where feasible, that the three
agencies should combine their examiner schools and stand-
ardize their curriculums.  (See ch. 10.)
Qualifying for examiner-in-charge
     FDIC and OCC use a formal evaluation process in addi-
tion to performance evaluation for determining whether an
assistant examiner is skillful enough tc bo in charge of a
bank examination. At FRS assistant examiners are advanced
to full examiner statlis on the basis of their performance.
(See ch. 10.)

     We believe that, in addition to performance evaluation,
a formal evaluation process is desirable to measure the
competence of assistant examiners to assume the responsi-
bilities of a full examiner. The agencies should work
together to develop a uniform approach to the formal
-valuation process.




                             11-5
Joint evaluation of foreign loans

     FRS and OCC independently evaluate the soundness of
loans to foreign governments and businesses. Loans to the
same foreign borrower were rated differently by the various
Reserve Banks and by OCC.   (See ch. 4.) This practice re-
sults in duplication of effort and inconsistent treatment of
credit to foreign borrowers. The Federal agencies should
coordinate their efforts to avoid these problems.

Joint examination of foreign branches
     The foreign branches and subsidiaries of U.S. banks
should be examined, but such examinations are costly because
of the travel involved. (See ch. 4.) OCC's London office
employs six _.-,aminers who are in charge of examining branches
and subsidiaries in Europe. In addition, FRS maintains
staffs of international examiners in New York, Chicago, and
San Francisco, and OCC maintain staffs in all their regions
who make onsite examinations of foreign branches and
subsidiaries.
     OCC and FRS should consider coordinating their examin-
ations of foreign branches and subsidiaries so that examiners
visiting a foreign city could examine branches of both State
and national banks.

Data processing
     An interagency agreement assigns responsibility for pro-
cessing data on all national and State member banks to FRS
and responsibility for processing data on State nonmember
banks to FDIC. FDIC subjects all of this data to edit-checks.
However, according to an OCC official, the interagency system
for processing data was inadequate because among other rea-
sc s, banks were not meeting established reporting deadlines,
and FDIC was taking approximately 4 months to keypunch and
computer-edit the data. Therefore, in connection with imple-
mentation of the National Banik Surveillance System (see
ch. 7), OCC began in December 1975 to process and edit data
on national banks shown in reports of condition and reports
of income, even though--pursuant to the interagency agree
ment--FRS already processes this data, FDIC edits it, and
OCC responds to errors noted by FDIC. A coordinated effort
would avoid this duplication.




                             il-6
Stervision of bank helding comranies
     FRS has primary responsibility for supervising and
regulating bank holding ccmpanies. Banks under the control
of these holding companies may he either State member,
r'nmember insured, or national banks, and may therefore
be examined by FRS, FDIC, or OCC. However, procedures
for coordinating efforts among the three agencies on holding
companies and their subsidiary banks are not fully effective.
(See ch. 4.)
     Because bank holding companies and their subsidiary
banks may substantially affect one another, the three agen-
cies should establish better procedires for coordinating
their supervisory responsibilities.
Joint evaluation of shared
loans to large corporations
     Some loans, especially those made to large corporations,
involve several parti:ipating banks, which may be either
national or State-chat tered.  Even though only one extension
of credit is involved. the three agencies reviewed the loan
differertly and. in so.ne cases, evaluate it differently.
(See ch. 7.)
     OCC recently initiated a program to review these loans
at a single location, thus assuring consistent treatment of
the loans at all participating national banks. This evalu-
ation is then incorporated into regular examinations of all
national banks which have participated in the loan.

     Both FRS and FDIC had been in contact with OCC about
the uniform review of shared national credits. However,
at the time of our review neither had used OCC's uniform
evaluations in examining participating banks. As a result,
loans which had been reviewed at the lead bank by OCC were
also reviewed at individual participating State baiks
by other FedeLal agencies; and the same loans in some cases
received different classifications from the three Federal
supervisory agencies. On December 21, 1976, FDIC head-
quarters advised its regional staffs to use the OCC classi-
fications when they examine the State participating banks.

     Full and prompt coordination among the three agencies
on the review of shared loans would allow more efficient
use of supervisory staff and fair and consistent treatment
of involved banks.


                              11-7
Criteria for identifyin_prEoblem banks
      The three regulatory agencies do not have common criteria
for determining which banks are designated as problem
                                                       banks.
(See ch. 8.) Since FDIC, FRS, and OCC all have an interest
in the condition of national banks, and FDIC and FRS
                                                      both
have an interest in the condition of State-chartered member
banks, we believe that the three agencies should work
                                                       to-
gether to develop uniform criteria for identifying problem
banks.
CONCLUSIONS

     While the agencies have to a large extent
ably effective in minimizing problems from the been   reason-
                                                overlap of
Federal supervisory jurisdiction over commercial
                                                  banks, no
mechanism exists to insure that the agencies act
                                                  in concert
to operate effectively and efficiently. There are
                                                   several
alternatives under which this could be achieved.
                                                   One
would be to establish a permanent interagency working
                                                        level
group. This group could monitor the agencies' operations
to identify areas where interagency cooperation would
beneficial and to make appropriate recommendations      be
                                                    to the
agency heads.

RECOMMENDATION

     We recommend that either (1) the Board of Directors,
FDIC; the Board of Governors, FRS; and the Comptroller
                                                        of
the Currency jointly establish a more effective mechanism
to combine their forces in undertaking significant
                                                    initia-
tives to improve the bank supervisory process or
                                                  in attack-
ing and resolving common problems, or (2) the Congress
enact legislation to establish a mechanism for more
tive coordination.                                   effec-
                    We would be glad to assist the committees
in drafting appropriate legislation.

AGENCY COMMENTS

     FDIC stated:

    "We recognize the merit of resolving common prob-
    lems of the three agencies through closer coordin-
    ation and cooperation.   Indeed, there is at the
    present time a substantial exchange of information
    between the agencies' headquarters as well as at
    the field levels.  However, if there is any merit



                            11-8
to the concept of separate federal supervisory
agencies, and to a dual banking system with State
and federal supervision of banks, the benefit
would seem to be the opportunity to try differ-
ent approaches and to have a diversity of exam-
ination and supervisory procedures. The possi-
bility of useful innovation and improvement in
the bank examination and supervisory processes
is greater if there are several agencies trying
different approaches than if every change in
examination methodology required approval of all
the agencies.   Nevertheless, the possibility
of establishing a particular vehicle for the
agencies to resolve common pcoblems and take
joint efforts in new Initiatives will receive
serious consideration."

FRS stacd:

"The Board is please-  hat this portion of the
report supports it  previous conclusions and
initiatives in this area and favors the legis-
lative approach.

"In December, 1975, Governor Holland testified
before the Senate Committee on Banking, Housing
and Urban Affairs and in that testimony made
reference to the concept of a joint Bank Exam-
Ination Council which at that time had received
substantial support within the Board.  In that
regard, he stated:

  Such a Council would be focused on the areas
  that we believe are most in need of improve-
  ment; that is, efficient and uniform moderni-
  zation of bank examination and vigorous and
  consistent follow-up procedures when bank
  weaknesses are revealed.  Such a Council could
  be established administratively or by statute.
  Its statutory authorization would undoubtedly
  give more impetus to the establishment of such
  a Council, and would also provide it with
  clear-cut authority to take definitive action
  within its statutorily defined areas of
  administration.




                        11-9
  The Federal Bank Examination Council should have
  authority to establish standards and procedures
  for bank surveillance, examination and follow-up,
  applicable to all the Federal banking agencies,
  and it should review significant problem cases
  when and a!' they develop. All three Federal
  banking acencies should be represented on th%
  Council.

"Subsequently, at our suggestion, Senator Stevenson
introduced the Federal Bank Examination Council Act
(S. 3494).  Such a Council would establish mandatory
uniform standards and procedures for Federal examin-
ation of ba-ks and uniform reporting systems and
conduct joint schools for examiners. The Board
believes that a proposal along these lines could
accomplish most of the objectives set out in the
report's recommendations in the examination area."

OCC stated:

"The OCC has always stood for the strongest possible
working relationships between federal supervisory
authorities.  At the December, 1976 meeting of the
Interagency Coordinating Committee, Mr. Robert Bloor.,,
Acting Comptroller of the Currency, asked that the
committee take up at its next meeting the subject of
strengthening coordination of examination procedures.
It will be proposed that a permanent staff group be
set up for this purpose.  We anticipate modification
and refinement of our newly implemented examination
approach on an ongoing basis.  Review and evaluation
   -uch changes as they affect problems common to the
,t, e agencies would be most useful."




                       11-10
                      r'~APTER 12

             SCOPE AND APPROACH OF GAO STUDY

                                               Page

Chartering of national banks                   12-2

Bank supervision and examination practices     12-2
    Failed oanks                               12-3
    Problem banks                              12-3
    Banks in general                           12-3

Survey of commercial bankers                   12-6
                         CHAPTER 12
              SCOPE AND APPROACH OF GAO STUDY

     During 1976 we evaluated the way FDIC, FRS, and OCC
supervised the Nation's commercial banks.
     Since we do not have audit authority at FRS or OCC
and our access to bank examination files of FDIC has
long been contested, we had to negotiate an agreement with
each supervisory agency to review itb records.  Although
the agreements contain some differences, the scope and
approach of our study remained the same at all three
agencies.

     Key provisions of the agreements which affected
our scope and approach follow:

     -- The agencies allowed full access on their
        premises to bank examination reports, corres-
        pondence files, and other records.  In return, we
        agreed not to publicly disclose any information
        about specific banks or their officers, affiliates,
        and customers. We also agreed not to evaluate the
        accuracy c the examiners' factual findings by
        independently examining the banks involved.

     -- We further agreed to consider the agencies' super-
        visory practices, procedures, and policies that
        existed from 1971 through 1975 and some of their
        planned changes.
     The FRS agreement barred us from evaluating certain
regulatory functions, such as the policies and procedures
for implementing the Bank Holding Company Act of 1956, as
amended, and the consumer protection statutes. FRS mone-
tary policy functions and certain FRS operations, such
as check clearing and electronic funds transfer, were also
excluded from review.

     Our access to information on bank holding companies
was limited to those whose subsidiary banks had holding-
company-related problems and were included in our samples
of banks selected for :eview.




                          12-1
     We reviewed legislation, rules and regulations, and
administrative and operating policies and procedures.
We interviewed numerous agency officials, bank examiners,
and employees at various organizational levels, and we
visited 6 FDIC and 9 OCC regional offices and 12 Federal
Reserve district banks to discuss the bank supervisory
process and review examination reports, workpapers, and
other records.
     In our study, we considered

     -- current practices and planned changes in the
        agencies' bank supervision policies and procedures,

     -- bank examination polici-- and procedures, as de-
        scribed in manuals and explained by examiners and
        officials, and

     -- status reports on supervisory activities to the
        agencies' headluarteLs from the regional offices
        or district banks.

CHARTERING OF NATIONAL BANKS

     Our work entailed analyzing 75 of the 322 ba-k char-
ter applications acted on by OCC from January 1974 through
April 1976 and all 71 charter conversion applications acted
on from January 1972 through April 19/6. Tn addition, we
determined how many national banks chartered from January
1958 through December 1972 were still operating as national
banks by April 30, 1976.
     We reviewed criteria and procedures for considering
national bank charter applications. We surveyed State
banking authorities to compare their chartering processes
with OCC's. We also reviewed several files on applications
for FDIC insurance and FRS membership.

BANK SUPERVISION AND EXAMINATION PRACTICES

     ~W discussed the bank supervisory process with exam-
iners and agency officials; reviewed examination reports,
supervisory files, and other supporting documents; and
analyzed and summarized the data collected on more than
900 banks of all sizes and locations.




                         12-2
        We drew samples representing

        -- banks which failed during a 5-year period,

        -- banks that had been designated as having
           problems serious enough to require more than
           normal supervision by the agencies, and

        -- banks from the total universe of about 14,400
           which are supervised by the three Federal
           agencies.
Failed banks

     Our study included 30 insured banks closed by their
chartering authorities between January 1971 and June
1976. In that period, 40 insured and 2 uninsured hanks
had failed. We analyzed examination reports and related
files covering the last 5 years of each bank's existence.
We also considered studies and congressional hearings
on failures of cwo banks--Franklin National Bank and
U.S. National Bank of San Diego.
Problem banks

     We selected two statistical samples of problem banks--
149 banks at December 31, 1970, and 145 banks at December
31, 1975. For each bank selected we noted the problems
identified by the examiner and the agency's efforts to
obtain corrective action. For each bank in the 1970
sample, we reviewed the most recent examination report
before December 31, 1970, and reports on subsequent exam-
inations until the bank returned to nonproblem status.
For each bank in the 1975 sample, we reviewed the examina-
tion report before the one which designated the bank as a
problem and subsequent examination reports up to June
30, 1976.

Banks    in general
     Using statistical sampling techniques, we selected
a total of 600 banks supervised by the 3 agencies.
For each of the banks selected, we identified the problems
noted by the examiners and the recorded followup actions
taken by the Federal and State agencies and we summarized
financial and operational data using supervisory files
and the three latest reports of examination.

                            12-3
        The following table summarizes our samples of banks.


                                                 Number
Spervisory agency                   Total       reviewed

FDIC:
   Failed banks                         29          19
   Problem banks:
      At 12/31/70                      190          55
      At 12/31/75                      275          55
   Banks in general                  8,594         199
FRS:
   Failed banks                          2           2
   Problem banks:
      At 12/31/70                       39          39
      At 12/31/75                       65          40
   Banks in general                  1,046         200
OCC:
   Failed banks                          9           9
   Problem banks:
     At 12/31/70                       123          55
     At 12/31/75                        85          50
   Banks in general                  4,744         201

Total:
   Failed banks                         40          30
   Problem banks:
     At 12/31/70                       352         149
     At 12/31/75                       425         145
   Banks in general                 14,384         600


Note:   In some cases the agencies could not locate
        from storage facilities all the records we
        requestea.  This neither seriously limited our
        scope nor affected the reliability of our samples.
        Regarding banks in general, we reviewed the latest
        three reports of examinations when available.
        A recently chartered bank 'night have been
        examined only on:e by the appropriate agency.




                             12-4
      Frcm our samples of banks, we found 20 bank holding
companies whose bank subsidiaries were identified as having
major problems caused by their affiliation. For these
20 companies, we reviewed available files of registration
statements, applications, memorandums, reports of inspec-
tion, annual financial reports, and related FRS analysis
and correspondence. We also reviewed the Bank Holding
Company Act of 1956, as amended (12 U.S.C. 1841 et seq.),
FRS policies and procedures for supervising holding com-
panies, and pertinent literature.

     Our study of international bank examinations included
a review of the last 3 reports of international examination
for 30 large banks. We discussed the process of evaluating
loans to foreign countries with officials of the Export-
Import Bank, as well as with FRS and OCC.

     For trust departments we reviewed and analyzed reports
of trust examination and related files on 33 banks. We
summarized data on violations and deficiencies reported
by examiners.

     Our study of electronic data processing examinations
included collecting and analyzing data from the 3 latest
reports of EDP examination or 38 banks' data processing
centers or outside servicers. We considered examination
frequency and duration, the type of EDP system, applica-
tions, operations, internal audit and control, deficiencies
reported by examiners, and remedial action by the agencies.

     We reviewed the efforts of the three bank supervisory
agencies to detect violations of consumer credit laws and
regulations. Considered were the examiners' training for
evaluating compliance, compliance examination procedures,
the reporting of violations, and the agencies' use of samp-
ling techniques. We also evaluated the agencies' plans
to expand compliance examination efforts.
     We studied the agencies' bank monitoring systems,
particularly their use of regularly reported data to iden-
tify certain trends within individual banks. We spoke
with representatives of the Federal Home Loan Bank
Board and other groups involved with bank supervision
about using monitoring systems to identify serious prob-
lems in financial institutions.




                         .12-5
     We reviewed FDIC, FRS, and OCC policies and proce-
dures concerning recruitment, career development, and
objectivity of bank examiners, to ascertain how they
affect the quality of bank supervision. Using a question-
naire, we obtained the views of 325 examiners at the 3
agencies.
SURVEY OF COMMERCIAL BANKER.
     Part of our study was a survey of commercial bankers'
views on Federal supervision of banks. We mailed a ques-
tionnaire to 1,678 commercial banks, of which 1,501, or
89.5 percent, responded. We selected our samples so as
to include banks of varying deposit size. Each agency
provided a list of banks receiving special supervisory
attention, from which we selected other samples. The
following table summarizes the number of banks surveyed.




                          12-6
                                              Banks
                                                       Number
Supervisory agency and    deposits   Total            surveyed

        (000,G00   omitted)

FDIC:
   $100 or more                         216              108
   $10 to $100                        4,105              216
   Less than $10                      3,993              210
   Special attention                    280              131

                                      8,594              665

FRS:
   $100 or more                         112               54
   $10 to $i00                          606              151
   Less than $10                        263              131
   Special attention                     65               33

                                      1,046              369

OCC:
   $100 or more                         510              251
   $10 to $100                        3,105              205
   Less than $10                      1,047              149
   Special attention                     85               39
                                      4,747              644

Total                                14,387            1,678



     Each bank's response to the questionnaire was
correlated with bank information routinely collected by
the three agencies--deposit size, supervisory status,
location, and rating. The responses are integrated
throughout the report and summarized in appendix IV.




                              12-7
APPENDIX I                                                       APPEN;.IX I




      Comptroller of the Currency
      Administrator of National Banks

      Washington, D,C.20219



       Jar.uary 14, 1977

       Honorablea Elmer B. Staats
       Comptroller General of the
         United States
       General Accounting Office
       441 G Street, N. W.
       Washington, n). C. 20548
       Dear Mr. Staats:
       Enclosed find original and one copy of our comments on the
       recommendations advanced in the draft General Accounting
       Office Report entitled "Study of Federal Supervision of our
       Nation's Banks".
       X understand that in accordance with the usual procedures
       our cowm.ents will be included in toto in the final report.
       Sincerely,



       Robert Bloom
       Acting Comptrollar of the Currency

       Enclosures




       Note:     Page references have been changed to conform to the
                 final report.
 APPENDIX I                                                              APPENDIX I


                                   PREAMBLE

                    Bank Examination and the Office of the
                          Comptroller of the currency


The Office of the Comptroller of the Currency (OCC) commends the General Accounting
Office (GAO) for the objective and workmanlike quality of GAO's report and for the
positive attitude shown by the GAO staff which prepared the report.

The GAO report correctly states that one important goal of bank regulation is
maintaining the soundness of the banking system; achievement of that goal requires
minimizing the number of bank failures. We agree with that goal, and suggest that
the banking agencies record over the last fcrty years has been a good one. For
example. 1974 witnessed a severe economic recession and the two laz 6 eat bank
failures in the history of the United States -- yet no depositors in these banks
lost money and confidence in the banking system was maintci..ed.  The average annual
bank failure rate since 1937 has been 0.'J8 percent -- s ,omarkably low failure rate
 for any human endeavor.

But it is the other goal of supervision uhich is not stressed in the GAO report.
The ultimate measure of how well a bank supervisory agency operates is how well
the banking system operates. The OCC believes that one of its major functions
is to preserve a competitive, responsive and innovative system. Bank supervision's
role is to ensure that the banking system is able to provide the widest possible
array of banking services to both the depositor and the borrower.

Thus, the ba k supervisory agency has two contradictory goals: monitoring soundness
and sponsoriLg the competitive, inoovative response. It is this dual role which
presents the basic paradox for the bank supervisory agency. An intensely
competitive industry can nDver be completely safe.

Striking the balance between these two gcals is the basic problem of the bank
supervisory agency. According to a former Comptroller of the Currency:
      One regulatory approach is to identify a problem in one area
      and remedy across the board, taking no notice of the different
      characteristics, or idiooyncracies of the components of the
      whole. That approach is acceptable if the object is to produce
      a "fail-safe" banking system. Believe me, I can screw down the
      National Binking System with enough regulations to prevent bank
      failure. But, under that regime, the banking industry would He
      financing the capital needs of the country and its citizens at
      about 601 of capacity, and that is not in the public interest.
      Equally important, it is contrary to the economic principles of
      our ration. Instead, I would advocate that we free up the system
      to manage itself, loosen the bonds and take the quite limited
      risks that some unit will slip through the supervisory net and
      founder.

                                         I-2
   APPENDIX I                                                                 APPENDIX I

A well known critic of bank sipervision, economist George J. Benston, has addressed
the question of the costs of bank regulation -- both the direct cost of running
the agencies and the indirect costs of limiting competition by the banking in-
dustry -- and has suggested that the best solution is improved supervisory tech-
niques. Specifically he recommended:

     1. A primary responsibility of the supervisory agencies is to determine
        the most effective method of examining banks.

     2. Supervisory Pqencies should be able to use bank reporting as a Ruidd to
        self-examination by the banks and as a preliminary examination tool.

     3.   Models should be developed that predict possible problems.

     4.   Banks that are likely to get into trouble should be examined more
          frequently and in greater depth.

That list, although not complete, is similar to the revisions of examination
procedures proposed by the consulting firm of Haskins & Sell and implemented by
the Office of the Comptroller of the Currency. Examination of the larger banks
has moved from a detailed examination of the bank's assets to an in-depth evalua-
tion of the bank's management, auditing, and control systems.  Instead of concen-
trating on the bank's loan customers, the OCC has moved to an evaluation of the
bank itself. During 1976, the OCC began to use bank filaancial reports as a
preliminary examination tool, identifying potential difficulties at individual
banks.

GAO reviewed these and other new procedures being adopted by the OCC, and con-
cluded:

          As discussed in Chapter 4, we believe that the traditional examiz:-
          tions of the three agencies have concentrated too smch on the review
          of loans and not enough on bank policies, procedures, practices, controls,
          and audit. The changes made by FDIC and FRS will not substantially remedy
          this defect. In our view the new procedures being implemented by the
          OCC offer the best opportunity for improvement. The OCC's revised
          commercial examination procedures should provide the agency with more
          meaningful information regarding the banks it supervises and .esuit in
          more complete and consistent eraminations.   More importantly, the new
          approach should result in early detection of situations which could
          lead to deterioration in some aspect of banking operations. This ap-
          proach could help avoid bank problems after they have occurred.

Thus the OCC is no, attempting to improve bank supervision through arbittary regula-
tions which might limit bank services to the public. Instead the OCC is attempting
to foster procedures in each bank through which that bank can better manage itself.

The GAO report -- while endorsing the new OCC procedures --   makers the implied
criticism of the OCC for not developing its new programs in   c .,junction witl the
two other agencies. As pointed out in the OCC responses to    th. GAO recommendations,
the OCC has attempted to share its new ideas with the other   Lt: agencies. The




                                          I-3
  APPENDIX I                                                            APPENDIX I

OCC also endorses the GAO recommendation of more formalized communication among
the agencies concernfllg new examination techniques.  The OCC takes issue, however,
with the apparent CAO assumption that the best way to geLrtate new ideas is through
an interagency committ:ee (or, am some have proposed, through a giant monolith
combining the three aigencies). A primary virtue of three agencies, each with some-
what differing statutory responsibilltieu, is the ability of a single agency to
experiment with a new idea or procedure. It is doubtful that the new OCC examining
techniques endorsed by GAO could have 'een developed otherwise. A unified approach
is important and apprepriate after a new idea has been proved successful, not
when it is being first developed.

In summary, the purpose of .he OCC is to operate so that economic progress dnd change
is not inhibited while simultaneously, preventing unsound banking practices. It
is that fine line of promoting innovative response while supervising the banking
system that bakes bank supervision so difficult. The banking system has just come
through its first major economic crisis since the world wide depression of the
1930s. There were some casualties. But, in fact, the threatened financial crisis
did not develop, and the banking system seems to be stronger today than it was
before. New nrocedures have been developed by the bank.ng system and the continuing
dynamic future of American banking is assured. For the first time we are assured
that, just as the industry has changed, the teectics and techniques of a major bank
supervisor, the Office of the Comptroller of the Currency, has changed in a similar,
positive, fashion.




                                        I-4
tPENDIX I                                                            APPENDIX   I
 Recommendation   (2-21)

 Accordingly, we reccmmend Lhat the Comptroller of the Currency (1) develop
 more definitive criteria for evaluating charter applications and (2) thoroughly
 document the decision-making process, including an identification by reviewers
 of each factor as fauorable or unfavorable.


 OCC Response:

 The OCC is the only federal agency with the responsibility for chartering
 banks. It charters banks in all of the 50 states and in Puerto Rico and the
 Virgin Islands. The widely differing banking environments found in the U.S.
 make it almost impossible to develop definitive criteria which can be universally
 applied such as in states like /,rizona, which has 6 National Banks, and in
 Illinois which has over 400 National Banks. The diversity of criteria therefore,
 is a function primarily of the differing political, social and economic onviron-
 wents in which the OCC must operate. The OCC's chartering criteria, of necessity,
 must be somewhat flexible. That is only to he expected since the OCC dbes not
 charter in one n;tvironment. Also, under the terms of the kcFadden Act, the
 OCC's actions are often affected by applicable state law.

 The new corporate guidelines, development of which began in September, 1975, and
 which became effective on Novek :r 1, 1976 answer many of the criticisms of the
 GAO. Written opinions containing reasons are now sent to applicants receiving
 denials, As examples, we quote from three recent letters sent to applicants
 denying their charters. One letter in part, states:

   Based upon the population and the median income per household, it
   would appear difficult for many individuals in the primary service
   area to qualify for a loan. Furthermore, income levels are inadequate
   to provide a sufficient deposit base for the proposed bank to become
   a viable institution.

   In another case, we quote in part: In view of the Supreme Court decision
   in Whitney and the Federal Reserve Board's decision in InterHountain Bank
   Shares, it would be an exercise in administrative futility for this Office
   to approve the present charter application...Should West Virginia change
   itp statutes or should the statute be successfully challenged, then this
   Office could consider a new application in light of these changed cir-
   cumstances.

   In still another case, the denial letter to the applicants stated: The
   new guidelines state that a new banking office will not be approved, if
   its establishment would threaten the viability of a newly chartered in-
   dependent bank. Such protection will typically not exceed one year. As
   you are aware, the new bank opened on September 27, 1976. It is the
   opinion of this Office that this newly chartered independent state bank
   is entitled to the protection set forth in the Comptroller's policy
   statement.




                                     I-5
APPENDIX I                                                             APPENDIX I
   Reconeandation    (2-21) Continued

   Every attempt is now made to document thoroughly rt'e decision-making process.
   Further efforts will '>e made by our Office to 'denfity each factor as fe--_r-
   able or unfavorable,

  Our decisions have Leen subject to -Jdicial review for many years.  In the long
  series of rourt cas;s covering our chartring process, the Comptroller's
  decision on a charter application has rever been finally overturned by a
  reviewing court. See annotations to 12 U.S.C. 21 et seq.

  Our Department of Research 6 Econoaf' Analysis has undertaken a market study
  of 35 mational banks chartered betw:en 1969 and 1971. The economic study
  attempts to identify, statistic-.ly, those factors which can be identified with
  the growth or lack of growth of these new banks.   The results of that study,
  if positive, will be incorporated into our decision-making process. We are
  hopeful that quantificatiou. of a sufficient number of pertinent factors appli-
  cable to a majority of cases will result.


  Recommendation    "-.7)

  Therefore, we recommend that the Board of Directors, FDIC, the Board of
  Governors, FRS, and the Comptroller of the Currency establish schedui'ng
  policies and procedures which would avoid the setting of examination patterns.


  OCC Response:

  Historically, the OCC has viewed surprise as an important element of an
  examination. However, a primary feature of our new examination approach
  entails the pre-examination analysis wherein the examiner will determine
  the adequacy of internal control and audit activity. The OCC feels the
  best deterrent for fraud is not periodic unannounced visits by examiners
  but rather the existence of sound bank policies, procedures, internal
  control and audit L.ctivity on a continuing basis. The element of surprise
  is neces
         gary only im those cases where such factors are suspect.


  Recommerdation    (4..k

  We recommend thatt the Board of Directors, FDIC, and the Board of Governors,
  FIS, adopt flexiNle policies for exaaiaation frequency which would allow
  them to concentrate their efforts on banks with significant problems.

  We recommend that the Congress amend the National Bank Act to allow the
  Comptroller of the Currency to examine National Banks at his/her discretion.


  OCC Response:

  We supi,-t the recommendation of legislation to permit OCC discretion in
  schedulit: the frequency of examinations.  The current method of adapting
  the depth of examinations to the needs of each bank, based aonNBSS data
  and pre-examination analysis, fully complies with law. However, greeter
  statutory discretion would enhance our effectiveness in this regard.


                                        1-6
APPENDIX I                                                            APPENDIX I
  Recommendat ion   (4-J)

  We recommend that the Board ef Covernors, FRS, and the Comptroller of the
  Currency develop and use a single approach to the classification of loans
  subject to country rirk.


  OCC Response:

  The OCC has a well established procedure using a single approach to the
  classification of country credits. This procedure makes use of information
  from many governmental and non-governmental sources and examiners in all
  fourteen national bank regions.

  Copies of the minutes of our comi.lttee meetings and any resulting classifications
  have always buen provided to members of the staff of the Board of Governors.

  The process of country risk evaluation is more precisely an art than a science.
  Most of t~ie evaluation process is judgemental. However, the interagency
  meetinCa held to date have been beneficial in determining basic differences in
  philosophies.


  Recommendations    (4-38)

  We recommend that the Board of Governors, FRS, and the Comptroller of the
  Currency implement procedures whereby major foreign branches and subsidiaries,
  including subsidiaries of Edge Act corporatiors, are examined periodically and
  whenever adequate information about their activities is not available at the
  home office.

  Also, we recommend that the Board of Governors, FRS, and the Comptroller of the
  Currency exchange each other's examiners' to cut expenses when conducting
  examinations in foreign countries.


  OCC Response:

  a)   Overseas Examination

      National Banks are required by Regulations K & M to provide examiners with
  whatever credit and financial information the examiner deems necessary to
  evaluate the condition of the bank's foreign branches and subsidiaries. Those
  regulations require such information be transmitted to and maintained at the
  bank's head office. The OCC has for practical purposes defined "head office"
  to include any foreqgn or domestic office of the bank which is readily accessible
  to its examiners. For example, all international credits of one large national
  bank are examined from two domestic offices and four foreign offices located in
  London, Caracas, Tokyo and Manila. All of that bank's many branches and Jub-
  sidiaries located in Europe the Middle East and Africa are examined from duplicate
  records in Londoi.




                                      I-7
APPENDIX I                ax                                          APPENDIX I
    Recommendations    (4-^) Continued
    Supplemental examLnatlons to determine the quality of the bank's operetioits
    are made on-site overseas when necessary. For purposes of performing asset
    and operational examinations, the OCC established in 1972 a London off:.ce
    permanently staffed by six examiners. In fulfilling its overseas examination
    obligations, the OCC in 1976 examined 141 overseas branches and subsidiaries
    of 25 banks located in 37 countries; 154 on-site examinations were performed
    by 215 National Bank Examiners.

    b) Joint Examinations

        The GAO reccnaendat/on has merit. As a bare minimum the physical support
    of the three agencies could be jointly provided. Further arrangements could
    be made so that any of the agencies could Jointly commission overseas examiners.
    In this regard, the OCC is willing to seek a cooperative solution with our
    sister agencies.

   Under present statutes, however, such a sharing of examiner forces may be
   difficult. Section 481 of Title 12 (12 U.S.C. 481) directs the Comptroller
   of the Currency to appoint examiners who shall examine every national bank.
   That same section empowers the Comptroller to make a thorough examination of
   all the affairs of the banks under his jurisdiction including the affairs
   of all affiliates of National banks "other than member banks", in order to
   disclose fully the relations between the benk and its affiliates and the
   "effect of such relations upon the affai;s of such bank". (Emphasis added.)


   Recommeudation     (7-25)

   We recommend that the Comptroller of the Currency invite FDIC and FRS to
   jointly review and evaluate its new examination approach. Further, we
   recommend that, in the event of a favorable assessment of the new process,
   the Board of Directors, FDIC, and the Board of Governors, FRS, revise their
   examination processes to incorporate the features of OCC's new examination
   approach.


   OCC Response:

       Examination Approach

       On November 23, 1976 OCC staff members made a presentation to approximately
   20 FRS and FDIC staff members on the revised examination procedures. Copies of
   our draft Handbook of Examination Procedures were furnished. Their review and
   evalu& ton on an ongoing basis is welcomed. The Acting Comptroller has proposed
   to the Interagency Coordinating Comuittee that a permanent staff group be set
   up for this purpose.




                                         I-8
APPENDIX I                t5                                            APPENDIX I
  Reconumell;a L ioL   ( -. W)

  Additionally, we recomlnlcIud tlat tlhi Uoard of DIrectors, FDIC, the Board of
  Governors, FRS, and the Comptroller of the Currency jointly staff a group
  to analyze shared national aredits at State and National lead banks under
  Federal supervision and that th; three agencies use the uniform classifica-
  tion of these loans when they examine the participating banks.


  OCC Response:

       Shared National Credits

      In 1974, meetings were held with representatives of the OCC, FRS and FDIC
  Present to discuss the possibilities of using a uniform program for the review
  of selected large shared loans. Both the FRS and the FDIC found merit in the
  program but they believed sufficient pitfalls existed to delay their partici-
  pation In the program. Also, in March of 1974 this Office met with representa-
  tives of the Conference of State Bank Supervisors to discuss the proposed
  program. They indicated interest and agreed to work out arrangements with
  various bank supervisors.

  In 1975, the Office of the Comptroller of the Currency conducted uniform reviews
  of shared national credits in applicable National Banks. The loan write-ups
  generated by these reviews were made available to both the FRS and .he FDIC
  In March, 1975 FRS expressed their continued interest in the program.and hoped
  they could participate if the "pitfalls" could be overcome. In November, 1975
  FRS revealed they were instituting a test review program involving state member
  banks paralleling our methods and procedures. In July, 1975 FDIC again expressed
  intereut and a meeting was held in September, 1975 with representatives of the
  FDIC. This Office indicated FDIC involvement would be welcomed in whateser way
  they deemed appropriate.

  During May, 1976 the second uniform review was conducted and again the data
  generated was made available to the FRS and FDIC.

  In July, 1976 the Comptroller of the Currency and the Vice Chairman of the Federal
  Reserve Board tet to discuss the approaches of the two agencies to shared national
  credits. It was agreed that the OCC should continue to provide FRS with the
  information developed under its program and to explore at a staff level whether
  uniform procedures could be developed between the two agencies which would be
  acceptable to all of the Federal Reserve Banks. It is our understanding that
  the New York Federal Reserve Bank is conducting a pilot project involving shared
  credits which may assist in resolving some of the anticipated problems associated
  with a combining of the approaches of the two agencies.


  Recommendation       (7-.26)

  We also recommend that the Board of Directors, FDIC, the Board of Governors,
  FRS, and the Comptroiler of the Currency work together in refining their
  monitoring systems and their approach to consumer credit compliance examinations.




                                       I-9
APPENDIX I                                                           APPENDIX I
   OCC Response:

       Monitoring

       The OCC has met on several occasions with officials of the other two
   federal supervisory agencies to present its NBSS system. Those orientations
   were given both orally and with complete sui 'ission of all relevant documents.
   Further, we have offered the other superviso- agencies computer programs and
   technical knowledge to implement the programs.

       Consumer Credit Compliance

       With reference to consumer credit compliance examinations the draft report
   does noM fully recognize that our new program is already operational. Over
   6Z of our field staff is currently allocated to the consumer area. We have
   conducted three two week schools which trained over 140 examiners in the new
   procedures; a second series of three schools is scheduled for March and April,
   and a third series will take place in the Fall. The schools stress examination
   techniques and feature heavy reliance on case stadies to give experience in
   examining for compliance. The procedures are tailored to spot problems most
   likely to result in harm to consumers. We make use of sophisticated advanced
   financial calculators, specially programmed for banking applications, and
   sampling techniques designed to increased our effectiveness.

   Eleven percent of the country's 4,700 national -.nks have been examined under
   the new procedures. Preliminary analysis of these reports indicates that our
   expanded efforts in this area are both justified and effective.

   The draft report also does not reflect the extent to which other agencies have
   cooperated in developing our new program. The Federal Reserve Board and h.U.D.
   aided in reviewing our procedures. Speakers from the 7ederal Reserve Board,
   H.U.D. and the Justice Department participated in our schools. Observers
   from the Federal Reserve Board, FDIC, N.C.U.A. and H.U.D. attended the schools
   to assess the new procedures. As a result many of our examination procedures
   and teaching materials have been adopted b-, these four agencies. This ex-
   perience has reinforced our awareness of te'a benefits ef such cooperative
   efforts.

                       Is
   Recommendation   (8-Ze)

   a). We recommend that the Board of Directors, FDIC, the Board of Governors,
   FRS and the Comptroller of the Currency establish more aggressive policies
   for using formal actions.


   OCC Response:

   We believe that in supervising the vast majority of national banks, our most
   effective remedy continues to be the examination process and the meetings held
   as part of that process between the board of directors of the bank and OCC
   personnel. Since December 23, 1975, the OCC has required meetings with boards
   of directors of each national bank at least once every calendar year and, in
   certain cases, following every examination. We believe that the increased use
   of such meetings together with our new examination procedures and early warning
   system will make our first-line, informal supervisory techniques even more effective.



                                     i-10
APPENDIX I             lB                                              APPENDIX I
 Recommeildation   (8-t_ )   Continued

 As the GAO report elsewhere notes, our informal supervisory techniques even
 without the improvements noted above, have proven effective in rehabilitation
 of most of the so-called problem bank situations. For example, over the period
 reviewed by GAO iti'frmal procedures utilized by OCC were successful 84% of the
 time. Nonetheless, de agree that increased use of formal agreements and cease
 and desist orders under tfe Financial Institutios Supervisory Act may accelerate
 correction of problems in :he more recalcitrant institutions.

 OCC use of such formal agLeements anp. orders has increased tenfold from 1970 to
 1975. The OCC has originated slightly more than half of the combined total (179)
 formal agreements and cease and desist orders issued by all three agencies during
 the last five years. The OCC, however, supervises fewer than half the number of
 banks supervised by the other two agencies combined. When compared to the
 number of banks supervised, the OCC over the past five years has used the formal
 enforcement tools of Financial Inetitutions Supervisory Act about two and one
 half times as often as the other two agencies.

 It should also be noted that the three banking agencies Jointly requested
 Congress in 1975 to refine and increase the agencies' formal enforcement powers.
 Congress failed to pass the necessary legislation.

 b). Written criteria should be developed to identify the types and magnitude
 of problems that formal actions appropriately could correct.

 OCC Response:

 The OCC has developed as part of its National Bank Surveillance System a severity
 anomaly ranking system which identifies every three months the national banks
 most likely to require special supervisory attention. A computerized action
 control system is designed to assure that the OCC responds promptly and appro-
 priately to these situations. The criteria built into these systems identifies
 more systematically and promptly those cases in which formal enforcement action
 is appropriate.
                      4q
 Recommendatiun    (8-.)

 We recommend that the Board of Directors, FDIC, the Board of Governors, FRS,
 and the Comptroller of the Currency develop uniform criteria for identifying
 problem banks.

 OCC Response:

 The term "problem bank" is banking agency jargon for many differe-nt fact patterns.
 To an outsider, it appears reasonable and logical to expect a uniform definition
 of the term. The agency staff person recognizes the difficulty of reducing all
 the variables to a single definition. At the same time, he has little difficulty
 in communicating with colleagues in other banking agencies on particular bank
 situations.

 OCC's approach is to co;puterize to the greatest extent possible the many variables
 which characterize a bank's condition and management from time to time. This re-
 sulte in a capability to rank all banks in relation to their peers. The final
 selection of banks needing special supervision can only be done subjectively by
 trained personnel using all the tools available and the results of our revised
 examinations.  The dividing line on the spectrum between "problem" and "non-problem"
 status is hard to define but OCC is more than willing to consult and cooperate with
 the other agencies in seeking such dividing lines.


                                         I-11
APPENDIX I                                                           APPENDIX I
   Recnu endation   (10-6)

   We recommend that where teasible thel Comptroller of the Currency, Board ot.
   nlrectorb, FDIC, and Board of Governors, FRS, combine their examiner schools
   and standardize their curricula.


   OCC Response:

   The OCC recognizes that a common training effort and a combined examiners'
   school would be highly desirable both in terms of expense and coordination
   of examination policy. Our Office stands ready to cooperate fully with all
   such efforts. Indeed, our Office is in receipt of a letter f.om Chairman
   Barnett of the FDIC asking our cooperation and financial iupport for a
   combined training facility to be constructed at a Rosslyn, Virginia site.
   This matter is receiving serious attention.

   The practical difficulty is that our Office has implemented the Haskins and
   Sells Report which has created fundamental changes in our examination process.
   These changes are so basic to our examination process that it would be
   difficult to coordinate a curriculum. A combined examiners' school is viable
   only if the other agencies modernize their techniques in line with those being
   implemented at the OCC. It would be Fossible, however, to offer jointly
   courses in more generalized subjects such as Economics and Accounting.

                         II
   Recommendation   (10-IRe)

   We recommend that the Board of Governors, FRS (1) establish a full-time
   training office to operate its examiner training program and (2) carry out
   the revision of examiner school curricula which it has recognized as needed
   for some time.

   We also recommend that the Comptroller cf the Currency, Board of Directors,
   FDIC, and Board of Governors, FRS, increase their training in EDP, Law and
   Accounting as desired by their examiners.


   OCC Response:

   As part of our acknowledged need for specialized training, and consistent with
   the advice of our consultants, the Training Division of the Personnel Management
   Department has identified a multitude of different specialized courses which
   selected examiners will take; they include 7 different commercial examination
   schools, 3 trust examination schools, an EDP school, and International school
   and a consumer examination school. That program has now been implemented and
   is in full operation. The schools are programmed for examiners at different
   stages of their professional development. Among the many courses that will be
   offered by skilled personnel, both from within the OCC and, where necessary,
   from outside, are ones in EDP, Law and Accounting. Among the other areas that
   will be covered in that curriculum development will be specialized work in
   Economics, Bank Marketing, Finance, Auditing and similar topics.




                                     I-12
APPENDIX I         ~~~~~~~~~APPENDIX~APPENDIXI                                    I
  Recommendation   (11-8)

  We recommend that the Board of Directors, FDIC, the Board of Governors, FRS,
  and the Comptroller of the Currency either (1) jointly establish a more
  effective mechanism for the three agencies to combine their forces in under-
  taking significant new initiatives to improve the bank supervisory process
  or in attacking and resolving problems coMnon to the three agencies, or
  (2) the Congress enact legislation to establish a mechanism for more
  effective coordination.


  OCC Response:

  The OCC has always stood tor the strongest possible working relationships
  between federal supervisory authorities. At the December, 1976 meeting of
  the Interagency Coordinating Comraittee, Mr. Robert Bloom, Acting Comptroller
  of the Currency, asked that the committee ta,ke up at its next meeting the
  subject of strengthening coordination of examination procedures.   It will be
  proposed that a permanent staff group be set up for this purpose. We
  anticipate modification and refinement of our newly implemented examination
  approach on an ongoing basis. Review and evaluation of such changes as they
  affect problems common to the three agencies would be most useful.




                                         I1-13
  APPENDIX II                                                   APPENDIX 11



07..
   -u~,/,~                 CHAIRMAN OF THE BOARD OF GOVERNORS
                                  FEDERAL RESERVE SYSTEM
             ',[: ,'   -   aWASHNGrION.          D. C. 20551



                                          January 16, 1977




 The Honorable Elmer B. Stoats
 Comptroller General of the United States
 Washington, D. C. 20548

 Dear Mr. Staats:

           We appreciate the opportunity to review the General Accounting
 Office's draft report on the "Study of Federal Supervision of our Nation's
 Banks."

           The data contained in the report reflect favorably on the
 Federal Reserve's supervisory performance with respect to both banks
 and bank holding companies.  'swever, the report does suggest a number
 of refinements in examination procedures and urges more uniformity of
 standards among the Federal bank regulatory agencies. In most instances,
 the Federal Reserve had already taken steps to accomplish the objectives
 of the .ecommendations.

           The Board's specific comments concerning individual recommenda-
 tions and its general comments concerning the GAO report are enclosed.
 It is our understanding that our responses to specific recommendations
 will appear verbatim in the report immediately following the applicable
 recommendation and that our general comments entitled "Statement by
 the Board of Governors of the Federal Reserve System" will appear in the
 Highlight Section of. the final report.

                                            Sincerely yours,



                                            Arthur F. Burns

 Enclosures
APPftNIL)X 11                                                 APPLNDIX     11


                                   STATE2EN'J' BY
              THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
                                ON THE GAO REPORT



              The agreement between the General Accounting Office and the

three bank regulatory agencies, pursuant to which the special GAO review

of the bank zupervisory process was commenced in May, 1976, provided

that each of the agencies involved would have an opportunity to comment

on the conclusions an; Lrcotnmendations set forth in that report.       In

addition to its speciti.       :nts on individual recommendations which

are set forth throughout the main body of the report, the Board also

believes that some introductory comments are appropriate.

              --The report co~nfirms the basic health and soundness
              of the banking system. The number of banks requiring
              special supervisory attention is a small percentage
              of the total number and the percentage which have
              in fact failers is much smaller still.

              --The report confirms the basic soundness of the
              current system of supervision. Refinements, rather
              than basic revisions in the current system, are
              recommended. In most instances, the Federal Reserve
              Board had already taken steps to implement such
              refinements and we believe the same to be true of
              the other agencies.

              --The report confirms the necessity for the legislative
              improvements in the bank supervisory and regulatory
              area which the Board recommended to Congress as
              early as September, 1975, as well as the Board's
              proposals for a Federal Bank Examination Council.

              The bulk of the GAO review focuses on banking institutions

which hav-'    required special supervisory attention and the responses

of the various agencies to this requirement.      Despite this limitation,

the report establishes that, at any one time, the percentage of banking




                                      II-2
 APPLNDIX   I!                                               APPtIDX     1I




institutions in the country which for vaLious reasons can be considered

to require special supervisory attention is extremely small, in the

neighborhood of 5 per cent.    The data in the report show that between

1970 and 1975, encompassing an exceptionally difficult economic period

for the country, only 42 of the approximately 14,000 commercial banks

in the country failed.    Most of those institutions were relatively small

and aggregate losses to depositors were minimal.

            Also relevant to an evaluation of the supervisory process

is the conclusion cf the report that the group of banks identified as

requiring special supervisory attention is fluid.    The composition of

the problem lists changes with some frequency as the regulatory agencies

identify problems and the banks respond to the need for corrective action.

            The recommendations made throughout the report indicate that

no need was found for any basic revisions in the country's present system

of bank regulation.    Rather, the report identifies a number of areas

which GAO believes need further attention by the agencies.    As noted

in our specific comments on the recommendations, in most instances the

Federal Reserve and the other regulatory agencies had already taken

actions in harmony with the basic thrust of the recommendations.    For

example, the Eoard was already focusing more of its supervisory resources

on institutions with known problems and less on those thought t- be

in good condition.

            The majority of the recommendations in the area of bank examina-

tion and supervision relate to a desire for greater uniformity in supervisory




                                   II-3
 APP[NDIX   11                                                 APPENDIX    II



treatment among the agencies.    These recommendations support the Board's

conclusions and initiatives in this area.    In December, 1975, Governor

Holland testified before the Senate Committee on Banking, Housing and

Urban Affairs and in that 'estimony made reference to the coIncept of

a joint bank examination council which at that time had received substantial

support within the Board.    In that regard, he stated:

            Such a Council would be focused on the areas that
            we believe are most in need of improvement; that
            is, efficient and uniform modernization of bank
            examination and vigorous and consistent follow-up
            procedures when bank weaknesses are revealed. Such
            a Council could be established administratively
            or by stdtute.  Its statutory authorization would
            undoubtedly give more impetus to the establishment
            of such a Council, and would also provide it with
            more clear-cut authority to take definitive action
            within its statutorily defined areas of administration.

            The Federal Bank Examination Council should have
            authority to establish standards and procedures
            for bank surveillance, examination and follow-up,
            applicable to all the Federal banking agencies,
            and it should review significant problem cases when
            and as they develop. All three Federal banking
            agencies should be represented on the Council.

            Subsequently, at the Board's request, Senator Stevenson introduced

the Federal Bank Examination Council Act    (S. 3494).    Such a council

would establish mandatory uniform standards and procedures for Federal

examination of banks as well as uniform reporting systems and conduct

joint schools for examiners.    The Board strongly supports such legislation

and believes a proposal along those lines could accomplish most of the

objectives set out in the report's recommendations in the examination

area.



                                    II-4
   APPENDIX II                                              APPENDIX II



            The report focuses extensively on the method by which the

agencies deal with problem bank situations and makes a number of recom-

mendations for improvements in this area which will be discussed later.

Further, in a number of instances the report specifically supports enactment

of various legislative proposals made by the Board on behalf of the

regulatory agencies.     As Chairman Burns stated in a letter of September 5,

1975 proposing such legislation, "All of these recommendations arise

:'ram the agencies concern over 'problem bank' situations and are designed

to help prevent or correct such situations."      H.R. 9743 and S. 2304,

which embodied these recommendations, would have provided civil penalties

for violations of various provisions of Federal law by banks and bankers;

imposed new restrictions on a bank's transactions with insiders; and

placed the ago,icies in a position to make more effective use of the

Financial Institutions Supervisory Act of 1966.      The Board believes

that the report pzovides strong support for tiit legislation.      In this

regard, we note that Senator Proxmire has just introduced a bill in

the 95th Congress which encompasses these recommendations.

           The GAO report stated that *Examiners found problems in nearly

all of the banks in our samples, including those not on the agencies'

problem lists . ..     ."   The tables contained in the review of this element

of bank supervision showed that examiners applied strict. standards;

e.g.,   in 70 per cent of the banks ti.- examiners criticized the volume

of classified loans; violations of law and regulations, whether merely1

technical or substantive, were identified in 55 per cent of the banks;




                                     II-5
 APPLNDIX   II
            1!                                               APPLNDIX



inadequate routines and controls we:e noted in 44 per cent of the banks.

We agree with the GAO and believe the report readily confirms that bank

examiners are effective in identify!ng problem areas in commercial banks.

            We believe that the stud,, also demonstrates that the supervisory

agencies are effective in resolving significant problems once they have

been identified by the examiners.    We are not convinced that analysis

of the dynamics of so-called 'problem lists" -- one of the techniques

employed by the GAO -- is a proper basis for measuring supervisory effective-

ness.   Tnus, we are somewhat concerned with the report'a focus on the

length of time an institution remains subject to special supervisory

attention as being c. indication of whether or not the supervisory process

is, in fact, working.   %h believe that substantial weight should also

be given to the percentage of banks which fail as an indication of whether

or not the process works.    During the period examined by the GAO, only

twu St.ate member banks failed, and they were relatively small.

            However, we believe that even the focus of the report on the

dynamics of the list of institutions subject tc special supervisory

attention demonstrates the effectiveness of the present system.    The

report shows that the composition of the lists changes with some frequency

as problems are identified by the regulators and resolved by the institu-

tions in conjunction with the regula ors.    During the period examined

by the GAO, 1,180 banks were added to t|hese lists and 897 were removed.

Furthermore, as set forth in more detail in our specific responses to

individual recommendatior.s, we believe the data gathered in chapter 8




                                     II-6
 APPlNDIX II                                                 APPENDIX I1




demonstrate that the performance of the three agencies is roughly thp

same and, in fact, aood for all three agencie:s.

          In addition to the recommendations   for greaser uniformity

in examination and follow-up among the agencies, the report makes a number

of recommendations relating to examination techniques and training.

As more specifically set forth in our responses to the particular recommen-

dations, the Board has taken, or is in the process of taking, effective

action compatible with the major thrust of most of the recommendations.

For instance, a major portion of the recommendations deal with the desire

that the agencies focus more of their resources on institutions with

known problems.    In this regard, the Board requires all problem banks

to be examined at a minimum of six-month intervals.    Further, the Board

has recently adopted limited scope Asset Quality and Management Performance

Examinations to be used on banks thought to be in relatively good condition.

The Board believes that these procedures give us the needed flexibility

while at the same time minimizing the likelihood that problems will

be overlooked.

          In the area of training, the Board has, among other things,

recently revised curricula for its various examiner schools and has

instituted new schools in the areas of consumer regulations and bank

holding company analysis.

          The Board would also like to comment on the broad purposes

of the bank examination process lest the sum of the report's recommendations

be misconstrued.   We believe that bank examination and supervision should



                                    11-7
 APPLNDIX IIAPPINDIX                                                    11




 be directed at securing compliance with banking laws and regulations

 and determining that a bank is operated soundly so as to assure, to

 the greatest extent possible, safety and soundness of depositors' funds

 and continued banking services to the community.    A system of bank regulation

 which goes beyond these goals imposes certain social costs and dangers.

 It is not the job of the supervisors to determine whether specific loans

should or should not be extended or whether a bank's resources should

be used in a particular tzanner unless such decisions contravene law

or affect the safety and soundness of the bank.     Rather, private initiative

should be encouraged to the greatest extent possible.

           Finally, the report also comments on the Board's supervision

of bank holding companies.   The data in the report confirm that, as in

the case of banks, the percentage of problem institutions is relatively

small.   Even utilizing a sample biased toward problem institutions,

there were limited instances in which bank holding companies were found

to have caused problems in the subsidiary banks.    Out of the sample

of 344 which were affiliated with bank holding companies, there were

22 banks in which the report stated that the problem was caused by the

parent holding company.   This constitutes 6.5 per cent of the sample

banks affiliated with bank holding companies.   However, the Board's

examination of the parent bank holding company in each of these instances

demonstrates that, in fact, the actions of only five holding companies

could be said to have caused any serious problem in the subsidiary banks.

In addition, the Board believes that it is taking effective supervisory



                                  II-8
               II                       APPENDIX



 action in those cases where holding companies are causing problems for

 the subsidiary banks.          In October, 1974, the Board's request for cease-
and-desist authority over bank holding companies was granted.                   Since
that time, the Board has significantly expanded its supervisory efforts
with respect to bank holding companies, concentrating primarily on those

exhibiting problems.          With respect to formal actions, in the 26 months
the Board has had the authority, it has issued 12 cease-and-desist orders

and 12 written agreements against holding companies.

              In concluding our general statement, we wish to note once
again that our banking system has weathered an extremely difficult period
successfully.          The bank supervisory process of this country, which by
no means is perfect, has materially contributed to this achievement.
                                   *******************


          The Board's further responses to individual recommendations
may be found throughout the body of the main report as follows:

Recommendations relating to                                          Page
          --        Scheduling of examinations --------------        4      7
         --         Flexible examination policies -------------      4   9
         --         Use of State examinations ---------------
                                                            …-       4-13
         --         Scope of examinations --------------------- 4-17

         --         Examination workpapers -         -------------   4-19
         --         Country risk evaluation --.-------.---------     433
         --         Examination of foreign operations ---------      4.35
         --         EDP examinations -------------------------- 4.39



                                           1-9
APPENDIX 11                                                 APPENDIX II



Recommendations relating to                                Page

          -- Supervision of holding companies ----------   4-51

          -- Examiners' meetings with directors --------   6- 5

          -- Examination report format -----------------   6-13

          -- Evaluation of the Comptroller of the
             Currency's examination procedures ---------   7-25

          -- Analysis of shared national credits ------- 7-25

          -- Policies for formal enforcement actions ---   8-18

          -- Criteria for identifying problem banks ----   8-49

          -- Combined examiner schools ----------------- 10- 6

          -- Separate training office ------------------ 10-11

          -- Evaluation of examiners ----------------- - 10-15

          -- Uniformity in the supervisory process ----- 11- 8




                                    II-10
               II                APPENDIX

Recommendat ion

          Therefore, we recommend that the Board of Directors, FDIC,
the Board of Governors, FRS, and the Comptroller of the Currency establish
scheduling policies and procedures which would avoid setting examination
patterns.

Comments

            This recommendation is based upon the premise that the agencies

view surprise as an important element of an examination.     The Board
believes that,in many cases, there is serious doubt as to the benefits

to be gained and hence the desirability of surprise examinations.        In
those instances where surprise is considered important, it has been,

and will continue to be,our practice to schedule examinations so that

they cannot be predicted in advance.

Recommendation

          We recommend that the Board of Directors, FDIC, and the Board
of Governors, FRS adopt flexible policies for examination frequency
which would allow them to concentrate their efforts on banks with known
serious problems.

          We recommend that the Congress amend the National Bank Act
to allow the Comptroller of the Currency to examine national banks at
his/her discretion. We would be glad to assist the committees in drafting
appropriate legislation.

Comments

            The Board already has established policies that are flexible

enough to allow us to concentrate our efforts on banks with known serious

problems.    Some years ago, the Board adopted the policy, which was reaffirmed

in 1975, that all banks considered to be in a problem status be examined

at a minimum of six-month intervals.    Howe-ver, we will continue to schedule

periodic examinations of all banks under our supervision    since a bank
may deteriorate with the passage of time.    As pointed out in the GAO

                                    II-11
                                                             APPENDIX II
 APPENDIX II


                                              of Asset Quality and Management
report, the Board recently approved the usage
                                             thought to be relatively
Peformance Examinations in the case of banks

free of major problems.   If this limited scope examination detects

                                                         is then commenced.
major changes or deterioration, a full scale examination
                                              the same time insuring
These procedures give us flexibility while at

that problems are not overlooked.

Recominendation

                                                          and the Board
          We recommend that the Board of Directors, FDIC,
                                                to use State examinations
of Governors, FRS, extend their current efforts
                                        they
and, If they do, we also recommend that

                                                       State examiner
            --develop minimum standards for acceptable
              training and examination procedures and

                                                              those standards.
            -- use only reports of State examinations meeting

Comments
                                                                to eliminate
            The report recognizes our current extensive efforts
                                                     and State examination
unnecessary duplication by utilizing StPte examiners
                                                               should
 reports.   If experience with our existing program in Indiana
                                                       GAO's recommendations
 indicate that expansion of this program is desirable,

 regarding standards would be appropriate.    Indeed, the purpose of the

                                    to develop such standards.   In this
 existing experimental program is
                                              that written standards
 connection, however, it should be recognized

 alone will not insure the success of any program.

 Recommendation
                                                           and the Board
           We recommend that the Board of Directors, FDIC
                                                  tha scope of each examination
 of Governors, FRS, establish procedures to base
                                                 the bank's controls,
 on the examiners' evaluation of the quality of
 policies, procedures, and audit.



                                      II-12
   APPENDIX II                                                   APPENDIX II
 Comments

             This recommenndation encompaasses what we are already doing.
 We review the policies, procedures, and controls in connection
                                                                with
 all bank examinations.    In moat large banks, our examiners currently
 perform a prtexamination review specifically focusing on controls,
                                                                     policies,
 and procedures. The results of such review are used to determine
                                                                    the
 amount of scrutiny given to each area.       In smaller banking institutions,
a review of the controls, policies and procedures in effect at
                                                               the last
examination is used to develop the scope of the examination.

Recommendation

          We recommend that the Board of Directors, FDIC, and the Board
of Governors, FRS, develop standards for the preparation, maintenance,
and use of examination workpapers.

Comments

          We believe that, in the vast majority of examinations, the
examination workpapers and line sheets prepared are adequate to
                                                                meet
the System's needs.    The manner in which examination workpapers should
be prepared and maintained is extensively covered in connection
                                                                with
the training of our examiners.

Recommendation

          We recommend that the Board of Governors, FRS, and the Comptroller
of the Currency, using all available information, develop and
single approach to classify loans subject to country risk.    use a

Comments

            The evaluation of the country risk element in international
loans calls for difficult analysis and judgment at the time lines
                                                                  of
credit are established or loans extended since 'country risk'
                                                              involves


                                      II-13
 APPENDIX II                                              APPENDIX II

an estimate of a country's political, economic, and social fortunes

over the life of the loan as they may affect the collectability of such

loans.   There is   serious question as to the validity of generalized

characterizations of credits based on the country of residency of the

borrower, particularly where the characteristics of the credit may well

vary with the borrower - private or governmental - as well as the nature

and extent of external resources available to support the loan.      For

a number of months now the Federal Reserve has had underway a review

of country risk problems in international lending as well as appropriate

supervisory treatment of the problem.    This review has included an on-going

appraisal of the system employed by the Comptroller of the Currency.

In this regard, we believe that, while there may be general agreement

on the desirability of uniform evaluation of the country risk element

in individual international credits, there is a real question as to the

desirability of rating individual countries.      It might be noted, for

instance, that the Comptroller's system focuses almost exclusively on

credits to individual governments.     In any event, we believe that we

should strive toward uniform treatment.      Of course, as with respect

to many of ';he recommendations, the Federal Bank Examination Council

proposal would accomplish this.

Recommendation

          We recommend that the Board of Governors, FRS, and the Comptroller
of the Currency implement procedures to examine (where permitted by
the country involved) major foreign branches and subsidiaries, including
subsidiaries o,e Edge Act corporations, periodically and whenever adequate
information ab,ut their activities is not available at the home office,




                                     II-14
APPi!DJI,\ I I                                                 APNl.DIX 11


          Also, we recommend that the Board of Governors, PRS, and the
Comptroller of the Currency utilize each others examiners to cut expenseP
when conducting examinations in foreign countries.

Comments

            The development of widespread networks of foreign branches

and subsidiaries by the major banks has brought the question of the

supervision of the banks' international operations to the forefront

in recent years.    We concur with the principle that examinations, wherever

conducted, should be adequate to provide the necessary supervisory information.

However, one constraint with which the Board has had to deal is, as

noted in the report, that, in many cases examinations of foreign subsidiaries

are not possible because of host country laws which preclude direct examina-

tions by other governmental authorities of banks chartered in those

countries regardless of the ownership.      The System has not only required

that banks maintain records at the head office adequate to appraise the

risk and exposure of the banks through their foreign operations, but the System

has also provided for direct visitations of examiners to major foreign

branches in those cases where such visitations have been legally possible.

            The Board believes that, on the whole, this system has worked

well.    The information available at head offices has, in general, been

adequate to assure that the banks were not unduly exposed to loss or

serious financial difficulties.   At the same time, there has been a

continual search for better and more efficient ways of satisfying the

Federal Reserve's supervisory responsibilities in the international

field.


                                    II-15
 APPENDIX II                                                APPENDIX II

           Beginning in the fall of 1976, on-site examinations were made

of foreign branches of State member banks where we had previously utilized

on-site inspections by State examiners or information at the head office.

Moreover, a number of foreign subsidiaries were directly examined for

the first time with the agreement of the host government.   A full evaluation

of those examinations has not yet been completed.   One preliminary result

of that exercise has been to provide assurance that a large portion

of the material needed for proper supervision of foreign branches and

bubsidiaries is in the management information systems at head offices.

In this connection, it should be noted that consultations are continuing

with foreign bank superisory authorities about the ways in which access

to foreign subsidiaries may be broadened to accommodate on-site reviews.

These consultations are part of a wider effort of international cooperation

in bank supervision.

Recommendation

          We recommend that the Board of Directors, FDIC, and the Board
of Governors, FRS develop reports of examination for EDP operations
which present the problems found, corrective action needed and any necessary
explanatory data in a clear and concise manner.

Comments

           The Board wishes to note that it believes its present EDP

examination report adequately presents the major problems found and

corrective action needed.   Furthermore, the System has already undertaken

a review of EDP examination procedures to :Determine whether there are

possible improvements, particularly in the review of internal controls,

and, in connection with that review, is preparing a revised examination

report.

                                   II-16
    APPENDIX II                                                  APPENDIX II

Recommendation

          We recoamend that the Board of Governors, FRS implement a
system of supervision which is based on o;site inspections of holding
companies and their major nonbanking subsidiaries. We also recommend
that the Board strengthen its oversight of holding company supervision
by establishing

           --a systemwide manual of inspection procedures,

           --a standard inspection report, and

             --periodic onsite evaluations of Reserve bank supervisory
               activities.

Comments

             The System has for some time conducted on-site inspections of

selected holding companies.     Partly as a result of these inspections and problems

which came to its attention, the Board in late 1974 requested and was

granted legislative authority to impose the same supervisory remedies

on holding companies that were applicable to banks under the Financial

Institutions Supervisory Act of 1966.     In early 1976,the Board directed

that this inspection program be significantly expanded with initial

efforts directed toward holding companies requiring special supervisory

attention.

             In addition, in 1975 the Board commenced work on a computer

based monitoring system in order to identify those holding companies

which might require special attention.     This program is partially operational

at the present time and is    expected to be fully operable within the

next few months.

             A manual of inspection procedures is currently under dev=lopment.

However, completion of such a manual has of necessity awaited experience



                                        II-17
      I,   II                                                APPi ..D1A 11



,j.ined from the direct on-site inspections which have been carried out.

we- believe that the recommendations relating to a standardized inspection

report as well as periodic on-site evaluations of Reserve Banks supervisory

activities warrant further consideration.   We might note that the initial

steps to set up such periodic evaluations already have been commenced

by the Board.

           While we see no difficulty with the thrust of the recommendations,

the Board is concerned that the method used in the GAO report may lead

to unwarranted fears as to the general health of bank holding companies.

The sample chosen was one in which problem banks were at least six times

more likely to occur than in the industry as a whole.    A samp'.e biased

toward problem banks is naturally biased toward problem holding companies.

           Under the heading 'Unsound Holding Companies' Expansion Applications

Approved" the report states that the Board approved applications by

15 of 20 'detrimental holding companies" to acquire additional banking

and nonbanking subsidiaries.   Our review of these companies indicates

that the problems of over two-thirds of these companies were problems

centered in the banking subsidiaries as opposed to problems in either

the parent holding company or a nonbanking subsidiary.    As such, these

problems would be most effectively handled by the primary examining

authority of the bank involved.   Furthermore, the majority of the applications

involving these institutions which are referred to were acted on in

the early 1970's, long before any of the institutions had experienced

difficulty or had been identified as requiring special supervisory attention.



                                   I I-1
   APPENDIX II                                                APPENDIX II


 In fact, only three applications were approved at a time when any
                                                                   of
 the institutions involved was considered to be in a problem condition.

Two of these applications consisted of corporate reorganizations
                                                                 having
no financial impact on the institution whatsoever.    The third application

 involved permission to engage in a nonleveraged, potentially profitable,

operation which was considered to be a positive factor to improve
                                                                  the
condition of the company involved.

           The Board regards its policy, adopted in June 1974, of curbing

bank holding company expansion into nonbanking activities, particularly

with respect to bank holding companies with financial problems, as
                                                                   being
an effective supervisory tool.   In fact, the Board has acted to deny

a significant percentage of applications on financial and managerial

grounds since this policy was introduced, and many more have been
                                                                  withdrawn
by applicants after discussions with staff.   The Board believes it has

applied this policy responsibly and it remains in effect.

Recomme ndat ion

          Therefore, we recommend that the Board of Directors, FDIC,
and the Board of Governors, FRS require their examiners to meet
                                                                with
the bank's board of directors or audit or examining committee
                                                              after
each examination.

Comments

           The System has for many years been concerned that the board

of directors be particularly aware of the results of an examination.

Thus, the System has historically required that the examination
                                                                report
be considered and discussed at a meeting of the board of directors.

To insure that this is done, directors are required to sign
                                                            a statement


                                   II-19
   APPENDIX II                                                       APPENDIX II

attached to the report that it has been so read and considered.           Further,

examiners are instructed to revieu the minutes of board of director

meetings to insure that the spirit of these requirements has been fully

carried out.

           With respect to meetings, the Board in 1975 directed that

an earlier existing policy for most of the System be expanded to all

Reserve Banks.    This policy requires that Reserve Bank staff meet with

the board of directors of all so-called problem banks.           The Board believes

that such meetings are important where significant problems are revealed.

Recommendation

          We recoafmend that the Board of Directors, FDIC, and the Board
of Governore, FRS, develop and use reports of examination which provide
the banks with the results of the examination and any necessary supporting
information.

Comments

           We believe the bank examination report presently provides

the banks with the results of an examination and necessary supporting

information.   We also believe it    should provide the System with the

information it needs to carry out its     supervisory functions.      The present

examination report adequately carries out these needs.           It should not be

forgotten that the System also uses other methods of communicating its

views to its   member banks, such as correspondence,     informal meetings,    ant

consultations on applications.      Of course,   the System is   continually

exploring methods of improving communications.



                                      II-20
   APPENDIX II                                                   APPENDIX II
Recommendation

          We recommend that the Comptroller of the Currency invite FDIC
and FRS to jointly evaluate its new examination approach. We further
recommend that, in the event of a favorable assessment of the new process,
the Board of Directors, FDIC, and the Board of Governors, FRS revise
their examination processes to incorporate the concepts of OCC's approaches.

Comments

              The Comptroller's new procedures are based in large part on
the Haskins and Sells report.      At the time that report was prepared,
the Comptroller furnished it to the other banking institutions in the

belief that some of the recommendations might be jointly applicable.

A task force at the Federal Reserve reviewed the report shortly after

its issuance and concluded that, in most instances, the Systeu had already

implemented those recommendations involved which would have been applicable

to the System.     Subsequent to that time, the development of new examination
procedures at the Comptroller's office has been substantially completed.
Recently, senior members of the Board's staff attended a briefing by

the Comptroller's office on these new examination procedures and the

report form to be used by that agency.       The Board believes that the
Comptroller has been most cooperative in sharing his new systems with

us and fully intends to use whatever benefits may be derived from the

Comptroller's efforts in this area in our on-going review of our examination

procedures.



                                     II-21
APPI;I Dill 11                                                   iPPLrUDIA( IX



Recommendation

          We recommend that the Board of Directors, FDIC, the Board
of Governors, FRS, and the Comptroller of the Currency jointly staff
a group to analyze shared national credits at State and national lead
banks under Federal supervision and that the three agencies use the
uniform classification of these loans when they examine the participating
banks.

          We recommend that the Board of Directors, FDIC, the -oacd
of Governors, FHS, and the Comptroller of the Currency work together
to refine their monitoring systems and their approaches to examining
for compliance with consumer credit laws.

Comments

            A joint approach to shared national credits is clearly desirable.

In fact, in June 1976 the Board and the Office of the Comptroller of

the Currency entered into a preliminary agreement which provides for

a sharing by each agency of examiners' classifications of a ,oational

credit.

            The second portion of this recommendation deals with the desirability

of uniform refinement of consumer credit enforcement and compliance

policies.        In the report, the GAO states that some agencies believe

there is a possible       oonflict between a bank's objective of financial

soundness and strict compliance with consumer credit laws."        The Board

does not agree with this statement.       On the contrary, we believe that
stringent enforcement of consumer laws and regulations will achieve

compliance and thereby reduce the likelihood that banks will incur

substantial liability as a result of consumer suits.

            The Federal Reserve has had the major responsibility for drafting
regulations to implement the explosion of legislation that has taken

place in this area over the past two years.        In this connection, the

                                        II-22
   APPENDIX II                                          APPENDIX II

 Board's Division of Consumer Affairs has worked very closely with the

 other agencies.   It has formed a Federal Reserve task force to develop
 approaches to the enforcement of newly enacted consumer credit laws.

A cadre of examination specialists who will concentrate tCn inspection

and compliance is being trained.   Two schools on consumer regulations
were conducted in 1976 and four have been planned for 1977.

           Additionally, examination manuals that deal with the full
array of consumer regulations have recently been prepared.    A new examination
report form dealing exclusively with this area has been prepared and

is expected to be in use in the near future.

Recommendation

          We recommend that the Board of Directors, FDIC, the Board
of Governors, FRS, and the Comptroller of the Currency establish more
aggressive policies for using formal actions. Written guidelines should
be developed to identify the types and magnitude of problems that formal
actions could appropriately correct.

Comments

           In this section, the report notes that each problem situation
has to be evaluated on a case-by-case basis and formal action would

not always be appropriate.   The report goes on to recommend that more
aggressive policies be used for formal actions and that written guidelines

be developed to identify the types and magnitude of problems that formal

actions could appropriately correct.   In this regard, we note that the
report confirms that all of the agencies have already markedly expanded

their formal enforcement activities.   On November 3, 1975 the Board issued
a policy statement emphasizing its intention to take formal action where

appropriate in connection with violations of the Bank Holdir!g Company

Act.
                                   II-23
   APPENDIX II                                                APPENDIX II

           Further, we do not believe that adequate weight has been given

 in the report to existing hindrances to formal action under the Financial

Institutions Supervisory Act of 1966.         This chapter does, however, support

the Board's existing recommendations for changes to the Financial Institutions

Supervisory Act which would enable the supervisory authorities to remove

bank officers for gross negligence and to assess civil penalties for violations

of laws and regulations.    These legislative recommendations were made

in response to procedural and substantive problems inherent in making

effective use of the present formal procedures set forth in the Financial

Institutions Supervisory Act.    In this regard, the Board's letter of

September 5, 1975, to the banking committees of both Houses of Congress

setting forth the legislative proposals made it clear that there were

a number of situations in which the existing formal regulatory remedies

would have little or no value in preventing or ameliorating problem bank

situations.   We believe that those recommendations, embodied in H.R.

9743 and S. 2304, would help to substantially reduce the incidence of

problem banking situations.   Further, the Board has continued to review

areas in which it appears that changes may be of substantial aid.        The

Board intends to submit further legislative proposals to this end in

the very near future.   a   this regard, Chairman Proxmire has introduced

legislation in the 95th Congress which encompasses the earlier

recommendations.

          The Board is further concerned that the discussion in this

chapter of the manner in which the agencies are handling problem bank

situations may not present an accurate view in all respects.        The major


                                   I   -,!;
  APPENDIX II                                           APPENDIX II

shortcoming in this regard stems from the fact that the different agencies

utilize problem bank lists for varying purposes.   Furthermore, even

between agencies with similar goals, different judgments may occur as

to the severity of an institution's problems and the length of time

monitoring is required.   Meaningful comparison between agencies' enforce-

ment activities in this area is therefore impossible.   We would, however,

note that the report's conclusions relating to the agencies' effectiveness

in returning institutions to nonproblem status are not supported by

the tables since the percentages used excluded institutions withdrawing

from membership and merging.   Presumably, the approving agency found

in the case of the mergers, as required by the Bank Merger Act, that

the financial and managerial condition of the resu.ting bank was satisfactory

and, in the case of withdrawals from membership, supervisory pressure

may well have contributed to such withdrawals.   Further, as noted in

the table, withdrawals and mergers are disproportionately high in the

sample for the Federal Reserve.

Recommendation

          We recommend that the Board of Directors, FDIC, the Board
of Governors, FRS, and the Comptroller of the Currency develop uniform
criteria for identifying problem banks.




                                    II-25
  APPENDIX II                                            APPENDIX II
Comments

           As previously noted in earlier responses, the rating systems

are utilized for different purposes within different agencies.    However,

we believe there is certainly room for much common ground in this area.

The legislative proposals for a Federal Bank Examination Council referred

to earlier would aid in this development, though judgmental evaluation

of any common criteria will likely lead to some diversity.

Recommendation

          We recommend that where feasible the Comptroller of the Currency,
the Board of Directors, FDIC, and the Board of Governors, FRS, combine
their examiner schools and standardize their curriculums.

Comments

           The examiner schools were a combined effort of the three agencies

when they were established in 1952 by the Federal Reserve.   However,

in 1962 the Office of the Comptroller of the Currency withdrew from

the program, believing it preferable to operate its own school.    In

the early 1970's the number of FDIC students necessitateei some sessions

held for FDIC examiners only and, when the FDIC enrollment needs continued

at this high level, it was   aecided that the only practical course of

action for the FDIC and 'the Federal Reserve System was to establish

separate schools.

           The Board believes that a joint effort in this area would

be appropriate and desirable.   This is among the reasons the Board supports

the concept of a Federal Bank Examination Council.   Short of this proposal,

the Board will explore with other agencies the feasibility of conducting

joint schools.


                                   II-26
APPL;I))Ix, 11                                                  'PL[i.DIA   11



Recommendation

          We recommend that the Board of Governors, FRS, (1) establish
a full-time training office to operate its examiner training program
and (2) carry out the revision of examiner school curriculums which
it has recognized as needed for sometime.

          We also recommend that the Comptroller of the Currency, the
Board of Directors, FDIC, and the Board of Governors, FRS, increase their
training in EDP, law, and accounting, as desired by their examiners.

Comments

            One individual currently administers the various Federal Reserve

examination schools held in Washington.       In addition, one full time

staff member is assigned to handle preparatory and procedural aspects

such as registration, printing and distribution of instructional materials

and day-to-day dealings with instructors and students.      Other responsibilities
for the different schools have been assigned to various members of the

Board's staff who are experts in each field of training.      For instance,
the curriculum for the newly established Holding Company School was

devised by members of the Federal Reserve staff expert in matters relating

to holding companies and the new Consumer Regulations School is handled

by individuals who have been actively involved in implementing the recent

consumer legislation.   The Board believes that this system has met its

needs.

            If the report's recommendation for a joint school is adopted,
this would reduce the need to consider a separate office at the Board.
However, if such arrangements cannot be worked out, the Board will consider

establishing such an office.




                                     II-XL7
  APPENDIX II                                                 APPENDIX II


           We might note that the portion of this recommendation relating

to a revision of examination curricula had been started prior to the

report.    At the direction of the System Education Committee, the curricula

for the schools for assistant examiners and examiners were updated and

revised in the spring and summer of 1976 and the curriculum for the

EDP school was revised in the fall.     The Holding Compa&n    School and

the Consumer Regulation School have been recently established and therefore

have new curricula.

           With respect to that portion of the recommendation relating

to additional training in specific areas, the Board has a previously

scheduled session of the EDP school set for 1977 which will use a recently

updated curriculum.   The laws relating to consumer affairs are extensively

covered in schools developed by the Office of Consumer Affairs now conducted

in Washington as part of the overall examination program.       The Board

will study the question whether additional training in the areas of

law and accounting should be provided to examiners.

Recommendation

          We recommend that the Board of Governors, FRS also establish
formal evaluation process to measure the competence of persons seeking
advancement to examiner status.

Comments

           We note that this recommendation is not based upon a conclusion

that the examiners of any one agency are more or less competent than

those of another agency.   Standardized tests are merely one way of arriving

at a formal evaluation, and we would not ,want to rely on them exclusively.



                                II-28
  APPENDIX II                                           APPENDIX II


however, there is something to be said in favor of formal tests as a

supplementary evaluation device, and the Board intends to investigate

their feasibility.

Recommendation

          We recommend that either (1) the Board of Directors, FDIC,
the Board of Governors, FRS, and the Comptroller of the Currency jointly
establish a more effective mechanism to combine their forces in undertaking
significant initiatives to improve the bank supervisory process or in
attacking and resolving common problems, or (2) the Congress enact legislation
to establish a mechanism for more effective coordination. We would
be glad to assist the committees in drafting appropriate legislation.

Comments

           The Board is pleased that this portion of the report supports

its previous conclusions and initiatives in this area and favors the

legislative approach.

           In December, 1975, Governor Holland testified before the Senate

Committee on Banking, Housing and Urban Affairs and in that testimony

made reference to the concept of a joint Bank Examination Council which

at that time had received substantial support within the Board.      In

that regard, he stated:

           Such a Council would be focused on the areas that
           we believe are most in need of improvement; that
           is, efficient and uniform modernization of bank
           examination and vigorous and consistent follow-up
           procedures when bank weaknesses are revealed. Such
           a Council could be established administratively
           or by statute. Its statutory authorization would
           undoubtedly give more impetus to the establishment
           of such a Council, and would also provide it with
           more clear-cut authority to take definitive action
           within its statutorily defined areas of administration.




                                  II-29
APPINDIX   II                                               APPENDIX   II




           The Federal Bank Examination Council should have
           authority to establish standards and procedures
           for bank surveillance, examination and follow-up,
           applicable to all the Federal banking agencies,
           and it should review significant problem cases when
           and as they develop. All three Federal banking
           agencies should be represented on the Council.

            Subsequently, at our suggestion, Senator Stevenson introduced

the Federal Bank Examination Council Act (S. 3494).   Such a Council would

establish mandatory uniform standards and procedures for Federal

examination of banks and uniform reporting systems and conduct

joint schools for examiners.   The Board believes that a proposal along

these lines could accomplish most of the objectives set out in the report's

recommendations in the examination area.




                                    II-30
APPENDIX III                                                                                APPENDIX III
                                               EUERAI I)EPUSIFr IN';lHRANCt
                                              F^                              ORPORATION,   '.I,,u4,
                                                                                                   o t 21;li.,'i

     , .'   .'~'   tlt ,   .:i,   ~AIHM AtJ




                                                                     January 17, 1977



Honorable Elmer B. Staats
Comptroller General of the United itates
Washington, D.C. 20548

Dear Mr. Staats:

       I appreciate the opportunity to comment on the draft of your report
to Congress on federal supervision of the commercial banks in this country.

        In general, I believe that the General Accounting Office has done a
workmanlike job with an extremely difficult task, made more difficult by a
relatively tight time frame. We feel that your comments as an impartial
professional observer should be studied carefully by us in an atmosphere
of cooperativeness and receptiveness. In that vein, I would like to comment
on a few points in the draft.

         1. The day-to-day relationship which the FDIC has with -;tate banking
supervisors i3 extremely important in our supervisory effort. Unlike the
Comptroller oi the Currency, we supervise banks who are operating under
50 state laws as well as the Federal Deposit Insurance Act. Those banks
are chartered by 50 different state supervisory authorities and the manner
of supervising those banks at the federal level differs as a result from state
to state.

        2. It is important to realize that the FDIC is the sole federal
regulator for the entire mutual savings      _--. industry, a $100 billion industry.
While I appreciate that you:r report is directed only to commercial banks,
I believe it is essential to take into account its activities with respect to
the mutual savings bank industry in order to understand the supervisory
effort of the FDIC.

        3. Your report emphasizes the need for flexibility in examination
techniques. We wholeheartedly concur and as a result of a continuing study
going back a number of years, we amended in early November of 1976 our
basic memorandum which governs our examination policy. This amended
General Memorandum No. 1 is quite consistent with the thrust of your report
and I am sorry that you did not include it and a full discussion of it in your
report. We like to think that the philosophy outlined in this memorandum,
which we have tested during the past few years by experimenting in different
APPENDIX 111                                                     APPENDIX    Ill


Honorable Elmer B. Staats
January 17, 1977
Page Two


regions, is the best philosophy for the FDIC to pursue in the examination
of nonmember banks. Since it is so central to our operations, .,nd since
it is a relatively new statement of a flexible examination policy, I would
personally have liked to have seen your in-depth comments about it.

        4. We believe, as your report recommends, that more formal
actions should be taken in the supervisory process by federal regulators.
We have attempted to pursue that policy, particularly since late spring and
early summer of 1976, and have requ2ested from the Congress additional
supervisory powers.

         5. The report notes the large number of violations of the law during
a typical examination. I was pleased to note that you point out that some of
the laws and regulations are complex and that some of the violations were
of a technical nature that would in no way affect the soundness of a bank.
Rightfully, you also point out that other types of violations, such as a loan
in excess of a bank's legal lending limit, could result in losses to a bank.
In our experience, the major portion of violations of laws set forth in reports
of examination do not affe :t the safety and soundness of a bank. All violations
of laws or regulations are a matter of concern, of course, but it is the par-
ticular responsibility of the bank regulator to consider each violation in terms
of whether it was intentional or willful, the consequences flowing therefrom,
the likelihood of continued violations, and other similar matters, and to then
take the appropriate corrective action.

        6. Finally, the report implicitly argues that Corporation examiners
should be criticizing loan policies before bad loans are made. I certainly
agree that a closer review of loan policies is important, and criticism of
such policies in advance of tLeir implementation he made where the policies
will obviously lead to an unsafe and unsound condition for the bank or to
violations of law. Most written loan policies will be stated in such a way,
however, that a reasonable examiner will find it extremely difficult to find
something significant in them to criticize. I suspect that the written
policies themselves are not the problem but rather the implementation
of those policies. I certainly see no expertise in our Corporation for
drafting standard written policies that banks we supervise should pursue.
The FDIC was not created to manage banks, nor do I believe that it is your
intention to have your report suggest that. Nevertheless, it does suggest
it, and I do feel obliged to make these conmments about that implication.



                                     III-2
APPENDIX   III                                                   APPENDIX III




   Honorable Elr.ner B. Staats
   January 17, 1977
   Page Three


           Finally, the FDIC Division of Bank Supervision has prepared exten-
   sive detailed comments concerning recommendations and comments
                                                                         made
   in your report which I enclose for your consideration. Please excuse
                                                                           the
   length and the detail of those commnents; I believe they reflect, however,
   the thoughtfulness with which we have reviewed your report.

           Thank you for permitting us the opportunity to comment on the
   draft of your report.

                                             Very truly yours,

                                               r-e,.4    £:T.Oa3 sa4
                                             Robert E. Barnett
                                             Chairman

  Eaclosure




                                 III-3
APPENDIX III                                                 APPENDIX III




                   FEDERAL DEPOSIT INSURANCE CORPORATION

                       DIVISION OF BANK SUPERVISION




           Staff General Comments and Agency Recomuendations




           Note:    Page references have been changed to conform
                    to the final report.
                                     111-4
APPENDIX III                                                 APPEJDIX III
                                CHAPTER 4


      The GAO report indicates that the agencies have not estab-

 lished criteria or levels of acceptability with respect to finan-

 cial ratios and comparisons used in the examination process.

 FDIC uses financial ratios as general guidelines for initial

 screening purposes.     In banking and in finance, ratios are only

 indicators, and as such need to be individually assessed.     The key

 element in banking, as in a number of other industries, aside from

 management, is    the quality and turnover rate of the inventory.    In

 banking, of course, inventory is principally made up of loans and

 securities.    Since no two banks have identical inventories, it

 logically follows that where the relevant ratios for two banks

 are identical or in the same range, further analysis is required

 before a meaningful evaluation of a bank's condition can properly

 be made.

      The examination is designed to and does enable the FDIC to

 ascertain the overall condition of the bank, the quality of its

 management, and the extent of compliance with applicable laws and

 regulations.     Moreover, the examination report, including the ex-

 aminer's recomnendations, is thoroughly reviewed and analyzed at

 the appropriate Regional Office.    During these reviews, the re-

 viewer also considers the Statements of Condition and Reports of

 Income and Dividends filed by the bank; the bank's complete cor-

 respondence file, showing its history and the attitudes and abili-

 ties of the bank's management; reports of loans to the bank's

                                   III-5
APPENDIX III                                                  APPENDIX III
 officers at other banks, reports of loans against the bank's stock

 at other banks, and any supervisory programs which are in effect;

 and, comn;   terized monitoring systems which subject the bank to a

 number of financial checks.    The major purpose of this review is

 to determine the extent and type of supervision which may be

 needed, not just "...for arithmetic accuracy, graammar, logic,

 support for statements, and internal consistency," as the GAO re-

 port states.

      After review of the examination report as well as other rele-

 vant data at the Regional level, another review process is    con-

 ducted at the Washington level for each bank.    Corrective and

 follow-up programs are initiated at the conclusion of the examina-

 tion, and in addition to possible on-sitG visitations or follow-

 up examinations, the bank's "vital signs" are monitored via an

 automated monitoring system fed by data from call reports, Reports

 of Income and Dividends, and examination data.

      The GAO Laport also states that examinations have not given

 enough emphasis "to the bank's basic management practices, opera-

 tions, and controls."    Both from a policy standpoint and the prac-

 tical application of that policy, the FDIC has been and is in the

 forefront of stressing the need to review, analyze and evaluate

 the policies and controls of a bank under examination.    Thus, the

 following quotations from the Manual of Examination Policies typi-

 fy our basic approach to this phase of the examination process:



                                  III-6
APPENDIX III                                               APPENDIX III

      "The Exaniner's evaluation of the loan portfolio in-
      volves much more than merely appraising the individual
      loans therein. Present management and administration
      of the overall loan account, including the establishment
      of sound lending and collection policies are of vital
      importance if the bank is to be continuously operated in
      an acceptable manner."   (Section H, page 3, paragraph
      III.)

       "Management of a bank's securities portfolio is facili-
       tated by the adoption of a definite investment policy.
       *** Details of the investment policy, expressed in
       writing, should establish standards for selection that
       thoroughly consider: (a) Quality, (b) Maturity, (c)
       Diversification, (d) Marketability, and (e) Income."
        (Section G, page 1, paragraph I.)

       "Sound portfolio management dictates that procedures be
       established and adhered to relative to the execution of
       purchases and sales, review of portfolio and maintenance
       of credit information."  (Section G, page 3, paragraph
       III.)

       "An important part of the Examiner's duties is the ap-
       praisal of the bank's internal controls to determine
       their adequacy for assuring both the necessary degrees
       of accuracy in recorded information and reasonable pro-
       tection of the bank's assets."   (Section P, page 7,
       paragraph III. A.)

       In addition, the essential thrust of the examination is prem-

  ised on the concept that the entire posture of the bank rests on

  its management practices, operations and controls and these areas

  of concern are carefully reviewed and evaluated in the course of

  an examination and at other key points in the supervisory process.

  For example, the examination report, which, by necessity, must be

  limited to essentials, includes 13 schedules dedicated to the prac-

  tices, operations and controls of the bank's management out of a

  total of approximately 30 schedules in the report.




                                  111-7
APPENDIX III                                                 APPENDIX III
      The GAO report states, in part:

      "While the agencies reported some violations of consumer
      protection laws and regulations, they acknowledged that
      they have not aggressively monitored xonsumer protection
      law compliance, and they have begun -evising their ap-
      proaches.   (See Ch. 7.)"

      While we do not argue with the implicat..on of the above state-

ment, the FDIC has expended considerable resources in the area of

 consumer protection.    It is estimated that about 10% of our super-

 visory effort is taken up with examining for compliance with con-

 sumer laws and other matters not related to safety and soundness.

We recognize, however, that additional efforts will be necessary

 to enforce the many recently enacted consumer laws and regulations.

Some of the major activities of the Corporation in the area of con-

 sumer protection are:     (1) adoption of a separate compliance report

 for reporting examinations for compliance with consumer laws, which

 has significantly increased the volume of violations cited over

 the former method used;   (2) establishment of the Office of Bank

 Customer Affairs which serves as a focal point within FDIC for

 protecting the legitimate interests of bank customers;    (3) expand-

 ed training for examiners and assistant examiners in consumer laws

 and regulations, including an orientation in consumer laws for as-

 sistant examiners, a week of training for senior assistant exami-

 ners, and case problems and additional training for commissioned

 examiners; and (4) providing information and education to bankers

 and to a lesser extent to consumers (e.g., FDIC has under active

 consideration issuance of a series of pamphlets to consumers cov-

 ering consumer laws and banking and FDIC's role in that area).

                                   III-E
APPENDIX III                                                 APPENDIX III
      In 1972, the FDIC considered issuing regulations and held

hearings on regulatory proposals dealing with the subject of dis-

 crimination in granting home loans.    However, for a number of rea-

 sons, including that there was a paucity of data needed to write

effective regulations, final regulations were not issued.     However,

a major undertaking conducted jointly by the FDIC and the OCC has

been undertaken to develop a program to insure that the banks un-

der their jurisdiction are complying with federal laws prohibit-

ing discrimination in the granting of home loans.    During the test

phase, anproximately 300 banks will use a specially designed form

in connection with their home mortgage lending activity.    The FDIC

expects that the new systems of data retention and analysis will

provide a reliable indication of where discriminatory lending is

taking place and serve as an adjunct to the examination and com-

plaint mechanisms already used by the Corporation.

     The GAO report implies that the FDIC has the authority to ex-

amine routinely all insured banks, including member and national

banks.   In point of fact, the legislative history of the Federal

Deposit Insurance Act of 1950 cquite clearly indicates that the in-

tent of Congress was to circumscribe the FDIC's examination of

member and national banks inrthe following manner (H.R. Rep. No.

3049, 81st Cong., 2d Sess. 3 and 4):

     "In providing direct authority to the Corporation to
     make a special examination of any national bank, District
     bank, or State member bank, the conferees were firmly of
     the opinion that such author ty is not to be utilized by
     the Corporation to embark upon a program of regular


                                III-9
APPENDIX III                                                APPENDIX III
      periodic examinations of such banks, which would only
      result in a needless duplication of effort. Such
      special examination authority is to be utilized by the
      Corporation only in a case where, in the judgment of the
      Board of Directors, after a review of the Federal Reserve
      or Comptroller of the Currency examination reports, there
      are indications that the bank may be a problem case, or
      that it is in a condition likely to result in loss to the
      depositors or to the Corporation."

      Unless otherwise directed by Congress, the FDIC feels con-

 strained to exercise its examination authority in accordance with

 the above statement of Congressional intent.   In addition, the

 further impplicati-i in the GAO report of overlapping examination

 authority having to be parceled out through voluntary agreement

bet _en the three agencies is not, at least with respect to the

 FDIC, completely accurate.

      The GAO report lists four criteria for scheduling examinations.

We simply note in passing that the list of criteria for scheduling

 examinations fails to mentionl the primary crit2ria employed by

FDIC, namely the overall condition, compliance posture, and needs

 of the bank about to be examined.

      The following comments are directed to the statements in the

GAO report relating to Electronic Data Processing (MDP) matters:

      The FDIC has recognized the need to devote additional atten-

tion to EDP operations and to expand EDP expertise within our ex-

aminer and supervisory staffs.   Efforts are continuing to develop

more EDP field examiners and provide an interim career path posi-

tion for a select cadre of our commercial examiner force.   While

our commercial examination effort addresses all aspects of bank


                                 IlI-10
APPENDIX III                                                   APPENDIX III
 EDP, including the developments in electronic funds transfer, we

 also recognize the need for tne development of EDP expertise in

 trust operations and will be devoting attention to that area dur-

 ing 1977.     We are planning to provide EDP review examiner positions

 for each of the 14 Regional Offices, as appropriate, to accommodate

EDP examination needs.

        The Corporation offers an introductory course in EDP for as-

sistant examiners, entitled Course in Examining a Computerized

Bank-I (CECB-I), which is designed to prepare them to evaluate EDP

input/output controls and reconcile the automated applications to

the general ledger control accountn.       Approximately 150 FDIC assis-

tant examiners are processed through this school each year.       In ad-

dition, a Course in Examining a Computerized Bank II      (CECB-II) is

offered for senior assistant and commissioned examiners to train

them in basic automation concepts and computerized examination

techniques.     Approximately 125 examiners complete this course each

year.    Finally, an eight-week advanced course entitled Field Exam-

iner Advanced Automation Training (FEAAT) was commenced in 1974 to

provide in-depth technical training in EDP matters.      Through 1976,

59 examiners have completed this course and two sessions have been

scheduled for 1977 for approximately 28 more examiners.      According-

ly, all of the FDIC's EDP training needs are provided in-house.

     The FDIC has developed and implemented an instalment loan

retrieval package for the use of examiners in conducting examina-

tions.    This package not only eliminates menial data-gathering


                                  III-11
APPENJDIX III                                                  APPENDIX III


 efforts and saves considerable manhours, but it has improved the

 quality of examinations, uncovering some practices which may have

 gone undetected heretofore.      Further, during 1976 three other de-

 posit EDP capabilities were added to the examiners' software pack-

 age and a mortgage loan capability will be implemented early in

 1977.    Other applications of EDP for use in conducting examina-

 tions are in various developmental stages and software will be

 considered for trust examinations during 1977.

         EDP techniques and capabilities are also being used within

 the Washington Office to seek and project solutions to problem

 and failing bank situations.

         While it is true that many banks do not have enough data

 processing activity to justify purchasing an in-house computer and

 satisfy their data processing needs through contract servicers, a

 number of small banks have acquired so-called mini-computers and

 perform their own data processing on-premises.      The evaluation

  (examination) of contract servicers presents no unusual problems

  for our trained EDP examiners and the evaluation procedures em-

  ployed parallel those used for bank-operated data centers.     How-

  ever, the evaluation of mini-computer operations presents unusual

  control considerations and our experience in this area has not

  matured.      We are continuing in our efforts to develop a sound ex-

  amination approach in this area.

         The Division of Bank Supervision Manual of Examination Poli-

  cies, Appendix C, provides guidance for the preparation of      D)P


                                      III-12
APPENDIX III                                                  APPENDIX III
 checklists, questionnaires, summary comments and report
                                                         of exami-
 nation treatment for banks with their own computers.    Memorandums
 to Regional Directors, EDP examiner conferences, and
                                                      EDP seminars
 provide communication and input for the redesign of examination

 practices and training courses.    Each Region adopts its own EDP

 examination program and some variance does occur, depending
                                                             on the
EDP sophistication found in the banks supervised.    The provisions
for the interim EDP examiner career path and EDP review
                                                        examiner
positions for each of the Regions during 1977 should result
                                                            in
improved examination efforts at the circumstances and need
                                                           dictate.
     The average number of man-days per EDP evaluation in 1975
                                                               was
3.9 and year-to-date 1976 is 4.1.    Our experience indicates that

Regional Offices with the more sophisticated    banks tend to devote

more manpower to EDP evaluations and to develop more expertise
                                                               in
EDP matters than Regional Offices with less sophisticated
                                                          banks.
Further, it seems, within certain limits, the more knowledgeable

the EDP examiner, the more time expended in conducting
                                                       evaluations.
     The FDIC furnishes the results of data center evaluations
                                                               to
the bank's management or to the independent data servicer
                                                          of a
state nonmember insured bank.   Where a data center evaluation is

conducted as part of a bank examination, the findings of
                                                         the
evaluation are incorporated into the report of examination.
                                                               Where
the data center evaluation is conducted independently of
                                                         a bank
examination, the findings are transmitted under separate
                                                         cover.
These evaluations findings may consist of the EDP examiner's


                                III-13
APPENDIX III                                                APPENDIX III
 summary comments with or without the questionnaire.   Where the

 questionnaire is included, appropriate explanation is provided to

 ensure that the reader understands that a negative response to a

 particular question does not necessarily constitute an unsatis-

 factory finding with respect to that part of the EDP operation

 covered by that section of the questionnaire.    Our experience in-

 dicates that many data center managements have requested the en-

 tire questionnaire for their review and we feel thait it serves as

 a useful educational tool for management.    However, the question-

 naire is viewed by the FDIC as a formal workpaper.    The results

 of an evaluation of servicer data centers are available to ser-

 viced state nonmember insured banks on request or at the option

 of the Regional Director .;ithcut any request.   They are also

 available to any other federally insured serviced institution upon

 request.    All data center evaluation reports developed by the FDIC

 are considered to be confidential and the property of the FDIC and

 appropriate statements to that effect accompany each such report

 released.

      The creation of EDP review examiner positions at the Regional

 Office level should provide the capacity to communicate more ef-

 fectively with all data centers and help to achieve more uniform

  correction of operational deficiencies.




                                   III-14
  APPENDIX III                                                 APPENDIX III
Recommendation   (page 4-7)

Therefore,   we recommend that the Board of Directors, FDIC, the Board of

Governors, FRS, and the Comptroller of the Currency establish scheduling

policies and procedures which would avoid setting examination
                                                              patterns.



FDIC Response

We believe that our recently adopted General Memorandum #1, which
                                                                  has
been under consideration and extensively tested for several years
                                                                  prior
to adoption, largely satisfies this recommendation.   For more extensive
comments on our General Memorandum, please refer to our comments on
                                                                    the
                                     q
recommendations contained on page 4-2 of the GAO Report.




                                    II1-15
  APPENDIX III                                                 APPENDIX III
Recommendations (page 4-X)

We recommend that the Board of Governors, FDIC and the Board of

Governors, FRS adopt flexible policies for examination frequency which

would allow them to concentrate their efforts on banks with known

serious problems.


We recommend that the Congress amend the National Bank Act to allow

the Comptroller of the Currency to examine national banks at his/her

discretion.    We would be glad to assist the committees in drafting

appropriate legislation.



FDIC Response

Although it was FDIC's long-standing policy to ex-mine each bank once

a year, it is inaccurate and misleading to suggest that that time-frame

was the only guideline used by the FDIC in scheduling examinations, or,

to state it another way, that examinations were not scheduled and con-

ducted by the FDIC based upon the "bank's sourdness; and the quality

of its policies, procedures, practices, controls, audit, and management."


During 1975, FDIC conducted 213 follt -up examinations and a number of

on-site visitations at banks presenting either financial or supervisory

problems.     Further, those banks which were not examined in 1975 largely

consisted of banks which would not fall within the one-year time-frame

guideline under General Memorardum #1.     Although General Memorandum #1

was formally adopted in November 1976 and implemented on January 1, 1977,

the concepts and practices embodied in it are not of recent origin.

Those concepts and practices have been under consideration at FDIC since

                                      III-16
  APPEIDIX III                                                 APPENDIX II1
early 1974,   ?urthermore, the concepts and practices have been experi-

mented with and tested in five of the FDIC's 14 Regional Offices prior

to formal adoption of General Memorandum #1.   We might add parentheti-

cally that FDIC policy is to experiment on a regional basis with major

policy changes before implementation for the entire Corporation.


Accordingly, while *1a recently issued General Memorandum #1 expresses

more definitively   .n;ft scheduling of examinations is not based on time-

frame priorities alone, nevertheless, we feel that the criticism of

past scheduling practices expressed in the GAO recommendation is mis-

placed.   The FDIC has followed and continues to follow a policy so

aptly stated in the said General Memorandum #1, namely:

     "The first priority has been and will continue to be, effec-
     tive surveillance and supervision of the institutions which
     present either supervisory or financial problems."




                                     III-17
  APPENDIX III                                                   APPENDIX III
Recommendations    (page 4-1t)

We recommend that the Board of Directors, FDIC, and the Board of Gov-

ernors, FRS, extend their current efforts to use State examinations and,

if they do, we also recommend that they

     --develop minimum standards for acceptable State examiner

       training and examination procedures and

     --use only reports of State examinations meeting those

       standards.



FDIC Response

The FDIC has determined that the Experimental Withdrawal Program con-

ducted in three states during the past three years will not be con-

tinued in its present form.      However, agreement to examine nonproblem

banks on an alternate-year basis has already been consummated with one

state and the possibility of entering into similar arrangements with

other states is being explored.     Furthermore, termination of the Experi-

mental Withdrawal Program should not be construed as a decline on the

part of the FDIC to cooperate to the fullest extent possible with the

various states or to place less reliance on the efforts of the state

supervisors.     The guidelines set forth in General Memorandum #1 provide

a workable framework for increased cooperation with the states.      Thus,

almost by definition, if the program expressed in General Memorandum #1

proves workable and if a state banking department performs in an ac-

ceptable manner, the frequency and scope of FDIC examinations in that

state will be reduced.



                                        III-18
  APPENDIX III                                                      APPENDIX III
                           Iq
Recommendation    (page 4-1 -and   4--

We recommend that the Board of Directors, FDIC and the Board of Gov-

ernors, FRS, establish procedures to base the scope of each examination

on the examiners' evaluation of the quality of the bank's controls,

policies, procedures, and audit.



FDIC Response

With respect to FDIC examinations, the findings and conclusions ex-

pressed by GAO are not accurate.         The primary factor influencing the

scope of the exam;ination is not size, but the known history of strengths

and weaknesses of the particular institution.        Furthermore, FDIC examiners

do pre-plan the scope of an examination, by studying applicable files and

previous examination reports, and noting any material changes in the man-

agement or style of operations since the last examination.


FDIC examiners have in recent years reviewed a bank's internal eontrols,

policies and procedures prior to actual commencement of the examination

in order to establish the scope of the examination within the minimum

standards prescribed.    With respect to smaller banks, however, such a

review tends to be less formal, hence harder for GAO to detect than with

larger banks.    Considerable leeway in this respect is provided for in the

recently adopted Ge, =ral Menmorandum #1, and we reiterate that these pro-

cedures were considered and extensively tested in five of the FDIC's 14

Regional Offices for several years prior to formal adoption.




                                          III-19
 APPENDIX III             1q                                   APPENDIX III
Recommendation    (page
                    n   4-d

We recommend that the Board of Directors, FDIC, and the Board of Gov-

ernors, FRS, develop standards for the preparation, maintenance, and

use of examination workpapers.



FDIC Response

The standards for the preparation, maintenance, use and importance of

examination workpapers are included in the course of study at the

various schools operated by the Corporation and in our on-the-job train-

ing program.     The examination workpapers do, in fact, cover a number of

items other than the details relating to specific loans and securities

in support of comments contained in a Report of Examination.    We be-

lieve our examination workpapers will permit a determination that ap-

propriate examination procedures have been followed, provide support

for the preparation of the Report of Examination, and are utilized at

the next examination.




                                      11II-20
 APPENDIX III                                                   APPENDIX III
RecoMnendation (page 4,-     )

We recommend that the Board of Directors, FDIC and the Board of Gov-

ernors, FRS develop reports of examination for EDP operations which

present the problems found, corrective action needed and any necessary

explanatory data in a clear and concise manner.



FDIC Response

The summary comments page of the FDIC EDP questionnaire provides clear

and concise descriptions of the results of a data center evaluation.

In our judgment, a new evaluation report is not necessary at this time

and our form, if effectively used, is comparable to the new one recently

adopted by the OCC.      However, we view our questionnaire as a constantly

evolving tool which will be revised frequently in order to stay abreast

of industry developments and to meet the burgeoning needs of our field

personnel.      See also our comments regarding EDP evaluation reports in-

cluded with our general comments.




                                       II111-21
APPENDIX III                                                    APPENDIX III
                              CHAPTER 5


      GAO stated, in relevant part, that:

      "The relationship between the frequency with which      banks
      were cited for problems with internal routines and      con-
      trols and violations of laws and regulations--both      of
      which are related to management effectiveness--and      the
      frequency of criticism of management effectiveness      was
      not what would have bean expected."



      "While the examiners frequently cited banks for having
      problems in two areas indicative of management effec-
      tiveness--internal controls and violations of laws and
      regulations--they did not often criticize management
      effectiveness. As shown below, management effective-
      ness was most often criticized in problem banks with
      less than $500 million in deposits even though 30 to
      50 percent of larger banks in the general and problem
      samples were also criticized for violations of laws and
      regulations and poor internal routines and controls."



      "Violations of laws and regulations reflect on manage-
      ment's capability."

      Generally, the size and character of the operation engaged

 in by a bank defines the scope and requirements of sound internal

 controls for that par*ecular bank.    Clearly, the internal con-

 trols deemed appropriate for a large,       ophisticated operation are,

 in most cases, not appropriate for a smaller, less complicated one.

 Management is clarged with the responsibility of deciding the in-

 ternal controls best suited for its bank in order to provide ade-

 quate protection for its assets and a meaningful flow of informa-

 tion to senior management.   Recognizing the practicalities of the

 situation, FDIC closely monitors the various internal controls

                                  II111-22
APPENDIX III                                                 APPENDIX III

 employed by banks under our direct supervision and our examiner

 personnel may comment on apparent weaknesses observed.    However,

 if the particular system has worked with reasonable effectiveness

 for a given bank, is within the general bounds of prudence, and

 does not constitute an unsafe or unsound practice, corrective

measures are not aggressively pursued, notwithstanding the criti-

 cal comment in the examination report.

     Banking is a highly controlled industry and, thus, is subject

 to a plethora of laws and regulations on both the federal and state

 levels.    It is, therefore, not unexpected that banks will on occa-

sion be found to have violated, intentionally or unintentionally,

a particular statute or regulation.     It is the job of the bank

regulator to consider each violation in terms of whether it was

intentional cr willful, the consequences flowing therefrom, the

likelihood of continued violations, and management's history of

compliance and attitude toward taking appropriate corrective mea-

sures.     Accordingly, if the violation is unintentional or merely

technical in nature and not recurring, criticism of management

effectiveness would not seem warranted.     If otherwise, of course,

criticism of management is probably appropriate.     In short, in

this area as well as all areas of its supervisory responsibility,

the PDIC attempts to follow a rule of reason.     Overreaction to

technical, unintentional violations of law or regulations could,

in our judgment     '_pactadversely on the entire enforcement pos-

ture of the Corporation.


                                  'III-23
APPENDIX III                                                      APPENDIX III
      GAO stated that:

      "The agencies rarely criticized a bank's loan policies
      until loan problems developed. For example, if a
      bank's managers had not adequately diversified the bank's
      risks, examiners did not criticize the inadequate diver-
      sification policy until those lines of credit actually
      became classified."



      "For example, inadequate loan policies were not cited
      by examiners until the banks had large amounts of clas-
      sified loans, as shown by data for banks in our general
      and problem samples combined."

      The FDIC, of course, encourages banks under our direct super-

 vision to adopt sound written loan policies.       Furthermore, in vir-

 tually every formal enforcement action, F'DIC routinely requires

 the of'   ding bank to prcvide written armu pcli.cies accepta'ole co

 the Corporation and the aT,l.nltRoate Wstes     ar'ts ittl   cowerett,

 oversight of a bank's written lowa, poo .cies    does not, and ic n%,t

 intended to, extend to -writing thn     loan policies Zor the bank or

 specifically prescribing how, when and to w. r. the credit facili-

 ties of the bank are to be used.      We view suclh action by the FDIC

 as objectionable on two grounds:       (1) as ei-crcaching on man&ge-

ment's prerogatives, and (2) perhaps constituting a ftom of cred-.

 it allocation.     Out task is   to review the ;olicies to determine

 that they are within the bounds of safe and sound bauaking practices.

 However, it may be somewhat naive ·       assume thlat a review of the

 written loan policies of a bank will, in most cases, reveal im-

 prudence.     Typically, it is the implementation of such policies

 which generates criticism.


                                     III-24
APPENDIX III                                                   APPLNDIX III




         It is not accurate to suggest that the failure to diversify

 risk is only criticized when "those lines of credit became clas-

 sified."    It is both FDIC policy and practice to comment on a

 failure to diversify (concentration of credit) without regard as

 to whether or not the assets involved have been adversely classi-

 fied.    The Division of Bank Supervision Manual of Examination

 Policies states in relevant part:

      "...the inclusion of a concentration of credit in a re-
      port implies criticism of a banc's policies amenable or
      susceptible to management control."  (Section H, page 6,
      paragraph IV. C.)




                GAO note:   Omitted comments pertain to material
                            in the draft report but omitted from
                            the final report.




                                  III-25
APPENDIX III                                                  APFENDIX III
                              CHAPTER 6


     The thrust of Chapter 6 may be summarized as follows:      examiners

seldom meet with bank directors, the examination reports do not convey

the bank's problems in a clear and concise manner to the directors, and

the material in the confidential section should be furnished to the

banks.   The recommendations are that the FDIC and the FRS require

examiners to meet with the directors or audit or examining committee

after each examination and that the FDC      and FRS develop and use

reports of examination "which provide the banks with the results of

the examination and any necessary supporting information."      As we view

it, the implication is that FDIC and the FRS redesign the report of ex-

amination along the lines of the OCC's new format.

     We believe that the statements and recommendations stem from a

misconception, or perhaps a misunderstanding, of the policies and

practices of the FDIC in the matters covered in Chapter 6.      The

following responses to the GAO recommendations tepresent a brief

summary of the FDlC's policies and practices, and efforts to improve

those policies and practices, regarding the supervisory areas dealt

with in Chapter 6.




                                 III111-26
  APPLNDIX III                                                APPENDIX III
Recommendation (page 6-5)

Therefore, we recommend that the Board of Directors, FDIC, and the

Board of Governors, FRS require their examiners to meet with the bank's

board of directors or audit or examining committee after each examina-

tion.



FDIC Response

FDIC cc-ducted approximately 7,900 examinations in 1975.   Senior offi-

cials from the various Regional Offices met with bEnk management on

approximately 1,750 occasions, representing 22% of all examinations.

Throughout 1975, there was an average of 224 banks under our supervision

which were formally designated as financial problems.   FDIC policy is

to meet with bank directors at least where problem situations exist.


FDIC staff has in the past year been reconsidering the question of how

often meetings with bank directors should be held.   In consideration of

this subject, the responsibilities of bank directors, the Corporation's

responsibility to bank directors, and our past and present practices in

holding board meetings were weighed.


In a broad sense, the board of directors of a bank is responsible for

th. formulation of sound policies and objectives of a bank, the effec-

tive supervision of its affairs, and promotion of its welfare.   In dis-

charging these responsibilities, a director's duty is to exercise due

care or be exposed to a charge of negligent performance of his duty.




                                   III-27
 APPLNDIX III                                                  APPENDIX III

To insure that bank directors are aware of the contents of examination

reports, the Corporation requires that a receipt accompanying each re-

port be signed by the bank's executive officer stating that the report

"...was duly considered by the directors...and a record of the action

taken thereon by the Board has been entered in the minutes."    Moreover,

at each examination, the examiner is charged with the responsibility

of determining that the bank's board minutes reflect a thorough consid-

eration of examination reports and correspondence received from super-

visory authorities since the last examination.


To enable bank managements to begin work on problem areas prior to re-

ceipt of the completed examination report, a list of adversely classi-

fied assets and other major criticisms is provided to the executive of-

ficer at the completion of each examination and most of the FDIC Re-

gional Offices have implemented deadlines for receipt of completed ex-

amination reports in the Regional Office--usually 1.0 calendar days after

the close of the examination.


The FDIC Manual of Examination Policies states, with respect to exami-

ners holding meetings with directors (Section Q, page 3, paragraph I.E.)

     "Except in instances where authority nas been delegated by
     the Regional Director, the Examiner should consult with the
     Regional Office before calling a board meeting. Ordinarily,
     ms.tings with the board of directors should be held at the
     conclusion of all examinations of problem banks. A meeting
     of the board may also be required when experience and in-
     stinct tells the Examiner a likelihood exists that the bank
     will be added to the problem list or will be earmarked for
     other special supervision. Additionally, where there is a
     substantial volume of c:lasified assets, low capital or other
     areas of important cri:icism, a board meeting may be desira-
     ble. This is particularly true when the trend has been un-
     favorable and previous admonitions have gone unheeded."

                                    iiJ-28
 APPENDIX III                                                APPENDIX III
In keeping w: h this policy, it is in fact the practice in most regions

for the exeainer to hold a meeting with bank directors if problems of

consequence Pxe found at the examination, or if significant adverse

trends are noted since the last examination.   In virtually all instances

involving problem banks, a representative from the Regional Office will

meet with the directors, and in most cases an invitation is extended to

the state authority to participate in the meeting.


The FDIC is cognizant of the benefits flowing from more frequent meet-

ings with the boards of directors of banks under our direct supervision

and anticipates holding such meetings with increased frequency in the

future.   We are also actively reviewing the posture of the FDIC in

this regard with a view of improving upon the timeliness and conduct of

such meetings.




                                    III-29
  APPENDIX III                                                  APPENDIX III
Recommendation    (page 6-10)

We recommend that the Board of Directors, FDIC, and the Board of Gov-

ernors, FRS, develop and use reports of examination which provide the

banks with the results of the examination and any necessary supporting

information.



FDiC Tresponse

FDIC conducted an intensive study in 1965 to assess the impact of its

examination report on banks.     As a result in 19o9, a new examination

report format was put into use.    We believe this report format, and

the guidelines under which it is used, provides a clear, concise pic-

ture of problem areas to bank managements.     Various FDIC staff members

have attended familiarization sessions on the (XCC's new examination

report format.     The OCC has tested his new format in only ten banks and

the impression of the FDIC staff members is that the report format is

somewhat cumbersome, especially in problem situa ions.


There appears to be some misunderstanding with respect to the purpose

and thrust of the confidential    (supervisory) section of the report of

examination.     The purpose and thrust of the confidential section are

to allow the examiner to comment on matters uncovered during the course

of the examination which may not lend themselves to complete substanti-

ation, but which may serve to alert his superiors that further investi-

gatory or supervisory efforts may be necessary.    For obvious reasons,

such material is not, and should not, be provided to the management of




                                     II-30
 APPEN;DIX III                                                APPENDIX III
the bank.   However, a thorough study of the role and use of the confi-

dential section was started some months ago and, when completed, will

probably result in significant changes in its thrust, format and con-

tent, or in its elimination.




                                    III-31
APPENDIX III                                                  APPENDIX III
                             CHAPTER 7


    As is indicated in the FDIC comments to the recommendations

made by GAO in this chapter, we view the impact of the changes in

the FDIC examination process set forth in General Memorandum #1

as significant and vital to an understanding of the Corporation's

examination philosophy and practices.    We believe the entire

General Memorandum should be included in the GAO report.    However,

in the absence of that we offer the following excerpts from General

Memorandum #1, with emphasis added:

     "The first priority has been, and will continue to be,
     effective surveillance and supervision of those insti-
     tutions which present either supervisory or financial
     problems."



     "Emphasis at these modified examinations should be placed
     on management policies and performance; the evaluation
     of asset quality, alignment and liquidity; capital ade-
     quancy; and, compliance with applicable laws and regulations."

     "In those banks with assets of $100 million or more, all
     report schedules which are presently in use and are appli-
     cable to the given bank will continue to be included in the
     examination report. Where the fixed asset investment is
     moderate in relation to capital, there are no statutory
     viol ,tions widh respect to fixed assets, and absent other
     pruvoems of significance, fixed asset schedules may be
     omitted from these examination reports. Further, examiners
     are instructed to assess the qualit; of management systems
     and reports as well as audit and control functions, and
     where it is permissible to do so without cnmpromising the
     irtegrity of the examinations, utilize the output of those
     systems. Cash counts and proof and verification procedures
     may be omitted in those banks where it is appropriate to
     do so, and branch offices whic do not hawe a s4 enificant
     volume of important assets nt .   Pt I- examined. nowever,
     in the latter instance, conditions as these offices should
     be reviewed with management priir to the conclusion of the
     examination."
                                  III-32
APPENDIX III                                                 APPENDIX III

     "If believed desirable in the opinion of the Regional
     Director, simultaneous examinations may be arranged of
     all closely related banks or subsidiaries of bank holding
     companies, requiring coordination with other bank regu-
     latory agencies. The type of examination employed in each
     bank at simultaneous examinations will be at the discretion
     of the Regional Director unless precluded by the guidelines
     for modified examinations."

                                * **


    "It is expected that the Corporation's automated bank
    examination programs and monitoring systems will be used
    wherever possible in an effort to provide increased effi-
    ciency and conserve manpower. This use should include the
    scheduling of examinations as well as their conduct. Further,
    sampling techniques should be used wherever possible."

     "It is expected that visitations will be frequently used as
     an investigatory and supervisory tool for those banks which
     show adverse trends, either at examinations or through a
     monitoring system, and to gauge compliance with provisions
     of cease and desist orders. Further, visitations subsequent
     to management or ownership changes should be used to assess
     the attitudes and abilities of the new management/ownership
     if the principals .re not already known to the Regional Office."

     "In addition to the required periodic examinations, it w1ll
     be the policy to conduct a visitation at each new bank quarterly
     during the first two years of operation (visitations need not
     be held during the quarter in which an examinat on, either by
     the Corporation or the state authority, is conducted). The
     purpose of these visitations is to gain some measure of the
     performance of management and the direction in which the bank
     is headed. At the discretion of the Regional Director, findings
     of the visitation may be reported in either memorandum form or
     examination report format."

     The GAO comments on the status of monitoring systems in th_ Office

of the Comptroller of the Currency and in the Federal Deposit Ins rance

Corporation set forth in chapter 7 of the report have served a usetul

purpose in that thU] focus on an aspect of bank supervision which has

grown in importance in the recent past few years and may be of even greater

importance in the future.   Some clprification is needed of t' e fundamentals

                                 III-33
APPENDIX III                                                  APPENDIX III
 of analysis of bank reports, of the various systems which have been

 developed to facilitate such analysis for supervisory purposes, and

 of a framework for evaluation of the efficiency of the programs.      For

 purposes of illustration, the following comments are based upon a com-

 parison of the National Bank Surveillan:e System (NBSS) and the systems

 in use at FDIC.

      a) An essential element of any monitoring system is a data

          collection system.   The quarterly Reports of Condition and

          the quarterly, in the case of large banks, and semi-annual,

          irn the case of smaller banks, Reports of Income comprise the

          primary data base for both the NBSS and the FDIC systems.

          Data from reports of examination are important supplements

          to the data base; at the present time FDIC probably relies

          more heavily than the NBSS on this source of information.

          Obviously, a monitoring system that depends on regular

          financial reports submitted by banks is only as good as the

          information in the reports.      The information items must be

          meaningful; they must be accurate; and they must be available

          on a timely basis.   Given that tle OCC and the FDIC use the

          same format of the Reports of Condition and Income, their

          divergence appeals to be in the areas of accuracy and Lime-

          liness.

          The OCC has put into effect an editing system which reiuires

          less stringent tests for mathematical accuracy and internal

          consistency in the national bank reports than that used by

          the FDIC in proceosi.n- reports for all insured banks.     FDIC

                                  1II-34
APPENDIX III
                                                              APPENDIX III
          has workcJ from another angle.    The Corporation has
          begun to levy fines on banks that get their reports in

          late.    All three federal bank regulatory agencies have

          cooperated in an effort to upgrade the quality of the bank

          reports so that less correction and revision are required;

          clearly much more needs to be done.     While this process is
          moving forward, both the OCC and the FDIC have had to modify

          their analytical systems in order to utilize bank reports

          that are sufficiently accurate for mor'toring purposes.

     b) Another essential cf a monitoring system is a computer
                                                               based
         program that compiles individual bank ratios of balance sheet

         and income and expense items and compares the ratios of each

         bank with the same ratios for comparable banks.     Most moni-
         toring systems use a technique known as "outlier analysis,"

         flagging banks if its ratios deviate substantially from the

         average of ratios for comparable banks.     The presumption is
         that such analysis can provide clues as to banks with finan-

         cial problems, current or prospective.

         In a banking system as diverse as that in the U.S., differences

         in operations among banks can be expected to be substantial.

         A very large money market bank's ratios may appear to be
                                                                  unusual
        or atypical of averages based upon ratios for all the banks,

        large and small.    When its ratios are compared with those of
        banks of comparable size, doing a comparable business,
                                                               i.e.,
        ratios of its "peers," such a bank may not be atypical
                                                               or, an
        outlier.

                                II-35
APPENDIX III                                               APPENDIX III
          Neither the OCC nor the FDIC could afford to wait for the

         completion of definitive studies on how to sort banks into

         peer groups.   Such work is continuing on a theoretical level

         as well as on an empirical level.   Currently, however, the

         3CC has established peer groups on the basis of bank asset

         size.

         At FDIC, the effort has been made to allow the Regional Director

          to specify the banks within his region that are "peers."     For

          analytical purposes of the Washington Office staff, peer groups

         have been defined primarily on the basis of asset size of bank

         within Region or state.

          With the large number of items in the Reports of Condition and

          Income and the frequency with which such reports are filed, the

          number of ratios that can be constructed for a particular period

          or as measures of change between periods is extremely large.

          Selection of the key indicator or indicators has consumed a

          considerable amount of time at FDIC.   One approach, the Early

          Warning System (EWS), examined literally hundreds of ratios to

          determine which were the best discriminators between known problem

          banks and control groups of banks with no known serious problems.

          The result was a winnowing down to 7 ratios, 2 based Vapon income

          and expense items and 5 based upon balance sheet items.    EWS is

          run annually to produce a list of banks whose sAven ratios indicate

          the similarity to banks with known problems.   A second approach

          (JAWS) selected 6 ratios (plus an additional 2 for large banks)

                                   III-36
     APPENDIX II                                          APPENDIX II

       which have proven to be indicators of basic changes in a bank's

       operations.   These indicators have been incorporated into on-

       line system available in the Regional Offices which flags banks

       with ratios atypical of peer group averages, and displays five

       important ratios based upon the latest report of examination

       of each of these banks.

       The OCC system includes certain ratios which have been designated

       is "key indicators," i.e., that provide the best general measures

       of unusual or changed circumstances in a bank.   The process is

       sequential in that analysis of banks with atypical values for

       key indicators is extended to additional financial ratios that

       round out the picture of a bank's condition in the critical area.

c)     A third essential element of a monitoring system is the develop-

       ment of a method for evaluating its effectiveness or results.

       The crux of the monitoring systems is the review of the output

       of the computer based systems by trained financial analysts and the

       FDIC has been using experienced examiners in this important function

      who have flagged "watch lists" of banks which should be examined

      earlier or more often than other banks.   In the final analysis,

      however, no monitoring system has yet been developed which is

       iOO% efficient in signaling banks with unusual problems.

      Thus, some flagged banks turn out, on further analysis, to be

      perfectly sound while some banks with serious pzublems are not

      flagged.   Presently, the most any system does is suggest that a

      bank exam. ation should be scheduled and the aspect or aspects

      of a bank's operation which requires special scrutiny.

                                    III-37
APPENDIX III                                                  APPENDIX III

      d)   The fourth or final element of a monitoring system is    implemen-

           tation.     At the present time, the monitoring exercise leads

           up to an examination of banks singled out by the financial

           analysts.    Optimally, the examiner receives a profile of the

           bank to be examined and a blueprint of the areas to be focused

           on with the most care.

      The GAO report      states, in essence, that the FDIC has recently

 established trust examiner specialist positions.Although the FDIC

 historically was the only one of the three federal bank regulatory

 agencies that did not designate trust examiner specialists as such,

 some FDIC bank examiners devoted a major portion of their examining

 time to trust work.      However, it is corrc.t that the FDIC has now

 established 14 trust examiner specialist positions and is in the process

 of filling these positions.




                                      III-38
  APPENDIX III                                                  APPENDIX III
Reconmiendations (page 7-25)

We recommend that the Comptroller of the Currency invite FDIC and FRS

to jointly evaluate its new examination approach.     we further recom-

mend that, in the event of a favorable assessment of the new process,

the Board of Directors, FDIC, and the Board of Governors, FRS revise

their examination processes to incorporate the concepts of OCC's ap-

proaches.



FDIC Response

In light of the limited testing that has been conducted (10 banks) of

the OCC's new process, we believe it is premature to consider that

process a success either for large or small banks.     Representatives of

the OCC admitted that, while the new procedures are workable in banks

 ith assets between $50 million and $1 billion, they do not appear

feasible for banks with assets of less than $25 million.     We therefore

qu, tion the logic and wisdom of GAO's recommendation that FDIC adopt

such proceas, either for the large or small banks under our direct su-

pervision, especially when it is recalled that 91% of the banks we di-

rectly supervise have assets of less than $50 million and 77% leas than

$25 million.     Since the number of large banks directly supervir   1 by

the FDIC has and continues to increase, our examination process is

necessarily designed to handle small, medium and large-sized banks.

However, we shall follow closely OCC's experience with the new examina.-

tion pro-ess as it undergoes further testing, and we ramain receptive

to further revision in our own examination approach which will b.      jene-

ficial to and improve our supervisory capabilities.

                                      III-39
  APPENDIX     III                                               APPE;NDIX III
In our judgment, the discussion of changes in FDIC's examination ap-

proach does not reflect sufficiently the impact and significance of

those changes, especially with respect to our review of the management

policies and internal controls of a bank under examination.     We believe

that the c4anc-es made by the FDIC represent, at the present time, the

most logical, beneficial, and prudent improvements in the examination

process.     We have blended the proven tecckniques and practices with a

new approach which we feel should enable FDIC to focus more directly

on, and devote more time and effort to, problem ane near-problem situ-

ations, and concomitantly less on healthy banks.     We refer to excerpts

from our General Memorandum #1, included with our general comments.




                                       III-40
   APPENDIX III                                                 APPENDIX III

Recormmendations (page 7-we)

We recommend that the Board of Directors, FDIC, the Board of Governors,

FRS, and the Cmanptroller of the Currency jointly staff a group to ana-

lyzet   shared national credits at State and national lead banks under Fed-

eraL supervision and that the three agencies use the uniformc classifica-

tion of these loans when they examine the participating banks.


We recommend that the Board of Directors, FDIC, the Board of Governors,

FRS, and the Comptroller of the Currency work together to refine their

monitoring systems and their approaches to examining for compliance

with consumer credit laws.



FDIC :Response

AlthouCh--as the GAO report points out--of the 183 participations in

shared national credits traced by GAO only 19 were to state nonmember

insured banks, the FDIC is now a participant in the Shared National

Credits Program.


We are, of course, in favor of the thr-ee federal bank regulatory agen-

cies sharing and working together in the important area of consumer

credit ccmpliance.     However, in many instances healthy competition in

the area of consumer credit compliance as well as in other areas of

banking supervision between the three federal bank regulatory aencies

can lead to a better system of supervision than complete uniformity.

Thus, the development of an independent approach by one or more of the

agencies may lead to a better end result.



                                      III-41
APPL;,DIX   III                                                APPENDIX III
                               CHAPTER 8


      Our comments here cover the general theme of the chapter,

namely the supervisory and enforcement practices of the three

agencies and their "problem bank" criteria.      We feel discussion

of these vital subjects is desirable in order to place them in

their proper perspective.

      The FDIC serves the dual roles of bank supervisor and insurer.

Accordingly, the FDIC "problem bank" definitions are based on those

banks which pose the greatest degree of financial risk to the

Corporation, with fine tuning of the designations into various

gradations of risk.    The three problem bank categories used are

analagots to the three adverse classifications of Substandard,

Doubtful, and Loss which the federal bank regulatory agencies

utilize to designate assets of greater than normal risk.

      There are no simple mechanical formulae that can be universally

applied to determine whether or not an operating bank warrants FDIC

problem bank status.   Indeed, we believe a problem bank designation

should only be imposed on a case-by-case basis after a comprehensive,

in-depth analysis of the entire bank.      Among the more important ele-

ments requiring analysis and evaluation are asset quality and liquid-

ity, the margin of capital protection, the degree of stability or

volatility in the bank's liability structure, the character and ability

of its management, the bank's earnings performance, and its adherence

to applicable laws and regulations.     These elements are closely inter-

related and, depending on the circumstances, each element may be




                                 III-42
APPENDIX III
                                                             APPENDIX III
 weighted differently.   Accordingly, the FDIC disseminates general
 criteria--not specific guidelines--for the designation
                                                        of problem
 banks to our Regional Directors in order to encourage
                                                       independent
 Judgment and provide some flexibility to meet the
                                                   new areas of
 regulatory concern as they arise.   The Waeshington Office of the
 Division of Bank Supervision then applies more standardized
                                                             analysis
 and evaluation to the recommendations of our Regional
                                                       Directors before
 determining whether to add a particular bank to or
                                                    delete it from
 our list of problem banks.   The listing themselves are not subject
 to approval by the Corporation's Board of Directors,
                                                      although the
Board regularly receives extensive information about
                                                     all problem
banks and may be directly involved in the imposition
                                                     and enforce-
ment of a corrective program with respect to particular
                                                        banks.
     FDIC also reviews examination reports of the FRS
                                                      and the OCC,
assesses the risk exposure which the banks examined
                                                    by those agencies
pose to the deposit insurance fund, and, where appropriate,
                                                            designates
state member and national banks as Other Problem,
                                                   Serious Problem or
Serious Problem-Potential Payoff. Although FDIC
                                                  does not directly
supervise these banks, we do follow closely the
                                                supervisory efforts
of the other agencies, largely because of our financial
                                                        stake in the
outcome.

     It should be noted that, with respect to banks under
                                                          the direct
supervision of the FDIC, an inferior financial condition
                                                         is not the
sole cause for more intense supervisory activity.
                                                   Causes for concern



                                 III-43
APEINDIX III                                                 APPENDIX III

 iay be reflected ill violations of laws or regulations, marginal

 management and policies, or a subpar financial condition which had

 not yet reached a level presenting an undue risk to the FDIC fund,

 and thus, does not warrant a formal prolbem designation.    For example,

 the various Regional Offices maintain informal listings of banks

 which pose supervisory--but not financial--problems, and the Washing-

 ton Office uses a computerized screening device which serves as an

 additional test for uncovering financial as well as non-financial

 supervisory problems.

        The fundamental approach of FDIC to banks exhibiting super-

 visory pi-    .ems or trends in that direction is to exercise preven-

 tive measures, that is to take necessary and appropriate measures

 early enough to keep the bank from deteriorating to a level requir-

 ing the assignment of a formal problem designation.     As the GAO

 report points out, informal methods are generally relied upon, and

 experience indicates that these methods have largely been success-

 fulo    One of the more useful methods of informal supervision which

 FDIC frequently employs has been effectively overlooked or ignored

 in your report.    The method we refer to involves the use of the

 so-called "Letter Agreement."     The Letter Agreement is used by our

 Regional Directors following an examination to confirm with bank

 directors a program which the Regional Director feels will, if adhered

 to, correct the situation.     The Letter Agreemert is not intended, and

 is not used, as a substitute for a formal written agreement entered



                                    IJI-44
APPLNDIX     ilI                                                 APPLINDIX    III
 into under Section 8 of the Federal Deposit Insurance
                                                       Act or cease
 and desist or termination of insurance proceedings,
                                                     although the
 letctr agreement may serve as a basis for such subsequent
                                                           action.
 Its use is generally confined to corrective measures
                                                      agreed to by a
 bank's board of directors when a bank first shows
                                                   problem or near
 problem characteristics

       In addition to the foregoing, the GAO report discusses
                                                              the use
 .f termination of insurance proceedings and atates,
                                                     in part, that
 canceling "a bank's deposit insurance does not solve
                                                      its problems."
      While this statement is perhaps literally true, it
                                                         could be mis-
 leading.      Termination of insurance authority has, through the
                                                                   years,
proven to be an effective and useful remedial enforcement
                                                          tool.         The
threat of instituting a,.d the institution of such
                                                   a proceeding has,
in the vast majority of cases, been the vehicle for
                                                    forcing a recalci-
trant and/or poorly managed bank to take effective
                                                   corrective
measJures.

      The table in the report dealing with the GAO sample
                                                          of 54 FDIC-
supervised problem banks shows that a request for
                                                  a formal response
to reported deficiencies was made in 44% of the cases,
                                                       that progress
reports were requested in 41%, that a meeting with
                                                   the bank's directors
was requested in 30%, that there were written communications
                                                             with 54%,
6% of the banks were visited, and that no credit is
                                                    given for special
examinations.      We do not believe that the table presents an accurate

picture of FDIC supervisory efforts.        In point of fact, the Regional

Director transmits a letter to each bank, reiterating
                                                      the problems


                                   III-45
APPUEDIX II                                                      APPEJDIX III

 disclosed, and requesting appropriate corrective efforts.        Frequently,

 in the letter to bank management, the Regional Directors request peri-

 odic progress reports which often lead to other exchanges of correspon-

 dence or meetings with respect to progress, or lack of it, shown in

 the reports, a board meeting may be scheduled, or visitations or a

 follow-up examination may be held.

      We note that the table shows that meetings with directors were

 held in only 30% of the banks.         It is the FDIC's policy to have a

 board meeting in all problem situations.        As indicated previously,

 in i975, conferences were held with the management of banks on approx-

 imately 1,745 occasions, and 1,750 in 1976.

      The GAO report, among other things, questions whether banks that

 remain on the problem list for e period of time are indeed problems.

      A': year-end 1974, 76% of the FDIC supervised banks on our problem

 list had been on the list for less than two years, and at year-end

 1975, 82%.   In addition, at year-end 1975 only 16 banks had been on

 the problem list in excess of three years (out of a total of 8,925

 FDIC-supervised banks.)     To summarize, some form of formal supervisory

 action was taken in seven, or 44%, of the sixteen cases and informal

 supervisory actions achieved improvements in another seven, or 44%,

 of the sixteen cases.     Correctior     of the problems in the remaining

 two banks is to a large degree dependert upon improvement in the

 severely depressed economy of the banks' market area.         In calendar

 year 1976, two of the sixteen oanks were rehabilitated and, since they



                                        II -46
APPENDIX III                                                APPEIDIX III
 no longer warranted prcLblem designation, were removed from the FDIC

 problem list.   In addition, two others were removed from the list--

 one through merger into a healthy institution and the other was closed.

      We also note in passing that e limited number of banks may present

 financial and/or supervisory problems of a continuing nature which,

despite aggressive corrective efforts, do not lend themselves to a

permanent and wholly acceptable solution,   In such cases, the banks
are not in serious enough condition to wt.rrant exther termination of

their insured status or of their charter.   It seems clear, however,
that these banks should be continued as problem banks and receive

special supervisory attention.




                                 III-47
                                                                  APPENDIX III
 APPENDIX III
                         Is
Recommendations (page 8-.6)

We recommend that the Board of Directors, FDIC, the Board of Governors,

FRS; and the Comptroller of the Currency establish more aggressive poli-

cies for using formal actions.    Written guidelines should be developed

to identify the types and magnitude of pLoblems that formal actions

could appropriately correct.


FDIC Response

Congress granted cease aad desist powers in 1966 w       h the enactment of

Section 8(b) of the Federal Deposit Insurance Act.       For several years

thereafter, there was some reluctance to utilize Section 8(b) powers

due mainly to a general misunderstanding of its purpose and usefulness.

Prior to enactment of Section 8(b), the FDIC's only experience with

formal administrative corrective measures was the termination of in-

surance proceedings, a severe form of action which could result in the

removal of the deposit insurance coverage of a bank.       Because of its

severity, the Section 8(a) proceeding wa& used judiciously and only

after all other means for accomplishing correction ware exhausted.

Apparently, albeit erroneously, that same rationale was largely applied

to Section 8(b) proceedings.     In addition, there was to a lesser extent

an unwillingness to try something new.       Commencing in 1970, a program

to educate FDIC personnel as to the usefulness of Section 8(b) action

was begun.   The FDIC first used its cease and desist authority in 1971

and between 1971 and 1975 issued 38 cease and desist orders and three

formal written agreements.     In contrast, in a recent renewed effort to


                                      III111-48
  APPENJDIX III                                                APPENIDIX III
foster the use and to test the effectiveness of cease and desist powers,

in calendar year 1976 alone FDIC issued 24 such orders and five emergen-

cy orders.   In addition, at year-end 1976, 18 more cease and desist ac-

tions were in various stage- of process.


While cease and '-sist action is in most cases effective as a correc-

tive measure, there are some instances where it may be of little or no

use and could perhaps be counterproductive.   For example, the recently

experienced worst economic period since the great depression caused

severe problems to the banking industry, many of which did not lend

themselves to correction through use of the cease and desist powers.

In short, it is not a panacea for the removal of all problems experi-

enced by the banking community.


The recommendation for adoption of criteria for use in formal actions,

contained in the last sentence of the recommendation, is troublesome.

We would recommend against adopting formal criteria for uise of Sec-

tion 8, because the statutory criteria are adequate.   The facts and

circumstances of bank problems seem so varied, and the remedial actions

can differ so much eccording to the problem, it would be inhibiting to

have to work within the confines of additional written criteria.   The

adoption of such criteria could give the banks additional bases for

contesting Section 8 actions.




                                   III-49
  APPENDIX III                                                APPENDIX III

Recommendation   (page 8-4Y)

We recommend that the Board of Directors, FDIC, the Board of Governors,

FRS, and the Comptroller of the Currency develop uniform criteria for

identifying problem banks.



FDIC Response

We believe our general comments clarify the posture of the three fed-

eral bank regulatory agencies with respect to problem banks, including

those which pose supervisory problems as well as those which present

inordinate financial risk to the FDIC.   Moreover, we do not believe

there is confusion or wide disagreement among the bank regulatory agen-

cies as to which banks should be accorded close surveillance and super-

vision by the respective agencies and that, except in a failing bank,

and to a limited extent in a bank holding company situation, there is

virtually no overlap of regulatory jurisdiction at the federal level.

Furthermore, the need to develop common criteria for problem banks is

not obvious and indeed may not be appropriate.


It is, we believe, appropriate and useful for the FDIC as an insurer

to view what constitutes a problem bank from a somewhat different per-

spective than the other two federal bank regulatory agencies.   In ad-

dition, the extent to which the three federal bank regulatory agencies

use somewhat different approaches to the issue of banks in need of in-

creased and intensified supervision could foster a greater degree of

innovation in this area of supervisory endeavor and could serve as a




                                    III-50
  APPENDIX III                                                APPENDIX III
check and balance in the promotion of the widest coverage of such

banks.   Finally, the objectives and detached review process conducted

by FDIC of all types of examinations, in order to assess the degree of

financial exposure to the insurance fund, provides an overall review

of all banks without imposing across-the-board guidelines which may

not be suitable for the three agencies on an individual basis.




                                  III-51
APPENDIX III                                               APPENDIX III
                               CHAPTER 9

      The GAO report states:

      "A recent FDIC study of 92 banks that failed between
      1960 and September 1976 showed that 57.6 percent were
      caused by improper loans to officers, directors or own-
      ers, or by loans to out-of-territory borrowers...."

      The experience noted above led to the issuance by FDIC in

 1976 of a regulation entitled "8337.3 Insidex Transactions," as

 part of the Corporation's "Unsafe and Unsound Flanking Practices"

 regulations.




                                   II111-52
APPENDIX III                                                    APPENDIX III
                              CHAPTER 10


     The following is a blief summary of the operation of the FDIC

Training Facility:

     The Division of Bank Supervision (DBS) Training Center located in

Rosslyn, Virginia, was established in February 1970 and presently has-

permanent staff complement of seventeen.     The training programs which it

conducts are directed toward achieving professional proficiency and the

maintenance of a highly qualified bank examination staff.

     Career training is accomplished, in balance with field examination

experience, primarily thrcugh our bark examination schools which are

comprised of seven diLferent schools or courses     of study.   Each school

has a duration of two to three weeks.      Subject schools include the basic

examination schools:   School for Assistait Examiners, designed for newly

employed examining petsonn.el; the School for Senior Assistant Examiners,

which provides training in accounting, EDP, and consumer protection laws;

the School for Examiners, which is designed for the development of the

commissioned examiner; and the Basic Trust School, which deals with the

basics of trust department examination.     In addition, more senior train-

ing is provided through the Advanced Trust School, the Course in Examining

a Computerized Bank, and the School for Commissioned Examiners.       Subject

matter within the various bank examination schools is well structured

both wfith respect to material to be covered in the daily presentations

as well as the pre-course study expected.     Students ordinarily spend

eight hourd a day Monday through Friday in classroom and related work.


                                  III-53
APPENDIX III                                                   APPENDIX III

       During the six-year period 1970 through 1975, 189 school sessions

were held involving nearly 5,100 students.     For the 1976 school year,

we held 46 school sessions with approximately 1,200 students attending.

Training is directed primarily towards FDIC personnel.      However, during

the period 1970 through 1975,    training was provided ior 549 state bank

examiners,   28 students nominated by foreign government banking authorities,

and 13 FRB examiners.    The related figures for 1976 are 157, 22, and 7,

respectively.

       An additional and important operation of the Training Center is the

Progress Evaluation Program for senior assistant examiners who are being

considered for career advancemenr to the status of commissioned examiner.

This    rlrigrarm assesses a candidate's knowledge and proficiency in rules,

regulations, and policies; loan analypis: and development of conclusions

and recommendations after review of a report of examination.      The program

includes both written and oral portions.     Findings of the progress evalu-

ation are weighed as one of several factors in considering a senior

assistant examiner for promotion to commissioned examiner status.

Between 100 and 200 such candidates are evaluated annually.      The eval-

uation utilizes a three-member panel of examiners over a th ee-day period

for each candidate.




                                    III-54
      APPENDIX III                                                  APPENDIX III
Recommendation (page 10-6)

We recommend that where feasible the Comptroller of the Currency; the

Board of Directors, FDIC; and the Board of Governors, FRS, combine

their examiner schools and standardize their curriculums.



FDIC Response

Although we find the comments and recommendations contained in the

report on examinet training provocative, on balance we believe teha

did not afford sufficient treatment or depth to the various examiner

training and educational programs offered by the FDIC.


We are especially dismayed by the fact that the GAO study largely ig-

nores tile operation of the FDIC Division of Bank Supervision       (DB.)

Training Cencer.       The FDIC Training Center is undoubtedly the best

bank examiner training program in the country.        Nevertheless, because

of our burgeoning training needs, the FDIC is considering constructing

its     awn,   larger facil.ty with resident dormitory quarters.   The FDIC

has approached the FRS and the OCC to join with the Corporation in a

cooperative training facility.       Both the FRS and the OCC have evidenced

interest in this project and discussions on a cooperative training ef-

fort are going forward.       A brief aurmmary of the operation of the FDIC

DDS Training Center is i.ncluded with our general comments.




                                         III-55
 APP;NDIX III                                                APPENDIX III
Recommendations   (page 10-31)

We recommend that the Board of Governors, FRS, (1) establish a full-

time training office to operate its examiner training program and (2)

carry out the revision of examiner school curriculums which it has

recognized as needed for sometime.


We also recommend that the Comptroller of the Currency; the Board of

Directors, FDIC; and the Board of Go-vernors, FRS; increase their train-

ing in EDP, law, and accounting, as desired by their examiners.



FDIC Response

We plan to give further attention to this apparent need.   It is worth

pointing out in passing, however, that, at least with respect to EDP

training, in addition to the regular bas4c EDP courses (Course in

Examining a Computerized Bank (CECB) I and II), an advanced eight-week

technical EDP school, known as Field Examiner Advanced Automation

Training (FEAAT), is presently offered ito examiners who have a desire

to become highly proficient technically in EDP matters.




                                     III-56
APPENDIX iII                                                   APPENDIX I1I

                             CHAPTER 11


     The GAO report indicates that a cooperative effort among the

federal bark regulatory agencies in the development of monitoring

systems may have "speeded development" and mentions the need for

continued coordination.

     Each agency is in the process of developing or has developed

monitoring systems and each has learned from its own experiences.

We agree that there should be coordination among the agencies in

these efforts and would point out that a significant amount of

sharing and exchange of concepts and ideas has already been effected.

However, as pointed out previously, there is also merit to the three

agencies developing systems independent of one another.     Innovation

i; fostered and a healthy competition to have the best system avail-

able could be beneficial to all the agencies.   In addition, although

the major objectives of the three federal bank regulatory agencies are

similar, there are unique characteristics of each which may render the

development of a system common to all inappropriate.   While we do not

presume to comment on the unique needs of the OCC and FRS, central to

the FDIC's needs is L-e developmant of a system to cope with the sub-

stantial number of small and medium sized as well as a significant

number of large sized banks under our direct supervision.    Thus, in

the case of FDIC, a system that is sufficiently flexible to meet the

needb of supervising large sophisticated banks, as well as smaller less

complicated banks, is apparently what is required.


                                 II'-57
APPENDIX III                                                     APPENDIX III
     Of course, adequate staffing and gathering accurate data on a

timely basis are two vital elements in the development, implementa-

tion, dnd maintenance of any monitoring system.        The FbIC is moving

forward in its efforts to satisfy these essential elements.        Finally,

FDIC has, in the main, completed the testing phase of our monitoring

systems and is in the process of integrating them into our examina-

tion process.

     The GAO report states that an OCC official indicated that the

interagency system for processing bank data was inadequate because

banks were not meeting established reporting deadlines and FDIC

took approximately four months to keypunch and computer-edit the

system.

     The FDIC does maintain the bank reported financial data for all

insured banks supervised by the OCC, FRS and FDIC.       Data submitted by

the national and state member banks are initially processed by the FRS

and submitted to the FDIC for edit testing and acceptance into the

finalized data base from which all of these agencies draw information.

The OCC is correct in asserting that the FDIC has taken up to four

months to process all of the reports from some 15,000 insured banks

and to produce a final data base.     However, delays in receipt of

correction data from the OCC and FRS where edit tests have failed

on banks under their respective supervision have been a major factor

in the finalization of the data base.        Efforts are being made to




                                    III-58
APPENDIX !II                                                  APPENDIX III
obtain agreement among the agencies on edit-check criteria so the.

corrections can be made on a more timely basis.

        In order to meet both the monitoring and other needs dependent

on bank reported financial data, it would, of course, be to the

benefit of all agencies to derive a set of editing criteria which

would produce an acceptable financial data base with greater alac-

rity.




                                    III->9
  APPkLNDIX III                                               APPENDIX III
Recommendation (page 11-8)

We recommend that either (1) the Board of Directors, FDIC: the Board

of Governors, FRS; and the Comptroller of the Currency jointly estab-

lish a more effective mechanism to cambine t'eir forces in undertaking

sigr.ificant initiatives to improve the bank supervisory process or in

attacking and resolving common problems; or (2) the Congress enact

legislation to establish a mechanism for more effective coordination.

We would be glad to assist the committees in drafting appropriate

legislation.



FDIC Response

We recognize the merit of resolving common problems of the three agen-

cies through closer coordination and cooperation.   Indeed, there is at

the present time a substantial exchange of information between the

agencies' headquarters as well as at the field levels.   However, if

there is any merit to the concept of separate federal supervisory agen-

cies, and to a dual banking system with state and federal supervisior

of banks, the benefit would seem to be the opportunity to try different

approaches and to have a diversity of examination and supervisory pro-

cedures.   The possibility of useful innovation and improvement in the

bank examination and supervisory processes is greater if there are

several agencies trying different approaches than if every change in

examination methodology required approval of all the agencies.   Neverthe-

less, the possibility of establishing a particular vehicle for the agen-

cies to resolve common problems and take joint efforts in new initiatives

will receive serious consideration.

                                      III-60
APPENDIX III                                                 APPI:NDIX III
                          FDIC ADDENDUM


     We note that the draft GAO report is silent with respect to

 the planning and modernization efforts undertaken by FDIC in re-

 cent years to keep our supervisory activities abreast of economic,

technical, and social developments.   We have attached a digest of

our planning and implementation of those planning efforts.




                                III-61
    APPLNDIX III                                               APPENDIX III


In 1965, an exhaustive analysis of the examination and supervision func-

tions of the Corporation, similar in many respects to the Haskins and Sells

study of the OCC, was undertaken by a committee of three experienced field

examiners who were detailed to the Washington Office.   Some of the recom-

mendations flowing from that study were:

     - Increased emphasis on examination-by-exception techniques with at

       least an annual visitation to each bank under our supervision

     - Mutual interchange of (non-confidential) data with state banking

       departments

     - The establishment of effective guidelines for the volume of loans

       which should be analyzed in a given bank

     - Development of a program of procedural audits of certain banks and

       furnishing audit assistance by the Corporation to some banks upon

       request

    - Revision of the report of examination to make it more usable to

       bank managements and the supervisory functions of the Corporation

     - Adoption of recommended policies by the Corporation in regard to

       asset reserves, common capital stock, classification of assets, and

       utilization of termination of insurance proceedings

    - Publication of the Corporation's policies

    - Limitation of field investigations of statutory applications to

       those which are of significance in respect to competitive and

       bank soundness considerations

    - Development of more efficient application and investigation forms


                                       III-62
  APPECIDIX III
                                                                APPENDIX III
    Streamlining and expediting of application
                                               processing within the
    Corporation

 -Delegation      of authority to the Regional Directors for acting
                                                                    on
   certain statutory applications

 -Restructuring     of the geographic and managerial composition
                                                                 of the
   Regions

 -Internal   revisions designed to follow a specialized,
                                                           functional
   approach promoting better communications and
                                                training
   Utilization of automated systems to aid in
                                              scheduling examinations,
   the review of examination reports, and gathering
                                                    in; rmation in con-
   nection with statutory applications

  Expansion of EDP training programs, and the
                                              selection and training
  of examiner personnel in the managerial aspects
                                                  of computer
  operations

  Strengthening of requirements     fo: commissioned examiners as well as

  revisions of the centralized evaluating process

-Expansion     and intensification of training of examiner
                                                           personnel,
  including the executive levels

  Conducting periodic staff meetings to include
                                                both Regional and
  Washington Office senior personnel

-The   interchange of senior examining personnel with
                                                      other Federal
  agencies for short periods of time

-The   revision and enhancement of expense allowances
                                                      for travel and
  relocations.



                                   III-63
    APPENDIX III                                                    APPEINDIX III

Long range planning programs have been continuous since the 1965 study.

The Projects and Planning Branch of the Division of Bank Supervision was

established in 1971, and the Board of Directors created the Office of

Crporate Planning in 1974.   Developments at the Corporation within the

past five years or se. flowing from planning efforts, and paralleling

recommendations in the Haskins and Sells study, include:

     - Implementation of completely revised examination report formats

       for commercial banks (late 1969) and mutual savings banks (late

       1972)

     - Development in 1970 of an extensive training center for our

       personnel as well as those of the Federal Reserve, Comptroller,

       State Banking Departments, and some foreign students

     - Reorganization of the Washington Office of the Division of Bank

       Supervision along functional lines and the addition of a legal

       counsel to our Regional structure in 1971

     - Extensive revision of the Manual of Examination Policies was

       begun in 1972

     - New forms for filing and investigating statutory applications were

       developed and implemented between 1971 and 1973

      - Delegation in 19'3 of specifically defined authority to the Regional

       Directors for approval of all statutory applications except those

        involving mergers and the grat   .;g of deposit insurance

      - Limitation on actual field investigations of statutory applications

        to those situations where the competitive or overall bank soundness

        c3nsideracions made them necessary


                                         III-64
      APPENDIX III                                               APPEPNDIX III
      - Dissemination of the Corporation's policy statements and decision

        guidelines was begun in 1970

      - The development of automated early warning, trend analysis,

        consumer loan evaluation, and review-by-exception systems was

        initiated in 1971

      - Emphasis was substantially increased on training programs and

        specialization, particularly in the areas of automation, trust,

       and international activities (although FDIC has limited direct

       involvement in the international field)

     - The development of guidelines and the initiation of experimentation

       with an examination-by-exception program which emphasizes the

       evaluation of management and systems

     - Study, experimentation, and implementation of statistical sampling

       as part of the examination process

     -More   widespread application of disclosure requirements in

       connection with securities offerings by banks

     - The development of a new examination report for trust departments

       and a complete revision of the Manual of Examination Policies

       relating to trust activities, and selection of Trust Specialists

       in order to provide more expertise in this complex area of
                                                                  bank
       examination.

Other FDIC planning efforts include reviewing considerations
                                                             of over-
lapping regulatory functions resulting in the development of
                                                             a recom-
mendation for regulatory reform, the experimental Selective
                                                            Withdrawal




                                       III-65
APPENDIX III                                               APPENDIX III
from Examination Program, and an experiment   in conducting separate

compi ance examinations, aimed largely at measuring adherence by banks

with consumer-oriented laws, regulations and policies.



A separate Office of Bank Customer Affairs was created in early 1975 to

oversee a variety of depositor and consumer-oriented fun-cions.   In

addition, a Consumer Affairs Unit within the Division of Bank Supervision

was established in 1971 and continues in operation.



Additionally, our examination staff has been expanded from about 900 in

1960 to approximately 2,000 at year-end 1975, and we expect to add

approximately 150 more examination personnel annually during the next few

years, spaced so as to allow efficient assimilation into our examination

corps.



Considerable effort has been expended on the development of information

systems, and data contained in Call and Income and Dividend Reporta have

been available to the public since 1972.



Along with the development of early warning systems, the Corporation has

increased its emphasis on the potential risks to the insurance fund flow-

ing from larger banks, liquidity, earnings performance as an indicator of

overall bank soundness, and failure to use or untimely use of enforcement

measures.   Early and more detailed review of problem and near-problem

situations at the Board level has led to an expanded review staff, and our

experiences in problem situations prompted issuance of a regulation

governing insider transactions in banks under our direct supervision.
                                  m11-66
APPENDIX IV                                     APPENDIX IV
                SURVEY OF COMMERCIAL BANKERS

     We sampled commercial bankers' opinions about Federal
bank supervision and examination. We mailed a question-
naire to a randomly selected sample of commercial banks
operating as of December 31, 1975, Our sample was drawn
from lists of banks supervised by the three Federal agencies.
SAMPLE DESIGN

     From our lists of banks we drew two samples. One sam-
ple comprised banks which were receiving special supervisory
attention at the end of 1975--the so called "problem banks."
We randomly selected about 50 percent of these banks (203)
regardless of their deposit size.

     The other sample comprised banks which were not receiv-
ing special supervisory attentior .1,475). They were selec-
ted to provide a representative b,smple of banks of different
deposit sizes.  (See ch. 12.)  In all, the questionnaire was
sent to the chief executive officers of 1,678 banks, and
1,501, or nearly 90 percent were returned.
THE QUESTIONNAIRE

     Following is a copy of our questionnaire. The percents
associated with each response represent all banks who answer-
ed a given question.




                            IV-1
APPENDIX          IV                                                                                      APPENDIX IV




                                              U.S. GENERAL ACCOUNTING OFFICE
                                       SURVEY OF COMMERCIAL BANKS

  INSTRUCTIONS:                                                         3. About how many applications to open new
                                                                           branches have you made within the last
     The purpose of the questionnaire is to identify the                   10 years? (Check one.)
  perceptions and attitudes of bank management oil the
  examination and supervisory processes as they affect                       I) C] none (go toquestion6)         57.4
  bank operations. Yoa will be asked to consicr the
  impact of examining !,"rsonnel on your bank, the                           2)   El   1-5                       29.5
  effectiveness of communications between the supervisory           I
  agencies and banks, and your a: -:....       ot pofs.-' I.e                3) 0      6-10                       6 6
  positive and negative aspects of these same superviscry/
  regulato:y processes.                                                      4)   0    11-15                       2.8

     The completed questionnaire should represent the                        5)   I    16-20                       0.8
  views of senior bank management.
                                                                             6)   E    over 20                     29
     We would like you to respond to each question. Some
  questions may appear to require a review of records id                4.   What is the typical length of time between the
  order to respond. Please do not perform any extensive                      date of application for a new branch and the
  review but rather provide your most informed estimate.                     date of approval or rejection of that application?
                                                                             (Check one. I
    The questionnaire is numbered only to permit us to
  delete your bank's name from our list when we receive                      I)   El   2 months or less           21.2
  your completed questionnaire and thus. avoid sending
  you an inappropriate follow-up request.                                    2)   0l   3-4 months                 46.7

    There are numbers printed beside the response boxes                      3)   El   5-6 months                 19.8
  to assist our keypunchers in coding the responset for
  computer analysis. Please disregard these numbers.                         4)   El   7-12 months                 8.8

  I. BANK CHARTER AND NEW BRANCH                                             5)   E 13-18 months                   2.2
     APPLICATIONS
       1.   For how many years has :.our bank held its' pre-                 6)   E    over 18 months              1.3
            sent charter? (Check one. I
                                                                        5.   How reasonable does thb length of time between
            I)   0   5 years or less             8.o                         applicltion and approval/rejection seem to you?
                                                                             (Check one.)
            2)       6-10years                   5.0
                                                                             I)   El   very reasonable            40.2
            3)   0 1l-.15years                   6.3
                                                                             2)   El   somewhat reasonable        36.5
            4)   016-20years                     2.6
                                                                             3) [ undecided                        4.9
            5)   COmore than 20 years           77.5
                                                                             4)   [    somewhat unreasonable      15.1
       2.   Was your bank previously chartered at another
            governmental level, within the last 10 years. i.e..              5)   0    very unreasonable           3.3
            if currently a national '" nk, did bank previously
            hold a state charter; if a,., ently a stats bank. did
            bank previously hold a national charter? (Check
            one. )
            I)   Oyes                             4.0

            2) O no                             96.0


                                                                IV-2
APPENDIX                   1V                                                                                              APPENDIX                IV



 II. BANK'S PERCEPTIONS CONCERNING THE                                                 9.     To what extent, if any, do Federal examinations
     EXAMINATION PROCESS                                                                      place a burden on bank operations. personnel
                                                                                              time. customer time and convenience? (Check
       6.     How does your bank usually first learn of the                                   oneforeach row)
              plans for an impending Federal examination?
              (Check one.)

              1)    a]    written notice                         0.4         l                                     _


              3)    0     personal visit                         0.9                                                        i        :'           Iv




                           3 )   __________          _________                   3.         Customer time                   .9             1.6
                                                                                            Bandconvenience       61.0              11.0                0.5
       7. In general how much advance notice of an ex-.
          amination does your bank receive? (Check one.)
                                                                                 10.         In a typical examination about how long are at
              1)    E     no advance notice                  98.1                            least some bank examin.7rs present on bank
                                                                                             premises? (Check one.
              2) 0        some notice but less than 2 days        .                                              2
                                                                                 3.         Ct, )      less than 2 weeks                     68.6
              3) C3 2-5 days                          0. 5
            7. In general how much advance notice of an  e0.1-
                                                                                             2) L fronm 2 to less than 4 weeks                   20.2
                                                                                             3) 0      from 4 to less than 6 weeks                1.8
             5) 61mo thay0                                       0.111.0




                                                                                            6) El from 3 to less than 4 months                   0.7
   8. Which of the following best describes the kind
      o preparat on required of your bank prior to                                          7)      El from 4 to less than 5 months              0.3
      the arrival of the Federal ank examiners? Check                                                             on
             one, or more notice                                                            8)         more than 5 months                        0.1
 78 9        1)     l    no preparation necessary                                11.        In general, how would you rate the Federal
                                                                                            examiners with respect to (I) their knowledge of
 4.1         2) Cl preparation for a minimal amount of                                      banking and (2) their professional demeanor?
                   manual retrieal of datays        0.2
 1.5         3)    preparation for an extensive amount ofn                                                                 6 weeks               5.8
                   manual retrieval of data0.1

 3.2         4)    E preparation for production of a minimal                                EXAMINER0.1
                         number of computer printouts the kind
 1.9         5o          preparation  production
                                      for        of an extensive
                                                        prior t                                                                 m
                         number of computer printouts                            I. Knowledge oft                        67.8              1.4
                                                                                    banking


                                                                                        demeanor                 29.5               6.4months          0.2



                                                                      IV-3
                                                                      IV-3
APPENDIX             IV                                                                                          APPENDIX                IV




 12. More specifica'ly, how would you rate the                              13.     Ili general. hou adequalte or inadequate is the
     competence of the Senior Federal examiner in                                   Senior Federal Exanminers' understanding ('f the
     the following areas? (Check one r;lting lor vcch                               lollo-ing specialized area'? (Clteck one rurine
     row.)                                                                          Ir each r:,w.)




                                                                                                           '5
                                                                                                                           V7
                                                                                                                           -         -




       03115
            of
         q68.li
           l4
       Illille
  I. Ability to deli -

                                 27.6
                                            66.5


                                            _s
                                                     5.1
                                                     5.1
                                                            (.7

                                                             .,l().1i
                                                            -ect.oui:
                                                                                1
                                                                                    . I1ao68 .4 1.3
                                                                                     1i ii    .t
                                                                                                   datt
                                                                                                          20.3
                                                                                                                 65.9
                                                                                                                        19.7      0.3A
                                                                                                                              4.2 -
  2. Kinowledge of                          56.0            NR                      pIoI0CNl1g            9.3            19.7 - 0.9
     banking laws and
        Sregula
           iioslla               42.6                1.3           0.1          3   lll      llalioal      _     70.7          2.6            7
  3. Abilitl to) asess                      66.3            0.9                     ollelatios            17.8           8.6         0.36
     capital adeillalc           25.3           7.2                0.3
  4. Ahility to sh.uc,                      68.4            ;.
     adequaciy o
     itiernal .:outulol          20.2                10.3           0.1

  5. Ability to evalualt                    67.4            1.4
     the collilvten.e6.4                                    1
     of Iaagetent                I 9.0               11.           0.

        he Abilint.tt) ev;jRMe   -          67,.5           1.5
       tile ningllws a                                       .
                                 matuagentent
                                 20.8        9.5                    0.6

   7. Ability to evaluate                   67.7            2.1
      tlle imipa;t o'
       growth itt haink
       soulndlpess               18.4                11.5          0.3

   S. Ability to vcalutate                  65.9            1.1
       hleadetquacloit
      liquidie!                  25.5                7.2            0.3
       ).
       Ahbility to dete-                    68.0            0.7
       miane tle iulpact
       ol' seil'-dealllgs
       oil solurndiless.             25.3            5.7            C.3

  !0. Ability to eitegrale                  68.1            1.4
      deta iled tintrmtta-

       preherlsive pIatulre
       of hatik oaltitillsn          20.1          _ 10.0           0.4

  I.   Other (please
       des.ribe)


        NR- No       usnse




                                                                         IV-4
APPENDIX           IV                                                                               APPENDIX IV




        the five items which you consider to be the most important. regardless of the agency's priorities. (Be sure to
        mark all vyour selections in column 1. Second, and converselv, again review the list. but this time check the five
       items which you considerto be the least impoi,ant in column 2.



                                                                                             _Mc:s      least
                                                                                RANK       Impotalnt Importalt      RANK

       Assurance that external pressures are not leading to unlsound
       hanking practices                                                               8     242         37.7         5
  2.   Evaluation oif internal control. including internal audit                       5    421          139         10

  3.   Presentlation of an integrated picture of bank operations                   13        7.3         6.0          2

  4.   Determnalltlion of existence of conflicts of interest                       11        11.7        24          7

  5.   Protection of tlle safety of depositors' funds                               1       65            47        14

  (.    L-valuatio,i ,,I portfolio halatce/imbalance                              12        10.2         441         4

  7.   Deterillinatiol ol existence of1sell-dcaliigs                               10       17.6         ZS          8

  8.   Fs.-cast of trends in the haenkil,~   il.str                                          2.6         71          1
  ).   Coutpiiance with laws and regulatilons                                      3                      5.8

  (10. L),'talion of deposit volatility                                           14        5.021                   3

 II.   Evaluation of capital adequa:                                               6        356         101         11

 12.   Evaluation of asset quality                                                 2           3         44         15

 13.   Ev'duation ,)t' managemient                                                 4        5.1          r8         12

 14.   Evaluation of' liquidity

 15.   Evaluation of'earnings                                                       9       2L4         31          6

 16.   Other (Please specify)




                                                           IV-5
                                                           IV-5
APPLNDIX             IV                                                                             APPENDIX                IV




  15.     To answrer this next question. we ask you to again consider this list. bhut from a different point of view. From
          your experience, which five items do you think the agencY considers to be tie most important? (Indicate ytu,-
          answer hy ckheckin thel upprpriaute hxtrf. isn idatumn 1.1 Conmerselv. which five do you think the agency considers
          to be the least important': IC/leck fi've ho,.rxs in co/umn 2.




                                                                                                   Most\         L-a'st
                                                                                      RANK      Imtp.oll;aml   Importatlt   RANK

           Assitrna.e Itha e\telllal pI'.lNlll'es         a.e ntt le.adilt              10         12.6          43.7            4
           unsititld hanlking placti.ce'
    2.      Rvaaliationl of inirle3al ¢o'tmol. intilliiig 'l' 111l .umdit                5         42.0          13.6        10

    3.     Presentatioll to all integrated ptcnre ot alink illeart injs                 13          5.2          63.4            2

    4.     De'iermttilalit       o'Xi:tletC.' *1t :imtllict*,
                                 *tt                               't     let'
                                                                        litn             9         20.0          22.3            7

    5.     Prote¢ttll olf the salIetv of dtllotiholr'             htinlds                4         48.5           6.2        12
                             '                    "l        '
    h.     Fvaluation o1po flil            halan i t      thalamice                     12         12.3          39.1            5
    7.     Determliltionl otf esicttentce        of   %elf-dealtllg\                      8        20.5          19.2            8

    8.     Fore¢:asI of lelid.in         the h.Inktlg Indtle                            1            1.8
                                                                                                     1.8
                                                                                                                 70.5
                                                                                                                 70.5            1

    9.     ('otmpliantce with laws atind eglaitions                                                73.7            1.9       15

   10.     Evaluatiotl ofI dclpsitl vldtilit\                                            14         4.3           53.4           3

   II.     Eval. tathlatit, Calaital adetutlac.                                             3      55.1            4.5       14

   12.     Evaluatiion of a3'sset qttalilt                                                  2       .57.5           5.2      13

   13.     Evaluatio, lo,1 Illtat.ltlCllet                                                7        32.5            14.7          9

    14. Evallltit ln to iqiutitidi t                                                     6          35.3          10.7       11
   I S.    Evaluation of eartnilng                                                       1          12.4          37.1           6

   O1. Other (Please specify)




                                                                             IV-6
APPENDIX                      IV                                                                                                   APPENDIX    IV




   16.        Does the examiner spend enough time in ex-                                      18.   From the viewpoint of bank management. how
              amining your bank?                                                                    useful is the bank examination process? (Check
                                                                                                    one.)
              1)     0    yes                                        72.2
                                                                                                    I)   0   of little or no Jse               1.0
              2)     E    probably yes                               23.2
                                                                                                    2)   0   a small degree of use             6.6
              3)     El   undecided                                      1.5
                                                                                                    3)   Q   a moderate degree of use         33.3
              4)    0 probably no                                        2.2
                                                                                                    4)   0   ahigh degreeof use               46.1
              5)    O no                                             0.9
                                                                                                    5)   L1 a very high degree of use         13.0
  17.         Indicate whether or not you feel the bank ex-
              aminer pays the appropriate amount of attention
              to each area. Do this byv checking one of the
             scale positions on the numbered boxes provided
             below. For example. if ywin feel the examiner
             spends either too little or too much time in a
             particular area, you should check an appropriate
             box at the end. or near the end of the scale. On
             the other hand. ifryou feel the examiner 's time is
             appropriately allocated. check *ither a middle
             box or one ofthe boxes near the middle.

         1)        Loan Assessment
                         41.4                                 6.3
                   1"*' 22 3                      4       5          6             7
               7.5   12.7 21.2 52.3                   3.9        1.8           0.6
         2)     Capital Adequacy
                              34.8                             [.7
                                                               [1

               5.8    9.7    19.3             55.5    6.3        2.9           0.5
        3)      Internal Control
                        30.4                                  22.5

       d of0 t J2                        IP    4
                                              0E0
                                                       5
                                                                 E
                                                                    b           7
                                                                                0
               3.8   7.8    18.8 47.0 13.7 7.0                                 1.9
        4)      Managemer' Assessment
                       23.2               28.5
                                      ]   28.5
               a1                                     0                        lOg
              3.1     4.9    15.21 48.3 115.Q 10.3 2.3
        5)     Compliance with Banking Laws and Reg-
               ulations 40 0                  9
                         40.0    1      1     9.7

              L0          0          0        00                E              0
           8.7  13.1 18.21 50.3                       5.5       3.2            1.0
        6) Other iSpecify'

               1          2          3        4       5          6             7
   t                      E          E        El      L[        0              0E



                                                                                       IV-7
APPENDIX IV                                                                                                      APPENDIX IV




  19.   To what extent would you agree or disagree with the following statements about the Federal examination
        proeess? (Check onetfireuch rnw./




                                                                                                    .-                      L
                                                                                                            2       z
                                                                                                    --      ri      -:     ,I     v
                                                                                                           47.2            2.6
   1.   The examinatiiiion prot:ess is uteful in provwidiug in indeleident appraisal olf                   47.2            2.6
        hatnk stundiie,.s                                                                          43.3             6.1           0.8

  2.      he C\t...illiial.till plcss i 1.tiel it hIalk
                                                     4a0iiu.tliatu1.d
                                                              .         in pli.ve'.'ig hank                40.9            12.6
        I:ailure                                                                                   20.9            20.6           5.0

  3.    The examinalionl                          plovidiu: lectogiiolil anld C11¢ollrage-
                           pltcess i Ilseltill in ll                                                       27.8            21.9
               o1 tie qualil1 of eliicel miad emploie.e iktMitaltla.e
        miiel tu                                                                                    8.0            32.6           9.7

  4.    Thle examlination pioces., i,            It hank mi'nalgelmlel ill tolecaslinlg
                                           wlll'ful                                                        11.2           33.5
        lultire t relld                                                                             2.1            33.3           19.9

  5              .. ioll
        The exa inmial          _ is uis llo Ii batik inliagenleni
                              roe."                                     th rough              ..          .19.2
                                                                                                           379            19.2
        reoMmllliendinlg ai comt
                              ll e    ll   11ille ;atiioll                                         7.4            27.2            8.3

  6.    The cxamiaiiation pti):oess is usel'il to hank nlanllgelltl     itll idenliifyin                   57.4           4.8
        pteIt:iall problems                                                                        26.9            9.6            1.3

   7.   Othel   (Please specify)




                                                                  IV-8
APPENDIX            IV                                                                                              APPENDIX          IV




 IF YOUR BANK IS A NATIONAL BANK, PLEASE                                             22.   Some observers have asserted that there are
 GO TO No. 22.                                                                             inconsistencies in communications received by
                                                                                           banks from t:.e Federal supervisory agencies.
       20. How are State examinations typically conducted?                                 Others disagree. They feel that in general com-
                                                                                           munications are basically consistent. To what
   17.7     1) - Coordinated but not conducted                                             extent, if at all, has your bank experienced the
                 concurrently with the Federal agency.                                     communications problems characterized by the
   41.6     2) 0 concurrently with the Federal agency                                      various situations described below?

   4D.7     3)   0 independently of the Federal agency


            are the state examinations than the Federal                                       _
            examinations from each of the following aspects?                                                           E   E'
                                                                                     COMMUNICATION
                                                                                           PROBLEMS


                                '              X                                i.      Disparity between
                                X                         X                            guidance given in
                                        .                                              'he
                                                                                       t examinlation
                                               ca _                                    report and other
                                        2= : .          c      M                       vwritten guidance
                                                       j=           PF.
                                                                    c,                 fromOF
                                                                                       I~     same_csuper-
          ASPECTS OF                                                                   vising agency         77.8                      a7
           STATE                                                                                              -
        EXAMINATIONS                                                           2.      Disparity betwee               2          24
                                _-      ,'~                   .,'   I:v                formlal comlouni-
                                        62            13.6                             cations from an
  1.      Usefulness .of                                                               agency and informal
          state exami.ations   3.1            753             L8                       contacts with per-
                                                                                       sonnel from that
  2.      Scope of state                66            94                               same ageny            69.1          7.3         L0
          examinations          8             80.6            L6               3.      Disparity between            26.0
                                                                               3.      Disparity between            260          37
  3.      Competence of                 S1            25.2                            communications
          examining                                                                   received from two
          personnel            L6             64.0            41                      or three different
  4.     Other  (please
                    Other
           '-4.(please         -        -      -      -                               Federal agencies a/    57.4          1L181
         specify)
                                                                          a/         We believe that an unknown percentage
                                                                                     of respondents interpreted the phrase
                                                                                     "d:ffezenL Federal agencies" to mean
                                                                                     other Federal agencies such as the
                               ......                                                 Internal Revenue Service, and Securi-
                                                                                     Lies and Exchange Commission,               and not
                                                                                     merely the three Federal bank super-
                                                                                     visory agencies.  This belief is ba!sed
                                                                                     on conversations we held with several
                                                                                     national and state nonmember bankers
                                                                                     who answered this question.




                                                               IV-9
APPENDIX IV                                                                                                           APPENDIX IV




  m. EXAMINATION REPORTI AND COMMUNICATION                                           27.   How long after tlhe examination is completed do
                                                                                           you usually have to wait for the report? (Check
    23. a)ln the last 5 years how many times has your                                      one. I
         bank been examined? lindicate rour ansiwer by
         r- ling a number.)                                                                I)    Q    less than a month                18.4

                   NO. OF TIMES BANK EXAMINED                                              2)    0    from I to less than 2 rr onths   59.0

            3 or less      4   5       (,       7       8       9   1) or more             3)    0     from 2 to less than 3 months    16.4

    24. a)ln how many examination reports. if any. have                                    4)    0] from 3 to less than 4 months        4.3
          you noticed a situation where major deficiencies.
          as noted in the text. were left out of the                                       S),   0     from 4 to less than S months     1.1
          "comments andconclusions" page? (Check one.)
                                                                                           6)    O from 5 to less than 6 months        0.7
            NO. OF REPORTS WHERE DEFIC:ENCfIES
                      WERE LEFT OUT                                                        7)    0 %ixn-nr.isormcre                    0.1

            0     1    2   3   4   5        6       7       8   9   10ororreM2             Pate the clarity with which the examination
                                                                                           r'-oFti. t;tally explain .le nature and extent of
    25.a) Also in how many of these reports. if any. have.                                 the probtlemls, if any. (Check one.!
          you noticed a situation where deficiencies reported
          in"comments and conclusions" page were not                                       I)    C) very clear                           32.3
          supported by the text? (Circle one.)
                                                                                           2)    C] generally clear                      63.5
                      )F REPORTS WHERE DEFICIENCIES
                          WERE NOT SUPPORTED                                               3)    0     borderline                         3.8

            0     1 2      3   4   5        6       7 F         9   10or more              4)    0 generally unclear                      0.3

                                                                                           5!        ] very unclear                       0.1
    26.     ro wha. extent if at all do the bankl examiners
            discuss their findings with the bank management
            before leaving to write their report? (Check one.)

     0.6 1)       0    little or no discussion

     8.1    2)    0    some general discussion of content area

    27.0 3)       0    general discussion of content area

    22.6 4)            detailed discussion of content area

    41.7    5)    0    detailed discussion of content area and
                       findings


       a)        DATA NOT AVAILABLE                         FOR QUESTIONS
                 23, 24. and 25.




                                                                                 IV-10
APPENDIX          IV                                                                                     APPENDIX         IV




  29.    In your opinion, how effective or ineffective is the Federal supervisory process, including examinations, in
         achieving each of the following objectives? (Check onefor each row.I




                                                                         a)              .

                                                                        RANK
                                                                                        >                                  >

    I    Assurance thati external pressures are not leading t,                                 45.6              12.3
                                                                          13
         unsound banking I..lctices                                                    6.6                32.8            2.7
   2.    Presentation of an integrated picture of hank operaions                               42.2       36.7   14.4
                                                                          15           4.3                36.7           2.4
   3.    Evaluatio   of internal controls including internal audit            6                59.9               4.9     0.3

   4.    Determinationl of existence (if conflicts   of interest          10                  564                 6.8     04
                                                                                       8.3                28.1            04
   5.    Protection of the safety of depositors' funds                        3       21.6    64.9                1.4
                                                                                      21.6                12.0            0.1
   6.    Evaluation of portfolie nalance/imnbalance                           9                56.9       28.7    5.2     0.5

   7.    Determination of existence of self-dealings                                  10.0     57.5       25.5    6.0
                                                                                                                  6.0      1.0
   8.    Forecast of trends in the banking industry                       16            1.7   18.3               28.8
                                                                          16      1           _.7         40.3           10.9

   9.    Evaluation of international operations                          12                   50.4                9.6
                                                                                       7.5                27.7             4.8
  10.    Compliance with laws and regulations                                 1         .0     61.7              0.5
                                                                                      33.0                 4.7            0.1
   I.    Evaluation of deposit volatility                                14            5.3    4           36.3           1.5

  12.    Evaluation of capital adequacy                                   5           16.0    66.5                3.1
                                                                                              70.0                1.30   0.4
  13.    Evaluation of asset quality                                          2       18.8    70.0         9.6    1.3    0.3

  14.    Evaluation of management                                        11            8.3          .2    27.4   6.9     1.2

  I5.    Evaluation of liquidity                                          4           15.3     69.1       12.    2.5      0.4
  16l.   Evaluation of earnings                                               7        8.8     59.7              6.6

  17     Other (Please specify)1.3




          a) The rank order is based on the sum of the "very effective"
             and "effective" responses.




                                                              IV~-11
APPENDIX IV                                                                                                                         APPENDIX IV



 IV. OVERALL OPINION ON BANK SUPERVISION                                                                    (2) Second. consider the disadvantages listed
                                                                                                            below. How great or how small do you think
        30.   There are both advantages and disadvantages to                                                these disadvantages are? Consider each of the
              Federal supervision of banking. In the following                                              disadvantages separately. (Check one for each
              three questions. we have listed some of these.                               '                 .}
              You are asked to consider the advantages and
              disadvantages and then to rate    en according
              to the amount of advantage         tlisadvantage
              brought to the banking industry as a result of                                                                 _
              Federal supervision.

               {I) First. consider the advantages. How great
               or now small are the advantages that are                                                                       _
               reali7ed by the banking industry? fC'heck one                                    D)ISAI)VAN'TAGL S            >                      L       > ;i
              for each row. )33.1                                                                                                             ,         4
                                                                                         I . Sii'l-¥Visitit        n
                                                                   'i        ::restricts
                                                                               .                         llexibility
                                                     o .,>         _         _          28~~it xliniopertiakes
                                                                                                     k                       44.6            16.9           1.0
                                                                            rZ 3                                                    38.3            6.7
                                                                                            2. laminattion takes
                                        e       >           ,                _il                  limle o h;bik
                                    i          -     t      Y      _                                 Ic>
                                                                                                     prtsnoel                35.4            18.1           1.5
          ADVANTA(1ilS          >                                                          3          xanlllling                    26.8            4.0
                                                    .-   ri ;.- l          .:          I             pe{'rsonnel use
                                             ' -v          s-l30.7 22.7     -bank                            facilities      55.5            12.8           0.9
          'Availahilit                                            22.7                                                               230.7
          sUlpervisory a
          supe.rvis.ory agenc       y4                                           .     4
                                                                                       4:n             aminaultion mtakes           22.4            3.6
          pelsonlnel l'o0                                                                            a possible contribu-
          advice alld cnt-                                                                           t1o0 to tile coll-
          sil at iollt          16.0              24.3       6.3                                     :mued ope raJ ion
                                              ___________ ___of                                        inlleicientl hanks 58.0               14.4           1.6
   2.     Reslictionll of th                 27.2       12.0                                                                        24.9            4.1
          extlremes nl                                                                 5          i    'tantion dupli-                .
                                                                                                 Cd!C olher tylles
          cmitpeliti~ot         27.9          _          29.7              3.2                   'fex 1 n revies             52.8            15.9           2.3
  3.      I-xternal1 review                 27.3                 25.7
          of Bank's internall                                                        (.          Other specify
          audit 1andconloAl
          piocedures            8.3                       33.4             5.3
  4.      Conlributioni                     23.2                 30.5                                   (3) Third. consider both the advantages and
          toward tihe pre-                                                                              disadvantages to the banking industry. Do you
                  ol hathink
          Ibilurventin                                                                                       the advantages outweigh the disadvantages.
          failure                7.4                      28.8            10.1                          or do you think the converse is true? (Check
  5.     Protection of the
         industry by an
         entranice screening                                                           48.2             1) 0       Advantages substantially outweigh the
         to reject unsound                                                                                         disadvantages
         applicants             17.7                     24.0             10.9
                                            9--nt           77
                                                          -4.0    -R       -           41.0            2)     [    Advantages outweigh the disadvantages
  6.     Protectionl of the9.4                                   28.3
         industry by main-                                                                 7.8         3)     0    Advantages and disadvantages balance
         taining a deposit
         insurance find        3.8          911.4 11.4                                                             equally
                                                                          47.1
  7.     Other (specify)                                                                   2.7         4)     0 Disadvantages outweigh the advantages
                                                                                               0.3     5)     =] Disadvantages substantially outweigh
                                                                                                                 the advantages




                                                                                IV-12
APPENDIX IV                                                                                                              APPENDIX IV



       31.    The following are four possible alternatives for         32. The following are possible changes to the exist-
              organizing bank supervisory agencies, Consider               ing Federal examination process. Do you support
              each, and indicate the degree to which you                   or oppose these changes? (Check one for each
              oppose or support the particular alternative.                row.)
              (Check one for each row.)



                                                                                                                                                          0


                    ~~ALTERNATIVES
                          v    ;~~z                                             . Restricing exami-         .        _     2.6              26'~.          .
        ORC;^NIZATIO N                                                          POSSIBLE
                                         15.6          324                        nations Cr:ANGES
                                                                                             only
        ALTERNATIVES              9.4          16.6       26.0                         edium sized ba           0.8                   3.9           67
                                                                                                                           2     .6         26      .9
                                              49.
                                               13.3
                                         -agencies                             I.     Restricting exami-
                                         15.6          32.4                          natior.ns to only
         wit  Only
               three Federal
         supervisory   agencie                                                        very b eq3.5uir
                                                                                           large   anks          1.4
         supervisory  agenciey                                             '          Restricting  exami-                  1.7              26.6
         and State
         and State super-
                     super-y                                                         special
                                                                                      nationssupervisory
                                                                                               a) only          3.0               6.8       2       .6
         agencies                259.4          16.6          126.0    5.                 sing thed bank4.3
                                                                                      edium                                                 3.
         Federal
              o3.sulpy
                    erviory                                                          Restriting
                                                                                             cyexai-                       0.8              23.8
         Fed4.Ol
               n     eeral                 svisorynations                                        o
         Ipenc~iesbut no                                                             nations to only
         Stat            supcnvisory
                 e supervisory.5    hgnosmaller                                              banks              0.6        _      2.9
                                                                                                                                  7.9               71.
        visory agencies          49.2           1.3           3.5      4.            Resricting exa                       1i-
                                                                                                                          7.4               2934.8
  3.    Onl    one
                 y Federal               18.6          23.3                           ations to o
                                                                                      r all
                                                                                         banks
                                                                                            requiring.7
                                                                                                                                                    25.1
        State supervisory                                                 baks to be                            3.0               6.8
        agencies                 25.2           14.2          18.7     5. Increasing the                                  4.3               38.2
  4.    Only one Federal         15.9                  4.9                 frequecy of
                                                                          examinations tor
        supervisory agency                                                all banks19
        and no State super-
                         ~~~supervisory
                                    agency                                 s~~~~oppeal   rory
                                                                                          r                     1.5
                                                                                                            -__7.9                                  48.1
        viso~ry agencies         65.4           8.0           5.8      6. Decreasing the                                  18.7              34.8
                                                                          fheirrequency of
 5.                                        Other (specify)                examinations

                                                                                      raIVlbank5.7                               15.7               25.1
                                                                      7.            Providing the                        44.9               7.4
                                                                                    opportuolity for
                                                                                    banks to be
                                                                                    examined on
                                                                                    their request, in
                                                                                    addition to the
                                                                                    regular examination      17.0                20.5               10.

                                                                      8.            Other (specify)




                                                               IV-13
APPENDIX IV                                                                                               APPENDIX IV




   33.    In the following question. you are asked to evaluate            8) Other (specify)
          several possible changes to Government involve-
          ment in the banking industry. no this by check-                                      0
          ing one of the scale positions on the numbered                    1           2      3      4      5      h
          boxes prov'ided below. For example. if you feel a                     o]                    o      o
          possible change would be "Beneficial" or
           "Detrimental." you should check an appropriate           V. ADDITIONAL COMMENTS
          box at the end. or near the end of the scale. On
          the other hand. if you feel there is little choice.         34.        If you have additional comments on any of the
          check either a middle box or one of the boxes                         items within the questionnaire .or topics not
          near the middle.                                                      covered. please express your views below on this
                                                                                page. Your answers and comments will be
         Indicate the degree to which you feel the                              greatly appreciated.
          changes are beneficial or detrimental.

    1)    Elimination of chartering by the Federal
          Government
               10.6                      70,4


      5.5
         0
             2.3
                 123
                 0
                    2.8 19.0
                            I    4
                                OE
                                  6.3
                                            5b

                                        17.2 46.9
                                                    0       0
    2) Elimination of chartering by State Govern-
       ments
             11.9                       71.6

          00            010             0           0
      6.1    2.7   3.1    16.5 4.5     16.8 50.3
   3) Elimination of the requirement for govern-
       ment approval for bank branches
            13.8                       72.8
      6.3   3.3            4
                          13.4   7.0   17.5  48.3
         000000                                             0
         6.3     3.3    4.2     13.4    7.0         17.5   48.3
   4)     Elimination of the requirement for govern-
          ment approval for bank mergers 77.6
               10.2
          i~'-    23             4            -s-
         00
         4.2     2.5
                        0
                        3.5
                            1   01 0
                                12.2 8.4
                                                    0
                                                 20.0
                                                            0
                                                           49.2
   5)     Elimination of all governmental bank ex-
          aminations
                5.4                       87.8

                         1      0o0 1               n00
      3.1   1.0   1.3   6.8   2.9    1.7 71.2
   6) Elimination of bank regulations entirely
            5.4                      89.4
       1 - 2          1     1 '       6      '


         3.4    0.6   1.4 15.21 3.8       9.5 76.1
    7)    Elimination of bank supervision entirely
                4.3                      90.1

         O0 n]          0       0             00
         3.1     0.8   0.9      5.1     2.7         10.3   77.1




                                                                  IV-14
APPENDIX V                                       APPENDIX V

               PRINCIPAL OFFICIALS RESPONSIBLE

                FOR ADMINISTERING ACTIVITIES

                  DISCUSSED IN THIS REPORT


                                     Tenure of office
                                    From            To
               DEPARTMENT OF THE TREASURY
SECRETARY OF THE TREASURY:
    W. Michael Blumenthal        Jan.   1977     Present
    William E. Simon             May    1974     Jan. 1977
    George P. Shultz             June   1972     May 1974
    John B. Connally             Feb.   1971     June 1972
    David M. Kennedy             Jan.   1969     Feb. 1971
     OFFICE OF THE COMPTROLLER OF THE CURRENCY
COMPTROLLER OF THE
  CURRENCY:
    Robert Bloom (acting)        July   1976     Present
    James E. Smith               July   1973     July 1976
    Justin T. Watson (acting)    Mar.   1973     July 1973
    William B. Camp              Nov.   1966     Mar. 1973
FIRST DEPUTY COMPTROLLER
  (note a):
    Justin T. Watson              Sept. 1962     July 1975
FIRST DEPUTY COMPTROLLER
  FOR POLICY (note a):
    Robert Bloom                 Aug.   L975     Present
FIRST DEPUTY COMPTROLLER
  FOR OPERATIONS (note a):
    H. Joe Selby                 Aug.   1975     Present
APPENDIX V                                              APPENDIX V
                                             Tenure of office
                                             From          To


             FEDERAL DEPOSIT INSURANCE CORPORATION

                     Board of Directors

CHAIRMAN:
    Robert E. Barnett                     Mar. 1976      Present
    Frank Wille                           April 1970     Mar. 1976

COMPTROLLER OF THE
  CURRENCY:
    Robert Bloom (acting)                 July   1976    Present
    James E. Smith                        July   1973    July 1976
    Justin T. Watson (acting)             Mar.   1973    July 1973
    William B. Camp                       Nov.   19Lt    Mar. 1973

DIRECTOR:
    George A. LeMaistre                   Aug.   1973    Present
    Vacant                                Mar.   1973    Aug. 1973
    Irvine H. Sprague                     July   1968    Mar. 1973

                 Division of Bank Supervision

DIRECTOR:
    John J. Early                         Aug.   1975    Present
    John J. McCarthy Jr.                  June   1975    Aug. 1975
      (acting)
    Edward J. Roddy                       Sep.   1971    June 1975
    John L. Flannery                      Sep.   1969    Sep. 1971
                     FEDERAL RESERVE BOARD

CHAIRMAN, BOARD OF GOVERNORS:
    Arthur R. Burns                       Feb.   1970    Present

VICE-CHAIRMAN, BOARD OF GOVERNORS:
    Stephen S. Gardner                    Feb.   1976    Present
    George W. Mitchell                    May    1973    Feb. 1976
    J. L. Robertson                       Mar.   1966    Apr. 1973




                                V-2
APPENDIX V                                             APPENDIX V

                                           Tenure of office
                                          Fromn           To

     Division of Bankin Supervision and Regulation
DIRECTOR:
    Brenton C. Leavitt                   Aug. 1974     Present
    Frederic Solomon                     Aug. 1959     Aug. 1974

GOVERNORS:
    David M. Lilly                       June   1976   Present
    J. Charles Partee                    Jan.   1976   Present
    Philip C. Jackson, Jr.               July   1975   Present
    Philip E. Coldwell                   Oct.   1974   Present
    Henry C. Wallich                     Mar.   1974   Present
    Robert C. Holland                    June   1973   May 1976
    Jeffrey M. Bucher                    June   1972   Jan. 1976
    John E. Sheehan                      Jan.   1972   June 1975
    Andrew F. Brimmer                    Mar.   1966   Aug. 1974
    J. Dewey Danne                       Nov.   1963   Mar. 1974
    George W. Mitchell                   Aug.   1961   Apr. 1973
    Sherman J. Maisel                    Apr.   1965   May 1972
    William W. Sherrill                  May    1967   Nov. 1971

                     FEDERAL RESERVE BANKS

                          District
PRESIDENTS:                 bank
    F. E. Morris          Boston         Aug.   1968   Present
    P. A. Volcker         New York       Aug.   1975   Present
    A. Hayes              New York       Aug.   1956   July 1975
    D. P. Eastburn        Philadelphia   Mar.   1970   Present
    We J. Winn            Cleveland      Sep.   1971   Present
    Vacant                Cleveland      Nov.   1970   Aug. 1971
    R. P. Black           Richmond       Aug.   1973   Present
    Vacant                Richmond       Jan.   1973   Aug. 1973
    A. N. Heflin          Richmond       Apr.   1968   Jan. 1973
    M. Kimbrel            Atlanta        Feb.   1968   Present
    R. P. Mayo            Chicago        July   1970   Present
    L. K. Roos            St. Louis      Feb.   1976   Present
    Vacant                St. Louis      Mar.   1976   Mar. 1976
    D. R. Francis         St. Louis      Jan.   1966   Feb. 1976
    B. K. MacLaury        Minneapolis    July   1971   Present




                               V-3
APPENDIX V                                            APPENDIX V

                                          Tenure of office
                                        From            To

    Vacant              Minneapolis     Feb.   1971    June 1971
    H. D.  Galusaa, Jr. Minneapolis     May    1965    Jan. 1971
    Roger Guffey        Kansas City     Mar.   1976    Present
    G. H. Clay          Kansas City     Mar.   1961    Feb. 1976
    E. T.  Baughman     Dallas          Dec.   1974    Present
    Vacant              Dallas          Oct.   1974    Dec. 1974
    P. E. Coldwell      Dallas          Feb.   1968    Oct. 1974
    J. J. Balles        San Francisco   Sep.   1972    Present
    Vacant              San Francisco   June   1972    Sep. 1972
    E. J. Swan          San Francisco   Mar.   1961    June 1972

VICE PRESIDENTS IN
  CHARGE OF BANKING
  SUPERVISION AND
  REGULATION:
    D. Aqu ino,          Boston         Oct. 1974      Present
       Senior Vice
       President
    L. J. Aubrey,        Boston         July 1969      Oct. 1974
       Vice President
    F.W. Piderit, Jr.    New York       July 1965      Present
       Senior Vice
       President
    T. K. Desch,         Philadelphia   Aug. 1972      Present
       Vice President
    J. R. Campbell,      Philadelphia   Jan. 1969      July 1972
       Senior Vice
       President
    H. W. Huning;        Cleveland      Oct. 1964      Present
       Vice President
    W. S. Farmer,        Richmond       June 1976      Present
       Senior Vice
       President
    J. L. Nosker,        Richmond       Jan. 1961      May   1976
       Senior Vice
        Prestdent
     R. Z. Heck,         Atlanta        Nov. 1972      Present
       Vice President
     R. M. Stephenson,   Atlanta        July 1964      Oct. 1972
       Vice President
     J. R. Morrison,     Chicago        Jan. 1970      Present
        Senior Vice
        President

                                  V-4
APPENDIX V                                          APPENDIX V

                                         Tenture of office
                                         From          To
   H. E. Uthoff,          St. Louis     Oct. 1970      Present
     Senior Vice
     President
   L. G. Gable,           Minneapolis   July 1967      Present
     Vice President
   W. T. Bilington,       Kansas City   July 1971      Present
     Senior Vice
     President
   R. E. Scott,           Kansas City   July 1970     July 1971
     Senior Vice
     President (acting)
   T. R. Sullivan,        Dallas        June 1962      Present
     Vice President
   H. B. Jamison,         San Francisco Nov. 1971      Present
     Vice President
   I. L. Jennings,        San Francisco Jan. 1969     Oct. 1971
     Senior Vice
     President




                              V-5