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FDIC Banking Review

Vol. 8 No. 3 - Article III - Published: February, 1996 - Full Article

Recent Developments Affecting Depository Institutions
by Benjamin B. Christopher
(a financial economist in the FDIC's Division of Research and Statistics.)

Reference sources:
American Banker (AB);
Wall Street Journal (WSJ);
BNA's Banking Report (BBR); and
Federal Register (FR).


Inter-Agency Actions

The federal bank and thrift regulatory agencies are engaging in joint or coordinated efforts in a number of regulatory areas that are mentioned specifically in this issue of the Review, among which are: risk-based capital standards, safety-and-soundness standards, supervision of U.S. operations of foreign banks, CRA regulations, single-borrower lending limits, affordable housing loan appraisals, and HMDA reporting requirements. For full information on the inter-agency actions included in this issue, reference is necessary to the pages devoted to each of the agencies and the Federal Financial Institutions Examination Council.

Federal Deposit Insurance Corporation

Assessments to Be Reduced For Most BIF-Insured Banks
The FDIC Board of Directors voted to reduce significantly the deposit insurance premiums paid by most banks but to keep existing assessment rates intact for savings associations. The decision closely resembles a proposal issued for public comment earlier this year (see this Review, Spring 1995, p. 25). The reduction in premium rates for banks is required by current law based on the anticipated recapitalization of the Bank Insurance Fund (BIF). Under the new rate structure, the best-rated institutions insured by the BIF will pay four cents per $100 of domestic deposits, down from the current rate of 23 cents per $100. The weakest institutions will continue to pay 31 cents per $100. Approximately 92 percent of the nearly 11,000 BIF-insured institutions would pay the lowest rate. The reductions in premiums will decrease the expenses of BIF members by approximately $4.4 billion annually.

Chairman Ricki Helfer said that widening the spread between the rates paid by the strongest and the weakest BIF-insured institutions (eight basis points under the current system, and 27 basis points under the new one) promotes the fundamental goals of a risk-related insurance system. "The wider range of insurance rates gives weak banks a big incentive to get healthy and encourages all banks to avoid unnecessary risk-taking," she said.

The latest FDIC projections indicate that the BIF likely was recapitalized, with reserves of $1.25 for every $100 of estimated insured deposits (or a reserve ratio of 1.25 percent), during the second quarter of 1995. The new BIF assessment rates will apply from the first day of the month after the BIF is recapitalized. The soonest the recapitalization of the BIF can be confirmed is in early September, when the agency finishes processing banks' "Call Reports" for the period ended June 30, 1995. Assuming that the BIF recapitalized during the second quarter, BIF members that have overpaid their assessments based on the newly-adopted premium rate schedule can expect to receive a refund of any overpayment plus interest.

In connection with the new rate schedule, the FDIC Board established a process for quickly raising or lowering all rates for BIF-insured institutions if changing conditions warrant a timely change. Under this new system, the Board would have the flexibility to adjust the entire BIF assessment rate schedule twice a year without having to seek public comment first, but only within a range of no more than five cents per $100 above or below the premium schedule adopted. PR-50-95, FDIC, 8/8/95.

The BIF Increased to 1.22 Percent of Insured Deposits in First Quarter

During the first quarter of 1995, the BIF rose by $1.3 billion to $23.2 billion. This growth reflects continuing high levels of assessment income, increased investment income, and continuing minimal bank failures. The fund balance amounted to 1.22 percent of estimated insured deposits at year-end 1994, about $516 million below the legislatively mandated level of 1.25 percent. Total revenues to the BIF in the first quarter were $1.65 billion, which included net assessment revenues of $1.4 billion and interest income on fund investments of $221 million. Non-assessment income amounted to 80 percent of the first quarter's expenses and losses. The fund's liquid assets comprise 79 percent of the fund balance.

The Savings Association Insurance Fund (SAIF) continued to grow slowly in the first quarter of 1995. Total revenues amounted to $283 million, and operating expenses were $4 million, resulting in the net income added to the fund of $279 million. The SAIF balance increased to $2.2 billion, or 0.32 percent of estimated insured deposits, from $1.9 billion and 0.28 percent at year-end 1994. First Quarter 1995 Financial Management Report, FDIC, 5/30/95.

Recapitalization of the SAIF

In testimony in late July, Chairman Ricki Helfer described the difficulties facing the SAIF, and discussed recommendations, which reflect discussions and analyses by the Department of the Treasury, the OTS, and the FDIC, for resolving those difficulties. At the current pace, and under reasonably optimistic assumptions, the SAIF is unlikely to reach the minimum designated reserve ratio of 1.25 percent until the year 2002.

A principal reason the SAIF is undercapitalized is that SAIF assessments have been diverted to purposes other than building the fund. Since 1989, $7.4 billion --- approximately three-quarters of SAIF assessments --- have been diverted from the fund to pay off obligations arising from the government's efforts to handle the thrift failures of the 1980s. The Resolution Funding Corporation (REFCORP) received $1.1 billion, the Federal Savings and Loan Insurance Corporation Resolution Fund (FRF) received $2 billion, and the Financing Corporation (FICO) has received $4.3 billion. Without these diversions, the SAIF would have reached its designated reserve ratio of 1.25 percent last year. Only the FICO obligation remains, but under current law it has an annual call of up to the first $793 million in SAIF assessments until the year 2017, with decreasing calls for two additional years thereafter. In 1995, the FICO draw is expected to amount to approximately 45 percent of all SAIF assessments. On July 1, 1995, the SAIF's potential obligations increased when it assumed responsibility from the RTC for resolving all new failures of SAIF-insured thrifts.

The FDIC strongly supports a proposal developed on an inter-agency basis for resolving the problems of the SAIF. Under this proposal, briefly summarized, the SAIF would be capitalized through a special up-front cash assesssment on SAIF-assessable deposits. The special assessment would amount to approximately 85 to 90 basis points, or 85 to 90 cents for every $100 of assessable deposits. A special assessment of this magnitude would produce approximately $6.6 billion, increasing the SAIF's balance to $8.8 billion and the reserve ratio to 1.25 percent. The special assessment would be based on SAIF-assessable deposits held as of March 31, 1995, and would be due on January 1, 1996. After the SAIF is capitalized, it's risk-related assessment schedule would be similar to the final schedule adopted for the BIF. Among other elements of the proposal are: the responsibility for the FICO payments would be spread proportionally over all FDIC-insured institutions; the BIF and the SAIF would be merged as soon as practicable, after a number of additional issues related to the merger are resolved. The FDIC and the OTS also recommended making unspent RTC funds available as a kind of reinsurance policy against extraordinary, unanticipated SAIF losses to limit the potential future costs to taxpayers from the existing full faith and credit guarantee of the U.S. Government that the SAIF enjoys. Testimony, Chairman Ricki Helfer, Committee on Banking, Housing and Urban Affairs, U.S. Senate, 7/28/95.

GAO Audits

The U.S. General Accounting Office, reporting on its audits of the financial statements of the BIF, the SAIF, and the FRF on December 31, 1993 and 1994, said the statements, taken as a whole, were reliable in all material respects. FDIC management fairly stated that internal controls in place on December 31, 1994, were effective in safeguarding assets against unauthorized acquisition, use or disposition. There was no reportable noncompliance with laws and regulations that were tested.

The report presents the GAO's recommendations to improve the FDIC's internal controls, discusses the improvements in the banking and savings association industries that have significantlyaccelerated the recapitalization of the BIF, and discusses the agency's concerns about the capitalization of the SAIF. Financial Audit Federal Deposit Insurance Corporation's 1994 and 1993 Financial Statements, U.S. General Accounting Office, March 1995.

Bank Exposure to Interest-Rate Risk

The FDIC is amending its risk-based capital standards to include a bank's exposure to changes in interest rates as a factor in evaluating the institution's capital adequacy, implementing Section 305 of the FDIC Improvement Act of 1991. The revised rule is scheduled to take effect 30 days after it appears in the Federal Register. The FDIC's rule applies only to state-chartered commercial banks that are not members of the Federal Reserve System and FDIC-supervised savings banks. The Board of Governors (FRB) and the Office of the Comptroller of the Currency (OCC) are expected to issue similar revisions to their capital standards for the commercial banks they supervise. A policy statement is being proposed that would serve as the basis for measuring and monitoring interest-rate risk. After an evaluation of the reliability and the accuracy of this framework, the regulators will consider proposing a regulation that would set definitive capital requirements. To avoid unnecessary regulatory burden, low-risk institutions, primarily small banks, would be exempted from having to complete the additional paperwork required to monitor interest-rate exposure. The FDIC estimates that approximately 7,025 out of the 10,847 commercial banks and FDIC-supervised savings banks nationwide would be exempt from additional reports. PR-42-95, FDIC, 6/27/95.

Capital Maintenance

The FDIC is amending its risk-based capital standards for insured state nonmember banks to implement a provision of the Riegle Community Development and Regulatory Improvement Act of 1994 (RCDRIA) of 1994 which states that the amount of risk-based capital required to be maintained by any insured depository institution, with respect to assets transferred with recourse, may not exceed the maximum amount of recourse for which the institution is contractually liable under the recourse agreement. The amendment is effective on April 27, 1995. FR, 3/28/95, p. 15858; 4/10, p. 17986 (OCC).

Policy Statement on Collateralized Letters of Credit

The FDIC issued a policy statement assuring the financial markets that certain collateralized letters of credit issued by insured banks and thrifts prior to the enactment of FIRREA on August 9, 1989, will continue to be treated substantially the same by the agency, as conservator or receiver for an insured depository institution, as they are now being treated by the RTC. The policy statement, effective immediately, is intended to remove doubts the financial markets may have about the FDIC's treatment of these instruments when the agency assumes responsibility for thrift receiverships from the RTC on July 1, 1995. These letters of credit include those issued by banks and thrifts as collateral for state or municipal bonds that finance low- and moderate-income housing developments and similar projects. The policy statement explains the limited circumstances when the FDIC would seek to repudiate a collateralized letter of credit issued by an insured institution that fails. PR-36-95, FDIC, 5/19/95, and Policy Statement.

Management Official Interlocks

The FDIC is withdrawing a proposed amendment to its regulations that implement the Depository Institution Management Interlocks Act. The proposal would have created limited exceptions to the prohibition on management official interlocks for depository institutions that control only a small percentage of the total deposits in the community or relevant metropolitan statistical area in which the institutions are located (see this Review, Winter 1995, p. 33). Section 338 of the RCDRIA modified the authority of the federal banking agencies to create regulatory exceptions to the bar on management interlocks. The FDIC Board believes the proposed amendment is not consistent with the limited authority to create exceptions on a bank-specific and case-by-case basis given the FDIC under the Interlocks Act as amended. FR, 2/7/95, p. 7139.

Limits on "Golden Parachutes" Proposed

The FDIC issued a proposal under which troubled holding companies, banks and thrifts would be prohibited from making "golden parachute" payments, which are typically large cash amounts paid to executives who resign just before an institution is closed or sold, subject to certain exceptions. Also, any holding company or FDIC-insured institution would be limited in its payments for an employee's or director's liabilities or legal expenses when that person is the subject of an enforcement proceeding. The proposed regulation would provide guidance to the industry on which payments would be considered legitimate and which would be considered abusive or improper. The regulation would implement anti-fraud legislation enacted in 1990, pursuant to which the FDIC issued an initial proposal in 1991. PR-24-95, FDIC, 3/21/95.

Payable Through Accounts

The FDIC issued guidelines that include more information about "payable through" accounts and suggested internal controls and procedures. Also called "pass by" accounts, these generally are checking accounts marketed to foreign banks that otherwise would not have the ability to offer their customers access to the U.S. banking system. U.S. banking entities that process large numbers of checks on accounts where signature cards have been completed abroad and submitted in bulk may have undertaken little or no effort independently to obtain or verify information about the individuals and businesses who use the accounts. Regulators are concerned that the use of these accounts may contribute to unsafe and unsound banking practices and other misconduct, including money laundering and related criminal activities. It is noted that the traditional use of "payable through" accounts by financial organizations in the U.S., such as by credit unions and investment companies, has not been a cause for concern. FIL-30-95, FDIC, 4/7/95.

FDIC's Right to Revoke Deposit Insurance Upheld

The U.S. Court of Appeals for the 4th Circuit upheld the FDIC's decision to terminate the deposit insurance of Doolin Security Savings Bank, New Martinsville, W. VA., for the bank's refusal to pay its insurance premium in full. Doolin protested in 1993 its not being placed in the FDIC's lowest risk-based premium category, citing the agency's failure to base its decision on objective criteria. In deciding for the FDIC, and upholding the decision of an administrative law judge, the court said the agency's decision was not unreasonable "that the subjective supervisory reports of primary regulators are relevant to determining whether an institution would cause the insurance fund to incur a loss." Following a 15-day period in which Doolin could ask for a rehearing, the bank will have 60 days to pay the remaining $15,000 on its assessed premium before its deposit insurance would be withdrawn. AB, 5/22/95, p.2.

Recordkeeping For Securities Transactions

The FDIC amended its regulation that establishes recordkeeping and confirmation requirements for securities transactions undertaken by an insured state nonmember bank for its customers. The action responds to reports from some banks of practical difficulties in complying with the requirements. The amendment, effective February 7, 1995, provides for a waiver of the requirements for good cause, affording the FDIC more flexibility in applying its requirements. FR, %-4 2/7/95, p. 7111.

The FDIC is waiving under certain circumstances its requirement that state nonmember banks carrying out securities transactions for customers disclose on the confirmation statement or separately the portion of the fee charged to customers represented by the amount of the bank's commission. This action, effective immediately, will eliminate a disparity in the rules for state nonmember banks in relation to state member and national banks, which are not required to provide the disclosures. Bank customers will continue to receive information about their transactions under existing securities industry standards, including disclosure of the total fees paid in connection with securities transactions. PR-22-95, FDIC, 3/21/95.

Housing Recovery Continuing at Slower Pace

The FDIC's latest quarterly survey of real-estate markets showed continuing improvement in many areas of the country, particularly for commercial properties. While the assessments of local housing markets across the country remained favorable overall, some continuing loss of momentum in that sector was indicated.

The national composite index of survey results fell to 61 in April from 62 in January and 72 in July 1994. Values of the index above 50 indicate more respondents believed conditions were improving than declining, compared to the previous quarter, while values below 50 indicate the opposite. The surveys, which began in April 1991, are based on interviews across the country with senior examiners and asset managers of federal bank and thrift regulatory agencies. The 401 participants in the latest survey were polled in late April.

The composite index for housing fell in April to 57 from 58 in January, continuing a decline in the index that began with the July 1994, survey. The proportion of respondents observing worsening conditions --- 18 percent --- was the highest to date. Thirty-two percent of the respondents reported excess supply of residential real estate in April, up from 28 percent in January. Declining from 69 percent in April 1991, this percentage reached a low of 27 percent in July 1994. Among other indicators of housing markets, 73 percent of the respondents in April reported new-home construction at "average" or "above-average" levels, down from 1994's average of 76 percent. The proportion of respondents who thought home sales were "above-average" --- 19 percent --- has declined in four consecutive surveys.

For commercial real estate, the composite index in April was 68, unchanged from January, and down by a moderate 5 percent from its survey high of 73 in April 1994. This index registered a low of 46 in January 1992. In April, 38 percent of the respondents thought conditions in their local commercial real-estate markets were better than three months earlier, the same percentage as in January, while the three percent seeing worsening conditions was down slightly. Fifty-three percent of respondents nationally reported excess supply in commercial real-estate markets, up from 52 percent in January, following consecutive declines since July 1993, when the figure was 82 percent.

Regionally, the indexes in April for both residential and commercial real-estate markets were equal to or off by not more than one point from the national indexes, except in the Northeast and West. The most significant improvement in April occurred in the Midwest, this being the only region where improvements were seen in both the commercial and residential real-estate markets. It may be noted that the Midwest's indexes had dropped sharply in January from the October 1994, survey. The indexes for the South, which were several points above the national data in January, declined to near those figures in April. In the Northeast, following significant gains in late 1993 and early in 1994, the indexes began a decline that continued for commercial markets in April. The proportion of respondents there reporting excess supply conditions in both commercial and residential markets continued to be the highest of any region. In California, 26 percent of the respondents saw improvements in commercial markets in April, and 18 percent in residential, representing small increases from January. Excess supply in commercial real estate was reported by 93 percent of the respondents. In contrast, for the West outside of California, 61 percent reported improvement in commercial real estate, compared to 38 percent nationally, and only 29 percent reported excess supply. Residential markets also were seen as stronger than average in those states. Survey of Real Estate Trends; FDIC, April 1995.

Reorganization and New Division of Insurance

The FDIC has created a Division of Insurance, whose mission will include identifying and assessing existing and emerging risks to the deposit insurance funds. Chairman Ricki Helfer said that "establishing this new division as a formal element in the structure of the organization is the next logical step in our effort to shift the FDIC from an agency that resolves bank failures to an agency working to keep banks open and operating safely and soundly." The new division is one of several organizational changes approved by the FDIC Board to enhance the Corporation's decision-making processes and to achieve the goals established by the agency's strategic plan which the Board adopted on April 24, 1995. Under the revised organizational structure, the Corporation's divisions and offices will generally report to one of the three deputies to the Chairman. A number of management changes were also announced, effective June 18, 1995. PR-30-95, FDIC, 4/24/95; PR-33, 5/17.

Bankers to Be Surveyed on Ways to Improve Examination Process

The FDIC will conduct surveys among bankers across the country aimed at improving the quality of safety-and-soundness examinations, detecting and changing aspects of the agency's examination process that may be inefficient, and reducing regulatory burden. The program, which is expected to run for one year, builds on previous informal surveys conducted on a regional basis by the Division of Supervision.

Chairman Ricki Helfer said "the emphasis in this program is on two-way communication, timely analysis and effective follow-up ... these elements are essential if the FDIC is to maintain an efficient supervisory program and work effectively with bankers to encourage safe and sound banking operations." PR-25-95, FDIC, 3/24/95.

As of early May, the Office of Thrift Supervision (OTS) had begun a similar program for evaluating its examiners, and the OCC was planning to start a program in June. AB, 5/9.

Final Guidelines For Appeals Process

The FDIC approved final guidelines establishing an appeals process for material supervisory determinations made by agency examiners and regional supervisory officials, implementing a requirement applicable to the federal banking agencies and the NCUA under the RCDRIA of 1994. Under the new guidelines, institutions have 60 days following receipt of written notice of a material supervisory determination to appeal that determination to a special Supervision Appeals Review Committee established in the Washington office. This Committee will consider and decide the appeal, and notify the institution of its decision within 60 days.

Institutions may appeal a variety of material supervisory determinations, including those relating to: examination ratings, such as CAMEL, compliance, and Community Reinvestment Act ratings; the adequacy of loan-loss reserve provisions; disputed asset classifications exceeding ten percent of total capital; and violations of law or regulations. Decisions to take prompt corrective action pursuant to Section 38 of the Federal Deposit Insurance Act, determinations for which other appeals procedures exist, and decisions to initiate formal or informal enforcement actions are not appealable under the new guidelines. There are also provisions designed to protect institutions from possible retaliation as a result of filing an appeal. PR-21-95, FDIC, 3/21/95; FIL-28-95, 4/4; FR, 3/28, p. 15923.

Deposit Activities of Foreign Banks

Pursuant to Section 107 of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, the FDIC proposed to amend its regulations to restrict the amount and types of initial deposits of less than $100,000 that could be accepted by an uninsured, state-licensed U.S. branch of a foreign bank. The proposal is intended to afford equal competitive opportunity to foreign and domestic banks. FIL-48-95, FDIC, 7/19/95; FR, 7/13, p. 36074.

Examinations Workshop For Minority Bankers

The FDIC will conduct a workshop at the National Bankers Association Annual convention this year on how bankers can prepare for examinations and how they can work with examiners in addressing any problems they may have. The convention will be held in New York City in September. Announcing the FDIC's participation which responded to a request from the NBA, Chairman Ricki Helfer said the workshop is an example of how the agency's focus has changed from resolving failed banks to concentrating on helping banks and other financial institutions to stay open and operate safely and soundly. Section 308 of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 calls on the FDIC to provide minority-owned banks with technical assistance and educational programs. PR-17-95, FDIC, 3/6/95.

Deposit Insurance Seminars

Beginning in May and through August 1995, the FDIC will conduct 22 seminars in 11 cities nationwide for bank officers and employees who have oversight responsibilities relating to the dissemination of accurate deposit insurance information. Instruction will be presented also on uninsured deposit-like products and how to assist employees and customers to distinguish them from insured deposits. FIL-33-95, FDIC, 4/28/95.

Information Availability Is Enhanced

To improve public access to information, the FDIC is now offering a new telephone service, "Action Update," which provides a recorded message about the most recent press releases and directives to institutions (Financial Institution Letters), as well as brief descriptions of the FDIC Board of Directors' most recent actions, a description of new publications, and a list of significant events. Callers can access the new service by dialing 202-898-7210, and can obtain copies of the documents referenced by calling 202-898-6996. FDIC press releases and certain other documents also are available through a fax retrieval system. PR-41-95, FDIC, 6/19/95.

Study of Bidder Competition and Resolution Policies

This study, by three FDIC staff members, investigates whether the changes in the FDIC's failure-resolution policies mandated by the FDIC Improvement Act of 1991 (FDICIA) decreased failure-resolution costs. Prior to FDICIA, the winning bid for a failed bank's assets and liabilities was not required to be the bid that minimized the FDIC's resolution costs. Generally, bids were divided into three categories according to whether the bidder proposed assuming virtually all, some, or few of the failed bank's assets. These three types of bids are termed whole-bank bids, purchase-and-assumption (P&A) bids, and deposit-transfer bids, respectively. Whole-bank bids were considered first, and if the most competitively priced whole-bank bid was less costly than a deposit payoff, that whole-bank bid was selected. If no whole-bank bid passed the cost test, the P&A bids were considered. Finally, if no P&A bids passed the cost test, the deposit-transfer bids were considered. If no bids passed the cost test, the FDIC conducted a deposit payoff.

FDICIA eliminated the preference to select whole-bank bids over P&A bids and P&A bids over deposit-transfer bids. The Act required that the winning bid be chosen solely on the basis of minimizing the FDIC's resolution costs. The least-cost resolution rule went into effect immediately upon passage of FDICIA on December 19, 1991. Because competition among bidders for failed banks prior to FDICIA was based not only on the cost to the FDIC, but also on the type of bid, it is possible that winning bids were not always cost minimizing to the FDIC. Based on the FDIC's actual and estimated losses on resolutions in the study period, the aggregate resolution costs were found to have decreased substantially after enactment of FDICIA. "Acquirer Gains in FDIC-Assisted Bank Mergers: The Influence of Bidder Competition and FDIC Resolution Policies," Matthew T. Billett, Jane F. Coburn, and John P. O'Keefe, May 1995.

Resolution Trust Corporation

Agency on Schedule to Sunset at Year-end

Established on August 9, 1989, to deal with the failure of much of the U.S. savings-and-loan industry, the RTC is completing its mission and is scheduled to terminate on December 31, 1995. The agency was created by amendments to the Federal Home Loan Bank Act made by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA). This legislation, as subsequently amended, gives the RTC responsibility for resolving savings institutions that were previously FSLIC-insured and that became insolvent before July 1, 1995; and liquidating the assets of those institutions. Savings associations that become insolvent after July 1, 1995, become the responsibility of the Savings Association Insurance Fund (SAIF) administered by the FDIC.

At sunset, all RTC assets and liabilities will be transferred to the FSLIC Resolution Fund (FRF), a fund administered by the FDIC, and the FDIC will succeed the RTC as conservator and receiver for any institutions under RTC control at that time. All RTC staff will also be returned to the FDIC, as provided by FIRREA. As required under the RTC Completion Act, the FDIC/RTC Transition Task Force was established in February of 1994 to effectuate this transfer in a coordinated manner. The Task Force is required by statute to resolve differences in the operations of the two corporations; to recommend which systems of the RTC should be preserved for use by the FDIC; to recommend procedures that would promote an orderly transfer; and to recommend which management enhancement goals and reforms applicable to the RTC should apply to the FDIC.

From its inception on August 9, 1989 to June 16, 1995, the RTC resolved all 747 institutions taken over through that date, protecting 25 million deposit accounts and $221 billion in deposits. Through April 30, the RTC had disposed of assets with a book value of $445 billion, leaving $20 billion (book value) of assets in its inventory. Recoveries from sales and collections totaled $388 billion, averaging 87 percent of original book value. The Congress has authorized $105 billion in loss funds for the RTC. The estimated total resolution costs, as of June 20, 1995, were $87 billion to $95 billion. = Testimony, Committee on Banking, Housing and Urban Affairs, U.S. Senate, June 20, 1995, J.E. Ryan, Acting CEO, RTC; FDIC/RTC Transition Task Force.

Federal Reserve Board

Evaluating the Risk Management of Derivative Contracts

The FRB issued a guidance for evaluating the risk-management practices used by banking institutions in acquiring and managing securities and off-balance-sheet (OBS) derivative contracts for nontrading purposes. It focuses on institutions' investments in cash securities and "end-user" derivatives activities, supplementing existing guidances and directives. Nontrading activities in this guidance involve the use of securities (both available-for-sale and held-to-maturity) and OBS derivative contracts that involve longer time periods than typically are associated with trading activities. Nontrading activities involve the full array of cash securities (including fixed- and floating-rate notes and bonds, structured notes, mortgage pass-through and other asset-backed securities, and mortgage derivative products), money-market instruments, and OBS derivative contracts (including swaps, futures, and options).

The overview of the guidance identifies basic factors that examiners should consider in evaluating the elements of a sound risk-management process, and contains specific guidance for evaluating an institution's management of each of the risks involved in these activities, including credit, market, liquidity, operating and legal risks. In evaluating an institution's risk-management process, examiners should consider the nature and size of its holdings. Examiners should focus particular attention on evaluating an institution's understanding of the risks involved in the instruments it holds. Banking organizations should ensure that their capital positions are sufficiently strong to support all the risks associated with nontrading activities on a fully consolidated basis and should maintain adequate capital in all affiliated entities engaged in these activities. In evaluating the adequacy of an institution's capital, examiners should consider any unrecognized net depreciation or appreciation in an institution's securities and derivative holdings. SR 95-17 (SUP), Division of Banking Supervision and Regulation, FRB, 3/28/95.

Capital Requirements

The FRB requested comment on a proposal to amend its risk-based capital requirements to incorporate a measure for market risk in foreign-exchange and commodity activities and in the trading of debt and equity instruments. The effect of the proposed rules would be that, in addition to existing capital requirements for credit risk, certain institutions would be required to hold capital based on the measure of their market risk exposure. The proposed rule is based on a proposal issued by the Basle Committee on Banking Supervision and would go into effect at the end of 1997.

The FRB also is requesting comment on a possible approach to setting capital requirements for market risk that would require a bank to specify the amount of capital it chose to allocate to support market risks. If cumulative losses over some subsequent trading interval exceed the commitment, the bank would be subject to regulatory penalties, such as fines, higher capital requirements, or restrictions on trading activities. Press Release, FRB, 7/14/95; FR, 7/25, p. 38142; p. 38082 (inter-agency proposal).

The FRB is amending, effective March 22, 1995, its risk-based capital guidelines for state member banks and bank holding companies to implement Section 350 of the RCDRIA. Section 350 states that the amount of risk-based capital required to be maintained by any insured depository institution, with respect to assets transferred with recourse, may not exceed the maximum amount of recourse for which the institution is contractually liable under the recourse agreement. Currently, under the guidelines an institution could be required to hold capital in excess of the maximum amount of loss possible under the contractual terms of the resource obligation. Press Release, FRB, 2/7/95; FR, 2/13, p. 8177.

The FRB issued a proposal, implementing Section 208 of the Riegle Act, that would have the effect of lowering the capital requirement for small-business loans and leases on personal property that have been transferred with recourse by qualifying banking organizations. For the general purpose of calculating risk-based and leverage capital ratios, qualifying institutions that transfer small-business obligations with recourse would be required to maintain capital only against the amount of recourse retained, subject to certain conditions. Press Release, FRB, 1/26/95; FR, 2/1, p. 6043.

The FRB, the OCC, the FDIC and the OTS issued an interim final rule, effective August 1, 1995, amending the capital adequacy guidelines for banks, bank holding companies, and savings associations to treat originated mortgage servicing rights (OMSRs) the same as purchased mortgage servicing rights (PMSRs) for regulatory capital purposes. Under the interim rule, which was developed in response to Financial Accounting Standards Board Statement No. 122, both OMSRs and PMSRs are included in regulatory capital when determining Tier 1 (core) capital for purposes of the agencies' risk-based and leverage capital standards, and in calculating tangible equity for purposes of prompt corrective action subject to the regulatory capital limitations that previously applied only to PMSRs. Press Release, FRB, 7/27/95; FR, 8/1, p. 39226.

Safety-and-Soundness Standards

The FRB issued final guidelines and a final rule, both effective August 9, 1995, regarding safety-and-soundness standards for state member banks as required by Section 132 of the FDICIA. As amended by the Community Development Act, Section 132 no longer requires the FRB, the OCC, the FDIC and the OTS to prescribe quantitative standards relating to asset quality and earnings but rather, mandates that the agencies prescribe standards that they deem appropriate. The agencies are therefore proposing asset quality and earnings standards, in guidelines form, that emphasize monitoring, reporting and preventive or corrective action. The guidelines set forth broad, principle-based standards that establish the objectives that proper operations and management should achieve, while leaving the methods for achieving those objectives to each institution. The rule establishes deadlines for submission and review of safety-and-soundness compliance plans that the federal bank regulatory agencies may require for insured depositories that fail to meet the guidelines. Press Release, FRB, 7/7/95; FR, 7/10, p. 35674 (inter-agency proposal).

Supervision of Foreign Banks' U.S. Operations

The FRB advised the Federal Reserve Banks that the banking supervisory authorities whose responsibilities include the U.S. operations of foreign banking organizations have developed a program of supervision relating to FBOs. The Board said that Reserve Banks should fully coordinate their FBO supervision activities with the appropriate state banking departments and regional offices of the other federal agencies in their districts. The FRB will designate a foreign bank's entire U.S. operation a single rating, regardless of how many units exist, which will diminish the negative impact on the entire institution of a poor rating at a small unit. Greater emphasis will be given to the foreign bank's risk-management, internal controls, and compliance activities. The guidelines require foreign banks to be a source of strength to their U.S. operations. AB, 4/19/95, p. 3; SR 95-22 (Sup. IB), Div. of Banking Supervision and Regulation, FRB, 3/31.

Tying Restrictions Are Revised

The FRB is adopting, effective May 26, 1995, a regulatory "safe harbor" from the anti-tying restrictions of Section 106 of the Bank Holding Company Act Amendments of 1970 and the Board's Regulation Y. The safe harbor permits any bank or nonbank subsidiary of a bank holding company to offer a "combined-balance discount," which is a discount based on a customer maintaining a combined minimum balance in products specified by the company offering the discount.

The BHC Act Amendments of 1970 generally prohibit a bank from tying a product or service to another product or service offered by the bank or any of its affiliates. The Board is authorized to grant exceptions to its restrictions by regulation or order. FR, 4/25/95, p. 20186.

Community Reinvestment Act Revised Regulations
The FRB issued a revised Regulation BB, and related conforming amendments to its Home Mortgage Disclosure Act regulation (Regulation C). Parallel regulations are being issued by the OCC, the FDIC and the OTS for institutions they supervise. The new CRA rule emphasizes performance over process and documentation. The 12 old CRA assessment factors for large retail banks and thrifts are replaced with three tests: for lending, services, and investments.

Institutions will no longer have to maintain extensive documentation of directors' participation in formulating and reviewing CRA policies, will no longer have to prepare a formal CRA statement, and will not have to document their efforts to market services in low- and moderate-income communities. Banks and thrifts will be evaluated based on loans made, services provided and investments in their communities. The rule emphasizes direct lending. A streamlined examination process is provided for independent banks and thrifts with assets under $250 million, or banks and thrifts with assets under $250 million that are members of a holding company with assets of under $1 billion. Larger institutions will collect and report to regulators aggregated data on their small-business and small-farm loans by census tract. They will not collect or report data on race and gender of small-business borrowers. HMDA data collection will be expanded for large institutions to include collection and reporting of mortgage loans outside the metropolitan statistical areas (MSAs) where the institutions have branch offices.

Under the final rule, there are no "safe harbors" from CRA protests. Institutions will continue to make their CRA ratings public, and the public will have an opportunity to comment on CRA performance before the start of a scheduled examination. The FRB, the FDIC, the OCC and the OTS will work together to develop and adopt uniform examination procedures. Joint examiner training programs will be developed and implemented. The rule becomes effective on July 1, 1995; some provisions become operational on January 1, 1996, and July 1, 1997. Press Release, FRB, 4/14/95; NEWS and "CRA Regulation Facts," OTS, 4/19; FR, 5/4, pp. 22156, 22223; FIL-35-95, FDIC, 5/17/95.

Equal Credit Opportunity

The FRB proposed amending its Regulation B to eliminate the general prohibition on collecting data relating to an applicant's race, color, sex, religion, and national origin, giving creditors the option to ask applicants to provide the information on a voluntary basis.

Creditors have expressed a variety of reasons for wanting to collect these data: to better audit their lending programs to ensure that they are in compliance with fair lending laws; to respond more effectively to CRA protests; and to collect data so that they can better evaluate their community outreach programs and the effectiveness of their marketing programs. Some regulatory agencies and community groups say the data may increase their ability to detect discrimination.

The proposal would allow data collection only; consideration of an applicant's race, color, sex, religion, and national origin in a credit decision would still be prohibited. FR, 4/26/95, p. 20436; Press Release, FRB, 4/21.

The FRB revised, effective June 5, 1995, the official staff commentary to its Regulation B. The commentary applies and interprets the requirements of the Regulation and is a substitute for individual staff interpretations. Issues on which the revisions provide guidance include disparate treatment, special purpose credit programs, credit scoring systems, and marital status discrimination. FR, 6/7/95, p. 29965.

Information on Banks' Selling Mutual Funds

The Federal Reserve will soon begin a nationwide education campaign about the sale of mutual funds and annuities at banks. The campaign will begin with a series of seminars for retirees and those planning for retirement. The seminars will be hosted by the 12 Federal Reserve Banks and will emphasize that mutual funds and annuities, unlike certificates of deposit, are not insured by the FDIC or in any way guaranteed by the banks that sell them. The Federal Reserve developed the program in cooperation with the American Association of Retired Persons, and conducted pilot seminars in the Boston area in late 1994. Press Release, FRB, 3/20/95.

Truth in Lending

The FRB amended its Regulation Z to implement changes made to the Truth in Lending Act by the RCDRIA, which imposes new disclosure requirements and substantive limitations on closed-end home-equity mortgage loans bearing rates or fees above a certain percentage or amount. The law also imposes new disclosure requirements to assist consumers in comparing the cost of reverse mortgage transactions, which provide periodic advances primarily to elderly homeowners and rely principally on the home's value for repayment. The rule is effective March 22, 1995, with compliance optional until October 1, 1995. Press Release, FRB, 3/16/95; FR, 3/24, p. 15463.

The FRB revised the official staff commentary to its Regulation Z to clarify regulatory provisions and provide further guidance on certain issues of general interest, such as the treatment of various fees and taxes associated with real-estate-secured loans and a creditor's responsibilities when investigating a claim of the unauthorized use of a credit card. The rule is effective April 1, 1995, with compliance optional until October 1, 1995.

The Truth in Lending Act requires creditors to disclose credit terms and the cost of credit as an annual percentage rate (APR). The Act requires additional disclosures for loans secured by a consumer's home, and permits consumers to cancel certain transactions that involve their principal dwelling. It also imposes limitations on some credit transactions secured by a consumer's principal dwelling. Press Release, FRB, 3/28/95.

Pursuant to requirements of the RCDRIA, the FRB requested comment on how rules for credit advertising could be modified to increase consumer benefit and decrease creditor costs, and on how current rules could be modified, if at all, for radio and television advertisements without diminishing consumer protection. Under present law, creditors that state a rate in an advertisement must state the APR. Stating the APR or other terms triggers additional disclosure requirements such as annual fees imposed on a credit line or the repayment terms for an installment loan. FR, 6/27/95, p. 33151.

Home Mortgage Disclosure

The FRB published for comment a staff commentary to its Regulation C. The proposed commentary provides guidance on various issues including the treatment under the Regulation of prequalifications, participations, refinancings, home-equity lines, mergers, and loan applications received through a broker. FR, 6/7/95, p. 30013.

Loans to Bank Officers

The FRB is revising, effective immediately, its Regulation O to implement a provision of the RCDRIA that eliminates a requirement for prior approval of the board of directors before a member bank may make a loan to an executive officer that is secured by a first lien on the officer's residence. FR, 4/7/95, p. 17635.

Insider Lending Limits

The National Bank Act and Regulation O establish the limit for single-borrower loans to any insider of a member bank and insider of the bank's affiliates to be 15 percent of the bank's unimpaired capital and unimpaired surplus for loans that are not fully secured, and an additional ten percent for loans that are fully secured by certain readily marketable collateral. The FRB amended its regulation to conform the definition of unimpaired capital and unimpaired surplus to the definitions recently adopted by the OCC in calculating the limit on loans by a national bank to a single borrower. Under that revised definition, a national bank's "capital and surplus" are equal to Tier 1 and Tier 2 capital included in the calculation of the bank's risk-based capital together with the amount of the bank's allowance for loan and lease losses not included in this calculation. FR, 4/20/95, p. 19689; Press Release, FRB, 6/8.

Suspicious Activity Reports

The FRB proposed to revise its regulations on reporting of suspicious activities by the domestic and foreign banking organizations supervised by the Federal Reserve, including the reporting of suspected violations of the Bank Secrecy Act (BSA). The principal proposed changes to the FRB's current criminal referral reporting rules include: a) simplifying and shortening the referral form; b) raising the mandatory reporting thresholds for criminal offenses, thereby reducing banking organizations' reporting burdens; c) filing only one form with a single repository, rather than submitting multiple copies to several federal law enforcement and banking agencies, thereby further reducing reporting burdens; and d) clarifying the criminal referral and suspicious financial transaction reporting requirements of the FRB, the OCC, the FDIC, the OTS, and the National Credit Union Administration and the Treasury Department associated with suspicious financial transactions. The above supervisory agencies, working with the Treasury's Financial Crimes Enforcement Network (FinCEN), are developing computer software to assist financial institutions in preparing and filing Suspicious Activity Reports (SARs). FR, 7/3/95, p. 34481; 7/17, p. 36366 (OTS notice).

Required Reporting Is Reduced For BHCs

The FRB adopted several revisions to its FR Y-6 which is an annual report filed by large bank holding companies, excluding foreign banking organizations. The report consists of consolidated and parent company financial statements in the company's own format, and is the Federal Reserve's principal source of internally generated and independently audited financial data on individual bank holding companies and their banking and nonbanking subsidiaries. Among the burden-reducing changes are: 1) eliminating the requirement to submit consolidated and parent company financial statements; 2) revising the requirement for audited financial statements to include only holding companies with assets of $500 million or more (raised from $150 million) and 3) eliminating the requirement to submit nonbank subsidiary financial statements which, as currently proposed, would be incorporated into an expanded standardized FR Y-11 report (financial statement of nonbank subsidiaries). Holding companies must still make available their annual reports and their Securities and Exchange Commission reports of financial condition. FR, 3/6/95, p. 12215; AB, 3/14, p. 3.

Establishment of Loan Production Offices

The FRB issued, effective April 6, 1995, an interpretation of its Regulation H that allows a state member bank to establish a back office facility that is not accessible to the public without such a facility being considered to be a branch. Loans originated by a loan production office may be approved at a back office location, rather than at the main office or a branch of the bank, without the loan production office being considered to be a branch, if the proceeds of those loans are received by customers at locations other than a loan production office or back office facility. This interpretation is intended to provide parity between state member banks and national banks with respect to the establishment of loan production offices and back office facilities. FR, 4/6/95, p. 17436.

Mortgage Unit May Sell Employment Histories

The FRB granted approval for an Iowa-based mortgage unit of Norwest Corp., Minneapolis, to sell employment histories to third-party depository institutions and affiliates for use in their banking activities. While the decision is the first of its kind, the expansion of banking powers is said to be small. A 1994 decision of the Board allowed Comerica Corp. to provide employment information and histories to depository institutions in connection with career counseling services. The mortgage firm's release of certain information, which it will gather from state employment departments and other sources, will depend upon the individual's prior consent. The firm will be subject to the Fair Credit Reporting Act. BBR, 5/15/95, p. 951.

Title Abstracting Approved as Banking-Related Activity

The FRB granted approval for First National Co., Storm Lake, Iowa, to engage in realty title abstracting through an acquisition. For the first time this activity as a source of fee income would be available to bank holding companies. Normally the realty title abstracting business involves recreating each county's title records, often converting them to electronic form, and then charging a fee for the title search. Permission for national banks to acquire title abstractors was granted by the OCC seven years ago. AB, 7/5/95, p. 2.

Data Processing Limits Under Reg. Y Are Broadened

The FRB gave approval for BNCCORP Inc. of Bismarck, ND to acquire a data processing firm and to include providing non-financial information in its data processing services. Under Regulation Y, bank holding companies can provide data processing and transmission services, databases, and access facilities, if the data are "financial, banking, or economic" in nature. The FRB said that in this case the non-financial information would be provided only as a part of a larger package of data processing services to a financial institution, and would not be offered on a stand-alone basis or to customers other than financial institutions. BBR, 1/16/95, p. 98.

Geographic Market Defined For EPT Network Services

The FRB granted approval for Electronic Payment Services Inc., Wilmington, Delaware, a joint venture subsidiary of four large bank holding companies, to acquire the ATM assets and some POS assets of National City Corp., a Cleveland-based bank holding company, and also approved National City to become a member of the joint venture. EPS provides data processing and transmission services to banks and retail merchants who are members of the ATM and POS network MAC. The four members of the joint venture are Bank One Corp., Columbus, CoreStates Financial Corp., Philadelphia, PNC Bank Corp., Pittsburgh, and KeyCorp, Cleveland. The FRB defined the appropriate geographic market in this case to be MAC's Mideast region, consisting of western Pennsylvania, Ohio, Indiana, Kentucky and West Virginia. A FRB study suggests that the geographic market for network access is an area significantly larger than local markets, and the markets for network services and ATM processing are thought to be at least regional. The FRB rejected arguments that the geographic markets should be defined on the basis of the boundaries of cities or states. BBR, 3/16/95, p. 517.

Electronic Fund Transfers

The FRB amended, effective April 24, 1995, its Regulation E to eliminate the requirement that an electronic terminal receipt disclose a number or code that uniquely identifies the consumer, the consumer's account, or the access device. This requirement posed a significant security risk to consumers and financial institutions by making information accessible to criminals that could be used to make fraudulent fund withdrawals. Press Release, FRB, 3/16/95.

Payments System Risk; Daylight Overdrafts

The FRB revised the increase in the fee charged to depository institutions for daylight overdrafts incurred in their accounts at the Reserve Banks that had been scheduled to take effect on April 13, 1995. The current effective daily fee of ten basis points was implemented in April 1994, with scheduled increases to 20 basis points on April 13, 1995, and to 25 basis points on April 11, 1996. In the aggregate, daylight overdrafts in Federal Reserve accounts have fallen by roughly 40 percent in response to the initial ten-basis-point fee. As a result of the sizeable reductions, as well as concerns about the possible effects of further rapid fee increases, the Board approved an increase in the fee to an effective daily rate of 15 basis points rather than 20 basis points. (The 15-basis-point fee equals an annual rate of 36 basis points, quoted on the basis of a 360-day year and a 24-hour day.) The Board will evaluate the desirability of any further increases in the daylight overdraft fee, based on the objectives of the payments system risk program, two years after the implementation of the 15-basis-point fee. Press Release, FRB, 3/2/95; FR, 3/7, p. 12559.

Fed Acts to Cut Costs of Services, Improve Efficiency

The FRB and the Federal Reserve Banks are undertaking a number of major consolidation and other budget-cutting measures. For example, a majority of the Federal Reserve Banks have implemented early-retirement programs during the last few years. Other recent or ongoing actions include: a) consolidation of mainframe data processing from the previous 12 sites to three: a hub in East Rutherford, NJ, with backup facilitates at the Dallas and Richmond Federal Reserve Banks; b) consolidation of supervision and decision-making on financial services such as check clearing and funds transfer at the St. Louis Federal Reserve Bank; and c) replacement of varied software used by the different Federal Reserve Banks with standardized systems. Individual Federal Reserve Banks are centralizing a number of operations, for example, the Atlanta Bank has brought its check processing sites down to five from 12. AB, 5/17/95, p. 1.

"Purposes and Functions" Is Updated

The FRB is publishing the eighth edition of Purposes and Functions, a paperback book first published in 1939 that explains the structure and operations of the Federal Reserve System. The revised and updated edition has been designed to appeal to a general audience and can supplement college-level classroom texts on the Federal Reserve's role in monetary policy and the global economy. Press Release, FRB, 3/2/95.

Office of the Comptroller of the Currency

Enhancing the Supervision of Bank Lending

Comptroller of the Currency Eugene Ludwig said that the agency's supervisory activities for safety and soundness in the credit area will be strengthened because of warning signs of slippage of credit quality. Among the steps being planned, a National Credit Committee, whose members include some of the agency's most senior and experienced credit analysts, will work with examiners in charge of supervision at larger national banks to ensure that adequate credit quality supervision is in place. Among the warning signals noted is a recent decline in the standard minimum payment on credit cards from five percent to two percent of the outstanding balance, and significant increases in high loan-to-value second-mortgage and home-equity lending. Some of the questions for bank managements and the examiners are the extent that the bank: 1) is taking risk into account in the pricing of loans; 2) is making exceptions to credit standard policies; 3) has compensation or other policies that encourage lending officers to lower credit standards; and 4) has significant credit concentrations in its portfolio. Also, how independent and effective is the credit review function; and are stress tests being performed on all or a portion of the credit portfolio to determine how loans will be repaid when the customer, the industry and/or the economy turn down. News %0 Release, OCC, 4/8/95.

In February 1995, the OCC decided to include information about concentrations of credit in the reports of examination of national banks. Examiners will report such concentrations amounting to over 25 percent of the bank's capital structure in the report of examination. Effective May 19, 1995, this reporting was extended to federal branches and agencies of foreign banks where credit concentrations exceed ten percent of the total assets of the branch or agency. Bulletin No. 95-7, OCC, 2/8/95; Bulletin No. 95-26, 5/19.

Interest-Rate Risk

Reaffirming and updating its statement issued in January 1990, the OCC said that during the past five years national bank managers have improved their interest-rate-risk management systems, in particular by: 1) advancing from measuring risk in simple repricing ("gap") reports to using simulation models to quantify and control the amount of short-term earnings that may be at risk; and 2) developing or enhancing ways to measure and control exposures arising from medium- and long-term positions. The agency's statement notes that the value of many banks' medium- and long-term instruments are highly sensitive to changes in interest rates, particularly those containing option features, such as the possibility of loan prepayments or the withdrawal of funds. Financial instruments such as collateralized mortgage obligations (CMOs), structured notes, credit-card lines, indexed CDs, and off-balance-sheet derivative instruments provide financial institutions with more services to offer customers and more tools for risk management, but the complexity of many of these instruments makes it more difficult to determine the sensitivity of their values to changes in interest rates.

Risk measurement systems should be able to identify and quantify the major sources of a bank's interest-rate-risk exposure on a timely basis. Where there are significant medium- and long-term positions, managers should be able to assess the longer-term impact of changes in interest rates on the earnings and capital of the bank. Senior management and the board or a committee thereof should receive reports on the bank's interest-rate risk on at least a quarterly basis, but more frequently as appropriate to the level of current and potential risk. The board's tolerance for interest-rate-risk exposure should be clearly communicated to senior management. Clear lines of responsibility should be established for measuring and managing risk exposures. Advisory Letter 95-1, OCC, 2/8/95.

In June, the agency provided question-and-answer information regarding its guidance issued on February 8. Bulletin No. 95-28, OCC, 6/20/95.

More Information Provided on Derivatives Activity

Bank Call Report data for the first quarter of 1995 include new information that provides a better measure of the market size, credit risk exposure, and revenue from bank derivatives activity. The notional amount of derivatives in commercial bank portfolios, which is an indicator of the level of derivatives activity, increased by 14 percent in the quarter. Nine commercial banks account for 93 percent of the total notional amount. First-quarter Call Report data include, for the first time, the gross negative and positive fair values of derivative positions, credit risk exposure in the form of "bilaterally netted" current exposure, the distribution of derivatives contracts by type, revenue from derivatives transactions and the diversification of earnings sources, and information on high-risk mortgage securities and on structured note holdings. News Release, OCC, 3/31/95; 6/14.

OCC and SEC Agree on Joint Examinations

The OCC and the Securities and Exchange Commission agreed to conduct joint examinations of certain entities in which both agencies have regulatory and supervisory interests. These entities are mutual funds advised by national banks or their subsidiaries and national banks and national bank subsidiaries providing advisory and other investment services to mutual funds. Among the areas of common interest to be evaluated are: systems of internal control used to ensure compliance with regulatory requirements, including disclosures to investors; risk management systems used by the adviser to monitor and control the risks in light of the fund's objectives; and management of conflicts of interest between the adviser and the advised funds or other advisory clients and the advised funds. The scope and staffing of particular examinations will be determined by both agencies on a case-by-case basis. Documents prepared or obtained by either agency in connection with a joint examination will be treated as confidential. Coordination of these examinations will enable the agencies to reduce the regulatory burden on banks involved in mutual fund activities, minimize government intrusion into bank operations, and also protect the interests of bank depositors and investors. Joint Release, OCC and SEC, 6/12/95.

Lending Limits

The OCC, effective March 17, 1995, revised its rules governing national bank lending limits, in order to eliminate inefficient and unduly burdensome requirements and refocus the lending limit rules on the areas of greatest safety-and-soundness concern. The final rule alters the definition of "capital and surplus" upon which lending limits are based. The new lending limit calculation draws upon risk-based capital components that a bank must already calculate for Call Report purposes. Thus, most national banks generally will be required to calculate their lending limit only once every quarter, rather than every time they propose to make a loan. A new exception to the lending limits will allow a bank to advance funds to renew and complete the funding of a qualifying loan where the additional advance will protect the position of the bank. The final rule also allows a bank to advance funds to pay taxes, insurance and other necessary expenses to protect its interest in the collateral securing a loan, and clarifies when a loan is considered "nonconforming." FR, 2/15/95, p. 8526.

The FRB adopted a conforming amendment to its Regulation O. FR, 6/13/95, p. 31053.

Court Upholds State Limits on Bank Insurance Activities

The U.S. Court of Appeals for the Eleventh Circuit denied a petition by Barnett Bank of Marion County, N.A. to rehear a ruling that would allow Florida's insurance commissioner to block Barnett's ownership of an insurance agency under state law (Barnett Bank of Marion County, N.A. v. Gallagher). A panel of the Court, affirming a trial court's decision, ruled in January that the McCarran-Ferguson Act overrides other federal laws and gives states the right to regulate bank insurance sales. The denial of the petition appears to conflict with a decision of the Sixth Circuit that federal law preempts a Kentucky anti-affiliation law (Owensboro National Bank v. Stephens), and a review by the U.S. Supreme Court is expected.

The Louisiana Court of Appeals upheld a state law that limits bank insurance sales in the state (First Advantage Insurance, Inc. v. Green). The court held that McCarran-Ferguson protects a state law that prohibits banks from selling insurance (except for credit life, credit health, and accident insurance) from preemption by the National Bank Act. AB, 4/12/95, p. 3; BBR, 4/3, p. 693; 3/13, p. 541.

Courts Rule on Retirement Account

A federal judge in New Mexico prohibited the state insurance regulator from interfering with a national bank's sale of the retirement CD (First National Bank of Santa Fe v. Chavez). The retirement certificate of deposit is a FDIC-insured product that is similar to an uninsured annuity. A customer makes one or a series of payments into a tax-deferred account and after reaching a designated age receives regular lifetime payments from the bank. In January the U.S. Supreme Court ruled in the Valic case (see this Review, Spring 1995, p. 39) that selling annuities is "incidental" to banking and a permissible activity under the National Bank Act. AB, 2/21/95, p. 2.

A judge in the U.S. District Court in Illinois ruled that the retirement CD is an annuity, and therefore should be regulated as an insurance product. AB, 6/6/95, p. 18.

Loans to Distributor of Bank's Mutual Funds

The OCC issued a no-objection letter with respect to a proposed financing arrangement under which Crestar Bank, N.A., Washington, DC, would provide loans to the distributor of the bank's mutual funds to finance the payment of brokerage commissions to a brokerage affiliate of the bank. The OCC's decision was made contingent upon the loans being structured on terms and conditions substantially the same as loans and extensions of credit provided to other nonaffiliates, and that any such loan be fully collateralized by a cash deposit or an equivalent amount of U.S. Government securities. Letter Regarding Proposed Financing Arrangement, OCC, 3/13/95.

Decision on Bank Officer's Services Not Reviewable

The U.S. District Court for Kansas ruled (Hammond v. OCC) that it lacked jurisdiction to review an OCC decision disapproving a proposed appointment of an executive to serve as president, chief executive officer, and a board member of a national bank. The OCC said the individual lacked the necessary integrity for the positions, having engaged in a tying violation while president of another bank. BBR, 4/17/95, p. 795.

Tying Restrictions

The OCC reminded national banks of their obligations under the antitying law, whose purpose is to keep banks from using bank credit and other services to coerce customers and reduce competition. The guidance includes, among other things, examples of tying arrangements that, unless exempted by the Board, are prohibited. For example, a bank may not condition the extension of credit or the reduction of the price of credit on the customer purchasing credit-related insurance from the bank. Also included are suggested systems and controls, and suggested audit and compliance programs. Bulletin No. 95-20, OCC, 4/14/95.

Bank Reports Do Not Violate Privacy Laws

A U.S. district court in Texas ruled that Marfa National Bank, Marfa, TX, was not violating financial privacy laws, but was complying with the Bank Secrecy Act when it reported two depositors suspected of engaging in actions to avoid coverage by the bank's currency transaction reports. AB, 6/22/95, p. 9.

Community Development Bank Chartered

The OCC issued a charter to Neighborhood Development Bank, N.A., which will serve the low- and moderate-income and minority neighborhoods of southeast San Diego, CA. The institution is the first bank focusing on community lending to be federally chartered, and an application has been filed with the Federal Reserve to establish a holding company, Neighborhood Bancorp. The bank will seek funding as a community development financial institution under the CDFI Fund, which was created by the RCDRIA. The OCC has granted approval for Wells Fargo Bank, N.A. to make an equity investment in both the bank and the proposed holding company. BBR, 2/13/95, p. 316.

Appraisals For Affordable Housing Loans

In a joint policy statement, the OCC, the OTS, the FDIC, and the FRB clarified that federally regulated financial institutions should ensure that appraisals of affordable housing projects consider and discuss the effect of certain types of financial assistance, such as low-income housing tax credits, subsidies and grants on the estimate of market value for such projects. Such financial assistance creates an incentive for developers and investors to undertake the project. When the benefits of such financial assistance are not appropriately reflected in the project's appraisal, the estimated cash flow of the project is negatively affected, resulting in a lower market value, and a loan-to-value ratio that may be too low to meet supervisory standards. The apppraisal should discuss the value of the financial assistance that would survive sale or foreclosure, and consider the effect of financial assistance that does not necessarily transfer to new ownership, when applicable. Joint Release, OCC, FDIC, FRB, OTS, 3/10/95.

Agency to Request Feedback on Examination Process

The OCC will begin surveying bankers at the conclusion of each examination to get their immediate feedback on how well the agency is doing its job in areas such as the effectiveness of its communications with banks, the reasonableness of agency requests for data and information, the quality of examiners' decision-making during the exam process, and quality of written exam reports. Completing the survey is voluntary; however, bankers will be asked to fill in their name in order to facilitate follow-up work by the OCC. The survey forms will be sent directly to the agency's Ombudsman, who will be responsible for analyzing and summarizing the responses. News Release, OCC, 4/17/95.

Approvals For Interstate Branching

Federal banking law dating from 1886 allows a national bank to move its main office up to 30 miles, even across a state line, and the OCC has approved the operation of the former main offices, following the moves, as branches. Among the recent approvals under this authority were: PNC Bank, Northern Kentucky, will move from Ft. Mitchell, Kentucky to Cincinnati, Ohio, combining two subsidiaries into a single Ohio bank with> ten Kentucky branches and 60 Ohio branches; NationsBank Middle Atlantic will move from Bethesda, Maryland to McLean, Virginia, consolidating subsidiaries into a single Virginia bank with branches in Virginia, Maryland and the District of Columbia; American National Bank and Trust Company of Wisconsin will move its main office from Genoa City, Wisconsin to Libertyville, Illinois, merging into an Illinois bank that will have 20 branches in Illinois and Wisconsin. The 30-mile rule has been used by about a dozen banks in the past year, and the OCC expects about the same number of applications in 1995. In recent approvals the OCC has argued that state laws prohibiting out-of-state banks from owning branches violates the U.S. Constitution's commerce clause, and also that these laws are preempted by federal law. AB, 3/13/95, p. 2; 3/20, p. 2.

Interpretive Rulings: Additions, Eliminations, Revisions

The OCC is proposing to revise the interpretive rulings that appear in part 7 of Title 12 of the Code of Federal Regulations. This proposal updates and streamlines OCC regulations and seeks to eliminate regulatory requirements that impose ineffective, inefficient and costly regulatory burdens on national banks. FR, 3/3/95, p. 11924.

Comments Sought on Various Issues

Among the issues on which the OCC is seeking comments are permitting banks to sell their excess data processing capacity, whether to prohibit states from barring national banks from engaging in actions permitted by federal rules through the use of restrictive licensing laws, and expanding the definition of interest rates that national banks may charge by including annual fees, late fees, and other fees. AB, 3/3/95, p. 1.

Disclosures of Information

The OCC proposed clarifications and technical amendments to its rules relating to the availability and release of information to update and streamline its regulations and reduce unnecessary regulatory costs and other burdens. FR, 3/27/95, p. 15705.

History Text Reissued

First published in 1968, The Comptroller and Bank Supervision: A Historical Appraisal has been reissued. The updated version includes a discussion of the changes in banking that have occurred over the past 30 years and the many legislative and regulatory changes that have shaped the current banking environment. News Release, OCC, 6/12/95.

Treasury Shortens Currency Transaction Report

The Treasury Department has revised the report that banks must file on their currency transactions exceeding $10,000, effective October 1 of this year. The new report will be more than one-third shorter than the former one. The box item used for reporting suspicious transactions will be eliminated, and instead banks will use for this purpose the criminal referral form, which also is being revised. Banks will no longer be required to identify the number of $100 bills involved in transactions covered by the report. While the old form required the signatures of two employees, in the future only one signature will be needed. AB, 5/18/95, p. 9.

Office of Thrift Supervision

Simplified Application For New Thrifts

The OTS proposed a simplified rule that would reduce the paperwork and administrative costs imposed on organizers of new federal savings associations and federal savings banks. The standard initial capitalization would formally decrease from $3 million to $2 million, the same as the requirement for deposit insurance imposed by the FDIC. The OTS would reserve the right to impose higher or lower initial capital requirements on a case-by-case basis. NEWS, OTS, 3/6/95; FR, 3/6/95, p. 12103.

Calculations For Loan Limits Are Simplified

The OTS is amending, effective March 28, 1995, its loans-to-one-borrower rule, to reflect recent changes to the OCC's lending limits regulation. The Home Owners' Loan Act requires that savings association lending limits parallel those applicable to national banks. This interim final rule amends OTS' regulation so that thrifts, like national banks, will use regulatory capital as the starting point for determining "unimpaired capital and unimpaired surplus" for LTOB purposes. The revised rule allows savings associations to figure loan limits by using the same calculations they already make to determine capital adequacy. Thus, thrifts avoid having to complete a complex extra worksheet and like national banks will find it substantially easier to calculate lending limits. The changes also remove other outdated or redundant provisions. NEWS, OTS, 3/28/95; FR, 3/28. p. 15861.

Community Development Investments

The OTS will not take enforcement action against thrift institutions for making investments in projects outside areas receiving "concentrated development assistance" under Title 1 of the Housing and Community Development Act (HCDA), provided certain standards are met. Federal associations no longer need to apply to the OTS for case-by-case no-action letters for investments that meet the investment standards. Associations may participate directly in real-estate investments that meet the standards and in a limited partnership or corporation that invests exclusively in real-estate investments that meet the standards. Among the standards set forth are: the investment must be located in a Title 1 Community Development Block Grant entitlement community, in a nonentitlement community that has not been specifically excluded by the state in statewide submissions for CDBG funds, or in an area that participates in the Small Cities Program; and the investment must be made in a residential housing project that benefits low- and moderate-income persons. In regard to investments that do not meet the standards, but that are consistent with program objectives embodied in the Home Owners' Loan Act, associations may continue to seek case-by-case OTS no-action review by the chief counsel. NEWS, OTS, 6/7/95.

Court Rules on Capital Agreements

The U.S. Court of Appeals for the District of Columbia, in a case involving the failed Great Life Savings Association of Sunrise, Florida, ruled that the OTS cannot compel compliance with capital infusion agreements made with buyers of troubled thrifts unless it shows that the buyer has been "unjustly enriched." Before 1990, purchasers of thrifts were required by regulators to guarantee that the institutions would always be fully capitalized. AB, 7/19/95, p. 4.

Release of Unpublished Information

The OTS issued a final rule describing the procedures that requesters must follow to obtain unpublished information by document or testimony and the criteria on which the agency will evaluate requests for such information. The rule includes requests for release of records that are exempt from disclosure under the Freedom of Information Act (FOIA), such as examination and related reports, and information relating to the business operations and finances of individual savings associations. Requesters who obtain unpublished OTS information may not disclose such information without the agency's authorization. The final rule, for the first time, authorizes savings associations to release their examination reports and related supervisory correspondence to their holding companies, and similarly authorizes holding companies to release their examination reports and related supervisory correspondence to their subsidiary savings associations. Reports and other information released under this rule remain the property of the OTS, regardless of where such reports or information are physically located. FR, 5/30/95, p. 28027.

Filing Fee Changes

The OTS has reduced fee levels for certain applications to more accurately reflect the agency's actual processing costs. Fees are lowered for Permission to Organize applications and Holding Company applications, and the fee is eliminated for processing service corporation applications for participation in Community Development Corporations. OTS' policy on the waiver of filing fees is clarified. Thrift Bulletin 48-13, OTS, 3/31/95.

Thrift to Offer Services on the Internet

The OTS gave approval for Cardinal Bancshares, Lexington, KY, to change a subsidiary, Security First Network Bank, Pineville, into an on-line bank serving customers on the Internet. The bank will offer services similar to those available from some banks by telephone. While a number of banks now offer information about their services on the Internet, Security First is unique in that it plans to do most of its business on-line, and will use the Internet for actual checking account transactions, not just information. Requirements to be imposed by the OTS include company-paid independent tests of certain security systems, and a report from the bank in six months on its lending to low- and moderate-income applicants, and precise definition of the community it is serving. Security First plans to make checking accounts the focus of its Internet operations and restrict its lending chiefly to the rural southeastern Kentucky county where it will maintain its only brick-and-mortar branch. AB, 5/12/95, p. 3.

Federal Financial Institutions Examination Council

Guidelines For Relying on State Examinations

The FFIEC adopted guidelines, effective on June 27, 1995, that establish standards for determining the acceptability of state reports of examination. A federal banking agency may conduct an annual, on-site examination of an insured depository institution in alternate 12-month periods (except those insured institutions with total assets of less than $250 million for which an 18-month examination cycle is permitted) if the federal banking agency determines that a state examination of that institution conducted during the intervening period is adequate.

The federal and state banking agencies have worked together, to varying degrees, in several areas, among which are conducting alternate, joint and concurrent safety-and-soundness examinations; processing examination reports and applications; using common examination report and application forms; and developing and issuing informal and formal enforcement actions. Currently, the federal banking agencies, individually, have entered into formal or informal arrangements or working agreements with most state banking departments in a number of supervisory areas, among which are the number of institutions to be examined on an alternating basis; the frequency of safety-and-soundness examinations; the type of examinations to be conducted (independent, joint, or concurrent) by each agency; and the responsibilities of each agency for processing reports of examination, and for conducting specialty examinations (compliance, information systems, trust, etc.).

Under the guidelines, the federal banking agencies will accept and rely on state reports of examination in all cases in which it is determined that state examinations enable the federal banking agencies to carry out effectively their supervisory responsibilities. Among the criteria that may be considered in determining the acceptability of a state report of examination are the completeness of the examination report; adequacy of documentation; and the adequacy of any formal or informal arrangement or working agreement between a state banking department and a federal banking agency. FR, 6/27/95, p. 33206.

Home Loans to Minorities Up Sharply in 1994

Disclosure statements from more than 9,800 lenders (including commercial banks, savings associations, credit unions, and mortgage companies) covered by the Home Mortgage Disclosure Act (HMDA) show that the number of their conventional home purchase loans rose in 1994 from 1993 by 27.0 percent for lower-income households, and 12.5 percent for the highest income households, the FFIEC reported. The numbers increased by 54.7 percent for blacks, 42.0 percent for hispanics, 23.8 percent for native Americans, 18.6 percent for Asians, and 15.7 percent for whites. Denial rates for those loans in 1994 were 33.4 percent for blacks (34.0 percent in 1993), 31.6 percent (27.8) for native Americans, 24.6 percent (25.1) for hispanics, 16.4 percent (15.3) for whites, and 12.0 percent (14.6) for Asians. The data suggest that the affordable home loan programs that mortgage originators have initiated in recent years --- to benefit low-income, moderate-income, and minority households and neighborhoods --- may be having an impact, the FFIEC said.

The FFIEC prepared and distributed the individual disclosure statements for lenders on behalf of its five member agencies and HUD. Upon request, lenders are required to make the statements available at their home office within three business days of receipt, and at certain branch offices in other metropolitan areas within ten business days of receipt. Press Release, FFIEC, 7/18/95.

Guide to HMDA Reporting

The FFIEC prepared an interim edition of the Guide to take account of amendments that the FRB adopted to its Regulation C in December 1994. The amendments require reporting in machine-readable format (except for institutions reporting 25 or fewer line entries), require institutions to update their loan application registers quarterly during the year as data are being collected, and make a number of other changes. The FFIEC will publish and distribute a more comprehensive edition of the Guide to HMDA respondents by year-end for use with 1996 data. The Guide was developed by the Department of Housing and Urban Development and member agencies of the FFIEC. A Guide to HMDA Reporting --- Getting it Right!, FFIEC, March 1995.

National Credit Union Administration

Corporate Credit Unions

The NCUA proposed a rule to strengthen the capital of corporate credit unions, reduce the risk of their investments, and improve asset-liability management. The rule would return corporate credit unions to their primary functions of serving as liquidity centers and service providers.

Specifically, the proposed rule would, among other things, limit corporate credit union membership to credit unions and other specified groups; restrict lending to member credit unions and limit lending to 100 percent of primary capital; set borrowing limits to meet liquidity needs at ten times capital or 50 percent of shares, whichever is less; and establish minimum primary capital at four percent, phased in over the next three and one-half years. Also, the proposal would require that 75 percent of overnight investments be matched with assets of similar terms; allow up to 25 percent of investments to be matched with variable-rate securities, with up to three-years maturity, that reprice monthly; require that term accounts be fully matched; and provide specific divestiture requirements. "Letter to Credit Unions No. 168," NCUA, 4/24/95; FR, 4/26, p. 20438; 5/23, p. 27240; BBR, 4/17. p. 785.

The assets, liabilities, and field of membership of Capital Corporate Federal Credit Union were acquired by Mid-Atlantic Corporate Federal Credit Union, of Harrisburg, PA. CapCorp had been operating under NCUA conservatorship since January 31, 1995 (see this Review, Spring 1995, p. 44). Losses from CapCorp's investment portfolio are estimated at about $61 million, all of which will be absorbed by its primary and secondary capital, with no loss to the National Credit Union Share Insurance Fund. BBR, 4/17/95, p. 787.

Divestitures of Risky Investments

The NCUA issued a clarification of its position on divestiture of Collateralized Mortgage Obligations (CMOs) and Real Estate Mortgage Investment Conduits (REMICs) that fail one or more parts of the high-risk securities test (HRST). A review by the agency of credit unions that have reported large investments in CMOs and REMICs indicated that 57 percent of these credit unions were holding at least one security that failed one or more parts of the HRST; 29 percent of these credit unions ran the HRST semiannually or less often; and 39 percent of the managers did not have an adequate understanding of the risks involved in these investments.

Federal credit unions are prohibited from purchasing fixed-rate CMOs or REMICS that fail any one of the three parts of the HRST, which are the average life test, average life sensitivity test, and price sensitivity test. When a credit union is holding securities that fail one or more parts of the HRST, it should immediately dispose of them or, within five business days of discovery, submit to the NCUA a written action plan. A credit union will be required to sell HRST-failed assets, in accordance with a written directive, if the examiner does not feel that a suitable action plan has been developed. Letter to Credit Unions No. 169, NCUA, April 1995.

Mergers or Conversions of Federally Insured Credit Unions to Non-Credit Union Status

The NCUA adopted with minor change the interim rule it issued in September 1994 (see this Review, Spring 1995, p. 44) with additional requirements to ensure an informed membership vote, to safeguard against potential safety-and-soundness problems and to prevent breaches of fiduciary duty. Key provisions are: NCUA Board approval is required in advance of any transaction whereby a federally insured credit union transfers all or any part of its members' shares or similar accounts to any non-credit union institution; a majority of all members of record must vote to approve the transaction; directors must agree to receive no benefits in excess of those available to the members; notice to members must be preapproved by the NCUA Board and must include all pertinent information required by the rule as well as any additional information deemed necessary on a case-by-case basis; FISCUs may only engage in the transaction if they obtain approval from the state authority to proceed with the merger or conversion; and FISCUs must follow the rule's provisions (part 708a) unless they obtain a waiver from the NCUA. FR, 3/8/95, p. 12659.

Credit Union Conversion to Savings Bank Approved

The NCUA approved the application of the $52.9 million-asset Lusitania Federal Credit Union, Newark, NJ, to convert to a federal mutual savings bank. It was the first such approval granted by the NCUA for a charter change, which would be transacted under the agency's rules in effect before the amendments that were adopted late last year. Only 20 percent of the credit union's total membership will be required to approve the conversion, while under the new rules a majority vote would have been necessary. If Lusitania's membership approves the conversion, the institution will be supervised by the OTS, and its deposits insured under the SAIF. BBR, 5/29/95, p. 1054.

Court Restricts CU Expansion

A U.S. District Court judge in Washington, DC ruled that the NCUA exceeded its authority when it permitted Communicators Federal Credit Union to expand its membership to anyone over 50 years old living or working within 25 miles of Houston, TX. In this case brought in 1994 by the Texas Bankers Association, the judge said NCUA's broad interpretation would render the common bond limitation meaningless. The NCUA has won previous court decisions involving credit unions taking into membership existing unrelated groups, each comprised of persons having a common bond within the group. The judge upheld the NCUA in allowing Communicators to add seven unrelated occupational groups, stating that where the law is "ambiguous" the courts must defer to the regulatory agencies. Communicators, originally sponsored by Southwestern Bell Telephone Co., now serves 93 different groups with a membership of over 38,000. AB, 6/5/95, p. 1.

Banks Can Sue Over CU Expansion

A judge in the U.S. District Court in Montana ruled that a group of seven banks in Montana can sue to negate an expansion in 1992 by the Missoula Federal Credit Union over a 3,600 square mile area in the western part of the state. The NCUA argued in the suit brought in 1993 that bankers did not have the right to sue because the Federal Credit Union Act was not designed to protect banks. The banks have " a competitive interest in limiting the expansion of MFCU pursuant to the common bond provision," the judge wrote. AB, 4/17/95, p. 15.


The NCUA proposed amending its regulation regarding the appraisals of real estate, adopted pursuant to Title XI of FIRREA, to clarify and expand the circumstances in which a Title XI appraisal is not required. The Board proposes to eliminate standards that parallel standards issued by the Appraisal Foundation, and to amend the regulation concerning appraiser independence to permit credit unions to use appraisals prepared for other financial-service institutions. Other parts of the proposal would simplify compliance for both credit unions and appraisers and reduce costs without affecting the reliability of appraisals used in connection with federally related transactions. FR, 3/13/95, p. 13388.

Incentive Compensation For CU Employees

The NCUA proposed to clarify its regulations that prohibit officials and certain employees of federally insured credit unions from receiving either incentive pay or outside compensation for certain activities related to credit union lending, and to authorize lending-related compensation in certain situations where it is currently prohibited, and to prohibit it in other situations.

The structure of the regulation would be changed to a broad prohibition, with specific exceptions, against an official or employee receiving compensation in connection with any loan made by the credit union. The proposal would allow loan officers to receive incentive pay; however, the incentives for making recommended or final decisions to approve or disapprove loans could not be based on the number or dollar amount of loans approved. The regulation also would require that the board of directors establish written policies and controls for any incentive plan and monitor compliance on at least a quarterly basis. FR, 4/20/95, p. 19690.

Guidelines For the Supervisory Review Committee

The NCUA issued a final Interpretive Ruling and Policy Statement, pursuant to the RCDRIA, concerning the establishment of an independent appellate process to review material supervisory determinations. In the final IRPS, which is effective March 22, 1995, a three-member supervisory review committee, and the time frames for committee action, are provided. FR, 3/20/95, p. 14795.

Operating Fee Exemptions

The NCUA proposed to exempt natural-person federal credit unions with assets of $500,000 and less from paying operating fees, and fees assessed on credit unions with assets between $500,000 and $750,000 would be cut by 40 percent. The NCUA currently does not assess operating fees on credit unions with assets of up to $50,000, which exempts only 59 institutions. The restructured operating fees would exempt a total of 839 credit unions, 780 of which currently pay an average fee between $100 and $117. An additional 349 institutions with assets of $500,000 to $750,000 would pay a minimum fee of $100, instead of the current average fee of $167. The total projected revenue shortfall from the proposed cuts in operating fees would be spread among all other federal natural-person credit unions. A $100 million-asset credit union is currently assessed $26,890 in operating fees, while a $500 million-asset credit union pays $265,000, which amounted to only .73 percent of their total operating expenses for 1994. NCUA NEWS, 6/14/95.


Interstate Banking/Branching

Interstate Regulatory Plan Developed

A plan developed by the Conference of State Bank Supervisors and approved by 45 state banking supervisors, would establish mechanisms to enable state-chartered banks to take advantage of the interstate banking provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, and be subject in respect to these activities to a single regulator. Implementation of the plan would be dependent upon states enacting the enabling legislation. Primary responsibility for conducting safety-and-soundness and compliance examinations would belong to an institution's home-state regulator, but the home state would coordinate its activities with the host states and federal authorities, and would use host-state examiners. The home state would share examination information and reports with the host state and federal regulators. The home state would have authority over applications for new branches, bank powers and mergers, subject to certain requirements involving analysis of the antitrust impact in the host state and compliance with its laws, and consultation with other regulators before approving any actions in other states. AB, 5/9/95, p. 2.

Alabama: A new law enacted pursuant to the Riegle-Neal Act allows nationwide banking, effective September 29, 1995. It permits interstate branching through merger and acquisition as of May 1997. BBR, 6/5/95, p. 1089.

Colorado: The Governor signed a bill that allows interstate branching in the state after June 1, 1997. The new law prohibits "de novo" interstate branching, and allows out-of-state banks to buy only branches that have existed for at least five years. BBR, 5/29/95, p. 1050.

Connecticut: The Governor signed legislation that "opts-in" under the Riegle-Neal Act, permitting merger transactions between in-state and out-of-state banks, and allowing de novo interstate branching. A five-year age limitation is imposed on target institutions, and a 30-percent limit on concentration of deposits in both interstate and intrastate acquisitions, mergers, and consolidations. BBR, 7/17/95, p. 107.

Idaho: A new law, to be effective July 1, 1995, allows out-of-state banking firms to convert banks they own in the state into branches. Under the Riegle-Neal Act, a bank holding company may convert a bank into a bank branch unless the state in which the bank is located enacts "opt-out" legislation before June 1, 1997. Continuing existing Idaho banking provisions, the new law does not permit de novo entry, only entry by acquisition. Also, it does not allow the purchase of branches only, the entire bank must be purchased. BBR, 3/20/95, p. 589.

Maryland: The legislature passed an "opt-in" bill which, if signed by the Governor, would become effective on September 29, 1995. Contingent upon reciprocity, an out-of-state bank could branch in Maryland either de novo or by acquiring an existing branch. AB, 4/13/95, p. 9.

Minnesota: A new law requires banks to be at least five years old before they are eligible to be purchased by out-of-state banking organizations. The law also places a 30-percent deposit cap on interstate banking operations. Northwestern Financial Review, 6/3/95, p. 21.

North Dakota: A recently enacted law "opts-in" under the Riegle-Neal Act by allowing interstate branching by consolidation after May 31, 1997. The law removes certain existing restrictions on interstate banking, including requirements for reciprocity, and lending commitments from out-of-state bank holding companies acquiring in-state banks. The legislation also expands intrastate banking by permitting banks to establish a "facility" anywhere in the state, starting August 1, 1996, and with no limit on the number of "facilities" a bank may have. "Facilities" will include bank paying and receiving stations, drive-in/walk-up facilities and banking offices. In-state commercial banks are permitted to purchase branches of savings-and-loan associations that were in existence on March 1 of this year and convert them into their own branch facilities. BBR, 5/1/95, p. 869.

Oregon: Oregon became the first state to enact "opt-in" legislation under the Riegle-Neal Act. The state's law went into effect on February 28, 1995. BBR, 3/13/95, p. 535.

Pennsylvania: An "opt-in" law, taking effect immediately, allows out-of-state banks to branch into the state either by acquisition or de novo, with a reciprocity requirement until June 1, 1997. State-chartered banks are given the same rights as national banks to branch into other states that allow interstate branching. AB, 7/25/95, p. 10.

Tennessee: The legislature voted "opt-in" legislation to be effective June 1, 1997, under the Riegle-Neal Act. BBR, 4/24/95, p. 820.

Texas: The Governor signed legislation that prohibits out-of-state banks from branching into Texas until at least September 1999, when the issue again will be taken up by the legislature. Texas allows out-of-state banking organizations to operate in the state through separately chartered banks. Texas banks will be able to branch outside the state in cases where federal regulators approve national bank 30-mile relocations. BBR, 5/1/95, p. 868; AB, 5/12, p. 6.

Utah: The Governor is expected to sign an "opt-in" bill that would take effect June 1, 1995. The bill prohibits de novo branching, and requires that an institution be at least five years old before being acquired by an out-of-state bank. BBR, 3/13/95, p. 535.

Virginia: New legislation creates a procedure for out-of-state banking firms to establish branches in the state beginning July 1, 1995, if those banks' home states have similar procedures allowing entry by Virginia banks. BBR, 4/10/95, p. 747.

Lending Limits

Iowa: Revisions in the state's banking code, now awaiting the Governor's signature, set the lending limit for state-chartered banks at 15 percent of their aggregate capital, defined as common and preferred stock, surplus, undivided profits, and loan-loss reserves. Banks could use another ten percent of aggregate capital to make loans on breeder livestock, in addition to the 15 percent general lending limit. AB, 4/17/95, p. 9.

Interest-Rate Restrictions Eliminated

Maine: A new law allows the state's banks to export interest rates into other states, and also deregulates bank credit-card fees. The revised credit code is now similar to Delaware's, putting Maine in a position to become a location for credit-card issuers. The new law identifies specific allowable credit-card charges, such as periodic charges, transaction charges, and late fees, and treats them as interest so they can be exported. A major reform law last year eliminated an 18-percent ceiling on interest rates, and the $12 maximum on annual fees, and replaced a prohibition on late fees with a five percent or $10 maximum fee. BBR, 6/5/95, p. 1087.

Lenders Allowed to Own Insurance Agencies

Michigan: A new law regulates the relationship between insurance firms and financial institutions, and in some cases allows lenders to own agencies and sell insurance. A lender may not require a borrower to buy any policy through a particular agency, nor may a lender fix or vary the terms of a loan as an inducement to purchase insurance. A lender generally is not allowed to require a person to buy any insurance product from the lender or an affiliate as a condition of making a loan. Among other provisions, lenders are allowed to provide names, addresses and similar information to agents or affiliated agencies, but cannot disclose account information or documents such as credit reports and financial statements. BBR, 1/23/95, p. 176.

Savings Bank Powers

Minnesota: The Governor signed a bill that updates state-chartered savings association laws. The state has 16 federal savings banks and no state-chartered savings banks. Savings banks are granted powers similar to powers possessed by the state's commercial banks. Northwestern Financial Review, 6/3/95, p. 21.

Securities Losses Cause For Concern

Minnesota: The Commerce Commissioner warned the 411 state-chartered banks that those with unusually high depreciation in securities portfolios or suspected of speculating "will receive special attention in examinations or targeted visitations." In part because of rising interest rates, the banks' portfolios shrank in 1994 by 3.5 percent. State officials emphasized that no individual banks are in danger at this time. They are concerned, however, that some banks have invested in sophisticated products such as financial derivatives without adequate knowledge about these instruments. AB, 3/1/95, p. 9.

Loan Limits, Charter Conversions

Mississippi: The Governor signed legislation, effective March 8, 1995, designed to clarify, modernize and improve various regulations that apply to commercial banks chartered by the state. Among the regulations involved are those governing loans to insiders, single-borrower loan limits, conversions of national banks to state-chartered banks, requirements applicable to the acquisition of branches, and conversion from federal savings associations to state-chartered associations. The mandatory examination cycle is lengthened from 12 months to 18 months. The Mississippi Banker, May 1995, p. 6.

Subsidized Loan Program

New York: Recently enacted legislation extends the state's linked-deposit loan program until April 1, 1998, and allows savings banks and savings-and-loan associations to participate. Under the program the state accepts below-market interest rates on certain state deposits in commercial banks that agree to make low-interest loans to small businesses. The program thus far has provided 155 small-business loans amounting to $66 million. BBR, 4/24/95, p. 821.

Constraints on Accountant Liability Suits

New Jersey: A new law makes accountants liable only for those financial statements they approve in writing for a specific user. Thus, each time anyone other than the client intends to use such a financial statement, the written verification procedure would be required. AB, 4/20/95, p. 20.

Environmental Liability

Michigan: A new law, revising legislation enacted in 1989-1990, changes the focus from ownership status to causation in creating environmental liability. Among other changes, the law revises the degree of cleanup that will be required based on the intended use of the property. Legislative-Legal Bulletin, Michigan Bankers Association, 6/5/95, p. 2.

Mississippi: The Governor signed legislation, effective July 1, 1995, that addresses lender liability and creates a limited environmental self-evaluation privilege. The limited privilege concerns the discovery or admissibility of information relating to voluntary self-evaluations in judicial and administrative proceedings. The state's existing penalty policy is amended to include a new and substantial mitigating policy for voluntary self-disclosure of non-compliance. The privilege does not apply in cases of fraud and in certain other cases. Mississippi became the eleventh state to enact environmental self-evaluation privilege/voluntary self-disclosure legislation, and the fourth state to allow voluntary self-disclosure to count as a mitigating factor. BBR, 4/17/95, p. 782.

Pennsylvania: Under a new law, lender environmental liability is changed from strict, joint and several liability to a direct causation standard. Instead of a "participation in management" concept, the new law holds a bank liable if the lender or its agents directly cause an immediate release or directly exacerbate a release of a regulated substance, or the lender or its agents knowingly and willfully compelled the borrower to take an action that caused an immediate release or violated a state environmental law. BBR, 6/12/95, p. 1153.

Texas: A new law, effective on signing, will protect companies that voluntarily disclose environmental violations found in self-audits from criminal, civil, or administrative penalties, provided they correct the non-compliance within a "reasonable" period of time. A decision by an administrative hearing officer that an audit is, or is not, privileged may be appealed in state district court. Thirteen other states have environmental audit privilege laws, including eight that have taken action in 1995. BBR, 6/5/95, p. 1103.

Banking Laws Updated

Texas: A new law, effective September 1, 1995, generally updates and recodifies the existing banking code. Among substantive changes is the elimination of the three-member Banking Board and transfer of its bank-chartering authority to the banking Commissioner. BBR, 7/3/95, p. 18.

New Banks

West Virginia: Citizens Southern Bank, Beckley, opened for business on June 12, the first new bank in the state in the past thirteen years. At least three more banks are being organized and expect to open soon. Among the reasons for the renewed interest in new banks is the turnaround in the economy of the state. The number of banks in West Virginia has declined to 140 from 235 a decade ago. The fact that most communities are now being served by branches of regional institutions has created opportunities for more locally owned banks, the organizers believe. AB, 6/16/95, p. 7.


Commercial Banks' Earnings Strong in First Quarter

FDIC-insured commercial banks reported net income of $11.1 billion (preliminary) in the first quarter of 1995, an increase of nearly $400 million from the previous three months. This followed record earnings of $44.7 billion for the year 1994, up by 3.7 percent from 1993. The main contributors to the improved earnings in the quarter were reductions in certain expense items, including noninterest expenses, securities losses, and provision for loan losses. Net interest income declined slightly, but still was $2.5 billion higher than in the same quarter a year ago.

Assets of insured commercial banks grew by 2.6 percent in the first quarter to $4.1 trillion. The increase in commercial and industrial loans of $32.7 billion was the largest quarterly increase in the more than 20 years that banks have reported quarterly loan data. The C&I loan growth was evident in all regions, but the largest share occurred at banks in the Northeast Region, while overall loan growth was strongest in Southeast Region banks. Banks' securities holdings declined for the fourth consecutive quarter, falling by $9.7 billion, most of which was in mortgage-backed securities. Noncurrent loans were up by $1.6 billion to $32.2 billion, the first quarterly rise since the first quarter of 1991. Most of the increase was in noncurrent real- estate loans, a substantial portion of which resulted from a new accounting rule (FASB 114) that caused some banks to report as nonaccrual loans assets that were previously reported as other real estate owned (OREO).

Total deposits at insured commercial banks fell slightly in the quarter, due to declines in demand and savings deposits in domestic offices, while deposits in foreign offices and time deposits in domestic offices both increased. A $105-billion rise in nondeposit liabilities was attributable mostly to higher trading account liabilities concentrated in a few large banks. Equity capital climbed by $12.1 billion in the first quarter to $324.2 billion, one-third of the increase resulting from new GAAP accounting rules. Banks' unrealized losses on available-for-sale securities, which under the new rules are deducted from equity capital, fell by $6.3 billion during the quarter, producing a $4.1 billion rise (net of tax effects) in equity capital. The ratio of equity capital to assets was 7.88 percent at the end of the quarter.

The number of insured commercial banks reporting financial results declined by 209 during the first quarter to 10,241. The number of banks absorbed through unassisted mergers and consolidations rose to 228, a quarterly high, over four-fifths of which resulted from consolidations within bank holding companies.

There were 215 commercial banks on the FDIC's "Problem List" on March 31, down from 247 at year-end 1994, and 383 a year ago. The assets of the problem banks totaled $27 billion, compared to $33 billion at year-end 1994 and $53 billion on March 31, 1994. Six insured banks, with assets totaling $867 million, have failed in 1995 (through July 31). FDIC Quarterly Banking Profile, First Quarter 1995; PR-40-95, FDIC, 6/14/95.

FDIC-insured, private-sector savings institutions earned $1.7 billion (preliminary) in the first quarter of 1995, up by $122 million from the fourth quarter and $448 million higher than in the first quarter of 1994. Earnings for the year 1994 totaled $6.4 billion. Over 94 percent of all savings institutions were profitable in the first quarter.

Industry assets rose by $5.2 billion in the quarter to $1.0 trillion, marking the third consecutive quarterly increase. The largest growth category was loans secured by 1-4 family residential properties. Deposits rose by $7.4 billion, the first quarterly increase since 1988. Other borrowed funds declined for the first time since 1992. Equity capital rose by $1.8 billion during the quarter, as thrifts retained over $900 million of their earnings, and also they reported an increase of $1.1 billion in the fair value of available-for-sale securities. The industry's first-quarter capital ratio of 8.07 percent was the highest since 1952. Noncurrent real-estate loans as a percent of total real-estate loans declined to 2.10 from 2.19 at the end of 1994, and 3.18 in the first quarter of 1994.

The number of savings institutions declined during the first quarter by 34 to 2,118, as takeovers by commercial banks and consolidation within the industry continued. Following 27 conversions from mutual to stock ownership, the number of stock-owned thrifts exceeded mutuals, with 1,066 institutions holding $830 billion in assets, compared to 1,052 mutuals holding $184 billion in assets. Seventy-one savings institutions with $39 billion in assets were on the FDIC's "Problem List" on March 31, both numbers unchanged from year-end 1994, and down from 118 institutions with assets of $89 billion in the first quarter of 1994.

Banks' Loans Grew Faster Than Securities in 1994

Half of the 117 bank investment managers surveyed by the American Bankers Association reduced their securities portfolios as a percentage of total assets last year, while only 23 percent increased the securities percentage. Analysts said that excess liquidity and low loan demand in the banking system in 1990-1993 were reversed in 1994. AB, 4/3/95. p. 1.

Banks Raise Mutual Funds Market Share

The assets of bank-managed mutual funds grew 7.3 percent in the first quarter of this year, exceeding the 6.2 percent growth rate of the mutual funds industry. The first-quarter increase brought the banks' share of the $2.3 trillion mutual fund business to 14.3 percent, up from 10.5 percent in March 1994. Most banks reportedly have been building mutual fund assets by reorganizing trust assets and acquiring mutual fund management companies. According to a survey prepared for the American Banker, Mellon Bank Corp., PNC Bank Corp., and NationsBank are the top three bank mutual fund management companies.

While the recent growth in mutual funds managed by banks, and the industry, has been strongest in equity funds, money-market mutual funds represent 57.8 percent of bank-managed mutual fund assets, compared to 29.5 percent for the mutual funds industry. Banks generally are said to be attempting to move closer to the industry average because of the higher potential profits in stock and bond funds. Of the 115 banks with proprietary mutual funds, 55 had less than $1 billion in fund assets under management at the end of March. Some of the smaller organizations may depart from the industry because of insufficient diversification and other reasons. AB, 5/10/95, pp. 1, 23.

Small Banks to Reduce Derivatives Investments

While 84 percent of more than 800 community banks recently surveyed currently invest in financial derivatives, less than 60 percent plan to invest in these instruments in the future. The complexity of financial derivatives and sharp declines in portfolio values with rising interest rates are seen as principal reasons for the decline. The largest decline expected is for structured notes, which is one of the more complex kinds of derivatives, and which also has had the most growth in the past year. AB, 5/16/95, p. 1.

Bank Fee Increases Exceed Inflation, Study Says

The annual maintenance costs to consumers for interest-bearing checking accounts rose by 11 percent, to $219, between 1993 and April 1995, and the costs for regular checking accounts rose ten percent, to $202, according to a study by the U.S. Public Interest Research Group. Among other findings, maintenance fees for savings accounts increased nine percent, to $31 a year, and the average checking-account balance required to avoid fees increased by 30 percent, to $1,242. Surveying 271 banks in 25 states and the District of Columbia, the highest fee states were reported to be Maryland, Florida, North Carolina, and Illinois, and also the District of Columbia, while the lower fees were found in Hawaii, Idaho, New Mexico, Maine and Washington. The American Bankers Association disputed the study's results, noting the survey's limited coverage, and the fact that the data do not reflect service quality improvements, and also the rising costs of administering consumer deposits which are making some accounts unprofitable. WSJ, 8/9/95, p. A2.

Credit Unions' Asset Growth Slows

Total assets of federally insured credit unions increased 4.5 percent in 1994, the smallest rate of growth since 1948. In the last six months, assets fell slightly, from $289.7 billion at midyear to $289.5 billion at year-end. The profitability of federally insured credit unions declined during 1994, as measured by a fall in the ratio of net income to average assets to 1.2 percent from 1.4 percent in 1993. There were 588 credit unions reporting a net loss in 1994, an increase of 58 from 1993. First-quarter 1995 data for the 1,160 federally insured credit unions with assets over $50 million show a two percent increase in assets to $206.4 billion. These institutions experienced a slight decline in return on assets in the quarter, from 1.2 percent to 1.1 percent, while their capital-to-assets ratio rose to 10.1 percent from ten percent. Letter to Credit Unions No. 166, NCUA, March 1995; NCUA NEWS, 6/2/95.

Bankers Surveyed on Regulatory Burden

According to the results of a recent survey by KPMG Peat Marwick, the Community Reinvestment Act and Fair-Lending are at the top of regulations that bankers consider to be the most burdensome. The three regulatory areas next in order of perceived burden are asset quality, truth-in-lending and truth-in-savings. Ninety-one percent of bank CEOs said the CRA was their first choice for regulatory reform, and 96 percent believed the Act should be extended to nonbank financial-service companies. Eighty percent of the CEOs said they had reviewed fair-lending policies and procedures for discrimination, however only 23 percent have tested their bank by using mystery shoppers, while 43 percent have done a quantitative analysis of application and loan files. A total of 1,311 banker questionnaires were sent out and 660 were completed and returned. AB, 3/23/95, p. 16.

Minority Discrimination Case Settled

Northern Trust Co., Chicago, and three suburban affiliates agreed to pay $566,500 to minorities to settle a Justice Department complaint that, in 1992 and 1993, Northern's employees made special efforts to qualify white applicants for mortgage loans but did not give similar assistance to minority applicants. The firm does not believe it violated the law, an official said. It was the sixth major fair-housing case filed and settled by the Justice Department, and is said to be unique in that Justice documented it with a review of individual loan files, rather than with statistical analyses. A Justice official said the message from the case is that "institutions should look at the procedures they use to process applications for financing and make sure they are affording minority applicants an opportunity to present qualifications that is comparable to the opportunity being afforded to white applicants." AB, 6/2/95, p. 1.

ATM Use Continues Growth

A telephone survey in six states --- Arkansas, Louisiana, Texas, Oklahoma, New Mexico and Colorado --- found that 60 percent of persons having a checking or savings account with a financial institution have an ATM card, up from 49 percent in 1993. The increase occurred in all states surveyed, among all age categories, both genders, and in all types of financial institutions. Cardholders used their card 3.47 times during a two-week period to make purchases this year, up from 1.62 times during the same period in 1993. Texas Banking, June 1995, p. 9.


Efficiency Improvement From Mergers Is Questioned

This study by Tanya Azarchs, published by Standard & Poor's, analyzes the results of mergers involving the nation's 30 largest banking companies, to determine whether these transactions resulted in increases in efficiency in the surviving institutions. Comparing institutions that merged with those that did not, using data for 1990 through 1994, the study found no advantages in efficiency, as defined here, that could be attributed specifically to the mergers. While cost savings occured in many cases, the author generally believes these benefits could have been realized by management implementation without mergers.

Expense/income ratios for the general population of banking organizations show that the ratios each year of firms having assets of $100 million or less were much higher than the industry average of about 70 percent. Beyond $1 billion in assets, increasing size does not appear generally to result in further cost efficiencies. The firms in the study group that had undergone significant mergers were not more efficient than those not involved in mergers, and the most efficient institutions were not more likely to be among those that merged. The non-merging firms generally experienced the greatest improvement in efficiency during the period. One of the benefits from mergers is that they can provide a politically acceptable justification and opportune situation for implementing what are otherwise very difficult cost cuts. However, the "real" benefits are more likely to be those that can result from a company's diversification --- an important factor in S&P ratings --- or the enhancement of market position where being a leader in a product line has tangible benefits such as enabling the firm to charge premium prices or attract clients. Standard & Poor's Creditweek, January 2, 1995.

Interstate Banking: Experience in Three States

This GAO report to Congress discusses interstate banking in three states --- California, Washington and Arizona --- that have allowed both interstate and intrastate banking for a number of years. The report evaluates the experience in these states, for the period 1985 through mid-1993, to determine whether their interstate banking laws have had any effect on the market share and number of large banks, the viability of the smaller banks, and the availability of credit to small businesses. Interstate Banking: Experiences in Three States, U.S. General Accounting Office, December 1994.

Outlook For Debit Cards

Debit cards have been the greatest disappointment thus far in the payments revolution but may be turning the corner, say Gordon H. Sellon, Jr. and John P. Caskey in this article. The authors analyze the factors that have limited the success of debit cards and examine prospects for their future growth. The failure of debit cards to reach their usage potential has resulted largely from, first, coordination issues among payments system participants that affect incentives to adopt new payments technology, and second, the inefficient pricing of existing methods of payment.

For the debit card to replace existing payment methods, not only must the merchant accept it, consumers must be willing to use it for retail purposes. Based on convenience and other non-cost factors, debit cards could replace cash transactions for some consumers, for example, because they find carrying a debit card to be more secure compared with checks. A debit card can be faster in checkout time, while checks have an advantage in delayed clearance, and they also permit more detailed recordkeeping. Some convenience users of credit cards could find advantages in debit cards in avoiding having to write monthly settlement checks, and making it easier to enforce personal budgets. Also, some retail stores permit personal debit card holders to receive cash, which is rarely permitted with credit cards. In summary, the outlook for acceptance of debit cards by consumers is believed to be the most favorable where they value its convenience, and with consumers who have limited access to existing payments media.

The acceptance of debit cards by merchants is more likely to be based on cost factors. But if debit cards are seen as a way to increase sales volume or as necessary to maintain market share, they may be adopted even with a cost disadvantage. Promotional programs of an informational or educational nature could be a key factor in determining the speed of debit card growth in the future. Also critical are technological developments, for example, the falling cost of debit card readers has influenced merchants' decisions to offer debit cards. Developments affecting alternative payments methods --- for example, check imaging and truncation may make checking more automated and less costly --- could also importantly affect debit card usage. Economic Review, Federal Reserve Bank of Kansas City, 4th Quarter 1994, pp. 79-94.

The Electronic Purse

This article by John Wenninger and David Laster discusses how an electronic purse system might work, the advantages of the system for consumers, merchants, and issuers, and the difficulties that could arise. The electronic purse, which is a multipurpose prepaid card the size of a credit card, could if successful bring fundamental change in the U.S. payments system.

In contrast to "closed system" cards which have one or a few possible uses, such as transportation cards, the electronic purse is in an "open system" card that can be used in a variety of locations for a broad range of purchases. In this system, a bank issues the cards to customers who then transfer value from their accounts to the cards at an ATM, a personal computer, or a specially equipped telephone. Funds are deducted directly from the cards and transferred to the terminals of the vendors, who in turn move the funds into their bank accounts whenever they wish to do so. As funds are spent from the cards, consumers can replace these funds from their accounts. Systems of the above type, while not in existence currently in the U.S., are operating in other countries, for example, Denmark and Finland.

For the electronic purse to have sufficient flexibility and protection against fraud they would probably require smart-card technology employing a plastic card in which one or more computer chips are embedded and having a capability of storing, retrieving and manipulating data. Regarding usage of such systems in the U.S., various issues are unsettled, for example, whether the transactions should be traceable, requiring a consideration of the benefits for law enforcement against the recordkeeping requirements which could be quite burdensome and expensive.

The advantages to consumers would appear to derive mainly from the convenience factor in the use of the card for small transactions, reducing the need for carrying cash and speeding transactions because the customer would always have the "exact change." Among the possible obstacles could be the creation of numbers of incompatible systems requiring consumers to carry several different cards. Similar advantages in respect to time-saving and enhanced security from reducing the handling of cash would also apply for merchants. Other benefits to them would be that prepaid cards will likely have lower transactions fees than on-line debit cards and unlike checks, offer assured payment, and perhaps open new markets such as pay-per-view television. If merchants, however, were required to pay transaction fees and purchase new card readers or retrofit existing ones, they could be reluctant to accept electronic purses unless their use generates enough new business to justify the costs.

Regarding the issuers of the cards, a significant advantage, with increased uses for electronic purses and the number of cards issued, could be the "float" from their earnings on investment of customer balances held in electronic purses. Among other issues involved in establishing the electronic purse is whether organizations other than banks would issue the cards. Some potential is seen for facilitating some kinds of money laudering. For example, if card systems allow person-to-person transfers of value and transfers over specially equipped phone lines, it would enable holders of prepaid card value to move funds rapidly to remote locations where they could make several smaller, undetected deposits. Current Issues in Economics and Finance, April 1995, Federal Reserve Bank of New York.

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