Federal Deposit Insurance Corporation FDIC Banking Review

1997 FederalVol. 10, No. 1 FederalFederalFederalCharter CharterCharterFederalFFederalA Unified Federal Charter CharterCharterFederalederalStatistical Sampling as a Management Tool ChartRecent Developments CharterCharterer FDIC Banking Review

FDICFDIC BankingBanking ReviewReview

19971997 Vol. 10, No. 1

ChairmanChairman Ricki Helfer Division of Research AA UnifiedUnified FederalFederal CharterCharter forfor BanksBanks andand SavingsSavings Institutions and Statistics, DirectorDirector by FDIC Staff Page 1Page 1 Wm. Roger Watson Deputy Directors ThisThis stafstafff studystudy addressesaddresses thethe issuesissues concerningconcerning thethe proposalproposal toto establishestablish aa singlesingle Barry Kolatch Steven A. Seelig federalfederal chartercharter forfor banksbanks andand savingssavings associations. TheThe studystudy discussesdiscusses thethe EditorEditor difdifferencesferences inin thethe powerspowers ofof bankingbanking ororganizationsganizations andand thriftthrift ororganizations. ItIt alsoalso Steven A. Seelig reviewsreviews thethe arargumentsguments andand evidenceevidence forfor andand againstagainst aa unificationunification ofof thethe federalfederal Editorial Committee Jack T. Reidhill charterscharters forfor depositorydepository institutions. Detta Voesar Managing Editor Detta Voesar Statistical Sampling as a Management Tool in Banking Editorial Secretary Cathy Wright by Charles D. Cowan Page 17Page 17 Design and Production Geri Bonebrake TheThe authorauthor describesdescribes thethe useuse ofof samplingsampling inin aa financialfinancial settingsetting andand focuses,focuses, asas anan illustration,illustration, onon somesome ofof thethe methodsmethods usedused byby thethe FDICFDIC toto valuevalue assetsassets inin TheThe viewsviews expressedexpressed areare liquidation.liquidation. ByBy usingusing sampling,sampling, asas opposedopposed toto valuingvaluing eacheach asset,asset, significantsignificant costcost thosethose ofof thethe authorsauthors andand dodo notnot necessarilynecessarily reflectreflect offi-offi­ savingssavings areare achievedachieved whilewhile ensuringensuring thethe accuracyaccuracy andand qualityquality ofof thethe results.results. cialcial positionspositions ofof thethe FederalFederal DepositDeposit InsuranceInsurance Corpora-Corpora­ tion.tion. ArticlesArticles maymay bebe rere-­ printedprinted oror abstractedabstracted ifif thethe FDICFDIC BankingBanking ReviewReview andand Recent Developments Affecting Depository Institutions author(s)author(s) areare credited.credited. PleasePlease provideprovide thethe FDIC'sFDIC's by Vby Valentine VValentine .. CraigCraig Page 24Page 24 DivisionDivision ofof ResearchResearch andand StatisticsStatistics withwith aa copycopy ofof anyany ThisThis regularregular featurefeature ofof thethe FDICFDIC BankingBanking ReviewReview containscontains information onon regula-regula­ publications containingcontaining rere-­ printed material. torytory agencyagency actions,actions, statestate legislationlegislation andand regulation,regulation, andand articlesarticles andand studiesstudies perti-perti­ Single-copy subscriptions nentnent toto bankingbanking andand depositdeposit insuranceinsurance issues.issues. areare availableavailable toto thethe publicpublic freefree ofof charge.charge. RequestsRequests forfor subscriptions, backback issuesissues oror addressaddress changeschanges shouldshould bebe mailedmailed to:to: FDICFDIC BankingBanking Re-Re­ viewview,, OfficeOffice ofof CorporateCorporate Communications, FederalFederal DepositDeposit InsuranceInsurance Corpora-Corpora­ tion,tion, 550550 17th17th Street,Street, N.W.,N.W., Washington, DC 20429.20429. A Unified Federal Charter

A Unified Federal Charter for Banks and Savings Associations

A Staff Study

his article addresses the issues tem and the depository institu­ consist of federal savings associa­ concerning the proposal to es­ tions within the system; tions,1 which are regulated by the Of­ Ttablish a single federal charter � strengthen the efficiency and fice of Thrift Supervision (OTS), and for banks and savings associations. It competitiveness of the U.S. bank- national banks, which are regulated is an FDIC staff study and was ing system in financial markets; by the Office of the Comptroller of originally published by the FDIC in � support reliance on market-based the Currency (OCC). Their respec­ October of 1996. Following the intro- incentives to guide depository in­ tive holding companies are savings­ duction, the differences in the powers stitution choices on strategies and and-loan holding companies, which of banking organizations and thrift business activities for meeting are under the jurisdiction of the organizations are summarized, and customer needs; OTS, and bank holding companies, data are presented on the various � reduce the current regulatory bur- which are regulated by the Federal categories of organizations. The next dens and supervisory costs on in- Reserve Board (FRB). section reviews the arguments and sured institutions and/or the cus- Federal savings associations have evidence for and against a unification tomers of those institutions; historically enjoyed four distinct of the federal charters for depository � advantages not accorded national institutions. The final section as­ provide flexibility for insured in- stitutions to respond to changes in sumes the decision is to unify the banks. These advantages were: (1) market conditions, technology, charters and considers the issues that preferential taxation; (2) the most and customer financial needs; would then have to be resolved. It liberal branching rights of all federal should be noted from the start, this � increase depository institutions’ depository institutions; (3) expanded review does not include the possible efficiency and/or effectiveness subsidiary powers; and (4) virtually expansion of powers beyond those in meeting specific, legislated, unlimited holding company activi­ currently exercised by either the public-policy goals; and ties. However, the magnitude of banking or thrift industries. Rather, � increase public access to banking these thrift advantages has dissipated the review is limited to powers that services. over time, and with enactment of the one or the other of the two industries Small Business Job Protection Act on currently possess. Major Differences Between Federal Savings 1 Technically, there are two distinct federal The analysis contained in this thrift charters, a federal savings-and-loan study flowed from seven broad princi­ Associations and association charter and a federal savings ples. Any prospective change needed National Banks bank charter. With the very limited excep­ tion of mutual state-chartered savings banks to: Federally chartered depository in- that convert to a federal savings bank char­ � strengthen the safety and sound­ stitutions insured by the Federal De­ ter, the two have identical powers and are re­ ferred to collectively in this paper as savings ness of the deposit insurance sys- posit Insurance Corporation (FDIC) associations.

1 FDIC Banking Review

August 20, 1996, the preferential tax In general, loans secured by nonresi­ be counted as qualifying assets. It treatment for thrifts has been elimi­ dential real estate may not exceed 400 also provided that an institution that nated. percent of capital. Commercial loans qualifies as a domestic building-and­ Balanced against the historical may not exceed 20 percent of assets, loan under the Internal Revenue benefits accruing to federal savings and amounts in excess of 10 percent Code is considered a qualified thrift associations, national banks have en­ must be used for small-business lender. (See footnote four.) joyed the ability to engage in a much loans. Unsecured residential con­ Failure to meet the QTL test has wider range of lending activities. struction loans may not exceed the several consequences. Probably the National banks were subject neither greater of 5 percent of assets or 100 most significant is that a holding to an enforced orientation toward a percent of capital. In combination, company owning a nonqualifying particular area, such as real-estate fi­ consumer loans, commercial paper savings institution is required to reg­ nancing, nor to specific asset-type and corporate debt securities may not ister as a bank holding company. lending constraints. National banks exceed 35 percent of assets. The activities of bank holding com­ may focus on a particular area of lend­ In order to receive many of the panies are significantly more limited ing and investment if they desire, but special benefits of a thrift, an institu­ than are the activities of most they are not forced to. tion must pass the qualified thrift savings-and-loan holding companies. lender (QTL) test, which requires A later section of this report summa­ This section explores the major ar­ rizes the differences in powers of eas where savings associations and na­ that at least 65 percent of an institu­ tion’s portfolio assets be qualified bank and savings-and-loan holding tional banks are treated differently. companies. Other consequences of (For a more detailed comparison of thrift investments, primarily residen­ tial mortgages and related invest­ failure to meet the QTL test are re­ their differences, a table prepared by ments. The Economic Growth and stricted access to Federal Home the OCC and the OTS can be made Regulatory Paper Reduction Act of Loan Bank (FHLB) financing and available upon request from the Divi­ 1996, enacted on September 30, 1996, accelerated repayment of outstand­ sion of Research and Statistics of the somewhat relaxed the QTL test by ing FHLB advances. FDIC). expanding the list of qualified invest­ At the end of 1995, 98 percent of ments to include small-business 1,437 savings associations met the Lending Constraints loans, and by increasing the amount QTL test. (As stated above, the test Federal savings associations2 per­ of consumer-oriented loans that can has since been relaxed.) The greatest form a similar financial intermedia­ tion function to that of commercial Table 1 banks. However, savings-and-loan Savings Institutions associations have a distinct focus from Data as of December 31, 1995 that of banks—the provision of home QTL Test Compliance Distribution mortgage credit. The laws promul­ Savings Institutions Total Assets Return on Assets gated by Congress for the industry in Range of QTL Ratio (Number) (Percent) ($MM) (Percent) (Percent) the 1930s were motivated by a na­ Below 55 percent 12 1 $7,279 1 1.55 tional policy to encourage home own­ 55-65 percent 21 1 2,099 0 1.03 ership, and this has remained the 65-75 percent 153 11 39,705 5 1.22 special focus of the thrift industry 75-85 percent 392 27 147,353 19 0.75 since that time.3 85-95 percent 550 38 312,445 41 0.69 Federal savings associations are Over 95 percent 309 22 262,138 34 0.66 subject to several specific lending Total 1,437 100 $771,020 100 0.72 constraints. These constraints were Commercial Banks also relaxed by the recent legislation. Data as of December 31, 1995 QTL Test Compliance Distribution Commercial Banks Total Assets Return on Assets Range of QTL Ratio (Number) (Percent) ($MM) (Percent) (Percent) 2 Parenthetically, it is worth mentioning that Section 28 of the Federal Deposit Insurance Below 55 percent 8,333 84 $3,629,043 84 1.18 Act (FDI Act), as added by Section 222 of the 55-65 percent 996 10 456,330 11 1.14 Financial Institutions Reform, Recovery, 65-75 percent 410 4 154,453 4 1.16 and Enforcement Act (FIRREA) of 1989, generally limits state-chartered savings asso­ 75-85 percent 165 2 59,117 1 0.91 ciations to activities and equity investments 85-95 percent 31 0 14,114 0 1.34 permissible for federal savings associations Over 95 percent 6 0 1,511 0 0.44 (12 U.S.C. §21831e). Total 9,941 100 $4,314,567 100 1.17 3 Federal Home Loan Bank Board, Agenda for Reform, Washington, DC, March 1983. Source: Division of Research and Statistics, FDIC

2 A Unified Federal Charter level of profitability of institutions Public Law 104-188, the Small Liberal Branching meeting the test, an ROA of 1.22 per­ Business Job Protection Act, which Rights cent for the group, was achieved by was signed by the President on The federal thrift charter confers institutions with QTL assets in the August 20, 1996, repealed the special range of 65 to 75 percent of portfolio bad-debt reserve provisions for the broadest geographic expansion assets (see Table 1). Six percent of thrifts. According to this law, thrifts authority of any federally insured commercial banks appeared to have are now treated the same as banks depository institution charter. Fed- asset portfolios that would meet the for federal income tax purposes. erally chartered savings-and-loan QTL test. The ROA of the 410 banks Banks are not permitted to use the associations that meet either the with QTL assets in the range of 65 to percentage-of-income method for ac- QTL test or the building-and-loan 75 percent of portfolio assets was 1.16 counting for bad debt. Large banks test can branch nationally with no percent, which was almost the same (those with aggregate assets over $500 “opting in” or “opting out” require- as the ROA for all banks, 1.17 per­ million) may not use any reserve ment. They also are not subject to cent. method of accounting for bad debt, any intrastate branching restrictions but must deduct bad debts as they oc- whereas banks are subject to a range cur (specific charge-off method); of restrictions on their statewide Tax Benefits small banks are allowed to use the branching. Figure 1 provides a As mentioned previously, the re­ experience method or the specific graphic representation of state branch­ peal of the thrift tax advantage be­ charge-off method. These rules now ing laws for commercial banks. came law on August 20, 1996. Prior to apply to thrifts. However, once again, the advan- this date, Section 593 of the Internal The Small Business Job Protection tage that thrifts enjoyed relative to Revenue Code (IRC) of 1986 permit­ Act also waived recapture of bad-debt banks has changed. The Riegle­ ted thrifts that met the definition of a reserves for the years prior to 1988. Neal Interstate Banking and Branch- domestic building-and-loan associa­ According to the Act, thrifts need only ing Efficiency Act of 1994 reduced tion4 to claim deductions for additions to recapture reserves set aside after much of the historical branching ad- to a bad-debt reserve, and to use January 1, 1988, rather than their en- vantage of savings institutions. Un­ either the percentage-of-income tire bad-debt reserves. Congressional estimates are that there are approxi­ der the terms of the Riegle-Neal method or the experience method in legislation, adequately capitalized calculating such additions.5 Those mately $14.7 billion in bad-debt re- serves in the industry, and that and managed bank holding compa­ thrifts electing to use the percentage- nies may acquire a bank in any state of-income method for additions to approximately $10.3 billion are pre­ 1988 reserves and thus exempt from beginning on September 29, 1995. their bad-debt reserve were allowed As of June l, 1997, banks will be to deduct against their taxable in­ taxation. come additions to the reserve equal to 8 percent of taxable income.6 Figure 1 State Branching Laws* San Francisco Boston Kansas City WA NH ME Chicago VT MT ND MN MA 4 OR New York To qualify as a domestic building-and-loan ID association, a thrift must pass a test similar to SD WI RI CT WY MI the QTL test. According to 26 U.S.C. NY §7701(19), at least 60 percent of the institu­ NE IA NV OH tion’s total assets must fall within certain UT IL IN PA categories, largely assets related to real- CA NJ KS DE estate financing. Qualifying assets are simi­ MO DC MD lar, but not identical, to assets specified for the QTL test. While no longer relevant to AZ tax treatment, the building-and-loan test CO may be passed as an alternative to the QTL Dallas Memphis KY WV VA test to be considered a qualified thrift lender. TN 5 AK Under the experience method, an institution HI OK AR NC maintains a bad-debt reserve — for which NM taxable deductions may be taken — that in MS SC general is based on the institution’s bad-debt AL GA TX LA Atlanta experience over the previous six years. Un­ der the percentage-of-income method, the additions to the bad-debt reserve are based imitation on Bran ing 1 FL on a percentage of the institution’s taxable in­ No imitation on Bran ing come. 6 Sour e: Con eren e o State Bank Su ervi or For tax years prior to January 1, 1987, this per­ State are grou e into t e eig t C S u ervi ory region . centage was 40 percent. 1 Colora o will ermit unre tri te tatewi e bran ing in 199 , eorgia in 199 , an rkan a in 1999.

3 FDIC Banking Review

permitted to merge and consolidate service corporations.7 Service corpo­ As of year-end 1995, 1,437 report­ their operations in the various states rations of federal savings associations ing savings associations had invest­ under one corporate structure, unless may “engage in such activities rea­ ments in a total of 2,035 service the state has “opted out” of inter­ sonably related to the activities of corporations. The total reported in­ state branching. As of May 1996, 24 Federal savings associations as the vestments in service corporations states and Puerto Rico had acceler­ Office [of Thrift Supervision] may were $5.4 billion, which represent­ ated the process by permitting inter­ determine and approve” (12 C.F.R. ed less than 1 percent of the assets state branching before June 1997, and §545.74(c)). Under this “reasonably of the savings associations. The consoli­ an additional 11 states had “opted in” related” standard the OTS has occa­ dated assets of the service corporations with interstate branching to begin on sionally, on a case by case basis, ap­ were $18.9 billion, or approximately June 1, 1997. Only one state, Texas, proved service corporation activities 2.5 percent of the assets of the sav­ had “opted out.” Of the states that that would not be permitted to a ings associations. Table 2 gives a have “opted in,” however, only Indi­ national bank such as insurance breakdown of the service corpora­ ana and Puerto Rico allow immediate underwriting. In addition, the OTS tions by major type of activity. interstate branching by de novo insti­ has approved by regulation a long list of permissible activities for thrift As shown in Table 2, the greatest tutions on a nonreciprocal basis and number of service corporations were without other restrictions. In regards service corporations, for which no prior approval is required. Most of the in the business of real-estate devel­ to intrastate branching, as depicted pre-approved activities are also per­ opment and sales (481 service corpo­ by the chart on state branching laws, missible for national banks. Major rations); followed by insurance most states have eliminated restric­ activities permissible for service cor­ brokerages and agencies (347 service tions on intrastate branching for com­ porations of federal savings associa­ corporations); acquiring improved mercial banks, with much of this tions but not for national banks are (1) real estate for sale or rental (254 serv­ liberalization having occurred since real-estate development and real- ice corporations); property manage­ 1985. Forty-one states now allow estate management for third parties ment and maintenance (117 service statewide branching and three addi­ and (2) selling many types of insur­ corporations); and mortgage lending tional states, Colorado, Georgia, and ance on an agency basis.8 (99 service corporations). Of these Arkansas, will permit statewide branch­ ing in 1997, 1998, and 1999, respec­ tively. Of the remaining six, all allow Table 2 statewide branching through acquisi­ 1 tion. Active Thrift Subsidiaries as of December 31, 1995 Number of Number Consolidated First-Tier of Their Total Assets2 Expanded Service Primary Type of Business3 Entities Subsidiaries ($000) Corporation Activities Subsidiary Savings Association 29 3 $3,326,957 Federal savings associations may Finance Subsidiary4 34 1 4,484,385 invest up to 3 percent of their assets in Risk-Controlled Arbitrage4 3 1 34,735 Real-Estate Development and Sales 287 194 1,391,956 Acquiring Improved Real Estate 7 Not less than one-half of investments in serv­ ice corporations that exceed 1 percent of a for Sale or Rental 140 114 450,291 federal association’s assets must be primarily Property Management and Maintenance 82 35 1,513,437 for community, inner-city, and community Mortgage Lending4 82 17 2,243,052 development purposes (12 U.S.C. §1464(c) Mortgage Banking4 54 9 790,240 (4)(B)). Thus, the maximum unfettered in­ 4 vestment in service corporations is 2 percent Commercial Lending 3 4 103,056 of an association’s assets. Consumer Lending4 28 5 1,174,043 8 Two recent Supreme Court cases have pro­ Insurance Brokerage, Agency5 285 62 350,792 vided authority for national banks to enter Escrow, Trustee Services4 35 8 39,056 insurance-related markets previously un­ 4 available to them. In NationsBank of N.C., N.A. Appraisal, Inspection Services 28 1 21,309 v. Variable Annuity Life Insurance Co., 115 S. Ct. EDP, RSU Services4 38 1 149,702 810(1995),theCourt heldthatbecause annui­ Other 383 69 2,807,156 ties are not insurance for purposes of the “town of 5,000" rule, national banks may sell Total 1,511 524 $18,880,176 annuities in any location. And in Barnett Bank of Marion County, N.A. v. Nelson, 116 S. Ct. 1103 Source: Division of Research and Statistics, FDIC. (1996), the Court held that states cannot re­ 1 Includes service corporations, their subsidiaries and joint ventures; excludes “operating strict the federal authority granted to national subsidiaries.” banks under 12 U.S.C.§92 to sell insurance in 2 Data are from Thrift Financial Report, Schedule CSS, Item 120. towns with populations of less than 5,000, al­ 3 Data are from Thrift Financial Report, Schedule CSS, Item 100. though it is still uncertain whether national 4 Activities that are also generally permissible for national banks. banks may use this authority to sell insurance 5 Activities that are also permissible under certain circumstances for national banks. in larger towns.

4 A Unified Federal Charter top five thrift service corporation ac­ two or more savings association sub­ The counting of savings-and-loan tivities, only mortgage lending and, to sidiaries that were acquired in other holding companies is complicated by a limited extent, insurance sales are than qualifying supervisory transac­ the existence of a number of multi- activities also permissible for national tions would also be in the restricted tiered organizations with a variety of banks. category. ownership arrangements. As of July 9, 1996, the OTS reported the Ten thrifts accounted for 75 per­ Unrestricted savings-and-loan hold­ following number of first-tier thrift cent of the industry’s investments, ing companies may engage, directly with two thrifts accounting for ap­ holding companies: 28 diversified or through their non-thrift subsidiar­ unitary holding companies; 650 non- proximately 57 percent of the in­ ies, in any activities that do not diversified unitary holding compa­ dustry’s total investment in service threaten the safety and soundness of nies; no diversified multiple holding corporations at December 31, 1995. their subsidiary savings associations companies; and 44 non-diversified These two thrifts are Household or that do not have the effect of ena­ multiple holding companies. The to­ Bank FSB of Prospect Heights, Illi­ bling a savings association to evade tal number of savings-and-loan first- nois, and Home Savings of America applicable laws or regulations. Be­ tier holding companies by this count FSB of Irwindale, California. yond these generalities, there are no was 722. limitations on the scope of permis­ In contrast to most savings-and­ sible activities of savings-and-loan Few Limitations on loan holding companies, bank hold­ holding companies in the unrestric­ Holding Companies ing companies are limited to “non­ ted category. Thus, savings-and-loan bank” activities the FRB has found, In considering a unification of the holding companies in the unrestric­ by regulation or order, to be “closely federal charters for depository institu­ ted category are generally permitted related to banking and a proper inci­ tions, questions arise not only from to engage in activities closely re­ dent thereto.” The broad categories the differences between the powers lated to banking, general securities of activities the FRB has found to of federally chartered depository in­ underwriting and dealing, other finan­ meet these criteria are securities bro­ stitutions but also from the differ­ cial services, real-estate investment kerage; to a limited extent securities ences between the powers of their and development, and commercial underwriting; mortgage banking; holding company owners. Corporate and industrial enterprises. The latter commercial finance; consumer fi­ owners of savings associations and categories allow activities as diverse nance; leasing; small-business in­ banks are holding companies: sav­ as manufacturing (cigarettes, contain­ vestment companies; insurance ings-and-loan holding companies for ers, furniture) to retail operations underwriting; and insurance agency. savings associations and bank holding (hotels, drug stores and cosmetics) The insurance activities are severely companies for banks. Savings-and­ and services (refuse collection, utili­ constricted by statute and are princi­ loan holding companies can be fur­ ties and advertising). In the submis­ pally limited to credit-related and ther subdivided into two categories: sion to Congress last year, the OTS grandfathered activities. those in which non-thrift activities are indicated that nearly all savings-and­ essentially unrestricted9 and those in loan holding companies in existence which non-thrift activities are re­ fell into the unrestricted category. stricted. The vast majority of savings­ Another savings-and-loan holding and-loan holding companies fall in company classification is between di­ 9 While non-thrift activities are essentially the first, or unrestricted, category. versified and non-diversified. A di­ unrestricted, dividend payments from thrift to parent are restricted to avoid abuses. A savings-and-loan holding com­ versified savings-and-loan holding 10 Qualifying supervisory transactions consist pany in the unrestricted category is company is defined by statute as one of transactions involving failed or failing in­ either a unitary holding company — in which the subsidiary savings asso­ stitutions and the participation or oversight one that controls only one savings as­ ciation and certain other financial ac­ of the FDIC or the FSLIC. 11 One of the exceptions to the Management sociation subsidiary, which meets the tivities represent less than 50 percent Interlocks Act is for a person who serves si­ QTL test — or a multiple holding of consolidated net worth and con­ multaneously as adirector of (1)a diversified company, all of whose savings associa­ solidated net earnings. One of the savings-and-loan holding company and (2) an unaffiliated depository institution or de­ tion subsidiaries meet the QTL test few legal consequences flowing from pository institution holding company [12 and where no more than one subsidi­ classification as a diversified savings­ U.S.C. §3204 (8)(A)]. Also, effective Octo­ ber 1, 1996, the OCC, the FDIC, the FRB, ary was not acquired in a qualifying and-loan holding company is that an and the OTS issued a final rule permitting supervisory transaction.10 A savings­ exception to the Management Inter­ management interlocks between institu­ and-loan holding company in the locks Act may be triggered.11 The tions with less than $20 million in assets and institutions withmore than$20 million in as­ restricted category has one or more major affiliations between savings as­ sets that are both located in the same metro­ savings association subsidiaries that sociations and non-banking organiza­ politan statistical area. Management interlocks between unaffiliated institutions do not meet the QTL test. A savings­ tions are found in diversified holding in the same community continue to be im­ and-loan holding company that has companies. permissible, regardless of size.

5 FDIC Banking Review

As of June 1996, the number of the charters are unified, the BIF and Consumer Credit... “The nexus bank holding companies was 5,293. the SAIF will be merged by January 1, between thrifts and housing largely These holding companies held al­ 1999.12 has been broken without any evident most 80.3 percent of the assets of all The arguments for a unified char­ detriment to housing finance avail­ FDIC-insured U.S. banks and thrifts. ter are not clear-cut — conflicting ability.” Bank holding company nonbank ac­ arguments and evidence can be ad­ Statistics would appear to bear tivities are concentrated in the larger vanced to either support or oppose a this out. Over a period of two dec­ bank holding companies, which are position. The major argument for a ades, the thrift industry has seen the required to report financial data on unified charter is that there is no gradual erosion of its share of the these activities. According to the lat­ longer a need for a thrift industry due market that the industry’s separate est data available from the FRB, in to structural changes in housing fi­ status was designed to foster. Be­ 1994, 238 holding companies report­ nance: the thrift industry is no longer tween 1975 and 1994, the market ed nonbank activities to the FRB. necessary to satisfy the societal need share held by savings institutions Total nonbank assets for these report­ for which it was established, and dropped from 45 percent of total ing companies were $270.2 billion, therefore the thrift charter should be mortgages to 13 percent; from 56 and the ratio of nonbank assets to total abolished. This argument is often percent of home mortgages to 14 per­ assets of the organizations was 8.40 buttressed with arguments that the cent; and from 39 percent of multi­ percent. long-term viability of the thrift indus­ family residential mortgages to 22 Nonbank net income was $2.9 bil­ try is in question, and that the current percent.13 Concerning originations, lion, and the ratio of nonbank net in­ restrictions on thrift activities hamper in 1975, thrifts originated 58 percent come to total net income was 8.29 the ability of thrift institutions to re­ of home mortgages. By 1994, home percent. For the period 1986 to 1994, spond to changes in the marketplace. mortgage originations by thrifts were the ratio of nonbank assets to total as­ Replacement of the current federal down to 20 percent of the total.14 sets for reporting companies ranged two-charter system for depository in­ Thus, the housing market — the from a low of 6.91 percent in 1991, to stitutions with a one-charter system support and development of which the high of 8.40 percent in 1994. Over would “level the playing field” be­ has provided the rationale for a le­ the same period, the ratio of nonbank tween thrifts and banks and allow gally distinct thrift industry — has net income to total net income ranged them to compete head-on. come to be less dependent on the from a low of 1.22 percent in 1991, to a These latter arguments for a uni­ thrift industry. Much of the thrift in­ high of 14.35 percent in 1989. fied charter, with a few twists, can also dustry’s lost share of mortgages it be used to support the major opposing held has gone to federally related Pros and Cons of position—that there is no need for mortgage pools—mortgage-backed Charter Unification charter unification, but easier entry securities guaranteed or issued by the Government National Mortgage The recently enacted Deposit In­ and exit between banks and thrifts. surance Funds Act of 1996 requires This position argues that what is the Secretary of the Treasury to sub­ needed are certain adjustments to mit a report to the Congress by March current law, short of charter unifica­ tion, that will enable banks and thrifts 12 Although not provided for in existing legis­ 31, 1997, on the issues surrounding lation, the BIF and the SAIF could be the development of a common char­ to switch charter types easily. These merged without unifying the two charters. ter for all insured depository institu­ changes will “level the playing field,” Indeed, thrifts, in the form of state- and allow the market to decide of its chartered savings banks, are already in­ tions and the abolition of separate and sured by the BIF. Similarly, if regulatory distinct charters for banks and savings own accord whether the thrift indus­ consolidation were thought to be desirable, associations. The Act further re­ try is viable and should survive. a single regulatory apparatus could be es­ tablished without charter unification. quires that the BIF and the SAIF be The major arguments are exam­ 13 Board of Governors of the Federal Reserve unified on January 1, 1999, provided ined below. System, Flow of Funds. Measuring market no insured depository institution re­ Arguments for Unification of shares of the mortgage market by the percentage of mortgages directly held re­ mains as a savings association at that Charters. According to proponents sults in a slight understatement of the po­ time. of this viewpoint, due to structural sition of savings institutions in the market. Savings institutions also hold securities is­ This section discusses the major changes in housing finance, a separate sued or guaranteed by the government- arguments for and against abolishing legal status for a class of institutions to related issuers of mortgage-backed securi­ the current two-charter federal sys­ ensure availability of housing finance ties. If their holdings of these securities were considered, savings institutions’ share tem for depository institutions and re­ has become unnecessary. As Federal of the total mortgage market in 1994 would placing it with a one-charter system. Reserve Board Chairman Greenspan increase from approximately 13 percent to Because it makes little sense to unify stated in his September 21, 1995, tes­ approximately 15 percent. 14 The Mortgage Market Statistical Annual for the charters without also unifying the timony to the Banking Subcommit­ 1995, Inside Mortgage Finance Publica­ BIF and the SAIF, it assumes that if tee on Financial Institutions and tions, Inc.

6 A Unified Federal Charter

Association, the Federal National eliminating the federal savings asso­ thrifts — has been whittled away Mortgage Association, the Federal ciation charter. If savings associations over time by activity of the states, Home Loan Mortgage Corporation, cannot redeploy their assets in re­ and, as discussed earlier, has been and the Farmers Home Administra­ sponse to the market, there will be ex­ addressed by the Riegle-Neal Inter­ tion. Much of the thrift industry’s lost cess capacity in the thrift industry. state Banking and Branching Effi­ share of mortgages that it originated This in turn will lead to lower profit­ ciency Act of 1994. Two major has gone to mortgage banking compa­ ability, difficulty in attracting new impediments remain to switching nies. capital, and a tendency to invest in charters. They are the prohibition It might be argued that though the riskier assets in order to maintain against banks owning service corpo­ thrift industry today appears to be less earnings. According to this view, it rations engaged in many insurance important to the health of the housing is better to eliminate the savings as­ activities and real-estate develop­ industry than in the past, the housing sociation charter than risk the losses ment activities;16 and the different industry would still be harmed if the — especially in light of federal de­ requirements for thrift and bank forced orientation of thrifts to housing posit insurance—resulting from an in­ holding companies — some corpo­ were removed. However, this is not flexible charter. rate owners of thrifts could not qual­ clear. The threshold for the QTL test Arguments against Unification of ify as bank holding companies. Short is 65 percent of portfolio assets in­ Charters. According to proponents of changing the laws governing banks vested in specified assets largely re­ of this viewpoint, the market — not and bank holding companies, one lated to housing finance. Yet as the government — should decide way to ease these impediments shown in Table 1, as of year-end 1995, whether a charter is obsolete. Thus, would be to allow a number of years 80 percent of thrifts held 75 percent or while the status quo is not desirable for a thrift or holding company to di­ more of their portfolio assets in assets because it impedes the workings of vest of the impermissible activity. that qualified for the QTL test — the market, if certain adjustments substantially more than was necessary were made to current law to enable Charter Unification to meet the test. Therefore, as the banks and thrifts to switch charter Implementation Issues QTL constraints appear to be non- types more easily, the institutions If a decision were made to unify binding, one would not expect that themselves could choose their future the federal bank and thrift charters, removing these constraints would re­ organizations based upon their indi­ implementation issues would arise at sult in a significant shift in thrift be­ vidual situations. If thrifts could be­ both the institution and holding com­ havior. Moreover, as noted earlier, come banks without penalty and pany level. Many of these issues, the QTL test has just been relaxed; without adverse consequences for such as the sale of insurance products thus, to the extent thrifts want to themselves or their owners, many, by depository institutions or the make incremental changes in their perhaps most, might do so. Removal separation between banking and portfolios, they will be able to do so. of many of the barriers to entry and commerce, are legitimate public- In addition, thrifts have not dem­ exit would allow the thrifts them­ policy concerns in their own right. onstrated a desire to expand into selves to decide their future. If hous­ The prospect of charter unification other fields by making full use of the ing finance were profitable, then brings them to the fore. asset powers now available to them. many thrifts — those that are oper­ For example, federal savings associa­ ated with the proper attention to con­ tions can invest up to 10 percent of trolling costs and to prudent practices their assets in commercial loans, but — would likely choose to remain as as of year-end 1995, their commercial thrifts. But if housing finance entered 15 The relationship between the legal limit loans amounted to only 1 percent of a period of doldrums, particularly for and actual use of other powers of federal assets.15 At that same date, only 89 an extended period of time, they savings institutions as of year-end 1995 was: loans secured by nonresidential real institutions had more than 5 percent would be free to reorient their efforts, estate—the limit is approximately 32 per­ of their assets in commercial loans. and the industry would not become cent of assets (400 percent of capital, which for the industry stands at approximately 8 Consequently, any shifts of institu­ burdened with excess capacity. percent of assets), loans amounted to 6 per­ tions from or to a focus on housing fi­ The current impediments to thrifts cent of assets; unsecured residential con­ nance is likely to be over an extended struction loans— the limit is the greater of 5 switching to banks were described percent of assets or 100 percent of capital period and in response to market earlier. The major financial penalty (which is approximately 8 percent of as­ forces. — the recapture of bad-debt reserves sets), residential and nonresidential con­ struction loans together totaled 2 percent of Indeed, lack of flexibility in re­ for thrifts that became banks — has assets. Of course, individual institutions sponding to changing market forces been addressed by legislation. An­ may be closer to these limits. caused by savings associations’ man­ other restriction — imposition of the 16 As discussed earlier, recent judicial deci­ banking industry’s remaining geo­ sions have narrowed the differences be­ datory orientation toward housing is tween banks and thrifts in the sale of another reason often advanced for graphic restrictions upon converting insurance.

7 FDIC Banking Review

This section discusses these im­ areas: the asset powers of the deposi­ activity permissible to subsidiaries of plementation issues and presents op­ tory institution; the powers of thrift national banks. tions for dealing with them. Again, as service corporations; and branching Insurance brokerage and agency stated in the introduction, the options restrictions. are basically sales-oriented activities it examines concern only those pow­ Asset Powers. At the institution and do not present safety-and­ ers that either banks or savings asso­ level, commercial banks have more soundness issues. The sale of insur­ ciations currently have. It does not extensive asset powers than savings ance by banks would provide cus­ broach financial modernization in its associations whose investment in cer­ tomers with greater choice, and broader sense. tain types of loans is restricted. As dis­ promote greater efficiency in the This section also reviews the im­ cussed in the previous section, the marketplace. Therefore, if federal pact that charter unification would major argument for unifying the fed­ bank and thrift charters were have in several related areas: the eral bank and thrift charters is that merged, a reasonable course of action QTL test, state-chartered thrift insti­ there is no longer a need for a special- would be to extend full insurance tutions, mutual savings associations, purpose charter focused on the hous­ agency powers to national banks. and the Federal Home Loan Bank ing industry. In addition, broader However, as a practical matter, such a System. Grandfathering is one option asset powers allow for greater diversi­ move might encounter significant to deal with some of the implementa­ fication and more competition, while political opposition. tion issues that would arise from char­ not precluding the possibility of an in­ Unlike insurance, real-estate ter unification. An appendix contains stitution specializing if that is its busi­ activities, especially real-estate devel­ an historical overview of grandfather­ ness strategy. Given the above, if the opment, do raise safety-and-sound­ ing within the context of financial in­ federal bank and thrift charters were ness issues.17 FIRREA required that dustry legislation. to be merged, the only plausible alter­ equity investments and loans to serv­ native is to give the resultant institu­ ice corporations engaged in activities Issues at the Depository tion the asset powers of a national not permissible for national banks be Institution Level bank. deducted from capital. As a result, Savings Association Service Cor­ federal savings associations no longer At the depository institution level, porations. One of the more difficult engage in real-estate activities on a implementation issues arise in three questions about charter unification at large-scale basis. Savings associa­ the institution level concerns the tions reported $77.7 billion in real- service corporations of federal sav­ estate service corporation assets at ings associations. As discussed ear­ year-end 1989.18 By year-end 1995, 17 The FDIC presents the risks in detail in the lier, federal savings associations can this figure had fallen to $3.4 billion. Federal Register publication, 61 FR 43486, “Proposed Rule: Activities and Investments invest up to 3 percent of their assets in Despite the current low level of of Insured State Banks,” August 23, 1996. service corporations. Also, while na­ real-estate investment by savings as­ 18 Institutions that were eventually taken over tional banks can perform most of the sociations, the divergent real-estate by the RTC held$11.1billionofthisamount. pre-approved activities permissible powers of federal savings associa­ 19 The FDIC has dealt with real-estate in­ for thrift service corporations, both vestments by depository institutions in tions and banks would need to be ad­ conjunction with applications made by directly and through operating sub­ dressed if the federal charters were state-chartered banks under Section 24 sidiaries, they are not permitted to en­ merged. One way to deal with those of the Federal Deposit Insurance Act (12 U.S.C. §1831a). The FDIC deals with gage in real-estate development and risks would be to require that any each Section 24 case individually. How­ the management of real estate for real-estate development or manage­ ever, in many cases, the FDIC has condi­ third parties, or to sell most types of tioned its approval of an application from a ment activities be conducted in a state-chartered bank to engage in real- insurance without restriction (al­ bona fide subsidiary, with the bank’s estate investment on the following condi­ though recent judicial decisions have investment (both equity and loans) tions: that the real-estate activity be con­ expanded the insurance agency pow­ ducted in an adequately capitalized, deducted from capital, and with the separately-operated subsidiary with at ers of national banks). subsidiary subject to Section 23 of least one separate director; that the bank’s As of year-end 1995, there were the Bank Holding Company Act type investment in the subsidiary (except arm’s-length end loans) be deducted from 255 savings associations with insur­ restrictions. With the exception of capital; that the capital deduction is also ance subsidiaries. Most of these were the Section 23 requirements, these used for setting risk-related premiums and prompt corrective action; and that the at relatively small institutions, 207 of conditions already apply to thrift restrictions of Section 23A and 23B of the the 255 had under $1 billion in assets. service corporations.19 Federal Reserve Act apply to transactions Although no data are available on the with the subsidiary. The FDIC has also Branching Restrictions. As dis­ proposed a “safe harbor” rule under which activities of these insurance subsidi­ cussed earlier, bank branching pow­ institutions meeting certain conditions aries, anecdotal evidence indicates ers are in some cases more restrictive may engage in real-estate activities after notice to the FDIC if the FDIC does not that many are restricted to the sale of than federal savings association object. credit-related insurance products, an branching powers, although they

8 A Unified Federal Charter have come much closer together over Table 3 time. Full interstate and intrastate 28 Thrift Unitary Diversified Holding Companies* branching provides for the greatest as of June 1996 diversification of risk, the greatest convenience for customers, and the Thrift greatest market efficiencies. Given Type of Assets Holding Company Business Thrift Name ($000s) these facts, the near universality to­ day of statewide branching, and the Acacia Mutual Life clear momentum to interstate branch­ Insurance Co. Insurance Acacia Federal Savings Bank $515,811 ing, a reasonable course of action American Mutual should the federal charters be unified Holding Company Life Insurance Amerus Bank 1,198,139 would be to allow full interstate and B.A.T. Industries Tobacco, intrastate branching. Cigarettes First FS&LA of Rochester 7,341,422 Carpenters Pension Trust Fund Southern Issues at the Holding California Pension Trust United Labor Bank, FSB 71,114 Company Level Club Corp. International Resorts Franklin Federal Bancorp., FSB 900,188 The most difficult issue regarding Equity Holdings Ltd. Real Estate Firstate Fin., F.A. 103,266 the single federal charter concerns Estate of Bernice holding companies. Except for possi­ Pauahi Bishop Non-Profit Educ. Southern Cal. FS&LA 1,694,535 ble grandfathered situations (and ig­ First Pacific Investment Numerous noring the complication that would Ltd. Holdings United Savings Bank 1,526,791 result if thrift charters were continued First Pacific Investment Numerous at the state level), the distinctions be­ Ltd. II Holdings United Savings Bank 1,526,791 tween savings-and-loan holding com­ Hawaiian Electric panies and bank holding companies Industries, Inc. Public Electric American Savings Bank, FSB 3,412,595 would have to be eliminated. Table 3 Heritage Mutual Insurance Co. Insurance Westland Savings Bank SA 91,405 contains a list of unitary diversified savings-and-loan holding companies, Hy-Vee Food Stores Grocery Midwest Heritage Bank, FSB 96,685 the type of savings-and-loan holding Illinois Mutual Life & Casualty Co. Insurance Bankplus, FSB 189,909 company most likely to contain sig­ nificant nonfinancial businesses. As Krause Gentle Corp. Gas and Food Liberty Savings Bank, FSB 76,903 can be seen from the table, as of June Massachusetts State Pension First Trade Union Carpenters Pension Fund Trust Savings Bank, FSB 286,468 1996, there were only 28 such compa­ nies. Massachusetts State Carpenters Guaranteed First Trade Union Four approaches to eliminating Annuity Fund Trust Savings Bank, FSB 286,468 the prospective differences between McMorgan & Co. Manages Union savings-and-loan holding companies Pension Funds United Labor Bank, FSB 71,114 and bank holding companies could be P H M Corporation Home Building First Heights Bank, FSB 252,057 taken (existing affiliations are dis­ Pacific Electric Wire cussed below): (1) holding compa­ & Cable Manufacturer Pacific Southwest Bank 1,337,198 nies could be allowed to engage in Prudential Insurance Co. Insurance The Prudential Savings virtually any activity, the approach Bank, FSB 203,641 taken with unrestricted savings-and­ Raymond James Security Raymond James loan holding companies; (2) holding Financial, Inc. Brokerage Bank, FSB 189,791 companies could be restricted to a Southwest Gas Corp. Gas Transmission Primerit Bank, FSB 1,704,885 limited number of financially related Sun Life Assurance Co. Insurance New London Trust, FSB 288,881 activities, the approach currently Temple Inland, Inc. Paper Guaranty Federal Bank, FSB 9,153,087 taken with bank holding companies; The Langdale Co. Manufacturing- (3) holding companies could be al­ Forest Based lowed to engage in most financially Products Commercial Banking Co. 33,684 related activities, including, with The Monticello Cos., Inc. Medicine Sales Monticello Bank 23,526 proper safeguards, investment bank­ United Services Automobile Insurance USAA Federal Savings Bank 5,805,837 ing and the insurance business, but Watts Health Systems, Inc. Health Plans Family Savings Bank, FSB 167,239 prohibited from nonfinancial activi­ ties; or (4) holding companies whose *First-Tier Holding Companies depository institutions met the QTL Source: The Office of Thrift Supervision

9 FDIC Banking Review

test (or similar test) could be allowed sense, some nexus would have to be amount of FHLB stock a non-savings to engage in any activity that did not established between the test and association FHLB member must threaten the safety and soundness of broader holding company powers. hold for a given amount of advances the institution. Absent such a nexus there would be (the higher the ratio, the less stock). Of these four options, the third op­ no reason to distinguish between the The role of the FHLBs and what tion — permitting bank holding com­ powers of a holding company of a de­ characteristics, if any, their members panies to expand into most financially pository institution that met the test should have is beyond the scope of related activities but with a contin­ and powers of one that did not. this study. Depending on the mis­ ued prohibition against nonfinancial As to existing affiliations, commer­ sion of the FHLB System, requiring activities — would appear to be the cial companies have not historically some continued portfolio orientation most desirable. While the elimina­ been a source of risk to the thrift in­ (although not necessarily the current tion of the separation between bank­ dustry. The OTS reports that unitary QTL assets) in order to enjoy the ing and commerce may be worth thrift holding companies, rather than benefits of FHLB advances may considering in the long run, a more having caused harm to their subsidiar­ make sense. cautious policy of bank expansion ies in the past, have in fact provided a State-Chartered Savings Asso­ into other financial activities is proba­ source of strength to them during ciations. If the federal savings asso­ bly a more prudent short-term course. times of need. Additionally, affilia­ ciation charter were eliminated, a Banking organizations have exper­ tions between thrifts and commercial major question is whether state- tise in managing certain financial organizations do not appear to be ex­ chartered savings associations should 20 risks. They should leverage this ex­ tensive. Thus, the grandfathering be eliminated as well. As noted ear­ pertise before branching out into of existing relationships might be fea­ lier, the Deposit Insurance Funds commercial ventures. In addition, sible. In fact, some affiliations be­ Act of 1996 requires that the BIF and bank regulators should develop a tween commercial companies and the SAIF be merged on January 1, body of experience to evaluate the bank holding companies were already 1999, provided no institution re­ safety-and-soundness implications of grandfathered by the 1970 Amend­ mains as a savings association at that any new financial affiliations before ments to the Bank Holding Company time. Act (see appendix). On the other allowing broader affiliations with Eliminating state-chartered thrifts hand, given the limited number of af­ firms exposed to a different range of might prove difficult. In order to filiations, divestiture would not re­ risks. On the other hand, compared to eliminate state-chartered thrifts ef­ quire widespread restructuring of the the status quo, allowing banks to ex­ fectively, such a ban would have to thrift industry. pand into other financially related include state-chartered savings activities — perhaps through either banks as well as state-chartered holding companies or direct subsidi­ Other Issues savings-and-loan associations. As a aries — would strengthen banking Charter unification raises issues in general matter, states are allowed to organizations by allowing diversifica­ addition to the powers of depository issue limited-purpose charters. In tion of income sources and better institutions, their affiliates, and their addition to chartering savings-and­ service to customers, and would promote holding companies. The topics in the loan associations and savings banks, an efficient and competitive evolution following discussion concern the the states issue charters for trust com­ of U. S. financial markets. QTL test, state-chartered savings as­ panies, cooperative banks, and in­ With respect to using the QTL sociations, mutual savings associa­ dustrial banks. To force them to test, or some variant thereof, to deter­ tions, and the Federal Home Loan eliminate a specific type of limited mine holding company powers, in or­ Bank System. charter would be a blow to the dual der for such an approach to make QTL Test. If the charters are banking system. It would also be dif­ merged, the QTL test would basi­ ficult to prevent a state from reincar­ cally be moot with two possible ex­ nating a charter that looked very ceptions. First, as noted earlier, the much like a savings association char­ QTL test could be used to exempt a ter with a different name. 20 Because unrestricted savings-and-loan holding companies are essentially unregu­ holding company from the strictures Short of mandating the elimina­ lated, only limited data on their activities of the Bank Holding Company Act. tion of the state thrift charter, state- exist. This makes it difficult to gauge, ex­ However, also as noted earlier, such a chartered savings associations could cept in the most general terms, the number engaged in nonfinancial activities, or activi­ distinction would only make sense if be subjected to Section 24 of the FDI ties not permissible to a bank holding com­ there was a nexus between the QTL Act, which would require that they pany. test and holding company powers. not engage in any activity not permis­ 21 Under current law, a state-chartered thrift Second, the QTL test — or more sible for a national bank without must apply to the FDIC to engage in any ac­ tivity not permissible to a federal savings as­ accurately the percentage of QTL FDIC approval.21 They could also sociation (12 U.S.C. §1831e). assets — is used to establish the be made subject to the Bank Holding

10 A Unified Federal Charter

CompanyCompanyCompanyCompany ActActActAct withwithwithwith whateverwhateverwhateverwhatever grand-grand-grand-grand­ attractive to new industry entrants. have the automatic capital support of fatheringfatheringfatheringfathering orororor otherotherotherother provisionsprovisionsprovisionsprovisions thatthatthatthat According to a preliminary review, the current system. However, it wouldwouldwouldwould applyapplyapplyapply totototo federalfederalfederalfederal savingssavingssavingssavings asso-asso-asso-asso­ only a handful of savings associations should be noted that as of August ciations.ciations.ciations.ciations.22222222 UnderUnderUnderUnder suchsuchsuchsuch circumstances, over the past ten years have chosen 1996, federal savings associations state-chartered savingssavingssavingssavings associations the mutual form of organization. At accounted for only 19 percent of wouldwouldwouldwould probablyprobablyprobablyprobably loseloseloselose theirtheirtheirtheir attractive-attractive-attractive-attractive­ least two were credit unions convert­ FHLBS members (commercial ness.ness.ness.ness. ManyManyManyMany state-chartered savingssavingssavingssavings ing to savings associations. It is not banks accounted for 65 percent, associationsassociationsassociationsassociations mightmightmightmight choosechoosechoosechoose totototo convertconvertconvertconvert clear that any of the new mutual char­ state-chartered thrifts 13 percent, totototo banksbanksbanksbanks andandandand somesomesomesome statesstatesstatesstates mightmightmightmight elimi-elimi-elimi-elimi­ ters over this period were true de novo and others 3 percent). Moreover, ac­ natenatenatenate theirtheirtheirtheir thriftthriftthriftthrift charters,charters,charters,charters, butbutbutbut thisthisthisthis mutual savings associations. cording to the Federal Housing Fi­ wouldwouldwouldwould bebebebe accomplished withoutwithoutwithoutwithout tam-tam-tam-tam­ Given the large number of mutual nance Board, since April 1995, when peringperingperingpering withwithwithwith thethethethe dualdualdualdual bankingbankingbankingbanking system.system.system.system. thrifts, it does not make sense to FHLBS membership was made vol­ Mutual Savings Associations.At change the status quo and require con­ untary for OTS-regulated state- June 30, 1996, there were 410 mutual version. The other options are to chartered thrifts, no such thrift has federal savings associations and 714 grandfather existing mutuals but not left the system.23 It is likely that stock federal savings banks. While in grant new mutual charters, or to con­ many federal savings associations number mutuals represent 36 percent tinue to grant new mutual charters, would also choose to retain their of federal savings associations, they effectively extending the possibility FHLBS membership if such mem­ accounted for only 10 percent of the of the mutual form to commercial bership were to become voluntary. assets held by such institutions ($72 banks. Historically, the mutual form The FHLBS is therefore unlikely to billion out of a total of $717 billion in of organization has not raised safety­ face crisis if the federal thrift charter assets). Including state-chartered and-soundness concerns. As such, were eliminated. savings and loans and savings banks there does not appear to be any reason there were a total of 943 mutual thrifts not to follow this latter course. and 1,038 stock institutions. Mutual Federal Home Loan Bank System institutions hold a total of 17 percent (FHLBS). Replacement of the two- of thrift assets ($179 billion out of a to­ charter federal system with a single 22 State-chartered savings banks are presently tal of $1,023 billion). Commercial charter would have an impact on the subject to the Bank Holding Company Act banks all take stock form. unless they elect under §10(e) of the Home Federal Home Loan Bank System Owners Loan Act to be treated as a thrift for The FDIC Division of Research (FHLBS). Federal savings associations purposes of §10 and comply with the QTL and Statistics has looked at recently are currently required to be members test. chartered de novo savings associations of the FHLBS. Elimination of the 23 One state-chartered savings-and-loan asso­ ciation, Wauwatosa Savings and Loan Asso­ to determine whether the mutual federal thrift charter could result in a ciation, managed to exit the system in April form of organization has proven to be voluntary FHLBS that would not 1993.

11 FDIC Banking Review

APPENDIX Grandfathering in Banking Legislation This appendix outlines how past provided that the FRB could not approve prevent undue concentration of legislation mandating changes in the an application by a bank holding com­ resources, decreased or unfair com­ banking industry dealt with the prob­ pany to acquire voting shares on sub­ petition, conflicts of interest, or un­ lem of existing activities and owner­ stantially all assets of a bank outside sound banking practices. The FRB ship arrangements. The approaches of its home state unless the acquisi­ was required to make such a determi­ taken fall into two general categories: tion was expressly permitted by the nation within two years if a com­ (1) requiring that existing activities law of the target state. Twelve exist­ pany's bank had assets of over $60 and arrangements be ceased or di­ ing interstate holding companies million or within two years of the vested; and (2) permitting the con­ were grandfathered. In the late 1970s reaching of that level by a bank. The tinuation of existing activities and and throughout the 1980s, states re­ divestiture period after such a deter­ arrangements. The second approach laxed their laws to permit various de­ mination by the FRB was ten years. is often termed “grandfathering” and grees of interstate expansion by bank Under the $60-million limitation, a itself encompasses a range of con­ holding companies. The Riegle-Neal bank holding company could only trols. At one end of the spectrum, the Interstate Banking and Branching Effi­ continue existing impermissible non- continuation of existing activities ciency Act of 1994 authorized inter­ banking activities and not engage in and arrangements has been tightly state expansion by bank holding new impermissible ones. circumscribed, even “frozen” as they companies beginning one year after Hardship Exemption. Under were on a grandfather date. At the its enactment. The Act also author­ Section 4(d) of the Bank Holding other end of the spectrum, few con­ ized interstate branching by banks Company Act (12 U.S.C. §1843(d)), trols have been placed on the con­ beginning on June 1, 1997, unless a the FRB could grant exemptions tinuation, and the activities have thus state either accelerates the effective from the Act for a company that enjoyed room for growth. An accom­ date or opts out of interstate branch­ became a bank holding company as a panying table summarizes the prohi­ ing. result of the Amendments, that con­ bition, divestiture, and grandfather Bank Holding Company Act trolled a single bank on July 1, 1968, provisions of the major laws covered Amendments of 1970. The Bank and that did not subsequently ac­ in the discussion. Holding Company Act Amendments quire another bank. The exemptions Glass-Steagall. Four provisions of 1970 brought single-bank holding could be subject to such conditions as of the Banking Act of 1933 largely re­ companies within the jurisdiction of the FRB considered necessary to quired the divestiture and continued the Act and gave the FRB leeway to protect the public interest. Unlike separation of the investment banking expand the nonbanking activities the grandfather privileges under the and commercial banking businesses. permitted bank holding companies. Section 4(a)(2) $60-million exemp­ The divestiture period was one year. Companies that became bank hold­ tion, an exemption under Section The Glass-Steagall Act is still the law, ing companies as a result of the 4(d) permitted a bank holding com­ but judicial and regulatory interpreta­ Amendments were given a ten-year pany to expand into new nonbanking tions and developments in financing period to divest impermissible activi­ activities. An exemption had to be and investment techniques have ties they were directly or indirectly based on one of three grounds: (1) to eroded many of the distinctions be­ engaging in. Two primary grandfa­ avoid disrupting business relation­ tween the two businesses. thered situations were provided for, ships that had existed over a long Bank Holding Company Act of the $60-million limitation and the period of years without adversely af­ 1956 — Nonbanking Activities. hardship exemption.1 fecting the banks or communities The Bank Holding Company Act of $60-Million Limitation. Under involved; (2) to avoid forced sales 1956 generally required multibank Section 4(a)(2) of the Bank Holding of small locally owned banks to pur­ holding companies to divest them­ Company Act (12 U.S.C. §1843(a)(2)), chasers not similarly representative selves of businesses extraneous to a company that became a bank hold­ banking. The divestiture period was ing company as a result of the Amend­ two years, which the Federal Reserve ments and that was engaged in 1 The Amendments also exempted from the Board (FRB) could extend in individ­ nonbanking restrictions (1) certain bank activities on June 30, 1968, that be­ holding companies that were also tax- ual cases to a maximum of five years. came impermissible because of the exempt labor, agricultural, or horticultural Amendments could continue to en­ organizations and (2) any one-bank holding Bank Holding Company Act of company that was more than 85 percent 1956 — Interstate Banking. The gage in the activities unless the FRB deter­ owned by a single family on June 30, 1968, Bank Holding Company Act of 1956 mined termination was necessary to and continued to be so.

12 A Unified Federal Charter

Prohibitions, Divestitures, and Grandfathering in Banking Legislation Selected banking industry legislation containing prohibition, divestiture, and grandfathering provisions are listed in this table. The provisions are described in greater detail in the accompanying text, which also covers additional legislation. Law Prohibitions and Divestitures Grandfathering

Glass-Steagall Act, 1933 Investment Banking and Commercial Banking — None One-Year Divestiture Period Bank Holding Company Act of 1956 (1) Bank Holding Company Nonbank Activities (1) None Unless Permissible — Two-Year Divestiture Period, Extendable to Five Years (2) Interstate Bank Holding Companies Prohibited (2) Existing Interstate Bank Holding Without State Permission Companies Bank Holding Company Act Bank Holding Company Nonbank Activities (1) Existing Nonbank Activities of Amendments of 1970 Unless Permissible — Ten-Year Divestiture Period Bank Holding Companies With Bank Subsidiaries Smaller Than $60 Million in Assets (2) Hardship Exemption International Banking Act of 1978 U.S. Nonbank Activities of Foreign Banks With Branches, Existing Securities Affiliates Agencies, or Commercial Lending Companies in U.S. — Seven-Year Divestiture Period Garn-St Germain Act, 1982 Bank Holding Company Insurance Activities Unless (1) Existing Insurance Activities Specifically Permitted by Statute (2) Any Insurance Activities by a Bank Holding Company Con­ ducting an Insurance Activity Prior to January 1, 1971 Competitive Equality Banking Act, Nonbank Banks (Nonbank banks were not prohibited, Existing Nonbank Banks (Owners that 1987 just brought within the Bank Holding Company Act's were not bank holding companies definition of a bank.) could continue ownership without becoming bank holding companies; owners that were bank holding companies could continue ownership despite what might otherwise be violations of interstate banking restrictions.) of community interests; or (3) to allow activities contained in the Bank 1987, a foreign bank that acquires a retention of a bank so small in relation Holding Company Act applicable to bank in the United States loses its to the holding company's total inter- a foreign bank that maintained a grandfather rights. est and so small in relation to the branch, agency, or commercial lend- Bank Holding Company In- banking market as to minimize the ing company in the United States (12 surance Activities. In 1982, the likelihood that the bank's powers to U.S.C. §3106(a)). Foreign banks Garn-St Germain Act, among other grant or deny credit would be influ­ could retain any nonbank investment things, amended Section 4(c)(8) of enced by a desire to further the hold- or continue any nonbank activity un­ the Bank Holding Company Act (12 ing company's other interests. til December 31, 1985. Grandfather U.S.C. §1843(c)(8)) to restrict the in- Altogether, the FRB granted ap­ privileges were granted beyond that surance activities of bank holding proximately 12 hardship exemptions. date for direct or affiliate activities companies. Two grandfather situa- Among the companies that received conducted on or applied for by July tions were provided for. First, insur­ exemptions were The Goodyear Tire 26, 1978. In addition, foreign banks ance agency activities conducted by a & Rubber Company, Olin Corpora- engaged since July 26, 1978, in under- bank holding company on May 1, tion, Minnesota Mining and Manu­ writing, distributing, or selling securi­ 1982, or approved for the company by facturing Company, and Beneficial ties in the United States through the FRB on or before that date, could Corporation. Data on the hardship “domestically controlled affiliates” be continued. Further, the activities exemptions are presented in an ac- were permitted to engage in new ac- could be expanded to new locations companying table. tivities through the affiliates or ac- in the state of the bank holding com- Foreign Banks — Nonbanking quire the assets of going concerns pany's principal place of business, in Activities. Among other things, the through the affiliates. Under an FRB adjacent states, and in other states International Banking Act of 1978 interpretation that was codified into where the activities were conducted made the restrictions on nonbanking the International Banking Act in on the grandfather date. And the

13 FDIC Banking Review

Section 4(d) Approvals agency activities could be expanded Holding Company and Bank Assets of Bank Board Action to include new types of insurance in- (in $ millions) suring against the same types of risk. Second, the FRB could approve new 1. The Goodyear Tire & Rubber Company $108 12/07/71 (A) Akron, Ohio insurance activities for a bank hold­ The Goodyear Bank, Akron, Ohio ing company engaged in insurance Goodyear Bank was part of Goodyear until 07/15/82. Now owned by National City Corp of agency activities prior to January 1, Cleveland. 1971, pursuant to FRB approval prior 2. Olin Corporation, New York, New York 20 12/07/71 (A) to that day. Insurance activities per­ Illinois State Bank, East Alton, Illinois mitted under this second grandfather Illinois State Bank of East Alton was controlled by Olin until 08/12/85. Now a branch of Magna Bank of St. Louis. provision were not limited to those 3. Milton Hershey School and School Trust 43 02/17/72 (A) conducted in 1971. The Garn-St Hershey, Pennsylvania Germain amendment also provided The Hershey National Bank, Hershey, Pennsylvania for the growth of a $10,000 ceiling it Hershey National Bank was affiliated with Milton Hershey until 03/14/86. Now a branch of PNC imposed on extensions of credit for Bank of Pittsburgh. which finance company subsidiaries 4. CPC International, Inc. 30 03/23/72 (A) of bank holding companies could sell Englewood Cliffs, New Jersey Argo State Bank, Summit, New Jersey credit-related insurance. The ceiling Argo State Bank was part of CPC until 08/04/82. It then became part of Harris Bancorp, which be­ increased annually to match the in­ came a subsidiary of Bank of Montreal. Still a bank under same identification number. Assets to­ crease in the Consumer Price Index. taled $192,517 (in thousands) as of 12/31/95. Competitive Equality Banking 5. Minnesota Mining and Manufacturing 29 05/09/72 (A) Company Act — Nonbank Banks. The St. Paul, Minnesota Competitive Equality Banking Act Eastern Heights State Bank, St. Paul, Minnesota of 1987 (CEBA) was signed into law Eastern Heights State Bank is still owned by MMM. Bank assets totaled $376,151 (in thousands) on August 10, 1987. The cut-off date as of 12/31/95. used in the grandfather provisions of 6. Beneficial Corporation 20 08/09/72 (A) this legislation was March 5, 1987. Wilmington, Delaware Peoples Bank and Trust Company, Among other things, CEBA closed Wilmington, Delaware the “nonbank bank” loophole in the Peoples Bank and Trust is still owned by Beneficial Corporation. Bank assets totaled $414,430 (in Bank Holding Company Act by thousands) as of 12/31/95. broadening the definition of “bank” 7. Heldenfels Brothers, Contractors 12 01/05/73 (A) in that Act to cover any institution Corpus Christi, Texas that either met the then-existing First National Bank, Rockport, Texas definition or was insured by the FNB of Rockport became a branch after it was merged into Victoria Bank and Trust Co. on 12/02/92. FDIC (12 U.S.C. §1841). Several 8. R. R. Donnelley & Sons Company 28 05/16/73 (A) grandfather situations were provided Chicago, Illinois Lakeside Bank, Chicago, Illinois for: Lakeside Bank was owned by Donnelley until 09/28/93. It is now owned by Lakeside Bancorp. Nonbank Holding Company Bank assets totaled $217,965 (in thousands) as of 12/31/95. Owners. A company that controlled 9. The Moody Foundation, Galveston, Texas 46 07/12/73 (A) a nonbank bank on March 5, 1987, The Moody National Bank of Galveston Galveston, Texas and was not a bank holding company Moody NB of Galveston was owned by Moody Foundation until 05/25/84. Now owned by Moody before the enactment of CEBA Bankshares. Bank assets totaled $289,724 (in thousands) as of 12/31/95. would not be treated as a bank hold­ 10. W. J. Young & Co., Clinton, Iowa 38 12/12/74 (A) ing company solely by virtue of its The Clinton National Bank, Clinton, Iowa control of the nonbank bank (12 Clinton National Bank is still owned by W. J. Young and Co. Bank assets totaled $225,444 (in U.S.C. §1843(f)). Within 60 days af­ thousands) as of 12/31/95. ter enactment, such companies had 11. Trustees of Dartmouth College 20 02/12/75 (A) to identify themselves to the FRB. Hanover, New Hampshire Dartmouth National Bank In general, grandfather rights would Hanover, New Hampshire be lost if the company otherwise be­ Dartmouth National Bank became a branch of Fleet Bank - NH on 10/01/89. came a bank holding company or if 12. Charles Stewart Mott Foundation 425 8/06/79 (A) the nonbank bank did one or more of Flint, Michigan several things: (1) began to engage in The Wayne Oakland Bank, Royal Oak, Michigan activities in which it was not lawfully The Wayne Oakland Bank was acquired by First of America on 06/06/83. engaged on March 5, 1987; (2) offered or marketed products or services of

14 A Unified Federal Charter affiliates that were not permitted for or come into compliance with the Explicit Exemptions. CEBA bank holding companies, or permit­ Bank Holding Company Act. A list of exempted certain special-purpose ted its products or services to be of­ nonbank banks and their parents is banks from the Bank Holding Com­ fered or marketed by affiliates whose given in an accompanying table. pany Act's new, broader definition of activities were broader than those Bank Holding Company Own­ a bank. These exemptions included permitted for bank holding compa­ ers. Notwithstanding most other limited-purpose trust companies, nies, unless the products or services provisions of Section 4 of the Bank credit-card banks, certain industrial were offered or marketed as of March Holding Company Act—the then- loan companies, and the U.S. branch­ 5, 1987, and then only in the same limitations on interstate banking op­ es of foreign banks. manner; (3) permitted any overdraft erations being the main concern—a Competitive Equality Banking on behalf of an affiliate or incurred bank holding company controlling an Act — Savings Banks. CEBA created any overdraft in its account at a Fed­ institution that became a bank by vir­ a grandfathered entity called a “quali­ eral Reserve Bank on behalf of an af­ tue of CEBA generally could retain fied savings bank,” which was defined filiate (with exceptions regarding control of the bank if the bank: (1) did as a state savings bank organized on inadvertent overdrafts and affiliates not engage after enactment in any ac­ that were primary dealers); or (4) in­ tivity that would have caused it to be a or before March 5, 1987. Under Sec­ creased its assets by more than 7 per­ bank pre-CEBA (that is, it did not be­ tion 3(f) of the Bank Holding Com­ cent in any one 12-month period gin both accepting demand deposits pany Act (12 U.S.C. §1842(f)) as beginning one year after enactment and making commercial loans); or (2) amended by CEBA, a “qualified of CEBA. A company losing its did not increase the number of loca­ savings bank” controlled by a bank grandfather exemption would have tions from which it conducted busi­ holding company was permitted to 180 days after loss of the exemption ness after March 5, 1987 (12 U.S.C. engage in any activities allowed by to either divest each bank it controlled §1843(g)). the law of its state, other than certain

Nonbank Banks and Their Parents December 31, 1995 Domestic Assets Nonbank Parent State ($000s)

American Express Centurion Bank Shearson American Express NY $11,173,428 Greenwood TC Sears Roebuck & Company IL 10,133,809 First Deposit NB Providian Corporation KY 2,183,269 Merrill Lynch Bank & Trust Co. Merrill Lynch & Company NY 1,891,714 Custodial Trust Company Bear Stearns Companies, Inc. NY 1,769,849 Hurley Street Bank Sears Roebuck & Company IL 1,558,562 Firstrust Savings Bank Semperverde HC PA 1,378,314 Prudential Bank & Trust Company Prudential Insurance Company NJ 1,369,450 Hickory Point Bank & Trust Co. Archer-Daniels-Midland Company IL 748,170 J C Penny NB J C Penny Company TX 683,531 Travelers Bank Commercial Credit Company MD 435,892 American Investment Bank NA Leucadia National Corporation NY 210,846 Franklin Bank Franklin Resources CA 182,056 Century Bank State Savings Bank OH 180,176 First Signature Bank & Trust Co. John Hancock Mutual Life Ins. Co. MA 156,959 California Central TR BK CORP Continental Corporation NY 139,627 Domestic L&IC Domestic Credit Corporation RI 118,166 Fidelity Management Trust Co. Fidelity Management & Research MA 89,344 First American Trust Company First American FC CA 40,096 Lyndon Guaranty Bk of New York ITT Corporation NY 18,714 Avco NB Textron RI 1,884 Total $34,454,856

15 FDIC Banking Review

insurance activities. The grandfather a Federal Reserve Bank on behalf of for a national bank unless the FDIC right would be lost if the savings bank an affiliate, except an inadvertent determines that an activity poses no was acquired by a company that was overdraft. CEBA also grandfathered significant risk to the deposit in­ not a savings bank or a savings bank cross-marketing arrangements in­ surance fund and the bank is in holding company, which was defined volving a savings-and-loan subsidiary compliance with applicable capital as a company whose qualified savings of a diversified savings-and-loan standards. The compliance period bank subsidiaries constituted at least holding company—a company whose was one year from the date of FDI- 70 percent of its assets. savings-and-loan subsidiary and re­ CIA's enactment. Certain very lim­ Competitive Equality Banking lated activities represented less than ited insurance activities provided Act — Savings-and-Loan Holding 50 percent of its consolidated net through subsidiaries were grandfa­ Companies. CEBA grandfathered worth and consolidated net earnings­ thered. State banks also cannot make rights for certain savings-and-loan —and an affiliate to the extent they equity investments that are not per­ holding companies that would other­ engaged in such arrangements on missible for a national bank, with wise cease to qualify as unrestricted March 5, 1987. certain exceptions and subject to the savings-and-loan holding companies FIRREA — Savings Associa­ grandfathering of limited state- because of a failure of their savings­ tion Activities and Investments. permitted investments in listed se­ and-loan subsidiaries to satisfy a new Section 222 of the Financial Institu­ curities. Impermissible equity in­ QTL test. Without grandfather pro­ tions Reform, Recovery, and En­ vestments had to be divested in five tection, the period to bring savings­ forcement Act of 1989 (FIRREA) years, except a three-year period was and-loan subsidiaries into compliance created Section 28 of the FDI Act. provided for compliance with the limitation on state-permitted invest­ with the new QTL test was two years. Section 28 prohibits any state savings ments in securities. A grandfathered savings-and-loan association from engaging in any type holding company was one that had re­ of activity, or in an activity in any Conclusion. Generalizations ceived permission prior to March 5, amount, that is not permissible for a about Congressional selections be­ 1987, to acquire control of a savings­ federal savings association unless the tween divestiture on the one hand and-loan association. Such a grandfa­ FDIC determines the activity would and a grandfather scheme on the thered company was permitted to en­ pose no significant risk to the affected other are difficult to make. Each gage in any activity in which it was insurance fund and the savings asso­ situation had its own unique circum­ lawfully engaged on that date. This ciation is and continues to be in com­ stances. The relative political power grandfather right could be lost for a pliance with certain capital standards of the defenders of the status quo and number of reasons: (1) the holding (12 U.S.C. §1831e).2 The compliance of those who sought change varied company acquired control of a bank or date was January 1, 1990, less than considerably from situation to situa­ another savings-and-loan association four months from the enactment of tion, as did the degree of the appar­ (except in a qualified supervisory FIRREA, but divestiture of existing ent “evil” that was the subject of the transaction); (2) any savings-and-loan non-conforming assets was not re­ legislation. Nevertheless, it seems subsidiary of the holding company quired. State savings associations also reasonable to conclude that the se­ failed to qualify under the Internal cannot make equity investments im­ lection was often influenced by mag­ Revenue Code thrift test; (3) the permissible for federal associations, nitude, that is, by the relative scope holding company engaged in any except that certain investments in of the activities concerned. Grand­ business activity in which it was not service corporations are permissible. father solutions appear to have been engaged on March 5, 1987, and which Impermissible investments had to be used more often in situations when was not otherwise permissible for divested by July 1, 1994. the relative impact would not be savings-and-loan holding companies; FDICIA — State Bank Activi­ large. (4) any savings-and-loan subsidiary of ties. Section 303 of the Federal the holding company increased its Deposit Insurance Corporation Im­ number of business locations after provement Act (FDICIA) created March 5, 1987, except by means of a Section 24 of the FDI Act, which re­ qualified supervisory transaction; and stricted the charter powers of insured (5) any savings-and-loan subsidiary of state banks (12U.S.C.§1831a). Section 2 Under certain circumstances, the FDIC the holding company permitted an 24 prohibits insured state banks from could allow a state association to engage in an activity permissible for federal associa­ overdraft on behalf of an affiliate or engaging directly or through subsidi­ tions to a greater extent than allowed for fed­ incurred an overdraft in its account at aries in any activities not permissible eral associations.

16 Statistical Sampling as a Management Tool

Statistical Sampling as a Management Tool in Banking

by Charles D. Cowan *

he purpose of this article is to eral Deposit Insurance Corporation some will be written off. Similar to discuss potential uses of sta­ (FDIC) also performs functions that the portfolios of banks, the FDIC Ttistical sampling in a financial are similar, or identical, to those in portfolio is turning over continuously institution environment. Banks and banks and thrifts, including the man- as new loans are acquired, old assets other financial firms are faced with a agement of loans acquired from failed exit the population of assets, and number of managerial challenges banks and thrifts and the resultant some loans are converted to real and where the use of sampling can pro- need to estimate both the financial personal property. In banking a simi­ vide information at a reasonable cost. risk and the value of these loan port­ lar process occurs. New loans are un­ Given today’s competitive environ- folios. This article describes the use derwritten with different amounts ment and the move toward consolida­ of sampling in a financial setting and and types of collateral; loans are paid tion in the banking industry, it is focuses, as an illustration, on some off, sold, written off, or converted to imperative for financial managers to of the methods used by the FDIC to property owned by the bank through be able to value assets of target insti­ value assets in liquidation as part of foreclosure. tutions quickly and efficiently. Simi­ its preparation of financial statements. In order for an institution’s man­ larly, as customers are faced with an By using sampling, as opposed to agement to assess its financial condi­ ever increasing array of financial- valuing each asset, significant cost tion, not to mention a potential service providers, the quality of serv­ savings are achieved while ensuring merger target, it needs to value the as- ice provided to customers becomes the accuracy and quality of the results. set portfolio. The same is true for the increasingly important for maintain- In fulfilling its mission as deposit FDIC. The FDIC annually is required ing market share. Manufacturing insurer and receiver of failed banks, to prepare financial statements for firms, hotel chains, and other busi­ the FDIC has acquired hundreds of each of the insurance funds under its nesses have long used sampling as a thousands of assets, including loans management, in accordance with means to assure that customers are re- and real-estate properties, that it Generally Accepted Accounting Prin­ ceiving quality goods and service. Fi­ manages until disposition. These ciples (GAAP), and these statements nancial institutions similarly can use range across the broad spectrum of sampling techniques to monitor the asset types and collateral. Some of quality of customer service and inter- the loans will be held by the FDIC actions. The need for this clearly in- until they are paid off in full, some creases as back office processing will be resolved through settlement *Charles D. Cowan is Director, Management operations and customer service hot negotiations with the borrower, some Consulting, Price Waterhouse. This article was prepared when Mr. Cowan held the posi­ lines become remote from the branch will be sold as individual assets, some tion of statistician in the FDIC’s Division of originating the business. The Fed- will be sold as part of a bulk sale, and Research and Statistics.

17 FDIC Banking Review

are audited by the U. S. General Ac­ Basics — The Tools We Use counting Office. As part of the prepa­ Suppose one has to value a single pool of homogeneous assets, such as per­ ration of its financial statements the forming commercial loans. The discussion that follows describes how to set a FDIC must determine the value of its sample size for the valuation of the pool, and how to extrapolate an estimate from claim against the various receiver­ the sample to the full population of loans. This methodology can easily be ex­ ships for failed institutions by deter­ tended to multiple asset types by treating each of the asset types as a stratum, mining the value of the underlying making separate estimates for each by stratum, and adding across strata to derive assets of the receiverships. More­ an estimate for the full population. over, intermediate valuations are pre­ pared to assist in the monitoring of There are two basic functions that can be used to estimate the market value of the financial position of the funds and the pool. We assume that for each asset there is a current book value that is to assist in the liquidation planning known and easily retrievable. We also assume that we are going to select a simple process. The use of sampling allows random sample without replacement. The question then becomes: How many for more frequent valuations at rela­ assets need to be selected? Alternatively, how large a sample is needed to obtain a tively low cost. good estimate of market value for the entire loan portfolio? The answer is driven Given the existence of a large num­ by the underlying distribution of the values we are trying to estimate and the ber of loans and other assets, and “estimator” we plan to use with the sample. An estimator is the mathematical for­ changing conditions in the economy mula that summarizes the data and extrapolates the sample back to the popula­ and financial markets, there is no way tion. One estimator we could use is a direct sample projection, hereafter called to value simultaneously all of the the “direct” estimator. Another is the “ratio” estimator that uses the additional loans held in a portfolio. Nor would information we can get from the book value of the loans. The formulas for each one want to do so, given the expense are: and time constraints that surround Y Direct: Y = N x ; where N is the number of assets in the pool, and the preparation of financial state­ D ments. Instead, a sample of assets is x is the average market value of the assets in the sample. Y valued, and the sample is extrapo­ Ratio: Y = (y / x) X; where y is the total market value of assets in the sample; lated to the full population of loans. R This process can be repeated multi­ x is the total book value of assets in the sample; and ple times during the year and can be X is the total book value of assets in the population. used to track the ongoing value of the Y Regression: Y = N [y − b (x − X)]; portfolio. The same can be done in Regr any bank, using the records and loan where y is the average market value of assets in the sample; systems of the bank and a few formu­ x is the average book value of assets in the sample; and las that are presented below. b is the slope coefficient in the regression of y on x. Sampling has become a standard part of audit methodology and is fairly The direct estimate is simply the average market value of the assets in the sam­ well known and accepted in that pro­ ple, multiplied by the number of assets in the population. If we value 100 assets fession as a useful tool. This article in a sample taken from 1,000 assets in the population, we calculate the average will, therefore, not attempt to intro­ market value for the 100 assets (a market value per asset) and multiply it times duce the reader to the rudiments of 1,000. The ratio estimate works in a similar fashion, but weights the market val­ sampling, but rather will focus on the ues obtained from the sample by their book values, rather than by counting each introduction of some basic assump­ with equal weight, which is what the direct estimate does. The ratio estimate cal­ tions to standard audit sampling culates the average recovery rate and multiplies this rate times the total dollar methodology. By introducing these book value in the pool. If the market value is well-correlated with the book value, assumptions one can decrease the re­ for example, the larger the book value, the larger the market value, and they track quired sample size and make the esti­ well, then the ratio estimate will be more accurate than the direct estimate. That mation process more efficient. While is, the ratio estimate will, in general, be closer to the true population value than the article focuses on the valuation of the direct estimate. The regression estimate is similar to the ratio estimate. assets, the same methodologies and techniques can be used to develop a If one is to rely on estimates derived from samples, a rule for determining the sample of customers to survey regard­ accuracy of the estimates is needed. This rule usually is determined by the size of ing their satisfaction with the services the confidence interval around the estimated market value. Suppose we want a provided by the bank. 95-percent level of confidence that the true population value will be within plus

18 Statistical Sampling as a Management Tool

or minus 5 percent of our estimate. To obtain this, we simply set the ratio of the Incorporating Knowledge in half confidence interval over the estimate equal to 5 percent .1 the Planning Process The market value estimate is obtained from one of the three formulas given Knowledge about the values to be above, and the variance is the sampling variance estimated from the sample col­ estimated can be incorporated in the lected. Sampling variance is the variability due to the fact that each sample yields estimation process in advance, and a slightly different estimate, which on average will be equal to the value we want the use of this information can reduce to estimate. In order to estimate the market value of a portfolio and determine the the sample size needed and improve sample size, one must have some knowledge of the variance of the market value es­ the accuracy of the estimates. The timate as well as the estimate itself. Obviously this is problematic because we do more information that is available, not know either the market value or its variance. the more cost-efficient the process of Knowing this in advance of doing the survey is the key to determining the sam­ estimating a total will become. ple size, but this appears somewhat backward because this is what we are trying to There are many sets of assump­ estimate. However, what we can know in advance is derived by having a good in­ tions that can be used to determine in tuitive feel for the data, some expectation about the results one might obtain, advance the sample size needed to possibly from previous analyses, and a little help from probability theory. The achieve a fixed confidence interval next section reviews some assumptions and how they work to solve the above around estimates. This discussion fo­ equations to derive the sample size. cuses on four that are easy to imple­ Before turning to the use of external knowledge in the sample selection pro­ ment and that highlight the different cess, it is worth reviewing the definitions for sample variance for both the direct assumptions made about the data and and ratio estimators for market value. The following are the mathematical ex­ the estimator to be used. Two of the pressions for the “population recovery rate,” that is, the ratio of the population’s scenarios are commonplace, while market value to book value, and the variance of the book and market values for the other two, though less well the population as a whole and the variance terms for the estimates of market value known, lead to a better understand­ obtained by using the direct estimator and the ratio estimator: ing of the sample sizes needed for es­ timation. Each of the four scenarios Population Recovery Rate = R = Y/X makes assumptions about what we \ know about the market values rela­ Population Variance of Total Book Value = S x \ tive to the book values. There is no Population Variance of Total Market Value = S y way to determine sample sizes for the \ N (x − X) N x sampling process without making S \ = ∑ i X= ∑ i x , where = the average book value some assumptions, no matter how i = 1 N i = 1 N simplistic. \ N N (x − Y) y i S \ i Y = ∑ y = ∑ , where = the average market value i = 1 N Scenario 1: i=1 N Traditional Sampling Theory With No Connection to the Valuations The direct estimator for total market value has sampling variance VD, which is The most common procedure in the variance of the estimate because we used a sample: basic survey sampling is to turn any n N\ problem into one that assumes a bino­ ⎛ ⎞ \ V = ⎜1− ⎟ S y mial distribution. This approach pro­ D ⎝ N⎠ n vides an easy solution to the sample N is the number of assets in the population, size problem and requires no explicit n is the number of assets in the sample, which is to be determined. assumptions about the data. Instead, The ratio estimator for total market value has sampling variance V : the approach uses an implicit as­ R sumption of an upper bound on the ⎛ n ⎞ N\ variance. If one is attempting to use V = ⎜1− ⎟ (S \ + RS\\ − 2RρSS ) R ⎝ N⎠ n y x y x sampling to estimate an error rate in financial records, that is, the propor­ where ρ is the correlation between the book value x and the market value y. tion of records containing an error, the largest variance will be found when 1The algebraic statement for this measure is: the error rate is 0.5. Based on this 1.96 ∗ Variance [Market Value Estimate] knowledge, one can work backwards = 5 percent Market Va lue Estimate to derive the sample size necessary to The value 1.96 is used to set the width of the confidence interval to cover 95 percent of the sample satisfy the criterion involving a fixed values that would come from the population. proportional confidence limit band.

19 FDIC Banking Review

This rationale, however, is inade- of market values. This is not the we need to make some assumptions quate for valuation measures because same as assuming that the book value regarding the joint distributions of one is measuring a dollar value, rather and the market value move in the the book value and the market value. than a proportion or number of errors. same direction or that they are corre- A simple assumption is that the book Hence, while this scenario is com- lated in any way. value and the market value are re­ monly used as a fallback procedure One can derive the necessary sam­ lated. A commonly made distribu­ for estimating sample size, it is in­ ple size by using the assumption that tional assumption is that the variables appropriate for many financial the relative variances of book values are jointly normally distributed. This applications because of the need to and market values are equal and then allows us to incorporate easily a estimate items calibrated in dollar solve for the sample size. By plugging straight line relationship assumption values. these two values into the formula pre­ and a parameter for correlation be­ tween the variables. The normal dis­ Scenario 2: sented above for the confidence in- terval, one can solve for “n,” the tribution is not required — we can Traditional Sampling Theory sample size needed for the valuation actually use any joint distribution that With No Probability of a portfolio.2 We do not need to does not constrain the values of either Assumptions Placed on the know anything more. Everything is variable, but does allow the two vari­ Valuations based on one simple assumption, two ables to be correlated. However, any The simplest assumption is that numbers easily calculated from the moderate distributional assumption almost nothing is known about the population, and reliance is placed on like this can lead to some very severe market value of the assets, but that the direct estimator, not the ratio esti­ complications, as will be seen as we the book values of the assets in the mator. However, the simple assump­ develop this method. pool are known. This is a very conser­ tion ignores anything else known The use of the assumption of a bi­ vative assumption. By using the book about the relationship between the variate normal distribution requires value of all the assets in the popula­ book values and the market values. that one know something about five tion, one can calculate the population This may be an overly conservative parameters: the two population means, value of the variability of the book assumption for many situations. the two population variances, and values (S2 ) and the population value x the correlation between market of the average book value (x). Both of Scenario 3: value and book value. Typically, in­ these are known with certainty and can be calculated easily from the data Linear Estimators in Sampling formation is readily available only on in most record systems. If one assumes Theory Combined With two of the five parameters: the mean that the relative variability of the mar- Assumptions That the Values to and variance of the book values (see ket value is equal to the relative vari- Be Estimated Have an the previous section). Estimates of ability of the book value, then one can Underlying Normal Distribution the population mean and variance of substitute the relative variance of To use supplemental information the market values and the correlation book values for the relative variance for the calculation of the sample size, between the book value and the mar­ ket value are needed. The latter can be estimated by using simple regres­ 2 This result is derived by noting that E(Y)=∗R E(X), where Y is the total market value of the sion analysis. In the case where one assumes a straight line relationship portfolio and X is the total book value, and using: between book value and market value, 2 2 2 Variance [Market Value Total] (1− n / N) N /R S , /n (1− n / N) S, /n = = one can assume to know something Market Value Total NR∗∗X X about the relative return on the as­ x S Both and , are calculated directly from the population, that is, from the book values, so sets, namely the rate of recovery, R. they are known. By inserting these two values into the formula above for the confidence in­ This value will be approximately terval, we now can solve for “n,” the sample size needed. what one would expect to see as the 1 1 measure of return in a linear equa­ 1.96 ∗ − s 1.96 ∗ Variance [Market Value Estimate] n N x tion: = =.05 Market Value Estimate X Market Value =+a b(Book Value) . 1 n= 2 ⎛ .05 ∗ X ⎞ 1 The value “b” estimated in this re­ ⎜ ⎟ + 1.96 ∗ s N lationship is the same as the coeffi­ ⎝ x ⎠ cient “b” estimated with regression 3 Note that the value of “a” in the linear equation is not determined. However, it is not neces­ analysis. However, one can assume sary to use regression analysis to estimate it because it is reasonable to assume that it is zero if that “b” is approximately equal to R, one is willing to assume that the market value of an asset is zero when the book value is zero. and from past experience an estimate

20 Statistical Sampling as a Management Tool of R may be obtainable. Specifically, of the book value but there still will 3), book and market values could data on past sales, audits, auction in­ be variability. Based on these as­ conceivably range from −∞ to +∞ . formation, etc., may be available. This sumptions, this would be a lower Assuming that both the book values assumption will be formalized in the bound for the variability of the and market values in the portfolio are next scenario. market value. And logically, if the both gamma distributed, one can in­ The use of regression analysis market value is only a proportion of corporate both assumptions about the allows for the estimation of the the book value, one would expect portfolio as well as previously known correlation between book value and that the variability of the market information. The gamma distribu­ market value. However, this still value would not be greater than the tion is a probability distribution that requires some knowledge about the variability of the book value, thus is skewed to the right, implying that variation of the market values (the providing an upper bound. This as­ the portfolio will have many assets y’s) separate from the variation of the sumption is used because it is conser­ with relatively small book values and book values (the x’s). Because vative. only a few with very large book val­ market values and book values are In this scenario the assumptions ues. In addition, it is assumed that supposed to be closely related, one placed no limitations on either the the market value is less than, or equal can define two (extreme) assump­ book value or the market value of the to, the book value. tions: (1) the market values are as assets. Both the book value and the Three parameters must be dealt variable as the book values, or (2) market value can take on any value with by using this approach, although the market values are only a portion between−∞ and+∞, though very large there is an additional assumption that of the book values, therefore they values of either are highly unlikely, the market value is bounded above vary proportionally less. and negative values also are unlikely. and below by the book value and In practice one is more likely to find Finally, an assumption about the zero, respectively. This assumption that assets carried with a positive expected market value total is need­ is consistent with floating-rate assets value have a market value that is posi­ ed: specifically, that the expected and those with short maturities. tive and even highly distressed assets value of the market value estimate is However, it will prove problematic typically will have a sales value equal to the recovery rate, times our when valuing fixed-rate loans with slightly greater than zero. There may known total book value. above-market rates or for fixed assets be exceptions, however, such as in where depreciation may have re­ Using the regression relationship the case of environmentally con­ duced the book value below the mar­ and the first variance assumption taminated property where the costs ket value. (S2y =S2x), a simplified variance of remediation (and potential legal formula that can be solved for “n”is liability) are greater than the value of Under these assumptions, and us­ derived, using the regression estima­ the property cleaned up, thus yield­ ing this distribution, one can deter­ tor given above.4 This formula looks ing a negative market value. The nor­ mine the population variances for remarkably like the formula obtained mal joint distribution also allows the both the book value (x) and the mar­ in scenario 2, but it is multiplied by a market value to be greater than the ket value (y), and also the correlation factor that incorporates information book value, which would happen if between the book value and the mar­ about the expected recovery rate. market interest rates are below the ket value. Substituting these values This factor will play an important role rates on financial assets or when prop­ into the variance equation given 5 in determining the sample size erty has appreciated in value. above for a ratio estimator, we get: needed. Scenario 4: If the second variance assumption 2 2 2 Ratio Estimators in Sampling (S y = R ∗ S ) ) is used instead, one gets a very strange result — the Theory Combined With 1 4 n= Assumptions That the Values 2 sampling variance is always equal to ⎛ .05 ∗ X ⎞ ⎛ 2 ⎞ 1 to Be Estimated Have an ⎜ ⎟ ⎜ ⎟ + zero! This occurs because the as­ 1.96 ∗ s 1− 2 N ⎝ x ⎠ ⎝ ⎠ sumption leads to a situation in which Underlying Conditional Gamma Distribution there are too many restrictions and 5This result is obtained by observing some the variability of the data is assumed An alternative approach that incor­ basic results for gamma distributions, namely that for the population S2 = (p+q)/ away under a normal distribution. porates more information about the x a2,S2 = p/a2, E(X) = (p+q)/a, E(Y) = p/a This makes no sense, because it may data clearly is more useful in making y ρ be reasonable to expect the market the sampling process more efficient and =p/(p+q) in terms of the parameters of the joint conditional gamma, and then using value to be less than the book value, and cost-effective. For example, when method of moments techniques we can sub­ and that the variability of the market using the assumption that the data x 2 stitute the known values of and S x to value will be less than the variability were normally distributed (scenario solve for functions of the parameter values.

21 FDIC Banking Review

Sampli£g Varia£ce [Market Value] = How to Choose £ -2 ⎛ ⎞ 2 ⎜1 − ⎟ S x R (1 − R) Based on the preceding discus­ ⎝- ⎠ £ sion, the choices may appear to be As was the case in scenario 3, there is a fortuitous relationship between the exceptionally confusing. How does known values and the parameters that causes unknown values to cancel out and one use this information and draw a thus the equation can be solved directly. This is much more appealing because we reliable sample? Fortunately, there is can get three parameter values and the interrelationships between market value good news regarding both the vari­ and book value directly from the three values we can observe or know through ance estimate and the assumption other sources, namely, total book value of the portfolio, the variability of the book choices. values, and the anticipated recovery rate.6 First, the variance estimates. The This results in the equation above, and solving for n again we get: assumptions reviewed above are of­ 1 fered as alternative ways to think n = \ about the data before assets are val­ ⎛ .05 ∗ X ⎞ ⎛ R ⎞ 1 ⎜ ⎟ ⎜ ⎟ + ued in order to avoid the selection of 1.96 ∗ S ⎝1R− ⎠ N ⎝ x ⎠ a larger sample than is necessary. However, once the sample has been The sampling variance equation is much more intuitive because it says that, selected and the valuation com­ as R approaches 1.0, which can only happen when all the assets have a market pleted, the assumptions no longer value equal to the book value, the sampling variance declines to zero. The same is come into play. The estimation of the true as R approaches 0.0, meaning all assets have no value, and so again there is market value and the confidence in­ no sampling variability. By placing bounds on the results when one estimates the terval around that estimate is strictly a market value, and by allowing the market value to be a random value conditional function of the actual data. The as­ on the book value, one obtains a more sensible solution in terms of prior expecta­ sumptions are not used in the estima­ tions, and at the same time a more sensible solution in terms of the effort required tion process, but only in the equations to conduct the valuation. used to derive sample size. With the equations presented above, one can Solving for the Sample Size use either the direct method or the ra­ If the population size N is large, then the term 1 over N in the denominator of tio method, and compare the results each of the solutions disappears, and we get equations for the sample size that are to see which makes more sense and easier to use and interpret. Each of the following equations for the sample size is provides the better confidence inter­ subscripted to correspond to the assumptions in each of the scenarios discussed val. The only requirement with re­ above. spect to their use is that the sample \ \ selected is a simple random sample. ⎡1.96 ∗ S ⎤ ⎡1.96 ∗ S ⎤ ⎛1R− \ ⎞ ⎡1.96 ∗ S ⎤ ⎛1 − R⎞ n = x ,n= x ⎜ ⎟ ,n = x ⎜ ⎟ Thus, even if the assumptions were \ ⎣ ⎦3 ⎣ ⎦ \ 4 ⎣ ⎦ ⎝ ⎠ .05X .05X ⎝ R ⎠ .05X R flawed, the estimates are not a func­ tion of the assumptions but of the ac­ Note that each of the sample sizes can be expressed as a function of the sample tual data sampled. However, bad size n2, the sample size required when we make no distributional assumptions. assumptions may lead to the choice of For the sample size required when we assume that the book value and the mar­ a sample that is either too large or too ket value are normally distributed and that the variance of the book value is small, yielding results that may not equal to the variance of the market value, we get much larger required sample measure up to expectations. sizes until the recovery rate exceeds 0.7. Note also that the sample size required The other piece of good news is for the joint gamma distribution assumption is less than the sample size re­ that one can test some of the assump­ quired for the no assumption scenario when the recovery rate exceeds 0.5. tions before choosing which scenario More importantly, the joint gamma assumption always yields a smaller required to use in deriving sample sizes. This sample size than the normal assumption. This is especially gratifying, because is done easily by simply charting the scenario 4 required fewer assumptions and placed some reasonable bounds on book values as a histogram and deter­ the data to be observed. mining whether the distribution appears to be uniform, normal, or gamma. (See the appendix for a dis­ cussion on how to create the histo­ gram.) This allows a reasoned choice 6 Data about the book values of a portfolio should be readily obtainable from accounting records and of scenario and distribution assump­ anticipated recovery rates can be based on previous studies or an a priori assumption based on gen­ eral knowledge of the portfolio. tion to be used in the calculation of

22 Statistical Sampling as a Management Tool sample size. In addition, if one be­ 90 percent of the book value of the scribed for the normal distribution lieves that the market values will fall loans being valued, then one might the standard error (half the confi­ between zero and book value, the be able to use the assumptions of sce­ dence interval) will increase by 133 choice of scenario 4 is clearly sup­ nario 4 to reduce the sample size. percent. For the gamma distribution ported. However, if the market value of the the standard error of the estimate will loans in the portfolio is estimated to increase by approximately 137 per- Hedging Our Sampling Bets be 80 percent after a valuation is com- cent. In either case, this is a rather The last point to be made is that pleted using a sample that assumed a large increase in the confidence inter- this process requires caution. If one 90 percent valuation, the sample size val and results from overly optimistic uses the assumptions listed above to was too small to achieve the desired assumptions. This problem can be determine how large a sample to se- confidence level used in the sample minimized by the conservatism in lect, significant cost and time savings construction. In order to obtain the making a priori assumptions about can be achieved. However, excessive desired level of confidence the sam­ the value of the portfolio, while at the optimism regarding the market value ple size will have to be increased. same time recognizing the cost trade- of the assets to be valued can lead to The impact on the final confidence offs associated with these decisions. the derivation of a sample size that is interval will differ according to the too small for the task. For example, if distributional assumption that is one expects that the market value is used. Specifically, in the situation de-

REFERENCES Raj, Des. Sampling Theory. New York: McGraw-Hill Book Company, 1968. Mardia, K.V. Families of Bivariate Distributions. London: Charles Griffin & Company Limited, 1970.

23 FDIC Banking Review

APPENDIX Creation of the Histogram One can easily create a histogram to assess which assumption concerning the distribution of the assets in a portfolio is the appropriate one to use. This process requires that a tabulation of book values of assets be obtained from the general ledger and that 20 segments be created. These segments for tabulation can be created by taking the maximum book value minus the minimum book value and dividing by 20. We call this value w: Maximum book value − Minimum book value w= 20 The twenty categories appear as follows:

Category 1: Minimum book value ≥ Minimum + 1w Category 2: Minimum + 1w ≥ Minimum + 2w � Category 20: Minimum + 19w ≥ Maximum

Count the number of assets with book values in each of these ranges and tabulate as a bar chart. If the distribution looks flat, then the portfolio has a uniform distribution and the best plan is to use scenario 2. If the distribution looks bell shaped and symmetric, then the best option is scenario 3, because the data appear to be normally distributed (no unusually large high or low values). If the distribution looks like a mound that leans to the right (most values are smaller, but there are a significant number of large values), then the data are good candidates for scenario 4. Scenario 4 is enhanced if you believe your market values fall between worthless (zero) and the book value.

24 Recent Developments

Recent Developments Affecting Depository Institutions

by Valentine V. Craig *

REGULATORY AGENCY ACTIONS Inter-Agency Actions provement Act, which requires the Proposal to Amend The federal bank and thrift regula­ agencies to review their regulations in Risk-Based Transaction tory agencies are engaging in joint or order to streamline and modify regu­ Requirements lations to improve efficiency, reduce coordinated efforts in a number of The OCC, the FRB, the FDIC, unnecessary costs, and eliminate un­ regulatory areas that are mentioned and the OTS proposed a rule to warranted constraints on credit avail- specifically in this issue of the Review. amend their respective risk-based ability. FR, Vol. 61, No. 150. pg. 40293, 8/2/96, These joint initiatives concern: capital standards to establish uni- OTS Transmittal, No. 154, 9/3/96. Bank Management form treatment for transactions sup- ported by qualifying collateral. The Interlocks Rule Changes Flood Insurance proposal would allow banks, bank The OCC, the FRB, the FDIC, On August 2, 1996, the Office of holding companies, and savings asso­ the OTS, the Farm Credit Admin­ the Comptroller of the Currency ciations to hold less capital for trans­ istration (FCA), and the National (OCC), the Federal Deposit Insur­ actions collateralized by cash or Credit Union Administration ance Corporation (FDIC), the Fed- qualifying securities. In order to receive (NCUA) adopted a final rule imple­ eral Reserve Board (FRB), and the such capital treatment, the lending menting the requirements of the Na- Office of Thrift Supervision (OTS) institution would need to maintain tional Flood Insurance Reform Act of published a joint final rule that rein- control over the collateral. FR, Vol. 61, 1994. Under the rule, financial insti­ terpreted the Depository Institution No. 160, pp. 42565-42570; OTS Transmittal, Management Interlocks Act (12 tutions are required to escrow flood No. 155, 9/3/96. U.S.C. 3201-3208). The new rule insurance premiums on properties permits management interlocks used as collateral for loans that are lo- within a relevant metropolitan statis­ cated in special flood hazard areas tical area (MSA) when either of the participating in the National Flood depository institutions in the MSA Insurance Fund. Lenders are not re- has assets of less than $20 million. quired to monitor loan portfolios con- The intent of this new rule is to ex­ tinuously to determine the status of flood insurance coverage. Institu­ pand the pool of available managerial *Valentine V. Craig is a program analyst in the talent for small depository institu­ tions may charge a fee to determine FDIC's Division of Research and Statistics. tions. The final rule implements pro- the need for flood insurance. OCC News Reference sources: American Banker (AB); visions of the Riegle Community Release, NR 96-90, 8/29/96; FR, Vol. 61, No. 169, Wall Street Journal (WSJ); BNA's Banking Re- Development and Regulatory Im­ pp. 45683-45716. port (BBR); and Federal Register (FR).

25 FDIC Banking Review

Final Rule AmendingAmending andand commerce, atat whichwhich itit anan-­ thethe mostmost frequentlyfrequently askedasked questionsquestions Risk-Based CapitalCapital nouncednounced thethe formationformation ofof anan interinter-- aboutabout community reinvestment. RequirementsRequirements agencyagency tasktask forceforce toto examineexamine con-con­ PublicPublic commentcomment isis invitedinvited onon aa con-con­ sumersumer protectionprotection issuesissues relatedrelated toto thethe tinuing basis. FR,FR, pp.pp. 54647-54667, 11/21/96.11/21/96. TheThe OCC,OCC, thethe FRB,FRB, andand thethe useuse ofof stored-value cards,cards, smartsmart cards,cards, FDICFDIC issuedissued aa jointjoint finalfinal rule,rule, effec-effec­ Bank Rating SystemSystem InternetInternet banking,banking, andand otherother elecelec-­ tivetive JanuaryJanuary 1,1, 1997,1997, amendingamending theirtheir tronictronic bankingbanking andand commercecommerce prod-prod­ UpdatedUpdated respectiverespective risk-basedrisk-based capitalcapital stanstan-­ ucts.ucts. TheThe tasktask forceforce consistsconsists ofof thethe TheThe FFIECFFIEC hashas expandedexpanded thethe dardsdards toto incorporateincorporate aa measuremeasure forfor U.S.U.S. Department ofof thethe TTreasuryreasury,, thethe UniformUniform FinancialFinancial InstitutionsInstitutions Rat-Rat­ marketmarket riskrisk forfor allall positionspositions inin anan FederalFederal TTraderade Commission (FTC),(FTC), inging System,System, inin effecteffect sincesince thethe latelate institution's tradingtrading accountaccount andand thethe FRB,FRB, andand thethe FDIC.FDIC. TheThe U.S.U.S. 1970s,1970s, toto taketake intointo consideration anan foreign-exchange andand commoditycommodity po-po­ Department ofof thethe TTreasuryreasury isis alsoalso additionaladditional riskrisk component. TheThe bankbank sitions.sitions. TheThe finalfinal rulerule implements anan examiningexamining international monetarymonetary ratingrating systemsystem knownknown asas “CAMEL”“CAMEL” amendment toto thethe BasleBasle CapitalCapital Ac-Ac­ policypolicy,, lawlaw enforcement, andand paypay-­ (which(which stoodstood forfor CapitalCapital AdequacyAdequacy,, cord,cord, andand requiresrequires thatthat anyany bankbank oror mentment systemssystems regardingregarding thethe globalglobal AssetAsset QualityQuality,, Management Admin-Admin­ bankbank holdingholding companycompany withwith signifi-signifi­ useuse ofof computerscomputers toto conductconduct busi-busi­ istration,istration, Earnings,Earnings, andand Liquidity)Liquidity) cantcant exposureexposure toto marketmarket riskrisk toto meas-meas­ ness.ness. ItIt expectsexpects toto reportreport itsits conclu-conclu­ hashas nownow beenbeen changedchanged toto “CAM“CAM-­ ureure thethe riskrisk usingusing itsits ownown internalinternal sionssions atat thethe GroupGroup ofof SevenSeven meetingmeeting ELS”ELS” toto adjustadjust forfor aa sixthsixth component, value-at-risk modelmodel andand holdhold aa com-com­ nextnext JuneJune inin DenverDenver,, Colorado.Colorado. BBR,BBR, SensitivitySensitivity toto MarketMarket Risk.Risk. TheThe newnew mensuratemensurate amountamount ofof capital.capital. Man-Man­ ppgg.. 436, 9/23/96. componentcomponent reflectsreflects anan institution's datorydatory compliancecompliance isis notnot rrequiredequired sensitivitysensitivity toto interest-rate changes,changes, until January 1, 1998. FDIC,FDIC, FIL-84-96,FIL-84-96, Check Fraud foreign-exchange raterate changes,changes, oror 10/10/96;10/10/96; FR, pp. 47358-47378, 9/6/96. TheThe BankBank FraudFraud WWorkingorking Group,Group, commoditycommodity oror equityequity priceprice movemove-­ Guidelines EstablishingEstablishing composedcomposed ofof representatives ofof thethe ments.ments. BBR, pg. 1052, 12/23/96. OCC,OCC, thethe FederalFederal BureauBureau ofof Investi-Investi­ Standards for SafetySafety Proposed Electronic Filing and SoundnessSoundness gation,gation, thethe FDIC,FDIC, thethe FRB,FRB, InternalInternal RevenueRevenue Service,Service, thethe JusticeJustice Depart-Depart­ Requirement for TheThe OCC,OCC, thethe FRB,FRB, thethe FDIC,FDIC, ment,ment, thethe OTS,OTS, thethe PostalPostal InspectorInspector,, Call Reports andand thethe OTSOTS jointlyjointly amendedamended thethe andand thethe SecretSecret Service,Service, hashas producedproduced TheThe FRB,FRB, thethe FDIC,FDIC, andand thethe InterInter-agency-agency GuidelinesGuidelines EstalishingEstalishing aa bookletbooklet entitledentitled “Check“Check Fraud:Fraud: AA OCC,OCC, underunder thethe aegisaegis ofof thethe FFIEC,FFIEC, StandardsStandards forfor SafetySafety andand SoundnessSoundness GuideGuide toto AAvoidingvoiding Losses.”Losses.” TheThe requestedrequested commentscomments onon whetherwhether toto toto includeinclude assetasset qualityquality andand earningsearnings bookletbooklet describesdescribes commoncommon checkcheck discontinuediscontinue CallCall ReportsReports inin hardhard copycopy standards.standards. TheThe guidelinesguidelines completecomplete fraudfraud schemesschemes andand fraudfraud preventionprevention formform andand toto requirerequire themthem toto bebe filedfiled thethe safety-and-soundness standardsstandards techniques.techniques. CopiesCopies cancan bebe obtainedobtained electronically oror onon computercomputer disk-disk­ requiredrequired byby thethe FederalFederal DepositDeposit In-In­ fromfrom thethe OfficeOffice ofof thethe Comptroller ofof etteette withwith thethe agencies'agencies' electronicelectronic col-col­ surancesurance Corporation Improvement thethe CurrencyCurrency,, Communications Divi-Divi­ lectionlection agent.agent. WWrittenritten commentscomments ActAct ofof 1991.1991. TheThe guidelinesguidelines givegive thethe sion,sion, WWashington,ashington, DC,DC, 20219.20219. OCCOCC NewsNews werewere requiredrequired byby JanuaryJanuary 33,, 1997.1997. FR,FR, pp.pp. insuredinsured depositorydepository institutionsinstitutions thethe Release, NR 96-125, 11/12/96. flexibilityflexibility toto adoptadopt systemssystems appropri-appropri­ 56737 -56740, 11/4/96. ateate toto theirtheir sizesize andand thethe naturenature andand scopescope ofof theirtheir activities,activities, andand shouldshould Federal Financial FederalFederal DepositDeposit notnot requirerequire well-managed instituinstitu-­ Institutions Examination InsuranceInsurance CorporationCorporation tionstions toto modifymodify theirtheir operations.operations. TheThe Council (FFIEC) guidelinesguidelines directdirect thatthat thethe systemssystems Electronic BankingBanking shouldshould bebe capablecapable ofof identifying Community Reinvestment IssuesIssues emeremergingging problemproblem assetsassets andand prepre-­ Act (CRA) Information OnOn SeptemberSeptember 12,12, thethe FDICFDIC host-host­ ventingventing deterioration inin thosethose assets;assets; DocumentDocument eded aa day-longday-long publicpublic hearinghearing onon thethe andand thatthat thethe systemssystems bebe ableable toto evalu-evalu­ TheThe OTS,OTS, thethe OCC,OCC, thethe FDIC,FDIC, technological changeschanges occurringoccurring inin ateate andand monitormonitor earnings,earnings, andand ensureensure andand thethe FRB,FRB, underunder thethe auspicesauspices ofof banking,banking, financefinance andand commercecommerce asas aa theythey areare sufficientsufficient toto maintainmaintain ade-ade­ thethe FFIEC,FFIEC, producedproduced aa document,document, resultresult ofof thethe evolutionevolution ofof electronicelectronic quatequate capitalcapital andand reserves.reserves. FR,FR, VVol.ol. 61,61, “Inter“Inter-agency-agency QuestionsQuestions andand AnAn-­ banking.banking. TheThe hearinghearing focusedfocused onon thethe No.No. 167,167, pp.pp. 43948-43952; OTSOTS TTransmittal,ransmittal, swersswers RegardingRegarding Community Rein-Rein­ useuse ofof stored-value cardscards andand federalfederal Number 156, 9/3/96. vestment.” TheThe documentdocument waswas insurance;insurance; whatwhat disclosuresdisclosures financialfinancial Electronic Banking publishedpublished inin thethe FederalFederal RegisterRegister onon institutionsinstitutions shouldshould provideprovide toto con-con­ OctoberOctober 21,21, 1996.1996. ItIt consolidates in-in­ sumers;sumers; andand safety-and-soundness TheThe U.S.U.S. Department ofof thethe formationformation aboutabout thethe revisedrevised CRACRA concerns.concerns. TheThe hearinghearing followedfollowed anan TTreasuryreasury heldheld aa two-daytwo-day conferenceconference regulationsregulations issuedissued byby thethe agenciesagencies onon FDICFDIC BoardBoard decisiondecision thatthat fundsfunds rep-rep­ inin SeptemberSeptember onon electronicelectronic bankingbanking MayMay 4,4, 1995,1995, andand attemptsattempts toto answeranswer resentedresented byby stored-value cardscards areare notnot

26 Recent Developments generallygenerallyprotectedprotectedbybyfederalfederaldepositdeposit statisticalstatistical datadata onon individualindividual FDIC-FDIC- JanuaryJanuary 11 forfor allall otherother SAIF-insured insurance.insurance. insuredinsured depositorydepository institutions. Us-Us­ institutions. TheThe BoardBoard hadhad previ-previ­ Subsequent toto thisthis publicpublic hearing,hearing, ersers areare nownow ableable toto searchsearch FDICFDIC rec-rec­ ouslyously establishedestablished aa risk-basedrisk-based sched-sched­ thethe FDICFDIC hashas begunbegun aa monthlymonthly “Cy-“Cy­ ordsords byby institution,institution, state,state, chartercharter uleule forfor SAIFSAIF assessmentassessment ratesrates rangingranging berbankingberbanking SpeakersSpeakers Series”Series” forfor itsits type,type, andand assetasset oror depositdeposit size.size. AAvail-vail­ fromfrom 44 ttoo 3311 centscents perper $100$100 ofof assess-assess­ employees,employees, whichwhich isis concernedconcerned withwith ableable datadata includeinclude quarterlyquarterly andand annualannual ableable deposits,deposits, andand waswas permittedpermitted toto issuesissues relatedrelated toto electronicelectronic banking.banking. statisticsstatistics onon incomeincome andand expensesexpenses andand adjustadjust thethe scheduleschedule byby asas muchmuch asas fivefive TheThe seriesseries focusesfocuses onon thethe latestlatest elec-elec­ keykey profitabilityprofitability ratios;ratios; institutional centscents withoutwithout notice-and-comment tronictronic technologies andand thethe implica-implica­ healthhealth andand performance ratingsratings areare rulemaking. tionstions forfor thethe financialfinancial regulatoryregulatory notnot available,available, howeverhowever.. ThereThere isis nono TheThe FDICFDIC BoardBoard alsoalso setset FICOFICO system.system. TheThe firstfirst event,event, heldheld onon No-No­ charchargege forfor thethe service.service. TheThe InternetInternet assessmentassessment ratesrates forfor thethe 19971997 firstfirst addressaddress forfor thethe FDICFDIC service,service, calledcalled semiannualsemiannual periodperiod atat 6.486.48 basisbasis pointspoints vembervember 6,6, 1996,1996, focusedfocused onon twotwo newnew InstitutionInstitution DDiirecrectorytory IDID developments: “smart-cards” andand thethe thethe ,o,orr service,service, forfor SAIFSAIF membersmembers andand 1.301.30 basisbasis government's plansplans toto paypay allall benefitsbenefits isis wwwwww.fdic.gov.fdic.gov.. BBR,BBR, pg.pg. 1004,1004, DecemberDecember pointspoints forfor BIFBIF members.members. TheseThese ratesrates electronically byby thethe yearyear 1999.1999. TheThe 16,16, 1996;1996; FDICFDIC NewsNews Release,Release, PR-94-96,PR-94-96, 12/10/96.12/10/96. areare inin additionaddition toto thethe insuranceinsurance funds'funds' secondsecond event,event, heldheld inin DecemberDecember,, fo-fo­ Bank Insurance Fund (BIF) assessments. FDICFDIC NewsNews Release,Release, PR-95-96,PR-95-96, cusedcused onon regulationregulation inin thethe worldworld ofof Premiums Remain at 12/11/96.12/11/96. electronic banking. FDICFDIC News,News, pp.pp. 1-6,1-6, Same Level Oakar Bank ReportingReporting 10/96.10/96. DueDue toto thethe currentcurrent financialfinancial RequirementsRequirements Semiannual AgendaAgenda strengthstrength ofof thethe bankingbanking industryindustry andand TheThe FDICFDIC hashas adoptedadopted aa finalfinal of RegulationsRegulations thethe BankBank InsuranceInsurance FundFund (BIF),(BIF), thethe rule,rule, effectiveeffective JanuaryJanuary 1,1, 1997,1997, limit-limit­ FDICFDIC BoardBoard ofof DirectorsDirectors votedvoted toto TheThe FDICFDIC publishedpublished itsits mostmost re-re­ inging OakarOakar institutionsinstitutions toto membership maintainmaintain assessmentassessment ratesrates forfor thethe BIFBIF inin theirtheir primaryprimary insuranceinsurance fundfund onlyonly.. centcent semiannualsemiannual regulatoryregulatory agendaagenda inin atat currentcurrent levelslevels (0(0 toto 2727 centscents perper thethe FederalFederal RegisterRegister onon NovemberNovember 29,29, OakarOakar institutions belongbelong toto oneone $100$100 ofof assessableassessable deposits)deposits) forfor thethe FDICFDIC insuranceinsurance fundfund butbut holdhold de-de­ 1996.1996. TheThe FDICFDIC publishespublishes thethe firstfirst sixsix monthsmonths ofof 1997.1997. TheThe BoardBoard agendaagenda toto informinform thethe publicpublic ofof itsits positsposits thatthat areare insuredinsured byby thethe otherother alsoalso votedvoted toto collectcollect anan assessmentassessment FDICFDIC insuranceinsurance fund.fund. AccordingAccording toto regulatoryregulatory actionsactions andand toto encourageencourage againstagainst BIF-assessable depositsdeposits toto bebe participation inin rulemaking. ManyMany ofof thethe newnew rule,rule, BIF-member banksbanks willwill paidpaid toto thethe FinancingFinancing Corporation continuecontinue toto bebe BIF-members afterafter thethe rulesrules havehave beenbeen sponsoredsponsored jointlyjointly (FICO)(FICO) asas authorizedauthorized byby thethe DepositDeposit withwith thethe otherother financialfinancial regulatoryregulatory acquiringacquiring SAIF-insured depositsdeposits inin InsuranceInsurance FundsFunds ActAct ofof 19961996 (Funds(Funds Oakar transactions. BBR,BBR, pg.pg. 911,911, 12/2/96.12/2/96. agencies.agencies. SomeSome areare inin responseresponse toto thethe Act);Act); eliminatedeliminated thethe $2,000$2,000 minimumminimum FederalFederal DepositDeposit InsuranceInsurance Corpora-Corpora­ annualannual assessmentassessment asas requiredrequired byby thethe Real-Estate MarketsMarkets tiontion Improvement ActAct andand thethe RiegleRiegle FundsFunds Act;Act; andand authorizedauthorized thethe refundrefund Continue to ImproveImprove Community Development andand Regu-Regu­ ofof thethe fourth-quarter portionportion ofof thethe TheThe outlookoutlook forfor thethe nation'snation's real-real- latory Improvement Act of 1994. semiannual minimumminimum assessment estateestate marketsmarkets continuedcontinued toto bebe favor-favor­ TheThe agendaagenda providesprovides informationinformation ($500)($500) charchargedged toto allall BIFBIF members.members. ableable duringduring thethe thirdthird quarterquarter ofof 19961996 aboutabout thethe FDIC'sFDIC's currentcurrent andand pro-pro­ Approximately 8,7008,700 institutionsinstitutions willwill accordingaccording toto thethe FDIC'sFDIC's OctoberOctober 19961996 jectedjected rulemakings, asas wellwell asas infor-infor­ receivereceive thethe refundrefund ofof $500$500 plusplus inter-inter­ SurveySurvey ofof RealReal EstateEstate TTrendsrends.. TheThe mationmation onon existingexisting regulationsregulations underunder est.est. AsAs ofof JuneJune 30,30, 1996,1996, thethe BIFBIF re-re­ quarterlyquarterly surveysurvey asksasks fieldfield personnelpersonnel reviewreview,, andand completedcompleted rulemakings. serveserve ratio was 1.32 percent. BBR,BBR, pg.pg. fromfrom allall federalfederal bankbank andand thriftthrift regu-regu­ ThereThere areare 3434 finalfinal oror proposedproposed 911, 12/2/96; FDIC, FIL-99-96, 12/9/96. latorylatory agenciesagencies aboutabout developments changeschanges toto FDICFDIC regulationsregulations inin thethe duringduring thethe priorprior threethree monthsmonths inin theirtheir mostmost recentrecent agenda.agenda. IncludedIncluded inin thisthis Savings Association locallocal real-estatereal-estate markets.markets. TheThe na-na­ agendaagenda isis thethe actionaction imposingimposing thethe Insurance Fund (SAIF) tionaltional compositecomposite index,index, summarizing one-timeone-time specialspecial assessment onon and FICO Assessments Set assessments ofof bothboth commercialcommercial andand SAIF-insured institutionsinstitutions andand thethe residentialresidential real-estatereal-estate markets,markets, stoodstood ffiinalnal rulerule loweringlowering SAIFSAIF assessments. TheThe FDICFDIC loweredlowered SAIFSAIF assess-assess­ mentment ratesrates toto aa rangerange ofof 00 ttoo 2277 centscents atat 6767 inin OctoberOctober,, downdown slightlyslightly fromfrom FDICFDIC NewsNews Release,Release, PR-91-96,PR-91-96, 12/3/96;12/3/96; FR,FR, pp.pp. 6868 inin JulyJuly.. VValuesalues aboveabove 5050 indicateindicate 63460-63469, 11/29/96. perper $100$100 inin assessableassessable depositsdeposits forfor thethe firstfirst sixsix monthsmonths ofof 1997.1997. TheThe newnew thatthat moremore examinersexaminers andand assetasset man-man­ Expansion of Data onon ratesrates areare identicalidentical toto thosethose previouslypreviously agersagers atat federalfederal bankbank andand thriftthrift regularegula World Wide WebWeb approvedapproved forfor BIFBIF members,members, andand be-be­ torytory agenciesagencies thoughtthought conditionsconditions were improving than declining. TheThe FDICFDIC expandedexpanded itit presencepresence camecame effectiveeffective OctoberOctober 1,1, 1996,1996, forfor onon thethe WWorldorld WWideide WWeebb bbyy providingproviding SasserSasser andand OakarOakar institutions, andand

27 FDIC Banking Review

Respondents to the survey were to a large extent improved conditions any such insider loans not be on terms especially positive concerning trends in California. Almost two-thirds of the unavailable to those not affiliated in commercial markets. The October respondents reported improving com­ with the bank or affiliate. The commercial summary index rose to mercial markets in California, and 70 amendment was in response to, and 72, the most positive assessment of percent reported a strengthened Cali­ conforms with, the Economic Growth this market in over two years. Almost fornia residential market. Survey of Real and Regulatory Paperwork Reduc­ half of the respondents — 46 percent Estate Trends, July 1996 and October 1996. tion Act of 1996, which amended the — reported improving conditions in preferential lending prohibition by the commercial market compared to Federal Reserve Board allowing extension of credit to insid­ 38 percent in the previous quarterly ers as long as the credit was available survey. Additionally, 29 percent of FRB Adopts Final to all employees of the lending bank, the respondents reported an over­ Reg M Rule and insiders were not given prefer­ supply of commercial space — the On September 18, the FRB ence over other employees. The lowest level since the survey began. adopted a final rule amending Regu­ OTS has also incorporated the FRB Eighty-four percent reported above- lation M, substantially changing the amendment, and savings associations average or average commercial prop­ way auto-leasing firms disclose the and their subsidiaries will be treated erty sales. cost of leasing a car. The final rule re­ in the same manner as banks in this The commercial real-estate sur­ quires that charges be presented in a regard. FR, Vol. 61, No. 218, pp. 57769­ vey results showed strong geographic more intelligible format, and for the 57770, 11/8/96; FR, Vol.61, No. 224, pg. 58782, differences. While 68 percent of the first time, requires disclosure of the 11/19/96; OTS Transmittal, No. 161, 11/26/96. respondents considered the commer­ total amount due when a lease is Rules Amended Expediting signed. According to the Consumer cial market in the West a little better Bank Entry into Bankers Association, leasing has in­ or a lot better than three months before, Other Businesses 48 percent in the South, 39 percent in creased 30 to 40 percent annually On October 23, the FRB issued in­ the Northeast, and 33 percent in the over recent years at some banks. The terim rules expediting the applica­ Midwest felt similarly. Only 2 per­ new disclosure requirements go into tion process for well-capitalized bank cent of all respondents considered effect on October l, 1997. BBR, pg. 438­ holding companies to enter new non- the direction of the commercial mar­ 439, 9/23/96. bank lines of business. The new rule ket to be a little worse. FRB Recommends implements provisions of the Eco­ Residential markets, while con­ Additional Day for nomic Growth and Regulatory Paper­ tinuing to be strong, did not register Holding Deposits work Reduction Act, signed by the the improvements in these markets President on September 30, which observed earlier. The summary index On October 9, 1996, the FRB rec­ ommended to Congress that banks be allowed bank holding companies to for residential markets fell to 63 in enter activities permitted under Regu­ October from 69 registered in July. allowed to hold funds deposited by check an additional day before re­ lation Y without first notifiying the Overall, 35 percent of the respon­ FRB. dents to the October survey consid­ quiring consumer access to the funds. The new rule applies only to well- ered the general direction of the Current law allows banks to hold capitalized bank holding companies. housing market better than three funds for two days, but most banks al­ Under the new rule, the FRB defines months before; in July, 45 percent of low access to the funds before the well-capitalized bank holding com­ the respondents saw an improved two-day period due to competitive panies as those which, on a consoli­ housing market. pressures. Check fraud costs the fi­ nancial industry $600 million a year. dated basis: (1) maintain a total risk- Again, the residential survey re­ According to the FRB study, an addi­ based capital ratio of 10 percent or sults showed wide geographic dis­ tional day-hold would catch 80 per­ more; (2) maintain a Tier 1 risk-based parities. The assessment for the West cent of all local returned checks capital ratio of 6 percent or more; (3) again was the most positive, with 55 before the funds were released. BBR, maintain either a Tier 1 leverage ratio percent of respondents reporting bet­ pg. 623, 10/14/96. of 4 percent or more, or have a com­ ter housing conditions there over the posite 1 rating, or have implemented quarter. This compares to 35 percent Amendment to Loans to risk-based capital measures for mar­ of the respondents in the Northeast Insiders Regulation ket risk; and (4) are not subject to any and South, and 24 percent in the Mid­ In November 1996, the FRB written agreements to meet and west reporting improvements. amended its Regulation O, which im­ maintain capital levels for any capital The positive real-estate assess­ poses limits on loans to insiders and measure. BBR, pg. 683, 10/28/96. ments reported from the West reflect insiders of affiliates, and requires that

28 Recent Developments

Preferred Stock to banks must disclose under the Truth­ range from $700 for opening a branch Count for in-Lending Act. The FRB also pro­ to $17,400 for receiving an independ­ Core Capital vided some lawsuit relief to banks by ent bank charter. According to the increasing the amount by which they OCC, 12 million U. S. households, or The FRB announced on October could misstate finance charges and 12.5 percent of the population, do not 21, 1996, that bank holding compa­ avoid liability. have an account with a depository in­ nies may use certain cumulative pre­ ferred stock to meet Tier 1 capital At a meeting of the FRB on De­ stitution. The OCC is also planning requirements. The preferred stock cember 20, the FRB withdrew a pro­ an educational forum to assist bank­ should be issued by special-purpose posal that would have encouraged ers in understanding the banking wholly-owned subsidiaries, who lend banks to record the race and gender of needs of this population. AB, 10/1/96. the proceeds of the offerings to the consumer and small-business bor­ Insurance Sales rowers. At the same meeting, the parent through long-term, subordi­ In November, the OCC gave per­ nated notes. BBR, pg. 685, 10/28/96. FRB raised the revenue limit on se­ curities underwriting by commercial mission to First Union Corp. and External Audits for banks through their Section 20 sub­ Mellon Bank to sell and market insur­ Poorly Managed sidiaries from 10 percent to 25 per­ ance anywhere, including from bank Foreign Branches cent. It also adopted a rule protecting offices, as long as the insurance ap­ plications were processed, and the to Be Required the confidentiality of fair-lending agent commissions paid, from a town self-tests. AB, pg. 3, 9/13/96; AB, 12/23/96; The FRB, in a November 12 guid­ AB, pg. 2, WSJ, 12/23/96. with fewer than 5,000 persons. ance to bank examiners, is requiring 11/14/96. all foreign bank branches, with mangement ratings of three or lower, Office of the Comptroller Expedited Process Allowing to hire independent accountants to of the Currency Bank Entry into perform audits of the branches. The Other Activities auditors are to look for unreported Derivatives Activity The OCC issued a final rule on losses; to verify the accuracy of re­ Increases November 20, 1996, revising OCC ports filed with regulators; and to rec­ The OCC reported that commer­ Part 5 rules governing bank corporate ommend improvements to internal cial bank derivatives activity in­ activities. The new rule creates an controls and oversight. This develop­ creased dramatically in the second expedited approval process for well- ment follows the Daiwa bank scan­ quarter of 1996, with the notional managed and well-capitalized banks dal, in which a New York branch of amount of bank derivatives rising (banks with a CAMEL 1 or 2 rating, a this Japanese bank hid a $1.1 billion $1.2 trillion to $19 trillion for the Satisfactory CRA rating, and without loss from regulators. AB, 11/18/96. quarter. Nine banks accounted for 94 enforcement orders against them) to Fees for Electronic Funds percent of the total notional amount enter into other bank-related busi­ nesses through their subsidiaries. Transfers Reduced of derivatives; 507 banks held deriva­ tives during the quarter, an increase Banks may also apply for approval to Effective January 2, 1997, the of 42 over the previous quarter. Inter- engage in business activities through FRB lowered the price for Fedwire est-rate and foreign-exchange con­ subsidiaries that are impermissible funds transfers to 45 cents per trans­ tracts accounted for 98 percent of the for the parent, but these requests will action. The FRB estimates that this notional amount of the derivatives. not receive expedited approval. The reduction, coupled with one made in Approximately $8 trillion of the de­ new rule is expected to facilitate en­ September, should save the industry rivatives were futures and forward try into securities and insurance un­ over $18 million annually. The FRB trades; swaps constituted almost $7 derwriting, data processing, and has also lowered fees on automated trillion; and over $4 trillion of the de­ information delivery by bank subsidi­ clearinghouse transactions. AB, 11/6/96. rivatives were options. OCC News Release, aries. The rule took effect on De­ cember 31, 1996. BBR, pp. 873-875, 11/25/96. Other FRB Actions NR 96-97, 9/13/96. Effective November 12, 1996, the OCC Provides Incentives OCC Amends Rules on FRB will exclude corporate and mu­ to Banks Entering National Bank Trust nicipal bond interest of “easily-sold” Low-Income Areas Activities securities from the cap on commercial Effective January 29, 1997, the underwriting revenue. This change The OCC has waived branching or OCC has eliminated several restric­ will permit certain Section 20 subsidi­ chartering fees for national banks tions governing bank fiduciary activi­ aries to earn more from underwriting entering low- and moderate-income ties. The new rules removed many activities. Effective October 21, the areas that are unserved by other de­ restrictions on collective investment FRB also revised the list of fees that pository institutions. These fees

29 FDIC Banking Review

funds. They rescind an OCC provi­ final rule. The OTS will issue guid­ governance. Savings institutions may sion barring individual trust accounts ance to thrifts on the impact of this now notify the OTS after adopting from constituting more than 10 per­ new law. OTS Transmittal, No. 158, 10/24/96; charter and bylaw amendments that cent of a collective investment fund; FR, pp. 50951-50984, 9/30/96. have been preapproved by the eliminate another provision barring agency rather than filing an applica­ banks from putting more than 10 Expanded Lending and tion and paying a fee. The final rule percent of a fund into one invest­ Investment Authority permits federal stock savings associa­ ment; eliminate restrictions on treat­ for Thrifts tions, and in some cases federal mu­ ment of a fiduciary's money before it The OTS published interim rules tual savings associations, to follow the is invested; and codify an earlier OCC on November 27 expanding thrifts' corporate governance law of their interpretive ruling that national ability to make credit-card, educa­ home state, their holding company's banks in a particular jurisdiction have tion, and small-business loans. Al­ home state, or Delaware General the same powers as state-chartered fi­ though the regulation is in effect im­ Corporation Law or the Model Busi­ duciaries. AB, 12/31/96. mediately, the OTS invites com­ ness Corporation Act. Other revisions ments for 60 days. remove restrictions on the location of shareholder meetings; authorize the Office of Thrift Supervision The rule changes implement pro­ gathering of proxies by telephone or visions of the Economic Growth and Lending and Investment electronically; and remove require­ Regulatory Paperwork Act of 1996 Regulations Streamlined ments for formal stockholder meet­ (EGRPRA). EGRPRA permits thrifts ings when unanimous written The OTS issued a final rule, effec­ to make credit-card and educational consent of shareholders exists. The tive October 30, 1996, that updated, loans without any percentage of as­ revisions do not require any institu­ reorganized and streamlined its lend­ sets investment limit. Additionally, it tions to change their charters. OTS Trans­ ing and investment regulations. The permits loans secured by business or final rule almost cut in half the mittal, No. 164, 12/10/96; FR, Vol. 61, No. 233, agricultural real estate to be made in pp. 64007-64021. number of lending and investment amounts up to 400 percent of capital, regulations — from 43 to 22 — and with additional secured and unse­ brings OTS regulations more in line cured business and farm loans al­ National Credit Union with those of the other banking agen­ lowed in amounts of up to 20 percent Administration cies. In many instances, more general of assets. It restricts loans above 10 rules have replaced detailed rules to Multiple-Group Fields percent of assets to small-business of Membership allow institutions greater flexibility. loans. The new law also amends the For convenience, all lending-related qualified thrift lender (QTL) test of A three-judge D. C. Circuit Court regulations have been reorganized in the Home Owners' Loan Act to count ruled on July 30 (First National Bank new Part 560. Other changes are: the small-business, credit-card, and edu­ & Trust Co. v. National Credit Union rule increases thrifts' commercial cational loans as qualified thrift in­ Administration) that federal credit lending authority through service vestments without restriction; other unions may only serve members of a corporations; does away with limits consumer loans can now count as single occupational group. At year- on the amount of loans relative to the qualifed thrift investments in end 1995, almost 2,000 of the approxi­ value of collateral and payback peri­ amounts up to 20 percent of the mate 7,300 federal credit unions had ods for manufactured housing; modi­ thrifts' assets. The legislation also multiple-group fields of member­ fies requirements for the selection of gives thrifts the option of complying ship. The NCUA has permitted indices to set interest rates on with the amended QTL test require­ multiple-occupational groups for fed­ adjustable-rate mortgages; narrows ments or the Internal Revenue's do­ eral credit unions since 1982. disclosure requirements for mestic building-and-loan association Following the Circuit Court rul­ adjustable-rate mortgages; modifies compliance requirements. BBR, pg. 929, ing, the NCUA requested a delay to restrictions on federal savings institu­ 12/2/96; OTS Transmittal, Number 163, 12/2/96; enforcement of a October 25 injunc­ tions in regard to investment in state FR, Vol. 61, pp. 60179-60185, 11/27/96. tion banning federal credit unions housing authorities and government from adding new groups from outside obligations; and relaxes limits on leas­ Corporate Governance the single occupational common ing. Rules Streamlined bond to existing fields of member­ The Economic Growth and Regu­ The OTS revised its corporate ship. Also, on November 14, the NCUA latory Paperwork Reduction Act of governance rules, effective January 1, adopted interim rules permitting 1996, passed by Congress on Septem­ 1997. The revisions, the first since occupation-based credit unions to ber 30, 1996 — the same day as the 1983, reduced by 36 percent the serve an entire profession rather than OTS new regulation — expands number of charter and bylaw rules just the employees of a single com­ thrift lending powers in many in­ and policy statements on corporate pany, subject to certain distance re­ stances beyond that provided in the strictions. The NCUA plan also would

30 Recent Developments allowallow creditcredit unionsunions withwith membersmembers agencyagency violatedviolated thethe Administrative 24,24, thethe U.U. S.S. CourtCourt ofof AppealsAppeals grantedgranted atat severalseveral locallocal companiescompanies toto retainretain ProceduresProcedures ActAct byby notnot publishingpublishing aa temporarytemporary staystay onon thethe injunctioninjunction andand membersmembers byby convertingconverting toto commucommunity-nity- advancedadvanced noticenotice ofof thethe NovemberNovember allowedallowed creditcredit unionsunions thethe rightright toto serveserve basedbased institutions, andand expandedexpanded thethe 1144 meetingmeeting andand byby notnot providingproviding allall companiescompanies withinwithin theirtheir existingexisting communitycommunity creditcredit unionunion chartercharter toto per-per- aaddvancedvanced noticenotice ofof thethe rulerule change.change. fieldsfields ofof membership, butbut preventedprevented mitmit institutionsinstitutions toto serveserve occupational OnOn DecemberDecember 4,4, thethe U.U. S.S. DistrictDistrict themthem fromfrom signingsigning upup newnew “non-core”“non-core” groups,groups, associational groups,groups, andand CourtCourt forfor D.C.D.C. setset asideaside thethe NCUANCUA members.members. community groupsgroups inin areasareas withwith interiminterim fieldfield ofof membership policypolicy andand TheThe NationalNational AssociationAssociation ofof CreditCredit populationspopulations ofof lessless thanthan aa millionmillion peo-peo­ declareddeclared nullnull andand voidvoid allall chartercharter con-con- UnionsUnions onon DecemberDecember 3030 askedasked thethe ple.ple. versionsversions andand commoncommon bondbond redesigna-redesigna- SupremeSupreme CourtCourt toto hearhear thethe case;case; thethe TheThe bankingbanking industryindustry askedasked thethe tionstions approvedapproved byby thethe NCUANCUA underunder itsits AmericanAmerican BankersBankers AssociationAssociation hashas courtcourt toto blockblock thethe NCUANCUA member-member- newnew policypolicy.. TheThe CourtCourt alsoalso denieddenied thethe alsoalso filedfiled aa briefbrief askingasking thethe SupremeSupreme shipship policypolicy onon thethe groundsgrounds thatthat thethe NCUA'sNCUA's requestrequest forfor aa delaydelay ofof thethe CourtCourt toto rejectreject thethe case.case. BBR,BBR, pg.pg. 454,454, 9/23/96;9/23/96; OctoberOctober 2525 injunction.injunction. OnOn DecemberDecember AB,AB, pg.pg. 1,1, 11/15/96;11/15/96; BBR,BBR, pg.pg. 895,895, 11/25/96;11/25/96; BBR,BBR, pp.pp. 983-984,983-984, 12/9/96;12/9/96; NYTNYT,, 12/25/96;12/25/96; AB,AB, 12/31/96.12/31/96.

STATE LEGISLATION AND REGULATION CaliforniaCalifornia newnew employeeemployee hiredhired aboveabove aa mini-mini- statestate savingssavings banksbanks shouldshould thethe courtscourts TheThe statestate ofof CaliforniaCalifornia enactedenacted mummum ofof 5050 beginningbeginning inin 1997.1997. InIn or-or- ultimatelyultimately disallowdisallow expansionexpansion outsideoutside legislation,legislation, effectiveeffective JanuaryJanuary 1,1, 1997,1997, derder toto qualifyqualify forfor thethe credit,credit, thethe banksbanks aa creditcredit union'sunion's originaloriginal commoncommon bond.bond. protectingprotecting banksbanks fromfrom toxictoxic wastewaste mustmust investinvest aa minimumminimum ofof $15,000$15,000 ThirtyThirty otherother statesstates currentlycurrently offeroffer aa cleanupcleanup liabilityliability underunder statestate andand loclocaall perper newnew employee.employee. TheThe creditcredit maymay statestate savingssavings bankbank chartercharter.. AB,AB, 12/10/96.12/10/96. lawlaw.. TheThe newnew statutestatute providesprovides iimm-­ notnot exceedexceed halfhalf ofof thethe bank'sbank's fran-fran­ munitymunity fromfrom environmental clean-uclean-upp chise tax.chise tax. AB, pg. 3, 11/15/96. MichiganMichigan costscosts toto unsecuredunsecured lenderslenders andand fidu-fidu- TheThe MichiganMichigan FinancialFinancial Institu-Institu- ciariesciaries ifif theythey werewere notnot responsibleresponsible FloridaFlorida tionstions BureauBureau reducedreduced manymany ofof thethe forfor thethe contamination andand diddid notnot StateState regulatorsregulators inin FloridaFlorida havehave feesfees itit charchargesges itsits financialfinancial institu-institu­ managemanage thethe propertyproperty beforebefore foreclo-foreclo­ proposedproposed aa newnew statestate savingssavings bankbank tions,tions, beginningbeginning inin OctoberOctober 1996.1996. sure.sure. TheThe statestate statutestatute expandsexpands re-re­ chartercharter thatthat wouldwould allowallow eithereither mu-mu- BankBank applicationapplication feesfees werewere reducedreduced centlycently passedpassed federalfederal protections, tualtual oror stockstock formform ofof ownership.ownership. TheThe toto $6200$6200 fromfrom $9000;$9000; consolidation whichwhich protectedprotected onlyonly lenderslenders withwith aa statestate currentlycurrently offersoffers charterscharters forfor applicationapplication feesfees werewere cutcut toto $1800$1800 securitysecurity interestinterest inin thethe propertyproperty.. commercialcommercial banksbanks andand savingssavings andand CaliforniaCalifornia environmental lawslaws areare fromfrom $2200;$2200; andand feesfees toto convertconvert toto aa loans;loans; thethe statestate diddid awayaway withwith mutualmutual consideredconsidered toto bebe thethe toughesttoughest inin thethe statestate bankbank werewere decreaseddecreased toto $1300$1300 nationnation accordiaccordinngg ttoo iittss statestate bankingbanking ownershipownership inin 1992.1992. TheThe proposedproposed fromfrom $2200.$2200. ItIt alsoalso abolishedabolished thethe re-re­ statestate chartercharter wouldwould allowallow thriftsthrifts toto tradetrade group.group. AABB,, 11/4/96.11/4/96. quirementquirement thatthat banksbanks publishpublish thethe re-re- continuecontinue inin businessbusiness shouldshould thethe fed-fed- DelawareDelaware locationlocation ofof principalprincipal officesoffices andand newnew eraleral thriftthrift chartercharter bebe mermergedged intointo aa branches,branches, andand abolishedabolished thethe $1000$1000 BanksBanks inin DelawareDelaware areare eligibleeligible toto federalfederal bankbank chartercharter.. IItt mightmight alsoalso bebe fee.fee. AB, 11/25/96. receivereceive aa $400$400 taxtax creditcredit forfor everyevery usedused byby creditcredit unionsunions toto convertconvert toto

BANK AND THRIFT PERFORMANCE President Signs Small- thrifts.thrifts. UnderUnder thisthis newnew lawlaw,, thriftsthrifts thethe 5050 percentpercent interestinterest exclusionexclusion onon Business Tax Bill needneed onlyonly recordrecord asas incomeincome bad-debtbad-debt EmployeeEmployee StockStock OwnershipOwnership PlanPlan OnOn AugustAugust 20,20, 1996,1996, PresidentPresident reservesreserves setset asideaside afterafter 19871987 ratherrather loansloans mademade byby financialfinancial institutions; ClintonClinton signedsigned thethe SmallSmall BusinessBusiness thanthan theirtheir entireentire bad-debtbad-debt reserves.reserves. createscreates “financial“financial assetasset securitizasecuritiza-- JobsJobs ProtectionProtection Act,Act, whichwhich containscontains ThisThis removesremoves aa majormajor financialfinancial disdis-­ tiontion investmentinvestment truststrusts (F(FASITASITs),s), al-al- somesome majormajor provisionsprovisions affectingaffecting de-de­ incentiveincentive forfor thriftsthrifts convertingconverting toto lowinglowing forfor thethe securitization ofof debtdebt positorypository institutions. OfOf specialspecial im-im­ banks.banks. Additionally,, thethe newnew lawlaw al-al- obligations;obligations; andand allowsallows somesome financialfinancial portance,portance, itit repealsrepeals thethe InternalInternal lowslows forfor tax-freetax-free conversionconversion ofof com-com- institutionsinstitutions toto bebe eligibleeligible forfor Sub-Sub­ RevenueRevenue CodeCode SectionSection 593593 bad-debtbad-debt monmon trusttrust fundsfunds toto mutualmutual funds;funds; chapter S Tchapter Treatment.reatment. BBR,BBR, pg.pg. 281,281, reservereserve recapturerecapture requirements forfor subjectsubject toto certaincertain restrictions,restrictions, repealsrepeals 8/26/96.8/26/96.

31 FDIC Banking Review

SAIF Capitalization Bill Third-quarter net interest income Delinquency Rates Improve Enacted was a record $41.4 billion, a 5.2­ in Third Quarter percent increase over the third quar­ On September 30, 1996, President According to an OCC survey of ex­ ter of 1995. More than half — 58 per­ Clinton signed legislation capitaliz­ aminers at the 82 largest national cent — of insured banks reported ing the SAIF and warding off a de­ banks, released on September 11, earnings gains for the 1996 third quar­ fault on FICO bonds. The legislation credit risk increased for the 12-month ter, and almost three-quarters re­ also approximately equalized the pre­ period ending May 1996, despite ported return on assets (ROA) in miums that banks and savings and tightening of retail underwriting excess of one percent. Third-quar­ loans pay for insurance. Legislation standards. The survey reported that ter ROA for the industry was an annu­ to capitalize the SAIF had been de­ credit cards, middle-market commer­ alized 1.19 percent. Asset-quality bated for two years. The new legisla­ cial loans and indirect consumer loans indicators remained favorable overall, tion requires the banking industry to were responsible for most of the in­ with noncurrent loans falling to the assist in paying the $8 billion in inter­ creased risk during the period. lowest level in the 15 years that they est on FICO bonds. According to the have been reported. However, an in­ At the same time, the FDIC re­ legislation, the thrift industry is re­ crease in troubled loans to individu­ ported a sharp rise in charge-off rates, sponsible for approximately 59 per­ als, primarily credit-card loans, was with levels rising from 1.40 percent of cent of the $780 million annual reported. At the end of the third loans during the second quarter of interest for the next three years, and quarter, 2.71 percent of credit-card 1994 to 2.24 percent of loans during the banking industry the remainder. loans were reported 30-89 days over­ the second quarter of this year. The After three years, the two industries due; 1.83 percent were reported past American Bankers Association (ABA) will share the cost on a pro rata basis. 90 days overdue or in non-accrual also reported a 13-basis point rise in Thrifts are also required to make a status; and an annualized year-to-date late credit-card payments during the one-time payment of $4.7 billion to net charge-off rate of 4.31 percent was second quarter of 1996, raising the capitalize the SAIF. The only excep­ reported. late-payment ratio to 3.66 percent, tion to the special assessment is for banks that own thrift deposits (for ex­ Profitability at FDIC-insured sav­ the highest level since 1974. How­ ample, Sasser and Oakar banks), ings institutions remained strong des­ ever, according to the ABA, this ratio whose special assessment has been pite a reported net loss of $55 million fell to 3.48 percent during the third quarter of 1996, the first improve­ reduced by 20 percent. The Washington for the third quarter of 1996. This loss Post, 10/2/96; FDIC News, pg. 1, 11/96; AB, was largely due to the $3.5 billion spe­ ment in two years. 10/2/96. cial SAIF assessment levied on the Meanwhile, the Mortgage Bank­ industry. Net earnings for the quarter Commercial Banks' Earnings ers Association reported that the third would have been approximately $2.2 quarter of 1996 represented the third Commercial bank earnings were billion, compared to $2.6 billion in straight quarter of improvement in $38.6 billion for the first nine months the previous quarter, absent the SAIF mortgage delinquency rates. For the of 1996, a 4.8-percent increase from assessment. Almost two-thirds of in­ three months ended September 30, the same nine-month period a year stitutions reported losses for the quar­ mortgage delinquencies fell to 4.16 before, according to preliminary data ter. However, of the 340 savings percent on a seasonally adjusted basis released by the FDIC. institutions with no SAIF deposits, from 4.35 percent the previous quar­ Approximately $13.2 billion in net only 5 percent were unprofitable for ter. Improvements in mortgage earnings were reported for the third the quarter. Net earnings for the first delinquencies occurred in all catego­ quarter of 1996. This represented the three quarters of 1996 were $4.9 bil­ ries — 30-day, 60-day, and 90-day-or­ third-highest quarterly net income lion, a decrease of $1.1 billion from more delinquencies. AB, pg. 1, 9/12/96; ever reported, but is a 4.5-percent de­ net earnings for the third quarter the BBR, pg. 439, 9/23/96; The Washington Post, cline ($618 million) from the previous previous year. 12/14/96; AB, 12/19/96. quarter, and a 4.8-percent decline The SAIF became fully capital­ Tax Ruling Affecting Banks ($666 million) from third-quarter ized as of October 1, 1996. A special earnings a year earlier. However, al­ assessment against all SAIF-asses­ The U.S. Tax Court upheld the In­ most all of the third-quarter earnings sable deposits raised $4.5 billion, ternal Revenue Service (IRS) in a dis­ decline was due to the one-time which brought the SAIF reserve ratio pute over international tax laws, SAIF assessment. The commercial to 1.27 percent of insured deposits. The ruling that Riggs National Bank of banks' share of the assessment was FDIC Quarterly Banking Profile, Second Quarter Washington, DC, was not entitled to approximately $1 billion, with an 1996 and Third Quarter 1996; FDIC News Re­ the tax write-offs it had taken to re­ after-tax net income impact of ap­ lease, PR-75-96, 9/11/96; PR-96-96, 12/13/96. duce taxes on profits from loans to proximately $650 million. Brazil. The Tax Court ruled that

32 Recent Developments bankbank andand BrazilianBrazilian officialsofficials inin anan andand stored-value functions.functions. Ameri-Ameri­ fourth-larfourth-largestgest bankbank managermanager ofof mu-mu­ “elaborate“elaborate legallegal fiction”fiction” camecame upup cancan ExpressExpress hashas alsoalso announcedannounced anan tual funds.tual funds. AB, pg. 1, 9/11/96. withwith aa planplan toto withholdwithhold taxestaxes fromfrom thethe agreementagreement withwith Banksys,Banksys, aa BelgianBelgian Home Banking Network interestinterest paidpaid toto thethe bank,bank, therebythereby cre-cre­ companycompany,, ttoo testtest marketmarket itsits smartsmart atingating aa U.S.U.S. taxtax write-ofwrite-offf thatthat thethe bankbank card.card. VVisaisa International hashas alsoalso de-de­ IBMIBM andand 1515 majormajor banks,banks, repre-repre­ passedpassed onon toto BrazilBrazil inin thethe formform ofof veloped a smart card. WSJ, 12/19/96. sentingsenting moremore thanthan halfhalf thethe retailretail bankingbanking populationpopulation ofof thethe UnitedUnited lowerlower interestinterest rates.rates. TheThe decisiondecision isis Credit-Card Cobranding expectedexpected toto costcost 300300 AmericanAmerican banksbanks StatesStates andand Canada,Canada, formedformed aa homehome hundredshundreds ofof millionsmillions ofof dollarsdollars inin fed-fed­ SearsSears Roebuck,Roebuck, whichwhich issuesissues itsits bankingbanking network,network, IntegrionIntegrion Finan-Finan­ eral taxes.eral taxes. The WThe Washington Post, 12/12/96. ownown proprietaryproprietary storestore card,card, hashas intro-intro­ cialcial Network.Network. IntegrionIntegrion willwill offeroffer ducedduced aa cobrandedcobranded cardcard withwith Master-Master- bank-branded remoteremote bankingbanking serv-serv­ Thrifts May SeekSeek CardCard International, andand isis testingtesting itit inin icesices throughthrough thethe Internet,Internet, on-lineon-line “Lost Profits”Profits” severalseveral marketsmarkets inin thethe MidwestMidwest andand consumerconsumer networks,networks, personalpersonal finan-finan­ TheThe U.U. S.S. CourtCourt ofof FederalFederal ClaimsClaims TTexas.exas. TheThe issuerissuer ofof thethe cardcard isis SearsSears cialcial software,software, andand telephone.telephone. TheThe ruledruled thatthat thriftsthrifts maymay useuse thethe “lost-“lost­ NationalNational BankBank ofof Phoenix.Phoenix. People'sPeople's networknetwork isis expectedexpected toto competecompete withwith profits”profits” theorytheory toto determinedetermine damagesdamages BankBank inin Connecticut hashas alsoalso anan-­ systemssystems currentlycurrently operatedoperated byby Micro-Micro­ againstagainst thethe government forfor renegingreneging nouncednounced thatthat itit isis issuingissuing aa cobrandedcobranded softsoft andand Intuit,Intuit, whichwhich havehave beenbeen pro-pro­ onon favorablefavorable goodwillgoodwill accounting. VISAVISA cardcard withwith TT.J..J. MaxxMaxx amdamd Mar-Mar­ vidingviding on-lineon-line bankingbanking softwaresoftware thatthat UnderUnder thethe lost-profitslost-profits theorytheory,, aa plain-plain­ shalls.shalls. L.L.L.L. BeanBean recentlyrecently issuedissued aa connectsconnects toto dozensdozens ofof financialfinancial insti-insti­ tiftifff cancan suesue forfor profitsprofits thatthat wouldwould havehave cobrandedcobranded VVisaisa cardcard withwith MBNAMBNA tutions.tutions. IntegrionIntegrion willwill allowallow anyany bankbank beenbeen earnedearned hadhad therethere beenbeen nono Bank of Delaware. AB, pg. 1, 9/11/96. toto joinjoin itsits network,network, andand sayssays itit isis inter-inter­ breach-of-contract. InIn 1989,1989, thethe Con-Con­ Fidelity and Schwab Work estedested inin signingsigning upup banksbanks asas eithereither ad-ad­ gressgress changedchanged thethe periodperiod forfor goodwillgoodwill ditionalditional co-ownersco-owners oror customers.customers. With Banks’ Trusts BothBoth ownerowner-banks-banks andand customercustomer-- amortization fromfrom 4040 yearsyears toto fivefive and Mutual Funds years,years, forcingforcing manymany thriftsthrifts intointo bank-bank­ banksbanks willwill bebe charchargedged thethe samesame serv-serv­ ruptcyruptcy.. TheThe suitsuit ofof GlendaleGlendale FederalFederal FidelityFidelity Investments ofof Boston,Boston, iceice rates.rates. OnOn DecemberDecember 22 thethe FRBFRB Bank,Bank, thethe firstfirst ofof thethe moremore thanthan 100100 MA,MA, thethe mutualmutual fundfund giantgiant andand approvedapproved purchasespurchases ofof votingvoting sharesshares thriftsthrifts seekingseeking redress,redress, willwill beginbegin onon numbernumber twotwo discountdiscount brokerbroker inin thethe inin IntegrionIntegrion forfor NorwestNorwest Corp.Corp. ofof February 24. AB, 12/20/96. UnitedUnited States,States, boughtbought partpart ofof aa bankbank Minneapolis andand severalseveral foreignforeign trust-processing firmfirm inin MayMay throughthrough banks.banks. AB,AB, pg.pg. 1,1, 9/10/96,9/10/96, TheThe WWashingtonashington Merger of FederalFederal whichwhich itit plansplans toto offeroffer record-keeping Post, 9/10/96; BBR, pg. 954, 12/9/96. Banking RegulatorsRegulators servicesservices linkinglinking FidelityFidelity fundsfunds andand Foreign Bank Activities SuggestedSuggested thethe FidelityFidelity fundfund supermarket toto bankbank trusttrust departments. CharlesCharles JapanJapan InIn aa recentlyrecently issuedissued report,report, thethe Schwab,Schwab, thethe numbernumber oneone discountdiscount GeneralGeneral AccountingAccounting OfficeOffice foundfound thethe JapaneseJapanese bankbank regulatorsregulators anan-­ brokerbroker inin thethe UnitedUnited States,States, hashas an-an­ bankbank oversightoversight systemsystem inin thethe UnitedUnited nouncednounced thethe closureclosure ofof HanwaHanwa Bank,Bank, nouncednounced plansplans toto serveserve asas aa fund-fund- StatesStates toto bebe duplicativeduplicative andand ineffi-ineffi­ thethe firstfirst closureclosure ofof aa JapaneseJapanese bankbank inin tradingtrading clearinghouse forfor bankbank bro-bro­ cient,cient, andand recommended collapsingcollapsing thethe postwarpostwar era.era. Hanwa,Hanwa, aa regionalregional keragekerage firmsfirms andand trusttrust departments, thethe OTS,OTS, thethe OCC,OCC, andand thethe supervi-supervi­ commercialcommercial bank,bank, mademade substantialsubstantial permittingpermitting themthem toto offeroffer Schwab'sSchwab's sorysory andand regulatoryregulatory responsibilities ofof real-estatereal-estate loansloans throughthrough twotwo affili-affili­ fundfund supermarket toto bankbank customerscustomers thethe FDICFDIC intointo aa newnew independent atesates duringduring thethe 1980s,1980s, andand hashas re-re­ underunder theirtheir ownown names.names. WSJ,WSJ, pg.pg. A5,A5, 9/23/96.9/23/96. federalfederal bankingbanking agencyagency.. IItt recom-recom­ portedported $694$694 millionmillion inin badbad loans.loans. TheThe BankBank ofof JapanJapan isis reportedlyreportedly extendingextending mendedmended thatthat thethe FRBFRB maintainmaintain itsits in-in­ NationsBank Offering dependence, andand alsoalso concludedconcluded thatthat moremore thanthan $360$360 millionmillion inin loansloans toto re-re­ thethe FDICFDIC retainretain itsits powerpower toto examineexamine Its Mutual Funds through pay depositors. TheThe WWashingtonashington Post,Post, 11/22/96.11/22/96. any bank.any bank. AB, 11/27/96. Schwab and Fidelity MexicoMexico NationsBank Corp.Corp. ofof Charlotte,Charlotte, “Smart Cards” TheThe government ofof MexicoMexico plansplans NC,NC, hashas announcedannounced thatthat itit willwill offeroffer toto beginbegin toto disposedispose ofof thethe estimatedestimated TheThe threethree majormajor U.U. S.S. cardcard compa-compa­ sevenseven ofof itsits 4444 mutualmutual fundsfunds throughthrough $40$40 billionbillion inin assetsassets (book(book value)value) thatthat niesnies —— MasterCard, AmericanAmerican ExEx-­ thethe CharlesCharles SchwabSchwab OneSourceOneSource net-net­ itit acquiredacquired inin itsits bank-bailout effort.effort. press,press, andand VVisa — continue toto workwork work.work. TheThe bankbank alsoalso offersoffers itsits ownown TheThe assetsassets consistconsist primarilyprimarily ofof loansloans onon developing consumerconsumer-friendly-friendly fundfund supermarket, calledcalled FundFund Solu-Solu­ andand realreal estate.estate. TheThe government hashas “smart-cards.” MasterCard anan-­ tions,tions, andand itsits fundsfunds areare alsoalso availableavailable createdcreated anan agencyagency calledcalled AssetAsset VValua-alua­ nouncednounced thatthat itit hadhad acquiredacquired 5151 per-per­ throughthrough FidelityFidelity Investment's Funds-Funds- tiontion andand SaleSale (VV(VVA).A). TheThe VVVVAA iiss ex-ex­ centcent ofof MondexMondex International, aa Network.Network. AfterAfter itsits acquisitionacquisition ofof pectedpected toto beginbegin thethe salessales byby holdingholding BritishBritish makermaker ofof “smart“smart cards.”cards.” TheThe Boatmen'sBoatmen's BancsharesBancshares ofof St.St. LouisLouis isis twotwo auctionsauctions earlyearly inin 1997.1997. WSJ,WSJ, 12/23/96.12/23/96. MondexMondex cardcard combinescombines credit,credit, debtdebt completed,completed, NationsBank willwill bebe thethe

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