Congressional Testimony: Bank Examinations Create “Unbridled Banking Agency Power”
TESTIMONY OF DAVID BARIS
EXECUTIVE DIRECTOR, AMERICAN ASSOCIATION OF BANK DIRECTORS
US HOUSE SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND CONSUMER CREDIT
AUGUST 16, 2011
Good morning Chairwoman Capito, Ranking Member Maloney and members of the Subcommittee. Thank you for the opportunity to submit this statement for the hearing record.
The American Association of Bank Directors provides advocacy, informational and educational support for bank and savings institution directors.
Your hearing today and previous hearings on the bank examination process on July 8 and May 26, 2011 are extraordinarily important. They help to shed light on a process that often is shrouded in secrecy. Bank examiners can make life and death discretionary examination decisions. Public pronouncements by federal banking agency heads, while made in good faith to make the process more transparent, may not always be consistent with what may happen during and after an examination of an individual bank.
The federal banking agencies have had virtually unbridled discretion in how they examine banks.
Until recently, Congressional oversight of the bank examination process has been limited and lacked depth.
Banks may appeal examination results to the Ombudsman of the agency that examines them, but many banks are reluctant to appeal for fear of retribution and others decide not to because they do not believe that the Ombudsman is truly independent of the agency.
Banks have no statutory right to appeal adverse results of an examination to a federal or state court.
The examiners in the field as well as some of their supervisors realize that if they err on the side of stringency, they will not be criticized. But they know that the Inspectors General of the respective federal banking agencies will criticize them for not having identified problems earlier in banks that ultimately failed. The reports of the Inspectors General frequently criticize the primary federal banking regulator of the failed bank for not having identified and acted on deficiencies earlier, but never criticize the regulator for being too stringent.
Bank examiners have discretion on a wide array of matters, including whether to classify a loan, whether to place a loan in nonaccrual even though it is performing, and to substitute their own ALLL methodology for that of the bank. This is so even though a bank might have had reasonable systems and controls in the bank to make reasoned determinations of their own, or may have relied on qualified third party auditors or loan review advisors for their determinations.
Many of these decisions are judgment calls based on the facts and circumstances of the individual bank. It matters a great deal as to the extent to which examiners allow banks to exercise reasonable discretion in exercising their good faith judgment.
During good times, examiners tend to give bankers some leeway in applying reasonable judgment as to these matters; but when the economy weakens, there is a greater tendency to substitute the examiners’ judgment for that of the bankers. This is unfortunate since examiner judgments can make a recession deeper and longer than it needs to be. That is because a bank’s financial condition will often dictate whether it can make loans to those who reside and do business in their community and because the uncertainty and unpredictability of examiner judgments make banks less willing to lend except in limited circumstances involving extraordinarily strong borrowers.
Another disincentive to lend is the risk of personal liability that bank directors face from enforcement actions and suits by the FDIC following a bank failure. AABD recently advised bank directors to stop approving loans until the FDIC satisfactorily provides a “safe harbor” under certain circumstances for bank directors who approve loans. The FDIC has declined the offer. Outside directors are generally individuals with no bank lender experience who rely in good faith on the recommendations of their banks’ lenders and credit officers. In his Grant Interest Rate Observer dated July 1, 2011, under the heading “Chill is in the air”, James Grant questioned whether bank directors will continue to approve loans in face of the potential personal liability they face if their bank fails or gets into trouble.
The banking regulators sometimes have exercised their enormous unfettered discretion in determining when to seize a viable community bank, resulting in catastrophic economic consequences for communities served by such community banks improperly seized and for their shareholders, and irreparable reputational and economic damage to the local business leaders who serve on local community bank boards of directors. There is a pressing need to protect against such regulatory abuse by requiring a higher level of accountability and transparency to ensure that the banking agencies act in accord with legal standards governing the extraordinary regulatory remedy of a bank seizure.
The Subcommittee’s hearing on January 21, 2010 on the closing of Park National Bank, Chicago, a leading community bank lender to Chicago’s inner city, raised significant questions about the propriety and wisdom of closing that bank.
In one especially troubling example of a plainly improper community bank seizure, a viable Denver bank with $400 million in available cash was seized by the OTS and FDIC without adequate statutory grounds. United Western Bank was on the verge of a $200 million private-sector recapitalization that would have further strengthened the bank’s financial position and avoided a large and wholly unnecessary loss to the FDIC Deposit Insurance Fund. But in the face of a private-sector solution that would have led to expanded community banking activities in the Denver market, the OTS and FDIC precipitously and improperly closed the bank because, we believe, the regulators did not like the bank’s business model.
Immediately following the seizure, all of the deposits and most of the assets of the bank were assumed by First-Citizens Bank and Trust Company, a North Carolina-based institution with over 400 branches that is owned by one of the 50 largest holding companies in the United States. Almost immediately following the January 2011 seizure and sale of the Bank by the OTS and FDIC, the acquiring bank closed four of United Western’s eight branches, suspended United Western’s large and successful SBA lending program, informed existing borrowers and new applicants that it would not make loans in the Denver market for at least 18 months, and fired approximately 50 local employees.
The regulators no doubt thought their drastic actions to impose the ultimate punishment on the bank for not embracing the business advice of the regulators would go unchallenged and their decision-making process remain secret, as they have in the almost 400 bank seizures since 2007. They were wrong in this instance. United Western Bank’s owners sued the OTS and FDIC demanding the return of the bank to its rightful owners. At every turn in that proceeding, which is pending in U.S. District Court in the District of Columbia, the OTS and FDIC have attempted to evade judicial scrutiny and the exposure of their secretive internal processes. First, the OTS and FDIC sought to dismiss the case on technical grounds. Later, and only after being ordered to do so by the Court, the OTS produced a hand-picked, sanitized administrative record that excluded all of the many discussions between the agencies concerning the FDIC’s distaste for the bank’s business model and directive that the OTS force the bank to change that model and any internal communications discussing whether failing the bank was the right answer given its relatively strong financial position relative to other regulator-defined “troubled banks.” Indeed, the regulators sought to persuade the Court that only a grand total of two internal email communications within or between the agencies were relevant to determination to seize the bank.
Notwithstanding these efforts to protect the secrecy of the regulatory proceedings leading to the seizure of this bank, in this case these proceedings may yet be exposed to public review. The OCC (who was substituted for the now-defunct OTS) was ordered by the court last week to certify the completeness of the censored administrative record or supplement the record as necessary after failing to convince the court that the administrative record, which will be made public, should consist of only those documents assembled by the OTS to support its position rather than everything, favorable or unfavorable, considered by the OTS. The court rejected soundly the longstanding position of the regulators that they are entitled by law to avoid judicial and public scrutiny of their actions and decision-making process related to seizing a community bank.1
While the United Western case and other subsequent cases involving other community bank seizures may ultimately cause the regulators to curtail the improper use of their extraordinary powers to seize community banks virtually at their whim, this subcommittee has the opportunity immediately to create transparency in the process and modify banking agency practice to conform to legal requirements.
1David Baris is a partner in the law firm of BuckleySandler LLP, which represents the former owners of United Western Bank.
This subcommittee has the authority to obtain agency materials and ask probing questions about the United Western Bank seizure and other comparably questionable recent seizures by the bank regulators. A strong community bank system is of critical importance throughout this nation to ensure availability of credit to small businesses and families. It should be the highest priority of the federal bank regulatory system to avoid wherever possible that which the FDIC and the OTS caused to occur in the case of United Western Bank, the seizure of a local bank and its resale to a large bank thousands of miles away that immediately stopped delivering certain basic banking products and services to the local community.
H.R. 2056, which passed the House of Representatives last month, is a step in the right direction. More can be done. The House Committee on Financial Services can direct the GAO to conduct a thorough study on the bank examination process to assure that the process is fair and consistent and properly gives banks reasonable discretion to classify loans, determine the accrual status of loans, adopt and apply a reasonable ALLL methodology, and make other reasonable determinations in operating their businesses.