I. Management’s Discussion and Analysis - The Year in Review The year 2004 marked continued changes within the FDIC, but maintaining stability of the nation’s financial services industry remained a primary focus. The FDIC continued to lead and participate in many interagency initiatives in an effort to meet the demands of an ever evolving financial services industry.
During 2004, the FDIC continued its emphasis on reducing regulatory burden, and also enhanced its examination program while promoting measures to improve its efficiency. Studies were conducted in various areas, identifying risks and promoting best practices among the regulatory and banking industries. In 2004, the FDIC actively contributed to efforts to address money laundering and terrorist financing risks as well as other financial crimes such as identity theft.
Highlights of the Corporation’s 2004 accomplishments are presented in this section for each of the FDIC’s three major business lines – Insurance, Supervision and Consumer Protection, and Receivership Management – as well as its program support functions.
The FDIC insures bank and savings association deposits. As insurer, the FDIC must continually evaluate and effectively manage how changes in the economy, the financial markets and the banking system affect the adequacy and the viability of the deposit insurance funds.
Deposit Insurance Reform
The FDIC again gave priority attention to enactment of comprehensive deposit insurance reform legislation in 2004.
The FDIC’s reform recommendations include:
Merging the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF).
Granting the FDIC’s Board of Directors the flexibility to manage a combined deposit insurance fund. Under the present system, statutorily mandated methods of managing the size of the BIF and SAIF may cause large premium swings and could force the FDIC to charge the highest premiums during difficult economic times when the industry can least afford it. Currently, safer institutions subsidize riskier institutions unnecessarily, while new entrants and growing institutions avoid paying premiums. To address these problems, the FDIC recommended that Congress give the Board of Directors the discretion to:
Manage the combined fund within a range.
Price deposit insurance according to risk at all times for all insured institutions.
Grant a one-time initial assessment credit to recognize institutions’ past contributions to the deposit insurance funds and create an ongoing system of assessment credits and rebates to prevent the fund from growing too large.
Indexing the level of deposit insurance coverage to ensure that basic account coverage is neither eroded over time by inflation nor made subject to irregular adjustments.
The House passed H.R. 522, the Federal Deposit Insurance Reform Act of 2003, on April 22, 2003, by a vote of 411 to 11. Although the Senate Banking Committee held a hearing on deposit insurance reform in February 2003, it did not act on a deposit insurance bill before the 108th Congress adjourned. The FDIC provided information and analysis to Congress in support of deposit insurance reform legislation. Support was obtained for a proposed assessment credit and rebate system as well as a new deposit insurance pricing system. Enactment of deposit insurance reform will remain a priority of the FDIC during 2005.
Improvements to the FDIC’s Loss Reserve Methodology
Discrepancies between projected failed assets and actual assets and projected and actual losses at failed financial institutions were reviewed at Financial Risk Committee meetings in March and September. No deficiencies in the methodology for projecting losses were noted.
During 2004, enhancements to the FDIC’s reserving process and methodology were also implemented, in accordance with recommendations from a comprehensive 2003 study. The Financial Risk Committee adopted new guidelines for deviating from actual historical failure rates and enhanced coefficients contained in the research model which is used to develop loss given failure estimates. In addition, a working prototype of an integrated fund model was developed to better measure and manage risk to the deposit insurance funds.
New International Capital Standards
The FDIC continues to actively participate in efforts to align capital standards with advances in financial institutions’ risk measurement and management practices, while ensuring that such institutions and the industry as a whole maintain adequate capital and reserves. During 2004, the FDIC was active on a number of global and domestic supervisory and policy groups and subgroups including the Basel Committee on Banking Supervision (BCBS), the Capital Task Force, and the Accord Implementation Group. The FDIC also participated in various U.S. regulatory efforts aimed at interpreting international standards and establishing sound policy and procedures for implementing these standards.
The BCBS published the “International Convergence of Capital Measurement and Capital Standards” in June 2004, which is more commonly referred to as “Basel II” or the “Revised Framework.” These broad international standards will provide the underpinnings for a U.S. revised capital rule, which is currently anticipated to be finalized by domestic bank and thrift regulatory authorities in mid -2006 for implementation in January 2008.
Ensuring the adequacy of insured institutions’ capital under Basel II remains a key objective for the FDIC. In 2004, the FDIC actively participated in domestic and international policy and implementation efforts to ensure these new rules are designed appropriately. These efforts included the development of examination guidance, which is intended to provide the industry with regulatory perspectives for implementation, and the performance of a fourth quantitative impact study (QIS) begun in 2004 to assess the potential impact of the Revised Framework on financial institution and industrywide capital levels.
The FDIC invested significant resources on several fronts in 2004 to ensure that the Revised Framework will be compatible with the Corporation’s roles as both deposit insurer and supervisor. Significant work was performed, both internationally and domestically, to assure that Basel II will be implemented efficiently, that effective supervisory oversight will continue, and that these new rules will not create unintended and potentially harmful consequences. To that end, the FDIC began to identify, hire and train personnel to ensure that a strong infrastructure will exist to meet the many challenges posed by adoption of the complex risk management standards put forth under Basel II.
Regulatory Burden Reduction Initiatives
During 2004, under the leadership of Vice Chairman John Reich, the federal bank and thrift regulatory agencies continued a cooperative three-year effort to review all of their regulations (129 in all) that impose some burden on the industry. The purpose of the review, which is mandated by the Economic Growth and Regulatory Paperwork Reduction Act of 1996 (EGRPRA), is to identify and eliminate any outdated, unnecessary or unduly burdensome regulatory requirements, while ensuring safety and soundness and consumer protections remain strong.
For the purposes of this review, the agencies categorized their regulations into 12 separate groups. Every six months, new groups of regulations are published for comment, giving bankers, community groups and others an opportunity to identify regulatory requirements they believe are no longer needed, as well as consumer protections that must be preserved. Comments on the first group of regulations, which included Applications and Reporting, Powers and Activities and International Banking, were solicited in 2003, and were analyzed during 2004. The agencies issued notices for comment on two more groups of regulations in 2004:
Lending-related consumer protection regulations, which include Truth-In-Lending (Regulation Z), Equal Credit Opportunity (Regulation B), Home Mortgage Disclosure Act (HMDA); and
Deposit-related and other consumer protection regulations, which include Privacy of Consumer Financial Information, Truth-In- Savings, and Deposit Insurance Coverage.
The agencies received over 700 responses to the request for comments on these two groups of regulations.
The agencies also held six outreach meetings in 2004, three for bankers and three for consumer and community groups. These outreach sessions were intended to increase industry awareness of the EGRPRA project and obtain feedback.
The FDIC and the other financial regulatory agencies undertook several initiatives in 2004 that are expected to relieve regulatory burden, improve operational efficiencies of banks, or assist financial institutions in assessing potential risk. They published additional interagency guidance and examination procedures on the USA PATRIOT Act. The FDIC also sought comments on proposed changes to its Community Reinvestment Act regulations and its regulations governing certain international activities. (Final regulations in both areas are expected in early 2005.)
The FDIC also redesigned the EGRPRA Web site to make it more comprehensive and user-friendly and redesigned its Financial Institution Letter (FIL) format to make it easier for financial institutions to identify whether the subject of the FIL applies to their specific institution and the area of the institution to which the FIL is most relevant.
In 2005, the agencies will continue to analyze the comments and other feedback that have been received and expect to propose legislative or regulatory changes, where appropriate, to address certain regulatory burdens and needed consumer protections.
Center for Financial Research
The Corporation established the FDIC Center for Financial Research (CFR) in late 2003 to promote research that provides meaningful insights regarding developments in deposit insurance, the financial sector, prudential supervision, risk measurement and management, regulatory policy and related topics that are of interest to the FDIC, the financial services industry, academia and policymakers. The CFR is a partnership between the FDIC and the academic community with prominent scholars actively engaged in administering and carrying out its research program. The CFR carries out its mission through an agenda of research, analysis, forums and conferences that encourage and facilitate an ongoing dialogue incorporating industry, academic and public-sector perspectives.
The CFR supports high-quality original research by sponsoring relevant research program lines and soliciting rigorous analysis of the issues within five program areas. These programs benefit from the leadership of program coordinators who are drawn largely from the outside academic community. Input is also obtained from six prominent economists who serve as Senior Fellows. The CFR sponsors a Visiting Research Fellows Program to provide support for in-residence scholars for defined time periods. In 2004, the CFR funded 17 research proposals, the results of which will be published in the new CFR Working Papers Series. The CFR also engaged leading scholars in banking and finance to collaborate with FDIC staff on subjects of mutual interest.
The CFR and The Journal for Financial Services Research (JFSR) sponsored their fourth annual research conference, “Risk Transfer and Governance in the Financial System,” in September 2004. The conference, which included 21 presentations selected from more than 60 submissions, attracted more than 100 researchers and included both domestic and international participants. The CFR held two workshops during the year for authors to present their interim results on CFR-sponsored research.
Identifying and Addressing Risks to the Insurance Funds
The FDIC prepares summary analyses each quarter on the condition of large insured financial entities, based primarily on information provided by their primary Federal regulators. These analyses assist the FDIC in identifying risk trends and potential exposure to the insurance funds. Identified risks are highlighted in various reports and communicated throughout the Corporation in both written format and by oral presentations.
All institution -specific concerns identified through this ongoing analytical process in 2004 were referred to FDIC regional offices for appropriate follow-up action. In most cases, these concerns were resolved in connection with the institution's primary Federal regulator.
The FDIC also conducted numerous outreach activities during 2004 on matters of economic and banking risk analysis with community groups, other regulators, and the banking industry. Among them were a series of internal and public roundtables that included a 2004 banking outlook roundtable in New York City, our third annual Washington, DC economic outlook roundtable, and an economics luncheon featuring Dr. Catherine Mann of the Institute for International Economics.
The Corporation also released four issues of FDIC Outlook during the year, along with a number of FYI electronic bulletins. Featured Outlook articles addressed topics such as emerging risks in mortgage and home equity lending, trends in commercial lending, and the challenges to banks facing rural depopulation. FYI reports published during the year featured an FDIC assessment of banking industry exposure to debt obligations of government-sponsored enterprises (GSEs) and a series of articles on the evolving nature of banking in America, including a look at the changing role of community banks, bank branching trends, and challenges from changing payment systems. Four quarterly issues of FDIC State Profiles were released for each state during 2004, and the results of those reports were discussed at regularly scheduled press briefings.
FFIEC Central Data Repository
The FDIC continued to provide leadership for an interagency initiative to implement the Central Data Repository (CDR). This effort includes the Federal Reserve Board and the Office of the Comptroller of the Currency. The CDR is designed to consolidate the collection, validation and publication of quarterly bank financial reports. The CDR will be accessible to regulators, financial institutions and the public. This initiative is being undertaken in cooperation with the Call Report software vendors and the banking industry, and will employ new technology that uses XBRL (Extensible Business Reporting Language) data standard to streamline the collection, validation and publication of Call Report data. Originally scheduled for implementation in October 2004, rollout of the CDR was postponed to address industry feedback and allow more time for system testing and enrollment of financial institutions. As a result, a two-phased implementation of the CDR during the second and third quarters of 2005 is now planned.
Members of the RAC Management Committee and Liaisons – Seated (l to r): Miguel Browne, Steve Fritts, Michael Jackson, and Don Inscoe. Standing (l to r) : Bill Stark, Jim Meyer, Sylvia Plunkett, and Tom Dujenski.
Risk Analysis Center
The Risk Analysis Center (RAC) was established in 2003 to provide information about current and emerging supervisory issues. The RAC brings together economists, bank examiners, financial analysts and others to monitor and analyze economic, financial, regulatory and supervisory trends, and their potential implications for the continued financial health of the banking industry and the deposit insurance funds. Comprehensive solutions are developed to address risks identified during the process. Guided by the FDIC’s National Risk Committee and the RAC Management Committee, the RAC serves as a clearinghouse for information generated by the FDIC’s six regional offices and sponsors a number of projects involving risk-related issues.
Two initiatives were implemented in 2004 to improve the dissemination of risk-related information. First, the Supervisory Discussion Room was initiated to provide interactive nationwide audio and video-conferences on various topics. Each session includes a presentation on a bank supervision matter. Second, the Examiner Forum was developed in conjunction with the Field Supervisor (FS) Council to increase examiner awareness of the RAC and to share information about emerging issues among the field examination staff. Both initiatives provide examiners an opportunity to exchange information across regions and with technical specialists in the Washington office.
RAC activities also include regular monitoring and analysis of economic and financial developments and communication of these issues with FDIC staff and management. Staff conducts a weekly conference call to discuss recent developments, and daily Economic Data Releases are sent by email to FDIC subscribers summarizing intra-day economic news. The RAC website also serves as a clearinghouse for internal analyses of emerging risks. Initial findings on emerging issues are often followed by more in-depth analysis in formal RAC projects.