The FDIC and the Banking Industry:
Perspective and Outlook

Introduction
The Congress created the FDIC in the Banking Act of 1933 to maintain stability and public confidence in the nation’s banking system. The statute provided a federal government guarantee of deposits in U.S. depository institutions so that depositors’ funds, within certain limits, would be safe and available to them in the event of a financial institution failure. As required by current law, the FDIC maintains and protects separate insurance funds for banks and savings associations. The FDIC shares supervisory and regulatory responsibility¹ for the institutions it insures with other regulatory agencies including the Board of Governors of the Federal Reserve System (FRB), the Office of the Comptroller of the Currency (OCC), the Office of Thrift Supervision (OTS), and state authorities. In addition to its role as insurer, the FDIC is the primary federal regulator of federally insured state-chartered banks that are not members of the Federal Reserve System.

¹The terms “FDIC-insured institution” and “insured depository institution” refer to all banks and savings associations insured by the FDIC. The term “FDIC-supervised institution” refers to those banks for which the FDIC is the primary federal regulator, i.e., FDIC insured state-chartered commercial banks that are not members of the Federal Reserve System, state-licensed insured branches of foreign banks, and state-chartered savings banks.

Over the next six years, the FDIC will face many challenges due to changes in the economy, structure of the financial services industry, regulatory requirements, and technology as they affect financial institutions. These challenges will require the FDIC to evaluate and periodically modify its business practices on a continuing basis in order to ensure that it is effectively carrying out its mission. When necessary, the FDIC will also pursue regulatory or statutory solutions to these challenges.

The Impact of the Economy
The performance of the economy at the national and regional levels directly affects the business strategies of individual financial institutions and may affect the industry's overall performance. Changes in the business cycle of sectors such as agriculture, commercial real estate, and energy, as well as interest rates, inflation, and unemployment, influence the lending and funding strategies of insured depository institutions. Adverse economic or financial conditions abroad could spill over and adversely impact the national and regional economies. An economic downturn could adversely impact the financial services industry, resulting in slower asset growth, increased loan losses, and diminished profitability.

Changing Structure of the Financial Services Industry
Changes in the structure of the financial services industry present new challenges for financial institutions and their regulators. These changes are being driven by financial modernization, privacy concerns, industry consolidation, the emergence of new institutions, new trends in borrowing and lending, globalization, and emerging technology.

The passage of financial modernization legislation by Congress in 1999 (the Gramm-Leach-Bliley Act) removed barriers that restricted providers of banking and related services from expanding product offerings to include insurance and securities. Such expansion poses new management challenges to financial institutions and new supervisory challenges to regulators. The mixing of banking and commerce is expected to be a challenging issue for regulators as well. As commercial enterprises not subject to typical bank holding company supervision increasingly own banking and financial entities through Industrial Loan Companies charters or other means, financial regulators must ensure that their supervisory programs remain effective without undue interference with commercial operations.

Mergers and consolidations have increased rapidly over the last five years and, despite an increase in the establishment of new banking institutions, have decreased both the number of insured financial institutions and the number of financial institutions for which the FDIC is the primary federal supervisor. Industry consolidation is expected to continue to decrease the aggregate number of FDIC-supervised financial institutions, although the growth of new institutions may also continue (new institutions are more vulnerable to economic volatility in their early years and provide greater challenges to the FDIC in the event of failure).

As a result of industry consolidation, the assets in the industry are also increasingly concentrated in a small number of large, complex institutions for which the FDIC is not, for the most part, the primary supervisor. The increased complexity of the industry and the concentration of risk to the insurance funds in the largest banking organizations are expected to grow more pronounced over time and to present greater risk-management challenges to the Corporation. A two-tiered banking system characterized by a limited number of very large, complex institutions and a much larger number of small community banks appears to be emerging. This will have significant operational implications for each of the Corporation’s three major business lines.

Competitive pressure within the industry and with non-bank lenders has induced financial institutions to seek more profitable, and possibly riskier, lines of business and has resulted in a greater reliance on non-interest income, which may be more volatile. In addition, institutions that have significant concentrations of certain loan products, such as credit card, sub-prime lending or commercial real estate loans, are potentially more vulnerable to losses in the event of an economic downturn.

New Regulatory Requirements
Over the past several years enacted new laws that place increasing focus on anti-terrorism, compliance, privacy and corporate governance issues. These new regulatory requirements have expanded the FDIC’s supervisory responsibilities. The USA PATRIOT Act (Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act) of 2001 requires financial institutions to implement programs to verify the identity of customers opening new accounts. The Gramm-Leach-Bliley Act of 1999, while lessening supervisory requirements in some areas, added new requirements regarding privacy and other issues. The Sarbanes-Oxley Act of 2003 imposes new reporting, corporate governance and auditor independence requirements on companies, including insured depository institutions and bank and thrift holding companies, with securities registered under federal securities laws. Large financial penalties may be assessed against financial institutions for the failure to obey consumer compliance laws or for breaches in corporate governance.

Protecting the privacy of consumer information is another challenge that has surfaced as a result of financial modernization and technological developments. The ease and speed with which information about individuals can be compiled and shared will require financial institutions to find the appropriate balance between information-sharing for normal business purposes and the need to protect individual privacy.

Financial institution supervisors also face increased challenges to coordinate regulations in an industry that is becoming more global. Efforts such as those undertaken by the Basel Committee on Bank Supervision to adopt new international capital standards will take on increasing significance and further emphasize the need for improved coordination and communication within the international financial services regulatory community.

Within the context of these new regulatory requirements, the FDIC is also committed to regulatory burden reduction on the institutions it supervises and insures. The FDIC is providing leadership within the federal regulatory community for an effort to identify and eliminate outdated, unnecessary, or unduly burdensome statutory or regulatory requirements, in accordance with requirements of the Economic Growth and Regulatory Paperwork Reduction Act of 1996 (EGRPRA).

Impact of Technology
Both the financial services industry and the FDIC will continue to employ technology to improve operational efficiency. As financial institutions leverage new technology, risk-management oversight issues will become more complex for both the institutions and their regulators. For example, emerging technology is introducing new ways for insured depository institutions to deliver and manage traditional products and services and, in some instances, to develop innovative offerings. In addition, new worldwide industry standards are being developed that could allow financial data to be exchanged more accurately and timely at less cost.