Statement of
Sandra L. Thompson, Director,
Division of Risk Management Supervision,
Federal Deposit Insurance Corporation
On H.R. 3461:
The Financial Institutions Examination Fairness and Reform Act
before the
Subcommittee on Financial Institutions
and
Consumer Credit Committee on Financial Services
2128 Rayburn House Office Building
February 1, 2012
Chairman Capito, Ranking Member Maloney, and members of the Subcommittee, I
appreciate the opportunity to testify on behalf of the Federal Deposit Insurance
Corporation (FDIC) about the "Financial Institutions Examination Fairness and Reform
Act" (H.R. 3461) and its potential impact on the supervisory process. In my testimony, I
will discuss the FDIC's perspectives on how the proposed legislation would affect the
bank supervisory process, which helps ensure the safety and soundness of our nation's
banks, and the Deposit Insurance Fund (DIF).
The FDIC continually seeks to improve the bank examination process, and we are
committed to ensuring that banks understand our examination findings and have the
opportunity to discuss, question and appeal those findings if they find it appropriate,
both formally and informally. This is a challenging time for financial institutions, and
examination findings reflect the difficult economic environment. These economic
difficulties, particularly as they affect real estate, have led to credit quality weaknesses
that have increased the volume of classified and nonaccrual loans. These credit quality
issues require remediation to help ensure that institutions remain solvent and risks to
the DIF are mitigated. At the same time, we recognize that banks are working very hard
to navigate the downturn. Among other challenges, they have had to increase efforts to
work with borrowers who are having difficulty making payments; address earnings
compression; and deal with the credit availability needs in their respective communities.
The FDIC shares the Subcommittee's goal of having a strong banking industry that
serves as a source of credit to our nations' communities. At the same time, we share the
responsibility with our fellow regulators of making certain that insured institutions remain
safe and sound and that their financial reports accurately portray their financial
condition.
The stated purpose of H.R. 3461 is to improve the examination of depository institutions
– also a goal that we share. However, the proposed legislation could mask problems at
insured depository institutions and inhibit our ability to require weak institutions to take
corrective action – potentially resulting in higher losses to the DIF. Most important, the
Sandra L. Thompson, Director,
Division of Risk Management Supervision,
Federal Deposit Insurance Corporation
On H.R. 3461:
The Financial Institutions Examination Fairness and Reform Act
before the
Subcommittee on Financial Institutions
and
Consumer Credit Committee on Financial Services
2128 Rayburn House Office Building
February 1, 2012
Chairman Capito, Ranking Member Maloney, and members of the Subcommittee, I
appreciate the opportunity to testify on behalf of the Federal Deposit Insurance
Corporation (FDIC) about the "Financial Institutions Examination Fairness and Reform
Act" (H.R. 3461) and its potential impact on the supervisory process. In my testimony, I
will discuss the FDIC's perspectives on how the proposed legislation would affect the
bank supervisory process, which helps ensure the safety and soundness of our nation's
banks, and the Deposit Insurance Fund (DIF).
The FDIC continually seeks to improve the bank examination process, and we are
committed to ensuring that banks understand our examination findings and have the
opportunity to discuss, question and appeal those findings if they find it appropriate,
both formally and informally. This is a challenging time for financial institutions, and
examination findings reflect the difficult economic environment. These economic
difficulties, particularly as they affect real estate, have led to credit quality weaknesses
that have increased the volume of classified and nonaccrual loans. These credit quality
issues require remediation to help ensure that institutions remain solvent and risks to
the DIF are mitigated. At the same time, we recognize that banks are working very hard
to navigate the downturn. Among other challenges, they have had to increase efforts to
work with borrowers who are having difficulty making payments; address earnings
compression; and deal with the credit availability needs in their respective communities.
The FDIC shares the Subcommittee's goal of having a strong banking industry that
serves as a source of credit to our nations' communities. At the same time, we share the
responsibility with our fellow regulators of making certain that insured institutions remain
safe and sound and that their financial reports accurately portray their financial
condition.
The stated purpose of H.R. 3461 is to improve the examination of depository institutions
– also a goal that we share. However, the proposed legislation could mask problems at
insured depository institutions and inhibit our ability to require weak institutions to take
corrective action – potentially resulting in higher losses to the DIF. Most important, the
bill would constrain the ability of bank supervisors to evaluate and work with banks to
address emerging problems while there is still a chance to correct the problems and
avoid needless failures.
The bank examination process in the U.S. has evolved over many decades and has
been shaped by our collective experience in both good times and bad. Recent
experience has reaffirmed an essential lesson of past crises: namely, on-going, robust
examination and early supervisory intervention are key to containing problems as they
develop. We believe the current supervisory regime helps to promote public confidence
by providing for the effective supervision of our nation's banks while protecting
depositors and the taxpayers.
Ensuring Accurate Portrayal of an Insured Depository Institution's Financial
Condition
The reliability and integrity of regulatory and financial reporting are fundamental to
understanding the health and performance of financial institutions. This is especially
important when weak economic conditions are causing increased problem asset levels.
Banking supervisors employ a standardized framework to evaluate a bank's risk profile,
identify higher-risk assets and business lines, and assess the institution's overall
financial health and consumer protection performance. These examination procedures
form a toolkit of risk assessment and mitigation activities that help supervisors address
problems as they emerge and protect the federal safety net from unnecessary outlays.
Assessing a bank's individual risks is a fact-specific process that depends greatly on the
institution's risk selection, managerial oversight, and market circumstances. At the most
fundamental level, bank supervision requires flexibility and use of expert judgment
customized to each bank's profile and risk-taking.
Classification of Loans - H.R. 3461 could impair the banking supervisors' ability to
assess and monitor risks by changing the method by which adverse classifications are
derived. Adverse classifications represent a specialized analysis of an institution's
problem assets. Regulators use these classifications to determine capital adequacy and
overall financial health. The process for deriving adverse classification was first
developed in the late 1930's and has been refined in successive decades to better
monitor risk. The classification system consists of designations that identify different
degrees of credit weaknesses. A loan is considered "classified" when it is rated either
"Substandard," "Doubtful," or "Loss." A statutory change to the classification process, as
described below, would reduce the effectiveness of the metrics that bank regulators rely
on to evaluate the condition of institutions, the adequacy of their capital and reserves,
the performance of management and the appropriate risk-based deposit insurance
premium.
When the financial condition and repayment capacity of a commercial borrower
deteriorates, the loan may be subject to adverse classification. In deciding whether to
classify a loan, supervisors look first and foremost to the borrower's cash flow and ability
address emerging problems while there is still a chance to correct the problems and
avoid needless failures.
The bank examination process in the U.S. has evolved over many decades and has
been shaped by our collective experience in both good times and bad. Recent
experience has reaffirmed an essential lesson of past crises: namely, on-going, robust
examination and early supervisory intervention are key to containing problems as they
develop. We believe the current supervisory regime helps to promote public confidence
by providing for the effective supervision of our nation's banks while protecting
depositors and the taxpayers.
Ensuring Accurate Portrayal of an Insured Depository Institution's Financial
Condition
The reliability and integrity of regulatory and financial reporting are fundamental to
understanding the health and performance of financial institutions. This is especially
important when weak economic conditions are causing increased problem asset levels.
Banking supervisors employ a standardized framework to evaluate a bank's risk profile,
identify higher-risk assets and business lines, and assess the institution's overall
financial health and consumer protection performance. These examination procedures
form a toolkit of risk assessment and mitigation activities that help supervisors address
problems as they emerge and protect the federal safety net from unnecessary outlays.
Assessing a bank's individual risks is a fact-specific process that depends greatly on the
institution's risk selection, managerial oversight, and market circumstances. At the most
fundamental level, bank supervision requires flexibility and use of expert judgment
customized to each bank's profile and risk-taking.
Classification of Loans - H.R. 3461 could impair the banking supervisors' ability to
assess and monitor risks by changing the method by which adverse classifications are
derived. Adverse classifications represent a specialized analysis of an institution's
problem assets. Regulators use these classifications to determine capital adequacy and
overall financial health. The process for deriving adverse classification was first
developed in the late 1930's and has been refined in successive decades to better
monitor risk. The classification system consists of designations that identify different
degrees of credit weaknesses. A loan is considered "classified" when it is rated either
"Substandard," "Doubtful," or "Loss." A statutory change to the classification process, as
described below, would reduce the effectiveness of the metrics that bank regulators rely
on to evaluate the condition of institutions, the adequacy of their capital and reserves,
the performance of management and the appropriate risk-based deposit insurance
premium.
When the financial condition and repayment capacity of a commercial borrower
deteriorates, the loan may be subject to adverse classification. In deciding whether to
classify a loan, supervisors look first and foremost to the borrower's cash flow and ability