Yesterday, the Senate Banking Committee’s Subcommittee on Financial Institutions held a hearing entitled “Examining the State of the Banking Industry.” Witnesses testifying before the Subcommittee included:

  • Sheila Bair, Chairman, Federal Deposit Insurance Corporation;
  • John C. Dugan, Comptroller of the Currency;
  • Daniel K. Tarullo, Member, Board of Governors of the Federal Reserve System;
  • Deborah Matz, Chairman, National Credit Union Administration;
  • Timothy T. Ward, Deputy Director, Examinations, Supervision, and Consumer Protection, Office of Thrift Supervision;
  • Joseph A. Smith, North Carolina Commissioner of Banks and Chairman, Conference of State Bank Supervisors; and
  • Thomas J. Candon, National Association of State Credit Union Supervisors.

The hearing was intended to provide an opportunity to identify, and suggest potential legal and regulatory solutions for, key issues remaining in the banking industry. The issues addressed included the increasing number of problematic commercial real estate loans on bank balance sheets, the increasing number of troubled insured depository institutions on the FDIC’s watch list, the availability of credit for consumers and small businesses, and the need to consider the implications of increased deposit insurance assessments and increased regulatory and capital standards on small, community banks.

Chairman Bair noted that, although there is evidence of economic recovery, the issues faced by insured depository institutions will lag the recovery. She noted that banks are facing elevated loss rates which are expected to remain at elevated levels as the unemployment rate remains high. In response to a question about the number of institutions she expected would fail through the end of 2009, she acknowledged that the FDIC anticipates there will be additional failures, but refused to provide exact projections. She was also challenged to defend the FDIC’s recent proposal to require insured depository institutions to prepay their assessments. Questioned as to whether this amounted to “punishment” for the healthy institutions that posed little risk to the financial market, the Chairman countered with the fact that insurance is designed to work in exactly this manner: insured parties posing little or no risk generally bear the burden for those posing or creating additional risk. She also noted that the prepayments were necessary to maintain the long-term health of the Deposit Insurance Fund.

Comptroller Dugan noted that credit quality is worsening across almost every class of assets and for every type of borrower, reflecting risks that have built up over time. He predicted that it will take time to work existing problem assets through the system. He asserted, however, that most national banks are strong and have sufficient capital and projected earnings to withstand the continued credit losses associated with write-downs on problem assets.

Mr. Tarullo also noted that the financial markets have generally stabilized, when compared to the financial condition of 8 to 12 months ago, but that important markets, such as the securitization market, credit markets and lending by commercial banks, have not yet recovered, which has a particularly severe impact on small businesses and consumers who rely on banks for a large portion of their financing.

Mr. Ward reiterated that the primary issues facing thrifts is the increasing number of troubled assets and the impact these assets have on thrift earnings. He observed that the economic stresses have caused a general decline in the safety and sounding ratings of all thrifts and increased the total number of problem thrifts.

Mr. Smith noted that majority of banks regulated by state agencies are not, as a rule, systemically significant but are, however, locally significant. He suggested that regulatory reform should focus on the direction the industry should be headed and should shape what the industry looks like when it emerges from the economic downturn. Stronger risk, liquidity and capital management practices should be the key components of reform efforts. He also urged the adoption of clear rules for private equity investments in financial institutions and that such investments should be allowed once those requirements have been met.

Ms. Matz stated that the largest risk faced by the NCUA is that posed by corporate credit unions. She noted that rules governing the investment activities of corporate credit unions, including investments in securitized assets, needed to be changed to reduce the amount of discretion and risk taken on by these institutions. With respect to retail credit unions, she noted that declining home values and harsh credit conditions had taken its toll on these institutions’ balance sheets.

Mr. Candon addressed the concerns faced by state-chartered credit unions, particularly increasing delinquency and charge-off rates. He noted that the regulators of these institutions are increasing their oversight of consumer credit products and new business lending. He also urged that supplemental capital be made available for these institutions to ensure that they are able to survive the remainder of the economic downturn.

The suggested consolidation of the current regulatory and supervisory framework was, unsurprisingly, opposed by the panelists. Comptroller Dugan and Mr. Tarullo generally took the position that, for each incremental increase in consolidation, there is a gain in efficiency but a loss in flexibility and creativity through the system. Chairman Bair and Commissioner Smith were more emphatic in their opposition to suggestions of agency consolidation.