LETTER TO THE HONORABLE JULIE WILLIAMS

Dated: October 9, 1998

The Honorable Julie Williams
Acting Comptroller of the Currency
Washington, D.C.20219

Dear Ms. Williams:

The American Association of Bank Directors wishes to express its concerns about your letter of September 18, 1998 addressed to national bank Board members and CEOs regarding the 1998 OCC Survey of Credit Underwriting Practices. We believe that your letter may have the unintended effect of influencing Boards of Directors, as a matter of self-preservation, to adopt loan underwriting standards that will unnecessarily constrict credit, with resultant potential damage to the financial system and the overall economy. We respectfully request that you clarify and expand your remarks by cautioning national banks and their directors that the results of the Survey may have no applicability to any particular bank, that only those banks that are engaging in unsafe or unsound banking practices need to tighten their underwriting standards and that any tightening should not go so far as to restrict credit to credit-worthy customers.

In the accompanying article ("Deterioration of Loan Underwriting Standards - a Challenge for Bank Directors") that I prepared for publication last month, I expressed concerns about the impact that your recent comments may have on the credit decision-making process in the bank Boardrooms across the United States, as follows: "If the banking agencies were to scare banks away from granting not just excessively risky loans, but also prudent loans to their (the banks’) community, then a recession could be triggered simply by the widespread contraction of credit."

Because bank directors face draconian administrative penalties and personal liability for even inadvertent infractions or "unsafe or unsound banking practices," it should not be surprising that when representatives of the federal banking agencies specifically address strongly worded warnings to "Board Members," Boards of Directors may react by not extending or renewing credits except to those with squeaky clean financial statements. As was evidenced by the last recession, the excessive constriction of credit accentuates the effects of the recession and may actually prolong it. In an otherwise robust American economy, the artificial tightening of credit may become the very catalyst which will produce the recession that all of us hope to avoid.

You stated in your letter that you were concerned about the continued easing in underwriting standards found in the survey and that OCC examiners have been instructed to "review a fresh sample of new credits in every national bank and to provide new ‘hard’ conclusions about the extent to which current underwriting practices conform to sound credit policies and standards as well as to the bank’s own policies." You further wrote that "when weaknesses point to fundamentally unsafe or unsound conditions, special supervisory action will be taken."

For directors who survived the rash of lawsuits and enforcement actions brought by banking agencies in the late 1980’s and early 1990’s, your statements may be seen as a signal that the process of targeting bank directors has begun again. This time around, you and the other banking agencies have even greater powers to threaten or impose huge penalties or force restitution for losses.

Public pronouncements may have no applicability to an individual bank, but leave the impression that whatever banking practice is being criticized may involve all banks. As a result, overcautious directors may squeeze credit, and examiners may unfairly penalize banks for sound credits. At best, generic warnings, in our view, are a crude instrument of bank supervision. Because the banking agencies have vast examination authority over banks they regulate, we urge that they utilize their examination authority, which is specific to the bank being examined and subject to strict confidentiality rules, rather than relying on overly broad public statements.

To illustrate this point, the survey of credit underwriting practices involved only national banking affiliates of the 75 largest bank holding companies in the country. All of the surveyed national banking affiliates had assets of at least $2 billion. Of the approximately 9,000 banks in the country, few have assets of $2 billion or more. The practices and competitive pressures of large publicly held banks are not necessarily the same practices and pressures of smaller, often privately held institutions. Yet you have instructed examiners to review new credits in "every" national bank to determine whether they conform to sound credit policies and have threatened every national bank with "special supervisory action" if weaknesses point to an unsafe or unsound condition.

While we agree that the annual survey on credit underwriting practices is useful and should be disseminated, and while we concur that some banks’ underwriting standards have deteriorated to a point where the banks may be engaging in unsafe or unsound banking practices, we are concerned that the manner in which you communicate the results may cause undue concern among bank directors whose banks have adopted and implemented underwriting standards that are safe and sound. Your communications to Board members also have not been tempered by a reminder that risk is a natural component of the lending process, that there is risk even in a so-called "good" loan, and that it is the intention of the OCC only to reduce or eliminate bad lending rather than the risk of lending. Our article urges the Boards of all banks to heed your warnings, but not to take steps to constrict lending to qualified borrowers.

We also have received anecdotal evidence that examiners are toughening their standards in classifying credits (where there is doubt, classify it), and are being more assertive in challenging the methodology used by management to determine the adequacy of the loan-loss reserve. If this is true, tougher examinations will only exacerbate the tendency of Boards of Directors to cut off credit to not just bad credits, but good credits as well.

Why may many bank directors overreact? Part of the problem is the enforcement regimen to which bank directors are subject. Since 1989, Congress has vastly expanded the enforcement powers of the banking agencies to a point of diminishing returns. In studies that AABD has commissioned in the past, we have found that certain banking laws deprive bank directors of their due process protections and, in some instances, federal banking agencies have unfairly targeted bank directors and officers or abused their discretion in pursuing insiders. As a result, qualified bank directors have resigned and qualified persons have refused to serve as bank directors because of fear of liability. Even after several years of few enforcement actions and lawsuits filed by the banking agencies, our surveys continue to show that fear of liability is a major reason that persons refuse to serve on bank boards.

Consequently, a banking agency’s expressed willingness to take enforcement action may motivate bank directors to overreact to warnings issued by banking agencies. The warnings become more ominous by the reality that bank directors cannot predict, given the inherent subjectivity of the examination process, what the examiners will consider a classified loan or adequate loan-loss reserve in any given year. The banking industry experienced the arbitrariness of the process in the late 1980’s and early 1990’s and is more wary this time. To help protect themselves from personal liability and to shield their banks from enforcement actions, bank directors will likely respond to regulatory warnings such as those in your September 18 letter by tightening credit more than market conditions would justify.

We ask for your assistance in identifying the enforcement powers that need to be repealed and those that you genuinely need to supervise banks effectively. For example, does the OCC really need the power to impose civil money penalties of $1,000,000 a day (plus an inflation adjustment) against directors for each day that a violation of law has been outstanding? Would it materially interfere with the OCC’s supervisory effectiveness to relinquish the power to unilaterally freeze the assets of a bank director, without having to prove first to a court of law that the freeze was necessary? How important is it to the OCC in meeting its responsibilities to have the power to impose civil money penalties of up to $25,000 a day on a director for each day that a violation of law exists, without having to prove that the director knew or should have known that the bank would commit the violation?

We urge that the OCC and the other federal banking agencies work with us during the next Congress to improve the statutory framework so that qualified Board members will continue to serve, and will not be led by fear to take actions that are neither in the best interests of the bank in which they serve nor in the best interests of the community.

Sincerely,

David Baris
General Counsel