[Senate Hearing 112-303]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 112-303
 
    STATE OF THE FDIC: DEPOSIT INSURANCE, CONSUMER PROTECTION, AND 

                          FINANCIAL STABILITY

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON

                   BANKING,HOUSING,AND URBAN AFFAIRS

                          UNITED STATES SENATE

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                                   ON

                    EXAMINING THE STATE OF THE FDIC

                               __________

                             JUNE 30, 2011

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


                 Available at: http: //www.fdsys.gov /




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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia             MARK KIRK, Illinois
JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina

                     Dwight Fettig, Staff Director

              William D. Duhnke, Republican Staff Director

                       Charles Yi, Chief Counsel

                   Catherine Galicia, Senior Counsel

                     Laura Swanson, Policy Director

                 William Fields, Legislative Assistant

                 Andrew Olmem, Republican Chief Counsel

                     Beth Zorc, Republican Counsel

                       Dawn Ratliff, Chief Clerk

                      Brett Hewitt, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)


                            C O N T E N T S

                              ----------                              

                        THURSDAY, JUNE 30, 2011

                                                                   Page

Opening statement of Chairman Johnson............................     1

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     2

                                WITNESS

Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation..     4
    Prepared statement...........................................    28
    Responses to written questions of:
        Senator Shelby...........................................    37
        Senator Hagan............................................    40
        Senator Toomey...........................................    43

              Additional Material Supplied for the Record

Letter submitted by Wayne A. Abernathy, Executive Vice President, 
  Financial Institutions Policy and Regulatory Affairs, American 
  Bankers Association............................................    46
Letter submitted by William B. Grant, Chairman of the Board, 
  President, and Chief Executive Officer, First United Bank & 
  Trust..........................................................    47

                                 (iii)


    STATE OF THE FDIC: DEPOSIT INSURANCE, CONSUMER PROTECTION, AND 
                          FINANCIAL STABILITY

                              ----------                              


                        THURSDAY, JUNE 30, 2011

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 2:22 p.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Tim Johnson, Chairman of the 
Committee, presiding.

           OPENING STATEMENT OF CHAIRMAN TIM JOHNSON

    Chairman Johnson. Good afternoon. I would like to call this 
hearing to order.
    Today we welcome back Sheila Bair, Chairman of the FDIC, to 
the Committee for the last time in her current position.
    Chairman Bair's time at the FDIC has been historic. Our 
Nation experienced a financial crisis of a magnitude not seen 
since the Great Depression, and Chairman Bair played a critical 
part in helping us navigate out of the crisis.
    Chairman Bair, you succeeded in maintaining public 
confidence in bank deposits, overseeing the resolution of over 
300 failed banks with over $600 billion in assets, monitoring 
banks' liquidity needs, developing programs to stabilize the 
banking sector, and unfreezing credit markets. I applaud you 
for your astute management of these tasks.
    Also, not only were you and your staff instrumental in the 
passage of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act, you have skillfully guided the FDIC as it 
assumes new, significant responsibilities. The FDIC is now a 
voting member of the Financial Stability Oversight Council, is 
in charge of the resolution of large, systemically important 
financial institutions, and insures each bank account of 
Americans up to $250,000.
    During your tenure the American people were fortunate to 
have a strong consumer advocate leading the way at the FDIC. 
You sounded the alarm about the threat of foreclosures and the 
need for loan modifications before the crisis hit, targeted 
high-risk mortgage products before other regulators, and led 
the way to find innovative solutions to include the unbanked 
and underbanked in the traditional banking system. And to give 
more emphasis to consumer protection, you pushed for the 
creation of the Division of Depositor and Consumer Protection 
within the FDIC.
    Last, you have worked hard to preserve the community 
banking system in rural communities like those in my home State 
of South Dakota. You have been a champion of the community 
banking system, and I appreciate your hard work.
    I thank you for being here today, and I look forward to 
hearing your insights on the opportunities and challenges faced 
by the FDIC during your time as Chairman. I also welcome any 
parting words of advice you have for us as we continue to 
implement Dodd-Frank and build on our Nation's economic 
recovery.
    I now turn to Ranking Member Shelby for his statement.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman.
    Today, as you said, we will examine the State of the 
Federal Deposit Insurance Corporation. This I believe is an 
appropriate time for this hearing as it comes at the end of 
Chairman Sheila Bair's 5-year term.
    Chairman Bair's time in office has been marked by the 
financial crisis and by profound changes in banking law, 
especially those enacted by the Dodd-Frank legislation. As 
history will record, Chairman Bair was an active participant in 
both events. She played a key role in first devising and then 
later implementing the Federal Government's response to the 
financial crisis. During the formulation of Dodd-Frank, she 
also exerted a strong influence over the final legislation, 
especially, as you pointed out, the resolution regime 
provisions.
    Given Chairman Bair's active tenure at the FDIC, I believe 
this is a unique opportunity to evaluate the successes and 
failures of the Federal Deposit Insurance Corporation. Only by 
learning from the past can we ensure that the FDIC remains a 
world-class regulator. One area, Mr. Chairman, that I would 
like to explore today is the FDIC's record regarding the 
Deposit Insurance Fund. Overseeing the fund should always be 
one of the FDIC's core missions.
    Since 2007, 373 insured depository institutions have 
failed. The estimated cost of these failures to the Deposit 
Insurance Fund, to my understanding, is almost $84 billion. And 
as a result, the balance of the Deposit Insurance Fund has 
declined dramatically. At its lowest point, the Deposit 
Insurance Fund had a negative balance of $20.9 billion.
    The high cost of resolving failed banks raises serious 
questions about whether the FDIC needs to reconsider how it 
deals with troubled banks. After the savings and loan crisis, 
Congress sought to improve the FDIC's resolution of banks by 
enacting the Prompt and Corrective Action regime. We call it 
PCA. The aim of PCA was to ensure that the FDIC closed troubled 
banks before they inflicted losses on the Deposit Insurance 
Fund.
    A recent report by the GAO, however, showed that there are 
real problems with PCA. The GAO found that, since 2007, every 
bank that underwent prompt and corrective action because of 
capital deficiencies and failed inflicted a loss to the Deposit 
Insurance Fund. The GAO also found that while the regulators 
identified problematic conditions among banks well before the 
failure, the FDIC did not always promptly close banks, allowing 
bank losses to grow. Most concerning, the GAO found that the 
average cost of resolving a bank was more than 30 percent of 
its assets.
    I believe it is clear that prompt and correct action has 
not worked as it was intended. The cost of resolving banks is 
far too high and undermines the health of both the Deposit 
Insurance Fund and our banking system. Accordingly, I would 
like to hear today how PCA can be improved.
    Another issue I would like to hear about today is capital. 
I believe that strong capital requirements are essential. 
Recently, the Basel Committee on Banking Supervision reached 
agreement on the new Basel III capital requirements. In 2006, 
right before this Committee in this same room, Chairman Bair 
raised serious concerns--and she was right--about the Basel II 
Capital Accords, arguing that they would dangerously reduce 
capital at our largest banks.
    Thanks to her efforts, the implementation of Basel II was 
delayed and subject to important safeguards. Given her strong 
views on Basel II, I am very interested to hear her assessment 
of Basel III and how we can ensure that capital requirements 
are not watered down as memories of the crisis fade.
    Finally, Mr. Chairman, I hope to hear how Chairman Bair 
believes we can ensure the viability of small banks. The FDIC 
has long been the regulator of small banks. Unfortunately, we 
have witnessed a significant decline in the number of small 
banks as the banking industry has consolidated. In 1984, there 
were 15,000 banking and thrift organizations. Today there is 
less than half that number.
    I fear that one of the consequences of the Dodd-Frank Act 
is that it will accelerate the decline of small banks by 
imposing new regulatory burdens on them. Big banks will always 
be better positioned to deal with regulatory costs. Unlike 
small banks, they have the size and the resources needed to pay 
for and comply with new regulations.
    Hence, bureaucracies like the new Consumer Financial 
Protection Bureau generally skew the competitive landscape in 
favor of big banks. The ultimate impact of the Dodd-Frank Act 
may well be to make the big banks bigger while wiping out the 
small banks in the coming tidal wave of regulatory compliance.
    I look forward, Mr. Chairman, to hearing from Chairman Bair 
what steps we can do to ensure that our regulatory landscape 
allows small banks to survive and, more importantly, to thrive.
    Thank you, Mr. Chairman.
    Chairman Johnson. Are there any other Members who wish to 
speak?
    [No response.]
    Chairman Johnson. Since Chairman Bair has been before the 
Banking Committee 14 times since her confirmation, we will move 
right to her testimony. Your full written statement will be 
included in the hearing record.
    Chairman Bair, please begin your testimony.

    STATEMENT OF SHEILA C. BAIR, CHAIRMAN, FEDERAL DEPOSIT 
                     INSURANCE CORPORATION

    Ms. Bair. Thank you, Chairman Johnson, Ranking Member 
Shelby, and Members of the Committee. Thank you for the 
opportunity to deliver my last testimony as FDIC Chairman on 
the state of the Federal Deposit Insurance Corporation. My 5 
years as Chairman have been among the most eventful for U.S. 
financial policy since the 1930s. I sincerely appreciate the 
opportunity given to me by this Committee in 2006 when you 
supported my nomination.
    The Members of this Committee and your colleagues in the 
Senate have always taken the time to listen to my concerns, and 
I hope you feel that I have done the same. Your advice and 
counsel were invaluable to me both during the crisis and the 
legislative reform process that followed.
    When I started my term in June 2006, the strong reported 
financial condition of the banking industry was masking 
underlying weaknesses associated with an overheated housing 
market, lax lending standards, and excess leverage throughout 
the financial system. The strong financial condition soon gave 
way to record levels of problem loans and large quarterly 
losses. In all, some 373 FDIC-insured institutions have failed 
since 2006, imposing total estimated losses of $84 billion on 
the Deposit Insurance Fund.
    Since early last year, we have seen earnings stage a modest 
recovery while problem loans have declined, although they still 
remain at elevated levels. The problem institutions are 
leveling off, and we expect fewer failures this year than last.
    As in the last banking crisis, these failures caused the 
DIF balance to become negative starting in late 2009. The FDIC 
responded by raising assessment rates, imposing a one-time 
special assessment, and requiring the industry to prepay 3 
years of estimated assessments. These actions both enabled the 
agency to avoid borrowing from taxpayers while minimizing the 
impact on the industry's capacity to lend. We expect the DIF 
balance to once again be positive when we report the June 30th 
results, and we are on track to restore the fund to its 
statutory minimums by 2020, as required by law.
    We remain keenly focused on the financial health of the 
banking sector as well as the industry's consumer obligations. 
My written statement highlights the FDIC's ongoing focus on 
consumer protection and economic inclusion. When the CFPB 
starts operations next month, it will be able to work with the 
new FDIC Division of Depositor and Consumer Protection to 
ensure the consistent application of simpler and more effective 
consumer rules and to minimize regulatory burden on community 
banks.
    We also remain intensely focused on financial stability. As 
I have testified several times over the past year, the Dodd-
Frank Act, if properly implemented, will not only reduce the 
likelihood and severity of future crises, but will enable 
regulators to handle large company failures without resorting 
to bailouts or damaging the financial system.
    Our highest implementation priorities relate to the new 
resolution framework for systemically important financial 
institutions, or SIFIs, and the strengthening of capital and 
liquidity requirements for banks and bank holding companies. 
Bank failures expose their owners and debt holders to losses, 
which is how capitalism is supposed to work. Failed companies 
should give way to successful companies, and the remaining 
assets and liabilities should be restructured and returned to 
the private sector.
    Bailouts are inherently unfair. They violate the principles 
of limited Government on which our free enterprise system is 
founded. That is why the FDIC was so determined to press for a 
more robust and effective SIFI resolution framework as the 
centerpiece of the Dodd-Frank Act. Titles I and II of the Dodd-
Frank Act authorize the creation of just such a resolution 
framework that can make the SIFIs resolvable in a future 
crisis. These provisions are designed to restore the market 
discipline to the megabanks, end their ability to take risks at 
the expense of the public, and eliminate the competitive 
advantage they enjoy over smaller institutions. We are making 
timely progress toward implementation of these provisions, as 
described in my written statement.
    Moreover, as we learned in the crisis, the single most 
important element of a strong and stable banking system is its 
capital base. In the years leading up to the crisis, capital 
requirements were watered down through rules that permitted the 
use of capital with debt-like qualities, that encouraged banks 
to move assets off the balance sheet, and that set regulatory 
capital thresholds based on internal risk models. The result 
was an increase in financial system leverage, particularly at 
bank holding companies and nonbank financial companies, that 
weakened the ability of the industry to absorb losses during 
the crisis and that has led to a dramatic deleveraging of 
banking assets in its wake. This is also why we have been such 
strong supporters of the Basel III process and other measures 
to enhance capital, including the Collins amendment and the 
SIFI capital surcharge.
    Last week, the group of Governors and heads of supervision 
of the Basel Committee on which I serve agreed to important 
changes in the capital rules that will strengthen the 
resilience of the world's largest systemically important 
banking firms. The agreement provided for capital requirements 
ranging from 1 percent above the Basel III minimums to 2.5 
percent, depending on the degree of systemic risk posed by each 
firm.
    Importantly, the new requirements must be met with common 
equity. The FDIC strongly supported this requirement since 
equity capital is the only instrument which proved to have 
loss-absorbing capacity during the crisis. As financial reform 
moves forward, there is understandable concern about the slow 
pace of the economic recovery. However, the challenges facing 
our economy are not the result of financial reform. Instead, 
they reflect the enormous and long-lasting impact the financial 
crisis has had on U.S. economic activity. This suggests 
regulatory priorities for both the short and long term. 
Immediate focus should be placed on addressing operational 
deficiencies at large mortgage servicing companies to contain 
litigation risk and reduce the foreclosure backlog that is 
holding back the recovery of U.S. housing markets. Emphasis 
should be placed on streamlined modification protocols, write-
offs of second liens where appropriate, and foreclosure 
alternatives such as short sales and cash for keys programs.
    Longer term, the banking industry needs to return to the 
business of lending that supports the real economy. A strong 
and stable financial system is vital to the economic and fiscal 
health of the U.S. and our competitiveness in the global 
economy. Stronger and more uniform capital requirements and a 
resolution framework that subjects every institution, no matter 
its size, to the discipline of the marketplace are necessary 
steps to level the competitive playing field and help return 
the focus of our banking system to making good loans that serve 
the needs of households and businesses of all sizes in every 
part of our Nation.
    Through its approval of last year's Dodd-Frank Act, the 
Committee took an important step forward in making our 
financial system stronger and more stable over the long term. 
Amid the controversies that accompany its implementation, I 
urge the Committee to maintain this long-term perspective and 
see essential reforms through to their completion.
    Thank you very much, and I would be happy to take your 
questions now.
    Chairman Johnson. Thank you for your testimony.
    We will now begin the questioning of our witness. Will the 
clerk please put 5 minutes on the clock for each Member for 
their questions?
    As we approach the 1-year anniversary of Dodd-Frank, 
efforts are underway to repeal parts of the act or the act in 
its entirety. What do you think of these repeal efforts? Should 
we go back to the system of regulation that existed before the 
financial crisis?
    Ms. Bair. I think we are much better off having the Dodd-
Frank Act than not having the Dodd-Frank Act. It is not a 
perfect law. There are things that we would have liked to have 
seen done differently. But I think overall it does give 
regulators the tools needed to make the essential reforms of 
practices that we know fed the crisis and led to its severity. 
So, no, I would hope that the regulators be given the tools and 
the latitude to implement it, obviously subject to robust 
oversight. We are not perfect either, and the Congress has a 
very important role to watch what we are doing and make sure we 
are doing it the most effectively and efficiently as possible. 
But I do think we are better off having the Dodd-Frank Act, and 
I would not encourage its repeal.
    Chairman Johnson. Without a director in place, the CFPB 
will not be able to exercise its examination and enforcement 
powers over nonbank financial institutions. Do you agree that 
this authority is essential to level the playing field between 
small community banks and their nonbank competitors and that it 
is important to move quickly on a director?
    Ms. Bair. Yes, I do think the ability to examine and 
enforce consumer laws against the nonbank sector is a very 
important part of the authorities of the new Consumer Bureau. 
This is a big problem. In the years leading up to the crisis, a 
lot of community banks in particular lost market share, 
especially with mortgage originations, because we had a lot of 
lightly regulated--if there was any regulation--independent 
mortgage originators selling into securitization vehicles. This 
did not serve community banks, and it did not do anything for 
borrowers either because many of these loans were so poorly 
underwritten and were clearly unaffordable.
    So I think this is very important, and it is good to get it 
going now before that sector perhaps tries to start making a 
comeback. We can have good lending standards, but if there is 
no enforcement mechanism for both banks and nonbanks, we are 
going to have the kind of regulatory arbitrage that fed the 
crisis to begin with. Community banks have lost so much market 
share, especially in consumer lending and mortgages, and they 
have been relegated mostly to commercial real estate lending. 
Most of them are now specialty commercial real estate lenders. 
We would like to see them have the ability to better diversify 
their balance sheet, and I think trying to help get them back 
into the consumer space would be good for them and good for 
consumers, too.
    Chairman Johnson. How would you respond to critics who say 
that Dodd-Frank does not end too big to fail? How would Dodd-
Frank better protect the taxpayers from future bailouts of 
banks?
    Ms. Bair. So I think we pushed very hard with this, and we 
worked with the Senate on a bipartisan basis, and the law 
clearly says you cannot do a bailout of a poorly managed 
institution. It is just not allowed. The regulators do not have 
the discretion to do that. We wanted that. We wanted to take 
regulatory discretion out of the decision making.
    So there is bankruptcy and there is a Title II process, but 
they are both harsh. They both impose losses on shareholders 
and unsecured creditors, which is where the losses should be. 
They are subject to claw-back provisions and other, we think, 
important measures to maintain market discipline over these 
firms. So I do not see how, going forward, a bailout could 
occur unless it was authorized by Congress, and I do not think 
Congress has any more appetite than we at the FDIC have to see 
bailouts in the future.
    So we tried to lock that down. I think it is locked down in 
the statute. The tools are there to have alternatives to 
bailouts that are orderly and do not pose broader harm to the 
economy, and they can and should be used.
    Chairman Johnson. There is concern that the biggest banks 
have only gotten bigger since the crisis and that these 
institutions are still too big to fail. Are you concerned about 
this? And has Dodd-Frank made financial institutions bigger?
    Ms. Bair. So I do not think any institution is too big to 
fail. I think that some need to simplify their legal structures 
and rationalize their legal structures with their business 
lines to make it easier to resolve them if they get into 
trouble in a future downturn.
    But the tools are there to resolve them now. It would be 
more difficult, more expensive, and more inefficient without 
appropriate resolution plans, and that is why we think 
implementing Title I with the Fed--which requires these large 
institutions to file acceptable, credible plans with us that 
show how they can be broken up and resolved in a bankruptcy 
framework--is extremely important.
    But, no, no bank is too big to fail, and there is a process 
now that can be used for them. If they get into trouble, we can 
deal with it in a way that does not provide broader disruptions 
to the economy.
    Chairman Johnson. The Basel III agreement proposes that 
large banks finance their asset purchases with more equity.
    Ms. Bair. Right.
    Chairman Johnson. The idea is to make banks more resilient 
to large losses and prevent another crisis. But there is some 
debate about the effects of this change. Banks argue that 
equity is more costly than that, and that new requirements will 
raise the cost of doing business and harm economic growth. 
Others think that new equity requirements are too low to guard 
against financial instability and say that fears of increased 
costs are exaggerated.
    As an advocate of commonsense capital requirements, what is 
your view of this debate? Will the new capital requirements 
effectively increase the stability of the financial system? And 
how would you evaluate the tradeoffs between increased equity 
funding of banks and financial stability?
    Ms. Bair. Well, I think it is a very good tradeoff. I think 
the higher capital requirements are more than justified. I 
think most of the independent academic research as well as the 
research done by the Bank for International Settlements staff 
in supporting the Basel III process and the SIFI surcharge show 
that you have ample justification for going higher than the 7 
plus the 2.5 for the SIFI surcharge that was ultimately agreed 
upon.
    There is some incremental impact on lending costs, but it 
is modest, and the tradeoff of having more financial stability 
and, more importantly, when the next downward swing in the 
business cycle comes, making sure there is an additional 
capital buffer to absorb the losses so you do not have to have 
this massive deleveraging that occurred as a result of the 
financial crisis. That is really what led to this Great 
Recession. That is what we are trying to avoid. So the long-
term benefit of doing this is tremendous, and any short-term 
costs in terms of an incremental increase in lending cost is 
quite modest. Also, I might add that the Basel Committee is 
providing several years to implement this. Our research shows 
that while most banks are at the 7-percent baseline Basel III 
requirement already, the larger ones can meet the higher SIFI 
surcharge in a couple of years, most of them through retained 
earnings. We do not anticipate that any will have to issue new 
common equity to meet these requirements.
    So the burden is not tremendous on the large institutions. 
The long-term benefits for a more resilient system are 
substantial, and the short-term costs on lending are 
incremental at best.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Bair, last week you claimed in a speech that the 
Dodd-Frank Act will end too big to fail. Other people believe 
that the Dodd-Frank Act has enshrined the doctrine that we have 
not done about too big to fail, maybe mitigated it.
    Ms. Bair. Right.
    Senator Shelby. Since the passage, however, S&P, Standard & 
Poor, has said that it will confer higher credit ratings on the 
largest banks because it continues to assume that there is 
still the potential for the Government to provide 
``extraordinary Government support'' to these banks.
    Do the S&P credit ratings for large banks show that our 
markets still believe that too big to fail is alive and well? 
How do you counter that?
    Ms. Bair. I have said that we have the tools to end too big 
to fail, and clearly in the statute--and we pushed for this 
with the support of a number of the Committee Members, which I 
appreciate--it said there would not be any regulatory 
discretion to do a bailout. It is simply prohibited. And when 
we tell the rating agencies that this is fair warning, they 
say, ``Well, we think Congress is going to do that,'' and that 
would really surprise me.
    So we all agree we should not have bailouts. We all agree 
we do not want that. I do not know why the market does not seem 
to be convinced of this, but I think that is part of our job, 
and the Fed's job, through the implementation of resolution 
plans and the FDIC's implementation of orderly liquidation 
authority. Next week we are going to be finalizing some more 
rules on building that infrastructure, a robust process for 
requiring resolution plans. I think we can.
    S&P has not made a final decision. Both Moody's and S&P 
have this bump-up that they give the large banks on review, and 
so I think there is a chance over time that we can convince 
them and the market that this is not appropriate. And at the 
end of the day, we really need the market to understand that 
there will be no more bailouts, because if they want to invest 
in these big banks, they need to understand their dollars are 
at risk, and they need to do their homework and make sure that 
their investment is done prudently in an institution that is 
well managed and transparent to them.
    Senator Shelby. Wouldn't it be good policy in a free market 
economy to basically let the world know and the banks know and 
businesses know that if they fail they are going to be closed 
up?
    Ms. Bair. Yes. And I say that a lot.
    Senator Shelby. You agree with that, don't you?
    Ms. Bair. I do. I absolutely agree with that. And I think 
it is important for the Government, for the Treasury, and for 
the Federal Reserve--and I think they have--for them to 
continue to say the same thing. I think that is very important, 
yes.
    Senator Shelby. Chairman Bair, the GAO's--I mentioned this 
in my opening statement--recent report on prompt, corrective 
action found that PCA did not prevent widespread losses to the 
Deposit Insurance Fund, which is a key goal of PCA and which we 
all were hoping for.
    Why has PCA not worked as it was intended? And what 
recommendations can you offer to improve PCA to ensure that it 
actually protects the Deposit Insurance Fund?
    I know you have thought about this.
    Ms. Bair. We have thought about this a lot. I think, on the 
positive side, PCA has worked in the sense that it has taken a 
lot of regulatory discretion and judgment out of the decision 
to close a bank. It is always unfortunate when a bank has to be 
closed. Our process is harsh. The shareholders and unsecured 
creditors take losses frequently. Uninsured depositors take 
losses, as well. It is sometimes difficult for the primary 
regulator, the chartering entity of the institution, to 
acknowledge the weakness of the institution and repeal the 
charter.
    The FDIC does not close the bank. The chartering authority 
is the one that revokes the charter and appoints us as receiver 
at that point. Though it is a collaborative process in terms of 
the timing. Prompt Corrective Action has taken a lot of 
discretion out, which has been positive.
    On the negative side, these failures have still been 
expensive and I think there are several reasons for that. One 
reason is, by definition, that this is a distressed sale when a 
bank closes, and so even though it may still be solvent on its 
books, the price you are going to get in a distressed sale is 
going to be at some discount. We have tried to counter that 
phenomenon by providing loss share credit support to acquiring 
institutions to provide them some comfort. Loss share 
agreements cover part of the acquirers losses over a period of 
time, given the fact that they are going to be putting some 
discount on their valuation of the distressed assets.
    When you have a broad crisis like this, the whole idea of 
PCA is to start providing more intensive supervisory pressure 
on banks to raise more capital. But in a crisis, there is not a 
lot of capital to be had, and so that has been another problem, 
to get them recapitalized.
    Finally, I think--this is something we are working on at 
the FDIC--to make the regulatory process more forward-looking. 
If a bank is not looking down the road to see what kinds of 
losses it may have in the future on these loans, it will be 
under-reserved and that will overstate its capital position, 
which, again, will compromise the efficacy of PCA.
    So I think, for my successor, there is a lot of good work 
to be done here, but it is important and we do think PCA is 
successful in the sense that it has taken a lot of the 
discretion out of this, which has been helpful to us. A lot of 
people want to resist closing institutions, but they need to be 
closed at some point and if they are not closed in a timely 
way, the losses will be higher.
    Senator Shelby. I have one quick question. Chairman Bair, 
on May 1, 2009, the FDIC was appointed receiver of Silverton 
Bank----
    Ms. Bair. Right.
    Senator Shelby. ----headquartered in Atlanta, Georgia. As 
part of its business, Silverton, as you well know, arranged and 
managed participation loans. These participation loans allowed 
a lot of the small banks, especially in the Southeast, to 
jointly engage in commercial lending.
    During the resolution of Silverton, the FDIC initiated 
foreclosures on several properties that were subject to 
participation loans. Complicated, I know. As a result, many 
small banks had to write down their loans and incur big losses, 
which occurred.
    Ms. Bair. Yes.
    Senator Shelby. When the FDIC--my question, I guess, is 
this. When FDIC resolves banks, to what extent does the 
Division of Resolutions and Receiverships work with the 
Supervision Division of FDIC to ensure that the resolution of a 
bank will not impose needless losses on other banks? In other 
words, you get it going and it never stops----
    Ms. Bair. That is right.
    Senator Shelby. ----especially probably dealing with 
participation.
    Ms. Bair. Right. So Silverton made a lot of bad loans. I 
will hasten to say we were not the primary regulator, but we 
had some bad banks, too, so all primary regulators had failures 
they would like to have not seen. But Silverton made a lot of 
bad loans and a lot of other banks participated in some of 
those bad loans and there is not much we can do about that.
    I will say I have heard these concerns before. We went out 
of our way to give the banks that own the participations a 
chance to buy them back. Their bidding was significantly----
    Senator Shelby. Did they always have a chance to buy them 
back?
    Ms. Bair. Yes, they did----
    Senator Shelby. OK.
    Ms. Bair. ----and several, actually, and we did----
    Senator Shelby. But in all instances, they had a chance to 
buy the loans back?
    Ms. Bair. They did.
    Senator Shelby. OK.
    Ms. Bair. They did, and their prices were significantly 
lower than others and the winning bidder.
    Senator Shelby. OK.
    Ms. Bair. We have a statutory obligation to maximize 
recoveries----
    Senator Shelby. Sure.
    Ms. Bair. ----to follow least-cost resolution and that was 
the process we followed here, and I know it has been difficult 
for some of the banks that own these participations, but we 
really made every effort we could to let them bid and they just 
did not come in high enough. We have to go with the highest 
bidder. Those are our rules.
    Senator Shelby. Thank you.
    Ms. Bair. You are welcome.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman, and let me 
commend you, Chairman Bair, for your extraordinary service----
    Ms. Bair. Thank you.
    Senator Reed. ----in very, very, very difficult times.
    Senator Shelby and I, I think, both have shared concern 
about capital over many, many years, and it is nice and 
refreshing to hear you talk about very high capital levels 
using as the measure common stock----
    Ms. Bair. Yes.
    Senator Reed. ----or what I think was referred as tangible 
capital----
    Ms. Bair. Tangible, yes----
    Senator Reed. ----and the stress test----
    Ms. Bair. Right.
    Senator Reed. ----and that is also related to the issue of 
leverage, because with capital low, the leverage is high and 
also liquidity.
    Just a couple of quick questions. One, as I understand it, 
Basel III applies to the big banks, but there is a host of 
other smaller institutions that have the same, I hope, 
requirements.
    Ms. Bair. Right.
    Senator Reed. Second, I understand under Dodd-Frank that 
there is a floor established for capital. It cannot go below 
that.
    Ms. Bair. That is right.
    Senator Reed. It raises the question, do you believe, not 
just FDIC but in other supervised entities, big as well as 
small banks, there will be adequate capital measures? Will some 
agencies take lower capital? Will some agencies adopt the 
minimum under the Dodd-Frank?
    Ms. Bair. Well, I think at the Federal level, certainly for 
all insured banks and their holding companies, we work very 
closely together, and so far have always been consistent in the 
rules that we have promulgated.
    I think you are right. Basel III really was designed more 
to address the capital needs of larger, internationally active 
banks, though certainly there are issues regarding banks of all 
sizes and their capital adequacy. The quality of capital 
definitions in Basel III--cleaning up what we count as 
capital--will apply to all banks of all sizes.
    In terms of the level of capital, whether you need the 7 
percent or, for the smaller banks, leave it at the same place 
it is now, that decision really has not been made yet. I would 
say, though, overwhelmingly community banks have much higher 
capital levels already. They are almost all well over the 7 
percent. One of the reasons is because they are small enough to 
fail, so the market demands a higher capital level from them. 
So however that issue is resolved, I do not think it would have 
a big impact on community banks. But you are right. The capital 
levels for the entire system need to be evaluated and 
strengthened.
    Senator Reed. And just to rule out a possibility, 
hopefully, you do not anticipate kind of regulatory competition 
to sign up banks based upon----
    Ms. Bair. No----
    Senator Reed. ----capital levels or interpretations of 
capital?
    Ms. Bair. No, certainly not domestically, or even 
internationally. These are international agreements and we 
compromised a bit resulting in lower numbers, but it was 
important to get all of the European countries involved. There 
are still some issues with regard to how European banks risk 
weight their assets and there is some work now that is being 
done to try to address this. There is too much discretion, 
frankly, with the individual banks under the Basel II Advanced 
Approaches which they implemented in Europe. We delayed it in 
the United States with support from Senator Shelby and others, 
and we appreciate that very much. So I think that is a real 
issue. But domestically, there should be no arbitrage, and even 
internationally, I think we have got a good chance of avoiding 
it.
    Senator Reed. In your testimony, you talk about the 
foreclosure backlog----
    Ms. Bair. Right.
    Senator Reed. ----is really inhibiting not only the banking 
industry, but overall economic growth. Right now, it seems the 
last remaining major opportunity to get this right is the 
deliberations between Federal regulators and the State 
Attorneys General. Could you outline what you believe should be 
in that settlement, so that not only we sort of clean up the 
servicers, but we actually have a foundation for expansion of 
housing growth and economic growth.
    Ms. Bair. Right. So I think the market needs to clear, and 
one of the many problems with these servicer deficiencies is 
that the courts are slowing down on foreclosures. They are not 
sure--rightfully so--and they are skeptical about whether the 
documentation is there--whether all the requirements have been 
fulfilled. There is also litigation risk going backwards in 
terms of wrongful foreclosure claims and there are issues with 
investors where the servicers have obligations to those 
investors to appropriately service loans.
    So we have suggested that there needs to be a look-back 
review to identify the wrongful foreclosures if they exist, and 
provide appropriate remediation of that. Going forward, 
frankly, we would like to see the modification process 
simplified. We have always been strong advocates of----
    Senator Reed. Including modification of principal, where it 
is appropriate?
    Ms. Bair. I think where it maximizes value, sure. And I 
think for distressed loans, and even where the loan cannot be 
restructured, or the borrower is in too big of a house, 
facilitating a short sale which involves a principal write-down 
is good for the homeowner to help them move on with their life 
and it can save the bank a lot of money, too, and the investors 
a lot of money by not having to go through the foreclosure, and 
it certainly helps those who want to buy the house. So I think, 
yes, in this context, it should be used.
    But we do need to streamline and simplify the process. I do 
worry that it is going to get more bogged down because of all 
this litigation risk and uncertainty about whether all the 
rules have been followed. The regulators really need to be very 
aggressive in getting this cleaned up, and make sure the 
servicers clean it up. The servicers need to obviously hire 
more staff, have single points of contact, and better quality 
control. I think those things are in place and I hope everybody 
will work together for the same end.
    Senator Reed. Can I mention a question for the record, Mr. 
Chairman?
    Chairman Johnson. Yes.
    Senator Reed. That is, and this is changing subjects very 
quickly and I will be very, very--obviously, with the Greek 
action today, there is some relief in Europe.
    Ms. Bair. Right.
    Senator Reed. But there are some larger economies that are 
potentially on the tipping point which could cause even more 
serious disruptions. Is this now the time for additional stress 
tests of our banks and major European banks to determine the 
exposure if a larger Euro economy or other economy defaulted?
    Ms. Bair. Well, I think the stress tests are going on in 
Europe right now. I believe the European banking authority 
plans to release its results in mid- to late-July. In the U.S., 
the Fed has been engaged with the larger bank holding companies 
and providing some additional stress scenarios based on certain 
sovereign debts potentially defaulting. And so I think that 
work is ongoing.
    Our direct exposure is not great to those sovereigns, but 
obviously the direct exposure to the European banking system is 
significant. So I think stress testing really has to be an 
ongoing process. These are still difficult times. The system is 
not as stable as it should be, and so that work is going on now 
and will continue.
    Senator Reed. Thank you. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Corker.
    Senator Corker. Thank you, Mr. Chairman, and thanks for 
having the hearing.
    I had other things going today, but I wanted to make sure 
that I came here to pay my respects to someone who I believe 
has been a very, very strong leader----
    Ms. Bair. Thank you.
    Senator Corker. ----and strong advocate for what she 
believes to be correct. I sometimes wish she had not been quite 
as strong of an advocate when we disagreed, but----
    [Laughter.]
    Senator Corker. ----you certainly have been that, and I 
know you leave here with certainly a very good legacy, a legacy 
of having gone through 5 years of tremendous turmoil. Again, I 
thank you for the access. We have talked multiple times on 
weekends and other times. I very much appreciate that. And 
again, sometimes you surprised me with your response, because I 
did not think that is what it would be, and it was very 
different, maybe, than what I was thinking, but it was always 
frank and I appreciate that, and I think all of us, especially 
in this atmosphere, like dealing with people who are direct and 
frank and are really telling us what they are thinking.
    With that, I know you were a strong advocate for the 
Consumer Protection Agency. Do you feel comfortable, and you 
have a board, I know, at the FDIC----
    Ms. Bair. Right.
    Senator Corker. The consumer agency has no board. Is that 
something you are comfortable with?
    Ms. Bair. Well, yes. I think boards have worked well. I 
think it is the same with a committee. It is nice to be a 
dictator, but, you know, you have to go round up your votes and 
that can be challenging sometimes. That is a healthy process. 
You get input. You get different perspectives. It can 
frequently lead to a better quality product, and so I have 
enjoyed working with my board and I like the board's structure.
    I think you can justify either structure. I think also with 
the Comptroller of the Currency, as well--would that be better 
to be a board? If you are looking at these structures----
    Senator Corker. Of course, you can always choose to be 
State-regulated on the OCC and move away from that.
    Ms. Bair. Yes, that is true.
    Senator Corker. The Consumer Protection Agency, you cannot. 
You would probably advocate that an organization like that have 
a board of some kind, would you not?
    Ms. Bair. Well, I think we did--during the Congressional 
consideration of the Dodd-Frank Act. We had suggested it be a 
board with a couple of bank regulators on that board. But that 
said, we are quite content to work with them as a single-headed 
agency. That person, once confirmed, will be on our board and I 
think that will help perhaps at least expose them to differing 
views on safety and soundness and other things, which would 
probably be healthy, yes.
    Senator Corker. Are you surprised with the amount--you 
know, when Dodd-Frank was coming through, you were not one of 
the ones advocating for this, I do not think, but a lot of 
people were talking about, well, we have got to have this for 
clarity. We have to have this for clarity. Are you a little 
surprised at the tremendous lack of clarity, especially during 
this time of economic turmoil----
    Ms. Bair. Right.
    Senator Corker. ----that Dodd-Frank has created since it 
was put in place, since----
    Ms. Bair. Well----
    Senator Corker. And basically, what has happened is we in 
the Senate have been sort of put in place as supplicants to 
regulators hoping good things are going to happen. It has been 
a little surprising, has it not, just the banks not knowing, 
the financial entities not really knowing what is going to 
happen----
    Ms. Bair. Right.
    Senator Corker. ----and that has placed some caution there, 
has it not?
    Ms. Bair. Look, I think there are a lot of rules. I think a 
lot of this relates to the proprietary trading restrictions and 
the derivatives restrictions, and I think there is an argument 
for phasing those provisions in over time. Also, there are 
interrelationships between those initiatives. For instance, 
some of the changes in bank capital requirements that are being 
made, not so much about increasing capital levels, but about 
how we are asking banks to risk weight their assets. So 
regarding coordination, I think FSOC is a good place for that 
to happen. And it is a very large law and it has a number of 
rulemakings in it.
    On the other hand, I would say that I think better 
coordination is always good. I think Congressional oversight is 
always good. I think writing rules that are short and clear 
whenever you can is good. It is a lot harder to write a short, 
clear rule than it is a 500-page very complex rule, and so I 
try to emphasize that at the FDIC. And I think coordination 
through FSOC, especially in terms of how these rules 
interrelate, and the costs, I think that would be a good role 
for the FSOC to perform----
    Senator Corker. So I am going to take that as a nonanswer 
and----
    Ms. Bair. OK. It is.
    [Laughter.]
    Senator Corker. Thank you. A good job. You know, the FSOC, 
I guess, is looking supposedly at macroprudential issues----
    Ms. Bair. Right.
    Senator Corker. ----and yet each of the members is sort of 
more oriented toward the micro side. Are you all really looking 
at things like U.S. Treasury defaults or Spain or Italy or some 
entity like that going down and the effect? Are you all 
beginning to look at those things and the effect it would have 
on our system?
    Ms. Bair. Yes, there have been a number of discussions 
about possible systemic risk, and the FSOC is required to file 
an annual report. It will be filed after I leave. But I think 
it will provide an overview of some of those discussions and 
some of the things that the FSOC is considering as potential 
systemic risk. So, yes. The short answer is, yes, that those 
discussions are taking place.
    Senator Corker. And this is my final question. I know you 
are obviously a very strong advocate for the resolution 
mechanism----
    Ms. Bair. Right.
    Senator Corker. ----that generally ended up being in place, 
and yet what Senator Shelby said is true. I mean, we are 
hearing--I am hearing from people who are actually buying some 
of these assets and they are just going, ``Corker, it is just 
unbelievable. I mean, they are selling these things for 
nothing.'' I mean, the taxpayer is getting totally drilled on 
this. I know you mentioned you wanted to take the judgment out, 
and there is some goodness in that, too----
    Ms. Bair. Right.
    Senator Corker. ----but, you know, you and I talked a 
little bit about resolution and you talked about the incredible 
cost of a bankruptcy resolution and that was one of the reasons 
you wanted to see--and for other reasons. But are you still 
convinced that in light of the GAO report and things that you 
know yourself that are taking place throughout our country, 
where basically bad judgments are being made--it is a massive 
organization--are you still convinced that that route is lesser 
expensive to the system than bankruptcy?
    Ms. Bair. Oh, it is absolutely much less expensive than 
bankruptcy. I think our loss rates on larger institutions are 
much lower because of the capital structure of larger 
institutions. At the largest failure, WaMu, there were no costs 
to the Deposit Insurance Fund. That is because, typically, 
large institutions have large cushions of unsecured debt which 
is available for loss absorption in our process as well as the 
bankruptcy process.
    A couple things we can do that bankruptcy cannot do that 
minimizes losses is, one, advance planning--be in an 
institution early, and have the institution start letting 
investors come in and do due diligence on an open institution 
basis so we are in a better position to sell it back into the 
private sector very quickly. We do not want it lingering in 
Government control or a bankruptcy process for a couple of 
years. So the advance planning is important. Second, we can 
provide temporary liquidity to keep it operational, to maintain 
the franchise as a going concern as it is sold.
    So it is absolutely much cheaper. I have no doubt in my 
mind that it would be much cheaper than a bankruptcy process, 
but it also imposes the same amount of market discipline. But 
because we are regulators, we can be in there early, advance 
plan, and provide liquidity support to keep it operational.
    Senator Corker. Mr. Chairman, thank you for your courtesy 
in letting me go a few minutes over. I am sure we are going to 
see you around----
    Ms. Bair. Right.
    Senator Corker. ----in public service in some other way and 
we thank you for what you have provided over the last 5 years.
    Ms. Bair. Thank you, Senator.
    Senator Corker. Thank you very much.
    Chairman Johnson. Senator Warner.
    Senator Warner. Thank you, Mr. Chairman.
    Let me start. I wanted to rush over here and extend, as my 
good friend, the Senator from Tennessee did, a real thanks. 
When I came on this Committee 2 years ago when we were in the 
midst of the crisis, you spent countless hours with me and my 
staff and your team did. Senator Corker and I, I always like to 
continue to point out that while there were a number of 
challenges around perhaps Dodd-Frank, Title I and Title II, I 
think, with the support of the Chairman and Ranking Member, got 
95 votes.
    Ms. Bair. It did.
    Senator Warner. Not a perfect solution set by any means, 
but a lot of that, you had a lot of effective guidance on.
    I do want to follow up on one comment that Senator Corker 
made, and let me be very clear on this. I do not want to have 
this question viewed on the solution set side----
    Ms. Bair. Sure.
    Senator Warner. ----because, obviously, that is the debate 
of the day. But I would like nothing more than for you to tell 
me that, as you have many times, that I may not be on the right 
path. But we talked a little bit about Greece and Portugal and 
their debts and what kind of contingency plans.
    Ms. Bair. Right.
    Senator Warner. How soon do we need to be starting to think 
the same in this country, when I think there is still an 
assumption from the financial community, the business 
community, that this is just one more political squabble and we 
will solve it at the eleventh hour, and sometimes a disconnect 
from our side, the political side, that do not understand at 
what point do people have to start covering?
    Ms. Bair. Yes, sir.
    Senator Warner. At what point do the shorts start to say, 
hey, this may be a great trade? And what kind of 
contingencies--and what kind of tools do we have left to put in 
place? As draconian as the challenges were when you and others, 
I think history will say, stepped up the right way, we do not 
have a TARP. We do not have stimulus. We do not have monetary 
policy in a major way left. I do not think this goes until 
August 2. I would love to have your reassurance to say, 
``Senator, do not worry. We are going to get through this one 
just fine.'' But in mid-July, if the shorts start going and 
people start covering----
    Ms. Bair. Right.
    Senator Warner. ----what are the contingencies that we have 
been thinking about for our country's financial system?
    Ms. Bair. Well, I think it is really a very dangerous game, 
and I think it is very important for people to understand that 
it is not just U.S. financial stability, it is world financial 
stability that rests on the financial integrity of the United 
States Government and our willingness to stand behind our 
obligations.
    I am passionate about deficit reduction. Last year I wrote 
a very strong op-ed on this and strongly supported the Bowles-
Simpson Commission and the work that you and others have been 
doing as essential. Because long term, if we do not have a 
credible deficit reduction plan, that could lead to a loss of 
investor confidence. But, in the short term, to play around 
with even talking about a default, even a so-called technical 
default on U.S. debt, I think, is highly problematic.
    You know, we still have time to do this, but will we? That 
is really the question. I gave a speech last week on short-
termism and what seems to be an increasing inability 
culturally, whether it is business, Government, whatever, to 
look beyond the immediate fix, and there is no immediate fix 
here. This is going to be a lot of hard work, a lot of hard 
decisions need to be made. It is going to take time to get 
these deficits down. It is going to have to be some combination 
of entitlement reform and revenue increases and it just seems 
like all those things are so obvious and that the political 
process does not seem to be able to produce the tough decisions 
that really need to be made and then execute on them.
    So we still have time, but if we keep kicking the can down 
the road, we will not, and we will start seeing the types of 
volatility that you are seeing with other countries that are 
viewed by the market as weak.
    Senator Warner. I guess what I--and I totally concur with 
what you have just said, but I guess, and I do not--on your 
last time testifying before the Committee, I guess I would ask 
two things. The notion that we can go up to the precipice----
    Ms. Bair. I do not think----
    Senator Warner. ----the notion that sometime, the second 
week, third week of July, the markets are going to have to 
start taking action, even some of the technical, just 
covering----
    Ms. Bair. Right.
    Senator Warner. ----is going to have to take place, I mean, 
am I wrong on that?
    Ms. Bair. No. I am sorry. No, you are not wrong. That is a 
very dangerous game with ramifications. Even if we go to the 
precipice, the market gets scared. The debt limits get raised. 
But what you have done, you have increased interest costs. You 
have increased Treasury's borrowing costs. And you have created 
a bigger deficit problem. So why even go there? Why even flirt 
with it? I just do not understand that. It is very harmful and 
will make the budget deficit worse.
    Senator Warner. Well, again, what I think--I scratch my 
head with Members of Congress who say they do not see any 
problem with this, and there seems to be no disagreement that 
every point that we raise on interest rates over a 10 year, 
over the baseline, is $1.3 trillion additional deficit 
reduction. So the notion of the $4.5 trillion plan that a 
bipartisan group have been talking about, that could be wiped 
away with a three-point interest rate. You know, I had a number 
of our community banks yesterday talk about still the challenge 
with the regulators and the mixed messages they are getting. 
But what would a 200 or 300 basis point interest rate 
increase----
    Ms. Bair. It would be----
    Senator Warner. ----do right now, not just to the deficit, 
but to business lending?
    Ms. Bair. It would be very damaging to our economy as 
sluggish as it is. We have been after the banks for a long time 
to be mindful of interest rate risk and to be able to withstand 
the stress of a 300 basis point jump. So I think they could--it 
would not be easy, and I certainly would like to avoid it, but 
it would certainly stress them more when they are not in the 
best condition now. Also, it is going to increase borrowing 
costs for households and businesses, and they are already tepid 
about borrowing and they are not sure about the economy. That 
is going to potentially tilt our economic trajectory downward 
again. It is so avoidable and there are so many really 
profound, very devastating ramifications to it. I just do not 
understand why we are even talking about getting to that point. 
I really do not.
    Senator Warner. And, Mr. Chairman, could I ask one more 
question, and then I would love to wait. If there is a second 
round, I have got questions on resolution. But again, I just 
want to pick up on one of your last points, which is even not 
getting to the precipice, somewhere----
    Ms. Bair. In between----
    Senator Warner. ----in between----
    Ms. Bair. It would be very bad.
    Senator Warner. ----between, you know, the week after the 
fourth and August 2, will not institutions, will not markets 
start building in a risk premium, and if we get close, that 
risk premium will not disappear even if we have some eleventh 
hour political solution?
    Ms. Bair. That is absolutely correct. That is absolutely 
correct. It will not. It is----
    Senator Warner. Fifty basis points? A hundred basis points? 
A hundred-and-fifty basis points?
    Ms. Bair. I would not want to put a number on it, but it 
would be there and it would probably be there for many years 
and exacerbate the problem we are trying to deal with and still 
have not solved.
    Senator Warner. It is just, again, remarkable to me, for 
all of the great work through the crisis that you did and what 
the Chairman and the Ranking Member, even when folks did not 
always agree with you, you have always been extraordinarily 
straightforward and, I think, a great representative of public 
service. We are going to miss your steady hand, and I sure as 
heck hope that we do not have one of these ``all hands on 
deck'' crises in the next 45 days. I think we are approaching 
the most predictable financial crisis in our lifetimes. I have 
this--and I have gotten a little obsessed about this, but this 
notion of, as a country, we are Thelma and Louise in that car 
with the foot on the accelerator heading toward a cliff.
    Ms. Bair. Yes.
    Senator Warner. Thank you, Mr. Chairman, and I look forward 
to another round of questions.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you.
    Chairman Bair, Basel II--III again--I hope we have seen the 
last of Basel II.
    Ms. Bair. Yes, me, too.
    Senator Shelby. As I understand the agreement of Basel III 
Capital Accords, the agreement and the thrust is to increase 
the amount of capital that large global banks must hold. What 
banks will that apply to in the United States?
    Ms. Bair. The Dodd-Frank Act requires higher prudential 
standards for bank holding companies $50 billion and above.
    Senator Shelby. $50 billion or bigger.
    Ms. Bair. Right. But I would also hasten to add this is the 
Fed's decision. They consult with us, but I believe they have 
publicly stated that for the smaller bank holding companies, 
any additional requirements will probably not be significant. 
So they will definitely----
    Senator Shelby. You mean smaller than $50 billion----
    Ms. Bair. No, I mean even for those that are above $50 
billion. I think the SIFI surcharge is really for the very, 
very largest institutions so that----
    Senator Shelby. Now, $50 billion is a pretty good size 
institution.
    Ms. Bair. It is.
    Senator Shelby. Now, how many banks----
    Ms. Bair. Not what it used to be.
    Senator Shelby. ----in the United States, roughly, do we 
have that would go up to $50 billion?
    Ms. Bair. That are under or over $50 billion?
    Senator Shelby. Are 50, right around--50 or up.
    Ms. Bair. 50 or up, I think it is around----
    Senator Shelby. Roughly.
    Ms. Bair. I think it is around 70.
    Senator Shelby. 70 banks----
    Ms. Bair. I can get the number for you, yes.
    Senator Shelby. And what do we have, three banks that are 
$1 trillion banks?
    Ms. Bair. We have four.
    Senator Shelby. Four banks. That would be Bank of America.
    Ms. Bair. Right.
    Senator Shelby. Wells.
    Ms. Bair. Right.
    Senator Shelby. Citicorp.
    Ms. Bair. Citi and B of A.
    Senator Shelby. And what is the other one?
    Ms. Bair. Citi and B of A. JPMorgan Chase, Citi----
    Senator Shelby. JPMorgan Chase.
    Ms. Bair. ----B of A, and Wells, yes.
    Senator Shelby. OK. Now, what will this do--how will this 
Basel III change the banking landscape as we know it?
    Ms. Bair. Well, I think----
    Senator Shelby. Or what do you think it will do?
    Ms. Bair. I think it will make the system more resilient by 
providing a greater cushion of capital to absorb losses.
    Senator Shelby. For the bigger banks.
    Ms. Bair. For the very largest banks, it will provide an 
extra layer of protection. It will reduce the risk that they 
could fail because they will have more loss-absorbing capacity. 
Another benefit of more capital; for some who worry about 
funding differentials between large banks and smaller banks, is 
that it will make it a little more expensive for them to fund 
themselves. So that is a good thing, I think, in terms of 
narrowing the spread between their funding costs and the 
smaller institutions funding costs.
    It will make small and even midsized institutions a little 
more competitive because they will only have to hold 7 percent 
capita.
    Senator Shelby. And what will the capital requirements of 
the banks say $50 billion, Basel III banks, what will their 
capital requirements be as opposed to, say, a $25 billion bank?
    Ms. Bair. So I think----
    Senator Shelby. Or a $1 billion or $500 billion.
    Ms. Bair. For $500 billion, so I think----
    Senator Shelby. $500 million, I mean.
    Ms. Bair. I am hesitating only because this is really a----
    Senator Shelby. Roughly.
    Ms. Bair. This is the Fed's--this will be done through bank 
holding company capital, which the Fed----
    Senator Shelby. And that is regulated by the Federal 
Reserve.
    Ms. Bair. Which is regulated by the Fed. So I do believe 
they expect to tier gradual increases starting with 
institutions with $50 billion in assets. There will probably 
not be much of an increase at the $50 billion level. And, 
again, with the 2.5 percent, going up----
    Senator Shelby. Today, as we are sitting here today, what 
is the required capital, tier one capital?
    Ms. Bair. Tier one capital, right.
    Senator Shelby. Of, say, your banks.
    Ms. Bair. Well, it is 8 percent and 10 percent to be well 
capitalized on a risk-weighted basis----
    Senator Shelby. Well capitalized would be 10 percent.
    Ms. Bair. For tier one and tier two, that is----
    Senator Shelby. Tier one.
    Ms. Bair. And tier two. Tier one is 8.
    Senator Shelby. OK. Now, what will Basel III require them 
to do? To go above that, right?
    Ms. Bair. Only half of that has to be tangible common 
equity. Actually for adequate capital----
    Senator Shelby. So it is how you define the capital, is 
that what you are----
    Ms. Bair. Right. So it is far too complicated----
    Senator Shelby. Let us slow down just a bit.
    Ms. Bair. Sure.
    Senator Shelby. Now, explain to the Committee and to the 
American people, because they will be watching you here, what 
you mean by capital----
    Ms. Bair. Yes.
    Senator Shelby. ----how it is broken down by----
    Ms. Bair. So that is a very----
    Senator Shelby. Just go step by step.
    Ms. Bair. Yes. That is a very good question because we are 
talking about tangible common equity, so we are not talking 
about hybrid debt products like trust----
    Senator Shelby. Are you talking about liquidity, too?
    Ms. Bair. We are talking about just capital. Just capital.
    Senator Shelby. This is just capital.
    Ms. Bair. This is tangible common equity. The type of thing 
that people think of as common equity. There were other things 
that regulators in the past let count toward capital----
    Senator Shelby. And how do you define--as a regulator, how 
do you define common equity?
    Ms. Bair. So it is basically determined by what you cannot 
count toward tangible common equity. It needs to be common, it 
cannot be preferred. It needs to be tangible, it cannot be 
goodwill. They can count a little bit of mortgage servicing, 
but just a little bit. We allowed a little bit of that in the 
compromise. You cannot allow----
    Senator Shelby. Is it real capital you are talking about?
    Ms. Bair. Real capital, yes.
    Senator Shelby. You are trying to get----
    Ms. Bair. Real capital.
    Senator Shelby. ----real capital, not----
    Ms. Bair. Real common----
    Senator Shelby. ----something that is called capital.
    Ms. Bair. That is right. That is exactly right. And so the 
requirement for tangible common equity, just to be adequately 
capitalized, is only 3 percent. Now, U.S. banks are much higher 
than that, but the international minimum is 3 and Basel III 
takes it up to 7. So it is quite a jump, and that is a good 
thing. That is a very good thing.
    Senator Shelby. Well, what happened, just to reach back a 
couple of years----
    Ms. Bair. Right.
    Senator Shelby. ----for the record, what happened to our 
banks when they got in trouble? Was it a lack of capital? Or 
was it a lack of liquidity? Was it both?
    Ms. Bair. They were related. There was insufficient 
capital. I think insured banks were in a better----
    Senator Shelby. And why was it insufficient capital? Was it 
because the regulators were not doing their job?
    Ms. Bair. I think regulators do have some share of the 
blame. I absolutely do.
    Senator Shelby. The regulators have some culpability here.
    Ms. Bair. They do. On capital standards they absolutely do.
    Senator Shelby. OK.
    Ms. Bair. Yes, that is absolutely true. We let things like 
hybrid debt count as tier one capital, which we should not have 
done. Fortunately, we did not----
    Senator Shelby. In other words, what you were calling 
capital really was----
    Ms. Bair. It was not really capital. It was not----
    Senator Shelby. And what were they counting as capital then 
that you will not let them count as capital now?
    Ms. Bair. The biggest piece of this which was addressed in 
the Collins amendment is something called trust preferred 
securities, which basically counted as tier one capital for 
bank holding companies, but never counted for banks. And so 
even though it is called an equity instrument, it basically 
gives the shareholder a right to perpetual cumulative 
dividends. So if a bank gets into trouble, for common equity, 
they can eliminate the dividend, right? They can conserve 
capital by eliminating the dividend. With trust preferred 
securities, you can suspend payment of your dividend, but it 
still accumulates, and at some point you have to pay it.
    So this is debt. It is not equity.
    Senator Shelby. Sure.
    Ms. Bair. And they liked it because they could deduct the 
interest on it as debt under the Tax Code, and the regulators 
let them count it as capital. And when the crisis hit, the 
markets said----
    Senator Shelby. But it sure did not make them any stronger, 
did it?
    Ms. Bair. No. The markets said it is debt, it is not 
equity, and it was debt and it is debt.
    You know, Senator, if you would indulge me for a minute, 
the Tax Code drives so much of this. The Tax Code makes it so 
much cheaper to finance with debt than equity by making the 
interest payments deductible for debt, with double taxation of 
dividends----
    Senator Shelby. Of dividends, I agree with you.
    Ms. Bair. So if we could equalize the treatment of debt and 
equity, I think a lot of this industry pressure to count debt 
as capital would go away.
    Senator Shelby. Last question. As a regulator--and you are 
a regulator, the FDIC.
    Ms. Bair. Yes, we are. Yes.
    Senator Shelby. As a regulator, shouldn't regulators, 
whether it is FDIC, the Federal Reserve, or the Comptroller, or 
whatever, shouldn't they know the condition of a financial 
institution and say, look, you are not paying dividends, you 
are not--a dividend, you are not even strong enough to maybe 
exist.
    Ms. Bair. Yes. Yes.
    Senator Shelby. Are you doing more and more of that now?
    Ms. Bair. We are, and we need to. And there was a couple 
hundred billion dollars of dividends that got paid out of banks 
and bank holding companies leading up to the crisis that should 
never, in my view, have happened. And I think that is another 
lesson learned from this crisis. And, again, typically it is 
the bank holding company that pays the dividend, but we have 
more and more been consulted by the Fed on this, and have urged 
caution, clearly now, especially with all the problems with the 
housing market and litigation risk related to the servicing 
issues. People need to be very cautious about dividends, even 
now as the banking system continues to heal.
    Senator Shelby. Thank you.
    Chairman Johnson. Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chair. And 
welcome.
    Ms. Bair. Thank you.
    Senator Merkley. And congratulations on the soon-to-be 
completed tenure that you have had and the vigorous efforts you 
have made to provide sound regulation.
    I also want to note that long before your term as FDIC 
Chairman, you were a voice calling out the abuses and systemic 
risk of subprime lending, and had many followed up on that much 
earlier, not only would we be better off in terms of our 
financial house, but millions of American families would be in 
better shape. So I thank you for that.
    I apologize that I missed the earlier questioning, but I 
just wanted to essentially see if you had points that, as we 
work to implement the division between investment banking and 
commercial lending, and you see the regulatory conversation 
proceeding, whether there are key points that this Committee 
should be paying a lot of attention to in order to really 
rebuild a secure financial foundation.
    Ms. Bair. So I think you are right, the Volcker rule in 
Dodd-Frank will help. The big investment banks are now bank 
holding companies, so they are in the safety net. Many of them 
are growing their insured banks, which is fine. But I do think 
that means that we should be particularly cautious about making 
sure that insured deposits are not used for proprietary 
speculative activity, and so we have been--directly or 
indirectly, very strong advocates for the best implementation 
of the Volcker rule.
    And I think that more generally there needs--particularly 
in derivatives markets--there needs to be greater transparency. 
Obviously moving them to centralized trading and clearing 
facilities where they are sufficiently commoditized will let 
that happen. But just even short of that, we need to have more 
transparency and better reporting mechanisms from these large 
institutions so that they can immediately tell regulators on a 
net basis and a gross basis what their exposures are. I think 
we are not quite there yet, but we need to have that for 
entities that have large positions, both regulated entities as 
well as nonregulated entities. There needs to be some greater 
capacity to identify who has the large exposures and whether 
they are financially capable of making good on them if their 
positions went against them.
    So I think there is a lot of work that is left to be done, 
and I hope--the SEC and CFTC, who have the primary 
responsibility for this, will have the resources they need to 
carry through, because, again, with the specter of a credit 
default event in Europe, we have been looking at this again, 
especially at the CDS market, and whether we can get a good 
handle on where the exposures are and who ultimately may be 
having to pay if there is a significant default event. And, 
frankly, the data could be a lot better than it is.
    Senator Merkley. Could you comment a little bit on the 
issue regarding margin requirements for end users and where 
that discussion is going in the regulatory process and where it 
should go?
    Ms. Bair. So thank you. Thank you for asking that question. 
I think there has been some misperception about what the bank 
regulators have proposed. Right now a bank or a bank holding 
company needs to set credit exposure limits for any credit 
exposures taken. So if it is lending, it needs to identify the 
creditworthiness of that entity that is borrowing and set some 
type of credit exposure limit and either not exceed that or 
require additional collateral or margin to protect its risk 
exposure. And so it is the same concept because the derivatives 
exposure creates a credit exposure for a bank or bank holding 
company, just as a loan might.
    So this is really a safety and soundness issue. My view is 
that this is the expectation for banks already. It is nothing 
new. It is just being formalized in this rule. Frankly, in 
retrospect, maybe we should not have put it in the derivatives 
rule; we should have just continued to enforce it as a safety 
and soundness matter.
    But I do think you need to distinguish banks and bank 
holding companies which have long been subject to safety and 
soundness regulation, and you are going to have safety and 
soundness principles apply to those entities in a more robust 
way than you might for a futures commission merchant or someone 
completely outside of the Federal support system for banking.
    Senator Merkley. There has been a discussion of the fact 
that there may be a very large number of places that take up 
the trading of derivatives, and in my own mind I keep picturing 
that within a couple years there will be natural forces that 
would create excessive consolidation primarily that if you are 
selling you want to be exposed to the maximum number of buyers, 
and if you are buying you want a maximum number of sellers.
    There has also been this question of separation between the 
trading function and the clearing function and whether those 
can be handled in a simultaneous fashion so you do not end up 
with lose ends hanging out that stymie the market. Your 
thoughts on those pieces?
    Ms. Bair. Well, I think they can be done, and that is 
certainly the traditional model for exchange-traded derivatives 
and securities, especially on futures exchanges. They are 
highly correlated. So, I mean, you cannot trade unless you 
centrally clear through the exchange facilities. So I think 
that model has worked pretty well, and I do not see why it 
could not--as these instruments became more commoditized why 
you could not follow that similar model.
    I only hesitate because this is a little bit out of the 
FDIC's portfolio, and I know you have engaged with the SEC and 
the CFTC on these issues, too. But I do think for standardized 
instruments that it is the best. Sure, exchanges and 
clearinghouses concentrate risk, but you also know where it is. 
You can better regulate it. You can make sure the margining is 
robust and the systems are robust. The securities and futures 
clearinghouses have really never presented any major issues 
throughout the history of financial crises, and that is true of 
the recent one as well. So I think that is a positive sign to 
try to move as much as you can to that type of framework.
    Senator Merkley. Thank you very much.
    Chairman Johnson. Senator Warner.
    Senator Warner. Thank you, Mr. Chairman. Thank you for 
letting me have a second round, and I will promise to be brief, 
although I guess when any of us, when we say that, that is a 
little bit of an oxymoron.
    I want to--I think Senator Shelby's line of questioning 
about the SIFIs and how we are going to work through this and 
the questions around Basel III in terms of the capital I think 
were great questions, questions about liquidity. But also the 
issue around resolution. I think if we think back to that 
problem in the crisis when there was not any resolution plan or 
road map, and one of the things that I know we have worked 
together on was trying to ensure that these large institutions 
had that resolution plan, at least on the shelf, constantly 
updated. And I want to--again, looking at--staff shared with me 
the list of the folks that you have put together in terms of an 
advisory board. I want to commend you on the quality of the 
folks there.
    How do you think the banks are coming on their resolution 
plans? How soon do we need to get them? You know, when is this 
going to become a reality? And I would just love your 
assessment of where we stand on the----
    Ms. Bair. Well, my hope--it is a joint rulemaking, and my 
last board meeting is next Wednesday, so I hope very much that 
we can get a final rule out on living wills and have the first 
set for the very largest institutions come in perhaps early 
next year.
    I think it is going to be an iterative process. I think the 
first round of resolution plans are probably going to need a 
lot of work. But this has been a priority for the international 
community as well. The Financial Stability Board has had a 
recovery and resolution project going on for quite some time. 
We have been working closely with the Bank of England on this, 
with our largest institutions, as well as most of the major 
European institutions, too. So through this international work, 
a lot of this has been done already.
    So I think even though the first round of plans will not be 
perfect, that will at least start the discussion and the 
process. And as I said before, I do think some of these 
institutions will need to make structural changes. They are too 
complex. They have too many legal entities. Their business 
lines can cross-cut thousands of legal entities, which would 
make a resolution not impossible, but very difficult and 
unnecessarily expensive.
    John Reed, one of our advisory committee members, made a 
comment at a recent committee meeting, which I thought was 
great, which was that corporate boards need to engage in this 
because this can really help them. If they are interested in 
understanding and learning what is going on inside these very 
large, complex organizations, simplifying the legal structures 
and aligning them with the business lines will also improve 
information management systems and their ability to get 
information, provide accountability and monitor what is going 
on inside of these large financial institutions.
    Senator Warner. And you do think--and I will just take one 
last----
    Ms. Bair. Sure.
    Senator Warner. One last question, and it will be two. But, 
you know, that coordination, since a lot of the problems were 
cross-border----
    Ms. Bair. Yes.
    Senator Warner. ----you feel it is moving forward and----
    Ms. Bair. Yes, it is. A lot of work has been done already, 
and I know cross-border resolutions will be difficult, but they 
will not be impossible, and pending an international resolution 
framework, we have bilateral agreements in progress or signed 
already with most of the major developed jurisdictions.
    Senator Warner. My last formal question to you as a Banking 
Committee Member, you know, we ought to go back to the issue 
that we have spent an enormous amount of time talking about, 
and that is, you know, how do we get that lending going to 
small business again. And I just--I thought we had kind of 
turned the corner. I have to tell you, as somebody with a lot 
of--my colleague Senator Merkley, we worked hard on that small 
business lending facility that--I know it is not your bailiwick 
and you are not going to comment, but the fact that a lot of 
those dollars still have not gone out, you know, and I think 
500 or 600 institutions have applied and there are still not 
any dollars distributed, you know, what--are there other 
tools--we had the help line in place in terms of whether the 
regulators were telling the banks--we still do hear this on a 
regular basis. The regulators are reclassifying all these loans 
as nonperforming even though they are still meeting payments. 
You know, are there any tools left in our quiver on this?
    Ms. Bair. So we have sent information for over 400 
institutions that qualify for the Treasury's criteria. They are 
pending at Treasury right now. We got another spate of 
applications when they got their criteria out for the 
subchapter S corporations. I have asked that this be done by 
July 15th, and I think it will. We have asked our staff to 
prioritize it.
    I have also been pushing the staff about what more we can 
do, and I found actually an interagency policy statement that 
we issued subsequent to the last financial crisis in 1993, and 
I want to remind the Committee and remind the banks about this. 
Perhaps we will release this later. We do have a policy that 
would allow banks to set aside small business loans as long as 
they do not exceed 20 percent of capital, where examiners will 
not scrutinize underwriting. They will look at the performance 
of the loans. And this was designed for that time and it could 
be designed again to give banks making small business loans 
more flexibility to make these loans in a way that will not 
lead to adverse outcomes for their supervisory rating. It is 
only for the CAMELS 1 and 2 banks, but this is still in effect. 
We are going to remind our banks about it and see if this----
    Senator Warner. Perhaps you could share that with us 
because that would----
    Ms. Bair. Yes. As we have discussed before, Senator, part 
of the problem is the lack of collateral, and there is not a 
lot we can do about that.
    Senator Warner. Thank you, Mr. Chairman. Thank you for 
giving me a second round, and thank you for calling this 
hearing. And, again, Chairman Bair, we--I know at least for 
this Senator--really respect your service and hope we get a 
chance to work again in the future.
    Ms. Bair. Thank you.
    Senator Warner. Thank you, Mr. Chairman.
    Chairman Johnson. Sheila, I would like to thank you again 
for all the work you have done to serve the people of the 
United States. I wish you well in all your future endeavors.
    Ms. Bair. Thank you.
    Chairman Johnson. Thanks again to my colleagues and our 
panelist for being here today. This hearing is adjourned.
    [Whereupon, at 3:39 p.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
                  PREPARED STATEMENT OF SHEILA C. BAIR
            Chairman, Federal Deposit Insurance Corporation
                             June 30, 2011
    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, thank you for the opportunity to testify today on the state 
of the Federal Deposit Insurance Corporation. The past 5 years, marking 
my tenure as FDIC Chairman, have been among the most eventful for U.S. 
financial policy since the 1930s. During this time our Nation has 
suffered its most serious financial crisis and economic downturn since 
the Great Depression. The aftereffects are still being felt and will 
likely persist in some measure for years.
    Despite the challenges, I am pleased to report significant progress 
in the recovery of FDIC-insured institutions and the Deposit Insurance 
Fund (DIF), as well as in implementing regulatory reform measures as 
authorized under the Dodd-Frank Wall Street Reform and Consumer 
Protection Act of 2010 (the Dodd-Frank Act). Following through on these 
reforms will be crucially important to the type of long-term financial 
stability that will be necessary to support economic growth in the 
years ahead.
    In my testimony today, I would like to summarize the progress that 
the FDIC has made in ensuring the safety and soundness of our banking 
system, protecting depositors, resolving failed institutions, and 
rebuilding the financial health of the DIF. I will highlight, in 
particular, efforts we are making to enhance consumer protection in the 
wake of a crisis where risky retail lending practices played a leading 
role. I will briefly summarize our progress in implementing the 
resolutions framework for systemically important financial institutions 
(SIFIs) that was authorized under the Dodd-Frank Act, and conclude with 
some additional thoughts on the importance of financial regulatory 
reform to the Nation's long-term economic health.
Condition of the Industry and the Deposit Insurance Fund
    Since my term began in June 2006, the landscape of the banking 
industry has undergone dramatic change. When I arrived, the industry 
was in the midst of its sixth consecutive year of record earnings. The 
ratio of noncurrent loans to total loans was a record-low 0.70 percent. 
\1\ There were only 50 problem banks, and we were in the midst of a 
record period of 952 days without a bank failure. However, as we soon 
learned, the apparently strong performance of those years in fact 
reflected an overheated housing market, which was fueled by lax lending 
standards and excess leverage throughout the financial system.
---------------------------------------------------------------------------
     \1\ Noncurrent loans are those that are on nonaccrual status or 
are 90 or more days past due.
---------------------------------------------------------------------------
    The industry quickly shifted from a period of apparently strong 
performance to record credit losses and some of the worst earnings 
quarters in U.S. banking history. The deterioration began with the 
onset of recession in late 2007. The trend worsened after the peak of 
the financial crisis, and the industry reported a record loss of $37 
billion in the fourth quarter of 2008. By early 2010, the ratio of 
noncurrent loans to total loans had risen nearly eight-fold to 5.5 
percent. The FDIC went from a long stretch of no failures to resolving 
373 institutions since the start of 2007, including the largest bank 
failure in U.S. history. In addition, the Federal Government and U.S. 
banking regulators had to provide assistance to our largest financial 
organizations to prevent their failure from causing an even more severe 
economic disaster.
    After showing signs of a turnaround in 2010, performance of FDIC-
insured institutions continued to strengthen in the first quarter of 
2011. Earnings have recovered to levels that remain lower than their 
prerecession highs, and asset quality indicators have also improved 
somewhat. However, problem assets remain at high levels, and revenue 
has been relatively flat for several quarters.
    Banks and thrifts reported aggregate net income of $29 billion in 
the first quarter, an increase of 67 percent from first quarter 2010 
and the industry's highest reported quarterly income in nearly 3 years. 
Industry earnings have registered year-over-year gains for seven 
consecutive quarters. More than half of institutions reported improved 
earnings in the first quarter from a year ago, and fewer institutions 
were unprofitable.
    The main driver of earnings improvement continues to be reduced 
provisions for loan losses. First quarter 2011 provisions for losses 
totaled $20.6 billion, which were about 60 percent below a year ago. 
Reduced provisions for losses reflect general improvement in asset 
quality indicators. The volume of noncurrent loans declined for the 
fourth consecutive quarter, and net charge-offs declined for the fifth 
consecutive quarter. All major loan types had declines in volumes of 
noncurrent loans and net charge-offs. However, the ratio of noncurrent 
loans to total loans of 4.71 percent remains above levels seen in the 
crisis of the late 1980s and early 1990s.
    The positive contribution from reduced loan-loss provisions 
outweighed the negative effect of lower revenue at many institutions. 
Net operating revenue--net interest income plus total noninterest 
income--was $5.6 billion lower than a year ago. This was only the 
second time in the more than 27 years for which data are available that 
the industry has reported a year-over-year decline in quarterly net 
operating revenue. Both net interest income and total noninterest 
income reflected aggregate declines. More than half of all institutions 
reported year-over-year increases in net operating revenue, but eight 
of the ten largest institutions reported declines.
    The relatively flat revenues of recent quarters reflect, in part, 
reduced loan balances. Loan balances have declined in ten of the past 
eleven quarters, and the 1.7 percent decline in the first quarter was 
the fifth largest percentage decline in the history of the data. 
Balances fell in most major loan categories. Recent surveys suggest 
that banks have been starting to ease lending standards, but standards 
remain significantly tighter than before the crisis. Surveys also 
indicate that borrower demand remains sluggish. Growth of well-
underwritten loans will be essential not only for banks to build 
revenues but also to provide a stronger foundation for economic 
recovery.
    The number of ``problem banks'' remains high, at 888. \2\ However, 
the rate of growth in the number of problem banks has slowed 
considerably since the end of 2009. As we have repeatedly stated, we 
believe that the number of failures peaked in 2010, and we expect both 
the number and total assets of this year's failures to be lower than 
last year's.
---------------------------------------------------------------------------
     \2\ ``Problem banks'' are those assigned a CAMELS composite rating 
of 4 or 5.
---------------------------------------------------------------------------
    In all, the failure of some 373 FDIC-insured institutions since 
2006 has imposed total estimated losses of $84 billion on the DIF. As 
in the last banking crisis, the sharp increase in bank failures caused 
the fund balance, or its net worth, to become negative. In the recent 
crisis, the DIF balance turned negative in the third quarter of 2009 
and hit a low of negative $20.9 billion in the following quarter. By 
that time, however, the FDIC had already moved to shore up its 
resources to handle the high volume of failures and begin replenishing 
the fund. The FDIC increased assessment rates at the beginning of 2009, 
which raised regular assessment revenue from $3 billion in 2008 to over 
$12 billion in 2009 and almost $14 billion in 2010. In June 2009, the 
FDIC imposed a special assessment that brought in an additional $5.5 
billion from the banking industry. Furthermore, to increase the FDIC's 
liquidity, the FDIC required that the industry prepay almost $46 
billion in assessments in December 2009, representing over 3 years of 
estimated assessments.
    While the FDIC had to impose these measures at a very challenging 
time for banks, they enabled the agency to avoid borrowing from the 
U.S. Treasury. The measures also reaffirmed the long-standing 
commitment of the banking industry to fund the deposit insurance 
system. Since the FDIC imposed these measures, the DIF balance has 
steadily improved. It increased throughout 2010 and stood at negative 
$1.0 billion as of March 31 of this year. We expect the DIF balance to 
once again be positive when we report the June 30 results. Over the 
longer term, the FDIC has put in place assessment rates necessary to 
achieve a reserve ratio (the ratio of the fund balance to estimated 
insured deposits) of 1.35 percent by September 30, 2020, as the Dodd-
Frank Act requires.
    The FDIC has also implemented the Dodd-Frank Act requirement to 
redefine the base used for deposit insurance assessments as average 
consolidated total assets minus average tangible equity. As Congress 
intended, the change in the assessment base, in general, will result in 
shifting some of the overall assessment burden from community banks to 
the largest institutions, which rely less on domestic deposits for 
their funding than do smaller institutions. The result will be a 
sharing of the assessment burden that better reflects each group's 
share of industry assets.
    The FDIC has used its new authority in setting reserve ratio 
targets and paying dividends to adopt policies that should maintain a 
positive DIF balance even during possible future banking crises while 
preserving steady and predictable assessment rates throughout economic 
and credit cycles. The FDIC also revised its risk-based premium rules 
for large banks. The new premium system for large banks goes a long way 
toward assessing for risks when they are assumed, rather than when 
problems materialize, by calculating assessment payments using more 
forward-looking measures. The system also removes reliance on long-term 
debt issuer ratings as required by the Dodd-Frank Act.
Consumer Protection and Economic Inclusion
    I would also like to address the various efforts underway at the 
FDIC that are focused on consumer protection. It is important to recall 
that a fundamental cause of the financial crisis from which the country 
is still emerging was a failure of consumer protection in the mortgage 
market. While the FDIC was at the forefront of efforts before the 
crisis to identify and try to address the implications of both subprime 
and nontraditional mortgage lending, the regulatory guidance on these 
loan products--which only applied to insured banks--came too late to 
prevent mortgage lending weaknesses from undermining the foundations of 
our housing and financial systems. Many other weaknesses--including 
inadequate capital resulting in too much leverage, lack of transparency 
in the derivatives markets, and poor coordination among regulators--
magnified and expanded the problems created in the mortgage markets. If 
the rules now in place had been in existence in 2004, the crisis would 
have been less severe, if not averted.
    The new Consumer Financial Protection Bureau (CFPB) can play an 
important role in making consumer protections both simpler and more 
effective. Already, CFPB proposals for simplifying mortgage disclosures 
currently made under the Truth in Lending Act (TILA) and the Real 
Estate Settlement Procedures Act (RESPA) have been well received by 
industry and consumer groups alike. More broadly, the CFPB also can 
fill an important void by ensuring that nonbank consumer financial 
companies are subject to the same rules and a similar regime of 
supervision and enforcement as are insured depository institutions. 
Many of the unsustainable mortgages made during the boom years were 
originated by nonbank mortgage companies. These firms simply were not 
subject to the kind of regular examination that FDIC-insured 
institutions must undergo. Leveling this playing field is extremely 
important to prevent regulatory arbitrage.
    As you know, the law mandates that banks with assets of less than 
$10 billion continue to be examined for consumer protection compliance 
by their primary Federal regulators. In our case, this means that the 
FDIC will continue to examine about 4,500 State-chartered, nonmember 
banks for compliance with consumer laws and regulations. To ensure that 
consumer protection continues to receive appropriate focus, the FDIC 
established a Division of Depositor and Consumer Protection (DCP) that 
will be able to work with the new CFPB to ensure consistent application 
of consumer rules.
    Moreover, the Dodd-Frank Act requires the CFPB to consult with the 
FDIC and other prudential regulators in the development of its 
regulations. This is a role we take very seriously. Along with our 
Division of Risk Management Supervision, DCP will ensure that we are 
institutionally prepared to engage in this consultation. An important 
part of the consultation process will involve making sure the CFPB 
understands the inter-relationship between consumer protection and 
safety and soundness, and also takes into account the potential impacts 
of its regulations on small, community banks. Simpler, clearer consumer 
protection rules will not only help consumers better understand their 
legal rights, but also help community banks engage in a broader array 
of consumer lending without burdensome legal compliance costs. The FDIC 
has many years of experience in supervising community banks for 
compliance with consumer laws and is highly supportive of the CFPB's 
goal of simplifying consumer rules, which should reduce regulatory 
burden on community banks. In addition, the Director of the CFPB will 
be a member of the FDIC's Board of Directors. This will further ensure 
the coordination of prudential regulation and consumer protection.
    Early in my term, the FDIC Board created the Advisory Committee on 
Economic Inclusion to provide advice and recommendations on expanding 
access to mainstream banking services for underserved consumers. The 
Committee's objective is to explore ways to lower the number of 
households without access to mainstream financial services by 
identifying appropriate incentives or removing obstacles to the 
provision of financial products that meet the needs of these 
households, with an emphasis on safety and affordability for consumers 
and economic feasibility for banks. These consumer protection 
initiatives are integral to the FDIC's mission to promote public 
confidence, access to the banking system, and the benefits of deposit 
insurance. Economic inclusion is about promoting widespread access to 
safe, secure, and affordable banking services so that everyone has the 
opportunity to save, build assets, and achieve financial security.
Implementing Reforms To Promote Financial Stability
    As I have testified several times over the past year, the Dodd-
Frank Act, if properly implemented, will not only reduce the likelihood 
and severity of future crises, but will provide effective tools to 
address large company failures when they do occur without resorting to 
taxpayer-supported bailouts or damaging the financial system.
    Our highest near-term regulatory priorities are two-fold: (1) 
implementing the various regulatory mandates that make up the new 
resolution framework for SIFIs, and (2) strengthening and harmonizing 
capital and liquidity requirements for banks and bank holding companies 
under the Basel III protocol and Section 171 of the Dodd-Frank Act, the 
Collins Amendment. The FDIC is also engaged in implementing the other 
important Dodd-Frank Act reforms where we have been given authority to 
do so. The following is a brief summary of our implementation 
activities and how we see them influencing the future course of the 
banking sector.
    SIFI Resolution Framework. The problem of financial companies that 
are Too Big to Fail has been around for decades. But the bailouts of 
troubled SIFIs that occurred in the crisis removed all doubt that this 
was a central problem facing our financial system.
    The bailouts were made necessary by the absence of an effective 
resolution process for bank holding companies and their nonbank 
affiliates. Without those powers, the failure of an FDIC-insured 
subsidiary would likely have resulted in the costly and disorderly 
bankruptcy of the holding company and a significant widening of the 
financial crisis. This was not a risk policy makers were willing to 
take at the time.
    The crisis of 2008 showed the overwhelming pressure that develops 
to provide Government bailouts when information is sketchy, when fear 
is the prevailing market sentiment, and when there is no clear sense of 
how bad things might get before the system begins to stabilize. But 
bailouts have consequences. They undermine market discipline. They 
inhibit the restructuring of troubled financial companies and the 
recognition of losses. They keep substandard management in place and 
preserve a suboptimal allocation of economic resources.
    In contrast, smaller banks are fully exposed to the discipline of 
the marketplace. Some 373 FDIC-insured institutions have failed since I 
became FDIC Chairman. This is how capitalism is supposed to work. 
Failed companies give way to successful companies, and the remaining 
assets and liabilities are restructured and returned to the private 
sector. That is why bailouts are inherently unfair. They violate the 
fundamental principles of limited Government on which our free-
enterprise system is founded. They undermine trust in governmental 
functions that most people would agree are necessary and appropriate.
    This is why the FDIC was so determined to press for a more robust 
and more effective SIFI resolution framework as the centerpiece of the 
Dodd-Frank Act. We were early advocates for a SIFI receivership 
authority that operates like the one we have applied thousands of times 
in the past to resolve failed banks. We pushed for liquidation plans by 
the SIFIs that would prove they could be broken apart and sold in an 
orderly manner, and for greater oversight and higher capital in 
relation to the risk these companies pose to financial stability.
    Titles I and II of the Dodd-Frank Act authorize the creation of 
just such a resolution framework that can make the SIFIs resolvable in 
a future crisis. These provisions are designed to restore the 
discipline of the marketplace to the megabanks, to end their ability to 
take risks at the expense of the public, and to eliminate the 
competitive advantage they enjoy over smaller institutions. In January, 
the Financial Stability Oversight Council (FSOC), of which the FDIC is 
a voting member, issued a Notice of Proposed Rulemaking describing the 
processes and procedures that will inform the FSOC's designation of 
nonbank financial companies under the Dodd-Frank Act. In April, the 
Federal Reserve Board (FRB) and the FDIC issued a request for comment 
of a proposed rule that implements the Dodd-Frank Act requirements 
regarding SIFI resolution plans and credit exposure reports. The FDIC 
Board has also approved a Notice of Proposed Rulemaking and an Interim 
Final Rule intended to provide clarity and certainty about how key 
components of the Orderly Liquidation Authority will be implemented. 
These measures will ensure that the liquidation process under Title II 
reflects the Dodd-Frank Act's mandate of transparency in the 
liquidation of covered financial companies.
    Despite the timely progress that has been made in implementing 
these authorities, there remains skepticism as to whether the SIFIs can 
actually be made resolvable in a crisis. I believe the skeptics 
underestimate the benefits of having so much more information about 
these institutions in advance, as well as the authority to require, if 
necessary, organizational changes that better align business lines and 
legal entities well before a crisis occurs. I have also tried very hard 
to dispel the misconception that the Orderly Liquidation Authority is a 
bailout mechanism or, alternatively, a fire sale that will destroy the 
value of receivership assets. It is neither. The Orderly Liquidation 
Authority strictly prohibits bailouts. It is a powerful tool that 
greatly enhances our ability to provide continuity and minimize losses 
in financial institution failures while imposing any losses on 
shareholders and unsecured creditors. It will result in a faster 
resolution of claims against a failed institution, smaller losses for 
creditors, reduced impact on the wider financial system, and an end to 
the cycle of bailouts.
    Strengthening Capital Requirements. The other major lesson of the 
crisis involves the dangers of excessive debt and leverage. The single 
most important element of a strong and stable banking system is its 
capital base. Capital is what allows an institution to absorb losses 
while maintaining the confidence of its counterparties and its capacity 
to lend.
    After the last banking crisis, in the early 1990s, Congress passed 
a number of important banking reforms that included stronger capital 
requirements. However, capital requirements were watered down over the 
years through rules that permitted use of capital with debt-like 
qualities, that encouraged banks to move assets off the balance sheet, 
and that set regulatory capital thresholds based on internal risk 
models. The result was an increase in financial system leverage--
particularly at bank holding companies and nonbank financial 
companies--that weakened the ability of the industry to absorb losses 
during the crisis and that has led to a dramatic deleveraging of 
banking assets in its wake.
    As the crisis has shown, overreliance on leverage is a short-term 
strategy with a big downside over the longer term. That is why the FDIC 
has been so committed to following through on the capital reforms that 
are taking place through the Basel III international capital accord. 
That is also why we have been such strong supporters of other measures 
to enhance capital, including the Collins Amendment to the Dodd-Frank 
Act and the SIFI capital surcharge.
    Last weekend, the Group of Governors and Heads of Supervision, the 
oversight body of the Basel Committee on Banking Supervision (BCBS), 
agreed to some important changes in the capital rules that will 
strengthen the resilience of the largest global systemically important 
banking firms--known as G-SIBs--and will create strong incentives for 
them to reduce their systemic importance over time. The assessment 
methodology for G-SIBs is based on an indicator-based approach, and 
comprises five broad categories: size, interconnectedness, lack of 
substitutability, global (cross-jurisdictional) activity and 
complexity. The agreement provided for capital requirements ranging 
from 1 percent above the Basel 3 minimums to 2.5 percent, depending 
upon the degree of systemic risk posed by each firm.
    Importantly, the agreement requires that the enhanced capital 
requirements be fully satisfied with common equity. The FDIC strongly 
supported this decision to require common equity since it is the only 
instrument which proved to have loss absorbing capacity during the 
crisis. Alternatives such as contingent capital and so-called ``bail-
in'' debt are worthy of further study, but remain untested in crisis 
situations. Our experience and judgment strongly suggest that these 
instruments still represent debt. The only proven buffer against the 
kind of widespread financial distress our system experienced in the 
crisis is tangible equity capital.
    Some banking industry representatives are claiming that higher 
capital requirements will raise the cost of credit and could derail the 
economic expansion. However, we believe the costs of higher capital are 
overstated, and the benefits understated. Recent research that shows 
higher capital requirements, in the range that we are talking about, 
will have a very modest effect on the cost of credit. \3\ Higher 
capital requirements will create a large net improvement in long-term 
economic growth by lessening the frequency and severity of financial 
crises that have historically proved devastating to economic growth. 
Over the long-term, these efforts to strengthen the capital base of the 
industry will benefit all parties concerned--including banks--by making 
our system more stable and less procyclical.
---------------------------------------------------------------------------
     \3\ See, Admati, Anat, Peter M. DeMarzo, Martin R. Hellwig, and 
Paul Pfleiderer. ``Fallacies, Irrelevant Facts, and Myths in the 
Discussion of Capital Regulation: Why Bank Equity Is Not Expensive'', 
Stanford Graduate School of Business Research Paper No. 2065, March 
2011. http://www.gsb.stanford.edu/news/research/Admati.etal.html; 
Hanson, Samuel, Anil Kashyap, and Jeremy Stein. ``A Macroprudential 
Approach to Financial Regulation'', Working paper (draft), July 2010. 
http://www.economics.harvard.edu/faculty/stein/files/JEP-
macroprudential-July22-2010.pdf; Marcheggiano, Gilberto, David Miles, 
and Jing Yang. ``Optimal Bank Capital'', London: Bank of England. 
External Monetary Policy Committee Unit Discussion Paper No. 31, April 
2011. http://www.bankofengland.co.uk/publications/externalmpcpapers/
extmpcpaper0031revised.pdf
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    The fact is that the capital requirements U.S. banks now face are 
mostly the same as those that were in existence before the crisis. The 
reason banks are not lending more is a combination of risk aversion on 
their part and reduced borrower demand. Most banks have plenty of 
capacity to lend. Large banks have been raising capital since the 
crisis started, and most either already meet the new Basel III 
standards, or are well positioned to do so solely through retained 
earnings. Banks that need more time will benefit from the extended 
phase-in periods designed to ensure seamless transition to the new 
standards, including any SIFI surcharge.
    Proprietary Trading and the Volcker Rule. The traditional function 
of banks has been to transform shorter maturity or more liquid 
liabilities into longer-term, less liquid loans. The economic value of 
this function, combined with its inherent susceptibility to depositor 
runs, has long been the justification for Government structures such as 
deposit insurance, the discount window, and Federal bank regulation 
that are designed to preserve stability in banking.
    It is harder to explain why the Government should subsidize a 
trading operation with deposit insurance and other support. This 
question became particularly pointed in the wake of the crisis. Losses 
in banks' trading books were extremely large in the early part of the 
crisis. These losses seriously weakened institutions and contributed to 
a loss of confidence by counterparties, driving the crisis in its early 
stages.
    The Volcker rule bans proprietary trading by banking organizations, 
and prevents them from simply moving proprietary trading operations 
into off-balance sheet vehicles by imposing meaningful limitations on 
bank investments in hedge funds and private equity funds. The statutory 
definition of prohibited proprietary trading is subject to important 
exceptions. In addition to risk-mitigating hedging, the most important 
of these exceptions involve market-making and securities underwriting. 
Notwithstanding the various permissible activity exceptions in the 
Volcker rule, in no event may the regulators permit activities that 
create material conflicts of interest, expose institutions to high-risk 
trading strategies, or threaten financial stability. The regulators 
have considerable discretion in how to interpret and implement the 
Volcker rule. The agencies' staffs have been working intently at 
crafting a proposed rule to implement this important mandate in an 
appropriate manner.
    I view the Volcker rule as a conceptually well-founded limitation 
of the Federal Government's safety-net support of trading operations by 
banking organizations, and I do not believe it presents concerns for 
the competitiveness of the U.S. economy. Any restrictions on activities 
under the rule will affect where risky trades are housed. Unlike credit 
intermediation, where the Federal safety net plays an important role in 
assuring a stable funding base through deposit insurance and access to 
the discount window, there is no public policy rationale for Government 
support of proprietary trading.
    OTC Derivatives Reform. At the June 2010 G-20 Summit in Toronto, 
the leaders reaffirmed a global commitment to trade all standardized 
OTC derivatives contracts on exchanges and clear through central 
counterparties (CCPs) by year-end 2012 at the latest. Further, the 
leaders agreed to pursue policy measures with respect to haircut-
setting and margining practices for securities financing and OTC 
derivatives transactions to enhance financial market resilience. 
Through the Dodd-Frank Act derivatives legislation, the U.S. is taking 
a leadership role in proposing concrete and actionable measures to 
accomplish these international commitments.
    Making good on these commitments is important to avoiding another 
derivatives-related crisis. During the decades leading up to the 
crisis, the perceived wisdom in the regulatory community was that OTC 
derivatives reduced risk in the financial system. The use of these 
essentially unregulated financial products grew exponentially precrisis 
but, at least in the case of credit default swaps (CDS), these products 
proved to hide and concentrate risks rather than mitigate them. Though 
CDS instruments did not cause the crisis, they helped to disguise the 
risks building in mortgage securitizations and greatly magnified the 
losses once securitized mortgages began to default.
    The Dodd-Frank Act has given the SEC and the CFTC important roles 
in addressing the lessons that the financial crisis taught us about 
CDS. For the CDS instruments they regulate, each Commission will 
require standardized CDS instruments to be traded on an exchange and 
cleared through a clearinghouse. They also are charged with setting 
margin and capital requirements for customized CDS instruments that 
cannot be cleared though a clearinghouse. When Section 716 of the Dodd-
Frank Act, the Lincoln amendment, becomes effective, dealer activity in 
uncleared CDS instruments is expected to migrate from banks to nonbank 
dealers that will be subject to the Commission's rules.
    While the SEC and the CFTC have been given important 
responsibilities, they have not been given the resources needed to 
discharge them. Earlier this month, both Commissions announced that 
they would not meet the 1-year deadlines for many of the regulations 
needed to address CDS and other risks in the system. They are now 
projecting completing such rules by December of this year.
    The Greek sovereign debt crisis has renewed scrutiny over the CDS 
market and who will bear the risk in the event of a default. While 
there has been some improvement in information available to regulators, 
risks in this market are highly inter-related, and it is difficult to 
know with certainty the capacity of counterparties to make good on 
their obligations in the event of a major credit event and where the 
ultimate exposure may reside. It is essential that the SEC and CFTC be 
able to move forward with needed reforms in this market. I strongly 
encourage you to ensure that the SEC and the CFTC have the resources 
needed to do their jobs.
The Importance of the Dodd-Frank Reforms to the Economic Recovery
    As the reform process continues, there is understandable concern 
about the slow pace of the economic recovery. The U.S. economy has been 
growing continuously for 2 years now. However, adjusted for inflation, 
consumer spending and non- real estate business investment remain near 
the levels that had been reached just prior to the recession, almost 
3\1/2\ years ago. By almost any measure, the real estate sector remains 
depressed. Meanwhile, the U.S. economy has regained just over 20 
percent of the 8.75 million payroll jobs lost as a result of the 
recession. In fact, there are over 1 million fewer U.S. private sector 
payroll jobs today than there were in December 1999, more than 11 years 
ago.
    While the economic situation merits the utmost concern of policy 
makers, it is important that this concern not be misplaced. The 
challenges facing our economy are not the result of financial reform. 
Instead, they are largely the result of the enormous and long-lasting 
impact the financial crisis has had on U.S. economic activity. The 
pattern of excessive leverage and subsequent financial collapse is not 
unique to the recent U.S. financial crisis but has been repeated many 
times, in many places.
    A Greater Focus on Real Estate Is Needed. One factor that greatly 
complicates the recovery from the crisis is that it is rooted in the 
real estate sector. According to CoreLogic, approximately 10.9 million 
residential mortgage loans--or more than one out of every five 
outstanding--are currently underwater, meaning that the borrower owes 
more than the property is worth. \4\ Underwater borrowers are at high 
risk of default in the event of financial distress because they lack 
the ability to satisfy the loan through the sale of the property. 
Underwater borrowers are also frequently unable to move in order to 
find work when it is available elsewhere.
---------------------------------------------------------------------------
     \4\ See, ``New CoreLogic Data Shows Slight Decrease In Negative 
Equity'', July 7, 2011. http://www.corelogic.com/uploadedFiles/Pages/
About_Us/ResearchTrends/CoreLogic_Q1_2011_Negative_Equity.pdf
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    The fact that so many residential and commercial properties are 
currently underwater goes a long way to explaining the continuing 
weakness of the small business sector, which is so important to the 
creation of new jobs. Almost half of the liabilities of nonfarm 
noncorporate businesses are secured by real estate, both residential 
and commercial. The large and persistent declines in real estate values 
in many areas of the country have hurt both the demand for small 
business products on the part of their Main Street customers as well as 
the ability of small businesses to borrow against the real estate 
collateral they own.
    Although the real estate market downturn is now entering its sixth 
year, signs of recovery remain elusive. Approximately 2.25 million 
mortgages remain mired in a foreclosure process that has been slowed by 
inefficiencies on the part of mortgage servicers, by deficiencies in 
the their handling of the legal paperwork, and by a frustrating 
inability to move quickly enough to modify troubled loans while there 
is still a chance to keep them out of foreclosure.
    In April 2011, the Federal banking agencies ordered 14 large 
mortgage servicers to overhaul their mortgage-servicing processes and 
controls, and to compensate borrowers harmed financially by wrongdoing 
or negligence. The enforcement orders were only a first step in setting 
out a framework for these large institutions to remedy deficiencies and 
to identify homeowners harmed as a result of servicer errors. The 
enforcement orders do not preclude additional supervisory actions or 
the imposition of civil money penalties. Also, a collaborative 
settlement effort continues between the State Attorneys General and 
Federal regulators led by the U.S. Department of Justice. It is 
critically important that lenders fix these problems soon to contain 
litigation risk and remedy the foreclosure backlog, which has become 
the single largest impediment to the recovery of U.S. housing markets 
and our economy. In addition, our combined regulatory and enforcement 
efforts should focus on helping to clear the market through streamlined 
modification protocols, write-offs of second liens where appropriate, 
and, for borrowers who cannot qualify for a loan modification, 
alternatives to the costly and time consuming foreclosure process such 
as ``cash-for-keys'' programs and short sales.
    Returning Banking to the Business of Lending. Over the longer term, 
the highest regulatory priority should be placed on returning the 
banking industry to a primary focus on safe and sound lending that 
supports real economic activity.
    A strong and stable financial system is vital to the economic and 
fiscal health of the U.S. and our competitiveness in the global 
economy. A well-functioning financial system supports economic growth 
by channeling savings into productive investment, allows consumers, 
businesses, and market participants to engage in financial transactions 
with confidence, and is a source of credit to the broader economy even 
in times of stress. The crisis exposed the vulnerabilities of an 
unevenly regulated and highly leveraged U.S. financial system that 
proved to be anything but strong and stable. The excessive leverage in 
the financial system entering the crisis forced a massive deleveraging 
after the credit losses associated with the crisis began to be realized 
in earnest.
    Since the beginning of the recession in December 2007, FDIC-insured 
institutions have set aside some $644 billion in loan loss provisions. 
During this period, loans and leases held by FDIC-insured institutions 
have declined by nearly $750 billion from peak levels, while unused 
loan commitments have declined by $2.7 trillion. This deleveraging, 
resulting from insufficient capital at the outset of the crisis, has 
been accompanied by the virtual disappearance of some important forms 
of nonbank credit intermediation. For example, while annual issuance of 
private mortgage-backed securities exceeded $1 trillion in both 2005 
and 2006, it averaged just $62 billion per year in 2009 and 2010--
almost 95 percent below peak levels.
    Stronger capitalization and stronger financial practices will be 
necessary to restore confidence in our banking system, the lending 
capacity of the banking industry, and the vitality of important nonbank 
credit channels like private mortgage-backed securitization. One of the 
strengths of our financial system is the presence of almost 7,000 
community banks with assets less than $1 billion and over 500 midsized 
banks with assets of between $1 billion and $10 billion. These 
institutions are, on average, much better capitalized than the largest 
institutions, and they earn profits primarily by lending to the local 
small businesses and households that represent the core strength of our 
economy.
    But the competitive position of small and midsized institutions has 
been steadily eroded over time by the Government subsidy attached to 
the Too Big to Fail status of the Nation's largest banks. In the first 
quarter of this year, the cost of funding earning assets was only about 
half as high for banks with more that $100 billion in assets as it was 
for community banks with assets under $1 billion. Stronger and more 
uniform capital requirements, and a resolution framework that subjects 
every institution--no matter its size--to the discipline of the 
marketplace, are necessary steps to level the competitive playing field 
and help return the focus of our banking system to making good loans 
that serve the needs of households and businesses of all sizes in every 
part of the Nation.
    Similarly, new rules recently proposed by the FSOC to require 
issuers of asset-backed securities to retain at least 5 percent of the 
credit risk, as mandated by the Dodd-Frank Act, are necessary to 
restore investor confidence in private securitization markets where 
issuance has virtually disappeared since the crisis began. Requiring 
that securitization deals have at least some equity behind them is 
necessary to give issuers a long-term interest in the performance of 
the underlying loans and to align their incentives with investors. 
Unless the interests of investors are protected in this way, we may not 
see a meaningful recovery in the private issuance of asset-backed 
securities, thereby forcing the vast majority of mortgage lending to 
take place either on bank balance sheets or through Government-
sponsored programs.
    The small extra cost associated with requiring that 5 percent of 
the mortgage pool be funded with equity instead of debt is trivial 
compared to the costs that have already been incurred due to the 
millions of defaults and foreclosures we have experienced in the crisis 
and the ensuing collapse of private securitization. Here again, the 
lesson is clear. Rules that align incentives and that enhance the 
transparency and stability of our financial markets and institutions 
are necessary to restore the capacity of the financial sector to 
support the real economy.
Conclusion
    Through its approval of the reform package embodied in last year's 
Dodd-Frank Act, the Committee took an important step forward in making 
our financial system stronger and more stable over the long term. Amid 
the controversies that accompany implementation of the Act, I urge the 
Committee to maintain this long-term perspective and see essential 
reforms through to completion.
    The implementation process has many facets, and a vigorous debate 
of the details is to be welcomed. But the central lessons of the crisis 
remain clear. The animal spirits that lead private financial 
institutions to new innovations and new efficiencies need clear 
regulatory rules within which to operate. These rules must check the 
inherent tendency of these markets to pursue excessive leverage that 
renders our financial system unstable. Every financial company, no 
matter how large, complex, and interconnected, also must be constrained 
by the discipline of the marketplace and face the credible threat of 
failure.
    The regulators charged with carrying out the implementation of 
these reforms will need your full support and encouragement if they are 
to be successful in their work. The work they have ahead of them is 
considerable, and without proper funding and, where needed, the 
confirmation of qualified leadership, the result could be needless 
uncertainty about the regulatory environment and failure to instill 
confidence in our financial markets and institutions.
    Thank you. I will be glad to take your questions.
        RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
                      FROM SHIELA C. BAIR

Q.1. Chairman Bair, on March 2, 2011, the American Banker, 
published an article that detailed allegations that the FDIC 
improperly used its administrative powers when it conducted an 
unscheduled examination in retaliation for the bank's refusal 
to comply with an FDIC enforcement order. During your testimony 
before the Committee you noted that regulators are ``not 
perfect either, and Congress has a very important role to watch 
what we are doing and make sure that we are doing it the most 
effectively and efficiently as possible.'' While it is the role 
of Congress to oversee regulators to ensure that the law is 
followed, the FDIC has been reluctant to share information with 
the Committee regarding the allegations discussed in the 
American Banker article. Do you agree that the FDIC's use of 
its authority is an appropriate line of Congressional inquiry? 
If so, do you believe that the FDIC should cooperate fully with 
such an inquiry? Were you aware of the decision to initiate the 
enforcement action detailed in the American Banker article and 
if so, did you authorize the enforcement action? If you did not 
authorize the enforcement action, who did and were you aware of 
that person's decision? What information within the possession 
of the FDIC that is related to this matter do you deem to be 
``confidential supervisory information''? Please be specific, 
explain your reasoning and provide legal support for your 
conclusion.

A.1. In recognition of Congress's very important oversight role 
over Federal agencies, the FDIC has a long history of fully 
cooperating with the Committee on requests for information and 
consultations with its staff.
    As FDIC senior staff previously discussed in a telephone 
conference call with senior Senate Banking Committee minority 
staff in March of this year, the documents and other 
information requested by the staff are confidential supervisory 
and law enforcement information concerning an individual 
depository institution, which institution is currently the 
subject of a pending administrative enforcement action under 
section 8 of the Federal Deposit Insurance Act (12 USC 1818). 
We should note that section 8 provides institutions that are 
subject to administrative enforcement actions with significant 
due process protections, including rights to challenge and 
appeal the actions of regulators before an administrative law 
judge and subsequently in Federal courts of appeal.
    As we discussed on the conference call, there are a number 
of Federal laws that protect against the disclosure of 
confidential supervisory information and information related to 
law enforcement proceedings, including administrative 
enforcement actions. The Freedom of Information Act (FOIA), for 
example, exempts from disclosure exam-related information, 
including but not limited to examination reports, and records 
contained in or related to examination, operating, or condition 
reports prepared by, on behalf of, or for the use of the FDIC 
or any agency responsible for the regulation or supervision of 
financial institutions. 5 USC 552(b)(8). The FOIA also exempts 
from disclosure information and records compiled for law 
enforcement purposes, including records the production of which 
could reasonably be expected to interfere with enforcement 
proceedings. 5 USC 552(b)(7). Similarly, beyond the foregoing, 
Congress has criminalized the unauthorized disclosure of 
examinations, investigations, records, or information by an 
officer or employee of the United States or any agency. See, 18 
USC 641; 1905; 1906.
    Of course, Congress has reserved to itself the right to 
obtain information otherwise exempted from disclosure under the 
FOIA. 5 USC 552(d); cf. 18 USC 1906. Under long-standing case 
law and agency practice, however, only the Chairman of a 
Congressional Committee (or Subcommittee) having jurisdiction 
over agencies, through duly authorized direction, has the 
authority to direct the production of confidential information. 
See, Exxon Corp. v. Federal Trade Commission, 589 F.2d 582, 
592-94 (D.C. Cir. 1978).
    Long-standing governmental policy, as reflected in these 
laws enacted by Congress, is intended to foster full 
cooperation and open and frank communications between bank 
regulators and the banks under their supervision without 
concern that these supervisory communications would be made 
public. They also are designed to ensure appropriate 
confidentiality in law enforcement matters. In addition, these 
laws reflect Congressional intent to protect confidential and 
proprietary information unique to individual banks so that they 
are not competitively disadvantaged by disclosures regarding 
their financial and business operations.

Q.2. Chairman Bair, you recently noted that money market funds 
``were an accident waiting to happen, and it did happen'' 
during the 2008 crisis. Money market funds are again a subject 
of concern because of their heavy exposure to European banks 
that hold a lot of Greek debt. If a large money market fund 
failed, would the FDIC have the expertise and resources to 
resolve it under the new resolution regime in Dodd-Frank? If 
so, would investors rather than taxpayers bear all of these 
losses?

A.2. The Dodd-Frank Act gives the FDIC the authority to resolve 
any nonbank financial company that is in default or in danger 
of default if a systemic risk determination is made under the 
Act. Among other things, the Secretary of Treasury (in 
consultation with the President and based on the recommendation 
of the Federal Reserve Board (FRB) and the FDIC) must determine 
that the company is in default or in danger of default, its 
failure would have serious adverse effects on U.S. financial 
stability, no viable private sector alternative exists, and 
action under the Dodd-Frank Act's orderly liquidation authority 
would avoid or mitigate the systemic consequences. In essence, 
the company cannot be dealt with under the existing Bankruptcy 
Code.
    Thus, if a large money market fund were found to be 
systemically important, in default or in danger of default, and 
not resolvable under the Bankruptcy Code, the Secretary of the 
Treasury could appoint the FDIC as receiver.
    To date, only bank holding companies with assets of $50 
billion or more are designated as systemically important 
financial institutions (SIFTs) by statute. The Dodd-Frank Act 
also charges the Financial Stability Oversight Council (FSOC) 
with identifying other SIFTs. As required by the Dodd-Frank 
Act, SIFTs will be required to draft credible resolution plans, 
which will be submitted after the FRB and the FDIC issue a 
joint final rule. Once the resolution plans are submitted, the 
FDIC will review them with the FRB. These so-called living 
wills will provide valuable advance information that will 
assist in implementing an orderly resolution of the financial 
company. If a large money market fund were to be designated as 
a SIFT, that fund would have to draft a credible resolution 
plan, which we would review jointly with the FRB.
    If the FDIC were appointed receiver of a money market fund 
or any other systemically significant failing financial 
company, we would resolve it with no cost to taxpayers, as 
required by the Dodd-Frank Act.

Q.3. Chairman Bair, earlier this year the FDIC published a 
study entitled ``The Orderly Liquidation of Lehman Brothers 
Holdings, Inc., Under the Dodd-Frank Act''. This study asserted 
that had the Dodd-Frank Act been law in 2008, market chaos 
would have been avoided and losses would have been smaller and 
provides specifics on how the FDIC intends to use its 
additional authority. The study relies on certain assumptions 
in its analysis of how the FDIC would have resolved the 
collapse of Lehman. In particular, the FDIC assumes that would 
have been able to find a buyer through ``a competitive bidding 
process and likely would have incorporated either loss-sharing 
to encourage higher bids or a form of good firm-bad firm 
structure in which some troubled assets would be left in the 
receivership for later disposition.'' How would the analysis 
change if the FDIC were unable to find a buyer for Lehman?

A.3. In the event the FDIC would have been unable to find a 
purchaser for Lehman Brothers Holdings Inc (LBHI) at the time 
of its failure, the Dodd-Frank Act authorizes the FDIC, as 
receiver of a covered financial company, to establish a bridge 
financial company to which the assets and liabilities of LBHI 
would have been transferred. Through a bridge company the FDIC 
would be able to continue key operations, services, and 
transactions that would maximize the value of LBHI's assets and 
operations in order to avoid a disorderly collapse in the 
marketplace.
    Certain assets and liabilities of LBHI would be retained in 
the receivership, while other assets and liabilities, as well 
as the viable operations of LBHI would be transferred to the 
bridge financial company. The FDIC also would transfer certain 
qualified financial contracts to the bridge financial company. 
The bridge financial company would operate until the FDIC 
stabilized the systemic functions of LBHI, conducted marketing 
for its assets, received any necessary regulatory approvals 
from foreign regulators for its sale or disposition, and found 
one or more appropriate buyers.
    As noted in the FDIC's paper on LBHI, a bridge financial 
company is a newly established, federally chartered entity that 
is owned by the FDIC and includes those assets, liabilities, 
and operations of the covered financial company as necessary to 
achieve the maximum value from the sale of the firm. 
Shareholders, debt holders, and other creditors whose claims 
were not transferred to the bridge financial company would 
remain in the receivership and receive payments on their claims 
based on the priority of payments set forth in section 210(b) 
of the Dodd-Frank Act. The covered financial company's board of 
directors and most senior management responsible for its 
failure would be replaced. The company's employees and FDIC 
contractors would continue to operate the bridge company under 
the strategic direction of the FDIC. The FDIC may operate a 
bridge financial company for 2 years with up to three 
additional 1-year extensions, although it would be the goal of 
the FDIC to sell the company as quickly as possible.

Q.4. Chairman Bair, until we receive additional data it will be 
difficult to determine the impact that Basel III will have on 
capital levels. Will a quantitative and qualitative analysis of 
the impact of Basel III on the largest banks be performed prior 
to the finalization of the rule? Would you agree to provide 
such an analysis to this Committee in advance of any final 
rulemaking information?

A.4. The capital impact of the Basel III agreement (Basel III) 
is critical to quantify before finalizing and implementing 
Basel III. During the formulation of Basel III, the Basel 
Committee on Banking Supervision (BCBS) conducted a robust 
quantitative analysis similar to those analyses performed as 
part of previous Basel agreements. This quantitative impact 
study included thirteen large U.S. banking organizations; 263 
banks from 23 BCBS member jurisdictions participated in the 
impact analysis (see the results released on December 16, 2010, 
at http://bis.org/publ/bcbsl 86.pdf). This analysis enabled the 
BCBS to reach its final conclusions and recommendations and 
calibrate the capital levels of Basel III. In addition, the 
Federal Reserve released the results of its Comprehensive 
Capital Analysis and Review in March 2011. This analysis 
included an evaluation of the capital plans for addressing the 
expected impact of Basel III, as well as a forward-looking 
evaluation of capital planning and stress-scenario analysis at 
the 19 largest U.S. bank holding companies. The scope of 
application of the Basel III standards in the U.S. and the 
costs and benefits of additional information collection 
regarding such standards outside of the normal notice and 
comment rulemaking process are still being considered.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR HAGAN
                      FROM SHIELA C. BAIR

Q.1. REITs--In the joint rulemaking proposed by the banking 
regulators related to credit risk retention for asset backed 
securities, the regulators specified certain criteria for 
qualifying loans that will be eligible for reduced risk 
retention. The definition of ``commercial real estate loans'' 
includes loans secured by real property that meet other 
requirements. Land and development loans, unsecured loans to 
developers, and loans to a real estate investment trust (REIT) 
were specifically carved out. REITs typically employ low 
leverage and are often publicly traded REITs. Additionally, 
these entities primarily invest in real estate to adhere with 
tax requirements. Could you explain why regulators excluded 
loans to REITs from its definition of ``qualifying commercial 
real estate loans''?

A.1. Although the associated risk is tied to commercial real 
estate (CRE), a loan to a REIT typically does not present the 
same type of risk as a loan secured by a particular CRE 
property. REITs can engage in a single purpose or a variety of 
CRE-related activities, such as renting, buying, operating, 
making CRE loans to others, and selling income-producing real 
estate. As a result, a REIT's primary source of repayment is 
through rental income, management fees, interest income, gain 
on sales, or a combination of these sources. By law, REITs are 
required to distribute 90 percent of the taxable income to 
their investors every year. This requirement creates a 
statutory restraint on the amount of operating income that can 
be retained as reserves and capital for a REIT to meet its 
payments in the event there is a reduction in its income 
stream. Further, investors may impose additional limitations on 
REITs to protect their pass-through tax positions. Given these 
restrictions and the unique risks associated with REITs, the 
regulatory agencies excluded loans to REITs from the definition 
of a qualifying CRE loan. The regulatory agencies encourage 
anyone with an interest in this aspect of the Credit Risk 
Retention proposal to submit a written comment.

Q.2. The Dodd-Frank Act amended the method by which the FDIC 
calculates deposit insurance assessments. Could you explain how 
these changes have affected how you calculate assessments--that 
is, are the assessments still risk based, and if so, is that 
risk the risk of a loss to the deposit insurance fund or the 
risk of loss to the system as a whole? Do the assessments now 
apply to all institutions holding financial assets or only to 
those that offer insured deposits?

A.2. The Dodd-Frank Act did not amend the statutory requirement 
that the FDIC establish a risk-based assessment system for 
insured depository institutions. A risk-based assessment system 
continues to be defined by statute as a system for calculating 
a depository institution's assessment based on the probability 
that the Deposit Insurance Fund (DIF) will incur a loss with 
respect to the institution, the likely amount of any loss, and 
the revenue needs of the DIF. Only insured depository 
institutions are required to pay these assessments.
    As it has since the inception of the risk-based assessment 
system in 1993, the FDIC determines an institution's risk-based 
assessment by multiplying a risk-based assessment rate by an 
assessment base. The Dodd-Frank Act did not change this basic 
methodology. It did, however, provide a statutory definition 
for the assessment base--average consolidated total assets 
minus average tangible equity (with possible modifications for 
the assessment bases of bankers' banks and custodial banks). 
Historically, the assessment base was defined as domestic 
deposits (with some adjustments).

Q.3. I'd like to hear your thoughts on the agreement that the 
Basel Committee on Bank Supervision recently reached with 
respect to capital requirements for global systemically 
important financial institutions.
    I know you addressed some of this in your testimony, but I 
am interested in your assessment of the Basel Committee's 
proposal and in particular, its proposals on contingent capital 
and risk weighted assets.
    I noted that the Basel Committee excluded contingent 
capital and instead required that the surcharge be met with 
Tier One Common Equity. The Committee agreed to review 
Contingent capital, and expressed support for its use for 
certain other purposes. What are your views on contingent 
capital as a tool for meeting the G-SIFI surcharge? It seems to 
me there are a lot of unresolved technical questions around 
contingent capital. And, it is my understanding that these 
instruments have tax benefits in foreign jurisdictions, that 
don't exist here in the United States.

A.3. The FDIC supports the BCBS's position that common equity 
is the most effective form of loss-absorbing capital, and its 
proposal that the G-SIFI surcharge be composed entirely of tier 
1 common equity. Contingent capital is an interesting concept 
that poses a number of potential issues. These include the 
potential liquidity consequences to an institution experiencing 
a conversion, potential downstream effects of a conversion on 
holders of the instrument being converted, and whether policy 
makers would attempt to intervene to prevent a conversion. 
Generally speaking, the experience with hybrid capital 
instruments has been unsatisfactory in terms of their ability 
to absorb losses, and we do not wish to set up a repeat of this 
experience with a new class of innovative capital instruments.

Q.4. One question that, to my understanding, was not addressed 
in the proposal is around Risk Weighted Assets. I have heard 
concerns from U.S. institutions, economists and regulators that 
the way Risk Weighted Assets are calculated and enforced may be 
different across jurisdictions. Is this the case?

A.4. Risk-weighted asset calculations may differ across 
jurisdictions for a variety of reasons. With the ``Advanced 
Approaches'' of Basel II, banks are essentially setting their 
risk-based capital requirements using their own estimates of 
risk. This creates the likelihood of differences in risk-
weighted assets for the same or similar exposures. Similar 
comments apply to the calculation of risk-weights for assets in 
trading accounts, since capital for the trading book is largely 
driven by banks' internal models, the results of which can vary 
widely. The Federal banking agencies have implemented Section 
171 of the Dodd-Frank Act by placing a risk-based capital floor 
under the Advanced Approaches, preventing large U.S. banks from 
reducing their capital requirements below the levels a smaller 
bank would face for the same aggregate exposures.

Q.5. It would seem to me that if we are driving towards 
international standards on capital, it would be important to 
drive towards standards on how risk weighted assets are 
calculated. Wouldn't you agree?

A.5. The Basel Committee has initiated a review of how assets 
are risk-weighted across jurisdictions. All other things equal, 
greater consistency in risk-weighted assets is desirable, and 
the Basel Committee's review may be a useful step towards 
greater consistency. In our view, however, the capital 
requirements produced by the Advanced Approaches are often too 
low and too subjective for comfort, and that is why we have 
supported the Section 171 capital floor as a way of achieving 
risk-weight consistency among U.S. institutions, consistent 
with safety-and-soundness objectives.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
                      FROM SHIELA C. BAIR

Q.1. At the Senate Banking Committee hearing with the FSOC in 
May, I expressed concern that the proposed rule on the 
designation of nonbank financial institutions (as SIFIs) 
essentially restated the statute and did not have enough 
specificity. You seemed to agree that we needed more clarity.
    Can you tell me what progress has been made on developing 
this additional clarity?
    Will it be a proposed rule with a 60-day comment period or 
guidance? If FSOC plans to issue guidance rather than a 
proposed rule, please explain why?

A.1. Over the past several weeks, we have been working with the 
other FSOC members to provide more clarity in the designation 
process for nonbank SIFTs. In response to the comments on the 
SIFT designation Notice of Proposed Rulemaking (NPR) that was 
issued in January 2011, the FSOC plans to issue a guidance 
document with a request for public comment, through which it 
will provide additional specificity with respect to the metrics 
and standards, both quantitative and qualitative, that the FSOC 
expects to use to designate a SIFI. The guidance also may be 
accompanied by a second NPR. Regardless of the form of the 
issuance, we expect the proposal will be published for comment 
for 60 days.

Q.2. The FDIC and Federal Reserve have put out a proposed rule 
on resolution plans or so-called ``living wills'' for 
systemically important financial institutions. My understanding 
is that if the Fed and FDIC determine that a plan is ``not 
credible,'' the consequences are significant--increased capital 
and liquidity requirements, leverage limits, activities limits 
and forced sales, and even structural changes to a firm. The 
proposed rule does not define or go into any specifics on what 
is a ``credible plan''? Given the consequences of a plan being 
deemed ``not credible,'' shouldn't there be more specificity 
regarding what constitutes ``credible''? What is your time 
frame on finalizing the rules?

A.2. We anticipate that the final rule for systemically 
important bank holding companies and nonbank financial 
companies will provide detailed requirements for a resolution 
plan, also known as a ``living will.'' We will continue to work 
with the Federal Reserve Board (FRB) to evaluate and address 
comments received on the proposed rule, to ensure that the 
requirements for resolution plans in the final rule are as 
clear as possible. In addition, the FRB and the FDIC anticipate 
providing additional guidance to the Covered Companies, once 
final rules are in place.
    We expect that we will finalize this rule by late summer.

Q.3. Several provisions of Dodd-Frank carve-out or treat 
smaller banks differently from larger banks. Will the various 
exemptions--from CFPB examination and interchange fee 
regulation, to name a couple--effectively protect smaller 
institutions? Can we have a tiered regulatory approach?

A.3. We agree that the majority of the provisions of the Dodd-
Frank Act should have no direct impact on community banks. The 
legislation's regulatory cost will fall, as it should, directly 
on the large institutions that create systemic risk. The Act 
will help level the competitive playing field between banking 
institutions and nonbanks, which will help preserve the 
essential diversity of our financial system and prevent any 
institution from taking undue risks at the public's expense.
    The FDIC believes that a balanced, even-handed supervisory 
approach for all institutions will ensure safety and soundness, 
adequate consumer protection, and avoid unnecessary regulatory 
burden. Clearly, large systemically important financial 
institutions require continuous on-site supervision to inform 
our regulatory process of systemic and idiosyncratic risks to 
the Deposit Insurance Fund (DIF), the financial markets, and 
the domestic/international economy as a whole. Conversely, 
community banks can be supervised effectively through an 
appropriate set of regulatory requirements with periodic on-
site examinations and off-site surveillance.
    Although our approach to examining the condition of large 
and small institutions differs, the underlying goals of 
prudential supervision remain the same. All institutions are 
bound by a similar set of laws and regulations that promote 
safe-and-sound operation and consumer protection. Large 
institutions, because of their systemic importance and 
regional/national footprint, are subject to more complex 
requirements for capital, the delivery of consumer financial 
products, corporate governance, and financial transparency. 
Community bank requirements are similar, but are more in line 
with their size and complexity of operations. This is 
consistent with the idea that supervision should be tailored to 
the complexity of each institution's business activities and 
the potential risk to financial stability and the DIF.

Q.4. In the prudential regulators? recently proposed 
derivatives margin rule, the FDIC and other regulators proposed 
requiring commercial end users to post margin if the value of 
their trades exceeds a prescribed limit. Congress made it clear 
that it did not intend for margin requirements to apply to end 
users. Why is the intent of the law being disregarded?

A.4. The FDIC understands and appreciates the intent of 
Congress with regard to margin requirements for commercial end 
users. The proposed rule does not explicitly require commercial 
end users to post margin for noncleared derivatives exposures. 
Rather, the proposed rule is consistent with current safe-and-
sound banking practices, which require banking organizations to 
have counterparty exposure limits. As such, commercial end 
users are not required to post margin against derivatives 
exposures provided the entities remain below exposure limits. 
Finally, the proposed rule would not establish minimum 
supervisory exposure limits.

Q.5. It has been brought to my attention that examiners are 
penalizing loan modifications by permanently placing loans on 
nonaccrual status even if the borrower has consistently 
demonstrated a pattern of making principal and interest 
payments on the modified loan. This classification makes the 
banks' capital position appear weak even though they are 
adequately capitalized. The result is their lending ability is 
hampered. Can you tell me what steps the FDIC has taken to 
address this problem?

A.5. The FDIC recognizes the challenges some borrowers face in 
making payments in this difficult economy and real estate 
market. The FDIC has joined several interagency efforts that 
encourage banks to originate and restructure loans to 
creditworthy borrowers and clarify outstanding guidance. For 
example, the Federal banking agencies issued the Interagency 
Statement on Meeting the Needs of Creditworthy Borrowers on 
November 12, 2008, which encouraged banks to prudently make 
loans available in their markets. The agencies also issued the 
Interagency Statement on Meeting the Credit Needs of 
Creditworthy Small Business Borrowers on February 12, 2010, to 
encourage prudent small business lending and emphasize that 
examiners will apply a balanced approach in evaluating loans. 
This guidance was issued subsequent to the October 30, 2009, 
Policy Statement on Prudent Commercial Real Estate Workouts 
(CRE Workouts Guidance) that encourages banks to restructure 
loans for commercial real estate mortgage customers 
experiencing difficulties making payments. The CRE Workouts 
Guidance reinforces long-standing supervisory principles in a 
manner that recognizes that pragmatic actions by lenders and 
small business borrowers are necessary to weather this 
difficult economic period.
    By statute, the accounting principles applicable to the 
regulatory reports that banks file must be uniform and 
consistent with, or no less stringent than, generally accepted 
accounting principles (GAAP). When FDIC examiners identify 
departures from GAAP during examinations, they recommend 
appropriate corrective action. Accounting for loan 
modifications that represent concessions granted to borrowers 
experiencing financial difficulties, generally known as 
troubled debt restructurings, is governed by GAAP, which deems 
such loans to be impaired. Usually, a loan that undergoes a 
troubled debt restructuring already will have been identified 
as impaired because bank management will have determined before 
the modification that collection of all amounts due according 
to the original contractual terms is not probable.
    The banking agencies' reporting instructions for the 
Consolidated Reports of Condition and Income include long-
standing guidance that specifies the circumstances in which a 
nonaccrual loan can be restored to accrual status. With respect 
to a troubled debt restructuring of a nonaccrual loan, when a 
well-documented credit evaluation of the borrower's financial 
condition provides reasonable assurance of repayment and 
performance according to the loan's modified terms, the loan 
need not be maintained in nonaccrual status. In response to 
your specific concern, we are not aware of a practice where 
examiners require banks to ``permanently'' place modified loans 
in nonaccrual status even though principal and interest 
payments are being made in accordance with the revised 
contractual terms. Because such a practice conflicts with our 
reporting instructions, we would invite bankers to provide 
examples of loans modified in troubled debt restructurings 
where permanent nonaccrual treatment has been directed, which 
would enable us to review and act on these cases.
              Additional Material Supplied for the Record
   LETTER SUBMITTED BY WAYNE A. ABERNATHY, EXECUTIVE VICE PRESIDENT, 
FINANCIAL INSTITUTIONS POLICY AND REGULATORY AFFAIRS, AMERICAN BANKERS 
                              ASSOCIATION


LETTER SUBMITTED BY WILLIAM B. GRANT, CHAIRMAN OF THE BOARD, PRESIDENT, 
         AND CHIEF EXECUTIVE OFFICER, FIRST UNITED BANK & TRUST






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