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We are also concerned that focusing attention on management problems after a hank's condition deteriorates denies the agencies an opportunity to help solve management weaknesses at an early stage. In chapter 4 we discuss a way in which we believe the agencies could be more effective in helping banks solve problems at an early stage. But implementing this requires placing more emphasis on management problems before the agencies find it necessary to take formal measures to force actions on bank managers.

Though experience has shown that surveillance systems can disclose a bank's financial deterioration before it reaches dangerous levels, the systems cannot disclose management weaknesses until they manifest themselves as financial problems. Therefore the agencies will, as they have stated in the past, have to maintain a mix of onsite visits and surveillance to assure banks' safety and soundness in today's regulatory environment. Onsite visits should naturally be aimed at areas that surveillance cannot effectively evaluate. In chapter 5 we discuss problems encountered by the agencies in integrating surveillance into their supervisory programs.

AGENCY COMMENTS

In oral comments, the Comptroller's officials pointed out that some of our cases occurred at a time when new examination procedures were still evolving. They believe that they are now emphasizing management more. We understand that any new procedure might go through a transitional phase during its evolution. At present, not enough "post-transitional" case studies exist to make a judgment on whether the Comptroller's examiners now emphasize management more often than they did during the "transitional phase."

Although we made no recommendations in this chapter, FDIC chose to offer a comment interpreting our evidence to support its methods of assessing bank management. Pointing to figures cited in paragraph 5 on page 21, the FDIC stated that it was "'bottom line' evidence of the comprehensive nature of FDIC's management evaluation process. (See app. V, p. 93.) Actually, what the figures show is that the agencies mention management problems before a bank's condition deteriorates and that FDIC appears to do this more often than do the other two agencies.

But our main point is that the agencies do not act upon those findings until a bank's financial condition deteriorates, and we offer further evidence of this, applicable to all three agencies. (See pp. 22 to 29.) Our recommendation as to what the agencies should do is in our next chapter, and we discuss agencies' comments on that recommendation on page 46.

CHAPTER 4

FORMAL ACTIONS IMPROVED, BUT INFORMAL

METHODS SHOULD BE MADE MORE EFFECTIVE

The Federal banking agencies are taking more formal actions to influence banks to solve problems. Their more aggressive attitude is aided by a more structured approach to using their supervisory powers and by new legal authority given them by the Congress.

Still, agencies use formal actions only after a bank's financial condition has deteriorated appreciably. At the earliest stages of a problem, agencies still use informal persuasive techniques, and they still avoid using what could be an effective aid to banks--making more specific, useful recommendations for correcting conditions that could lead to more serious problems.

FORMAL ACTIONS USED MORE OFTEN, BUT
ONLY AFTER FINANCIAL CONDITION DETERIORATES

In 1977, GAO concluded that the Federal bank regulators could have used their formal enforcement powers sooner and more often to effect solutions to bank problems. We recommended that they establish more aggressive policies and more structured guidelines for using the powers.

Using new powers granted by the Congress in 1978, the agencies have become more aggressive and have established more structured guidelines. But they still wait to use their formal powers until a hank's condition has deteriorated significantly. This is caused by a desire to develop a strong case before applying legal sanctions.

We have grouped as formal actions "administrative" and "legal" enforcement measures. We have defined administrative actions as understandings between a bank and its supervisory agency on ways to solve problems. They include memoranda of understanding and the more formalized written agreements. Legal enforcement actions are specifically authorized by law and are used as a last resort to induce bank managers to solve their problems. They include cease and desist orders, civil money penalties, and removal and suspension of bank officials. We have also included the new authority allowing agencies to disapprove prospective bank purchases because it could be punitive in nature and was designed as a safety and soundness measure. The agencies can deny a bank's application (for a new branch, for example) as an enforcement action. However, we have not

considered such actions here because, in the application process, banks may be discouraged from filing if they know their applications would not be accepted. Since documentation of that informal exchange between bankers and regulators might be fragmentary at best, we could not quantify its use.

Taken as a group, these formal actions are used when informal persuasion fails to influence bankers to solve problems.

Formal actions used more often

Each of the agencies has increased its use of formal actions in recent years, especially considering the fact that the number of banks requiring special attention has declined from the high in the mid-1970s. The following table shows the number of formal actions taken by the agencies over the last 10 years:

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Removal and Suspension of Management

7 11 7 _

17 7

4 3 1 Totals

13 27 34 32

51 71 101 135

71 101 135 161 205 a/Data for 1971-1977 not readily available.

b/An FDIC official said that in the last 2 years FDIC has resumed

using memoranda of understanding after a lapse of some years.

Data not readily available. c/New supervisory tool, instituted with FIRA (Nov. 10, 1978).

The following graph compares the number of banks requiring special attention over the same period to the number of formal actions shown on the previous page:

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In the previous graph, special attention figures are combined totals taken from lists maintained by each of the agencies. FDIC includes national and State member banks on its problem bank lists, in addition to State nonmember banks--for which they have supervisory responsibility. However, the special attention figures represent only the State nonmember banks on FDIC's problem bank lists. National and State member special attention bank figures were obtained from the Comptroller and the Federal Reserve, respectively.

As the graph shows, considering the total number of these banks has been stable or slightly decreasing since 1977, the use of formal actions has increased significantly.

Formal actions linked to financial condition

Reinforced by new structured guidelines for using formal actions, the agencies use the actions only after a bank's condition has deteriorated significantly. They are, therefore, not used at the earliest stages when potential problems could be solved, perhaps by correcting management weaknesses.

In our 1977 report, we observed that the banking agencies had delayed using formal actions until a bank's problems had become very severe, especially in cases in which the banks eventually failed. 1/ We reported that for the banks listed as problems on November 30, 1976, and against which the agencies took formal actions, 2) an average of 57 months elapsed from the date of the problem designation to the date the action was taken.

Using a new procedure adopted by all three agencies, regulators are taking actions faster. During 1979, the regulators set up policies for the use of formal legal and administrative actions. These guidelines were established to assure greater uniformity among the field offices and to set forth minimum standards for the treatment of banks requiring more than normal supervision. The policy statements require the field offices to implement or consider some type of supervisory action after giving the bank a "3," "4," or "5" rating. (See footnote on p. 23 for explanation of ratings.)

1/0CG-77-1, page 8-17.

2/Formal actions as defined in our 1977 report did not include

memoranda of understanding.

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