Fcdeial Deposit Insurance Coiporaiiun
Gh airman
WilliamTaylor
Division of Research
and Statistics,
Director
Wm. Roger Wa[son
Editor
George E. French
lid itori al Com mi ttee
Fredericks, Cams
Gary S. Kissel
Arthur J. Murton
Adminis trati ve M an ager
Delia Voesar
Editorial Secretary
Cathy Wright
Design and Production
Graphic? and Distribution Unit
The view? expressed are those
of the authors and do not ncces-
sarily reflect official positions of
the Federal Deposit Insurance
Corpora lion. Articles may be re
printed or abstracted i£ the Re
view and author are credited.
Please provide the FDIC's Di
vision of Research and Statist ici
with a copy of any publications
containing reprinted material.
Single-copy subscriptions are
available to the public free of
charge. Requests for subscrip
tions, back issues or address
changes should be mailed to-
FDIC Banting Review. Oflice of
Corporate Ccmmunications.
Federal Deposit Insurance Cor
poration, 550 17th Street, NW,
Washington, DC, 20429,
FDIC
Banking
Review
Fall 1991
Vol. 4, No. 2
Table of Contents
Early Corrective Action For Troubled Banks
by George E. French page!
Data pertinent to the operation of the supervisory system for U.S. commercial banks are presented
in this paper. Supervisors generally identify banks' problems well in advance of failure, and
influence banks' dividend payments and capital injections in the "correct" direction. The author
concludes, however, that improvements are possible in forcing realistic loss recognition, limiting
dividend payments and resolving troubled institutions earlier.
Bank Dividend Patterns
by David K. Home page 13
Commercial bank dividends increased substantially during the 1980s, both in absolute dollars and
as a proportion of earnings. The historical trend of dividend payments, and their distribution across
the banking industry, are examined in this paper. A number of factors appear to influence dividend
distributions. The impact of these factors, with particular emphasis on equity capital, is analyzed
using a statistical model. The effects of dividend restrictions are discussed also.
A Framework For Analyzing Deposit Insurance Pricing
by Christine E. Blair and Gary S. Fissel page 25
The question of whether to revise the current system of flat-rate deposit insurance premiums in
favor of a risk-based system is addressed. While there is general agreement that relating an insured
bank's premium to the risk it poses to the insurance fund would be desirable, the information-in
tensive nature of the intermediation process in which banks specialize makes risk measurement
a difficult task. An overview of alternative methods for establishing risk-based premiums is
presented, followed by a discussion of the arguments for and against risk-based premiums.
Recent Developments Affecting Depository Institutions
by Benjamin B. Christopher page 39
This regular feature of the FDIC Banking Revtew con tains information on regulatory agency actions,
state legislation and regulation, and articles and studies pertinent to banking and deposit insurance
Gh airman
WilliamTaylor
Division of Research
and Statistics,
Director
Wm. Roger Wa[son
Editor
George E. French
lid itori al Com mi ttee
Fredericks, Cams
Gary S. Kissel
Arthur J. Murton
Adminis trati ve M an ager
Delia Voesar
Editorial Secretary
Cathy Wright
Design and Production
Graphic? and Distribution Unit
The view? expressed are those
of the authors and do not ncces-
sarily reflect official positions of
the Federal Deposit Insurance
Corpora lion. Articles may be re
printed or abstracted i£ the Re
view and author are credited.
Please provide the FDIC's Di
vision of Research and Statist ici
with a copy of any publications
containing reprinted material.
Single-copy subscriptions are
available to the public free of
charge. Requests for subscrip
tions, back issues or address
changes should be mailed to-
FDIC Banting Review. Oflice of
Corporate Ccmmunications.
Federal Deposit Insurance Cor
poration, 550 17th Street, NW,
Washington, DC, 20429,
FDIC
Banking
Review
Fall 1991
Vol. 4, No. 2
Table of Contents
Early Corrective Action For Troubled Banks
by George E. French page!
Data pertinent to the operation of the supervisory system for U.S. commercial banks are presented
in this paper. Supervisors generally identify banks' problems well in advance of failure, and
influence banks' dividend payments and capital injections in the "correct" direction. The author
concludes, however, that improvements are possible in forcing realistic loss recognition, limiting
dividend payments and resolving troubled institutions earlier.
Bank Dividend Patterns
by David K. Home page 13
Commercial bank dividends increased substantially during the 1980s, both in absolute dollars and
as a proportion of earnings. The historical trend of dividend payments, and their distribution across
the banking industry, are examined in this paper. A number of factors appear to influence dividend
distributions. The impact of these factors, with particular emphasis on equity capital, is analyzed
using a statistical model. The effects of dividend restrictions are discussed also.
A Framework For Analyzing Deposit Insurance Pricing
by Christine E. Blair and Gary S. Fissel page 25
The question of whether to revise the current system of flat-rate deposit insurance premiums in
favor of a risk-based system is addressed. While there is general agreement that relating an insured
bank's premium to the risk it poses to the insurance fund would be desirable, the information-in
tensive nature of the intermediation process in which banks specialize makes risk measurement
a difficult task. An overview of alternative methods for establishing risk-based premiums is
presented, followed by a discussion of the arguments for and against risk-based premiums.
Recent Developments Affecting Depository Institutions
by Benjamin B. Christopher page 39
This regular feature of the FDIC Banking Revtew con tains information on regulatory agency actions,
state legislation and regulation, and articles and studies pertinent to banking and deposit insurance
Early Corrective Action For Troubled Banks
Early Corrective Action
For Troubled Banks
by George E. French^
In order for proposals to reduce
deposit insurance costs through
improved bank supervision to be
effective, it is necessary that:
i) supervisors identify banking
problems early enough to be able to
affect insurance costs; n) supervisors
have the capability and willingness to
affect bank behavior in ways that will
reduce insurance costs; and iii) the
current supervisory mechanism can
be improved. This paper examines
data pertinent to these questions and
evaluates proposals to improve the
supervisory process in light of the
information presented. While there
are aspects of bank supervision that
can be improved, claims for massive
and costless reductions in insurance
costs through "early closure" appear
overblown. Nevertheless, it is argued
in this paper that an early-closure
policy that allows for limited
supervisory exceptions would
represent an improvement over the
current system.
Events in the 1980s demonstrated
the potential costs of deposit insur
ance, as the insolvency of hundreds of
savings and loan associations precipi
tated the bankrupting of the Federal
Savings and Loan Insurance Corpora
tion, and the Federal Deposit Insur
ance Corporation began incurring
unprecedented losses. Many observ
ers have attributed a large part of the
blame for these losses to inadequate
supervision.
Recent deposit insurance reform
proposals would reduce the discretion
available to bank supervisors, in order
to correct their supposed lack of will
ingness to use their authority aggres
sively. The proposals typically
require earlier closure or other super
visory sanctions; which sanctions to
use would be based on a bank's capital
ratio.
The potential for bank supervision
to play an important role in controlling
deposit insurance costs should be
evaluated in light of evidence on how
supervisors have influenced bank be
havior. This paper presents informa
tion on the operation of the
commercial bank supervisory system
in terms of detection and disclosure of
banking problems, influence over
bank dividends and capital injections,
and recovery rates of undercapitalized
banks. Areas where the system could
be improved are identified based on
this information.
Detection and Disclosure
ofProblems
This section presents evidence rel
evant to two general questions. First,
do bank supervisors do a good job of
ensuring the integrity and accuracy of
banks' financial statements? Second,
are bank supervisors able to detect
bank problems early enough to take
actions that might reduce the proba
bility of loss to the insurance funds?
Accuracy of Financial
Statements
In terms of sheer man-hours, the
mostimportantactivityof bank super
visors is to examine banks. Among the
most important goals of examinations
are to detect banking practices that
pose a high risk to the deposit insur
ance funds, and to ensure that banks'
financial statements fairly present
their financial condition. A bank's un
insured depositors, other general non-
deposit creditors and current and
potential equity holders have an inter
est in obtaining accurate information
about the financial condition of the
bank. The deposit insurer and pri
mary supervisory authority also have
such an interest. Bank management
or other bank insiders, however, may
sometimes have an interest in paint
ing an overly optimistic picture of a
bank's financial condition.
Incentives to overstate bank in
come and net worth may arise from a
desire to maintain low-cost deposits or
other funding sources, to attract capi-
Chief, Financial Markets Section, Division of Re
search and Statistics, Federal Deposit Insurance Cor
poration. This paper could not have been completed
without the invaluable research assisianee of Kenneth
Walsh.
Early Corrective Action
For Troubled Banks
by George E. French^
In order for proposals to reduce
deposit insurance costs through
improved bank supervision to be
effective, it is necessary that:
i) supervisors identify banking
problems early enough to be able to
affect insurance costs; n) supervisors
have the capability and willingness to
affect bank behavior in ways that will
reduce insurance costs; and iii) the
current supervisory mechanism can
be improved. This paper examines
data pertinent to these questions and
evaluates proposals to improve the
supervisory process in light of the
information presented. While there
are aspects of bank supervision that
can be improved, claims for massive
and costless reductions in insurance
costs through "early closure" appear
overblown. Nevertheless, it is argued
in this paper that an early-closure
policy that allows for limited
supervisory exceptions would
represent an improvement over the
current system.
Events in the 1980s demonstrated
the potential costs of deposit insur
ance, as the insolvency of hundreds of
savings and loan associations precipi
tated the bankrupting of the Federal
Savings and Loan Insurance Corpora
tion, and the Federal Deposit Insur
ance Corporation began incurring
unprecedented losses. Many observ
ers have attributed a large part of the
blame for these losses to inadequate
supervision.
Recent deposit insurance reform
proposals would reduce the discretion
available to bank supervisors, in order
to correct their supposed lack of will
ingness to use their authority aggres
sively. The proposals typically
require earlier closure or other super
visory sanctions; which sanctions to
use would be based on a bank's capital
ratio.
The potential for bank supervision
to play an important role in controlling
deposit insurance costs should be
evaluated in light of evidence on how
supervisors have influenced bank be
havior. This paper presents informa
tion on the operation of the
commercial bank supervisory system
in terms of detection and disclosure of
banking problems, influence over
bank dividends and capital injections,
and recovery rates of undercapitalized
banks. Areas where the system could
be improved are identified based on
this information.
Detection and Disclosure
ofProblems
This section presents evidence rel
evant to two general questions. First,
do bank supervisors do a good job of
ensuring the integrity and accuracy of
banks' financial statements? Second,
are bank supervisors able to detect
bank problems early enough to take
actions that might reduce the proba
bility of loss to the insurance funds?
Accuracy of Financial
Statements
In terms of sheer man-hours, the
mostimportantactivityof bank super
visors is to examine banks. Among the
most important goals of examinations
are to detect banking practices that
pose a high risk to the deposit insur
ance funds, and to ensure that banks'
financial statements fairly present
their financial condition. A bank's un
insured depositors, other general non-
deposit creditors and current and
potential equity holders have an inter
est in obtaining accurate information
about the financial condition of the
bank. The deposit insurer and pri
mary supervisory authority also have
such an interest. Bank management
or other bank insiders, however, may
sometimes have an interest in paint
ing an overly optimistic picture of a
bank's financial condition.
Incentives to overstate bank in
come and net worth may arise from a
desire to maintain low-cost deposits or
other funding sources, to attract capi-
Chief, Financial Markets Section, Division of Re
search and Statistics, Federal Deposit Insurance Cor
poration. This paper could not have been completed
without the invaluable research assisianee of Kenneth
Walsh.