[Senate Hearing 113-58]
[From the U.S. Government Publishing Office]



                                                         S. Hrg. 113-58
 
          LESSONS LEARNED FROM THE FINANCIAL CRISIS REGARDING 

                          COMMUNITY BANKS
=======================================================================


                                HEARING

                               before the

                              COMMITTEE ON

                   BANKING,HOUSING,AND URBAN AFFAIRS

                          UNITED STATES SENATE

                    ONE HUNDRED THIRTEENTH CONGRESS

                             FIRST SESSION

                                   ON

   EXAMINING THE MAJOR TRENDS AFFECTING COMMUNITY BANKS AND LESSONS 
    LEARNED FROM COMMUNITY BANK FAILURES DURING THE FINANCIAL CRISIS

                               __________

                             JUNE 13, 2013

                               __________

  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              MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York         RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon                 MARK KIRK, Illinois
KAY HAGAN, North Carolina            JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia       TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts      DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota

                       Charles Yi, Staff Director

                Gregg Richard, Republican Staff Director

                  Laura Swanson, Deputy Staff Director

                   Glen Sears, Deputy Policy Director

                    Phil Rudd, Legislative Assistant

                  Greg Dean, Republican Chief Counsel

              Jelena McWilliams, Republican Senior Counsel

                       Dawn Ratliff, Chief Clerk

                      Kelly Wismer, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)


                            C O N T E N T S

                              ----------                              

                        THURSDAY, JUNE 13, 2013

                                                                   Page

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

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

                               WITNESSES

Richard A. Brown, Chief Economist, Federal Deposit Insurance 
  Corporation....................................................     3
    Prepared statement...........................................    18
    Responses to written questions of:
        Senator Crapo............................................    46
Jon T. Rymer, Inspector General, Federal Deposit Insurance 
  Corporation....................................................     5
    Prepared statement...........................................    21
    Responses to written questions of:
        Senator Crapo............................................    48
Lawrance L. Evans, Jr., Director, Financial Markets and Community 
  Investment, Government Accountability Office...................     6
    Prepared statement...........................................    26
    Responses to written questions of:
        Senator Crapo............................................    52

                                 (iii)


  LESSONS LEARNED FROM THE FINANCIAL CRISIS REGARDING COMMUNITY BANKS

                              ----------                              


                        THURSDAY, JUNE 13, 2013

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:27 a.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. I apologize for being a bit late, but the 
vote was called. Good morning. I call this hearing to order.
    Today we will discuss three recent studies on community 
banks: the GAO's study, ``Causes and Consequences of Recent 
Bank Failures''; the FDIC Inspector General's ``Comprehensive 
Study on the Impact of the Failure of Insured Depository 
Institutions''; and the ``FDIC Community Banking Study''.
    Between January 2008 and December 2011, 414 insured U.S. 
banks failed. Of these, 353 were depository institutions with 
less than $1 billion in assets. Despite these failures, over 
7,000 small financial institutions survived. We know that 
community banks did not cause the financial crisis, but many 
were casualties of the Great Recession that followed.
    Community banks entered the crisis with strong capital and, 
despite weakening earnings, most of them remained well 
capitalized through the crisis. However, some banks saw an 
increase in nonperforming loans and a decrease in income that 
strained their capital levels.
    I look forward to today's witness testimony. The FDIC, the 
GAO, and FDIC IG have taken important steps to analyze the 
impact of the financial crisis on community banks, and 
specifically the GAO and IG studies looked at the factors that 
contributed to the bank failures during this period. All three 
studies have provided lessons learned from the crisis regarding 
community banks and have made recommendations that would 
strengthen the community bank model and improve regulation and 
supervision.
    Since community banks play such a vital role in so many 
cities and towns of all sizes, including many in my home State 
of South Dakota, it is important for this Committee to explore 
major trends affecting community banks and lessons learned from 
the financial crisis. It is my hope that this Committee can 
find consensus and ways to strengthen community banks and the 
communities they serve without undermining safety and soundness 
regulation or consumer protection.
    Ranking Member Crapo, do you have an opening statement?

            OPENING STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Yes, Mr. Chairman, and thank you.
    Today the Committee will hear about the lessons we have 
learned from the financial crisis regarding community banks. I 
want to thank the FDIC and the GAO for coming to testify 
pursuant to a statutory requirement to brief us on bank 
failures and their causes.
    This is a critical issue since small banks represent the 
lifeblood of many communities across America, and especially 
rural communities, in Idaho and elsewhere. In fact, the FDIC's 
Community Banking Study, commissioned by Chairman Marty 
Gruenberg, shows that community banks hold the majority of 
banking deposits in rural counties, with one in five U.S. 
counties having no other banking presence.
    Banking used to be a community-based enterprise, relying on 
local knowledge and expertise to extend credit based on 
creditworthiness of the bank's depositors. Many community banks 
continue to operate that way even today.
    Despite the many benefits of such relationship-based 
banking, the industry has become increasingly concentrated 
since the 1980s. The number of banking organizations has shrunk 
by nearly one-third from 1990 to 2006, and most of this 
contraction has involved small community banks whose numbers 
have now fallen by more than 3,000 during that time.
    The financial crisis of 2008 only exacerbated the 
consolidation trend. Between January 2008 and December 2011, 
414 U.S. banks failed, according to the GAO. Of those, 85 
percent, or 353 banks, had less than $1 billion in assets. 
Those banks often specialized in small business lending, so 
their failure has had a disproportionately large impact on 
small business lending and local employment.
    We must carefully examine what led to such a large number 
of small banks closing and the residual effect on local 
communities.
    We also need to be able to put this most recent crisis in 
perspective and examine how it compares to past community bank 
crises. While this hearing is focused on lessons learned from 
the most recent financial crisis, much can be learned from the 
postcrisis response as well. The regulatory framework that 
emerged out of Dodd-Frank has made it increasingly difficult 
for community banks to maintain and operate their business 
presence in many communities. Community banks are 
disproportionately affected by increased regulation because 
they are less able to absorb the additional cost.
    The majority of community banks today have $250 million or 
less in assets, according to the GAO, which often translates 
into a one- or two-person compliance department. Small 
institutions simply do not have the resources necessary to 
review and parse through thousands of pages of new rules. As a 
result, many community and small banks have identified Dodd-
Frank as imposing overwhelming regulatory burdens on them or 
serving as barriers to entry.
    As Federal Reserve Governor Duke outlined in a November 
2012 speech, ``If the effect of a regulation is to make a 
traditional banking service so complicated or expensive that 
significant numbers of community banks believe they can no 
longer offer that service, it should raise red flags and spur 
policy makers to reassess whether the potential benefits of the 
regulation outweigh the potential loss of the community bank's 
participation in that part of the market.''
    I believe we have reached that point, and I look forward to 
the testimony from our witnesses today.
    Thank you, Mr. Chairman.
    Chairman Johnson. Thank you, Senator Crapo.
    Are there any other Members who wish to make a brief 
opening statement?
    [No response.]
    Chairman Johnson. Thank you all.
    I want to remind my colleagues that the record will be open 
for the next 7 days for opening statements and any other 
materials you would like to submit. Now I will introduce our 
witnesses.
    Mr. Richard Brown is Chief Economist at the FDIC.
    The Honorable Jon T. Rymer is Inspector General of the 
FDIC.
    Mr. Lawrance L. Evans, Jr., is Director for Financial 
Markets and Community Investment at the GAO.
    I thank all of you for being here today. I would like to 
ask the witnesses to please keep their remarks to 5 minutes. 
Your full written statements will be included in the hearing 
record.
    Mr. Brown, you may begin your testimony.

STATEMENT OF RICHARD A. BROWN, CHIEF ECONOMIST, FEDERAL DEPOSIT 
                     INSURANCE CORPORATION

    Mr. Brown. Chairman Johnson, Ranking Member Crapo, and 
Members of the Committee, I appreciate the opportunity to 
testify on behalf of the FDIC regarding the FDIC Community 
Banking Study. This research effort was initiated in late 2011 
to better understand the changes that have taken place among 
community banks over the past quarter century. This effort was 
motivated by our sense of the importance of community banks to 
small businesses and local economies in every part of the 
country and by our understanding that community banks have 
faced a number of challenges in the postcrisis financial 
environment.
    Our research confirms the crucial role that community banks 
play in our financial system. As defined by the study, 
community banks represent 95 percent of all U.S. banking 
organizations. They account for just 14 percent of U.S. banking 
assets but hold 46 percent of the industry's small loans to 
farms and businesses.
    While their share of total deposits has declined over time, 
community banks still hold the majority of bank deposits in 
rural and other nonmetropolitan counties. Without community 
banks, many rural areas, small towns, and urban neighborhoods 
would have little or no physical access to mainstream banking 
services. The study identified 629 counties where the only 
banking offices are those operated by community banks.
    Our study examined the long-term trend of banking industry 
consolidation that has reduced the number of banks and thrifts 
by more than half since 1984. But the results cast doubt on the 
notion that future consolidation will continue at this same 
pace or that the community banking model is in any way 
obsolete.
    Since 1984, more than 2,500 institutions have failed, with 
the vast majority failing in two crisis periods. To the extent 
that future crises can be avoided or mitigated, bank failures 
should contribute much less to future consolidation. About 80 
percent of the consolidation that has taken place resulted from 
eliminating charters within bank holding companies or from 
voluntary mergers, and both of those trends were facilitated by 
the relaxation of geographic restrictions on banking that took 
place in the 1980s and the early 1990s.
    But the pace of voluntary consolidation has slowed over the 
past 15 years as the effects of these one-time changes were 
realized.
    The study also showed that community banks that grew 
prudently and that maintained diversified portfolios or 
otherwise stuck to their core lending competencies exhibited 
relatively strong and stable performance over time, including 
during the recent crisis. By comparison, institutions that 
pursued more aggressive growth strategies underperformed.
    The strongest performing lending groups across the entire 
study period were community banks specializing in agricultural 
lending, diversified banks with no single specialty, and 
consumer lending specialists. Agricultural specialists and 
diversified nonspecialists also failed at rates well below 
other community banks during the study period. Other types of 
institutions that pursued higher-growth strategies--frequently 
through commercial real estate or construction and development 
lending--encountered severe problems during real estate 
downturns and generally underperformed over the long run.
    Now, with regard to measuring the costs of regulatory 
compliance, the study noted that the financial data collected 
by regulators does not identify regulatory costs as a distinct 
category of noninterest expenses. As part of our study, the 
FDIC conducted interviews with a group of community banks to 
try to learn more about regulatory costs. Most participants 
stated that no single regulation or practice had a significant 
effect on their institution. Instead, most said that the strain 
on their organization came from the cumulative effects of a 
number of regulatory requirements that have built up over time. 
Several of those interviewed indicated that they have increased 
staff over the past 10 years to support their responsibilities 
in the area of regulatory compliance. Still, none of the 
interview participants said that they actively track the 
various costs associated with compliance, citing the 
difficulties associated with breaking out those costs 
separately.
    In summary, despite the challenges of the current operating 
environment, the study concluded that the community banking 
sector will remain a viable and vital component of the overall 
U.S. financial system for the foreseeable future.
    Thank you for the opportunity to testify, and I look 
forward to your questions.
    Chairman Johnson. Thank you, Mr. Brown.
    Mr. Rymer, please proceed.

 STATEMENT OF JON T. RYMER, INSPECTOR GENERAL, FEDERAL DEPOSIT 
                     INSURANCE CORPORATION

    Mr. Rymer. Thank you, Chairman Johnson, Ranking Member 
Crapo, Senator Warren. Thank you for the opportunity to testify 
today on the lessons learned from the financial crisis. As you 
requested, I will focus my remarks on the study my office 
conducted on the impact of the failure of insured financial 
institutions. I will summarize the study's overarching 
conclusions and general observations. In addition, I will 
highlight some of the work my office has completed over the 
last 5 years that could contribute to the Committee's ``lessons 
learned'' discussion.
    The events leading to the financial crisis, and the 
subsequent efforts to resolve it, involved the dynamic 
interplay of laws, regulations, agency policies and practices 
with the real estate and financial markets. Banks expanded 
lending, fueling rapid growth in construction and real estate 
development. Many of the banks that failed did so because 
management relaxed underwriting standards and did not implement 
adequate oversight and control.
    For their part, many borrowers did not always have the 
capacity to repay loans and, in some cases, pursued many 
projects without considering all the risks involved.
    As for the regulators, while they generally fulfilled their 
responsibilities, most of the material loss reviews conducted 
by the three bank regulatory IGs found that the regulators 
could have provided earlier and greater supervisory attention 
to troubled banks and thrifts.
    Four general observations emerged from our study, and they 
are as follows:
    First, the FDIC's resolution methods--including the shared 
loss agreements--were market driven. Often, failing banks had 
poor asset quality and little or no franchise value, and as a 
result did not attract sufficient interest from qualified 
bidders for the FDIC to sell the banks without a loss-share 
guarantee. The FDIC used these agreements to leave failed bank 
assets in the financial services industry, thereby supporting 
asset values and reducing losses to the Deposit Insurance Fund, 
or the DIF.
    Second, most community bank failures were the result of 
aggressive growth, asset concentrations, poor underwriting, 
deficient credit administration, and declining real estate 
values.
    Third, we found that examiners generally followed and 
implemented longstanding policies. However, they did not always 
document all of the examination steps they performed.
    And, fourth, the FDIC has investment-related policies in 
place to protect the DIF and to ensure the character and 
fitness of potential investors.
    In my remaining time, I would like to highlight some of the 
other work my office has completed related to the financial 
crisis.
    My office has conducted over 270 reviews of failed banks to 
determine the reason for the failure and, in many cases, to 
assess the FDIC's supervisory performance as the primary 
Federal regulator of these banks.
    In addition to these reviews, we separately summarized the 
major causes, trends, and common characteristics of bank 
failures. In a December 2010 report, we examined the FDIC's 
supervisory actions taken up to that point in the crisis and 
offered recommendations geared to further enhance the FDIC's 
supervisory program.
    Although our focus was primarily on failed banks, we have 
also looked to gain an understanding of why similarly situated 
banks did not fail. Our findings from an October 2012 report 
were not surprising as essentially they confirmed that 
planning, risk management, and strong leadership at both the 
bank management and board levels are the key ingredients to a 
successful bank.
    Finally, my office, along with the other two bank 
regulatory IGs, looked at the use and impact of prompt 
regulatory actions established in the FDI Act. In a September 
2011 report, we found that prompt corrective actions occurred 
too late to rescue most troubled institutions. And while 
critically undercapitalized institutions were closed promptly, 
the losses to the DIF were still significant.
    In closing, the main lessons that should be learned from 
the work we did during the crisis is for the FDIC to remain 
vigilant in its supervisory activities in both good economic 
times and in bad. Focusing examination attention on key 
processes and risk management before an institution experiences 
financial and capital decline is the supervisory key to 
maintaining healthy banks.
    FDIC management must ensure that the lessons learned from 
the crisis become ingrained in its day-to-day operations in 
order to avoid a repeat of the last 5 years. We must all 
realize that these lessons will become more difficult to apply, 
or sustain, as the economy improves and banks return to 
profitability.
    This concludes my prepared statement. Thank you for the 
opportunity to be here today and join in this discussion. I 
look forward to answering your questions.
    Chairman Johnson. Thank you, Mr. Rymer.
    Mr. Evans, please proceed.

   STATEMENT OF LAWRANCE L. EVANS, JR., DIRECTOR, FINANCIAL 
  MARKETS AND COMMUNITY INVESTMENT, GOVERNMENT ACCOUNTABILITY 
                             OFFICE

    Mr. Evans. Chairman Johnson, Ranking Member Crapo, and 
Senator Warren, I am pleased to be here this morning to discuss 
our January 2013 report on bank failures.
    Between 2008 and 2011, 414 insured U.S. banks failed. Since 
then, there have been 67 additional failures. Examining failed 
institutions, especially in contrast to their nonfailing peers, 
provides an opportunity to glean lessons learned that may be 
useful for regulators and policy makers going forward. Whereas 
my written statement covers a number of issues, my oral remarks 
today will focus on the causes of community banks failures.
    As we detailed in our report, 72 percent of the failures 
were concentrated in 10 States--in the West, Midwest, and 
Southeast. Almost all the failures involved small and medium-
size banks. As mentioned, 85 percent of the banks had less than 
$1 billion in assets at the time of failure. Our analysis of 
these failures revealed four key issues.
    First, the failures were associated with high 
concentrations in commercial real estate, particularly 
acquisition, development, and construction loans. These loans 
grew rapidly and exceeded the regulatory thresholds for 
heightened scrutiny by a significant margin. ADC concentrations 
at failed banks grew from roughly 100 percent of total risk-
based capital to nearly 260 percent in 2008. At the onset of 
the financial crisis, ADC loans made up 30 percent of the total 
loans at failed banks, roughly 20 percentage points higher than 
at their open peers.
    Second, ADC and CRE concentrations were often associated 
with aggressive growth, poor risk management, weak credit 
administration, and risky funding sources. In some cases, IG 
reviews noted that failed banks engaged in lending outside of 
their normal geographical trade areas where they had no 
experience. We found that 28 percent of the failed banks had 
been chartered for less than 10 years at the time of their 
failure. According to regulators, many of these were formed to 
take advantage of the commercial real estate boom but lacked 
the experience necessary to manage the risks associated with 
heavy concentrations.
    FDIC staff noted that in many cases these young failed 
banks departed sharply from the approved business plan 
originally filed with the FDIC. Our econometric analysis found 
that banks with higher ADC concentrations and greater use of 
broker deposits were more likely to fail, while banks with 
better asset quality and greater capital adequacy were less 
likely to fail over the 2008-11 period.
    Our model found that high concentrations of CRE loans 
unrelated to acquisition, development, and construction did not 
increase the likelihood of failure, of course, abstracting from 
extreme concentrations.
    Third, the majority of the assets held by failing banks 
were not subject to fair value accounting. In fact, less than 1 
percent of the assets held by failed banks were subject to fair 
value accounting on a recurring basis. We found that the 
biggest contributors to credit losses at failed institutions 
were nonperforming loans recorded at historical costs.
    Significant declines in real estate values contributed to 
these losses because, as collateral-dependent loans suffered 
impairment, accounting rules required that they be written down 
to the value of the collateral.
    Last, loan loss reserves were not adequate to absorb credit 
losses, in part because the accounting model for estimating 
credit losses is based on historical loss rates or incurred 
losses. As a result, estimated losses were based on economic 
conditions that understated default risk. As the level of 
nonperforming loans began to rise during the crisis, banks were 
forced to increase loan loss allowances and raise capital when 
they were least able to do so.
    To address this issue, accounting standard setters have 
proposed a more forward-looking approach that focuses on 
expected losses and would, therefore, incorporate a broader 
range of credit information. If operationalized, an expected 
loss model could potentially reduce the cycle of losses and 
failures that emerged in the recent crisis and could also 
encourage prudent risk management practices.
    Federal Reserve staff noted that if management at failed 
banks were forced to recognize loan losses earlier, it may 
provided an incentive to limit concentrations and the types of 
loans that later resulted in significant losses.
    Chairman Johnson, Ranking Member Crapo, and Members of the 
Committee, this concludes my opening statement. I will be happy 
to answer any questions you have.
    Chairman Johnson. Thank you, Mr. Evans, and thank you very 
much for your testimony.
    As we begin questions, I will ask the clerk to put 5 
minutes on the clock for each Member.
    Mr. Evans and Mr. Rymer, with the vast majority of 
community banks that survived the financial crisis, what 
characteristics based on your research helped them survive? 
What lessons should community banks and regulators learn from 
those that failed? Mr. Rymer, let us begin with you.
    Mr. Rymer. Yes, sir, thank you. I think that is a great 
question to start with. We did do a study on that particular 
question a couple of years ago. We looked at banks that did 
have--I think all three of us have noted that concentrations in 
ADC--acquisition, development, and construction lending in 
commercial real estate--such concentrations, which had been a 
problem at many of the failures. We identified over 400 banks 
during the period of 2007 to 2011 that had concentrations of 
300 percent or more of capital in ADC loans.
    We looked at a particular group of those banks, 18 banks in 
that group that were high-performing or well-performing banks, 
either CAMELS--rated 1 or 2, and what we found in those banks 
was that the common characteristics were strong and engaged 
board leadership, strong management, a focus on local markets, 
strong core funding or local funding, and a focus on risk 
management and planning.
    So, in net, it is all the things that you would expect a 
well-run bank or a well-run business to do. I think the key is, 
in those community banks that are actively engaged in ADC 
lending, to recognize the risks associated with that business 
line and invest in the controls and management to manage that 
risk.
    Chairman Johnson. Mr. Evans.
    Mr. Evans. So I will speak on net here because our findings 
were quite similar. We found that it was unhealthy 
concentrations in acquisition, development, and construction 
loans that were very important. And I think that underlies the 
core issues, which were poor risk management and aggressive 
growth. So I think, in this case--and we saw this across all 
banks, even the large institutions--we saw poor risk 
management, aggressive growth strategies, and weak credit 
administration practices. It just materialized a bit different 
for the small banks as opposed to their larger peers, and their 
larger peers were, of course, concentrated in nontraditional 
residential mortgage loans. And, of course, with the community 
banks, it was large and unhealthy concentrations in 
acquisition, development, and construction loans.
    Now, to build on the October 2012 report that the IG 
referred to, we also have some findings that are consistent 
with those findings. We found through our rigorous econometric 
analysis that CRE concentrations themselves, once you control 
for capital adequacy and asset quality, did not lead to an 
increased likelihood of failure. Of course, these were non-ADC 
portions of commercial real estate, so your strip malls and 
your gas stations and the like. That abstracts again from very 
large and significant concentrations of, say, 600 percent, 
something well beyond the regulatory thresholds that would 
trigger additional scrutiny.
    Chairman Johnson. Mr. Brown, have community banks fully 
recovered from the financial crisis? And how have community 
banks strengthened their balance sheets since the crisis?
    Mr. Brown. Chairman Johnson, community banks have made 
significant progress in overcoming the challenges they faced in 
the crisis. They still have some way to go. As a group, as we 
have defined them in our study, they earned a pretax return on 
assets of 1.06 percent in 2012. That is an update to our study. 
That is 3 times more than their profitability in 2010, so that 
gives you a sense of the progress that they have made.
    But as our study documented, half of the loan portfolios of 
these institutions are real estate secured, and real estate is 
still in a difficult situation in many parts of the country. 
Problem loan levels remain elevated, and that is one of the 
reasons that loan growth remains slow.
    Now, the community banks were steady providers of credit 
during the depths of the crisis. I think the noncommunity banks 
showed much larger contractions in the credit that they 
provided. But community bank loans have grown slowly recently, 
largely because of the loans secured by nonfarm, nonresidential 
properties, in many cases where real estate serves as 
collateral for what otherwise is a commercial loans. So there 
are still some challenges that they face.
    Chairman Johnson. Senator Crapo.
    Senator Crapo. Thank you very much, Mr. Chairman.
    Mr. Evans, in December 2012, the FDIC issued a 
comprehensive report on community banks, and some of the 
findings of that report suggest that bank consolidation has 
very real consequences for the economy because community banks 
and small banks play such a vital role in the local source of 
credit. Yet some industry observers are estimating that nearly 
2,000 banks will need to be acquired or to sell their assets in 
the aftermath of the crisis. Others speculate that 90 percent 
or more of small banks with less than $1 billion in assets are 
not likely to survive.
    First of all, did you agree with this assessment that the 
smaller banks still face a very serious potential of not 
surviving in large numbers? And what can the FDIC do given the 
causes that you have just identified and discussed with us of 
so much of the failure, what can the FDIC do to ensure that 
community banks, especially in rural areas, do survive?
    Mr. Evans. Very important question, especially given the 
importance of community banks for local communities.
    I would say our work here is fairly limited that would 
allow me to answer this question. But I will note that as of 
the end of the first quarter of 2013, there were 612 banks on 
the problem bank list. So that indicates that there are still 
issues that need to be worked through.
    I think some of the issues with respect to community banks, 
where the examiners can play a more significant role, is 
determining what it really means when concentration thresholds 
are exceeded, and they say it requires additional scrutiny or 
heightened scrutiny. What does that mean? Because it is really 
those significant concentrations that contributed to the 
problems that we saw across the board.
    And, again, just regulators in general, there are a number 
of issues we should be thinking about in terms of regulatory 
burden and right-sizing regulations.
    Senator Crapo. I know you have studied the regulatory 
burden that our community banks or smaller banks have faced. 
Could you give us any--just comment on what your conclusions 
are with regard to whether we have too excessive a burden right 
now or whether we need to fine-tune the approach that we have 
taken?
    Mr. Evans. Right. So, I mean, and this is an important 
issue. It is important to frame it appropriately, and I think 
there is a minimization problem that we are trying to solve, so 
we are trying to minimize regulatory burden on institutions, 
especially when some of the regulations were designed to impact 
the largest, most complex and internationally active 
institutions.
    So, clearly, there is a minimization problem that needs to 
be solved here, but there is a constraint, and that constraint 
is safety and soundness. So framing the debate in that way 
suggests that it is important for regulators to use their 
flexibility as granted by Dodd-Frank to offer exemptions and 
tier these regulations appropriately.
    Again, that having been said, safety and soundness is an 
important concern. Certain regulations are certainly 
appropriate for banks of all sizes. And so starting to have 
that dialog I think will be appropriate in determining where we 
can tier and right-size some of these regulations.
    Senator Crapo. Thank you.
    Mr. Rymer, in the time I have got left, I would like to 
talk with you about the examination process just briefly. The 
FDIC has reviewed its examination rulemaking and guidance 
processes during 2012, and as a result of that review, the FDIC 
has implemented a number of enhancements to its supervisory and 
rulemaking processes.
    What feedback, if any, have you received from your 
revisions from the institutions that are being supervised? How 
is this working?
    Mr. Rymer. Well, very little direct feedback from the 
industry. Those changes to the FDIC's supervisory processes are 
very recent, but many of those changes I believe were 
responsive to some of the work we did in our 2009 and 2010 
reports.
    The FDIC, in general, is focused on community bank 
examination, and I know this Committee is very interested in 
that issue. I know we received a letter from Chairman Johnson, 
I believe early last year, on that very topic. We have looked 
at examination frequency and examination consistency. It is my 
view that the FDIC is taking more of a risk-based approach to 
spending more examination time, frankly, on banks that may 
deserve it. There is an awareness in the agency that banks are 
in the business of banking, not in the business of complying 
with regulation, although regulation, as it has been noted, is 
critical to the business.
    Banking is a highly regulated industry. It does receive 
support in the sense of insured deposits from the FDIC, so the 
FDIC does have a duty to protect those deposit insurance funds. 
But I think there is an acknowledgment within the FDIC through 
the more risk-focused examination process and its attention to 
the community banking industry through some of the work that 
Rich and his staff has done and then Chairman Gruenberg's 
recently forming of a community bank advisory council. There 
seems to me to be a focus within the institutions, the FDIC, 
and the industry as a whole about the critical importance of 
the examination process.
    Senator Crapo. Thank you.
    Chairman Johnson. Senator Warren.
    Senator Warren. Thank you, Mr. Chairman, thank you, Ranking 
Member Crapo, for holding this hearing, and thank you all for 
being here.
    I believe we need banks of all sizes, including community 
banks. Community banks are important because they increase 
consumer choice, they promote competition, they counteract the 
concentration that we have with too-big-to-fail banks.
    But one of the principal benefits that community banks 
bring us is lending to small businesses, and I think the data 
show that disproportionately it is our community banks that are 
out there making these loans to small businesses.
    The smallest banks, those with $250 million or less in 
assets, account for only 4 percent of the assets in the banking 
industry. And yet they constitute 13.7 percent of all the 
business loans out there. So small businesses really count on 
these community banks.
    When I was working on the Congressional Oversight Panel 
during the crisis, we warned about the concentration in the 
banking industry and about the impact it would have on small 
business lending. And here we are 5 years out now, still 
worrying about concentration in the industry.
    So what I would like to do is just give you a chance here, 
Mr. Evans, if you could talk for just a minute about the GAO's 
findings in your report about the impact that concentration in 
banking has on small business lending.
    Mr. Evans. OK. So in this particular report, when we looked 
at concentration what we were trying to get at is whether the 
bank failures created the types of concentration concerns that 
would trigger potential anticompetitive effects. And so in this 
particular report, when we looked at it, we saw that the 
acquiring banks generally stepped in and limited concentration 
levels from going above that point where we would be concerned 
about anticompetitive effects.
    Senator Warren. Well, let me push back, though, just a 
little bit on that, Mr. Evans, because part of the concern I 
have is not simply whether there is physically a bank outlet 
operated somewhere, but that community banks do more small 
business lending, and once they are swallowed up by big banks, 
whether they are swallowed up because they were failing or 
whether they were just bought up, whether they were gobbled up 
by the big banks, that what we see is that small businesses 
have much more trouble getting access to capital.
    Mr. Evans. Right, and that is one of the things we really 
could not get at in the study, but we do point it out. We point 
out that the patterns of lending could change because of some 
of these acquisitions. And those institutions and borrowers 
likely to be most hurt would be those that rely on their local 
community banks for small business loans.
    Senator Warren. Good. Then let me just follow up on a 
question that Senator Crapo had put out on the table about how 
we maintain a strong environment for our community banks, 
because they are so important to the rest of our economy.
    You know, after the crisis, there was just nearly a panic 
about people who could not get access to credit. One of the 
responses, of course, was Dodd-Frank, but one of the concerns 
that I have is that in Dodd-Frank we now have a regulatory 
system that, while Dodd-Frank made some distinctions between 
large and small banks, small banks are still subject to many 
regulations that were written for the larger financial 
institutions.
    And so what I am concerned about is that we now have a 
regulatory system for which many parts of it are neutral on its 
face, but the impact on smaller financial institutions that 
cannot afford to hire an army of lawyers to go and interpret 
these rules turns out to be crushing.
    So the question I want to ask, and I hope we have time that 
I can ask it of all of you, is whether or not we are reaching a 
point where we should really think about a two-tiered 
regulatory system.
    Mr. Rymer, would you like to address that?
    Mr. Rymer. Yes, ma'am, to the extent I can. We have not, 
again, done a lot of work in that area in terms of post- Dodd-
Frank. Our focus on Dodd-Frank will be--as we have some work 
planned--related to the effect of Dodd-Frank. We are planning 
work later this fall to look at whether examination efforts are 
coordinated between the CFPB and the primary Federal regulators 
as it relates to regulatory burden, and there are clear 
dividing lines between CFPB responsibilities in a bank and the 
primary Federal regulator.
    But I think the broader question that you are asking is 
what can the regulators do and potentially the Congress do to 
encourage or improve the health and sustainability of the 
community bank model. Frankly, I think whatever we can do to 
encourage profitability and encourage the types of positive 
behaviors in a community bank that make it successful. The key 
to community banking, frankly, is profitability. The majority 
of banks that have evaporated from the community bank landscape 
have done so through merger and acquisition, and that is 
because the folks that owned those banks chose to sell those 
banks, and perhaps in many cases those banks were not as 
profitable as they could have been. So I think enhanced 
profitability ultimately has got to be the focus.
    Senator Warren. Although I am not sure we regulate that 
directly here in Washington. If I can just have a few more 
seconds, if that is all right, Mr. Chairman, I would really 
like to hear Mr. Brown's comments on this since they are doing 
this at the FDIC. Have we reached a point where it is time to 
think about a two-tier regulatory system for our small banks?
    Mr. Brown. Well, Senator, the issue that you bring up is a 
very important one, and I think it is addressed in the 
supervisory process by a risk-focused supervisory system that 
tries to scale the nature of the supervisory process to the 
risk and the complexity of institutions. And it is something 
where it is sort of hard to write rules in advance and create 
thresholds that work for all cases. I think supervisors at the 
FDIC try very hard to make sure that the process is scaled to 
the risk and complexity of those institutions.
    I would just add that in the precrisis years there 
definitely was a performance gap between the larger 
noncommunity banks and community banks. The noncommunity banks 
grew much faster. They earned much more money. And, of course, 
they did so through----
    Senator Warren. I am sorry. Can we also add to that the 
noncommunity banks were the ones that took on all the risk and 
crashed the economy?
    Mr. Brown. Yes, I was headed in that direction.
    Senator Warren. Which sort of suggests that maybe they did 
not have proper oversight.
    Mr. Brown. And I think the reforms in Title I and Title II 
of Dodd-Frank, ending too big to fail, is a very important 
element to leveling the playing field and making sure that the 
community banking sector stays vibrant in the years ahead.
    Senator Warren. Thank you very much.
    Thank you for your indulgence, Mr. Chairman.
    Chairman Johnson. Senator Moran.
    Senator Moran. Chairman, thank you. I appreciate the 
opportunity to visit with individuals from the FDIC.
    Most of my time in the Senate, which is short, certainly in 
the Banking Committee we have raised the topic of regulations 
of community banks, and I have raised that not just with the 
FDIC but other regulators. There is a pretty standard response 
to those questions about how we understand the value of 
community banks. We treat them differently. We have an advisory 
committee that we get input from. And yet the statistics and 
trends continue with additional consolidation. I see it in the 
numbers in Kansas. The number of banks is less than it was a 
year ago. And I heard it anecdotally, the continual 
conversation, and it makes sense to me that the increasing cost 
of regulation means that a bank has to be larger in order to 
cover the costs of those regulations. Fixed costs matter.
    I remember a banker telling me that an examiner was in the 
bank and suggested that they hire two more people in the bank 
to comply with rules and regulations. The bank employs eight 
people. Two people is a significant increase in the number of 
people working there. Increasing employment would be a good 
thing, but not if you cannot afford to do that.
    And so our bankers' options, particularly as the economy 
becomes more difficult, their options generally are find some 
other bank interested in buying them. And I think there is a 
significant consequence to rural America in the absence of 
community financial institutions, the ability to--the 
relationship banking remains important to my farmers, ranchers, 
small business men and women. And my concern or complaint is 
that--I do not want to be pejorative and say we continue to 
provide lip service to this issue, but I cannot ever find any 
evidence that we are really doing anything differently in 
regard to the regulatory environment that community financial 
institutions face.
    Maybe you could satisfy me with the suggestion that we have 
a different examining standard, we have different criteria when 
our examiners are in the bank, we have a different set--we have 
eliminated--give me an example of regulations that we have 
eliminated or modified because of the size and scope of the 
bank. And, again, I would portray this, at least in my view, 
that all of this is in the context of financial institutions 
that are not too big to fail and that have little consequence--
significant consequence in a community or to shareholders, but 
little consequence systemically to the economy.
    Can you assure me that the conversations that I have had 
with individuals who regulate banks and are responsible for 
those regulations over the last 2\1/2\ years have done more 
than tell me they understand my problem and have done something 
about it?
    Mr. Brown. Senator, your question on consolidation is a 
very good one, and I do want to put it in perspective, that 
after----
    Senator Moran. My other questions are not?
    [Laughter.]
    Mr. Brown. They are all very useful.
    After two-and-a-half decades of consolidation that we 
followed in our study, 95 percent of banking organizations in 
2011 were community banks, and we saw the biggest decline among 
very small community banks. The number under $25 million 
actually declined by 96 percent, much less consolidation at 
slightly larger size groups.
    In fact, the number of charters with assets between $100 
million and $1 billion increased by 19 percent over the study 
period, and that is where 65 percent of community banks 
currently operate.
    We did studies of economies of scale. How much do average 
costs fall as asset size increases? For some lines of business, 
like commercial real estate lending, there were some economies 
of scale, but most of them are realized at an asset size of 
$100 to $300 million. So, you know, the idea that you have to 
be a $2 or $3 billion bank to do business, I am not sure that 
the numbers square up with that.
    That said, we also understand that the overhead expenses of 
community banks are very sensitive to regulatory costs and 
staffing for regulatory purposes. The FDIC has undertaken a 
number of steps--you described them--to try to mitigate those 
costs, provide services that are valuable to the banks in terms 
of meeting those regulatory requirements.
    Senator Moran. That answer is different than the other 
answers I have received over the last 2\1/2\ years. What are 
the specific examples of modifications that the FDIC has made 
to accommodate--and I guess let me further indicate to you that 
I understand--if this was a matter of bank consolidation 
because of normal free market economic principles about size of 
scale economies, that to me is a different issue for us than 
one that is driven by the regulatory environment and the fixed 
costs or the costs associated with meeting those requirements.
    I do not know whether your study demonstrates what--is 
there an explanation for why those costs increase and the 
economies of scale--I guess to further indicate that a $25 
million bank is important to me and to a community in Kansas, 
and when you assure me that things get better at $100 million 
and above, I mean, I am pleased to know that, but there are a 
lot of banks in Kansas that fall between that $25 million and 
that $100 million that are very important certainly to the 
people who work there, who own that bank, but more importantly, 
to the community that they serve.
    Mr. Brown. Well, understood, and I think those economies of 
scale that I referred to, the decline in average cost includes 
both regulatory and nonregulatory costs. The fact is we do not 
have the data to break down overhead expenses between those two 
categories, so we can only look at overall overhead costs. But 
for the community banking sector the last 3 years, those 
overhead costs as a percent of assets have been stable at 2.9 
percent of average assets. And so we are not seeing large 
increases in overall overhead expenses.
    We do understand, though, the need on the part of the FDIC 
to provide technical assistance. We have created a Web-based 
pre-exam tool to make sure that information requests are 
synchronized and very clear with the bank being examined. We 
have created a regulatory calendar that reminds institutions of 
when the comment periods and what the compliance periods are. 
And we have created a series of videos on our Directors 
Resource Center that provide very detailed technical 
information about how to comply with the various standards 
coming down the pike so consultants are not needed to explain 
that. So we think those can be helpful in terms of helping to 
navigate.
    Senator Moran. Thank you very much. My time has expired. I 
would only point out that what the FDIC does is critical in 
this arena. You are at least one of the few, if not the one 
regulator that the bank cannot escape. As we have seen in our 
State and elsewhere in the country, as banks have rechartered 
to become State institutions to alter this regulatory 
environment, they are never going to get away from you. And 
what you do matters to the success not just of my banks, but 
the communities that they serve.
    Thank you.
    Chairman Johnson. Senator Heitkamp.
    Senator Heitkamp. You are going to hear a recurring theme 
here. Thank you, Mr. Chairman, and thank you for this hearing. 
You are going to hear a recurring theme in all of this. We are 
deeply concerned in a very nonpartisan way with the viability 
and the continuing operation of small community banks. And our 
overall concern is that we are now in an era where we create an 
atmosphere too big to fail and what the net result is too small 
to succeed.
    And I would suggest, Mr. Evans--and without having any 
dialog behind this--that, in fact, when you say you look at 
overall overhead costs and they have not increased, I would 
suggest to you that is because banks are doing things that--are 
not doing things that they have done in the past because they 
do not want to get in trouble. And one of those issues that is 
very critical in North Dakota is housing. Our small community 
banks have always been a huge part of financing residential 
development, and we are seeing a huge retraction from that 
responsibility to the community, not as a matter of choice but 
as a matter of--we do not know that we can comply. We do not 
know that we have the capacity to comply with what is coming at 
us.
    And so where I listened to the discussion that you had 
today about, you know, we are listening, we are moving, I had a 
conversation with the Chairman and suggested that he needs to 
listen directly to the small community banks. And I am grateful 
to report that he, in fact, will be coming out to North Dakota 
to do roundtables with our small community banks in North 
Dakota to address these issues.
    But I want to take this in a little different direction. 
You know, there is postcrisis research regarding community 
banks showing that public benefits provided in the crisis and 
in the recovery stages after the crisis actually minimized the 
direct effect. Having a good relationship with your bank gave 
you the ability to continue to get the capital that you needed, 
the operating loans that you needed.
    You know, their central role--and, you know, I know you 
guys deal with numbers, but a lot of this in little towns in 
North Dakota, in Hankinson, North Dakota, it is about 
relationships. They have a generation-generation-generation 
relationship with their depositors. They have done operating 
loans for years, and now they are terrified to do them. And, 
you know, that may be drive, in fact, by reality or it may be 
driven by just the fear of what is coming down.
    And so I cannot impress upon this panel enough that we are 
deeply concerned about consolidation. We think it is being 
driven by regulation--I do think it is being driven by 
regulation. And we want to know whether this will reach the top 
runs in terms of evaluating what we can do to stop 
consolidation on the lower level and continue the viability of 
small community banks. I will start with you, Mr. Evans.
    Mr. Evans. So the re-occurring theme here I think is 
important because it speaks to the need to minimize, where 
appropriate, burdens on community banks. And so I would take 
this time to plug some of the work we have done on Dodd-Frank 
where we have made recommendations to the regulators to 
strengthen their prospective analysis before they write these 
rules, as well as the retrospective analysis, because we have 
heard from community bankers that it is the cumulative burden 
of these regulations--``death by a thousand cuts,'' as it is 
often referred to--that raises the most significant concern. 
And so retrospective analysis there would be extremely 
important because this will allow us to really assess the 
impact of various regulations.
    And we have also asked the regulators to start to plan and 
think about the data they need to collect in order to do this 
assessment, because we do need to understand the impact of 
regulations and exemptions on stability, efficiency, and 
competitiveness.
    Mr. Brown. I think one thing to keep in mind is that the 
forces of consolidation include, potentially, regulation going 
forward, but in the past they also have included bank failures. 
We had more than 2,500 bank failures during the study period 
that led to consolidation. And I think that the safety and 
soundness of the industry is one of the important factors, 
obviously, in determining the future pace of consolidation.
    I think one of the other things that we have observed is 
that the banks that came through the crisis in pretty good 
shape are generally pretty conservatively run. They generally 
have high supervisory ratings. They have the types of 
governance qualities that Mr. Rymer described in his statement 
and generally comply with the regulatory requirements as they 
are.
    And so I know that the cost of the change in regulation is 
disconcerting for many. We are trying to help them work through 
that. We think that communication is absolutely critical to 
making sure there are no surprises and making sure that there 
is an agreement between supervisors and banks as to how the 
regulations are going to work going forward.
    Senator Heitkamp. Mr. Chairman, if I could just take--just 
make one more point, which is enforcement versus regulation. 
There is not a kid that you grew up with who does not like 
being lumped in when their older siblings do something wrong 
and they all get punished, right? And so, you know, we are in 
an atmosphere--in North Dakota, no bank failures, but yet my 
banks are suffering the consequences of what happened. And I 
would suggest to you that the lack of enforcement of existing 
regulations before Dodd-Frank is a critical component to bank 
failures, and the reaction has been to regulate, and some would 
argue excessively, in response to that, which is one-size-fits-
all, we are going to punish you all equally regardless of your 
appropriate conservative management of your financial 
institution.
    And so be very careful, because I am going to judge things 
very carefully on regulatory versus enforcement, and what I 
would suggest to you may have failed is enforcement, but what 
we got was regulation.
    Chairman Johnson. Senator Crapo will make a statement.
    Senator Crapo. Thank you, Mr. Chairman. Before we wrap up, 
I just wanted to make a very brief summary statement, and to 
the panel, again, thank you for coming and for the work you are 
doing on this critical issue. I think every Senator who has 
been at the hearing here today has raised the same issue set 
with you. We are concerned about whether we have it right in 
law and in regulation and implementation in terms of the 
regulatory system that we are applying to our smaller and 
community banks, whether it is a question of whether we need to 
move to a two-tier system or whether we need to do other 
reforms at the congressional level, at the policy level, or 
whether we need to be more aggressive at making the appropriate 
distinctions in the regulatory, implementation, and the 
examination process, or what have you.
    I would just encourage you to help us answer this question 
correctly, to do the kind of analysis and studies that gets to 
the answers to some of the questions that we do not have 
answers to yet, and to work with us to help identify the proper 
structure and system that we need to have in place to create 
the best safety and soundness and the best profitability for 
our strong community bank system.
    Thank you.
    Chairman Johnson. I want to thank our witnesses for their 
testimony today as well as their continued focus on efforts to 
strengthen the community bank system.
    This hearing is adjourned.
    [Whereupon, at 11:24 a.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
supplied for the record follow:]
                 PREPARED STATEMENT OF RICHARD A. BROWN
         Chief Economist, Federal Deposit Insurance Corporation
                             June 13, 2013
    Chairman Johnson, Ranking Member Crapo, and Members of the 
Committee, we appreciate the opportunity to testify on behalf of the 
Federal Deposit Insurance Corporation (FDIC) regarding the state of 
community banking and to describe the findings of the FDIC Community 
Banking Study (the Study), a comprehensive review based on 27 years of 
data on community banks. \1\
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     \1\ FDIC Community Banking Study, December 2012, http://
www.fdic.gov/regulations/resources/cbi/study.html.
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    As the Committee is well aware, the recent financial crisis has 
proved challenging for all financial institutions. The FDIC's problem 
bank list peaked at 888 institutions in 2011. Since January 2008, 481 
insured depository institutions have failed, with banks under $1 
billion making up 419 of those failures. Fortunately, the pace of 
failures has declined significantly since 2010, a trend we expect to 
continue.
    Given the challenges that community banks, in particular, have 
faced in recent years, the FDIC launched a ``Community Banking 
Initiative'' (Initiative) last year to refocus our efforts to 
communicate with community banks and to better understand their 
concerns. The knowledge gathered through this Initiative will help to 
ensure that our supervisory actions are grounded in the recognition of 
the important role that community banks play in our economy. A key 
product of the Initiative was our FDIC Community Banking Study, 
published last December, which is discussed in more detail below.
    In my testimony, I describe some key lessons from the failures of 
certain community banks during the recent crisis identified by the FDIC 
Community Banking Study. Consistent with the studies performed under 
P.L. 112-88 by the FDIC Office of Inspector General (OIG) and 
Government Accountability Office (GAO), the Study found three primary 
factors that contributed to bank failures in the recent crisis, namely: 
(1) rapid growth; (2) excessive concentrations in commercial real 
estate lending (especially acquisition and development lending); and 
(3) funding through highly volatile deposits. By contrast, community 
banks that followed a traditional, conservative business plan of 
prudent growth, careful underwriting, and stable deposit funding 
overwhelmingly were able to survive the recent crisis.
FDIC Community Banking Study
    In December 2012, the FDIC released the FDIC Community Banking 
Study, a comprehensive review of the U.S. community banking sector 
covering 27 years of data. The Study set out to explore some of the 
important trends that have shaped the operating environment for 
community banks over this period, including: long-term industry 
consolidation; the geographic footprint of community banks; their 
comparative financial performance overall and by lending specialty 
group; efficiency and economies of scale; and access to capital. This 
research was based on a new definition of community bank that goes 
beyond the asset size of institutions to also account for the types of 
lending and deposit gathering activities and the limited geographic 
scope that are characteristic of community banks.
    Specifically, where most previous studies have defined community 
banks strictly in terms of asset size (typically including banks with 
assets less than $1 billion), our study introduced a definition that 
takes into account a focus on lending, reliance on core deposit 
funding, and a limited geographic scope of operations. Applying these 
criteria for the baseline year of 2010 had the effect of excluding 92 
banking organizations with assets less than $1 billion while including 
330 banking organizations with assets greater than $1 billion. 
Importantly, the 330 community banks over $1 billion in size held $623 
billion in total assets--approximately one-third of the community bank 
total. While these institutions would have been excluded under many 
size-based definitions, we found that they operated in a similar 
fashion to smaller community banks. It is important to note that the 
purpose of this definition is research and analysis; it is not intended 
to substitute for size-based thresholds that are currently embedded in 
statute, regulation, and supervisory practice.
    Our research confirms the crucial role that community banks play in 
the American financial system. As defined by the Study, community banks 
represented 95 percent of all U.S. banking organizations in 2011. These 
institutions accounted for just 14 percent of the U.S. banking assets 
in our Nation, but held 46 percent of all the small loans to businesses 
and farms made by FDIC-insured institutions. While their share of total 
deposits has declined over time, community banks still hold the 
majority of bank deposits in rural and micropolitan counties. \2\ The 
Study showed that in 629 U.S. counties (or almost one-fifth of all U.S. 
counties), the only banking offices operated by FDIC-insured 
institutions at year-end 2011 were those operated by community banks. 
Without community banks, many rural areas, small towns and urban 
neighborhoods would have little or no physical access to mainstream 
banking services.
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     \2\ The 3,238 U.S. counties in 2010 included 694 micropolitan 
counties centered on an urban core with population between 10,000 and 
50,000 people, and 1,376 rural counties with populations less than 
10,000 people.
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    Our Study took an in-depth look at the long-term trend of banking 
industry consolidation that has reduced the number of federally insured 
banks and thrifts from 17,901 in 1984 to 7,357 in 2011. All of this net 
consolidation can be accounted for by an even larger decline in the 
number of institutions with assets less than $100 million. But a closer 
look casts significant doubt on the notion that future consolidation 
will continue at this same pace, or that the community banking model is 
in any way obsolete.
    More than 2,500 institutions have failed since 1984, with the vast 
majority failing in the crisis periods of the 1980s, early 1990s, and 
the period since 2007. To the extent that future crises can be avoided 
or mitigated, bank failures should contribute much less to future 
consolidation. In addition, about one third of the consolidation that 
has taken place since 1984 is the result of charter consolidation 
within bank holding companies, while just under half is the result of 
voluntary mergers. But both of these trends were greatly facilitated by 
the gradual relaxation of restrictions on intrastate branching at the 
State level in the 1980s and early 1990s, as well as the rising trend 
of interstate branching that followed enactment of the Riegle-Neal 
Interstate Banking and Branching Efficiency Act of 1994. The pace of 
voluntary consolidation has indeed slowed over the past 15 years as the 
effects of these one-time changes were realized. Finally, the Study 
questions whether the rapid precrisis growth of some of the Nation's 
largest banks, which occurred largely as a result of mergers and 
acquisitions and growth in retail lending, can continue at the same 
pace going forward. Some of the precrisis cost savings realized by 
large banks have proven to be unsustainable in the postcrisis period, 
and a return to precrisis rates of growth in consumer and mortgage 
lending appears, for now anyway, to be a questionable assumption.
    The Study finds that community banks that grew prudently and that 
maintained diversified portfolios or otherwise stuck to their core 
lending competencies during the Study period exhibited relatively 
strong and stable performance over time. The strongest performing 
lending groups across the entire Study period were community banks 
specializing in agricultural lending, diversified banks with no single 
specialty, and consumer lending specialists, although the latter group 
had shrunk to fewer than one percent of community banks by 2011. 
Agricultural specialists and diversified nonspecialists also failed at 
rates well below other community banks during the Study period. Other 
types of institutions that pursued higher-growth strategies--frequently 
through commercial real estate or construction and development 
lending--encountered severe problems during real estate downturns and 
generally underperformed over the long run.
    Moreover, the Study finds that economies of scale play a limited 
role in the viability of community banks. While average costs are found 
to be higher for very small community banks, most economies of scale 
are largely realized by the time an institution reaches $100 million to 
$300 million in size, depending on the lending specialty. These results 
comport well with the experience of banking industry consolidation 
during our Study period (1984-2011), in which the number of bank and 
thrift charters with assets less than $25 million declined by 96 
percent, while the number of charters with assets between $100 million 
and $1 billion grew by 19 percent.
    With regard to measuring the costs associated with regulatory 
compliance, the Study noted that the financial data collected by 
regulators does not identify regulatory costs as a distinct category of 
expenses. In light of the limitations of the data and the importance of 
this topic in our discussions with community bankers, as part of our 
Study the FDIC conducted interviews with a group of community banks to 
try to learn more about regulatory costs. As described in Appendix B of 
the Study, most interview participants stated that no single regulation 
or practice had a significant effect on their institution. Instead, 
most stated that the strain on their organization came from the 
cumulative effects of all the regulatory requirements that have built 
up over time. Many of the interview participants indicated that they 
have increased staff over the past 10 years to support the enhanced 
responsibility associated with regulatory compliance. Still, none of 
the interview participants indicated that they actively track the 
various costs associated with regulatory compliance, because it is too 
time-consuming, too costly, and so interwoven into their operations 
that it would be difficult to break out these specific costs. These 
responses point to the challenges of achieving a greater degree of 
quantification in studying this important topic.
    In summary, the Study finds that, despite the challenges of the 
current operating environment, the community banking sector remains a 
viable and vital component of the overall U.S. financial system. It 
identifies a number of issues for future research, including the role 
of commercial real estate lending at community banks, their use of new 
technologies, and how additional information might be obtained on 
regulatory compliance costs.
Examination and Rulemaking Review
    In addition to the comprehensive study on community banks, the FDIC 
also reviewed its examination, rulemaking, and guidance processes 
during 2012 with a goal of identifying ways to make the supervisory 
process more efficient, consistent, and transparent, while maintaining 
safe and sound banking practices. This review was informed by a 
February 2012 FDIC conference on the challenges and opportunities 
facing community banks, a series of six roundtable discussions with 
community bankers around the Nation, and by ongoing discussions with 
the FDIC's Advisory Committee on Community Banking.
    Based on concerns raised in these discussions, the FDIC has 
implemented a number of enhancements to our supervisory and rulemaking 
processes. First, the FDIC has restructured the pre-exam process to 
better scope examinations, define expectations, and improve efficiency. 
Second, the FDIC is taking steps to improve communication with banks 
under our supervision. Using Web-based tools, the FDIC created a 
regulatory calendar that alerts stakeholders to critical information as 
well as comment and compliance deadlines relating to new or amended 
Federal banking laws, regulations, and supervisory guidance. The 
calendar includes notices of proposed, interim, and final rulemakings, 
and provides information about banker teleconferences and other 
important events related to changes in laws, regulations, and 
supervisory guidance. The FDIC also is actively taking steps to provide 
bankers with additional insights on proposed or changing rules, 
regulations, and guidance through regional meetings and outreach. 
Further, we clarify and communicate whether specific rules, 
regulations, and guidance apply to the operations of community banks 
through the use of statements of applicability in our Financial 
Institution Letters.
    Finally, the FDIC has instituted a number of outreach and technical 
assistance efforts, including increased direct communication between 
examinations, increased opportunities to attend training workshops and 
symposiums, and conference calls and training videos on complex topics 
of interest to community bankers. In April, the FDIC issued six videos 
designed to provide new bank directors with information to prepare them 
for their fiduciary role in overseeing the bank. A second installment, 
to be released very soon, is a virtual version of the FDIC's Directors' 
College Program that regional offices deliver throughout the year. A 
third installment, expected to be released by year-end will provide 
more in-depth coverage of important supervisory topics and focus on 
management's responsibilities. The FDIC plans to continue its review of 
examination and rulemaking processes, and continues to explore new 
initiatives to provide technical assistance to community banks.
Conclusion
    The recent financial crisis has proved challenging for financial 
institutions in general and for community banks in particular. Analyses 
of bank failures during the crisis by the FDIC, the FDIC OIG, and the 
GAO point to some common risk factors for institutions that failed 
during the recent crisis, including rapid growth, concentrations in 
high-risk loans, and funding through volatile deposits. In contrast, 
community banks that followed traditional, conservative business models 
overwhelmingly survived the recent crisis. The FDIC's extensive study 
of community banking over a 27-year period shows that while these 
institutions face a number of challenges, they will remain a viable and 
vital component of the overall U.S. financial system in the years 
ahead.
                   PREPARED STATEMENT OF JON T. RYMER
        Inspector General, Federal Deposit Insurance Corporation
                             June 13, 2013
    Chairman Johnson, Ranking Member Crapo, and Members of the 
Committee: Thank you for the opportunity to testify in today's hearing 
on the lessons learned from the financial crisis related to community 
banks. As you requested, I will focus on the broad and comprehensive 
study, required by Public Law 112-88, that the Federal Deposit 
Insurance Corporation (FDIC) Office of Inspector General (OIG) 
conducted on the impact of the failure of insured depository 
institutions during the recent financial crisis. Specifically, I will 
summarize the study's general observations, findings, conclusions, and 
recommendations contained in the report, Comprehensive Study on the 
Impact of the Failure of Insured Depository Institutions (Report No. 
EVAL-13-002, dated January 3, 2013). In addition, I will highlight some 
of the work my office has completed over the last 5 years that could 
contribute to the Committee's ``lessons learned'' discussion.
    The OIG is an independent office within the FDIC, established to 
conduct audits, investigations, and other reviews to prevent and detect 
waste, fraud, and abuse relating to the programs and operations of the 
FDIC, and to improve the efficiency and effectiveness of those programs 
and operations. I was appointed as the Inspector General of the FDIC by 
President Bush, and confirmed by the Senate in June 2006.
    Through its audits, evaluations, and other reviews, my office 
provides oversight of FDIC programs and operations. Our work is either 
required by law or self-initiated based on our assessment of various 
risks confronting the FDIC. Our audits, evaluations, and other reviews 
assess such areas as program effectiveness, adequacy of internal 
controls, and compliance with statutory requirements and corporate 
policies and procedures. We perform our work using internally available 
resources, supplemented by contracts with independent public accounting 
firms when expertise in a particular area is needed or when internal 
resources are not available. Our work, as well as that of our 
contractors, is performed in accordance with standards applicable to 
Federal audit, evaluation, and investigative entities.
    Before I discuss the study's high-level observations and resulting 
recommendations, and to provide helpful context, I will briefly 
describe the regulatory framework and the individual regulator 
responsibilities for overseeing insured depository institutions and 
resolving those institutions when they fail.
Regulatory Framework and Regulator Responsibilities
    In the wake of the savings and loan and banking crisis of the 
1980s, the Congress passed two laws that drove the closure and 
resolution decisions we witnessed in this most recent crisis. These 
laws were the Financial Institutions Reform, Recovery, and Enforcement 
Act of 1989 and the FDIC Improvement Act of 1991. Taken together, these 
laws amended the Federal Deposit Insurance (FDI) Act to require, among 
other things, that (1) institutions maintain minimum capital levels and 
the chartering regulator promptly close critically undercapitalized 
institutions through prompt corrective action provisions, (2) the FDIC 
resolve banks in the least costly manner, and (3) the FDIC maximize 
recoveries from failed institutions. The FDI Act also placed 
requirements on how the regulators examine institutions, including 
establishing minimum examination frequency requirements, requiring the 
agencies to establish standards for safety and soundness, and requiring 
the agencies to establish appraisal standards. In response, the FDIC 
and the other regulators issued implementing regulations and policy 
statements pertaining to many of the topics discussed in our report.
    The Office of the Comptroller of the Currency (OCC), the Board of 
Governors of the Federal Reserve System (FRB), and the FDIC oversee the 
Nation's insured depository institutions to ensure they operate in a 
safe and sound manner. The OCC supervises national banks, the FRB 
supervises State-chartered banks that are members of the Federal 
Reserve System and bank holding companies, and the FDIC supervises 
State-chartered banks that are not members of the Federal Reserve 
System (State nonmember banks). The FDIC has additional 
responsibilities for insuring deposits, effectively resolving failed 
institutions, and maximizing the recovery of receivership assets.
    In examining insured depository institutions, the regulators assess 
the condition of institutions through off-site monitoring and on-site 
examinations, and have longstanding policies for reviewing an 
institution's lending and loan review functions, assessing capital 
adequacy, and recommending improvements, if needed. When regulators 
determine that an institution's condition is less than satisfactory, 
they may take a variety of supervisory actions, including informal and 
formal enforcement actions, to address identified deficiencies. Each 
regulator has somewhat different approaches to enforcement actions.
    Should an institution's condition decline to a point that it 
becomes Critically Undercapitalized, the chartering regulator (a State 
banking authority or the OCC) is generally required by law to promptly 
close institutions that cannot be recapitalized. The FDIC is required 
by law to resolve failing institutions in the least costly manner.
Study Results--Observations, Findings, and Conclusions
    The financial crisis had devastating impacts on the banking 
industry, businesses, communities, and consumers. At the time of our 
review, over 400 institutions had failed and some of the country's 
largest institutions had required Government intervention to remain 
solvent. Commercial real estate (CRE) collateral values had fallen by 
more than 42 percent. Construction starts remained partially complete 
and continued to detract from the quality of neighborhoods and home 
values. Trillions of dollars of household wealth had vanished, and 
almost 18 million loans had faced foreclosure since 2007. Unemployment 
peaked at 10 percent in October 2009 and remained stubbornly high at 
the time of our study.
    Events leading to the financial crisis and subsequent efforts to 
resolve it involved the dynamic interrelationship of laws passed by the 
Congress, regulatory rules, and agency-specific policies and practices 
with the real estate and financial markets in ways that are continuing 
to play out. In that regard, our study indicated the following:

    The markets drove behaviors that were not always prudent. 
        Banks expanded lending to keep pace with rapid growth in 
        construction and real estate development, rising mortgage 
        demands, and increased competition. Many of the banks that 
        failed did so because management relaxed underwriting standards 
        and did not implement adequate oversight and controls. For 
        their part, many borrowers who engaged in commercial or 
        residential lending arrangements did not always have the 
        capacity to repay loans and pursued many construction projects 
        without properly considering the risks involved. Ultimately, 
        these loans created significant losses for the institutions 
        involved and often left the FDIC with the challenge of managing 
        and disposing of troubled assets.

    In response to unprecedented circumstances, the regulators 
        generally fulfilled their supervisory and resolution 
        responsibilities as defined by statutes, regulations, 
        accounting standards, and interagency guidance in place at the 
        time. In addition, the regulators reacted to a rapidly changing 
        economic and financial landscape by establishing and revising 
        supervisory policies and procedures to address key risks facing 
        the industry. While not a focus of this study, our report does 
        acknowledge, however, material loss review findings that showed 
        the FRB, OCC, and FDIC could have provided earlier and greater 
        supervisory attention to troubled institutions that ultimately 
        failed. For its part, among other initiatives associated with 
        resolutions, the FDIC reinstituted the use of shared loss 
        agreements (SLA) with acquiring institutions and took steps to 
        promote private capital investments in failing institutions.

    In our report, we provided a detailed presentation of our findings 
and conclusions for each of the topics under the law's eight matters. 
These matters include (1) SLAs, (2) significance of losses at 
institutions that failed, (3) examiner implementation of appraisal 
guidelines, (4) examiner assessment of capital adequacy and private 
capital investment in failing institutions, (5) examiner implementation 
of loan workout guidance, (6) application and impact of formal 
enforcement orders, (7) impact of FDIC policies on investments in 
institutions, and (8) the FDIC's handling of private equity company 
investments in institutions. In addressing these matters, we also made 
the following observations:

    The FDIC's resolution methods--including the SLAs that we 
        studied--were market driven. Often, failing banks with little 
        or no franchise value and poor asset quality did not attract 
        sufficient interest from viable bidders to enable the FDIC to 
        sell the banks without a loss-share guarantee. The FDIC used 
        SLAs to keep failed bank assets in the banking sector, support 
        failed bank asset values, and preserve the solvency of the 
        Deposit Insurance Fund (DIF). The FDIC has established controls 
        over its SLA monitoring program, which help protect the FDIC's 
        interests, promote loan modifications, and require equal 
        treatment of SLA and legacy loans. We did find, however, that 
        the FDIC should place additional emphasis on monitoring 
        commercial loan extension decisions to ensure that acquiring 
        institutions do not inappropriately reject loan modification 
        requests as SLAs approach termination. In addition, we 
        concluded that the FDIC needed to formulate a better strategy 
        for mitigating the impact of impending portfolio sales and SLA 
        terminations on the DIF so that the FDIC will be prepared to 
        address the potentially significant volume of asset sale 
        requests.

    The majority of community banks failed as a result of 
        aggressive growth, asset concentrations, poor underwriting, and 
        deficient credit administration coupled with declining real 
        estate values. These factors led to write-downs and charge-offs 
        on delinquent and nonperforming real estate loans as opposed to 
        examiner-required write-downs or fair value accounting losses.

    The regulators have longstanding policies for classifying 
        problem assets, monitoring appraisal programs, assessing 
        capital adequacy, evaluating CRE loan workouts, and 
        administering enforcement actions, when warranted. The 
        regulators also have processes and controls, training programs, 
        and job aids to help ensure examiner compliance and 
        consistency. We found that examiners generally followed 
        relevant policies and implemented them appropriately. For 
        example, examiners usually did not classify as loss loans that 
        the institution claimed were paying as agreed without 
        justification, nor did they question or reduce the appraised 
        values of assets securing such loans. However, examiners did 
        not always document the procedures and steps that they 
        performed to assess institutions' appraisal and workout 
        programs. We also noted that the regulators had different 
        approaches to enforcement actions, particularly related to 
        nonproblem banks.

    The FDIC has investment-related policies in place to 
        protect the DIF and to ensure the character and fitness of 
        potential investors. These policies are largely based in 
        statute. By their nature, such policies are going to have an 
        impact on investments in institutions. The FDIC approved most 
        change-in-control and merger applications, although approval 
        rates were lower for States such as California, Florida, and 
        Nevada that were heavily impacted by the financial crisis. The 
        FDIC has policies and procedures for certain aspects of the 
        review of private capital investors, and the FDIC generally 
        followed those policies. Purchases of failed institutions by 
        private capital investors accounted for 10 percent of total 
        failed bank assets acquired. Finally, we identified instances 
        where the FDIC did not accept proposed open bank investments 
        and instead closed an institution. However, in each case, we 
        found that the FDIC identified concerns with the proposed 
        investment related to safety and soundness issues, proposed 
        management, or proposed business plans, or determined that the 
        proposed transaction would not present the least loss option to 
        the DIF.
Recommendations
    While the regulators generally implemented their policies 
appropriately, our study identified certain areas for improvement and 
issues warranting management attention. In the interest of 
strengthening the effectiveness of certain supervisory activities and 
helping ensure the success of the FDIC's ongoing resolution efforts, we 
made seven recommendations. Five were addressed specifically to the 
FDIC and two were directed to the three regulators. These 
recommendations, which the regulators concurred with and proposed 
actions that adequately addressed the recommendations' intent, involved 
the following areas:

    SLA Program. We made recommendations related to developing 
        additional controls for monitoring acquiring institutions' 
        commercial loan modification efforts and developing a more 
        formal strategy for mitigating the impact of impending 
        portfolio sales and SLA terminations on the DIF.

    Appraisals and Workouts. We made several recommendations 
        related to clarifying how examiners should review institutions' 
        appraisal programs and strengthening examiner documentation 
        requirements to more clearly define examination methodologies 
        and procedures performed to assess institutions' appraisal and 
        workout programs. These recommendations should help to assure 
        agency management that examiners are consistently applying 
        relevant guidance.

    Enforcement Orders. We recommended that the regulators 
        study differences between the types of enforcement actions that 
        are used by the regulators and the timing of such actions to 
        determine whether there are certain approaches that have proven 
        to be more effective in mitigating risk and correcting 
        deficiencies that should be implemented by all three 
        regulators.
Study Approach
    Signed into law on January 3, 2012, Public Law 112-88 required my 
office to conduct this study and submit a report to the Congress not 
later than 1 year after the date of enactment. The legislation required 
my office to conduct work at the FDIC, OCC, and FRB, and as required, 
our scope included open and failed State member, State nonmember, and 
national banks. Our scope did not include institutions formerly 
regulated by the Office of Thrift Supervision. Our review time frames 
generally covered a 4-year period (i.e., 2008 through 2011).
    My office performed work at three FDIC regions, three OCC regions, 
eight reserve bank districts, and selected State banking agencies. In 
conducting our work, we

    Interviewed agency officials and bank examiners, 
        representatives at open banks, investment bankers, and 
        compliance contractors;

    Reviewed relevant policies and guidance;

    Reviewed examination reports, working papers, material loss 
        review reports, and documentation supporting loan workouts and 
        enforcements orders;

    Analyzed institution financial data and agency enforcement 
        action statistics; and

    Surveyed borrowers of failed institutions.

    We conducted our work from January 2012 through October 2012, in 
accordance with the Council of the Inspectors General on Integrity and 
Efficiency's Quality Standards for Inspection and Evaluation. KPMG LLP 
assisted us with several areas of review. We also coordinated with the 
U.S. Government Accountability Office as that office conducted its work 
pursuant to Public Law 112-88.
Other OIG Work
    As the Committee continues the discussion of the financial crisis 
and possible ``lessons learned,'' I wanted to highlight some of the 
other work my office has completed. Over the last 5 years, my office 
was heavily involved in the efforts to explain what happened during the 
financial crisis. The following is a brief snapshot of this work.
    During the financial crisis, my audit and evaluation staff was 
dedicated to conducting reviews of the FDIC-supervised banks that 
failed, and providing feedback to the FDIC to assist the Corporation in 
improving its bank supervision program. As required by section 38(k) of 
the FDI Act, and amended by the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (Dodd-Frank Act), my office, along with our 
fellow financial regulatory OIGs, was required, at some level, to 
review the 484 institutions that failed during the crisis. To date, we 
have issued 107 reports that take a comprehensive look at why the 
failed bank caused a material loss to the DIF and provide an assessment 
of the FDIC's supervision of that bank. Since the Dodd-Frank Act 
amended the FDI Act, my office has also performed 166 failed bank 
reviews, where the failure was below a certain loss threshold and no 
unusual circumstances existed to warrant a more in-depth review of the 
loss.
    In a separate report, Follow-Up Audit of FDIC Supervision Program 
Enhancements (Report No. MLR-11-010), issued in December 2010, we 
examined the supervisory actions the FDIC had taken in response to an 
internal memorandum we issued in May 2009, which outlined major causes, 
trends, and common characteristics of the eight bank failures we had 
reviewed to date, and identified new trends and issues that emerged 
from our reviews of subsequent failures. Our January 2013 study further 
supported the existence of these trends and issues, which included 
concentrated assets in the CRE and acquisition, development, and 
construction (ADC) loan portfolios, inadequate risk management 
practices for loan underwriting and credit administration, and reliance 
on volatile funding sources to support growth.
    In October 2012, my office issued a report, Acquisition, 
Development, and Construction Loan Concentration Study (Report No. 
EVAL-13-001), detailing our evaluation of FDIC-supervised institutions 
with significant ADC loan concentrations that did not fail during the 
economic downturn. We studied the characteristics and supervisory 
approaches for these institutions and identified the factors that 
helped them mitigate the risks associated with ADC concentrations 
during periods of economic stress. Our findings were not surprising, in 
that they confirmed what regulators have been saying are the 
ingredients for a strong bank--a well-informed Board, strong 
management, controlled growth, sound credit administration and 
underwriting, and adequate capital. We also observed that surviving 
banks were responsive to supervisory actions and guidance and 
maintained or secured capital needed to absorb losses in response to 
regulatory demands.
    My office also teamed up with the other bank regulatory OIGs and 
evaluated prompt regulatory action, as described in sections 38 and 39 
of the FDI Act. The OIGs from the FDIC, FRB, and Department of the 
Treasury issued a comprehensive joint report in September 2011, 
Evaluation of Prompt Regulatory Action Implementation (Report No. EVAL-
11-006), which discussed the use and impact of prompt corrective action 
(PCA) and the safety and soundness standards during the crisis. We 
found that PCA occurred too late to rehabilitate most troubled 
institutions and while critically undercapitalize institutions were 
closed promptly, failure losses were still significant. We recommended 
the regulators consider several options for strengthening the prompt 
regulatory action provisions.
    The reports noted above are available on our Web site, 
www.fdicig.gov.
    This concludes my prepared statement. Thank you for the opportunity 
to discuss the work of the FDIC OIG. I will be pleased to answer any 
questions that you may have.
              PREPARED STATEMENT OF LAWRANCE L. EVANS, JR.
   Director, Financial Markets and Community Investment, Government 
                         Accountability Office
                             June 13, 2013








































        RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
                     FROM RICHARD A. BROWN

Q.1. Academic researchers estimate that when Dodd-Frank is 
fully implemented, there will be more than 13,000 new 
regulatory restrictions in the Code of Federal Regulations. 
Over 10,000 pages of regulations have already been proposed, 
requiring more than 24 million compliance hours each year. As 
FDIC's Chief Economist, how are you trying to track the total 
compliance costs for community banks? Please share specific 
details.

A.1. Quantifying Costs--The costs of regulatory compliance and 
their effect on profitability and competitiveness are frequent 
topics of discussion among community bankers. While our ability 
to quantify the costs of regulatory compliance is somewhat 
limited, the FDIC has undertaken a number of initiatives 
designed to make those costs as small as possible.
    This topic was repeatedly addressed in the six Roundtable 
discussions hosted by the FDIC in 2012 as part of the Community 
Banking Initiative, and also has been a frequent topic of 
discussion in meetings of the FDIC's Community Bank Advisory 
Committee.
    Notwithstanding the high degree in interest in this topic 
by all concerned parties, regulatory data reported through the 
quarterly Call Reports provide only a limited picture of bank 
overhead expenses. While all FDIC-insured institutions report 
total noninterest expenses each quarter, these expenses are not 
broken down into regulatory and nonregulatory components. 
Expressed as a percent of total assets, noninterest expenses 
for community banks have been flat for three consecutive years 
(2010-12) at 3.0 percent.
    In view of the data limitations, FDIC researchers conducted 
interviews with nine community bankers as part of our 2012 
Community Banking Study to try to better understand what drives 
the cost of regulatory compliance and, where possible, obtain 
actual financial data to better understand how regulation and 
supervision affects bank performance.
    Most participants stated that no single regulation or 
practice had a significant effect on their institution. 
Instead, most cited the cumulative strain imposed by a number 
of regulatory requirements over time. Several indicated that 
they have increased staff over the past 10 years to support 
regulatory compliance. Yet none indicated that they actively 
track compliance costs, citing the difficulties of breaking out 
these costs separately.
    These responses from community bankers speak to the careful 
balance regulators must achieve when trying to measure 
regulatory costs. While community bankers themselves are 
certainly in the best position to understand their cost 
structure, requiring that they report more detailed data about 
the nature of those costs would itself impose a new regulatory 
burden.
    Supervisory Approach--As the primary Federal regulator for 
the majority of smaller, community institutions (those with 
less than $1 billion in total assets), the FDIC is keenly aware 
of the challenges facing community banks and we already tailor 
our supervisory approach to consider the size, complexity, and 
risk profile of the institutions we oversee.
    In addition, the FDIC has implemented a number of 
initiatives to mitigate the compliance costs associated with 
new regulations, based on feedback we received from community 
banks during our Examination and Rulemaking Review undertaken 
in 2012. This effort was informed by a national conference to 
examine the unique role of community banks in our Nation's 
economy and the challenges and opportunities they face and a 
series of roundtable discussions conducted in each of the 
FDIC's six supervisory regions that focused on the financial 
and operational challenges and opportunities facing community 
banks, and the regulatory interaction process.
    First, as a result of comments we received, we developed a 
Web-based tool (e-Prep) that generates a preexamination 
document and information request list tailored to a specific 
institution's operations and business lines.
    Second, we instituted a new Regulatory Calendar that alerts 
stakeholders to critical information as well as comment and 
compliance deadlines relating to changes in Federal banking 
laws and regulations.
    Third, to enhance the ability of community banks to comply 
with regulatory requirements without the need for outside 
consultants, the FDIC recently made available new online 
resources. A new Director's Resource Center provides links to 
more than a dozen new instructional videos, including a new 
Virtual Director's College, designed to provide valuable 
information and advice to bank managers and directors. (In an 
effort to help reduce banks' compliance training costs, we have 
been conducting director and banker colleges in each region for 
some time now.) In addition to these efforts, the FDIC includes 
in all Financial Institution Letters a Statement of 
Applicability that clarifies whether the specific rules, 
regulations, and guidance will apply to community banks.
    The FDIC continues to conduct outreach sessions, training 
workshops, and symposia to provide technical training and 
opportunities for discussion on subjects of interest to 
community bankers.

Q.2. Do you agree with Federal Reserve Chairman Bernanke's 
statement at a recent hearing that the burden of Dodd-Frank 
regulations falls disproportionately on small and community 
banks? If so, what can be done to reduce that burden?

A.2. As demonstrated in the crisis of 2008, the economic costs 
of financial instability are enormous. Prudential regulation 
and supervision of depository institutions have been instituted 
under the Federal Deposit Insurance Act and other statutory 
mandates to promote financial stability and to reduce the 
frequency and severity of such crises.
    The costs of complying with these regulatory requirements 
on the part of FDIC-insured institutions are not insignificant. 
Moreover, these costs include some that vary a great deal with 
the size and complexity of the institution, and some that are 
relatively fixed. With regard to the latter category of fixed 
regulatory costs, it is true to say that they fall 
disproportionately on smaller institutions, which employ fewer 
people and have fewer financial resources that can be devoted 
to complying with regulatory requirements.
    At the same time, there are many examples of regulatory 
costs and requirements that have been designed to vary with the 
size and complexity of the institution, and therefore, do not 
necessarily impose a higher cost on smaller institutions. Among 
these are the premiums charged by the FDIC for deposit 
insurance, which are based on both the size and the risk of 
each institution. It is worth noting that an important 
requirement of the Dodd-Frank Act was to broaden the assessment 
base for deposit insurance premiums from domestic deposits to 
total liabilities minus net worth. This shift, implemented by 
the FDIC in 2010, served to reduce the annual premiums paid by 
small banks (with assets under $1 billion) by about 30 percent. 
In addition, accommodations were made for smaller institutions 
when the Dodd-Frank mortgage rules were implemented. Special 
exemptions reduced the regulatory requirements and lowered 
compliance costs for smaller institutions. These exemptions 
were included in several key regulations, including those 
related to servicing, the ability-to-repay, and qualified 
mortgage regulations.
    Nonetheless, the FDIC continues to pursue initiatives that 
will help to further reduce the costs of regulatory compliance 
on community banks, as described in the response to Question 1. 
These efforts recognize the potential for regulatory compliance 
costs to fall disproportionately on smaller institutions and 
include specific steps designed to help smaller institutions to 
minimizethose costs.

Q.3. In light of FDIC's thorough report on community banks and 
their failures, is there a single element that we should 
monitor in the event of future crises?

A.3. The FDIC Community Banking Study and the Material Loss 
Reviews conducted by the FDIC Office of Inspector General (OIG) 
both identified a collection of business strategies that proved 
to be especially problematic in the recent crisis and are now 
subject to close supervisory attention by the FDIC.
    The Community Banking Study showed that institutions 
pursuing high-growth strategies--frequently through commercial 
real estate or construction and development lending--
encountered severe problems during real estate downturns and 
generally underperformed over the long run. In contrast, 
community banks that grew prudently and that maintained 
diversified portfolios or otherwise stuck to their core lending 
competencies during the study period exhibited relatively 
strong and stable performance over time.
    According to Material Loss Reviews conducted by the OIG in 
the aftermath of bank failures, losses at community banks 
during the crisis were most often caused by management 
strategies of aggressive growth and concentrations in 
commercial real estate loans, including notably, concentrations 
in acquisition, development and construction loans, coupled 
with inadequate risk management practices in an environment of 
falling real estate values that led to impairment losses on 
delinquent and nonperforming loans. Another common 
characteristic of failed banks was reliance on volatile 
brokered deposits as a funding source.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
                       FROM JON T. RYMER

Q.1. Public Law 112-88 requires that the FDIC OIG conduct a 
study on the impact of the failure of insured depository 
institutions during the recent financial crisis. One of the 
findings in your study is that the FRB, OCC, and FDIC could 
have provided earlier and greater supervisory attention to 
troubled institutions that ultimately failed. In your view, 
what have the regulators done to address such deficiencies? 
What else should they do?

A.1. While not a focus of the review called for in Public Law 
112-88, we noted in our report that material loss reviews (MLR) 
performed by our office and the Inspectors General (IG) of the 
Board of Governors of the Federal Reserve System (FRB) and 
Department of the Treasury showed that the FRB, Office of the 
Comptroller of the Currency (OCC), and Federal Deposit 
Insurance Corporation (FDIC) could have provided earlier and 
greater supervisory attention to troubled institutions that 
failed. As noted in our report, the regulators generally 
fulfilled their supervisory responsibilities as defined by 
statutes, regulations, accounting standards, and interagency 
guidance in place at the time. Our report also pointed out that 
the regulators reacted to a rapidly changing economic and 
financial landscape by establishing and revising supervisory 
policies and procedures to address key risks facing the 
industry.
    The three reports summarized below describe the efforts the 
FDIC has made to strengthen its supervision program in light of 
the issues we identified in the nearly 100 MLR reports our 
office issued and other related work our office performed since 
the crisis began in 2008. Although one of the reports also 
comments on the efforts the FRB and OCC have made to strengthen 
their supervision programs, we are not the IG for the OCC or 
FRB and, accordingly, have not assessed the efforts or progress 
they may have made to strengthen their respective supervision 
programs.
    Follow-up Audit of FDIC Supervision Program Enhancements 
(Report Number MLR-11-010, December 2010). In this audit, we 
discussed the efforts that the FDIC had taken to strengthen its 
supervision program in response to the financial crisis. We 
noted that the FDIC had implemented a comprehensive review and 
analysis of its approach to supervision and had implemented or 
planned actions that substantially addressed our reported MLR 
trends and issues. In particular, we reported that the FDIC 
had:

    emphasized a forward-looking supervisory approach, 
        consisting of a comprehensive training program and 
        various financial institution and examiner guidance, 
        including guidance related to de novo banks;

    implemented other cross-cutting initiatives, such 
        as establishing relevant Corporate Performance Goals in 
        2009 and 2010 related to some MLR issues;

    implemented a post-MLR assessment process to 
        identify lessons learned from the bank failures and 
        conclusions included in our MLR final reports and 
        solicited input from its examination staff regarding 
        suggested changes to policies and procedures. This 
        process also resulted in the identification of 
        potential best practices related to the FDIC's 
        examinations;

    enhanced offsite monitoring activities;

    enhanced coordination between its risk management 
        and compliance examination functions;

    improved interagency coordination for charter 
        conversions; and

    worked with the other Federal regulatory agencies 
        to implement a new agreement associated with the FDIC's 
        backup examination authority.

    Evaluation of Prompt Regulatory Action Implementation 
(Report Number EVAL-11-006, September 2011). In this 
evaluation, conducted jointly with the FRB and Department of 
the Treasury Offices of Inspector General (OIG), we reported 
that the regulators had begun to incorporate a number of 
lessons learned from the financial crisis into their regulatory 
processes, including those resulting from their respective IGs' 
MLR reports. We reported that the regulators had recognized the 
need to re-emphasize a supervisory approach that encompassed 
consideration of an institution's risk profile in all facets of 
the examination process. As it relates to the FDIC, we noted 
that the purpose of its supervisory enhancement initiative was 
to build upon the strengths of the supervision program, 
emphasize balanced and timely response to weak management 
practices and identified risks, and emphasize a more proactive 
approach to examination analysis and ratings based upon the 
lessons learned from recent failures. Importantly, we reported 
that although the new emphasis was a step in the right 
direction, sustaining long-term improvement depended on not 
forgetting the lessons learned once the economy and banking 
industry improve.
    Acquisition, Development, and Construction Loan 
Concentration Study (Report Number EVAL-13-001, October 2012). 
In this evaluation, we looked more specifically at a particular 
area of concern contributing to the crisis--the excessive 
concentration of acquisition, development, and construction 
lending on the balance sheets of many financial institutions. 
In our report, we noted that the FDIC, in response to MLR 
findings and other issues, had issued specific examiner and 
financial institution guidance and taken actions, including:

    Recognizing factors that are indicative of elevated 
        risk associated with management, which included high-
        risk appetite and degree of responsiveness to examiner 
        recommendations;

    Issuing additional guidance regarding the 
        inappropriate use of interest reserves;

    Emphasizing to examiners the risks that the use of 
        noncore funding can present to a financial institution;

    Issuing guidance regarding consideration of 
        brokered deposits in the deposit insurance risk 
        assessment process, use of such funding sources for 
        institutions that are in a weakened condition, 
        processing requests for brokered deposit waivers, and 
        interest rate restrictions for banks that are less than 
        Well Capitalized; and

    Issuing guidance to emphasize the importance of 
        monitoring institutions subject to enforcement actions, 
        including the need to clarify expectations for 
        quarterly progress reports, meet with an institution's 
        Board at the beginning of a corrective program, and 
        conduct on-site supervisory activities between 
        examinations.

    With regard to the question as to what else can be done, we 
believe, as we note in each of the reports described above, 
that sustaining long-term improvement will depend on the 
regulators remaining vigilant in their supervisory activities 
and not forgetting the lessons learned once the economy and 
banking industry begin to improve. In particular, early 
regulatory intervention (i.e., before an institution 
experiences financial and capital decline) is key to 
maintaining healthy banks. When examiners identify practices, 
conditions, or violations of law that could result in losses to 
a financial institution, they must aggressively address them 
and ensure that management takes prompt and effective 
corrective action. We acknowledge that these lessons may become 
more difficult to apply, or sustain, as the banks return to 
profitability. We also believe that the regulators should 
pursue interagency efforts to jointly address some of the more 
systemic MLR trends, such as capital definitions, capital 
levels, and liquidity.

Q.2. Your study also found that examiners did not always 
document the procedures and steps that they performed to assess 
institutions' appraisal and workout programs, and that the 
regulators had different approaches to enforcement actions, 
particularly related to nonproblem banks. How much progress 
have the regulators made to address such deficiencies? What 
else should the regulators do?

A.2. Provided below is how each of the three agencies responded 
to the findings detailed in our study related to documentation 
concerns.

    The OCC responded that while the agency believed 
        its supervisory examination strategy and core 
        assessment processes satisfied this recommendation, the 
        OCC had plans to improve its guidance by including a 
        section specific to appraisals in the commercial real 
        estate and mortgage handbooks that are currently being 
        revised.

    The FRB responded that it is continually looking 
        for ways to improve its examination processes, 
        including ways to improve documentation procedures.

    The FDIC agreed to coordinate with the FRB and OCC 
        to review the interagency Appraisal and Evaluation 
        Guidelines and determine the most appropriate way to 
        strengthen examination documentation requirements.

    As we do not oversee the OCC or FRB, we have not made an 
assessment of the internal progress that these regulators may 
have made to respond to our recommendations. As for the FDIC, 
we have been provided information through our audit follow-up 
process regarding the Corporation's efforts. Specifically, FDIC 
officials indicated that the FDIC, OCC, and FRB staff consulted 
in January and February 2013, and these officials continue to 
discuss with the OCC and FRB whether documentation requirements 
need to be strengthened going forward. At a February 2013 
Federal Financial Institutions Examination Council (FFIEC) Task 
Force on Supervision meeting, the FDIC also discussed its plans 
to strengthen documentation, which include reiterating the 
FDIC's existing working paper documentation guidance to 
examiners and monitoring examiner compliance as part of the 
FDIC's internal control function. Finally, in February 2013, 
the FDIC clarified how examiners should approach and document 
their review of appraisal and workout programs during a policy 
conference call with regional FDIC representatives. The FDIC 
OIG will continue to monitor progress of these efforts until 
such time the FDIC takes sufficient action to close the 
recommendation.
    Regarding the question as to what else regulators should 
do, our office believes that the FDIC should continue to 
identify efficient ways to document procedures that were 
performed during an examination.
    The second part of the question related to the different 
approaches that regulators employ regarding enforcement actions 
and the progress that has been made to address such 
deficiencies. We do not view the regulators having different 
approaches to enforcement actions to be a deficiency on any 
regulator's part. In our report, we pointed out the differences 
and recommended that the regulators study them to determine 
whether there are common approaches that should be implemented 
by all three agencies. All three regulators concurred on this 
recommendation. At the abovementioned February 19, 2013, FFIEC 
meeting, representatives of the FDIC, FRB, and OCC agreed to 
research this recommendation as part of a joint Task Force on 
Supervision project.
    As previously noted, as we do not oversee the OCC or FRB, 
we have not made an assessment of any internal initiatives 
these regulators may be pursuing. As noted in the comments on 
our study's report, the FDIC agreed to conduct an internal 
study in 2013 on its approach for using informal and formal 
enforcement actions to determine whether an alternative 
approach to mitigate risk and correct deficiencies may be more 
effective. We understand that the FDIC has begun an internal 
review of the scope and effectiveness of enforcement actions 
and will complete the study in 2013.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
                  FROM LAWRENCE L. EVANS, JR.

Q.1. As Director for Financial Markets at the GAO, you have to 
analyze historical data. How does the most recent financial 
crisis compare to past crises with regard to community banks?

A.1. While we did not review the failure of community banks in 
past crises as part of our recent bank failures study, prior 
GAO work has addressed failures that occurred during the 
banking crisis of the 1980s and early 1990s. Between 1990 and 
1994, more than 1,600 banks insured by FDIC were closed or 
received FDIC financial assistance. In our May 1989 report, 
``Bank Failures: Independent Audits Needed To Strengthen 
Internal Control and Bank Management'' (GAO/AFMD-89-25), we 
reviewed the 184 bank failures that occurred during 1987. The 
vast majority of these failed banks were small institutions. 
\1\ Common to the failures we studied in both crises were 
internal weaknesses in bank management and board oversight that 
led to weak underwriting, aggressive growth strategies fueled 
by riskier funding sources, and high loan concentrations.
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     \1\ Ninety-two percent (172) of the banks that failed in 1987 had 
assets under $100 million. At that time, banks were considered 
community banks if they had assets under $250 million.

Q.2. Did you recognize any of the underlying causes of past 
crises in this crisis that caused community banks to fail? If 
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so, please describe such shared causes.

A.2. As indicated above, we found several similarities in the 
underlying causes of the bank failures we studied in the 
banking crisis of the 1980s and early 1990s and the most recent 
crisis, in particular internal weaknesses in bank management 
and board oversight that led to weak underwriting, aggressive 
growth strategies fueled by riskier funding sources, and high 
loan concentrations.
    The objectives of the 1989 review were in part to summarize 
data on internal weaknesses that Federal banking examiners 
cited in examinations of these banks prior to their failure. Of 
the internal control weaknesses Federal banking regulators 
identified, those that contributed most significantly to the 
184 bank failures were lack of general lending policies (79 
percent), inadequate supervision by the bank's board of 
directors (49 percent), weak loan administration (42 percent), 
and poor loan documentation and inadequate credit analysis (41 
percent). Other internal weaknesses regulators cited related to 
an overreliance on volatile funding sources such as brokered 
deposits (32 percent), unwarranted loan concentrations (24 
percent), excessive out-of-area lending (16 percent), 
excessively growth-oriented policies (26 percent), and a 
failure to establish adequate loan loss allowances (29 
percent). We found that Federal regulators cited neither a 
single weakness nor a specific combination of weaknesses as the 
sole contributing factor to a bank's failure. Rather, each bank 
demonstrated a unique combination of weaknesses.
    As we noted in our recent report, inadequate management of 
risks associated with high concentrations of CRE loans, and in 
particular, ADC loans were a primary cause of failure in small 
banks. Other internal control weaknesses we reported included 
weak underwriting and credit administration practices. In 
addition, these failed banks had often pursued aggressive 
growth strategies using nontraditional, riskier funding 
sources--particularly brokered deposits. Similar to the past 
crisis, failed banks often did not maintain an adequate loan 
loss allowance and some had engaged in out-of-territory lending 
through loan participations.

Q.3. If you had to single out one dominant cause for banks' 
failure in this past crisis, what would that be?

A.3. As our econometric analysis showed, banks with high 
concentrations of ADC loans and a greater use of brokered 
deposits were more likely to fail between 2008 and 2011. 
However, the build-up of such high concentrations of risky 
loans via a reliance on nontraditional funding sources is 
ultimately a reflection of aggressive growth strategies and 
poor risk management at these banks.
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