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Our sample analyses show that the regulators are taking action faster after the first "3," "4," or "5" rating now than they did before the new procedures were adopted.
of those sample banks that had a formal action taken against them under the new policy, 87 percent of the actions were taken within 6 months of the ending date of the examination. This compares with 53.7 percent for actions taken before the new procedures were implemented. Under the new procedures, in 78.3 percent of the sample cases in which the agencies took formal action, it was before the next examination started. The regulators took action before the next examination in only 61.0 percent of the sample cases before the new policy was instituted.
However, our detailed cases showed that the agencies still do not take formal actions until a bank's condition has deteriorated. Formal action, either by the Federal agency or the State bank supervisor, was taken in 13 of our 17 cases. In all of them, the regulators waited until the effects of the problems became evident before designating the banks as institutions requiring special attention and taking formal actions.
officials at all three agencies agreed that formal actions generally are not used until a bank's financial condition has been affected. They apply moral suasion to bank management until the effects of the bank's problems are serious, at which time they will take formal action.
This reluctance is induced by a concern for building a strong case before applying legal sanctions. According to agency officials, legal actions go through numerous agency reviews before they are issued against banks. There is concern about building enough support for the action should the bank dispute it. One of the Comptroller's officials stated that a case for a legal enforcement action could not be sustained unless the bank's condition had deteriorated. Regarding one of our detailed case studies, an FDIC official explained that the State regulators can act more quickly on a legal action than the Federal agency because of the long process and many reviews the Federal agency must go through. When State laws are less cumbersome, the Federal agency may let a State take action against a State-chartered bank. A Federal Reserve official expressed a similar position.
Anticipated flexibility in new legal powers partly realized
The Congress attempted in 1978 to give the bank regulators new flexibility to deal with the primary cause of bank problems-bad managers--before banks suffer serious financial harm. The new tools given to the regulators--improved cease and desist authority, civil money penalties, easier removal and suspension
of officers, and control over changes in ownership of banks--have proved useful, but not necessarily to the extent originally envisioned.
Cease and desist still most used
One legal sanction used by regulators to deal with a bank's problems is the cease and desist order, which requires the bank to stop an action that the regulator believes is harming the bank. Cease and desist authority was improved by applying it to individuals as well as to institutions. 1This was prompted by agency complaints that previous cease and desist authority, aimed only at institutions, was often inappropriate.
The cease and desist order is still the most often used legal power, and it is still used mostly against institutions, not individuals. Examiners, overall, participated in examinations in which more cease and desist orders were recommended than any other formal legal action. The results of our survey show that 58.7 percent of the respondents said that in the past 5 years they have participated in at least one examination in which the examiner-in-charge recommended a cease and desist order. But, in 1980, only 7 of the 67 cease and desist orders issued by the Federal bank regulators were directed at individuals by name. Of course, in some other orders, individuals may have been affected even if not named as respondents.
Cease and desist authority is still felt by examiners to be the most effective legal measure to discourage improper acts and influence banks to solve problems. of the examiners surveyed, only 28.5 percent had experience with a civil money penalty and 27.6 percent with a removal or suspension. Almost 58 percent thought that their agency's authority to issue cease and desist orders helped them discourage, to a great or very great extent, illegal or unsound banking practices. Also, 67.2 percent of the examiners felt, to a great extent or more, this same authority helped influence banks to address problems within a reasonable time; and 64.4 percent indicated that, to the same extent noted above, the authority to issue cease and desist orders helped their agencies influence banks to solve problems before they endangered bank solvency. As can be seen by referring to the following figure, examiners rated the deterrent capabilities of cease and desist orders considerably higher than they rated the other legal actions.
1/Public Law 95-630, Sec. 107.
The Congress gave the agencies authority to levy civil money penalties as an intermediate power. Before, the regulators, faced with certain violations of laws or regulations, had to choose to either take no legal action or impose an unduly harsh penalty Daily money penalties were thought of as deterrents to violations and a more flexible alternative to treat their occurrence. In its task force report, GAO endorsed the granting of authority to impose civil money penalties.
The examiners have had less experience with the civil penalty power, but the Comptroller's examiners have had more than those of the other two agencies. Forty-six percent of the Comptroller's examiners surveyed said they had participated in one or more examinations in which a civil money penalty was recommended as compared to 10.4 percent of the Federal Reserve examiners and 12.3 percent of the FDIC examiners. According to officials at all three Federal banking agencies, the reason the Comptroller has used this power more is that he must enforce more Federal banking laws than do the other two agencies. Still, the Comptroller's staff told us they would have imposed more civil money penalties if they had more personnel to develop cases, and headquarters officials at all the agencies consider them to be effective deterrents.
Removal and suspension still difficult
The Congress expanded removal and suspension authority in order to make it easier to deal with officers and directors who were not necessarily dishonest but were nonetheless detrimental to their banks. In the past, agencies could only remove bank officials if they had evidence of personal dishonesty. They could not remove them merely for gross negligence even if they had caused problems. The 1978 law allowed removal proceedings against those whose actions demonstrate "a willful or continuing disregard for the safety or soundness of the bank" if "the agency determines that the bank has suffered or will probably suffer substantial financial loss or other damage or that the interests of its depositors could be seriously prejudiced * * *." 1/ GAO also supported this new authority in its task force report.
In practice, though the new legal enforcement authority is less restrictive, the agencies still feel they must wait until a bank's condition has been substantially impaired before they can take action. According to one official, a bank must be in poor condition before removal action can even begin. We were told that a court would never rule in favor of an agency removing someone just because he/she was a bad manager. Showing that management actions caused, or would have caused, damage to a bank is extremely difficult, the agencies said, and the standard of proof is very strict. Because of the hurdles that must be overcome and the time-consuming process involved, agencies use alternatives to their removal authority. An FDIC official said they issue cease and desist orders to have banks' boards of directors hire management acceptable to an agency, and they can influence the boards to deal with managers on their own.
Calling the lack of control over transfers of bank ownership one of the most glaring regulatory gaps, the Congress gave the banking agencies authority in the Change in Bank Control Act to deny a purchase by an individual for any of several reasons. 2/ The reasons for disapproval include the determination that the proposed owners might jeopardize the financial
1/Public Law 95-630, Sec. 107(a)(1).
2/Under the Bank Holding Company Act, the Federal Reserve already
had authority to approve or deny bank purchases by business organizations that qualified as holding companies.
stability of the bank or are of questionable competence, experience, or integrity. 1/
Though seldom used, this authority has proven effective when it has been employed. In one of the cases we reviewed in detail, the change-in-control authority was used to prevent an individual from buying a controlling interest in a national bank. The individual who applied for the purchase was president of another bank in the immediate community and chairman of a bank corporation. The Comptroller denied the request based, in part, on information provided by FDIC and the Federal Reserve. The bank of which the prospective buyer was president was under an FDIC memorandum of understanding, and a cease and desist order was about to be initiated. Federal Reserve officials informed the Comptroller that the bank corporation which controlled the aforementioned bank was itself in unsatisfactory financial condition. The Comptroller's denial stated that the competence, experience, and integrity of the applicant were in question and that his ownership might substantially lessen competition in the community. Had the change-in-control authority not been granted to the agencies, they could not have prevented the purchase by an individual known to have caused problems in a bank he already owned.
In two other cases, damaging purchases were made before change-in-control authority was granted, and the new power could have prevented problems that developed. The Comptroller had unconfirmed information on the potential owner of one bank, suggesting that he might be detrimental to the bank's condition. At that time, the Comptroller could not disapprove the purchase but was aware that the bank had the potential for problems caused by the new controlling group. Eleven months after the change in ownership, the Comptroller's staff detected major problems in the bank, which were attributed to new management's policies and procedures, its influence over junior officers, and its apparent control over the board of directors.
In the second case, if the Comptroller had received information on the financial position of the prospective buyers of a bank and had the power to act on it, he might have been able to prevent or at least anticipate the problems that ensued. The individuals who purchased the bank had need of funds and eventually gave themselves inordinately high salaries and preferential loans to directors, using the bank for their own purposes. These insider abuses were discovered in an examination 1 year
1/Public Law 95-630, Title VI.