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Showing posts with label FDIC. Show all posts
Showing posts with label FDIC. Show all posts

Thursday, March 19, 2015

FDIC CHAIRMAN GRUENBERG'S STATEMENT BEFORE COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS

FROM:  FEDERAL DEPOSIT INSURANCE CORPORATION 
Speeches & Testimony
Statement of Martin J. Gruenberg, Chairman, Federal Deposit Insurance Corporation: Examining the Regulatory Regime for Regional Banks before the Committee on Banking, Housing, and Urban Affairs; 538 Dirksen Senate Office Building; Washington, DC
March 19, 2015

Chairman Shelby, Ranking Member Brown, and members of the Committee, I appreciate the opportunity to testify on the regulatory regime for regional banks. My testimony will begin with a profile of the large companies subject to the enhanced prudential standards requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). I then will describe how regulators have implemented the enhanced standards requirements. Finally, I will review various considerations important to any discussion of proposals to change these requirements.

Profile of Large Companies Subject to Section 165

Section 165 of the Dodd-Frank Act requires the Board of Governors of the Federal Reserve System (Federal Reserve) to establish enhanced prudential standards for certain groups of institutions. The Act defines these institutions to include bank holding companies with total consolidated assets equal to or greater than $50 billion and nonbank financial companies that the Financial Stability Oversight Council (Council) has designated for Federal Reserve supervision.
The companies that meet the $50 billion threshold for enhanced prudential standards represent a significant portion of the U.S. banking industry. As of December 31, 2014, 37 companies with combined assets of $15.7 trillion reported total assets greater than $50 billion. They owned a total of 72 FDIC-insured subsidiary banks and savings institutions, with combined assets of $11.3 trillion, or 73 percent of total FDIC-insured institution assets.

The 37 companies represent a diverse set of business models. The four largest companies, holding combined assets of $8.2 trillion, are universal banks that engage in commercial banking, investment banking, and other financial services. Another twenty companies holding $3.3 trillion in assets are diversified commercial banks that essentially take deposits and make loans. The remaining 13 companies, with a combined total of $4.2 trillion in assets, do not engage predominantly in traditional commercial banking activities. These companies include two investment banks, four custodial banks, two credit-card banks, one online bank, and four specialty institutions. The 37 institutions include eight U.S.-owned institutions that are designated as global systemically important banks by the Financial Stability Board. They include the four universal banks, two investment banks, and two custodial banks.

By way of contrast, the FDIC's Community Banking Study of December 2012 profiled institutions that provide traditional, relationship-based banking services. The FDIC developed criteria for the Study to identify community banks that included more than a strict asset size threshold. These criteria included a ratio of loans-to-assets of at least 33 percent, a ratio of core deposits-to-assets of at least 50 percent, and a maximum of 75 offices operating in no more than two large metropolitan statistical areas and in no more than three states. Based on criteria developed in the Study, 93 percent of all FDIC-insured institutions with 13 percent of FDIC-insured institution assets currently meet the criteria of a community bank. This represents 6,037 institutions, 5,676 of which have assets under $1 billion. The average community bank holds $342 million in assets, has a total of six offices, and operates in one state and one large metropolitan area.

The FDIC does not have a similar set of criteria to identify regional banks. Regional banks may be thought of as institutions that are much larger in asset size than a typical community bank and that tend to focus on more traditional activities and lending products. These institutions typically have expanded branch operations and lending products that may serve several metropolitan areas and they may do business across several states. Regional banks are less complex than the very largest banks, which may have operations and revenue sources beyond traditional lending products.

The 20 holding companies identified as diversified commercial banks -- the subset of the 37 institutions with total assets over $50 billion noted earlier -- have a traditional banking business model that involves taking deposits and making loans, and they derive the majority of their income from their lending activities. Operationally, however, the 20 diversified commercial banks are much more complex than traditional community banks. They operate in a much larger geographic region, and have a much larger footprint within their geographic region.

Of the 20 holding companies:

Seven have total assets from $50 billion to $100 billion. They have an average of nearly 700 offices, and operate in 12 states and 22 large metropolitan areas.
Nine have assets from $100 billion to $250 billion. They have an average of nearly 1,200 offices, and operate in 12 states and 24 large metropolitan areas.
Four have total assets from $250 billion to $500 billion. They have an average of nearly 1,800 offices, and operate in 18 states and 24 large metropolitan areas.
The operational complexity of these 20 diversified commercial bank holding companies presents challenges that community banks do not. Supervisory tools and regulations need to match the complexity of these large $50 billion plus organizations. Any particular institution at the lower to middle part of the grouping may be a dominant player within a particular geographic or market segment and as such may require greater regulatory attention. If there would be a failure, the resolution of any one of these organizations may present challenges. In addition, the failure of more than one of these institutions during a period of severe financial stress could present challenges to financial stability.
Implementation of Enhanced Prudential Standards

Section 165 provides the FDIC with explicit responsibilities in two substantive areas related to prudential supervision: resolution plans and stress testing. In both areas, the FDIC has tailored requirements to fit the complexity of the affected institutions.

Resolution planning

Resolution plans, or living wills, are an important tool for protecting the economy and preventing future taxpayer bailouts. Requiring these plans ensures that firms establish, in advance, how they could be resolved in an orderly way under the Bankruptcy Code in the event of material financial distress or failure. The plans also provide important information to regulators, so they can better prepare for failure to protect markets and taxpayers.

In 2011, the FDIC and the Federal Reserve jointly issued a final rule implementing the resolution plan requirements of Section 165(d) of the Dodd-Frank Act (the 165(d) rule) for bank holding companies. The FDIC also issued a separate rule that requires all insured depository institutions (IDIs) with greater than $50 billion in assets to submit resolution plans to the FDIC for their orderly resolution through the FDIC's traditional resolution powers under the Federal Deposit Insurance Act (FDI Act). The 165(d) rule and the IDI resolution plan rule are designed to work in tandem by covering the full range of business lines, legal entities, and capital-structure combinations within a large financial firm.
Bank holding companies with $50 billion or more in total consolidated assets and nonbank financial companies regulated by the Federal Reserve are subject to the requirement to prepare resolution plans. However, the FDIC and the Federal Reserve used our statutory discretion to develop a joint resolution planning rule which recognizes the differences among institutions and scales the regulatory requirements and potential burdens to the size and complexity of the institutions subject to that rule. The joint rule also allows the agencies to modify the frequency and timing of required resolution plans.

Our resolution plan regulations also are structured so that both firms and regulators are focused on the areas of greatest risk. Smaller, simpler, and less complex institutions have much smaller and simpler resolution plans than more systemic institutions, with complex structures, multiple business lines, and large numbers of legal entities.

In implementing the requirement for resolution plans, the FDIC and the Federal Reserve instituted a staggered schedule for plan submissions to reflect differing risk profiles. The first group of companies required to file plans on or before July 1, 2012, included bank holding companies with $250 billion or more in nonbank assets. This group comprised 11 institutions—seven U.S. bank holding companies and four foreign banking organizations. These institutions generally ranked among the largest institutions in the United States, although some equally large institutions with smaller amounts of nonbank assets, did not file in this group.

The second group was comprised of bank holding companies with $100 billion or more, but less than $250 billion, in total non-bank assets. These firms submitted their initial resolution plans on or before July 1, 2013. The remaining companies, those subject to the rule with less than $100 billion in total non-bank assets, submitted their initial plans on or before December 31, 2013.

Grouping the firms by their holdings of nonbank assets provided the agencies with an initial proxy for firm complexity. By delaying the submission of plans for those with fewer nonbank assets, less complex firms were given more time to prepare. The FDIC and the Federal Reserve also were able to focus on those firms that are more likely to pose serious adverse effects to the U.S. financial system should they need to be resolved under the Bankruptcy Code. Based on their groupings and measured by asset size as of December 2011, no U.S. bank holding company (BHC) with less than $200 billion in total consolidated assets was required to file with either the first or second group of filers.

For their initial submissions, bank holding companies with less than $100 billion in total nonbank assets and 85 percent or more of their assets in an insured depository institution also were generally permitted to submit tailored resolution plans. Tailored resolution plans simplify the task of creating a living will by aligning it with the FDIC’s IDI resolution plan requirement and focusing on the firm’s nonbank operations. Since the initial filings, the FDIC and Federal Reserve have further recognized differences among institutions with less than $100 billion in nonbank assets and nearly all U.S. institutions in this category filed tailored plans.

Though smaller firms are less systemic, appropriately tailored resolution plans or other enhanced prudential supervision requirements for these firms provide important benefits. Any particular institution at the lower to middle part of the grouping may be a dominant player within a particular geographic or market segment, and its failure would likely have a sizeable impact for those markets. The Deposit Insurance Fund also would face a substantial loss from the failure of even one of these firms. Finally, the size of these firms presents an obstacle in arranging the sale to another firm as only other larger firms would be likely acquirers. Therefore, the FDIC and Federal Reserve should continue to receive and review resolution plans in order to ensure that a rapid and orderly resolution of these companies through bankruptcy could occur in a way that protects taxpayers and the economy.

Stress testing

Section 165(i)(2) of the Dodd-Frank Act requires the federal banking agencies to issue regulations requiring financial companies with more than $10 billion in total consolidated assets to conduct annual stress tests. The statutory language governing stress testing is more detailed and prescriptive than the language covering other prudential standards, leaving the regulators with less discretion to tailor the stress testing process. The Act requires IDIs and BHCs with assets greater than $10 billion to conduct an annual company-run stress test, while BHCs with assets greater than $50 billion must conduct semiannual, company-run stress tests and also are subject to stress tests conducted by the Federal Reserve. The company-run tests must include three scenarios and the institutions must publish a summary of the results.

In October 2012, the FDIC, OCC, and the Federal Reserve issued substantially similar regulations to implement the company-run stress test requirements. The FDIC’s stress testing rules, like those of the other agencies, are tailored to the size of the institutions consistent with the expectations under section 165 for progressive application of the requirements. Under the agencies' implementing regulations, organizations in the $10 billion to $50 billion asset size range have more time to conduct the tests and are subject to less extensive informational requirements, as compared to larger institutions. Currently, 107 IDIs are subject to the banking agencies’ stress testing rules, with the FDIC serving as primary federal regulator for 28 of these IDIs.

Stress testing requirements are an important risk-assessment supervisory tool. The stress tests conducted under the Dodd-Frank Act provide forward-looking information to supervisors to assist in their overall assessments of a covered bank’s capital adequacy and to aid in identifying downside risks and the potential impact of adverse outcomes on the covered bank. Further, these stress tests are expected to support ongoing improvement in a covered bank’s internal assessments of capital adequacy and overall capital planning.

Other Regulatory Standards Affecting Regional Banks

Many of the standards required under section 165 address issues that are within the longstanding regulatory and supervisory purview of the federal banking agencies. For example, with respect to banking organizations, the agencies have pre-existing authority to establish regulatory capital requirements, liquidity standards, risk-management standards, and concentration limits, to mandate disclosures and regular reports, and to conduct stress tests or require banking organizations to do so. These are important safety and soundness authorities that the agencies have exercised by regulation and supervision in the normal course and outside the context of section 165.

The FDIC's capital rules are issued pursuant to its general safety and soundness authority and the FDI Act. In many cases, FDIC capital regulations and those of other federal banking agencies are consistent with standards developed by the Basel Committee on Banking Supervision. For example, recent comprehensive revisions to the agencies’ capital rules and the liquidity coverage ratio rule incorporated aspects of the Basel III accord, which was developed separate and independent from, and mostly before, the Dodd-Frank Act was finalized.

These capital and liquidity rules play an important role in promoting the safety and soundness of the banking industry, including regional and larger banks. The agencies’ capital rules are entirely consistent with the statutory goal in section 165 of progressively strengthening standards for the largest institutions. As a baseline, a set of generally applicable capital rules apply to all institutions. A defined group1 of large or internationally active banking organizations are subject to more extensive U.S. application of Basel capital and liquidity standards. In addition, eight Global Systemically Important Banks (G-SIBs) are subject to enhanced supplemental leverage capital requirements.
Policy Considerations

Section 165 establishes the principle that regulatory standards should be more stringent for the largest institutions. This idea is rooted in the experience of the financial crisis, where the largest financial institutions proved most vulnerable to sudden market-based stress, with effects that included significant disruption of the real economy. The thresholds in the enhanced prudential standards legislative framework state Congress’s expectation for the asset levels at which enhanced regulatory standards should start to apply, while providing for regulatory flexibility to set the details of how those standards should progress in stringency.
In our judgment, the concept of enhanced regulatory standards for the largest institutions is sound, and is consistent with our longstanding approach to bank supervision. Certainly, degrees of size, risk, and complexity exist among the banking organizations subject to section 165, but all are large institutions. Some of the specializations and more extensive operations of regional banks require elevated risk controls, risk mitigations, corporate governance, and internal expertise than what is expected from community banks. We should be cautious about making changes to the statutory framework of heightened prudential standards that would result in a lowering of expectations for the risk management of large banks.

That being said, it is appropriate to take into account differences in the size and complexity of banking organizations when formulating regulatory standards. The federal banking agencies have taken into account such differences in a number of contexts separate and apart from section 165. Examples include asset thresholds for the interagency capital rules, trading book thresholds for the application of the market risk rule, and proposed notional derivatives thresholds for margin requirements. These examples and other size thresholds illustrate that precedents exist apart from section 165 for the application of different and heightened regulatory standards to larger institutions, and that different size thresholds may be appropriate for different types of requirements. Finally, many of the rules that apply to more complex capital market activities do not apply, as a practical matter, to the types of traditional lending activities that many regional banks conduct.

Conclusion

Section 165 provides for significant flexibility in implementation of its requirements. The agencies have made appropriate use of this flexibility thus far, and where issues have been raised by industry, we believe that we have been responsive. The FDIC remains open to further discussion on how best to tailor various enhanced prudential standards and other regulations and supervisory actions to best address risk profiles presented by large institutions, including regional banks.

Saturday, November 8, 2014

FED BANKING AGENCIES REPORT "SERIOUS DEFICIENCIES IN UNDERWRITING STANDARDS AND RISK MANAGEMENT OF LEVERAGED LOANS"

FROM:  FEDERAL DEPOSIT INSURANCE CORPORATION 
For Immediate Release November 7, 2014 
Credit Risk in the Shared National Credit Portfolio is High; Leveraged Lending Remains a Concern

The credit quality of large loan commitments owned by U.S. banking organizations, foreign banking organizations (FBOs), and nonbanks is generally unchanged in 2014 from the prior year, federal banking agencies said Friday. In a supplemental report, the agencies highlighted findings specific to leveraged lending, including serious deficiencies in underwriting standards and risk management of leveraged loans.

The annual Shared National Credits (SNC) review found that the volume of criticized assets remained elevated at $340.8 billion, or 10.1 percent of total commitments, which approximately is double pre-crisis levels. The stagnation in credit quality follows three consecutive years of improvements. A criticized asset is rated special mention, substandard, doubtful, or loss as defined by the agencies' uniform loan classification standards. The SNC review was completed by the Federal Reserve Board, Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency.

Leveraged loans as reported by agent banks totaled $767 billion, or 22.6 percent of the 2014 SNC portfolio and accounted for $254.7 billion, or 74.7 percent, of criticized SNC assets. Material weaknesses in the underwriting and risk management of leveraged loans were observed, and 33.2 percent of leveraged loans were criticized by the agencies.

The leveraged loan supplement also identifies several areas where institutions need to strengthen compliance with the March 2013 guidance, including provisions addressing borrower repayment capacity, leverage, underwriting, and enterprise valuation. In addition, examiners noted risk-management weaknesses at several institutions engaged in leveraged lending including lack of adequate support for enterprise valuations and reliance on dated valuations, weaknesses in credit analysis, and overreliance on sponsor's projections.

Federal banking regulations require institutions to employ safe and sound practices when engaging in commercial lending activities, including leveraged lending. As a result of the SNC exam, the agencies will increase the frequency of leveraged lending reviews to ensure the level of risk is identified and managed.

In response to questions, the agencies also are releasing answers to FAQs on the guidance. The questions cover expectations when defining leveraged loans, supervisory expectations on the origination of non-pass leveraged loans, and other topics. The FAQ document is intended to advance industry and examiner understanding of the guidance, and promote consistent application in policy formulation, implementation, and regulatory supervisory assessments.

Other highlights of the 2014 SNC review:

Total SNC commitments increased by $379 billion to $3.39 trillion, or 12.6 percent from the 2013 review. Total SNC outstanding increased $206 billion to $1.57trillion, an increase of 15.2 percent.

Criticized assets increased from $302 billion to $341 billion, representing 10.1 percent of the SNC portfolio, compared with 10.0 percent in 2013. Criticized dollar volume increased 12.9 percent from the 2013 level.

Leveraged loans comprised 72.9 percent of SNC loans rated special mention, 75.3 percent of all substandard loans, 81.6 percent of all doubtful loans, and 83.9 percent of all nonaccrual loans.

Classified assets increased from $187 billion to $191 billion, representing 5.6 percent of the portfolio, compared with 6.2 percent in 2013. Classified dollar volume increased 2.1 percent from 2013.

Credits rated special mention, which exhibit potential weakness and could result in further deterioration if uncorrected, increased from $115 billion to $149 billion, representing 4.4 percent of the portfolio, compared with 3.8 percent in 2013. Special mention dollar volume increased 29.6 percent from the 2013 level.
The overall severity of classifications declined, with credits rated as doubtful decreasing from $14.5 billion to $11.8 billion and assets rated as loss decreasing slightly from $8 billion to $7.8 billion. Loans that were rated either doubtful or loss account for 0.6 percent of the portfolio, compared with 0.7 percent in the prior review. Adjusted for losses, nonaccrual loans declined from $61 billion to $43billion, a 27.8percent reduction.

The distribution of credits across entity types—U.S. bank organizations, FBOs, and nonbanks—remained relatively unchanged. U.S. bank organizations owned 44.1 percent of total SNC loan commitments, FBOs owned 33.5 percent, and nonbanks owned 22.4 percent. Nonbanks continued to own a larger share of classified (73.6 percent) and nonaccrual (76.7 percent) assets than their total share of the SNC portfolio (22.4 percent). Institutions insured by the FDIC owned 10.1percent of classified assets and 6.7 percent of nonaccrual loans.
The SNC program was established in 1977 to provide an efficient and consistent review and analysis of SNCs. A SNC is any loan or formal loan commitment, and asset such as real estate, stocks, notes, bonds, and debentures taken as debts previously contracted, extended to borrowers by a federally supervised institution, its subsidiaries, and affiliates that aggregates $20 million or more and is shared by three or more unaffiliated supervised institutions. Many of these loan commitments also are participated with FBOs and nonbanks, including securitization pools, hedge funds, insurance companies, and pension funds.

In conducting the 2014 SNC Review, the agencies reviewed $975 billion of the $3.39 trillion credit commitments in the portfolio. The sample was weighted toward noninvestment grade and criticized credits. In preparing the leveraged loan supplement, the agencies reviewed $623 billion in commitments or 63.9 percent of leveraged borrowers, representing 81 percent of all leveraged loans by dollar commitments. The results of the review and supplement are based on analyses prepared in the second quarter of 2014 using credit-related data provided by federally supervised institutions as of December 31, 2013, and March 31, 2014.

Friday, October 24, 2014

6 GOVERNMENT AGENCIES APPROVE FINAL RISK RETENTION RULE

FROM:  U.S. FEDERAL DEPOSIT INSURANCE CORPORATION 
Six Federal Agencies Jointly Approve Final Risk Retention Rule

Six federal agencies approved a final rule requiring sponsors of securitization transactions to retain risk in those transactions. The final rule implements the risk retention requirements in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).

The final rule is being issued jointly by the Board of Governors of the Federal Reserve System, the Department of Housing and Urban Development, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the Office of the Comptroller of the Currency, and the Securities and Exchange Commission. As provided under the Dodd-Frank Act, the Secretary of the Treasury, as Chairperson of the Financial Stability Oversight Council, played a coordinating role in the joint agency rulemaking.

The final rule largely retains the risk retention framework contained in the proposal issued by the agencies in August 2013 and generally requires sponsors of asset-backed securities (ABS) to retain not less than five percent of the credit risk of the assets collateralizing the ABS issuance. The rule also sets forth prohibitions on transferring or hedging the credit risk that the sponsor is required to retain.

As required by the Dodd-Frank Act, the final rule defines a "qualified residential mortgage" (QRM) and exempts securitizations of QRMs from the risk retention requirement. The final rule aligns the QRM definition with that of a qualified mortgage as defined by the Consumer Financial Protection Bureau. The final rule also requires the agencies to review the definition of QRM no later than four years after the effective date of the rule with respect to the securitization of residential mortgages and every five years thereafter, and allows each agency to request a review of the definition at any time. The final rule also does not require any retention for securitizations of commercial loans, commercial mortgages, or automobile loans if they meet specific standards for high quality underwriting.

The final rule will be effective one year after publication in the Federal Register for residential mortgage-backed securitizations and two years after publication for all other securitization types.

Monday, January 13, 2014

FDIC AND FRB RELEASE PUBLIC SECTIONS OF RESOLUTION PLANS FOR LARGE BANK HOLDING COMPANIES

FROM:  FEDERAL DEPOSIT INSURANCE CORPORATION 
Agencies Release Public Sections of Resolution Plans
The Federal Reserve Board and the Federal Deposit Insurance Corporation (FDIC) on Friday made available the public portions of resolution plans for 116 institutions that submitted plans for the first time in December 2013, the latest group to file resolution plans with the agencies.
The Dodd-Frank Wall Street Reform and Consumer Protection Act requires that bank holding companies (and foreign companies treated as bank holding companies) with total consolidated assets of $50 billion or more and nonbank financial companies designated for enhanced prudential supervision by the Financial Stability Oversight Council periodically submit resolution plans to the Federal Reserve Board and the FDIC. Each plan must describe the company’s strategy for rapid and orderly resolution in the event of material financial distress or failure of the company, and include both a public and confidential section.

Companies subject to the resolution plan requirement filed their initial resolution plans on a staggered schedule. The 116 companies whose initial resolution plans were due by December 31, 2013, are those that generally have less than $100 billion in qualifying nonbank assets.
Two groups of institutions have already filed resolution plans. The first group, generally those bank holding companies with $250 billion or more in qualifying nonbank assets, submitted initial plans in July 2012 and their second annual plans in October 2013. The second group, generally those with $100 billion or more, but less than $250 billion, in qualifying nonbank assets, submitted their initial plans in July 2013. The group that was required to file their initial plans last month represents the third group of filers.

The public portions for the 116 companies’ resolution plans, as well as those of institutions that filed previously, are available on the Federal Reserve and FDIC websites.

In addition, the FDIC released the public sections of the recently filed resolution plans of 22 insured depository institutions. The majority of these insured depository institutions are subsidiaries of bank holding companies that concurrently submitted resolution plans. The insured depository institution plans are required by a separate regulation issued by the FDIC. The FDIC’s regulation requires a covered insured depository institution with assets greater than $50 billion to submit a plan under which the FDIC, as receiver, might resolve the institution under the Federal Deposit Insurance Act.

The public portions for the 22 covered insured depository institutions are available on the FDIC website.

Wednesday, November 20, 2013

FDIC ANNOUNCES SETTLEMENT WITH JP MORGAN CHASE & CO. IN RESIDENTIAL MORTGAGE-BACKED SECURITIES CASE

FROM:  U.S. FEDERAL DEPOSIT INSURANCE CORPORATION

The Federal Deposit Insurance Corporation (FDIC) as Receiver for six failed banks has announced a $515.4 million settlement with JPMorgan Chase & Co. and its affiliates (JPMorgan) of the receiverships' federal and state securities law claims based on misrepresentations in the offering documents for 40 residential mortgage-backed securities (RMBS) purchased by the failed banks. The settlement funds will be distributed among the receiverships for the failed Citizens National Bank, Strategic Capital Bank, Colonial Bank, Guaranty Bank, Irwin Union Bank and Trust Company, and United Western Bank. As part of the settlement, JPMorgan has agreed to waive any claims for indemnification from the FDIC in its corporate capacity or its capacity as Receiver for the failed Washington Mutual Bank based on any part of JPMorgan's $13 billion settlement with the United States Department of Justice and other government entities of claims relating to the sale of RMBS, including the $515.4 million settlement with the FDIC.

FDIC Chairman Martin J. Gruenberg said, "The settlement announced today will provide a significant recovery for the six FDIC receiverships. It also fully protects the FDIC from indemnification claims out of this settlement. The FDIC will continue to pursue litigation where necessary in order to recover as much as possible for FDIC receiverships, money that is ultimately returned to the Deposit Insurance Fund, uninsured depositors and creditors of failed banks."

As receiver for failed financial institutions, the FDIC may sue professionals and entities whose conduct resulted in losses to those institutions in order to maximize recoveries. From May 2012 to September 2012, the FDIC as Receiver for five of the failed banks filed ten lawsuits against JPMorgan, its affiliates, and other defendants for violations of federal and state securities laws in connection with the sale of RMBS. As of October 30, 2013, the FDIC has authorized lawsuits based on the sale of RMBS to a total of eight failed institutions and has filed 18 lawsuits seeking damages for violations of federal and state securities laws.

Citizens National Bank and Strategic Capital Bank were each placed into receivership on May 22, 2009; Colonial Bank was placed into receivership on August 14, 2009; Guaranty Bank was placed into receivership on August 21, 2009; Irwin Union Bank and Trust Company was placed into receivership on September 18, 2009; and United Western Bank was placed into receivership on January 21, 2011.

Wednesday, November 6, 2013

FDIC, BANK OF ENGLAND AND OTHERS WANT UNIFORM LANGUAGE IN DERIVATIVE CONTRACTS

FROM:  U.S. FEDERAL DEPOSIT INSURANCE CORPORATION

Federal Deposit Insurance Corporation, Bank of England, German Federal Financial Supervisory Authority and Swiss Financial Market Supervisory 

Authority Call for Uniform Derivatives Contracts Language 
Change Would Facilitate the Resolution of a Global Systemically Important Financial Institution

The Federal Deposit Insurance Corporation (FDIC), together with the Bank of England, the German Federal Financial Supervisory Authority (BaFin), and the Swiss Financial Market Supervisory Authority (FINMA), have authored a joint letter to encourage the International Swaps and Derivatives Association, Inc. (ISDA) to adopt language in derivatives contracts to delay the early termination of those instruments in the event of the resolution of a global systemically important financial institution (G-SIFI).

In the letter, the resolution authorities express support for the adoption of changes to ISDA's standard documentation to provide for short-term suspension of early termination rights and other remedies in the event of a G-SIFI resolution. The adoption of such changes would allow derivatives contracts to remain in effect throughout the resolution process following the implementation of a number of potential resolution strategies. By minimizing the disorderly unwinding of such contracts, these changes would place resolution authorities in a better position to resolve G-SIFIs in a manner that promotes financial stability while providing market certainty and transparency.

"Uniform contractual language that limits termination rights with respect to derivatives transactions will greatly enhance the success of a resolution of a global systemically important financial institution (G-SIFI) which by its nature will have significant cross-border operations," said FDIC Chairman Martin J. Gruenberg. "The international regulatory community has worked closely to harmonize the statutory approach to this issue and our request to ISDA reinforces this effort. Continued efforts among international regulators to cooperate on cross-border resolution issues such as this will reduce the risk of global financial instability and minimize moral hazard in the event of a G-SIFI resolution."

Wednesday, October 30, 2013

"OCC AND FDIC PROPOSE RULE TO STRENGTHEN LIQUIDITY RISK MANAGEMENT"

FROM:  FEDERAL DEPOSIT INSURANCE CORPORATION 
OCC and FDIC Propose Rule to Strengthen Liquidity Risk Management

The Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) proposed a rule on Wednesday to strengthen the liquidity risk management of large banks and savings associations.

The OCC and FDIC’s proposed liquidity rule is substantively the same as the proposal approved by the Board of Governors of the Federal Reserve System on October 24, 2013. That proposal, which was developed collaboratively by the three agencies, is applicable to banking organizations with $250 billion or more in total consolidated assets; banking organizations with $10 billion or more in on-balance sheet foreign exposure; systemically important, non-bank financial institutions that do not have substantial insurance subsidiaries or substantial insurance operations; and bank and savings association subsidiaries thereof that have total consolidated assets of $10 billion or more (covered institutions). The proposed rule does not apply to community banks.

Liquidity generally is a measure of how much cash or cash-equivalents and highly marketable assets a company has on hand to meet its obligations. Under the proposed rule, covered institutions would be required to maintain a standard level of high-quality liquid assets such as central bank reserves, government and Government Sponsored Enterprise securities, and corporate debt securities that can be converted easily and quickly into cash. Under the proposal, a covered institution would be required to hold such high-quality liquid assets on each business day in an amount equal to or greater than its projected cash outflows less its projected cash inflows over a 30-day period. The ratio of the firm's high-quality liquid assets to its projected net cash outflow is specified as a "liquidity coverage ratio," or LCR, by the proposal.

"We learned during the financial crisis just how important liquidity is to the stability of the system as a whole, as well as for individual banks," said Comptroller of the Currency Thomas J. Curry. "A number of large institutions, including some with sufficient levels of capital, encountered difficulties because they did not have adequate liquidity, and the resulting stress on the international banking system resulted in extraordinary government actions both globally and at home. The proposed liquidity rule will help ensure that a bank’s cash, and not tax-payer money, is the first line of defense if it faces a short-term funding stress."

"The recent financial crisis demonstrated that liquidity risk can have significant consequences to large banking organizations with effects that spill over into the financial system as a whole and the broader economy. The proposed rule acted on today would establish first quantitative liquidity requirement applied by federal banking agencies and is an important step in helping to bolster the resilience of large internationally active banking organizations during periods of financial stress," said FDIC Chairman Martin J. Gruenberg.

The liquidity proposal is based on a standard agreed to by the Basel Committee on Banking Supervision. The proposed rule is generally consistent with the Basel Committee's LCR standard, but is more stringent in some respects such as the range of assets that will qualify as high-quality liquid assets and the assumed rate of outflows of certain types of funding. In addition, the proposed rule’s transition period is shorter than that included in the Basel framework. The accelerated transition period reflects a desire to maintain the improved liquidity positions that U.S. institutions have established since the financial crisis. Under the proposal, U.S. firms would begin the LCR transition period on January 1, 2015, and would be required to be fully compliant by January 1, 2017.

Wednesday, September 18, 2013

REMARKS BY FDIC VICE CHAIRMAN HOENIG ON 5 YEAR ANNIVERSARY OF LEHMAN BROTHERS MELTDOWN

FROM:  FEDERAL DEPOSIT INSURANCE CORPORATION 
Lehman Brothers: Looking Five Years Back and Ten Years Ahead
Remarks by Thomas M. Hoenig, Vice Chairman, Federal Deposit Insurance Corporation
Presented to the National Association of Corporate Directors, Texas TriCities Chapter Conference, Houston, Texas 
September 2013 
Introduction

A fundamental principle in economics is that incentives matter.  If the rules of the game provide advantages to some over others, protect players against the fallout of taking on excessive risk, or enable irresponsible behavior, we can be confident that the choices people make will be imprudent and the results of the misaligned incentives will be bad.

In the US financial system these conditions were in force during the decade leading to the Great Recession. It was a decade when monetary policy was highly accommodative; when government protections and subsidies were extended to ever more financial activities; when market discipline became a buzz word rather than a tool; and when the competitive advantage bestowed on some sectors of the industry led to a less competitive market.

More concerning is that five years after the crisis, despite new laws and regulations, we are replicating many of the conditions that contributed to the crisis, but we somehow are expecting things to end differently.   How so?

This morning, I will discuss the parallels between this earlier period and now, and I will make a case for a bolder set of actions to address weaknesses in a system that continues to impede our financial markets and economy.

Setting the Stage: Low Interest Rates

Extended periods of exceptionally low interest rates undermine a sound economy.  Their short-term effects on the economy can be favorable and dramatic, which creates a significant temptation for policymakers to keep rates low for a considerable period.   However, history suggests that extended periods of abnormally low rates often lead to negative long-run effects as they weaken credit standards, encourage the heavy use of credit, and too often adversely affect financial and economic stability.

For example, starting with the Mexican financial crisis of 1994 through the Asian and Russian crises of the late ’90s, aggressive expansionary US monetary policy was used with apparent success.  In each instance, the immediate crisis was staunched, markets continued operating, and the economy bounced back. Such success led to the expectation that monetary policy could clean up the effects of any financial excess or imbalance that the US economy might develop.   Low interest rates became the expected remedy that would stimulate the economy and avoid recession, or that would prevent the proliferation of a crisis.

Having been successful during the ’90s, the Federal Open Market Committee (FOMC), "doubled down" its use of low interest rates during the subsequent decade as it encountered financial and economic weaknesses. Following the collapse of the tech bubble, the real federal funds rate was negative for most of the period 2002 through 2005. It is noteworthy that in June 2003, the nominal federal funds rate was lowered from 1 1/4 percent to 1 percent and remained there for nearly a year, despite the fact that the economy grew at a rate of nearly 7 percent in the quarter following this rate reduction.

Because there were no signs of accelerating inflation, the FOMC felt confident that there was no need to quickly reverse policy, so it remained either highly or relatively accommodative well into the recovery. The first increase in the federal funds rate occurred in June 2004, only after evidence was overwhelming that economic activity had begun to accelerate. Not until March 2006 did the federal funds rate reach its long-term average level.

Within an environment of a highly accommodative monetary policy and sustained low interest rates, credit growth accelerated and serious financial imbalances developed. During the period 2002 to the end of 2007, total debt outstanding for households and financial and non-financial firms increased from $22 trillion to $37 trillion, or almost 70 percent. In hindsight, of course, it seems obvious that problems would result.

This history begs the question, therefore, of how current monetary policy might affect economic and financial conditions in 2013 and beyond. The FOMC again is fully engaged in conducting a highly accommodative monetary policy. The target federal funds rate is currently zero to 25 basis points. Through the Federal Reserve’s Quantitative Easing policy, its balance sheet and bank reserves have ballooned to nearly four times the size they were in January 2008. As a result, the real federal funds rate has been negative for most of the period from 2008 to the present.

As with the earlier period, inflation in the US remains relatively subdued, facilitating continued low rates. However, the US also is experiencing significant price increases in various assets, including, for example, land, stocks, and bonds. Banks and the entire financial sector are exposed, directly and indirectly, to significant negative price shocks in nearly all interest rate-sensitive sectors. Also, as capital desperately seeks out yield, there have been significant US dollar capital flows across the globe, causing what appears to be increased financial vulnerability, uncertainty, and instability.

Thus, the actions the FOMC has taken since the crisis ended are more aggressive and will be in place far longer than those taken in the early part of the last decade.

Those who support current money policy insist that circumstances are different this time - a phrase itself that should cause alarm. They suggest that policymakers have better tools to deal with imbalances in the form of renewed market discipline and macro-prudential supervision. However, as I describe below, financial conditions within the system are not as different than many presume. Market discipline has not been strengthened, and macro-prudential supervision may be a new name but it is hardly a tool that was unavailable in the earlier period.

Extending the Safety Net: Adding Risk to the System

During the early part of the last decade, at the time the US was engaging in a systematic expansion of monetary policy, it had just extended the public safety net to an ever wider set of financial activities and firms. In 1999, the Glass-Steagall Act was repealed, which confined the safety net – defined as access to the Federal Reserve liquidity facility and FDIC insurance -- to commercial banks. In its place, the Gramm-Leach-Bliley Act was passed to allow the melding of commercial banking, investment banking, and broker-dealer activities. These changes were intended to enhance the market's role in the economy, to increase competition, and to create a more diversified, stable system.

In practice, however, Gramm-Leach-Bliley undermined that very goal. It allowed firms with access to the public safety net to control a much wider array of financial products and activities, and it provided them a sizable advantage over financial firms outside the safety net. It enabled firms inside the net to fund themselves at lower costs and expand their use of debt -- that is, to lever-up. Under such conditions, firms outside the net, to survive, found it necessary to join this favored group through mergers or other actions. The result is a more highly concentrated industry that is more dependent on government support and where, in the end, the failure of any one firm threatens the broader economy.

Gramm-Leach-Bliley fundamentally changed the financial industry’s business model. Previously, commercial banking involved principally the payments system that transfers money around the country and world, and the intermediation process that transforms short-term deposits into longer-term loans. That model cultivated a culture of win-win, where the success of the borrower meant success to the lender in terms of the repayment of the loan and growth of the credit relationship.

After Gramm-Leach-Bliley, as broker dealer and trading activities began to dominate the banking model, the culture became one of win-lose, with the parties placing bets on asset price movements or directional changes in activity. Thus, broadening the range of activities and risks that banking firms could bring within the safety net changed the risk/return trade-off and significantly changed the incentive structure in banking. While such non-traditional commercial banking activities are essential to the market's function, placing them within the safety net became lethal to the industry and to the economy.

A related effect of the government’s rich financial subsidy was a significant increase in industry leverage, especially among the largest firms. Between 2000 and 2008, the leverage among the 10 largest US firms reached unprecedented levels, as the ratio of tangible assets to tangible common equity capital increased from 22 to 1 to levels exceeding 47 to 1.1

Once the financial panic was set in motion and confidence was lost, firms were forced to rapidly deleverage their balance sheets, creating a chaotic market. The effects were channeled through a highly interconnected financial system to the real economy, causing significant declines in asset values, wealth, and jobs. Between 2008 and the end of 2009, well over 8 million jobs were lost within the US economy alone, and containing the crisis required enormous amounts of FDIC and taxpayer support.

Now, five years after the crisis, we should not ignore that many of the conditions that undermined the economy then still remain within our financial system. These conditions include: a few dominant financial firms – those that are too big to fail - controlling an ever greater portion of financial assets within the US; continued government protections and related subsidies; and the continued reliance on a business model with its heavy use of debt over equity and increased risk in the pursuit of higher, subsidized returns on equity.

Yes, the Dodd-Frank Act introduced hundreds of regulations designed to control the actions of financial firms. It gives financial supervisors increased oversight of firms and activities, and it requires the Federal Reserve and the FDIC to oversee the development of resolution programs for the largest firms. However, when you work through the details, the law and rules mostly reiterate powers long available to supervisors. It adds numerous rules and moves responsibilities among regulators, but it makes no fundamental change in the industry’s structure or incentives that drive firms’ actions.

Dodd-Frank adds new supervisory and resolution authorities intended to end bail outs of financial firms and related subsidies. However, this is an old promise and has yet to be successfully implemented. Consider that the US financial system is more concentrated today and the largest firms hold more market power than prior to the crisis. The 10 largest financial firms control nearly 70 percent of the industry's assets, up from 54 percent in 2000. The eight globally systemic US banking firms hold in assets the equivalent of 90 percent of GDP, when you place the fair value of derivatives onto their balance sheets. Moreover, given the breadth and complexity of activities of these firms, they remain highly interconnected and the failure of any one will likely cause a systemic crisis, demanding government intervention.

Dodd-Frank introduces new rules designed to check the expansion of the subsidy. The Volcker Rule, for example, is supposed to move bank trading activities away from the insured bank. However, the rule has yet to be implemented, and even if it is fully implemented, it allows broker-dealer activities to stay within the same corporate entity, which itself benefits from the government’s safety net.

Consistent with these observations, there is a long list of studies documenting the existence of a government subsidy unique to the largest firms that extends across their balance sheets. While the industry vigorously argues that no subsidy exists, the preponderance of evidence suggests otherwise.2 Thus, while new authorities designed to mitigate this subsidy have been introduced, they have yet to be used or successfully tested. It is worth noting, for example, that under the Bank Holding Company Act, regulatory authorities have long had the authority to force divestiture of non-bank affiliates if they threaten the viability of the related bank. To my knowledge, this authority has never been used.

Therefore, as before the crisis, too big to fail and its subsidy continue to affect firms’ behavior. They enable the largest firms to fund themselves at lower cost than other firms providing a competitive advantage that facilitates the biggest firms’ dominance within the industry and multiplying their impact to the broader economy.

Also, although the US has introduced a supplemental leverage ratio to the capital standards, these largest firms carry significantly more leverage following from the subsidy than the industry more broadly. Using International Financial Reporting Standards, the average leverage ratio of the eight globally systemic US banks is nearly 25 to 1.3 This leverage is comparable to what the largest US firms carried in the years leading up to the crisis in 2008 and, as events demonstrated, it reflects too little capital to absorb significant shocks that might occur within the financial sector.

These leverage ratios stand in contrast to those for the remainder of the US banking industry. For example, the average leverage ratio for each category of banks -- from community, to regional, to super-regional -- is less than 14 to 1. This lower ratio reflects the fact that creditors of these firms are more directly exposed to loss should failure occur and, therefore, they insist on a larger capital cushion.

Thus, in comparing today’s financial system to that of 2008, I worry that the industry is more concentrated, that the system remains vulnerable to shock, and that the economy remains vulnerable to crisis. Even within the confines of Dodd-Frank, the industry’s structure, incentives and balance-sheets are more similar to 2008 than different. And, as always, we can’t anticipate the source of the shock until it strikes.

Rethinking Status Quo Solutions

It has been noted that, “We cannot solve our problems with the same thinking we used when we created them.”4 The economy has struggled through this recovery in a post Dodd-Frank environment perhaps because the public realizes that while we have more rules, too little has changed. It is my hope that people remain cautious so that five years from now – ten years after the collapse of Lehman Brothers – we will not be in an all-too-familiar place, facing an all-too-familiar banking crisis.

We need to regain our economic footing by rethinking our solutions. As I have been suggesting since before joining the FDIC, the US requires a monetary policy that better balances short-term and long-term policy goals. We need to rationalize, not consolidate, the structure of the financial industry and narrow the federal safety net to its intended purpose of protecting only the payments and intermediation systems that commercial banks operate.5 At a minimum, simplifying the structure would enhance the FDIC’s ability to implement its new authorities to resolve institutions should they fail. In addition, the US must lead the world in strengthening and simplifying the capital requirements for regulated financial firms, particularly for the largest, most systemically important firms.6 A strong capital base for individual firms and the industry is essential to a strong, market-based financial system.

A decentralized financial structure supported by a strong capital base and market accountability, too long ignored but fundamentally correct, would further change industry incentives and strengthen its performance. Finally, and importantly, these conditions would make the industry more responsive to the market, providing opportunity for success and failure -- both of which are essential elements of capitalism.



The views expressed are those of the author and not necessarily those of the FDIC

1 Tangible common equity capital is total equity capital less non-Treasury preferred stock, goodwill and other intangible assets.

2 http://www.fdic.gov/news/news/speeches/litreview.pdf
http://www.richmondfed.org/publications/research/special_reports/safety_net/pdf/safety_net_methodology_sources.pdf

3 The International Financial Reporting Standards (IFRS) approach to financial statement reporting is set by the International Accounting Standards Board.  A significant difference between U.S. GAAP and IFRS is IFRS only allows the netting of derivative instruments on the balance sheet when the ability and intent to settle on a net basis is unconditional. http://www.fdic.gov/about/learn/board/hoenig/capitalizationratios2q13.pdf

4 The quote is widely attributed Albert Einstein, though scholars have not verified its authenticity. http://www.albert-einstein-quotes.org.za/

5 “Restructuring the Banking System to Improve Safety and Soundness” white paper by Thomas M. Hoenig and Charles S. Morris - http://fdic.gov/about/learn/board/Restructuring-the-Banking-System-05-24-11.pdf
“A Turning Point: Defining the Financial Structure” speech by Thomas M. Hoenig to the Annual Hyman P. Minsky Conference at the Levy Economics Institute of Bard College. April 17, 2013 - http://fdic.gov/news/news/speeches/spapr1713.html

6 “Basel III Capital: A Well-Intended Illusion” speech by Thomas M. Hoenig to the International Association of Deposit Insurers 2013 Research Conference in Basel, Switzerland. April 9, 2013 - http://fdic.gov/news/news/speeches/spapr0913.html

Friday, August 2, 2013

SEEKING GUIDANCE ON DODD-FRANK STRESS TEST GUIDANCE FOR MEDIUM-SIZED FIRMS

FROM:  FEDERAL DEPOSIT INSURANCE CORPORATION

Agencies Seek Comment on Dodd-Frank Act Stress Test Guidance for Medium-sized Firms

Three federal bank regulatory agencies are seeking comment on proposed guidance describing supervisory expectations for stress tests conducted by financial companies with total consolidated assets between $10 billion and $50 billion.

These medium-sized companies are required to conduct annual company-run stress tests beginning this fall under rules the agencies issued in October 2012 to implement a provision in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).

To help these companies conduct stress tests appropriately scaled to their size, complexity, risk profile, business mix, and market footprint, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency are proposing guidance to provide additional details tailored to these companies.

The stress test rules allow flexibility to accommodate different approaches by different companies in the $10 billion to $50 billion asset range. Consistent with this flexibility, the proposed guidance describes general supervisory expectations for Dodd-Frank Act stress tests, and, where appropriate, provides examples of practices that would be consistent with those expectations.

The public comment period on the proposed supervisory guidance will be open until September 25, 2013.

Saturday, July 13, 2013

THOMAS HOENIG'S STATEMENT ON BASEL III AND FINANCIAL STABILITY

FROM:  FEDERAL DEPOSIT INSURANCE CORPORATION 
Statement by Thomas Hoenig: Basel III Capital Interim Final Rule and Notice of Proposed Rulemaking

I wish to thank the many individuals from the U.S. and international communities involved in the Basel process for their efforts to improve the capital standard: its definition, measures of risk, and levels of protection. I am particularly aware that our FDIC staff shared a heavy burden in the work, and they deserve our thanks.

Despite this impressive effort, I am able to support only one of the two proposals before us today.

It is often suggested that Basel III provides more and better capital than earlier versions of the Basel standards. However, this is not a worthy standard of comparison given Basel II's contribution to the last crisis. To compare nearly any standard to Basel II will show improvement.

I support more and better capital; however, the Basel III standard without a binding leverage constraint remains inadequate to the task of assuring the American public, who paid a high price for the financial crisis, that our capital standards are adequate to contribute to financial stability. A capital standard, to be useful, must be understandable and enforceable and must be sufficient to absorb unexpected loss. Unfortunately, the Basel III interim final rule, as proposed, fails to fully meet these criteria.

The interim final rule continues the disparity in capital requirements between and among banks, and affects operational and competitive positions within the financial industry. This disparity has been confirmed as recently as last week in a study released by the Basel Committee.

While Basel III strengthens the definition of capital, its primary reliance on a risk-weighted asset standard employs the same techniques as Basel II with ratios that remain unduly complex, difficult to compute and requiring a vast number of calculations just begging to be gamed. This result is well illustrated when considering that the percentage of risk-weighted assets to total assets for the world's largest banks has systematically declined almost since the introduction of the Basel standards. The result has been confusion instead of clarity among the public and among bank directors who have a responsibility to oversee these firms.

The supervisory world has been made aware through a growing body of research that risk-weighted capital measures correlate poorly with actual future losses, reflecting the reality that complexity does not assure predictability nor enable individuals to know in advance how risks will shift among assets. Despite these flaws, the interim final rule continues to rely on risk-based measures, ignoring the usefulness of the leverage ratio to constrain excess risk taking for the largest, most complex institutions.

To that point, Basel III provides for a 3 percent supplemental leverage ratio applicable to advanced approach firms. This ratio measures capital against total assets and a portion of off-balance sheet exposures. It is important to know that just prior to the crisis these firms held tangible capital averaging just under 3 percent of assets, an amount that proved woefully inadequate. That a 3 percent leverage ratio is too low was appropriately noted by the Board of Governors during its July 2 discussions of this topic.

Also, a wide variety of studies and data accumulated during the comment period provide further evidence of the significant contribution that a stronger leverage ratio would bring to these firms' balance sheets. Thus, failure to include an adequate leverage ratio in the interim final rule leaves a gaping hole in the Basel III standard that has been pointed out to policymakers for months.

Moreover, nothing is accomplished by acting now and failing to wait an extra 60 or 90 days to receive comment and then implement a complete rule with a stronger leverage ratio. All of the largest, most complex U.S. firms currently meet the requirements of the interim final rule. It does nothing in the interim to strengthen the balance sheets of U.S. banks. Thus, by separating the implementation of Basel III from the supplemental leverage ratio proposal, we gain little and risk a stronger leverage ratio being delayed, or worse, not being adopted.

In summary, I support the FDIC's leadership in proposing to raise the supplemental leverage ratio for the eight largest financial holding companies in the U.S. to 6 percent for the banks and 5 percent for the holding company. I also would encourage comment on whether these capital levels are sufficient. I cannot support the interim final rule because without a binding leverage ratio, it is incomplete and inadequate. You cannot have a strong capital standard without an adequate leverage ratio, and it should be part of any rule we adopt, even on an interim basis.

Finally, I have voiced my concerns with the inadequacies of Basel III and have advocated for a stronger leverage ratio over the past year in hopes of creating a capital program that serves the broader economy. My divided vote today signals my continued concern for what is left undone. I remain fully committed to engaging with my colleagues to strengthen U.S. capital standards and to ensure that promised improvements are realized.

Thursday, July 11, 2013

FDIC CHAIRMAN GRUENBERG GIVES STATEMENT ON MITIGATING SYSTEMIC RISK THROUGH REFORM

FROM:  FEDERAL DEPOSIT INSURANCE CORPORATION 

Statement Of Martin J. Gruenberg, Chairman, Federal Deposit Insurance Corporation on Mitigating Systemic Risk Through Wall Street Reform before the Committee on Banking, Housing, and Urban Affairs of the U.S. Senate; 538 Dirksen Senate Office Building

July 11, 2013 

Chairman Johnson, Ranking Member Crapo and members of the Committee, thank you for the opportunity to testify today on the Federal Deposit Insurance Corporation's (FDIC) actions to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).

With the three-year anniversary of the Dodd-Frank Act approaching, the FDIC has made significant progress in implementing the new authorities granted by the Act, 1 particularly with regard to the authorities to address the issues presented by institutions that pose a risk to the financial system. We also have moved forward in our efforts to strengthen the Deposit Insurance Fund and to improve the resiliency of the capital framework for the banking industry.

My written testimony will address three key areas. First, I will provide a brief overview of the current state of the banking industry and the federal deposit insurance system. Second, I will provide an update on our progress in implementing the new authority provided to the FDIC to address the issues posed by systemically important financial institutions. Finally, I will discuss the Act’s impact on our supervision of community banks.

Overview of the Banking Industry

The financial condition of the banking industry in the United States has experienced three consecutive years of gradual but steady improvement. Industry balance sheets have been strengthened and capital and liquidity ratios have been greatly improved.

Industry net income has now increased on a year-over-year basis for 15 consecutive quarters. FDIC-insured commercial banks and savings institutions reported aggregate net income of $40.3 billion in the first quarter of 2013, a $5.5 billion (15.8 percent) increase from the $34.8 billion in profits that the industry reported in the first quarter of 2012. Half of the 7,019 FDIC-insured institutions reporting financial results had year-over-year increases in their earnings. The proportion of banks that were unprofitable fell to 8.4 percent, down from 10.6 percent a year earlier.

Credit quality for the industry also has improved for 12 consecutive quarters. Delinquent loans and charge-offs have been steadily declining for over two years. Importantly, loan balances for the industry as a whole have now grown for six out of the last eight quarters. These positive trends have been broadly shared across the industry, among large institutions, mid-size institutions, and community banks.

The internal indicators for the FDIC also have been moving in a positive direction over this period. The number of banks on the FDIC's "Problem List" – institutions that had our lowest supervisory CAMELS ratings of 4 or 5 – peaked in March of 2011 at 888 institutions. By the end of last year, the number of problem banks stood at 651 institutions, dropping further to 612 institutions at the end of the first quarter 2013. In addition, the number of failed banks has been steadily declining. Bank failures peaked at 157 in 2010, followed by 92 in 2011, and 51 in 2012. To date in 2013, there have been 16 bank failures compared to 31 through the same period in 2012.

Despite these positive trends, the banking industry still faces a number of challenges. For example, although credit quality has been improving, delinquent loans and charge-offs remain at historically high levels. In addition, tighter net interest margins and relatively modest loan growth have created incentives for institutions to reach for yield in their loan and investment portfolios, heightening their vulnerability to interest rate risk and credit risk. Rising rates could heighten pressure on earnings at financial institutions that are not actively managing these risks. The federal banking agencies have reiterated their expectation that banks manage their interest rate risk in a prudent manner, and supervisors continue to actively monitor this risk.

Condition of the FDIC Deposit Insurance Fund

As the industry has recovered over the past three years, the Deposit Insurance Fund (DIF) also has moved into a stronger financial position.

Restoring the DIF

The Dodd-Frank Act raised the minimum reserve ratio for the DIF (the DIF balance as a percent of estimated insured deposits) from 1.15 percent to 1.35 percent, and required that the reserve ratio reach 1.35 percent by September 30, 2020. The FDIC is currently operating under a DIF Restoration Plan that is designed to meet this deadline, and the DIF reserve ratio is recovering at a pace that remains on track under the Plan. As of March 31, 2013, the DIF reserve ratio stood at 0.59 percent of estimated insured deposits, up from 0.44 percent at year-end 2012 and 0.22 percent at March 31 of last year. Most of the first quarter 2013 increase in the reserve ratio can be attributed to the expiration of temporary unlimited deposit insurance coverage for noninterest-bearing transaction accounts under the Act on December 31, 2012

The fund balance has grown for thirteen consecutive quarters and stood at $35.7 billion at March 31, 2013. This is in contrast to the negative $21 billion fund balance at its low point at the end of 2009. Assessment revenue and fewer anticipated bank failures have been the primary drivers of the growth in the DIF balance.

Prepaid Assessments

At the end of 2009, banks prepaid to the FDIC more than three years of estimated deposit insurance assessments, totaling $45.7 billion. The prepaid assessments were successful in ensuring that the DIF had adequate liquidity to handle a high volume of bank failures without having to borrow from the Treasury. In accordance with the regulation implementing the prepaid assessment, the FDIC refunded almost $6 billion in remaining unused balances of prepaid assessments to approximately 6,000 insured institutions at the end of June.

Improving Financial Stability and Mitigating Systemic Risk

Capital Requirements

On July 9, the FDIC Board acted on two important regulatory capital rulemakings. First, the FDIC issued an interim final rule that significantly revises and strengthens risk-based capital regulations through implementation of Basel III. This rule consolidates the proposals issued in the three separate notices of proposed rulemakings (NPRs) that the agencies issued last year and includes significant changes from the original proposals to address concerns raised by community banks. Second, the FDIC issued a joint interagency NPR to strengthen the leverage requirements for systemically important banking organizations.

Interim Final Rule on Basel III

The interim final rule on Basel III would strengthen both the quality and quantity of risk-based capital for all banks by placing greater emphasis on Tier 1 common equity capital. Tier 1 common equity capital is widely recognized as the most loss-absorbing form of capital. The interim final rule adopts with revisions the three notices of proposed rulemakings or NPRs that the banking agencies proposed last year. These are the Basel III NPR, the Basel III advanced approaches NPR, and the so-called Standardized Approach NPR. These changes will create a stronger, more resilient industry better able to withstand environments of economic stress in the future.

This interim final rule is identical in substance to the final rules issued by the Federal Reserve Board and the Office of the Comptroller of the Currency (OCC) and allows the FDIC to proceed with the implementation of these revised capital regulations in concert with our fellow regulators. Issuing the interim final rule also allows us to seek comment on the interactions between the revised risk-based capital regulations and the proposed strengthening of the leverage requirements for the largest and most systemically important banking organizations which is described in more detail below.

During the comment period on these proposals, we received a large number of comments, particularly from community banks, expressing concerns with some of the provisions of the NPRs. The interim final rule makes significant changes to aspects of the NPRs to address a number of these community bank comments. Specifically, unlike the NPR, the rule does not make any changes to the current risk-weighting approach for residential mortgages. It allows for an opt-out from the regulatory capital recognition of accumulated other comprehensive income, or AOCI, except for large banking organizations that are subject to the advanced approaches requirements. Further, the rule reflects that the Federal Reserve has adopted the grandfathering provisions of section 171 of the Dodd Frank Act for Trust Preferred Securities issued by smaller bank holding companies. Comments received on all these matters were extremely helpful to the agencies in reaching decisions on the proposals.

The interim final rule includes requirements for large banking organizations subject to the advanced approaches requirements that do not apply to community banks. For example, these advanced approach large institutions would be required to recognize AOCI in regulatory capital and also would face strengthened capital requirements for over-the-counter derivatives.

Consistent with the Basel III international agreement, the interim final rule includes a three percent supplementary leverage ratio that applies only to the 16 large banking organizations subject to the advanced approaches requirements. This supplementary leverage ratio is more stringent than the existing U.S. leverage ratio as it would include certain off-balance sheet exposures in its denominator. Given the extensive off-balance sheet activities of many advanced approaches organizations, the supplementary leverage ratio will play an important role. Finally, the rule maintains the existing U.S. leverage requirements for all insured banks, with the minimum leverage requirements continuing to set a floor for the leverage requirements of advanced approaches banking organizations.

Although the new requirements are higher and more stringent than the old requirements, the vast majority of banks meet the requirements of the interim final rule. Going forward, the rule would have the effect of preserving and maintaining the gains in capital strength the industry has achieved in recent years. As a result, banks should be better positioned to withstand periods of economic stress and serve as a source of credit to local communities.

While much contained in these rules does not apply to community banks, we want to be certain that community banks fully understand the changes in the capital rules that do apply to them. To that end, the FDIC is planning an extensive outreach program to assist community banks in understanding the interim final rule and the changes it makes to the existing capital requirements. We will provide technical assistance in a variety of forms, targeted specifically at community banks, including community bank guides on compliance with the rule, a video that will be available on the FDIC website, a series of regional outreach meetings, and subject matter experts at each of our regional offices whom banks can contact directly with questions.

Interagency NPR on the Supplementary Leverage Ratio

The FDIC joined the Federal Reserve and the OCC in issuing an NPR which would strengthen the supplementary leverage requirements encompassed in the interim final rule for certain large institutions and their insured banks. Using the NPR’s proposed definitions of $700 billion in total consolidated assets or $10 trillion in assets under custody to identify large systemically significant firms, the new requirements would currently apply to eight U.S. bank holding companies and to their insured banks.

As the NPR points out, maintenance of a strong base of capital at the largest, most systemically important institutions is particularly important because capital shortfalls at these institutions can contribute to systemic distress and can have material adverse economy effects. Analysis by the agencies suggests that a three percent minimum supplementary leverage ratio would not have appreciably mitigated the growth in leverage among these organizations in the years preceding the recent crisis. Higher capital standards for these institutions would place additional private capital at risk before calling upon the DIF and the Federal government’s resolution mechanisms.

The NPR would require these insured banks to satisfy a six percent supplementary leverage ratio to be considered well capitalized for prompt corrective action (PCA) purposes. Based on current supervisory estimates of the off-balance sheet exposures of these banks, this would correspond to roughly an 8.6 percent U.S. leverage requirement. For the eight affected banks, this would currently represent $89 billion in additional capital for an insured bank to be considered well-capitalized.

Bank Holding Companies (BHCs) covered by the NPR would need to maintain supplementary leverage ratios of a three percent minimum plus a two percent buffer for a five percent requirement in order to avoid conservation buffer restrictions on capital distributions and executive compensation. This corresponds to roughly a 7.2 percent U.S. leverage ratio, which would currently require $63 billion in additional capital.

An important consideration in calibrating the proposal was the idea that the increase in stringency of the leverage requirements and the risk-based requirements should be balanced. Leverage capital requirements and risk-based capital requirements are complementary, with each type of requirement offsetting potential weaknesses of the other. Balancing the increase in stringency of the two types of capital requirement should make for a stronger and sounder capital base for the U.S. banking system.

Resolution of Systemically Important Financial Institutions

In addition to these capital proposals, the FDIC has made progress on policies and strategies to build a more effective resolution framework for large, complex financial institutions. One of the most important aspects of the Dodd-Frank Act is the establishment of new authorities for regulators to use in the event of the failure of a systemically important financial institution (SIFI).

Resolution Plans – “Living Wills”

Under the framework of the Dodd-Frank Act, bankruptcy is the preferred option in the event of the failure of a SIFI. To make this objective achievable, Title I of the Dodd-Frank Act requires that all bank holding companies with total consolidated assets of $50 billion or more, and nonbank financial companies that the Financial Stability Oversight Council (FSOC) determines could pose a threat to the financial stability of the United States, prepare resolution plans, or “living wills,” to demonstrate how the company could be resolved in a rapid and orderly manner under the Bankruptcy Code in the event of the company’s financial distress or failure. The living will process is an important new tool to enhance the resolvability of large financial institutions through the bankruptcy process.

The FDIC and the Federal Reserve Board issued a joint rule to implement Section 165(d) requirements for resolution plans (the 165(d) rule) in November 2011. The FDIC also issued a separate rule which requires all insured depository institutions (IDIs) with greater than $50 billion in assets to submit resolution plans to the FDIC for their orderly resolution through the FDIC’s traditional resolution powers under the Federal Deposit Insurance Act (FDI Act). The 165(d) rule and the IDI resolution plan rule are designed to work in tandem by covering the full range of business lines, legal entities and capital-structure combinations within a large financial firm.

The FDIC and the Federal Reserve review the 165(d) plans and may jointly find that a plan is not credible or would not facilitate an orderly resolution under the Bankruptcy Code. If a plan is found to be deficient and adequate revisions are not made, the FDIC and the Federal Reserve may jointly impose more stringent capital, leverage, or liquidity requirements, or restrictions on growth, activities, or operations of the company, including its subsidiaries. If compliance is not achieved within two years, the FDIC and the Federal Reserve, in consultation with the FSOC, can order the company to divest assets or operations to facilitate an orderly resolution under bankruptcy in the event of failure. A SIFI’s plan for resolution under bankruptcy also will support the FDIC’s planning for the exercise of its Title II resolution powers by providing the FDIC with a better understanding of each SIFI’s structure, complexity, and processes.

2013 Guidance on Living Wills

Eleven large, complex financial companies submitted initial 165(d) plans in 2012. Following the review of the initial resolution plans, the agencies developed Guidance for the firms to detail what information should be included in their 2013 resolution plan submissions. The agencies identified an initial set of significant obstacles to rapid and orderly resolution which covered companies are expected to address in the plans, including the actions or steps the company has taken or proposes to take to remediate or otherwise mitigate each obstacle and a timeline for any proposed actions. The agencies extended the filing date to October 1, 2013, to give the firms additional time to develop resolution plan submissions that address the instructions in the Guidance.

Resolution plans submitted in 2013 will be subject to informational completeness reviews and reviews for resolvability under the Bankruptcy Code. The agencies will be looking at how each resolution plan addresses a set of benchmarks outlined in the Guidance which pose the key impediments to an orderly resolution. The benchmarks are as follows:

Multiple Competing Insolvencies: Multiple jurisdictions, with the possibility of different insolvency frameworks, raise the risk of discontinuity of critical operations and uncertain outcomes.
Global Cooperation: The risk that lack of cooperation could lead to ring-fencing of assets or other outcomes that could exacerbate financial instability in the United States and/or loss of franchise value, as well as uncertainty in the markets.
Operations and Interconnectedness. The risk that services provided by an affiliate or third party might be interrupted, or access to payment and clearing capabilities might be lost;
Counterparty Actions. The risk that counterparty actions may create operational challenges for the company, leading to systemic market disruption or financial instability in the United States; and
Funding and Liquidity. The risk of insufficient liquidity to maintain critical operations arising from increased margin requirements, acceleration, termination, inability to roll over short term borrowings, default interest rate obligations, loss of access to alternative sources of credit, and/or additional expenses of restructuring.
As reflected in the Dodd-Frank Act and discussed above, the preferred option for resolution of a large failed financial firm is for the firm to file for bankruptcy just as any failed private company would. In certain circumstances, however, resolution under the Bankruptcy Code may result in serious adverse effects on financial stability in the United States. In such cases, the Orderly Liquidation Authority set out in Title II of the Dodd-Frank Act serves as the last resort alternative and could be invoked pursuant to the statutorily prescribed recommendation, determination and expedited judicial review process.

Orderly Liquidation Authority

Prior to the recent crisis, the FDIC’s receivership authorities were limited to federally insured banks and thrift institutions. The lack of authority to place the holding company or affiliates of an insured depository institution or any other non-bank financial company into an FDIC receivership to avoid systemic consequences severely constrained the ability to resolve a SIFI. Orderly Liquidation Authority provided under Title II of the Dodd-Frank Act gives the FDIC the powers necessary to resolve a failing systemic non-bank financial company in an orderly manner that imposes accountability on shareholders, creditors and management of the failed company while mitigating systemic risk and imposing no cost on taxpayers.

The FDIC has largely completed the core rulemakings necessary to carry out its systemic resolution responsibilities under Title II of the Dodd-Frank Act. For example, the FDIC approved a final rule implementing the Orderly Liquidation Authority that addressed, among other things, the priority of claims and the treatment of similarly situated creditors.

Under the Dodd-Frank Act, key findings and recommendations must be made before the Orderly Liquidation Authority can be considered as an option. These include a determination that the financial company is in default or danger of default, that failure of the financial company and its resolution under applicable Federal or State law, including bankruptcy, would have serious adverse effects on financial stability in the United States and that no viable private sector alternative is available to prevent the default of the financial company.

To implement its authority under Title II of the Dodd-Frank Act, the FDIC has developed a strategic approach to resolving a SIFI which is referred to as Single Point-of-Entry. In a Single Point-of-Entry resolution, the FDIC would be appointed as receiver of the top-tier parent holding company of the financial group following the company’s failure and the completion of the recommendation, determination and expedited judicial review process set forth in Title II of the Act. Shareholders would be wiped out, unsecured debt holders would have their claims written down to reflect any losses that shareholders cannot cover, and culpable senior management would be replaced. Under the Act, officers and directors responsible for the failure cannot be retained.

During the resolution process, restructuring measures would be taken to address the problems that led to the company’s failure. These could include shrinking businesses, breaking them into smaller entities, and/or liquidating certain assets or closing certain operations. The FDIC also would likely require the restructuring of the firm into one or more smaller non-systemic firms that could be resolved under bankruptcy.

The FDIC would organize a bridge financial company into which the FDIC would transfer assets from the receivership estate, including the failed holding company’s investments in and loans to subsidiaries. Equity, subordinated debt, and senior unsecured debt of the failed company would likely remain in the receivership and be converted into claims. Losses would be apportioned to the claims of former equity holders and unsecured creditors according to their order of statutory priority. Remaining claims would be converted, in part, into equity that will serve to capitalize the new operations, or into new debt instruments. This newly formed bridge financial company would continue to operate the systemically important functions of the failed financial company, thereby minimizing disruptions to the financial system and the risk of spillover effects to counterparties.

The healthy subsidiaries of the financial company would remain open and operating, allowing them to continue business and avoid the disruption that would likely accompany their closings. Critical operations for the financial system would be maintained. However, creditors at the subsidiary level should not assume that they avoid risk of loss. For example, if the losses at the financial company are so large that the holding company’s shareholders and creditors cannot absorb them, then the subsidiaries with the greatest losses would have to be placed into resolution, thus exposing those subsidiary creditors to loss.

The FDIC expects the well-capitalized bridge financial company and its subsidiaries to borrow in the private markets and from customary sources of liquidity. The new resolution authority under the Dodd- Frank Act provides a back-up source for liquidity support, the Orderly Liquidation Fund (OLF). If it is needed at all, the FDIC anticipates that this liquidity facility would only be required during the initial stage of the resolution process, until private funding sources can be arranged or accessed. The law expressly prohibits taxpayer losses from the use of Title II authority.

In our view, the Single Point-of-Entry strategy holds the best promise of achieving Title II’s goals of holding shareholders, creditors and management of the failed firm accountable for the company’s losses and maintaining financial stability at no cost to taxpayers.

Statement of Policy

Informing capital markets, financial institutions, and the public on what to expect if the Orderly Liquidation Authority were to be invoked is an ongoing effort. While the FDIC has already been highly transparent in our planning efforts, we also are currently working on a Statement of Policy which would provide more clarity on the resolution process. We anticipate the release of a proposal for public comment before the end of the year.

In addition, the Federal Reserve, in consultation with the FDIC, is considering the merits of a regulatory requirement that the largest, most complex U.S. banking firms maintain a minimum amount of unsecured debt at the holding company level. Such a requirement would ensure that there are creditors at the holding company level to absorb losses at the failed firm. Questions surrounding a debt requirement are complex and include issues on the amount, seniority structure, and its relation to equity capital.

Cross-border Issues

Advance planning and cross border coordination for the resolution of globally active, systemically important financial institutions (G-SIFIs) will be critical to minimizing disruptions to global financial markets. Recognizing that G-SIFIs create complex international legal and operational concerns, the FDIC is actively reaching out to foreign host regulators to establish frameworks for effective cross-border cooperation and the basis for confidential information-sharing, among other initiatives.

As part of our bilateral efforts, the FDIC and the Bank of England, in conjunction with the prudential regulators in our respective jurisdictions, have been working to develop contingency plans for the failure of G-SIFIs that have operations in both the U.S. and the U.K. Of the 28 G-SIFIs designated by the Financial Stability Board (FSB) of the G-20 countries, four are headquartered in the U.K, and another eight are headquartered in the U.S. Moreover, approximately 70 percent of the reported foreign activities of the eight U.S. G-SIFIs emanates from the U.K. The magnitude of these financial relationships makes the U.S.-U.K. bilateral relationship by far the most significant with regard to the resolution of G-SIFIs. As a result, our two countries have a strong mutual interest in ensuring that, if such an institution should fail, it can be resolved at no cost to taxpayers and without placing the financial system at risk. The FDIC and U.K authorities released a joint paper on resolution strategies in December 2012, reflecting the close working relationship between the two authorities. This joint paper focuses on the application of “top-down” resolution strategies for a U.S. or a U.K. financial group in a cross-border context and addresses several common considerations to these resolution strategies.

In addition to the close working relationship with the U.K., the FDIC is coordinating with representatives from other European regulatory bodies to discuss issues of mutual interest including the resolution of European G-SIFIs. The FDIC and the European Commission (E.C.) have established a joint Working Group comprised of senior executives from the FDIC and the E.C. The Working Group convenes formally twice a year -- once in Washington, once in Brussels -- with on-going collaboration continuing in between the formal sessions. The first of these formal meetings took place in February 2013. Among the topics discussed at this meeting was the E.C.’s proposed Recovery and Resolution Directive, which would establish a framework for dealing with failed and failing financial institutions. The overall authorities outlined in that document have a number of parallels to the SIFI resolution authorities provided here in the U.S. under the Dodd-Frank Act. The next meeting of the Working Group will take place in Brussels later this year.

The FDIC also is engaging with Switzerland, Germany, Japan, and Canada on a bilateral basis. Among other things, the FDIC has further developed its understanding of the Swiss resolution regime for G-SIFIs, including an in-depth examination of the two Swiss-based G-SIFIs with significant operations in the U.S. During the past year, we also have participated in several productive workshops with the Federal Financial Supervisory Authority (BaFin), the German resolution authority. The FDIC anticipates a principals-level meeting with Japan later this year.

To place these working relationships in perspective, the U.S., the U.K., the European Union, Switzerland and Japan account for the home jurisdictions of 27 of the 28 G-SIFIs designated by the Financial Stability Board (FSB) of the G-20 in November 2012. Progress in these cross-border relationships is thus critical to addressing the international dimension of SIFI resolutions.

The Volcker Rule

The Dodd-Frank Act requires the Securities and Exchange Commission (SEC), the Commodities Futures Trading Commission (CFTC), and the federal banking agencies to adopt regulations generally prohibiting proprietary trading and certain acquisitions of interest in hedge funds or private equity funds. The FDIC, jointly with the FRB, OCC, and SEC, published an NPR requesting public comment on a proposed regulation implementing the prohibition against proprietary trading. The CFTC separately approved the issuance of its NPR to implement the Volcker Rule, with a substantially identical proposed rule text.

The proposed rule also requires banking entities with significant covered trading activities to furnish periodic reports with quantitative measurements designed to help differentiate permitted market-making-related activities from prohibited proprietary trading. Under the proposed rule, these requirements contain important exclusions for banking organizations with trading assets and liabilities less than $1 billion, and reduced reporting requirements for organizations with trading assets and liabilities of less than $5 billion. These thresholds are designed to reduce the burden on smaller, less complex banking entities, which generally engage in limited market-making and other trading activities.

The agencies are evaluating a large body of comments on whether the proposed rule represents a balanced and effective approach or whether alternative approaches exist that would provide greater benefits or implement the statutory requirements with fewer costs. The FDIC is committed to developing a final rule that meets the objectives of the statute while preserving the ability of banking entities to perform important underwriting and market-making functions, including the ability to effectively carry out these functions in less-liquid markets. Most community banks do not engage in activities that would be impacted by the proposed rule.

The Dodd-Frank Act and Community Banks

While the Dodd-Frank Act has changed the regulatory framework for the financial services industry, many of the Act’s reforms are geared toward larger institutions, as discussed above. At the same time, the Act included a number of provisions that impacted community banks. Of particular relevance to the FDIC, the Act made changes to the deposit insurance system that have specific consequences for community banks.

In the aftermath of the crisis, the Dodd-Frank Act made permanent the increase in the coverage limit to $250,000, a provision generally viewed by community banks as a helpful means to attract deposits.

The FDIC also implemented the Dodd-Frank Act requirement to redefine the base used for deposit insurance assessments as average consolidated total assets minus average tangible equity. As Congress intended, the change in the assessment base shifted some of the overall assessment burden from community banks to the largest institutions, which rely less on domestic deposits for their funding than do smaller institutions. The result was a sharing of the assessment burden that better reflects each group's share of industry assets. Aggregate premiums paid by institutions with less than $10 billion in assets declined by approximately one-third in the second quarter of 2011, primarily due to the assessment base change.

In the aftermath of the financial crisis and recession, as well as the enactment of the Dodd-Frank Act, many community banks had concerns about their continued viability in the U.S. financial system. Prompted by that concern, the FDIC initiated a comprehensive review of the U.S. community banking sector covering 27 years of data and released the FDIC Community Banking Study in December 2012.

Our research confirms the crucial role that community banks play in the U.S. financial system. As defined by the Study, community banks represented 95 percent of all U.S. banking organizations in 2011. These institutions accounted for just 14 percent of the U.S. banking assets, but held 46 percent of all the small loans to businesses and farms made by FDIC-insured institutions. While their share of total deposits has declined over time, community banks still hold the majority of bank deposits in rural and micropolitan counties. 2 The Study showed that in 629 U.S. counties (or almost one-fifth of all U.S. counties), the only banking offices operated by FDIC-insured institutions at year-end 2011 were those operated by community banks. Without community banks, many rural areas, small towns and urban neighborhoods would have little or no physical access to mainstream banking services.

The Study found that community banks that grew prudently and that maintained diversified portfolios or otherwise stuck to their core lending competencies funded by stable core deposits during the Study period exhibited relatively strong and stable performance over time. Institutions that departed from the traditional community bank business model generally underperformed over the long run. These institutions pursued higher-growth strategies – frequently through commercial real estate or construction and development lending – financed by volatile funding sources. This group encountered severe problems during real estate downturns and characterized the community banks that failed during the aftermath of the crisis.

As the primary federal regulator for the majority of smaller institutions (those with less than $1 billion in total assets), the FDIC is keenly aware of the challenges facing community banks. The FDIC has tailored its supervisory approach to consider the size, complexity, and risk profile of the institutions it oversees. For example, large institutions (those with $10 billion or more in total assets) are generally subject to continuous supervision (targeted reviews throughout the year), while smaller banks are examined periodically (every 12 to 18 months) based on their size and condition. Additionally, the frequency of our examinations of compliance with the Community Reinvestment Act can be extended for smaller, well-managed institutions. Moreover, in Financial Institution Letters issued to the industry to explain regulations and guidance, the FDIC includes a Statement of Applicability to institutions with less than $1 billion in total assets.

In addition to the changes in the Dodd-Frank Act affecting community banks, the FDIC also reviewed its examination, rulemaking, and guidance processes during 2012 as part of our broader review of community banking challenges, with a goal of identifying ways to make the supervisory process more efficient, consistent, and transparent, while maintaining safe and sound banking practices. Based on the review, the FDIC has implemented a number of enhancements to our supervisory and rulemaking processes. First, the FDIC has restructured the pre-exam process to better scope examinations, define expectations, and improve efficiency. Second, the FDIC is taking steps to improve communication with banks under our supervision through the use of web-based tools, regional meetings and outreach. Finally, the FDIC has instituted a number of outreach and technical assistance efforts, including increased direct communication between examinations, increased opportunities to attend training workshops and symposiums, and conference calls and training videos on complex topics of interest to community bankers. The FDIC plans to continue its review of examination and rulemaking processes, and continues to explore new initiatives to provide technical assistance to community banks.

Conclusion

Thank you for the opportunity to share with the Committee the work that the FDIC has been doing to address systemic risk in the aftermath of the financial crisis. I would be glad to respond to your questions. (Attachment)

1 A summary of the FDIC’s progress implementing the provisions of the Dodd-Frank Act is attached to this testimony.

2 The 3,238 U.S. counties in 2010 included 694 micropolitan counties centered on an urban core with populations between 10,000 and 50,000 people, and 1,376 rural counties with populations less than 10,000 people.