Statement of
John Corston, Acting Deputy Director
Complex Financial Institution Branch
Division of Supervision and Consumer Protection
Federal Deposit Insurance Corporation
on
Systemically Important Institutions
and the
Issue of "Too Big To Fail"
before the
Financial Crisis Inquiry Commission
Room 538, Dirksen
Senate Office Building
September 1, 2010
Chairman Angelides, Vice Chairman Thomas, and Commissioners, I appreciate the
opportunity to testify on behalf of the Federal Deposit Insurance Corporation (FDIC) to
address the FDIC's supervision of systemically important financial institutions during the
recent financial crisis and the importance of effectively managing systemic risks going
forward.
Specifically, my testimony will discuss the challenges faced by the FDIC and other
federal regulators in resolving large and complex financial institutions in the supervisory
and regulatory environment that existed prior to the passage of the Dodd-Frank Wall
Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act). As
requested by the Commission, I will discuss the chain of events and factors that led to
the collapse and sale of Wachovia and contrast this event with the failure of another
large institution, Washington Mutual Bank (WaMu). Next, my testimony outlines actions
taken over the past few years to improve the FDIC's ability to provide backup
supervision and to resolve large complex financial institutions. These measures
culminated in several important provisions included in the Dodd-Frank Act.
FDIC Supervision of Large and Complex Institutions
Prior to the financial crisis, the FDIC's on-site presence and access to information at
systemically important institutions were limited. The FDIC maintained a modest on-site
presence at the eight largest insured depository institutions (IDI) under its Dedicated
Examiner (DE) program pursuant to the terms and conditions established by a 2002
Interagency Agreement titled "Coordination of Expanded Supervisory Sharing and
Special Examinations." Specifically, the agreement permitted only a single FDIC senior
examiner to be on-site full-time with the primary federal regulator's (PFR) examination
team at each of these institutions. Further, while the agreement provided that the staff of
the PFR were "expected to keep the [DE] informed of all material developments," on-
site examinations were restricted since the interagency agreement provided for the PFR
to "invite the [DE] to observe and participate in certain examination activities." In cases
John Corston, Acting Deputy Director
Complex Financial Institution Branch
Division of Supervision and Consumer Protection
Federal Deposit Insurance Corporation
on
Systemically Important Institutions
and the
Issue of "Too Big To Fail"
before the
Financial Crisis Inquiry Commission
Room 538, Dirksen
Senate Office Building
September 1, 2010
Chairman Angelides, Vice Chairman Thomas, and Commissioners, I appreciate the
opportunity to testify on behalf of the Federal Deposit Insurance Corporation (FDIC) to
address the FDIC's supervision of systemically important financial institutions during the
recent financial crisis and the importance of effectively managing systemic risks going
forward.
Specifically, my testimony will discuss the challenges faced by the FDIC and other
federal regulators in resolving large and complex financial institutions in the supervisory
and regulatory environment that existed prior to the passage of the Dodd-Frank Wall
Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act). As
requested by the Commission, I will discuss the chain of events and factors that led to
the collapse and sale of Wachovia and contrast this event with the failure of another
large institution, Washington Mutual Bank (WaMu). Next, my testimony outlines actions
taken over the past few years to improve the FDIC's ability to provide backup
supervision and to resolve large complex financial institutions. These measures
culminated in several important provisions included in the Dodd-Frank Act.
FDIC Supervision of Large and Complex Institutions
Prior to the financial crisis, the FDIC's on-site presence and access to information at
systemically important institutions were limited. The FDIC maintained a modest on-site
presence at the eight largest insured depository institutions (IDI) under its Dedicated
Examiner (DE) program pursuant to the terms and conditions established by a 2002
Interagency Agreement titled "Coordination of Expanded Supervisory Sharing and
Special Examinations." Specifically, the agreement permitted only a single FDIC senior
examiner to be on-site full-time with the primary federal regulator's (PFR) examination
team at each of these institutions. Further, while the agreement provided that the staff of
the PFR were "expected to keep the [DE] informed of all material developments," on-
site examinations were restricted since the interagency agreement provided for the PFR
to "invite the [DE] to observe and participate in certain examination activities." In cases
where disagreements occurred between the PFR and DE, the issue would need to be
elevated to the FDIC Chairman for resolution.
As recently reported by the FDIC and Treasury Department Inspector Generals and
discussed at the Senate Permanent Subcommittee on Investigations hearing in April
2010, the terms of the 2002 Interagency Agreement were too restrictive on the FDIC's
ability to adequately exercise its backup examination authorities. Accordingly, a new
Memorandum of Understanding between the regulatory agencies was developed and
recently signed to address weaknesses in the 2002 agreement.
In addition to its on-site DE program, the FDIC carries out its supervisory responsibilities
by performing off-site risk analyses of large banks under its Large Insured Depository
Institution (LIDI) program. This program is designed to provide comprehensive and
forward-looking assessments of the risk profiles of IDIs over $10 billion in assets. In
addition, this program provides on-site support through technical experts, operates a
continuous presence at the eight insured institutions that represent the highest level of
risk and complexity, and assists in developing and recommending strategies on specific
institutions. Further, and most important, we consider the potential loss severity that the
failure of these institutions could represent to the Deposit Insurance Fund. To quantify
the level and direction of risk, each institution covered by the LIDI program is assigned a
rating (A through E, with A being the best) and an outlook (positive, stable, or negative).
Ratings and outlooks are assigned at least quarterly, with interim changes made when
necessary. All relevant sources of information available are used in performing LIDI
analysis, including both public information and confidential bank supervisory
information. Supervisory information or internal bank reports are obtained from or
through the PFR for all non-FDIC supervised institutions.
The FDIC's ability to reduce the impact of the failure of a large IDI is governed by
statutory provisions enacted by the FDIC Improvement Act of 1991, also known as
FDICIA. This law requires the FDIC to choose the "least costly" resolution method and
defines the method that minimizes expenditures from the Deposit Insurance Fund. The
least-cost test involves the FDIC performing a cost analysis of possible resolution
alternatives, based on the best available information at the time, when deciding how to
resolve a failed insured depository institution. The FDIC has developed the capabilities
to do this, but accurate and timely information is critical to perform such an analysis
effectively. Further, the FDIC's ability to perform an analysis in an effective manner can
be significantly affected by the complexity of the institution and the short time period of
notice prior to the failure – elements that are likely present in the case of a very large
bank.
Under FDICIA, there is an exemption to the least-cost requirement for certain
extraordinary circumstances under the "systemic risk exception." Generally, this
exception applies if both the FDIC Board and the Federal Reserve Board (FRB), by a
vote of at least two-thirds of their members, and the Secretary of the Treasury, in
consultation with the President, determine that compliance with the least-cost
requirement "would have serious adverse effects on economic conditions or financial
elevated to the FDIC Chairman for resolution.
As recently reported by the FDIC and Treasury Department Inspector Generals and
discussed at the Senate Permanent Subcommittee on Investigations hearing in April
2010, the terms of the 2002 Interagency Agreement were too restrictive on the FDIC's
ability to adequately exercise its backup examination authorities. Accordingly, a new
Memorandum of Understanding between the regulatory agencies was developed and
recently signed to address weaknesses in the 2002 agreement.
In addition to its on-site DE program, the FDIC carries out its supervisory responsibilities
by performing off-site risk analyses of large banks under its Large Insured Depository
Institution (LIDI) program. This program is designed to provide comprehensive and
forward-looking assessments of the risk profiles of IDIs over $10 billion in assets. In
addition, this program provides on-site support through technical experts, operates a
continuous presence at the eight insured institutions that represent the highest level of
risk and complexity, and assists in developing and recommending strategies on specific
institutions. Further, and most important, we consider the potential loss severity that the
failure of these institutions could represent to the Deposit Insurance Fund. To quantify
the level and direction of risk, each institution covered by the LIDI program is assigned a
rating (A through E, with A being the best) and an outlook (positive, stable, or negative).
Ratings and outlooks are assigned at least quarterly, with interim changes made when
necessary. All relevant sources of information available are used in performing LIDI
analysis, including both public information and confidential bank supervisory
information. Supervisory information or internal bank reports are obtained from or
through the PFR for all non-FDIC supervised institutions.
The FDIC's ability to reduce the impact of the failure of a large IDI is governed by
statutory provisions enacted by the FDIC Improvement Act of 1991, also known as
FDICIA. This law requires the FDIC to choose the "least costly" resolution method and
defines the method that minimizes expenditures from the Deposit Insurance Fund. The
least-cost test involves the FDIC performing a cost analysis of possible resolution
alternatives, based on the best available information at the time, when deciding how to
resolve a failed insured depository institution. The FDIC has developed the capabilities
to do this, but accurate and timely information is critical to perform such an analysis
effectively. Further, the FDIC's ability to perform an analysis in an effective manner can
be significantly affected by the complexity of the institution and the short time period of
notice prior to the failure – elements that are likely present in the case of a very large
bank.
Under FDICIA, there is an exemption to the least-cost requirement for certain
extraordinary circumstances under the "systemic risk exception." Generally, this
exception applies if both the FDIC Board and the Federal Reserve Board (FRB), by a
vote of at least two-thirds of their members, and the Secretary of the Treasury, in
consultation with the President, determine that compliance with the least-cost
requirement "would have serious adverse effects on economic conditions or financial