The meeting was called to order by the Chairman of the Board of Directors of the Federal Deposit Insurance Corporation and Chairman of the FDIC Advisory Committee on Banking Policy, Donald E. Powell.

The members of the Committee present at the meeting were: Sheila C. Bair, Dean’s Professor of Financial Regulatory Policy, Isenberg School of Management, University of Massachusetts - Amherst, Amherst, Massachusetts; Reverend Dr. Floyd H. Flake, Allen AME Church, Jamaica, New York; Richard R. Hollington, Jr., Baker & Hostetler, LLP, Cleveland, Ohio; Terry J. Jorde, President, CountryBank USA, Cando, North Dakota; John G. Medlin, Jr., Chairman Emeritus, Wachovia Corporation, Winston-Salem, North Carolina; Dennis D. Powell, Senior Vice President, Corporate Finance, Cisco Systems, Inc., San Jose, California; Gray D. Lindsey, Senior Vice President, Business Development and Systems Economics, Coca-Cola North America, The Coca-Cola Company, Atlanta, Georgia; Louise M. Parent, Esq., Executive Vice President and General Counsel, American Express Company, New York, New York; Roger B. Porter, IBM Professor of Business and Government, John F. Kennedy School of Government, Harvard University, Cambridge, Massachusetts; Andrew B. Craig, III, Rivervest Venture Partners, St. Louis, Missouri; and John T. Sinnott, Senior Advisor, Marsh, Inc., New York, New York. Erica F. Bovenzi, Designated Federal Officer for the Committee and Deputy General Counsel of the Federal Deposit Insurance Corporation, was also present at the meeting. Committee member Jean Becker, Chief of Staff, Office of President George H.W. Bush, Houston, Texas, was absent from the meeting.

John M. Reich, Vice Chairman of the Corporation’s Board of Directors, and Thomas J. Curry, Director (Appointive) of the Corporation’s Board of Directors, were present at the meeting. Also attending the meeting were: John F. Bovenzi, Steven O. App, John M. Brennan, Robert W. Russell, Jodey C. Arrington, C.K. Lee, Catherine Topping, William F. Kroener, III, Michael J. Zamorski, Arleas Upton Kea, Arthur J. Murton, Frederick S. Selby, Mitchell L. Glassman, Michael E. Bartell, Robert E. Feldman, Alice C. Goodman, Gaston Gianni, Douglas H. Jones, David C. Cooke, Donna J. Gambrell, George E. French, Glen Bjorklund, Thomas Peddicord, Steven Fritts, Miguel Torrado, David Barr, Beth A. Wilt, Michael H. Krimminger, Claude Rollin, Penny Elgas, Joan van Berg, Donna Soto, and Mary Simms.

Chairman Powell presided at the meeting.

Chairman Powell opened the meeting, and then William F. Kroener, III, General Counsel, briefed the Committee members regarding federal preemption of state laws. He noted that, in January 2004, the Office of the Comptroller of the Currency (“OCC”) had issued two final rules that addressed the applicability of state laws to national banks -- the preemption rule and the visitorial powers rule, which clarified (from the OCC’s perspective) the extent to which the operations of national banks are subject to state laws and the exclusive nature of the OCC’s authority to examine, supervise, and regulate the affairs of a national bank as it conducts activities authorized under federal law. Mr. Kroener further noted that the rules extend to operating subsidiaries of national banks, which in many instances are state-chartered entities but in the OCC’s view, are to be treated as national banks for the purposes of preemption. He added that the Office of Thrift Supervision (“OTS”) has similar authority with respect to those institutions that it charters, generally federal savings associations; and that the OTS has asserted statutory authority to preempt for those institutions.

Mr. Kroener continued, noting that state representatives and banking-related organizations have expressed opposition to the OCC regulations and have criticized the OCC’s proposal for allowing operating subsidiaries – state chartered entities – that may engage in abusive lending practices to escape stricter state consumer laws; that the House Financial Services Committee’s Subcommittee on General Oversight and the Senate Banking Committee had held hearings regarding the OCC’s stance regarding preemption of state law; and that the issue continues to be of interest at congressional hearings on unrelated subjects. Mr. Kroener added that, unlike the OCC and the OTS, the FDIC does not charter institutions; instead the FDIC is the supervisor of state-chartered banks. He noted that the preemptive actions taken by OCC and OTS are based on federal statutes that do not generally apply to state-chartered institutions of the sort that the Corporation primarily supervises.

Mr. Kroener advised that, on May 25, 2004, the United States District Court for the District of Connecticut had issued a decision in the matter of Wachovia Bank, National Association, Charlotte, North Carolina, and Wachovia Mortgage Corporation, Charlotte, North Carolina (collectively “Wachovia”) versus the Banking Commissioner for the State of Connecticut. In that regard, he noted that Wachovia had sought to enjoin the Banking Commissioner’s enforcement of certain Connecticut statutes that require businesses engaged in the making of first and second mortgage loans to obtain and maintain a Connecticut state license; and that the court had ruled in favor of Wachovia.

The Committee members and staff of the Corporation then discussed at length the preemption of state laws and a variety of related issues which included the impact of local and regional banking markets, the benefits of market competition, the pros and cons of a dual banking system, the need for a strong national anti-predatory lending standard, and the interests and preferences of consumers and businesses with respect to banking services. A representative from the Conference of State Bank Supervisors noted the organization’s concerns on federal preemption.

Next, Arthur J. Murton, Director, Division of Insurance and Research, briefed the Committee regarding the Corporation’s Center for Financial Research. He first introduced Center participants Alan S. Blinder, the Gordon S. Rentschler Memorial Professor at Princeton University; Mark J. Flannery, BankAmerica Eminent Scholar in Finance at the University of Florida and director of the Center; and Paul Kupiec, Associate Director, Division of Insurance and Research, and co-director of the Center.

Continuing, he noted that the Corporation had established the Center for Financial Research to encourage and support innovative research on topics that are important to the Corporation’s role as deposit insurer and bank supervisor – deposit insurance, risk measurement, bank performance, corporate finance, and policy and regulation; that separate coordinators provide direction and guidance for research and related activities in each of the five research lines; and that a group of senior fellows provides general strategic guidance to the Center. Professor Blinder and Mr. Flannery followed with an overview of the Center’s activities, which included the invitation issued for the submission of research papers for a conference to be held in September 2004. Dr. Porter encouraged staff and senior fellows to distribute as broadly as possible the information generated through the Center’s research activities.

At the conclusion of the foregoing, Chairman Powell, noting that some of the Committee members had inquired about his remarks before the Exchequer Club in Washington, D. C., on May 19, 2004, next requested that staff of the Division of Administration provide the Committee with information regarding the Corporation’s hiring, recruiting, and employment policies. He followed, however, with an announcement that the meeting would recess briefly. Accordingly, at 10:20 a.m., the meeting stood in recess.

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The meeting was reconvened at 10:32 a.m. that same day.

First, Michael J. Zamorski, Director, Division of Supervision and Consumer Protection, introduced a representative of the Chinese Banking Regulatory Commission, Quiang Chen, who was working with the division as an intern on a four-month detail.

Next, Arleas Upton Kea, Director of the Division of Administration, and members of her staff briefed the Committee regarding the Corporation’s employee environment and the Corporation’s existing and proposed employment policies and practices.

After discussion of the foregoing had concluded, Mr. Kroener discussed with the Committee various issues relating to payday lending. He first informed the Committee that payday loans were small-dollar, short-term, unsecured loans that borrowers promise to repay out of their next paycheck or regular income payment; that such loans are usually priced at a fixed-dollar fee; and that because of the very short terms to maturity, the cost of borrowing, expressed as an annual percentage rate, could range from 300 percent to 1,000 percent, or more.

Mr. Kroener noted that federal law authorizes federal and state-chartered insured depository institutions making loans to out-of-state borrowers to “export” favorable interest rates provided under the laws of the state where the bank is located, meaning that a state-chartered bank is allowed to charge interest on loans to out-of-state borrowers at rates authorized by the state where the bank is located, regardless of the usury limitations imposed by the state laws of the borrower’s residence; that there were a number of states where there were no interest rate limits or no interest rate limits that would impact the annual percentages rates that are charged; and that interest rate exportation has allowed credit card issuers to provide a uniform, nationwide rate to their cardholders.

Mr. Kroener advised that a small number of banking institutions have formed business relationships with payday lenders; that the partnerships between payday lenders and banks rely on interest rate exportation; and that a bank forming such a business relationship has been accused by some consumer advocates of “renting” the bank’s charter to the payday lender to avoid usury and other state consumer protection laws.

Mr. Kroener reported that even though this activity is legal for state nonmember banks, institutions have faced reputation risks when they enter into these arrangements with payday lenders, including arrangements to originate loans on terms that are less favorable to the borrower than would be permitted under state law for non-bank lenders and that because of the reputation risk, the Corporation’s position has been that institutions should implement risk management practices to identify, measure, monitor, and control these risks. He further reported that the Corporation’s guidelines addressed appropriate actions for managing risks associated with the third parties who offer payday loans and include strict requirements for managing third party relationships and agreements, which are all designed to address safety and soundness concerns: maintenance of higher capital levels--perhaps up to dollar-for-dollar capital--and sufficient loan loss allowances for payday lending portfolios, depending on the level and volatility or risks; limits on the total amount of payday loans an FDIC-insured institution may extend as a percentage of its capital; restrictions on “rollovers” including an appropriate cooling-off period; limits on the number of loans per customer allowed within a designated time period; requiring banks to charge off certain loans; and Community Reinvestment Act downgrades for discriminatory or illegal credit practices.

Mr. Kroener then advised that both the Office of the Comptroller of the Currency (“OCC”) and the Board of Governors of the Federal Reserve System (“Federal Reserve”) have largely banned payday lending by banks that are either chartered by the OCC or members of the Federal Reserve; that the Corporation’s view was that the activity was lawful, safe, and sound generally; and that this difference from the Corporation’s policy has led to Congressional inquiries and continuing concerns particularly among the consumer groups about whether these activities are or can be harmful to consumers. He also noted that there has been a certain amount of litigation in this area.

Following Mr. Kroener’s report, a discussion followed where various Committee members expressed concern with the integrity of payday lending activities, the need for the Corporation to provide appropriate supervision and control with regard to such activities, and the need for providing aggressive educational programs to consumers on alternative sources of lending and in getting banks to consider offering low-cost short-term credit alternatives to payday loans. Two members of the public noted their concerns over payday lending. One trade association representative for payday lenders advised that the association voluntarily adopted a number of best practices to address policy concerns.

At the conclusion of the discussion, Chairman Powell announced that the meeting would recess. Accordingly, at 12:01 p.m. the meeting stood in recess.

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The meeting was reconvened at 1:33 p.m. that same day at which time George E. French, Deputy Director (Policy and Examination Oversight), Division of Supervision and Consumer Protection, informed the Committee of the revisions to the regulatory capital framework that was to be set forth under the Basel II Accord. By way of background, he noted that the initial regulatory capital framework set forth in the first Basel Accord (“Basel I”) was adopted by the Basel Committee on Banking Supervision and endorsed by the Group of Ten countries (current member countries included Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the United Kingdom and the United States), and that the framework established common international standards for the definition of regulatory capital and the method by which the adequacy of capital was evaluated.

Mr. French commented that Basel I, however, was a blunt instrument with respect to credit-risk differentiation and was becoming more and more outdated; that institutions subject to Basel I were required to maintain a minimum ratio of regulatory capital-to-total risk-weighted assets of at least 8 percent; and that the arbitrary capital requirements were not connected to the risk of particular loans and thus gave banks an incentive to engage in riskier loans. He reported that a new regulatory capital framework set forth in a second Basel Accord (“Basel II”) developed by the Basel Committee on Banking Supervision was expected to be put forth for implementation in the near future; and that while Basel II would not be binding on any country, each country was expected to go forward with implementation of the capital standards in its own way. Mr. French advised that, in the United States, a notice of proposed rulemaking to provide for the implementation of the new regulatory capital framework was expected to be issued by the financial institutions regulatory agencies in 2005; that a number of quantitative impact studies on the potential competitive effects of the new accord and its impact on the risk-based capital requirements for specific activities were expected to be performed in the interim; and that implementation of the capital standards set forth in Basel II was expected to essentially begin with the ten largest banking institutions in the United States in 2008. He noted that implementation of Basel II by other smaller depository institutions would be optional.

Mr. French apprised the Committee that, under Basel II, each banking institution subject to the new capital requirements would essentially set its own capital requirements by establishing individual risk parameters for all of its loans or pools of loans; that those established parameters would be then entered into formulas provided by regulators, which would establish the capital requirement for those individual loans or pool of loans as the case may be; and that the bank’s total capital requirement would be the sum of all the individual capital requirements for each loan and pool of loans plus an operational risk-capital requirement set basically by agreement between the bank and its supervisory authority.

Mr. French commented that Basel II would influence the way large banks conducted business in that it would force banks to have certain processes, internal controls, and a disciplined approach to risk management in place and would provide a framework that will determine whether any additional capital would be needed for certain exposures like subprime lending and the like.

Mr. French then advised the Committee of certain policy issues that were developing in connection with the impending implementation of Basel II. He noted that one of the more serious issues that had been raised concerned the minimum capital ratio--the well-capitalized standard of 5 percent of total assets--which was a legislative requirement that all depository institutions in the United States were required to comply with. Mr. French reported that large institutions were concerned that the retention of the minimum capital ratio at the 5 percent of total assets level would inhibit their ability to take full advantage of any significant capital reductions that could result from their implementation of the new capital standards, and that to require the retention of capital higher than what the bank’s own capital model estimates it should be would induce the institutions to engage in riskier lending activities.

During the discussion that followed, various Committee members expressed concern with the Corporation’s placing reliance on the bank’s required capital estimates. Mr. Medlin indicated that some premium capital requirement over and above an institution’s capital model estimates should be necessary inasmuch as the capital model estimates would not take into account the economic or social costs associated with unexpected events and unanticipated shifts in the marketplace.

Next, Vice Chairman Reich reported on the efforts by the Corporation and the other banking regulatory agencies pursuant to the Economic Growth and Regulatory Paperwork Reduction Act of 1996 in reviewing and reducing the regulatory burden on the banking industry as mandated by Congress.

Chairman Powell then announced that the meeting would recess. Accordingly, at 2:21 p.m. the meeting stood in recess.

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The meeting was reconvened at 2:28 p.m. that same day at which time Vice Chairman Reich presented a list of all of the rules and regulations that had been imposed on the banking industry since the creation of the Financial Institutions Recovery, Reform, and Enforcement Act of 1989.

Mr. Murton then reported on the Corporation’s two-tiered approach to bank supervision and on the “too big to fail” concept as it relates to the federal deposit insurance system. He began by noting that two main trends that had occurred in the banking industry were the consolidation of the industry over the last 20 years where the number of community banks have declined since 1985 from over 14,000 to just over 7,000 today and the concentration of more of the industry’s assets and deposits into larger organizations. He further noted that in 1985, the top 10 banking institutions held 16 percent of the industry’s deposits and today their share was 40 percent.

Mr. Murton reported that this consolidation trend suggested even larger growth for the largest institutions and a continued decline in the number of community banks and that the trend would ultimately pose some significant questions for policymakers and have a profound impact on how the federal safety net of regulation and deposit insurance are administered for the regulated financial services industry.

Mr. Murton indicated that it seemed appropriate, therefore, to explore a “two-tiered” approach to bank regulation, supervision, and safety net arrangements. He informed the Committee that elements of a two-tiered approach were already in place, with Basel II capital rules, regulations that provide exemptions or require less reporting for smaller banks, failure-resolution rules that allow for extending safety net protections for banks that pose systemic risks, and so forth. Mr. Murton commented, however, that there was some concern whether the Corporation should go further.

In this regard, he noted that the Corporation had long argued that building a deposit insurance fund in advance of problems was beneficial, since it ensured that financial resources were available and thereby made forbearance less likely when problems arise. He also noted that it was not clear that that argument was valid when applied exclusively to the largest banks since it seemed unlikely that a fund large enough to address severe problems at any of those institutions would be practicable. In light of these concerns, he questioned whether the FDIC should be thinking about different funding arrangements for large and small banks.

Mr. Murton advised that one option the Corporation was considering was an ex post funding arrangement for the largest institutions where instead of an insurance fund, this approach would result in a pre-specified set of rules and obligations for the members of this group to fund any insurance losses going forward.

Then turning to the concept of “too big to fail” and its impact on the federal deposit insurance system, Mr. Murton noted that failures of financial institutions in the early 1980s were handled in a departure from past practices where protection was provided only to covered insured depositors to instill discipline and that a conclusion of the banking crisis during that period had been that the Corporation had gone too far in providing protection to not just insured depositors but uninsured depositors and creditors. He apprised the Committee that the failure of a large bank, particularly one of the largest and most complex banks, represented a risk not only to the insurance funds but also to the banking system itself, because of the sheer size of the potential loss; and that one option that was being considered by the Corporation was whether to have, in a sense, a deposit insurance system which provided two means by which the risk to the system would be shared. In this regard, he noted that small institutions would be responsible for the small bank pool to a greater extent than they are now and that the larger institutions would have some risk-sharing arrangement among themselves. Also with regard to the larger institutions, he indicated that one option was to consider whether the Corporation should look to the market in pricing some of the risks to the insurance system and for guidance on the way the risks are changing over time and are related to one another.

Mr. Murton further advised that another option still to be considered would be to create a system where financial institutions could opt out of the federal deposit insurance system and continue to operate, thus protecting the deposit insurance system from some of these risks.

During the discussion that followed, various Committee members expressed concern with financial institutions opting out of the federal deposit insurance system and the need for the retention of the safety provided through the federal deposit insurance to depositors with accounts of $100,000 or less. In conjunction with that discussion, Ms. Jorde added that, with regard to the two-tiered approach to bank regulation, she would suggest that the Corporation give some consideration to lifting some of the regulatory burden that is currently imposed upon all banks and to lengthening the time period within which small banks are required to file reports of condition and income with the Corporation.

Following that discussion, the Committee members and the Corporation staff then briefly discussed the Corporation’s role in implementing the Bank Secrecy Act.

There being no further business, the meeting was adjourned.