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entitled 'Deposit Insurance: Assessment of Regulators' Use of Prompt 
Corrective Action Provisions and FDIC's New Deposit Insurance System' 
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Report to Congressional Committees: 

United States Government Accountability Office: 

GAO: 

February 2007: 

Deposit Insurance: 

Assessment of Regulators' Use of Prompt Corrective Action Provisions 
and FDIC's New Deposit Insurance System: 

GAO-07-242: 

GAO Highlights: 

Highlights of GAO-07-242, a report to congressional committees 

Why GAO Did This Study: 

The Federal Deposit Insurance Reform Conforming Amendments Act of 2005 
required GAO to report on the federal banking regulators’ 
administration of the prompt corrective action (PCA) program under 
section 38 of the Federal Deposit Insurance Act (FDIA). Congress 
created section 38 as well as section 39, which required regulators to 
prescribe safety and soundness standards related to noncapital 
criteria, to address weaknesses in regulatory oversight during the bank 
and thrift crisis of the 1980s that contributed to deposit insurance 
losses. The 2005 act also required GAO to report on changes to the 
Federal Deposit Insurance Corporation’s (FDIC) deposit insurance 
system. This report (1) examines how regulators have used PCA to 
resolve capital adequacy issues at depository institutions, (2) 
assesses the extent to which regulators have used noncapital 
supervisory actions under sections 38 and 39, and (3) describes how 
recent changes to FDIC’s deposit insurance system affect the 
determination of institutions’ insurance premiums. GAO reviewed 
regulators’ PCA procedures and actions taken on a sample of 
undercapitalized institutions. GAO also reviewed the final rule on 
changes to the insurance system and comments from industry and academic 
experts. 

What GAO Found: 

In recent years, the financial condition of depository institutions 
generally has been strong, which has resulted in the regulators’ 
infrequent use of PCA provisions to resolve capital adequacy issues of 
troubled institutions. Partly because they benefited from a strong 
economy in the last decade, banks and thrifts in undercapitalized and 
lower capital categories decreased from 1,235 in 1992, the year 
regulators implemented PCA, to 14 in 2005, and none failed from June 
2004 through January 2007. For the banks and thrifts GAO reviewed, 
regulators generally implemented PCA in accordance with section 38. For 
example, regulators identified when institutions failed to meet minimum 
capital requirements, required them to implement capital restoration 
plans or corrective actions outlined in enforcement orders, and took 
steps to close or require the sale or merger of those institutions that 
were unable to recapitalize. Although regulators generally used PCA 
appropriately, capital is a lagging indicator and thus not necessarily 
a timely predictor of problems at banks and thrifts. In most cases GAO 
reviewed, regulators had responded to safety and soundness problems in 
advance of a bank or thrift’s decline in required PCA capital levels. 

Under section 38 regulators can take noncapital supervisory actions to 
reclassify an institution’s capital category or dismiss officers and 
directors from deteriorating institutions, and under section 39 
regulators can require institutions to implement plans to address 
deficiencies in their compliance with regulatory safety and soundness 
standards. Regulators generally have made limited use of these 
authorities, in part because they have chosen other informal and formal 
actions to address problems at troubled institutions. According to the 
regulators, other tools, such as cease-and-desist orders, may provide 
more flexibility than those available under sections 38 and 39 because 
they are not tied to an institution’s capital level and may allow them 
to address more complex or multiple deficiencies with one action. 
Regulators’ discretion to choose how and when to address safety and 
soundness weaknesses is demonstrated by their limited use of section 38 
and 39 provisions and more frequent use of other informal and formal 
actions. 

Recent changes to FDIC’s deposit insurance system tie the premiums a 
bank or thrift pays into the insurance fund more directly to the 
estimated risk the institution poses to the fund. In the revised 
system, FDIC generally (1) differentiates between larger institutions 
with current credit agency ratings and $10 billion or more in assets 
and all other, smaller institutions and (2) requires all institutions 
to pay premiums based on their individual risk. Most bankers, industry 
groups, and academics GAO interviewed and many of the organizations and 
individuals that submitted comment letters to FDIC on the new system 
generally supported making the system more risk based, but also had 
some concerns about unintended effects. FDIC and the other federal 
banking regulators intend to monitor the new system for any adverse 
impacts. 

[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-242]. 

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Yvonne D. Jones at (202) 
512-8678 or jonesy@gao.gov 

[End of section] 

Contents: 

Letter: 

Results in Brief: 

Background: 

Since the Enactment of FDICIA, the Financial Condition of Depository 
Institutions Has Been Strong and Regulators' On-site Monitoring Has 
Been More Frequent: 

Regulators Used PCA Appropriately in Cases We Reviewed and Other 
Enforcement Actions Generally Preceded Declines in These Institutions' 
PCA Capital Categories: 

Regulators Have Made Limited and Targeted Use of the Noncapital 
Supervisory Actions Available under Sections 38 and 39: 

FDIC Has More Tightly Linked Deposit Insurance Premiums to 
Institutional Risk, but Some Expressed Concerns about Certain Aspects 
of the New System: 

Agency Comments: 

Appendix I: Objectives, Scope, and Methodology: 

Appendix II: Comments from the Board of Governors of the Federal 
Reserve System: 

Appendix III: GAO Contact and Staff Acknowledgments: 

Tables: 

Table 1: Definitions of Risk: 

Table 2: PCA Capital Categories: 

Table 3: Sampled Institutions with PCA Taken to Address Capital 
Deficiencies: 

Table 4: Sampled Institutions Where Use of PCA Was Not Required: 

Table 5: Institutions with Material Losses and PCA to Address Capital 
Adequacy, 1992-2005: 

Table 6: Distribution of Institutions among Risk Categories in FDIC's 
Previous Deposit Insurance System, as of December 31, 2005: 

Table 7: Base Rate Premiums by Risk Category under FDIC's New Deposit 
Insurance System: 

Figures: 

Figure 1: Total Assets, Total Net Income, Return on Assets, and Return 
on Equity for Federally Insured Commercial Banks and Savings 
Institutions, 1992-2005: 

Figure 2: Number and Percentage of Institutions in PCA Capital 
Categories, 1992-2005: 

Figure 3: Number of Problem Institutions and Total Assets, 1992-2005: 

Figure 4: Failed Banks and Thrifts and Their Estimated Losses, 1992- 
2005: 

Figure 5: Section 38 Mandatory and Discretionary Requirements: 

Figure 6: Institutions on Regulator Watch Lists: 

Figure 7: Timeline of Enforcement Actions, FDIC Open Bank 1: 

Figure 8: Timeline of Enforcement Actions, New Century Bank: 

Figure 9: Timeline of Enforcement Actions, Compubank: 

Figure 10: Timeline of Enforcement Actions, Georgia Community Bank: 

Figure 11: Regulators Use of Section 8(e), 1992-2005: 

Figure 12: Regulators Use of Section 39, 1995-2005: 

Abbreviations: 

BSA: Bank Secrecy Act: 

CAMELS: capital, asset quality, management, earnings, liquidity, 
sensitivity to market risk: 

FDIA: Federal Deposit Insurance Act: 

FDIC: Federal Deposit Insurance Corporation: 

FDICIA: Federal Deposit Insurance Corporation Improvement Act of 1991: 

IG: inspector general: 

OCC: Office of the Comptroller of the Currency: 

OTS: Office of Thrift Supervision: 

PCA: prompt corrective action: 

Y2K: Year 2000: 

United States Government Accountability Office: 
Washington, DC 20548: 

February 15, 2007: 

The Honorable Christopher J. Dodd: 
Chairman: 
The Honorable Richard C. Shelby: 
Ranking Member: 
Committee on Banking, Housing, and Urban Affairs: 
United States Senate: 

The Honorable Barney Frank: 
Chairman: 
The Honorable Spencer Bachus: 
Ranking Member: 
Committee on Financial Services: 
House of Representatives: 

With the failure of more than 2,900 federally insured banks and thrifts 
in the 1980s and early 1990s, federal regulators were criticized for 
failing to take timely and forceful action to address the causes of 
these failures and prevent losses to the deposit insurance fund and 
taxpayers.[Footnote 1] In response to the federal banking regulators' 
failure to take appropriate action, Congress passed the Federal Deposit 
Insurance Corporation Improvement Act of 1991 (FDICIA), implementing 
significant changes to the way banking regulators supervise the 
nation's depository institutions.[Footnote 2] FDICIA created two new 
sections in the Federal Deposit Insurance Act (FDIA)--sections 38 and 
39--that required the federal banking regulators to create a two-part 
framework to supplement their existing supervisory authority to address 
capital deficiencies and unsafe or unsound conduct, practices, or 
conditions.[Footnote 3] The addition of sections 38 and 39 to FDIA were 
intended to improve the ability of regulators to identify and promptly 
address deficiencies at an institution to better safeguard the deposit 
insurance fund. Specifically, section 38 requires regulators to 
classify depository institutions into one of five capital categories 
based on their level of capital--well capitalized, adequately 
capitalized, undercapitalized, significantly undercapitalized, and 
critically undercapitalized--and take increasingly severe actions, 
known as prompt corrective action (PCA), as an institution's capital 
deteriorates.[Footnote 4] Section 38 primarily focuses on capital as an 
indicator of trouble, thus the supervisory actions authorized under it 
are almost exclusively designed to address an institution's 
deteriorating capital level (for example, requiring undercapitalized 
institutions to implement capital restoration plans). However, section 
38 also authorizes noncapital supervisory actions (for example, 
removing officers and directors or downgrading an institution's capital 
level).[Footnote 5] Section 39 required the banking regulators to 
prescribe safety and soundness standards related to noncapital 
criteria, including operations and management; compensation; and asset 
quality, earnings, and stock valuation, and allows the regulators to 
take action if an institution fails to meet one or more of these 
standards.[Footnote 6] Since the passage of FDICIA, banks and thrifts 
have benefited from a strong economy, but this has not diminished the 
importance of the need for regulators to take early and forceful action 
to address capital and noncapital deficiencies. 

FDICIA also granted the Federal Deposit Insurance Corporation (FDIC) 
the authority to establish and maintain a system--the deposit insurance 
system--to assess the relative risk of federally insured banks and 
thrifts and charge them premiums based on that risk. In February 2006, 
Congress granted FDIC the authority to make substantive changes to the 
deposit insurance system, including the way the regulator assesses risk 
and assigns premiums.[Footnote 7] FDIC issued its final rule 
implementing changes in November 2006. 

This report responds to the mandate contained in section 6 of the 
Federal Deposit Insurance Reform Conforming Amendments Act of 2005 
requiring the Comptroller General to report on issues relating to the 
federal banking regulators' administration of the PCA program under 
section 38 of FDIA as well as various aspects of FDIC's deposit 
insurance system.[Footnote 8] Because the banking regulators also 
monitor the safety and soundness of depository institutions using 
criteria other than capital levels, this report also includes a review 
of the federal banking regulators' use of safety and soundness 
standards under section 39. Specifically, this report (1) describes 
trends in the financial condition of banks and thrifts and federal 
regulators' oversight of these institutions since the passage of 
FDICIA, (2) evaluates how federal regulators have used PCA to resolve 
capital adequacy issues at the institutions they regulate, (3) 
evaluates the extent to which federal regulators have used the 
noncapital supervisory actions of sections 38 and 39 to address 
weaknesses at the institutions they regulate, and (4) describes FDIC's 
deposit insurance system and how recent changes to the system affect 
the determination of institutions' risk and insurance premiums. 

To address these objectives, we reviewed relevant laws, regulations, 
and regulators' policies and procedures and interviewed officials from 
the four federal banking regulators--FDIC, the Board of Governors of 
the Federal Reserve System (Federal Reserve), the Office of the 
Comptroller of the Currency (OCC), and the Office of Thrift Supervision 
(OTS)--as well as industry officials and academics. We also reviewed 
our previous reports on PCA.[Footnote 9] To describe trends in the 
financial condition of banks and thrifts and regulators' oversight of 
these institutions since the passage of FDICIA, we reviewed relevant 
industry reports and analyses. We also analyzed regulator and industry 
data to determine, among other things, the number of well-capitalized, 
adequately capitalized, and undercapitalized institutions and the 
number of institutions appearing on the problem institutions list since 
1992, the year regulators implemented FDICIA.[Footnote 10] To assess 
how federal regulators have used PCA to resolve capital adequacy issues 
at the institutions they regulate, we reviewed section 38 and its 
implementing regulations, as well as regulators' policies and 
procedures. We also examined reports of examination, informal and 
formal enforcement actions, and institution-regulator correspondence 
for a nonprobability sample of 24 institutions from a population of 157 
institutions that fell below one of the three lowest PCA capital 
thresholds at least once from 2001 through 2005. We chose this period 
for review based on the availability of examination-and enforcement- 
related documents and to reflect the most current policies and 
procedures used by the regulators. The sample reflects a mix of 
institutions regulated by each of the four regulators as well as a mix 
of the three lowest PCA capital categories. In 6 of these 24 cases, 
regulators did not implement PCA because they determined that it was 
not warranted.[Footnote 11] In addition, we reviewed the material loss 
reviews of all banks and thrifts that failed from 1992 through 2005 and 
in which the primary regulator implemented PCA to address capital 
adequacy issues.[Footnote 12] To determine the extent to which federal 
regulators have used the noncapital supervisory actions of sections 38 
and 39 to address weaknesses at the institutions they regulate, we 
reviewed regulators' policies and procedures related to sections 
38(f)(2)(F) and 38(g) (the provisions for dismissal of officers and 
directors and reclassification of a capital category, respectively) and 
section 39, as well as data on the number of times and for what 
purposes they used these noncapital authorities. To provide context on 
the extent of regulators' use of these noncapital provisions, we also 
obtained data on the number of times regulators used their authority 
under section 8(e) of FDIA to remove officers and directors from office 
and section 8(b) to enforce compliance with safety and soundness 
standards.[Footnote 13] Finally, to describe how changes in FDIC's 
deposit insurance system affect the determination of institutions' risk 
and insurance premiums, we reviewed FDIC's notice of proposed rule 
making on deposit insurance assessments, selected comments to the 
proposed rule, and FDIC's final rule on deposit insurance 
assessments.[Footnote 14] We also interviewed representatives of five 
depository institutions (three large and two small) and two trade 
groups representing large and small institutions and two academics to 
obtain their views on the impact of FDIC's changes to the system. 
Appendix I contains a more detailed description of our scope and 
methodology. We conducted our work in Washington, D.C., and Chicago 
from March 2006 through January 2007 in accordance with generally 
accepted government auditing standards. 

Results in Brief: 

Since the enactment of FDICIA, the financial condition of federally 
insured depository institutions generally has been strong and 
regulators have increased their presence at banks and thrifts. Net 
income and total assets exceeded $133 billion and $10 trillion, 
respectively, in 2005, and the industry's two primary indicators of 
profitability--returns on assets and equity--remained near highs at the 
end of 2005. In this strong economic environment, the percentage of 
well-capitalized institutions steadily has increased from 94 percent in 
1992, the year regulators implemented FDICIA, to just over 99 percent 
in 2005, while the percentage of well-capitalized institutions with 
capital in excess of the well-capitalized minimum increased from 84 
percent in 1992 to 94 percent in 2005. Over the period, the number of 
institutions in undercapitalized and lower capital categories 
experienced a corresponding decline from 1,235 in 1992 to 14 in 2005, 
and the number of failed institutions also fell dramatically. In 
addition to requiring regulators to take prompt corrective action 
against institutions that fail to meet minimum capital requirements, 
FDICIA also required examiners to conduct annual, on-site examinations 
at all federally insured banks and thrifts to improve their ability to 
identify and address problems in a more timely manner. Although we did 
not evaluate the regulators' timeliness in conducting examinations, 
regulatory data show that the average time between examinations fell 
from a high of 609 days in 1986 to 373 in 1992. Based on information we 
obtained from all four regulators, the average interval between 
examinations for all institutions generally has remained from 12 to 18 
months since 1993 (the year after FDICIA requirements were implemented) 
and in many instances, has been even shorter, especially for problem 
institutions (those with composite CAMELS ratings of 4 or 5).[Footnote 
15] 

For the sample of 18 banks and thrifts that were subject to PCA, we 
found that regulators generally implemented PCA in accordance with 
section 38, consistent with findings in our 1996 report.[Footnote 16] 
For example, regulators identified when each of the institutions failed 
to meet minimum capital requirements, required these institutions to 
implement capital restoration plans or corrective actions outlined in 
enforcement orders, and took steps to close or require the sale or 
merger of those institutions that were unable to adequately 
recapitalize. Fifteen of the 18 institutions in our sample remain open 
or were merged into other institutions or closed without causing losses 
to the deposit insurance fund, and 3 failed causing losses, one of 
which was a material loss (that is, a loss exceeding $25 million or 2 
percent of an institution's assets, whichever is greater). Although 
regulators appeared to have used PCA appropriately, capital is a 
lagging indicator and thus not necessarily a timely predictor of 
problems at banks and thrifts. All four regulators generally agreed 
that by design, PCA is not a tool that can be used upon early 
recognition of a bank or thrift's troubled status. In most cases we 
reviewed, regulators had responded to safety and soundness problems in 
advance of a bank or thrift's decline in PCA capital category. For 
example, each of the 18 institutions subject to PCA appeared on one or 
more regulatory watch lists prior to or concurrent with experiencing a 
decline in its capital category, and a majority of the 18 institutions 
had at least one enforcement action in place prior to becoming 
undercapitalized. Finally, the inspectors general (IG) of the federal 
banking agencies found that in 12 of 14 cases where regulators used PCA 
to resolve capital problems at an institution that failed with material 
losses, the regulators' use of PCA was appropriate. In two cases, the 
IG found that the regulator could have used PCA sooner than it did. 

Regulators have made limited use of noncapital supervisory actions 
under sections 38 and 39, which allow them to reclassify institutions' 
capital categories, dismiss officers and directors from deteriorating 
banks and thrifts, and require institutions to implement plans to 
address deficiencies in their compliance with regulatory safety and 
soundness standards. For example, since the implementation of FDICIA, 
only OCC has used the authority granted under section 38 to reclassify 
an institution's capital category. According to the regulators, section 
38's reclassification provision is of limited use because they can use 
other enforcement actions to address deficiencies, including capital 
and noncapital deficiencies (such as deficiencies in asset quality, 
risk management, and the quality of bank management). These other 
enforcement actions can be used even when an institution is well 
capitalized or adequately capitalized by PCA standards. Similarly, 
since the implementation of FDICIA, regulators made limited use of 
section 38's dismissal authority--FDIC has made the most frequent use 
of the authority (six times), while OCC used it once and the Federal 
Reserve and OTS have never used it. Regulators told us that they often 
rely on moral suasion to encourage problem officers and directors to 
resign from institutions, or when an individual's misconduct is severe, 
they may use their authority under section 8(e) of FDIA to remove that 
individual from an institution and prohibit him or her from further 
employment in the industry. FDIC, OCC, and OTS also used section 39 
authority in limited circumstances to address safety and soundness 
deficiencies at the institutions they regulate. However, amendments to 
section 39 in 1994 increased regulator flexibility over when and how to 
use the authority and regulators maintain considerable discretion to 
choose how and when to address safety and soundness weaknesses, as 
demonstrated by their varied use of noncapital supervisory actions 
under sections 38 and 39 and other informal and formal enforcement 
actions. Regulators have used section 39 predominantly to address 
noncompliance with certain laws or requirements or when management was 
willing and able to implement required corrective actions, but may not 
have been responsive to prior informal regulatory criticisms. 
Regulators told us that they prefer to use formal enforcement actions, 
such as section 8(b) cease-and-desist orders, to address complex or 
multiple deficiencies at an institution or in cases where management 
was not willing or able to quickly implement the required corrective 
actions. 

Recent changes to FDIC's deposit insurance system tie the premiums a 
bank or thrift pays into the deposit insurance fund more directly to an 
estimation of the risk that the institution poses to the fund than 
under the previous system. To do so, FDIC created a system that 
generally (1) differentiates between larger institutions with current 
credit agency ratings and $10 billion or more in assets and all other, 
smaller institutions; (2) for institutions without credit agency 
ratings, forecasts the likelihood of a decline in financial health; (3) 
for institutions with credit agency ratings, uses financial market 
information to evaluate institutional risk; and (4) requires all 
institutions to pay premiums based on their individual risk.[Footnote 
17] However, FDIC did not completely follow risk-based pricing tenets 
to set the premiums. Rather, FDIC has chosen to set the base rate 
premium for the riskiest banks and thrifts at 40 basis points, or 60 
percent below the indicated premium of 100, the amount needed to cover 
expected losses in the event of failure. In doing so, FDIC officials 
told us they sought to address long-standing concerns of the industry, 
regulators, and others that premiums should not be set so high as to 
prevent an institution that is troubled and seeking to rebuild its 
health from doing so. Most bankers, industry groups, and academics with 
whom we spoke and many of those organizations that submitted comment 
letters to FDIC on its new system generally supported FDIC's efforts to 
make the system more risk based, but many also expressed concerns about 
certain elements and questioned whether the new system might produce 
unintended consequences. For example, some were concerned that what 
they said should be an objective calculation of premiums now will give 
attention to such subjective factors as the quality of bank management. 
Others noted that because a bank or thrift receiving a lower CAMELS 
rating can now expect an increase in premiums, this could create 
disincentives for bank and thrift management to be cooperative or 
forthcoming during examinations. FDIC officials said that FDIC, along 
with the other federal regulators, plans to monitor the new system for 
adverse effects. 

We provided a draft of this report to FDIC, the Federal Reserve, OCC, 
and OTS for their review and comment. In written comments, the Federal 
Reserve concurred with our findings relating to PCA (see app. II). In 
addition, FDIC, the Federal Reserve, and OCC provided technical 
comments, which we incorporated as appropriate. 

Background: 

Four federal banking regulators--FDIC, the Federal Reserve, OCC, and 
OTS--oversee the nation's banks and thrifts to ensure they are 
operating in a safe and sound manner. The failure of more than 2,900 
depository institutions during the 1980s and early 1990s led to the 
passage of FDICIA, which amended FDIA to require regulators to take 
action against institutions that failed to meet minimum capital levels 
and granted regulators several authorities to address noncapital 
deficiencies at the institutions they regulate. FDICIA also required 
FDIC to establish a system to assess the risk of depository 
institutions insured by the deposit insurance fund. 

Federal Regulation of Banks and Thrifts: 

FDIC insures the deposits of all federally insured depository 
institutions, generally up to $100,000 per depositor, and monitors 
their risk to the deposit insurance fund. In addition, FDIC is the 
primary regulator for state-chartered nonmember banks (that is, state- 
chartered banks that are not members of the Federal Reserve System), 
the Federal Reserve is the primary regulator for state-chartered member 
banks (state-chartered banks that are members of the Federal Reserve 
System) and bank holding companies, OCC is the primary regulator of 
federally chartered banks, and OTS is the primary regulator of 
federally and state-chartered thrifts and thrift holding 
companies.[Footnote 18] 

Federal regulators have defined several categories of risk to which 
depository institutions are exposed--credit risk, compliance risk, 
legal risk, liquidity risk, market risk, operational risk, reputational 
risk, and strategic risk (see table 1).[Footnote 19] 

Table 1: Definitions of Risk: 

Risk: Compliance; 
Definition: The risk arising from violations of or nonconformance with 
laws, rules, regulations, prescribed practices, or ethical standards. 

Risk: Credit; 
Definition: The risk that a borrower or counterparty to a transaction 
will default on an obligation. 

Risk: Legal; 
Definition: The risk that potential unenforceable contracts, lawsuits, 
or adverse legal judgments could negatively affect the operations or 
condition of an institution. 

Risk: Liquidity; 
Definition: The risk arising from an institution's inability to meet 
its obligations when they come due because of an inability to liquidate 
assets or obtain adequate funding. 

Risk: Market; 
Definition: The risk arising from adverse movement in market rates or 
prices, such as interest rates, foreign exchange rates, or equity 
prices. 

Risk: Operational; 
Definition: The risk that inadequate information systems, operational 
problems, breaches in internal controls, fraud, or unforeseen 
catastrophes will result in losses. 

Risk: Reputational; 
Definition: The risk that potential negative publicity regarding an 
institution's business practices could cause a decline in the customer 
base, costly litigation, or revenue reductions. 

Risk: Strategic; 
Definition: The risk arising from adverse business decisions or 
improper implementation of those decisions, improper business planning, 
or inadequate responses to changes in the industry. 

Source: GAO. 

[End of table] 

Banks and thrifts, in conjunction with regulators, must continually 
manage risks to ensure their safe and sound operation and protect the 
well-being of depositors--those individuals and organizations that act 
as creditors by "loaning" their funds in the form of deposits to 
institutions to engage in lending and other activities. Regulators are 
responsible for supervising the activities of banks and thrifts and 
taking corrective action when these activities and their overall 
performance present supervisory concerns or have the potential to 
result in financial losses to the insurance fund or violations of law. 
Losses to the insurance fund may occur when an institution does not 
have sufficient assets to reimburse customers' insured deposits and 
FDIC's administrative expenses in the event of closure or merger. 

Regulators assess the condition of banks and thrifts through off-site 
monitoring and on-site examinations. Examiners use Reports of Condition 
and Income (Call Report) and Thrift Financial Report data to remotely 
assess the financial condition of banks and thrifts, respectively, and 
to plan the scope of on-site examinations.[Footnote 20] As part of on- 
site examinations, regulators more closely assess institutions' 
exposure to risk and assign institutions ratings, known as CAMELS 
ratings, that reflect their condition in six areas: capital, asset 
quality, management, earnings, liquidity, and sensitivity to market 
risk.[Footnote 21] Each component is rated on a scale of 1 to 5, with 1 
the best and 5 the worst. The component ratings then are used to 
develop a composite rating also ranging from 1 to 5. Institutions with 
composite ratings of 1 or 2 are considered to be in satisfactory 
condition, while institutions with composite ratings of 3, 4, or 5 
exhibit varying levels of safety and soundness problems. Also as part 
of the examination and general supervision process, regulators may 
direct an institution to address issues or deficiencies within 
specified time frames. 

When regulators determine that a bank or thrift's condition is 
unsatisfactory, they may take a variety of supervisory actions, 
including informal and formal enforcement actions, to address 
identified deficiencies and have some discretion in deciding which 
actions to take. Regulators typically take progressively stricter 
actions against more serious weaknesses. Informal actions generally are 
used to address less severe deficiencies or when the regulator has 
confidence that the institution is willing and able to implement 
changes. Informal actions include, for example, commitment letters 
detailing an institution's commitment to undertake specific remedial 
measures, board resolutions adopted by the institution's board of 
directors at the request of its regulator, and memorandums of 
understanding. Informal actions are not public agreements (meaning, 
regulators do not make them public through their Web sites or other 
channels) and are not enforceable by the imposition of 
sanctions.[Footnote 22] In comparison, formal enforcement actions are 
publicly disclosed by regulators and enforceable and are used to 
address more severe deficiencies or when the regulator has limited 
confidence in an institution's ability to implement changes. Formal 
enforcement actions include, for example, PCA directives, cease-and- 
desist orders under section 8(b) of FDIA, removal and prohibition 
orders under section 8(e) of FDIA, civil money penalties, and 
termination of an institution's deposit insurance.[Footnote 23] 

All four regulators have policies and procedures that describe for 
examiners the circumstances under which they should recommend the use 
of informal and formal enforcement actions to address identified 
deficiencies. Each federal banking regulator also has established a 
means through which senior management of the applicable federal 
regulator reviews all enforcement recommendations to ensure that the 
proposed actions are the best and most efficient means to bring an 
institution back into compliance with applicable laws, regulations, and 
best practices. 

Capital and Noncapital Actions of FDIA: 

Section 38 of FDIA requires regulators to categorize depository 
institutions into five categories on the basis of their capital levels. 
Regulators use three different capital measures to determine an 
institution's capital category: (1) a total risk-based capital measure, 
(2) a tier 1 risk-based capital measure, and (3) a leverage (or non- 
risk-based) capital measure (see table 2). To be considered well 
capitalized or adequately capitalized, an institution must meet or 
exceed all three ratios for the applicable capital category. 
Institutions are considered undercapitalized or worse if they fail to 
meet just one of the ratios necessary to be considered at least 
adequately capitalized. For example, an institution with 9 percent 
total risk-based capital and 6 percent tier 1 risk-based capital but 
only 3.5 percent leverage capital would be undercapitalized for PCA 
purposes. 

Table 2: PCA Capital Categories: 

Capital category: Well capitalized[C]; 
Total risk-based capital[A]: 10% or more and; 
Tier 1 risk-based capital: 6% or more and; 
Leverage capital[B]: 5% or more. 

Capital category: Adequately capitalized; 
Total risk-based capital[A]: 8% or more and; 
Tier 1 risk-based capital: 4% or more and; 
Leverage capital[B]: 4% or more[D]. 

Capital category: Undercapitalized; 
Total risk-based capital[A]: Less than 8% or; 
Tier 1 risk-based capital: Less than 4% or; 
Leverage capital[B]: Less than 4%. 

Capital category: Significantly undercapitalized; 
Total risk-based capital[A]: Less than 6% or; 
Tier 1 risk-based capital: Less than 3% or; 
Leverage capital[B]: Less than 3%. 

Capital category: Critically undercapitalized; 
Total risk-based capital[A]: An institution is critically 
undercapitalized if its tangible equity is 2% or less regardless of its 
other capital ratios.[E]. 

Sources: Capital measures and capital category definitions: FDIC--12 
C.F.R. § 325.103 (2006), Federal Reserve--12 C.F.R. § 208.43 (2006), 
OCC--12 C.F.R. § 6.4 (2006), and OTS--12 C.F.R. § 565.4 (2006). 

[A] The total risk-based capital ratio consists of the sum of tier 1 
and tier 2 capital divided by risk-weighted assets. Tier 1 capital 
consists primarily of tangible equity. Tier 2 capital includes 
subordinated debt, loan loss reserves, and certain other instruments. 

[B] Leverage capital is tier 1 capital divided by average total assets. 

[C] An institution that satisfies the capital measures for a well- 
capitalized institution but is subject to a formal enforcement action 
that requires it to meet and maintain a specific capital level is 
considered to be adequately capitalized for purposes of PCA. 

[D] CAMELS 1-rated institutions not experiencing or anticipating 
significant growth need only have 3 percent leverage capital to be 
considered adequately capitalized. 

[E] Tangible equity is equal to the amount of core capital elements 
plus outstanding perpetual preferred stock minus all intangible assets 
not previously deducted, except certain purchased mortgage-servicing 
rights. 

[End of table] 

Under section 38, regulators must take increasingly severe supervisory 
actions as an institution's capital level deteriorates. For example, 
all undercapitalized institutions are required to implement capital 
restoration plans to restore capital to at least the adequately 
capitalized level, and regulators are generally required to close 
critically undercapitalized institutions within a 90-day period. 
Section 38 allows an exception to the 90-day closure rule if both the 
primary regulator and FDIC concur and document why some other action 
would better achieve the purpose of section 38--resolving the problems 
of institutions at the least possible long-term cost to the deposit 
insurance fund. 

Resolving failed or failing institutions is one of FDIC's primary 
responsibilities under PCA. In selecting the least costly resolution 
alternative, FDIC's process is to compare the estimated cost of 
liquidation--basically, the amount of insured deposits paid out minus 
the net realizable value of an institution's assets--with the amounts 
that potential acquirers bid for the institution's assets and deposits. 
FDIC has resolved failed or failing institutions using three basic 
methods: (1) directly paying depositors the insured amount of their 
deposits and disposing of the failed institution's assets (depositor 
payoff and asset liquidation); (2) selling only the institution's 
insured deposits and certain other liabilities, with some of its 
assets, to an acquirer (insured deposit transfer); and (3) selling some 
or all of the failed institution's deposits, certain other liabilities, 
and some or all of its assets to an acquirer (purchase and assumption). 
Within this third category, many variations exist based on specific 
assets that are offered for sale. For example, some purchase and 
assumption resolutions also have included loss-sharing agreements--an 
arrangement whereby FDIC, in order to sell certain assets with the 
intent of limiting losses to the deposit insurance fund, agrees to 
share with the acquirer the losses on those assets. 

Section 38 also authorizes several non-capital-based supervisory 
actions designed to allow regulators some flexibility in achieving the 
purpose of section 38. Specifically, under section 38(g) regulators are 
permitted to reclassify or downgrade an institution's capital category 
to apply more stringent operating restrictions or requirements if they 
determine, after notice and opportunity for a hearing, that an 
institution is in an unsafe and unsound condition or engaging in an 
unsafe or unsound practice. Under section 38(f)(2)(F) regulators can 
require an institution to make improvements in management, for example, 
by dismissing officers and directors who are not able to materially 
strengthen an institution's ability to become adequately 
capitalized.[Footnote 24] 

Section 39 directs regulatory attention to noncapital areas of an 
institution's operations and activities in three main safety and 
soundness areas: operations and management; compensation; and asset 
quality, earnings, and stock valuation. As originally enacted under 
FDICIA, section 39 required regulators to develop and implement 
standards in these three areas, as well as develop quantitative 
standards for asset quality and earnings. However, in response to 
concerns about the potential regulatory burden of section 39 on banks 
and thrifts, section 318 of the Riegle Community Development and 
Regulatory Improvement Act of 1994 amended section 39 to allow the 
standards to be issued either by regulation (as originally specified in 
FDICIA) or by guideline and eliminated the requirement to establish 
quantitative standards for asset quality and earnings.[Footnote 25] The 
regulators chose to prescribe the standards through guideline rather 
than regulation, essentially providing them with flexibility in how and 
when they would take action against institutions that failed to meet 
the standards.[Footnote 26] Under section 39, if a regulator determines 
that an institution has failed to meet a prescribed standard, the 
regulator may require that the institution file a safety and soundness 
plan specifying the steps it will take to correct the 
deficiency.[Footnote 27] If the institution fails to submit an 
acceptable plan or fails to materially implement or adhere to an 
approved plan, the regulator must require the institution, through the 
issuance of a public order, to correct identified deficiencies and may 
take other enforcement actions pending the correction of the 
deficiency. 

Deposit Insurance System: 

In addition to adding sections 38 and 39 to FDIA to address capital 
inadequacy and safety and soundness problems at depository 
institutions, FDICIA also required FDIC to establish a system--the 
deposit insurance system--to assess the risk of federally insured 
depository institutions and charge premiums to finance a deposit 
insurance fund meant to protect depositors in the event of future bank 
and thrift failures. 

At the urging of FDIC, in February 2006 Congress enacted legislation 
granting the regulator authority to make substantive changes to the 
deposit insurance system, including the way it assesses the risk of 
institutions and determines their premiums. In July 2006, FDIC issued 
its proposed rule outlining proposed changes to the deposit insurance 
system and opened a public comment period. FDIC adopted a final rule in 
November 2006. Recalculated premiums and other changes reflected in the 
final rule were effective January 1, 2007. As of September 30, 2006, 
FDIC insured over 60 percent of all domestic deposits, totaling more 
than $4 trillion. 

Since the Enactment of FDICIA, the Financial Condition of Depository 
Institutions Has Been Strong and Regulators' On-site Monitoring Has 
Been More Frequent: 

The nation's banks and thrifts have benefited from a strong economy 
since 1992--as demonstrated by steady increases in several of the 
industry's primary performance indicators and growing numbers of 
institutions meeting or exceeding minimum capital levels. For example, 
in 2005, the industry reported record total assets ($10 trillion in 
2005) and net income ($133 billion in 2005) (see fig. 1). Similarly, 
the industry's two primary indicators of profitability--returns on 
assets and equity--have improved since 1992 and remain near record 
highs. 

Figure 1: Total Assets, Total Net Income, Return on Assets, and Return 
on Equity for Federally Insured Commercial Banks and Savings 
Institutions, 1992-2005: 

[See PDF for image] 

Source: GAO analysis of FDIC data. 

[End of figure] 

As a result of institutions' overall strong financial performance, few 
have failed to meet minimum capital requirements since 1992, the year 
regulators implemented PCA. The percentage of well-capitalized 
institutions has increased from 93.99 percent in 1992 to 99.71 percent 
in 2005, while the percentage of undercapitalized and lower-rated 
institutions generally has declined (see fig. 2). For example, the 
percentage of significantly undercapitalized institutions declined from 
2.74 percent (394 institutions) to 0.06 percent (5 institutions) in 
this period, while the percentage of critically undercapitalized 
institutions fell from 1.64 percent to 0.01 percent (236 to 
1).[Footnote 28] 

Figure 2: Number and Percentage of Institutions in PCA Capital 
Categories, 1992-2005: 

[See PDF for image] 

Source: GAO analysis of Call and Thrift Financial Report data. 

[End of figure] 

Further, the percentage of institutions carrying capital in excess of 
the well-capitalized leverage capital minimum (that is, 5 percent or 
more of leverage capital) also increased from 84 percent of all 
reporting institutions in 1992 to 94 percent in 2005.[Footnote 29] The 
percentage of institutions carrying at least two times as much capital 
(200 percent or more of the well-capitalized leverage capital minimum) 
increased from 25 percent to 41 percent over the period. 

According to regulators, the improved financial condition of banks and 
thrifts may have contributed to the sharp decline in the number of 
problem institutions (those with composite CAMELS ratings of 4 or 5), 
from 1,063 in 1992 to 74 in 2005 (see fig. 3). 

Figure 3: Number of Problem Institutions and Total Assets, 1992-2005: 

[See PDF for image] 

Source: GAO analysis of FDIC data. 

[End of figure] 

Similarly, regulators said that institutions' improved financial 
condition may have also contributed to the significant decline in the 
number of failures and losses to the insurance fund since 1992 (see 
fig. 4). From 1992 through 2004, the number of failed banks and thrifts 
fell from 180 (with estimated losses to the insurance fund of $7.3 
million) to 4 (with no estimated losses). No bank or thrift failed from 
June 2004 through January 2007.[Footnote 30] 

Figure 4: Failed Banks and Thrifts and Their Estimated Losses, 1992- 
2005: 

[See PDF for image] 

Source: GAO analysis of FDIC data. 

[End of figure] 

In addition, regulators' on-site presence at banks and thrifts 
increased beginning in the early 1990s, in part as a result of reforms 
enacted as a part of FDICIA that required regulators to conduct full- 
scope, on-site examinations for most federally insured institutions at 
least annually to help contain losses to the deposit insurance 
fund.[Footnote 31] Historical data show that the interval between full- 
scope, on-site examinations for all institutions peaked in 1986 when it 
reached 609 days. Subsequent to the enactment of FDICIA in December 
1991, the average interval between examinations for all institutions 
declined to 373 days in 1992.[Footnote 32] Based on information we 
obtained from all four regulators, the average interval between 
examinations for all institutions generally has remained from 12 to 18 
months since 1993 (the year after FDICIA requirements were implemented) 
and in many instances has been even shorter, especially for problem 
institutions. 

Regulators Used PCA Appropriately in Cases We Reviewed and Other 
Enforcement Actions Generally Preceded Declines in These Institutions' 
PCA Capital Categories: 

For the sample of banks and thrifts we reviewed, we found that 
regulators generally implemented PCA in accordance with section 38. For 
example, when institutions failed to meet minimum capital requirements, 
regulators required them to submit capital restoration plans or imposed 
restrictions through PCA directives or other enforcement actions. 
Regulators generally agreed that capital is a lagging indicator of poor 
performance and therefore other measures are often used to address 
deficiencies upon recognition of an institution's troubled status. This 
contention was supported by the fact that in a majority of the cases we 
reviewed, institutions had one or more informal or formal enforcement 
actions in place prior to becoming undercapitalized. Most of the 
material loss reviews conducted by IGs also found that regulators 
appropriately used PCA provisions in most cases, although in two 
reviews they found that regulators could have used PCA sooner. 

Regulators Used PCA Appropriately to Resolve Capital Problems at Banks 
and Thrifts We Reviewed: 

Based on a sample of cases, we found that regulators generally acted 
appropriately to address problems at institutions that failed to meet 
minimum capital requirements by taking increasingly severe enforcement 
actions as these institutions' capital deteriorated, as required by 
section 38. 

PCA Requires Regulators to Take Specific Actions When Capital Declines: 

Institutions that fail to meet minimum capital levels face several 
mandatory restrictions or requirements under section 38 (see fig. 
5).[Footnote 33] Specifically, section 38 requires an undercapitalized 
institution to submit a capital restoration plan detailing how it is 
going to become adequately capitalized. When an institution becomes 
significantly undercapitalized, regulators are required to take more 
forceful corrective measures, including requiring the sale of equity or 
debt, or under certain circumstances requiring an institution to be 
acquired by or merged with another institution; restricting otherwise 
allowable transactions with affiliates; and restricting the interest 
rates paid on deposits. In addition to these actions, regulators also 
may impose other discretionary restrictions or requirements outlined in 
section 38 that they deem appropriate. After an institution becomes 
critically undercapitalized, regulators have 90 days to either place 
the institution into receivership or conservatorship (that is, close 
the institution) or to take other actions that would better prevent or 
reduce long-term losses to the insurance fund.[Footnote 34] Regulators 
also have some discretion in how they enforce PCA restrictions and 
requirements--they may issue a PCA directive (a formal action that 
requires an institution to take one or more specified actions to return 
to required minimum capital standards) or delineate the restrictions 
and requirements in a new or modified enforcement order, such as a 
section 8(b) cease-and-desist order. 

Figure 5: Section 38 Mandatory and Discretionary Requirements: 

[See PDF for image] 

Source: 12 C.F.R. Parts 308 and 325, September 29, 1992. 

[End of figure] 

Regulators Used PCA Appropriately at the Banks and Thrifts We Reviewed: 

For the cases we reviewed, consistent with our 1996 report, we found 
that regulators generally implemented PCA in accordance with section 
38, the implementing regulations, and their policies and 
procedures.[Footnote 35] Regulators used PCA to address capital 
problems at 18 of 24 institutions we sampled from among those that fell 
below one of the three lowest PCA capital thresholds (that is, 
undercapitalized, significantly undercapitalized, or critically 
undercapitalized based on Call or Thrift Financial Report data). (See 
table 3.) 

Table 3: Sampled Institutions with PCA Taken to Address Capital 
Deficiencies: 

Institution name: Pulaski Savings Bank; 
Primary regulator: FDIC; 
PCA capital category[A]: Critically undercapitalized. 

Institution name: Rock Hill Bank and Trust; 
Primary regulator: FDIC; 
PCA capital category[A]: Critically undercapitalized. 

Institution name: FDIC Open Bank 1; 
Primary regulator: FDIC; 
PCA capital category[A]: Significantly undercapitalized. 

Institution name: FDIC Open Bank 2; 
Primary regulator: FDIC; 
PCA capital category[A]: Significantly undercapitalized. 

Institution name: CIB Bank; 
Primary regulator: FDIC; 
PCA capital category[A]: Undercapitalized. 

Institution name: Southern Pacific Bank; 
Primary regulator: FDIC; 
PCA capital category[A]: Undercapitalized. 

Institution name: Deuel County State Bank; 
Primary regulator: Federal Reserve; 
PCA capital category[A]: Critically undercapitalized. 

Institution name: New Century Bank; 
Primary regulator: Federal Reserve; 
PCA capital category[A]: Critically undercapitalized. 

Institution name: Federal Reserve Open Bank 1; 
Primary regulator: Federal Reserve; 
PCA capital category[A]: Significantly undercapitalized. 

Institution name: Federal Reserve Open Bank 2; 
Primary regulator: Federal Reserve; 
PCA capital category[A]: Significantly undercapitalized. 

Institution name: Bank of Greenville; 
Primary regulator: Federal Reserve; 
PCA capital category[A]: Undercapitalized. 

Institution name: Harbor Bank; 
Primary regulator: OCC; 
PCA capital category[A]: Critically undercapitalized. 

Institution name: Compubank; 
Primary regulator: OCC; 
PCA capital category[A]: Significantly undercapitalized. 

Institution name: First National Bank (Lubbock); 
Primary regulator: OCC; 
PCA capital category[A]: Undercapitalized. 

Institution name: Georgia Community Bank; 
Primary regulator: OTS; 
PCA capital category[A]: Critically undercapitalized. 

Institution name: OTS Open Thrift 1; 
Primary regulator: OTS; 
PCA capital category[A]: Significantly undercapitalized. 

Institution name: First Heights Bank FSB; 
Primary regulator: OTS; 
PCA capital category[A]: Significantly undercapitalized. 

Institution name: Enterprise FSB; 
Primary regulator: OTS; 
PCA capital category[A]: Undercapitalized. 

Source: GAO analysis of Call and Thrift Financial Report data. 

[A] We do not name institutions that are still active, but refer to 
them by regulator and number. We selected institutions for our sample 
randomly by regulator and by capital category (based on Call and Thrift 
Financial Report data) so that the numbers of institutions regulated by 
each of the regulators and numbers of institutions in each of the 
capital categories generally were equal. An institution's capital 
category as listed in this table does not necessarily reflect the only 
capital category in which it appeared, based on Call or Thrift 
Financial Report data, during the period of our review (2001-2005); 
rather it represents the capital category from which it was selected 
for the sample. 

[End of table] 

In each of the 18 cases in which regulators used PCA to address capital 
deficiencies, the relevant regulator identified the institution as 
having fallen below one of the three lowest PCA capital thresholds and 
in most cases required the institution to address deficiencies through 
a capital restoration plan or a PCA directive or other enforcement 
order. 

Regulators' use of PCA is illustrated by the following examples: 

* From the end of March 2002 to the end of June 2002, Rock Hill Bank 
and Trust's capital level declined from well capitalized to critically 
undercapitalized. In response, FDIC issued a notice informing the bank 
of the restrictions applicable to critically undercapitalized 
institutions under section 38. Within approximately 2 months of first 
becoming critically undercapitalized, the bank entered into a purchase 
and assumption agreement with another institution. 

* Federal Reserve examiners required Federal Reserve Open Bank 2 to 
submit a capital restoration plan more than a year and a half prior to 
the bank's failure to meet minimum capital requirements. Federal 
Reserve examiners, prepared to issue a PCA directive when the bank's 
capital fell to significantly undercapitalized in March 2005, noted in 
a June 2005 report of examination that the bank had taken steps to 
raise its capital level to undercapitalized, and then issued a PCA 
directive requiring the bank to submit a capital restoration plan. By 
September 2005, the bank was well capitalized by PCA standards. 

* OCC examiners notified First National Bank (Lubbock) of its 
critically undercapitalized status shortly after the closing date of 
the bank's June 30, 2003, Call Report filing. In November 2003, the 
bank was sold to a bank holding company and recapitalized. Concurrent 
with the bank's June 30, 2004, Call Report filing date, OCC conducted a 
full-scope examination and found the bank to be critically 
undercapitalized and directed it to file a capital restoration plan. 
The bank merged into an affiliate in early 2005, in accordance with its 
capital restoration plan. 

* After Enterprise FSB's capital level declined to undercapitalized in 
September 2001, OTS issued a PCA directive that required the 
institution to submit a capital restoration plan and make arrangements 
to sell or merge with another institution. On several occasions, OTS 
modified its original PCA directive to allow additional time to process 
the institution's merger application. With the exception of one quarter 
in which Enterprise FSB's capital level increased to well capitalized, 
the institution remained undercapitalized until the merger was 
completed in early 2003. 

Regulators said that PCA was most effective when it was used to close 
or require the sale or merger of institutions as a means of minimizing 
or preventing losses to the insurance fund. Fifteen of the 18 
institutions we reviewed were able to recapitalize or merged or closed 
without losses to the insurance fund. The remaining three institutions 
failed with losses to the insurance fund: Pulaski Savings Bank ($1 
million), New Century Bank ($5 million), and Southern Pacific Bank ($93 
million). The failure of Southern Pacific Bank resulted in material 
losses to the insurance fund. In its material loss review for the bank, 
the FDIC IG noted that even though FDIC examiners applied PCA in 
accordance with regulatory guidelines, other factors, including the 
bank's failure to abide by FDIC recommendations related to the 
administration of its loan program, resulted in an overstatement of 
both net income and capital and limited PCA's effectiveness in 
minimizing losses to the insurance fund. In our review of FDIC's 
reports of examination and other information for the bank, we found 
that FDIC examiners continually informed the bank of its capital status 
and made repeated requests to management to recapitalize. However, the 
bank's reported capital level never fell to critically 
undercapitalized--the point at which FDIC has the authority to close an 
institution under section 38. 

In 6 of the 24 sampled cases we reviewed, we determined that use of PCA 
was not required to address declines in capital reported on quarterly 
Call and Thrift Financial Reports (see table 4). 

Table 4: Sampled Institutions Where Use of PCA Was Not Required: 

Institution name: First Bank of Texas; 
Primary regulator: FDIC; 
Reason regulator did not use PCA to address decline in capital 
category: First Bank of Texas was in the process of merging into 
another institution when it became undercapitalized for one quarter. 
The bank did not present any capital or supervisory concerns prior to 
its merger. 

Institution name: Madison Bank; 
Primary regulator: Federal Reserve; 
Reason regulator did not use PCA to address decline in capital 
category: Madison Bank experienced an operating loss as a result of a 
pending merger, which caused it to become undercapitalized for one 
quarter. The loss and impact on capital were reported after the 
institution merged, thus Federal Reserve examiners did not apply PCA. 

Institution name: First National Bank of Springdale; 
Primary regulator: OCC; 
Reason regulator did not use PCA to address decline in capital 
category: First National Bank of Springdale became critically 
undercapitalized for one quarter that coincided with its merger into 
another institution. The bank presented no supervisory concerns at that 
time. 

Institution name: Household Bank of Nevada; 
Primary regulator: OCC; 
Reason regulator did not use PCA to address decline in capital 
category: Household Bank of Nevada was significantly undercapitalized 
on two occasions because it miscalculated capital ratio information. 
OCC officials told us that during this period, the bank had other 
safety and soundness weaknesses rather than capital problems. 
Therefore, OCC, in conjunction with FDIC and OTS, took steps to 
consolidate Household Bank and other subsidiaries of the bank's parent 
company so that they could be acquired by another institution. 

Institution name: Century Bank; 
Primary regulator: OCC; 
Reason regulator did not use PCA to address decline in capital 
category: Century Bank failed to meet the total risk-based capital 
requirement for only one quarter and only by a fraction of a percent 
(0.01 percent). The bank was otherwise well capitalized and did not 
have any other indicators that it was a troubled institution during 
this period. 

Institution name: OTS Open Thrift 2; 
Primary regulator: OTS; 
Reason regulator did not use PCA to address decline in capital 
category: OTS Open Thrift 2 was undergoing a reorganization that 
involved the issuance of stock. The issuance was oversubscribed, 
causing the thrift's tier 1 leverage capital to fall below the required 
minimum and appear as undercapitalized for one quarter. The thrift did 
not present any capital or supervisory concerns before or after the 
stock issuance. 

Source: GAO analysis of regulatory data. 

[End of table] 

Regulators Used Other Enforcement Actions to Address Deficiencies in 
Sampled Institutions Prior to Declines in Their PCA Capital Categories: 

Although PCA requires regulators to take regulatory action when an 
institution fails to meet established minimum capital requirements, 
capital is a lagging indicator and thus not necessarily a timely 
predictor of problems at banks and thrifts. Although capital is an 
essential and accepted measure of an institution's financial health, it 
does not typically begin to decline until an institution has 
experienced substantial deterioration in other areas, such as asset 
quality and the quality of bank management. As a result, regulatory 
actions focused solely on capital may have limited effects because of 
the extent of deterioration that may have already occurred in other 
areas. All four regulators generally agreed that by design, PCA is not 
a tool that can be used upon early recognition of an institution's 
troubled status--in all of the cases we examined, regulators took 
steps, in addition to PCA, to address institutions' troubled 
conditions. 

For example, 12 of the 18 banks and thrifts subject to PCA that we 
examined experienced a decline in their CAMELS ratings to composite 
ratings of 4 or 5 prior to or generally concurrent with becoming 
undercapitalized. CAMELS ratings measure an institution's performance 
in six areas--capital, asset quality, management, earnings, liquidity, 
and sensitivity to market risk. These ratings are a key product of 
regulators' on-site monitoring of institutions, providing information 
on the condition and performance of banks and thrifts, and can be 
useful in predicting their failure. The FDIC IG found a similar trend 
among the banks it examined as part of an evaluation of FDIC's 
implementation of PCA.[Footnote 36] 

All of the 18 institutions we examined also appeared on at least one of 
three regulator watch lists--the FDIC problem institutions list, the 
FDIC resolution cases list, and the FDIC projected failure list--prior 
to or concurrent with becoming undercapitalized (see fig. 6).[Footnote 
37] Regulators use these and their own watch lists to monitor the 
status of troubled institutions and, in some cases, ensure their timely 
resolution (that is, facilitating the merger or closure of institutions 
to prevent losses to the insurance fund); the lists were another means 
through which regulators monitored and addressed problems or potential 
problems at the 18 institutions prior to declines in PCA capital 
categories. 

Figure 6: Institutions on Regulator Watch Lists: 

[See PDF for image] 

Source: GAO analysis of regulatory data. 

[End of figure] 

Consistent with banks and thrifts exhibiting declining CAMELS ratings 
and appearing on one or more watch lists prior to or concurrent with 
becoming undercapitalized, at least 15 of the 18 banks and thrifts that 
we reviewed had informal or formal enforcement actions in place prior 
to becoming undercapitalized.[Footnote 38] Although we did not examine 
the effectiveness of these prior actions in addressing deficiencies, 
the following examples illustrate the types and numbers of enforcement 
actions regulators took at some of the institutions in our 
sample.[Footnote 39] 

Although FDIC Open Bank 1 and FDIC examiners disagreed over the bank's 
capital status, FDIC required the bank's board of directors to execute 
a board resolution to address certain safety and soundness deficiencies 
identified as part of an examination (see fig. 7). When the bank failed 
to adequately address the identified deficiencies, FDIC issued a cease- 
and-desist order. 

Figure 7: Timeline of Enforcement Actions, FDIC Open Bank 1: 

[See PDF for image] 

Source: GAO analysis of regulatory data. 

[End of figure] 

When New Century Bank opened in July 1999, the Federal Reserve, the 
state regulator, and FDIC all required the bank to maintain capital in 
excess of the PCA well-capitalized minimums to obtain a state charter 
and FDIC insurance (see fig. 8). Throughout its existence, the bank not 
only failed to maintain these capital levels, but also failed to remain 
adequately capitalized by PCA standards. The Federal Reserve attempted 
to address these capital and other safety and soundness deficiencies 
through PCA directives and other formal enforcement orders. When the 
bank proved incapable of maintaining minimum capital levels, the state 
regulator closed it and appointed FDIC as receiver. 

Figure 8: Timeline of Enforcement Actions, New Century Bank: 

[See PDF for image] 

Source: GAO analysis regulatory data. 

[End of figure] 

OCC examiners identified Compubank as posing serious safety and 
soundness concerns related to earnings when the bank was well 
capitalized by PCA standards (see fig. 9). The bank had high operating 
losses because of high overhead expenses caused by expanding operations 
in anticipation of high growth. As a result, OCC required the bank to 
enter into a written agreement, which stipulated that the bank 
implement a capital restoration plan and develop a contingency plan to 
sell, merge, or liquidate. Five months later, the bank reported that it 
was critically undercapitalized by PCA standards. The bank began the 
self-liquidation process and closed in June 2002. 

Figure 9: Timeline of Enforcement Actions, Compubank: 

[See PDF for image] 

Source: Gao analysis of regulatory data. 

[End of figure] 

Approximately 5 months before Georgia Community Bank became 
undercapitalized, OTS and the institution entered into a supervisory 
agreement in response to regulator concerns about the institution's 
asset quality and management (see fig. 10). When the institution 
reported it was significantly undercapitalized, OTS issued a PCA 
directive; however, the institution was unable to recapitalize and as a 
result, it merged into another institution in July 2005. 

Figure 10: Timeline of Enforcement Actions, Georgia Community Bank: 

[See PDF for image] 

Source: GAO analysis of regulatory data. 

[End of figure] 

Most Material Loss Reviews Also Found Appropriate Use of PCA, but Some 
Reviews Found Regulators Could Have Used PCA Sooner: 

We also reviewed material loss reviews of all institutions that failed 
with material losses to the insurance fund--losses that exceed $25 
million or 2 percent of an institution's assets, whichever is greater-
-from 1992 through 2005 and in which regulators used PCA to address 
capital problems (see table 5).[Footnote 40] In 12 of these 14 cases, 
the relevant IG found that PCA was applied appropriately--meaning that 
when institutions failed to meet minimum capital requirements, 
regulators required that they submit capital restoration plans and 
adhere to restrictions and requirements in PCA directives or other 
enforcement orders. 

Table 5: Institutions with Material Losses and PCA to Address Capital 
Adequacy, 1992-2005: 

Institution: Bank of Harford; 
Regulator: FDIC; 
Year of failure: 1994; 
Appropriate use of PCA: Yes. 

Institution: The Bank of San Pedro; 
Regulator: FDIC; 
Year of failure: 1994; 
Appropriate use of PCA: Yes. 

Institution: Bank of Newport; 
Regulator: FDIC; 
Year of failure: 1994; 
Appropriate use of PCA: Yes. 

Institution: First Trust Bank; 
Regulator: FDIC; 
Year of failure: 1995; 
Appropriate use of PCA: Yes. 

Institution: Pacific Heritage Bank; 
Regulator: FDIC; 
Year of failure: 1995; 
Appropriate use of PCA: Yes. 

Institution: BestBank; 
Regulator: FDIC; 
Year of failure: 1998; 
Appropriate use of PCA: Yes. 

Institution: Pacific Thrift and Loan Company; 
Regulator: FDIC; 
Year of failure: 1999; 
Appropriate use of PCA: Yes. 

Institution: Connecticut Bank of Commerce; 
Regulator: FDIC; 
Year of failure: 2002; 
Appropriate use of PCA: Yes. 

Institution: Pioneer Bank; 
Regulator: FRB; 
Year of failure: 1994; 
Appropriate use of PCA: Yes. 

Institution: Mechanics National Bank; 
Regulator: OCC; 
Year of failure: 1995; 
Appropriate use of PCA: Yes. 

Institution: First National Bank of Keystone; 
Regulator: OCC; 
Year of failure: 1999; 
Appropriate use of PCA: No. 

Institution: Hamilton Bank; 
Regulator: OCC; 
Year of failure: 2002; 
Appropriate use of PCA: Yes. 

Institution: NextBank; 
Regulator: OCC; 
Year of failure: 2002; 
Appropriate use of PCA: Yes. 

Institution: Superior Bank; 
Regulator: OTS; 
Year of failure: 2001; 
Appropriate use of PCA: No. 

Source: GAO analysis of regulatory data. 

[End of table] 

Regulators appropriate use of PCA in institutions that failed with 
material losses are demonstrated by the following examples: 

* According to the FDIC IG's material loss review on Connecticut Bank 
of Commerce, FDIC used enforcement actions other than PCA directives to 
address the bank's capital and other problems. Connecticut Bank of 
Commerce experienced capital deficiencies from 1991 through 1996 as a 
result of its poor asset quality. The bank operated under several cease-
and-desist orders (1991, 1993, and 2001) and a memorandum of 
understanding, each of which contained requirements that the bank hold 
capital in excess of the required PCA minimums. Upon the detection of 
fraud in April 2002, the bank's capital was immediately exhausted and 
it became critically undercapitalized. On June 25, 2002, FDIC issued a 
PCA directive ordering the dismissal of the bank's chairman and 
president. On June 26, 2002, the Banking Commissioner for the State of 
Connecticut declared Connecticut Bank of Commerce insolvent, ordered it 
closed, and appointed FDIC as receiver. 

* Prior to the implementation of legislation implementing PCA, Federal 
Reserve examiners attempted to restore Pioneer Bank to a safe and sound 
operating condition through written agreements entered into in 1986 and 
1991. Despite these enforcement actions, the bank's condition continued 
to deteriorate and in June 1994, the Federal Reserve issued a PCA 
directive requiring Pioneer Bank to become adequately capitalized 
though the sale of stock or to be acquired by or merge into another 
institution. When the bank was unable to comply with the terms of the 
PCA directive, the California State Banking Department issued a capital 
impairment order on July 6, 1994, and closed the bank on July 8, 1994. 
In its material loss review of Pioneer Bank, the Federal Reserve IG 
concluded that the level of supervisory actions taken by the Federal 
Reserve was within the range of acceptable actions for the problems the 
bank experienced. 

* In October 2001, NextBank's capital level dropped from well 
capitalized to significantly undercapitalized based on findings from an 
examination conducted by OCC's Special Supervision and Fraud Division. 
The Department of the Treasury (Treasury) IG noted in its material loss 
review that the bank was at that point automatically subject to 
restrictions under PCA. In November 2001, OCC issued a PCA directive 
requiring the bank, among other things, to develop a capital 
restoration plan; file amended Call Reports; restrict new credit card 
account originations to prime lenders; and restrict asset growth, 
management fees, and brokered deposits. By December 2001, NextBank 
advised OCC that it would not be able to address its capital 
deficiency. In January 2002, NextBank and its parent company took steps 
to liquidate the bank. OCC appointed FDIC as receiver on February 7, 
2002. While the Treasury IG did not find fault with OCC's use of PCA to 
address NextBank's capital deficiencies, it found that PCA's 
effectiveness in NextBank's situation was difficult to assess given the 
short amount of time that passed between when the bank's capital 
declined below PCA minimum requirements and when the bank failed. 

In two cases, the relevant IG determined that the regulator's use of 
PCA was not appropriate--First National Bank of Keystone (Keystone) and 
Superior Bank, regulated by OCC and OTS, respectively. In both cases, 
the Treasury IG found that the regulator failed to identify the 
institution's true financial condition in a timely manner and thus 
could not apply PCA's capital-based restrictions because the 
institution's reported capital levels met or exceeded the minimum 
required levels. Because PCA was not implemented timely in these cases, 
it was not effective in containing losses to the deposit insurance 
fund.[Footnote 41] 

* According to the Treasury IG, Keystone's operating strategy entailed 
growth into the high-risk areas of subprime lending and selling loans 
for securitization.[Footnote 42] The bank's growth in these areas 
occurred without adequate management systems and controls, and 
inaccurate financial records masked the bank's true financial 
condition. At the time of the bank's failure, allegations of fraud were 
under investigation. In its material loss review of the bank, the IG 
noted that if OCC had reclassified the bank's capital category from 
well capitalized to adequately capitalized following an examination in 
late 1997, OCC could have restricted the bank's use of brokered 
deposits and applied certain interest-rate restrictions in an effort to 
curb the bank's growth 6 months before its capital levels showed 
serious signs of decline. Instead, these restrictions were not put in 
place until June 1998 when OCC required the bank to adjust its reported 
capital based on examination findings--this adjustment resulted in a 
downgrade in the bank's capital category from well capitalized to 
undercapitalized and trigged PCA restrictions. Despite this finding, 
the IG noted that it was unclear whether reclassification would have 
actually had its desired effect--after the restrictions were trigged in 
June 1998, the bank continued to intentionally violate them. 

* The Treasury IG's material loss report on Superior Bank notes that 
while the immediate causes of the bank's insolvency in 2001 appeared to 
be improper accounting and inflated valuations of residual assets, the 
causes could be attributed to a confluence of factors going back as 
early as 1993, including asset concentration, rapid growth into a new 
high-risk activity, deficient risk management systems, liberal 
underwriting of subprime loans, unreliable loan loss provisioning, 
economic factors affecting asset valuation, and lack of management 
response to supervisory concerns.[Footnote 43] Our 2002 testimony on 
the failure of Superior Bank and the IG's material loss review 
suggested that had OTS acknowledged problems at Superior Bank when 
examiners became aware of them in 1993, PCA would have been triggered 
sooner and might have slowed the bank's growth and contained its losses 
to the deposit insurance fund.[Footnote 44] The IG further noted that 
OTS's delayed detection of so many critical problems suggests that the 
advantage of PCA as an early intervention tool depends as much on 
timely supervisory detection of actual, if not developing, problems as 
it does on capital. 

Regulators Have Made Limited and Targeted Use of the Noncapital 
Supervisory Actions Available under Sections 38 and 39: 

Under section 38 regulators have the ability to reclassify an 
institution's capital category and dismiss officers and directors from 
deteriorating banks and thrifts. However, regulators have made limited 
use of these authorities, preferring instead to use moral suasion (as 
part of or separate from the examination process) or other enforcement 
actions to address deficiencies. Under section 39, regulators can 
require institutions to implement plans to address deficiencies in 
their compliance with regulatory safety and soundness standards. 
Regulators have used section 39 with varying frequency to address 
noncapital deficiencies; however, those that use the provision use it 
to address targeted deficiencies, such as noncompliance with certain 
laws or requirements, and when an institution's management generally is 
willing and able to comply with required corrective actions. 

Regulators Prefer to Use Other Informal and Formal Enforcement Powers 
over PCA's Reclassification and Dismissal Authorities: 

In addition to their authority under PCA to reclassify an institution's 
PCA capital category or require improvements in management at 
significantly undercapitalized institutions, regulators also can use 
other means--such as moral suasion or more formal enforcement actions-
-to address deficiencies or effect change at an institution. Under 
section 38(g), regulators have the authority to reclassify or downgrade 
an institution's PCA capital category to apply PCA restrictions and 
requirements in advance of a decline (or further decline) in capital if 
the regulator determines that the institution is operating in an unsafe 
or unsound manner or engaging in an unsafe or unsound 
practice.[Footnote 45] Regulators also may treat an undercapitalized 
institution as if it were significantly undercapitalized if they 
determine that doing so is "necessary to carry out the purpose" of PCA. 
In practice, this means that regulators may, in certain circumstances, 
treat a well-capitalized institution as if it were adequately 
capitalized, an adequately capitalized institution as if it were 
undercapitalized, and an undercapitalized institution as if it were 
significantly undercapitalized. Regulators are prohibited from 
reclassifying or downgrading an institution more than one capital 
category and cannot downgrade a significantly undercapitalized 
institution to critically undercapitalized. Regulators also may require 
improvements in the management of a significantly undercapitalized 
institution--for example, through the dismissal of officers and 
directors. This provision can be used alone or in conjunction with the 
reclassification provision. In the latter case, a regulator can require 
the dismissal of officers and directors from an undercapitalized 
institution. 

All four regulators said that they generally prefer other means of 
addressing problems to PCA. According to the regulators, the authority 
to reclassify an institution's capital category is of limited use on 
its own because regulators' ability to address both noncapital (such as 
management) and capital deficiencies through other informal and formal 
enforcement actions prior to a decline in capital effectively negates 
the need to reclassify an institution to apply operating restrictions 
or requirements. Regulators' use of section 38's reclassification 
authority is consistent with their views on it--since 1992, FDIC, the 
Federal Reserve, and OTS have never reclassified an institution's 
capital category. OCC has used the authority twice. 

All four regulators said that section 38's dismissal authority under 
section 38(f)(2)(F) is valuable as a deterrent and a potential tool, 
despite their infrequent use of it--FDIC has used the authority six 
times since 1992 and OCC once; the Federal Reserve and OTS have never 
used the authority. They said that the PCA authority occupies the 
middle ground between moral suasion and the removal and prohibition 
authority under section 8(e) of FDIA. According to the regulators, the 
first step in confronting problem officers and directors is moral 
suasion--that is, reminding the board of directors that it has an 
obligation to ensure that the institution is competently managed. In 
many cases, we were told that this reminder often is enough to force 
the resignations of problem individuals.[Footnote 46] Dismissal under 
section 38 represents a "middle of the road" option--it results in a 
ban from serving as an officer or director in the institution in 
question. In order to be reinstated, the dismissed individual must 
demonstrate that he or she has the capacity to materially strengthen 
the institution's ability to become adequately capitalized or correct 
unsafe or unsound conditions or practices. Regulators also have a more 
severe option--removal under section 8(e), which results in an 
industrywide prohibition and consequently, requires proof of a high 
degree of misconduct or malfeasance.[Footnote 47] Data show that 
regulators have used section 8(e) with some regularity (see fig. 11). 
The regulators said that if an individual's misconduct rises to the 
level required to support removal and prohibition under section 8(e), 
use of that authority generally is preferable to dismissal under 
section 38. 

Figure 11: Regulators Use of Section 8(e), 1992-2005: 

[See PDF for image] 

Source: GAO analysis of regulatory data. 

[End of figure] 

The regulators also noted that moral suasion and section 8(e) are not 
necessarily capital based, meaning that both can be used at times when 
PCA cannot. The regulators acknowledged that section 38 permits them to 
reclassify an institution's capital category to dismiss an officer or 
director; however, they said that because section 38 only allows them 
to dismiss individuals from institutions that are undercapitalized or 
worse by PCA standards, the tool generally is not available to them in 
these good economic times when all or most of the institutions they 
regulate are well capitalized. OCC was of the view that section 38's 
dismissal authority could be more useful if it were uncoupled from 
capital and instead triggered by less-than-satisfactory ratings in the 
management component of the CAMELS rating. In particular, OCC officials 
said that linking the authority to the CAMELS rating could provide 
regulators with the authority to dismiss individuals who did not meet 
the criteria for removal and prohibition under section 8(e) and from 
institutions with boards that were unresponsive to regulators' moral 
suasion. 

Regulators Use Section 39 to Address Targeted Safety and Soundness 
Deficiencies: 

Changes to section 39 in 1994 gave regulators considerable flexibility 
over how and when to use their authority under the section to address 
safety and soundness deficiencies at the institutions they 
regulate.[Footnote 48] Like section 38's dismissal authority, section 
39 represents a "middle of the road" option between informal 
enforcement actions (such as a commitment letter) and formal 
enforcement actions (such as a cease-and-desist order). In varying 
degrees, they have used section 39 to address deficiencies in the three 
broad categories defined under the section: operations and management; 
compensation; and asset quality, earnings, and stock valuation (see 
fig. 12). Finally, regulators said that they prefer to use section 39 
when regulators are certain that management is willing and able to 
address identified deficiencies, even if management has not been 
responsive to informal regulatory criticisms in the past. For example, 
FDIC, OCC, and OTS have all used section 39 to require institutions to 
achieve compliance with Year 2000 (Y2K) or Bank Secrecy Act (BSA) 
requirements (both of which relate to institutions' operations). 

Figure 12: Regulators Use of Section 39, 1995-2005: 

[See PDF for image] 

Source: GAO analysis of regulatory data. 

[End of figure] 

Officials from the Federal Reserve told us that they use memorandums of 
understanding in the same way that the other three regulators use 
section 39--that is, to address targeted deficiencies at institutions 
that are willing and able to make required changes. 

According to the regulators, formal enforcement actions, such as 
section 8(b) cease-and-desist orders or written agreements, are better 
reserved for institutions that have multiple or complex problems and in 
cases where management is unable to define what steps must be taken to 
address problems independent of the regulator or is unwilling to take 
action. Since 1995 (the year regulators issued the section 39 
guidelines), regulators have made frequent use of section 8(b) of FDIA 
to address problems associated with operations and management; 
compensation; and asset quality, earnings, and stock valuation. From 
1995 through 2005, FDIC and the Federal Reserve issued 288 and 98 cease-
and-desist orders or written agreements, respectively, to address 
deficiencies in these three areas. OTS issued 47 cease-and-desist 
orders related to deficiencies in operations.[Footnote 49] 

FDIC Has More Tightly Linked Deposit Insurance Premiums to 
Institutional Risk, but Some Expressed Concerns about Certain Aspects 
of the New System: 

Under authority provided by the Federal Deposit Insurance Reform Act of 
2005, FDIC now prices its deposit insurance more closely to the risk 
FDIC officials judge an individual bank or thrift presents to the 
insurance fund. To do this, FDIC has created a system in which it 
evaluates a number of financial and regulatory factors specific to an 
individual bank or thrift. This replaces a system that was also risk 
based, but which differentiated risk less finely. Industry officials 
and academics to whom we spoke and selected organizations that 
submitted comment letters to FDIC generally supported the concept of 
the new system. However, several voiced concern about what they saw as 
the new system's subjectivity and complexity and questioned whether the 
new system might produce unintended consequences, including upsetting 
relations between bankers and their regulators. 

Changes to FDIC's Deposit Insurance System More Closely Tie Premiums to 
the Risk Institutions Present to the Deposit Insurance Fund, but Stop 
Short of Completely Risk-Based Pricing: 

FDIC's recent changes to the deposit insurance system more closely tie 
an individual bank or thrift's deposit insurance premium to the risk it 
presents to the insurance fund. In general, FDIC does this by 
considering three sets of factors--supervisory (CAMELS) ratings and 
financial ratios or credit agency ratings--while also distinguishing 
between large institutions with credit agency ratings and all other 
institutions. However, the system stops short of completely risk-based 
pricing. 

Old System Relied on Two Factors to Determine Risk and Premiums: 

FDIC's previous method for determining premiums relied on two factors-
-capital levels and supervisory ratings--to determine institutions' 
risk and premiums.[Footnote 50] FDIC established three capital groups-
-termed 1, 2, and 3 for well-capitalized, adequately capitalized, and 
undercapitalized institutions, respectively--based on leverage ratios 
and risk-based capital ratios.[Footnote 51] Three supervisory groups-- 
termed A, B, and C--reflected, respectively, financially sound 
institutions with only a few minor weaknesses; institutions with 
weaknesses, which if not corrected could result in significant 
deterioration and increased risk of loss to the insurance fund; and 
institutions that pose a substantial probability of loss to the 
insurance fund unless effective corrective action is taken. Based on 
its capital levels and supervisory ratings, an institution fell into 
one of nine risk categories (see table 6). However, the vast majority 
of institutions--95 percent at year-end 2005--fell into category 1A, 
even though, according to FDIC officials, there were significant 
differences among individual institutions' risk profiles within the 
category. 

Table 6: Distribution of Institutions among Risk Categories in FDIC's 
Previous Deposit Insurance System, as of December 31, 2005: 

Capital group: 1: Well capitalized; 
Supervisory category: A: 1A; (8,358); 
Supervisory category: B: 1B; (373); 
Supervisory category: C: 1C; (50). 

Capital group: 2: Adequately capitalized; 
Supervisory category: A: 2A; (54); 
Supervisory category: B: 2B; (7); 
Supervisory category: C: 2C; (1). 

Capital group: 3: Undercapitalized; 
Supervisory category: A: 3A; (0); 
Supervisory category: B: 3B; (0); 
Supervisory category: C: 3C; (2). 

Source: FDIC. 

[End of table] 

Further, according to FDIC, in 2005, 95 percent of institutions did not 
pay premiums into the insurance fund because the agency was barred from 
charging premiums to well-managed and well-capitalized institutions 
when the deposit insurance fund was at or above its designated reserve 
ratio, and was expected to remain there.[Footnote 52] Because nearly 
all institutions paid the same rate under the old system, lower-risk 
institutions effectively subsidized higher-risk institutions.[Footnote 
53] 

The New System Links Risk and Premiums More Closely: 

To tie institutions' insurance premiums more directly to the risk each 
presents to the insurance fund, FDIC created a system that generally 
(1) differentiates between large and small institutions, specifically 
between institutions with current credit agency ratings and $10 billion 
or more in assets and all other institutions; (2) for institutions 
without credit agency ratings, forecasts the likelihood of a decline in 
financial health (referred to throughout this report as the general 
method); (3) for institutions with credit agency ratings, uses those 
ratings, plus potentially other financial market information, to 
evaluate institutional risk (referred to throughout this report as the 
large-institution method); and (4) requires all institutions to pay 
premiums based on their individual risk.[Footnote 54] 

Premiums under the general method and the large-institution method are 
calculated differently, based on the availability of relevant 
information for institutions in each category. The general method uses 
two sources of information as inputs to a statistical model designed to 
predict the probability of a downgrade in an institution's CAMELS 
rating: (1) financial ratios (such as an institution's capital, past- 
due loans, and income) and (2) CAMELS ratings. According to FDIC 
officials, little other information is readily available to assess risk 
for these institutions. However, FDIC data show that the higher on the 
CAMELS scale institutions are rated, the higher the rate of failure-- 
the 5-year failure rate is 0.39 percent for CAMELS 1-rated banks, 3.84 
percent for 3-rated banks, and 46.92 percent for 5-rated banks--thus 
making CAMELS ratings and financial ratios a reasonable basis for 
assessing risk.[Footnote 55] 

The large-institution method also uses CAMELS ratings. But rather than 
employ financial ratios, it incorporates market-based information-- 
credit agency ratings of an institution's debt offerings. FDIC 
officials told us that incorporating debt ratings provides a fuller, 
market-based picture of an institution's condition than do financial 
ratios. For example, some large institutions concentrate in certain 
activities, such as transactions processing or credit cards, while 
others provide more general services. According to FDIC officials, 
financial ratios may not adequately distinguish among such different 
activities. Also, credit ratings determine how much institutions must 
pay to obtain funds in capital markets--well-rated banks and thrifts 
will pay less, while institutions the market judges as riskier will pay 
more. Thus, according to FDIC officials, it makes sense to align 
premiums with these market-based funding costs. In addition to its 
ability to use the CAMELS and credit ratings, FDIC also has the 
flexibility to adjust premiums for large institutions up to 0.5 basis 
points up or down based on other relevant information (such as market 
analyst reports, rating-agency watch lists, and rates paid on 
subordinated debt) as well as stress considerations (such as how an 
institution would be expected to react to a sudden and significant 
change in interest rates).[Footnote 56] If a large institution does not 
have an available credit agency rating, its premium is calculated 
according to the general method.[Footnote 57] 

The new insurance system places banks and thrifts into one of four risk 
categories, each of which has a corresponding premium or range of 
premiums. These "base rate" premiums range from 2 to 4 basis points for 
banks and thrifts in the best-rated category, risk category I, to 40 
basis points for institutions in the bottom category, risk category IV 
(see table 7).[Footnote 58] Thus, for example, under the base rate 
schedule the riskiest institutions (risk category IV) pay a premium 
rate 20 times greater than the best-rated banks and thrifts (minimum 
rate, risk category I). Even within the best category, riskier 
institutions pay twice the rate paid by the safest banks and thrifts, 
reducing the tendency for subsidies under the old system.[Footnote 59] 
The same premium schedule applies to all institutions, regardless of 
their premium assessment method. 

Table 7: Base Rate Premiums by Risk Category under FDIC's New Deposit 
Insurance System: 

Annual base rate (premiums in basis points); 
Risk category: I: Minimum - 2; Maximum - 4; 
Risk category: II: 7; 
Risk category: III: 25; 
Risk category: IV: 40. 

Source: FDIC. 

[End of table] 

Under the new system, FDIC has limited authority, without resorting to 
new rule making, to vary premiums from the base rates as necessary and 
appropriate. For assessments beginning in 2007, FDIC has used this 
flexibility to increase premiums by 3 basis points over the base rates. 
Thus, the current rate for risk category I is 5 to 7 basis points, 
rather than 2 to 4 basis points; for risk category II, the premium is 
10 basis points; for risk category III, the premium is 28 basis points; 
and for risk category IV, the premium is 43 basis points. According to 
FDIC, the increase in premiums for 2007 was necessary because of strong 
growth in insured deposits and the availability of premium credits to 
many institutions under the terms of the Federal Deposit Insurance 
Reform Act of 2005. 

In general, to set the premium rates for each of the four risk 
categories, FDIC officials told us they considered both what the 
differences should be in premiums among risk categories and, taking 
those differences into account, the level at which the premiums should 
be established. Considering the two together, the goal was to create a 
schedule of rates with the best chance of maintaining the insurance 
fund with a designated reserve ratio from 1.15 percent to 1.35 percent 
of insured deposits, with the former representing the required minimum 
under the Federal Deposit Insurance Reform Act of 2005, and the latter 
being the level at which mandated rebates of premiums to banks and 
thrifts must begin.[Footnote 60] FDIC officials told us they 
established the level of premiums based on four factors: (1) historical 
data on insurance losses, (2) FDIC operating expenses, (3) projected 
interest rates and their effect on FDIC investment portfolio income, 
and (4) expected growth of insured deposits.[Footnote 61] 

While Focusing More on Risk, the New System Stops Short of Completely 
Risk-Based Pricing: 

Although the new system ties premiums more specifically to the risk an 
individual institution presents to the insurance fund, it does not 
represent completely risk-based pricing. As a result, some degree of 
cross-subsidy still exists in the new system. In particular, as 
estimated by FDIC, institutions in risk category IV would need to pay 
premiums of about 100 basis points to cover the expected losses of the 
group. However, FDIC has chosen to set the base rate premium for these 
banks and thrifts at 40 basis points, or 60 percent below the indicated 
premium. In doing so, FDIC officials told us they sought to address 
long-standing concerns of the industry, regulators, and others that 
premiums should not be set so high as to prevent an institution that is 
troubled and seeking to rebuild its health from doing so. In contrast, 
some have suggested that capping premiums to address such concerns 
ultimately may cost the insurance fund more in the long run--lower 
premiums for riskier institutions may allow them to remain open longer, 
resulting in greater losses if and when they eventually fail. FDIC 
officials said that the number of institutions in category IV is small 
and thus the trade-off between lower premiums for troubled institutions 
and potentially larger losses later is not significant. Further, they 
said that the 40 basis point base rate applicable to the highest risk 
institutions represents a sizable increase over the assessment rate for 
these institutions under the previous system. 

Another way FDIC's new premium pricing system stops short of being 
completely risk based is that it does not take into account "systemic 
risk." In a fully risk-based system, premiums would be set to reflect 
two major components: expected losses plus a premium for systemwide 
risk of failure or default. According to academics we spoke to, FDIC's 
new system reflects the first component, but not the second. 
Incorporating the notion of systemic risk into the premium calculation 
would acknowledge that failure of some banks could have repercussions 
to the financial system as a whole and that such failures are more 
likely during economic downturns. FDIC officials told us that the new 
system does not reflect systemic risk for several reasons. First, there 
is an alternative mechanism for capturing what is effectively a 
systemic risk premium.[Footnote 62] Second, FDIC officials said that 
charging an up-front premium for systemic risk could prevent 
institutions from getting the best premium rate on the basis of their 
size, which is not permitted under the 2005 Federal Deposit Insurance 
Reform Act.[Footnote 63] And finally, FDIC officials said that FDIC has 
other sources of financing available to address losses resulting from 
large-scale failures, including borrowing from the industry, a $30 
billion line of credit with Treasury, and the ability to borrow from 
the Federal Financing Bank and the Federal Home Loan Bank system. 

Industry Officials and Academics Generally Support the New System, but 
Have Voiced Concerns about Certain Aspects: 

In our review of selected comments to FDIC's proposed rule and 
interviews with bankers, industry trade groups, and academics, we found 
that the industry generally supported the concept of a more risk-based 
insurance premium system.[Footnote 64] However, several of those to 
whom we spoke and many organizations that submitted comments to FDIC 
raised several concerns about the new system. First, many said that the 
new system places too much weight on subjective factors, which could 
result in incorrect assessments of institutions' actual risk. 
Specifically, officials from two trade associations and one small bank 
who we interviewed questioned the inclusion of, or the weight given to, 
the management component of the CAMELS ratings.[Footnote 65] One 
considered this component to be the most subjective of the CAMELS 
component areas. Six additional organizations noted in comment letters 
their concern with FDIC's plan to assign different weights to the 
CAMELS components, noting in at least one case that FDIC had provided 
no evidence to support using a weighted rating in place of the 
composite rating. FDIC officials said that the weights were set in 
consultation with the other federal banking regulators and represent 
the relative importance of each component as it pertains to the risk an 
institution presents to the insurance fund. Specifically, FDIC 
officials said that asset quality, management, and capital are often 
key factors in an institution's failure and any subsequent losses to 
the insurance fund, and thus warrant more consideration than other 
factors in the calculation of risk. 

Similarly, in comment letters to FDIC, five large banks, three trade 
groups, and one financial services company expressed concern with the 
part of the rule that gives FDIC flexibility to adjust large 
institutions' premiums up or down based on other information, including 
other market information and financial performance and conditions 
measures (such as market analyst reports, assessments of the severity 
of potential losses, and stress factors). All of these organizations 
cautioned that to do so would undermine the assessments of 
institutions' primary regulators regarding their performance and health 
(as expressed in CAMELS ratings, a primary component of FDIC's system). 
According to FDIC, this authority to adjust ratings in consultation 
with other federal regulators is necessary to ensure consistency, 
fairness, and the consideration of all available information. FDIC 
officials said that the agency plans to clarify its processes for 
making any adjustments to ensure transparency and plans to propose and 
seek comments on additional guidelines for evaluating whether premium 
adjustments are warranted and the size of the adjustments. 

Related to these concerns, officials from one large bank, one small 
bank, and one trade association and one of the academics with whom we 
spoke said that FDIC's new system is overly complicated and that it 
might not be readily apparent to bank or thrift management how 
activities at their respective institutions could affect the 
calculation of their insurance premiums. Seven others expressed similar 
concerns in comment letters to FDIC. In its final rule, FDIC stated 
that while the pricing method is complex, its application is 
straightforward. For example, if an institution's capital declines, its 
premium will likely increase. Further, FDIC officials said that the 
FDIC Web site contains a rate calculator that allows an institution to 
determine its premium and to simulate how a change in the value of debt 
ratings, supervisory ratings, or financial ratios would affect its 
premium. 

Officials we interviewed from all three of the large banks said that 
the level and range of premiums for top-rated institutions generally 
was too high, given the actual risk they believe their institutions 
pose to the insurance fund. Officials from one large bank and one trade 
association we spoke with said that the best-rated banks and thrifts 
should pay no premiums, or that the base rate range of premiums should 
be reduced from 2 to 4 to 1 to 3 basis points. An additional nine 
organizations supported similar changes in their comment letters. Risk 
category I, the top-rated premium category, accounts for the majority 
of total deposits, meaning that even small changes in premium 
assessment rates could produce a significant difference in revenue to 
the insurance fund, and hence assessments to the industry. FDIC 
officials said that the 2 to 4 basis point spread is more likely to 
satisfy the insurance fund's long-term revenue needs than a 1 to 3 
basis point spread. FDIC officials also said that FDIC could, based on 
authority in the final rule, reduce rates below the current base rate 
"floor" of 2 to 4 basis points if the agency determined that such a 
reduction was warranted. 

Further, one bank official we spoke to said that the new system was 
incorrectly based in the idea of institutions failing, rather than on 
the more nuanced notion of actual losses expected to be suffered by the 
deposit insurance fund if failures occurred. As a result, he said, FDIC 
failed to give appropriate credit to how large banks handle risk. Three 
organizations that submitted comments on FDIC's new system supported 
this notion, saying that FDIC should not assess premiums on all 
domestic deposits because losses suffered by uninsured depositors 
should impose no burden on the insurance fund--the magnitude of any 
loss would be lessened to the extent that depositors in foreign 
branches, other uninsured depositors, general creditors, and holders of 
subordinated debt absorbed such losses.[Footnote 66] FDIC officials, 
citing research the agency has done on failures and losses, said that 
the differences in rates and categories were empirically based, and 
thus adequately reflected all institutions' risk. Further, FDIC 
officials said that loss severity is one of the many factors the agency 
is permitted to consider as part of its assessment of the risk of large 
institutions. 

Officials from the two small banks, one large bank, and both industry 
trade groups and the academics with whom we spoke questioned FDIC's 
choice on initial placement of institutions into risk categories. 
Because most institutions are now healthy, FDIC placed them into the 
best-rated premium category, risk category I, for which base rate 
premium charges range from 2 to 4 basis points. Within this top-rated 
category, FDIC initially assigned approximately 45 percent of 
institutions to receive the minimum rate of 2 basis points, and 5 
percent of institutions to receive the highest rate of 4 basis points. 
The remainder fell in the middle of the range. These officials and 
academics generally agreed that FDIC should establish risk criteria, 
and then assign institutions to appropriate groups based on those 
criteria, rather than start with a predetermined distribution in mind. 
Three additional organizations expressed similar concerns in comment 
letters to FDIC. Further, officials from the other two large banks with 
whom we spoke said that given the economic good times and institutional 
good health, the 45 percent of institutions with the lowest rate was 
too small a grouping and, as a result, healthy institutions arbitrarily 
would be bumped into higher premiums. FDIC officials said that based on 
the agency's experience, a range of 40 to 50 percent appeared to be a 
natural breaking point in the distribution of institutions by risk, and 
that over time, the percentage of institutions assigned the lowest 
premium in the top-rated category may vary. 

Some also thought the new system had the potential to create tension or 
discourage cooperative relations between bank management and federal 
examiners. Under the old system, there was no difference in premiums 
for well-capitalized, 1-rated institutions and well-capitalized 2- 
rated institutions. However, under the new system, such a difference 
could lead to higher premiums because CAMELS ratings are factored into 
premium calculations. As a result, according to officials we 
interviewed from one trade group, management might be less willing to 
discuss with examiners issues or problems that could prompt a lower 
rating, although raising and resolving such problems ultimately might 
be good for both the institution and the insurance fund. FDIC officials 
acknowledged the concern, and said that FDIC and the other federal 
regulators plan to monitor the new system for adverse effects. However, 
they said that it was important to include CAMELS ratings in the 
assessment of risk because the ratings provide valuable information 
about institutions' financial and operational health. 

Finally, officials from one trade association and one of the large 
banks with whom we spoke also expressed concern that regional or 
smaller institutions could be disadvantaged under the new system. 
Officials from two credit rating agencies echoed this view, saying that 
larger, more diverse institutions (by virtue of factors such as 
revenue, geography, or range of activities) typically have steadier 
income, which increases security and decreases risk. In contrast, 
regional or smaller institutions can have geographic or line-of- 
business concentrations in their lending portfolios that could hurt 
supervisory or credit ratings, leading to higher deposit insurance 
premiums. FDIC said that while size or geography could affect an 
institution's risk profile, management could offset that risk by 
maintaining superior earnings or capital reserves, requiring higher 
collateral requirements on loans, or using hedging vehicles. 

FDIC officials told us that the agency plans to monitor the new deposit 
insurance system to ensure its proper functioning and the fair 
treatment of the institutions that pay premiums into the deposit 
insurance fund. For example, in addition to assessing whether the new 
system creates friction between examiners and bank and thrift 
management, as discussed above, FDIC officials also said that the 
agency will, among other things, assess over time whether the 
percentage of institutions paying the lowest rate in risk category I-- 
those receiving the best premium rate--should be increased and whether 
different financial ratios should be considered in the calculation of 
premiums. 

Agency Comments: 

We provided FDIC, the Federal Reserve, OCC, and OTS with a draft of 
this report for their review and comment. In written comments, the 
Federal Reserve concurred with our findings related to PCA. These 
comments are reprinted in appendix II. The Federal Reserve noted that 
PCA has substantively enhanced the agency's authority to resolve 
serious problems expeditiously and that PCA has generally worked 
effectively in the problem situations where its use became applicable. 
In addition, FDIC, the Federal Reserve, and OCC provided technical 
comments, which we incorporated as appropriate. 

We are sending copies of this report to the Chairmen of the Federal 
Deposit Insurance Corporation and the Board of Governors of the Federal 
Reserve System, the Comptroller of the Currency, the Director of the 
Office of Thrift Supervision, and interested congressional committees. 
We will also make copies available to others upon request. In addition, 
the report will be available at no charge on the GAO Web site at 
[Hyperlink, http://www.gao.gov]. 

If you or your staff have any questions concerning this report, please 
contact me at (202) 512-8678 or at jonesy@gao.gov. Contact points for 
our Offices of Congressional Relations and Public Affairs may be found 
on the last page of this report. Key contributors to this report are 
listed in appendix III. 

Signed by: 

Yvonne D. Jones: 
Director, Financial Markets and Community Investment: 

[End of section] 

Appendix I: Objectives, Scope, and Methodology: 

The objectives of this report were to (1) describe trends in the 
financial condition of banks and thrifts and federal regulators' 
oversight of these institutions since the passage of the Federal 
Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), (2) 
evaluate how federal regulators used the capital or prompt corrective 
action (PCA) provisions of FDICIA to resolve capital adequacy issues at 
the institutions they regulate, (3) evaluate the extent to which 
federal regulators use the noncapital provisions of FDICIA to identify 
and address weaknesses at the institutions they regulate, and (4) 
describe the Federal Deposit Insurance Corporation's (FDIC) deposit 
insurance system and how recent changes to the system affect the 
determination of depository institutions' risk and insurance premiums. 
Our review focused on FDIC, the Board of Governors of the Federal 
Reserve System (Federal Reserve), the Office of the Comptroller of the 
Currency (OCC), and the Office of Thrift Supervision (OTS) and was 
limited to depository institutions. 

To describe trends in the financial condition of banks and thrifts, we 
summarized financial data (including total assets, net income, returns 
on assets, returns on equity, the number of problem institutions, and 
the number of bank and thrift failures) from 1992, the year FDICIA was 
implemented, through 2005. We obtained this information from FDIC 
Quarterly Banking Reports, which publish industry statistics derived 
from Reports on Condition and Income (Call Report) and Thrift Financial 
Reports. All banks and thrifts must file Call Reports and Thrift 
Financial Reports, respectively, with FDIC every quarter. We also 
analyzed Call and Thrift Financial Report data for 1992 through 2005 
that FDIC provided to determine (1) the number of well-capitalized, 
adequately capitalized, undercapitalized, significantly capitalized, 
and critically undercapitalized depository institutions from 1992 
through 2005 and (2) the amount of capital well-capitalized banks and 
thrifts carried in excess of the well-capitalized leverage capital 
minimum for each year from 1992 through 2005.[Footnote 67] We chose to 
use Call and Thrift Financial Report data because the data are designed 
to provide information on all federally insured depository 
institutions' financial condition, and FDIC collects and reports the 
data in a standardized format. We have tested the reliability of FDIC's 
Call and Thrift Financial Report databases as part of previous studies 
and found the data to be reliable.[Footnote 68] In addition, we 
performed various electronic tests of the specific data extraction we 
obtained from FDIC and interviewed FDIC officials responsible for 
providing the data to us. Based on the results of these tests and the 
information we obtained from FDIC officials, we found these data to be 
sufficiently reliable for purposes of this report. 

To describe federal regulators' oversight of banks and thrifts since 
the passage of FDICIA, we reviewed the provisions of the Federal 
Deposit Insurance Act (FDIA) requiring regulators to conduct annual, on-
site, full-scope examinations of depository institutions as well as 
several GAO and industry reports discussing the federal regulators' 
oversight of depository institutions prior to the failures of the 1980s 
and early 1990s and after the enactment of FDICIA, including their use 
of PCA to address capital deficiencies.[Footnote 69] We also obtained 
data from each of the four federal regulators on the interval between 
examinations for each year, from 1992 through 2005. We interviewed 
officials from FDIC, the Federal Reserve, OCC, and OTS to assess the 
reliability of these data. Based on their responses to our questions, 
we determined these data to be reliable for purposes of this report. 

To determine how federal regulators used PCA to address capital 
adequacy issues at the institutions they regulate, we reviewed section 
38 of FDIA, related regulations, regulators' policies and procedures, 
and past GAO reports on PCA to determine the actions regulators are 
required to take when institutions fail to meet minimum capital 
requirements.[Footnote 70] We then analyzed Call and Thrift Financial 
Report data to identify all banks and thrifts that were 
undercapitalized, significantly undercapitalized, or critically 
undercapitalized (the three lowest PCA capital categories) during at 
least one quarter from 2001 through 2005. We chose this period for 
review based on the availability of examination-and enforcement-related 
documents and to reflect the regulators' most current policies and 
procedures. From the 157 institutions we identified as being 
undercapitalized or lower from 2001 to 2005, we selected a 
nonprobablity sample of 24 institutions, reflecting a mix of 
institutions supervised by each of the four regulators and institutions 
in each of the three lowest PCA capital categories. We reviewed their 
reports of examination, informal and formal enforcement actions, and 
institution-regulator correspondence for a period covering four 
quarters prior to and four quarters following the first and last 
quarters in which each institution failed to meet minimum capital 
requirements to determine how regulators used PCA to address their 
capital deficiencies. As discussed above, we have tested the 
reliability of Call and Thrift Financial Report data and found the data 
to be reliable. To supplement our sample, we also reviewed material 
loss reviews from 14 banks and thrifts that failed with material losses 
from 1992 through 2005 and in which regulators used PCA to address 
capital deficiencies.[Footnote 71] Because of the limited nature of our 
sample, we were unable to generalize our findings to all institutions 
that were or should have been subject to PCA since 1992. 

To determine the extent to which federal regulators have used the 
noncapital supervisory actions of sections 38 and 39 of FDIA to address 
weaknesses at the institutions they regulate, we reviewed regulators' 
policies and procedures related to sections 38(f)(2)(F) and 38(g)--the 
provisions for dismissal of officers and directors and reclassification 
of a capital category, respectively--and section 39, which gives 
regulators authority to address safety and soundness deficiencies. We 
analyzed regulator data on the number of times and for what purposes 
the regulators used these noncapital authorities. To provide context on 
the extent of regulators' use of these noncapital provisions, we also 
obtained data on the number of times regulators used their authority 
under section 8(e) of FDIA to remove officers and directors from office 
and section 8(b) of FDIA to enforce compliance with safety and 
soundness standards. Based on regulators' responses to our questions 
related to these data, we determined the data to be reliable for 
purposes of this report. 

Finally, to describe how changes in FDIC's deposit insurance system 
affect the determination of institutions' risk and insurance premiums, 
we reviewed FDIC's notice of proposed rule making on deposit insurance 
assessments, selected comments to the proposed rule, and FDIC's final 
rule on deposit insurance assessments.[Footnote 72] We also interviewed 
representatives of three large institutions, two small institutions, 
and two trade groups representing large and small institutions and two 
academics to obtain their views on the impact of FDIC's changes to the 
system. We selected the large institutions based on geographic location 
and size and the small institutions based on input from the Independent 
Community Bankers Association on which of its member organizations were 
familiar with FDIC's proposed changes to the deposit insurance system. 
We also interviewed officials from two credit rating agencies on the 
factors--financial, management, and operational--they consider when 
rating institutions' debt offerings. 

We conducted our work in Washington, D.C., and Chicago from March 2006 
through January 2007 in accordance with generally accepted government 
auditing standards. 

[End of section] 

Appendix II: Comments from the Board of Governors of the Federal 
Reserve System: 

Board Of Governors Of The Federal Reserve System: 
Washington, D.C. 20551: 

Roger T. Cole: 
Director: 
Division Of Banking Supervision And Regulation:

January 12, 2007:  

Ms. Yvonne Jones: 
Director, Financial Markets and Community Investment: 
United States Government Accountability Office: 
441 G Street, N.W. 
Washington, DC 20548: 

Dear Ms. Jones: 

Thank you for the opportunity to review and comment on the Government 
Accountability Office (GAO's) draft report entitled. Deposit Insurance 
- Assessment of Regulators ' Use of Prompt Corrective Action Provisions 
and FDIC's New Deposit Insurance System. The report (1) examines how 
regulators have used Prompt Corrective Action (PCA) to resolve capital 
adequacy issues at depository institutions; (2) assesses the extent 
that regulators have used noncapital supervisory actions under sections 
38 and 39; and (3) describes how recent changes to the FDIC's deposit 
insurance system affect the determination of institutions' insurance 
premiums. 

Based upon our agency's supervisory experience, the Federal Reserve 
concurs with the GAO's findings relating to PCA. As noted in the 
report, the Federal Reserve and other agencies have typically taken 
supervisory action well in advance of PCA becoming effective. 
Nonetheless, we believe that the PCA provisions enacted in 1991 have 
substantively enhanced the Federal Reserve's authority to resolve 
serious problems expeditiously. While banking conditions have been 
exceptionally strong since PCA was enacted, the PCA provisions 
implemented by the Federal Reserve have generally worked effectively in 
the relatively few problem situations where they became applicable. As 
the report notes, although the Federal Reserve, to date, may not have 
utilized all of the provisions of PCA given alternative authorities and 
supervisory tools, circumstances in the future may differ and enhance 
the utility of these provisions. In addition to the foregoing, we note 
that the mandatory nature of many of the PCA remedial actions required 
to be taken by a primary federal regulator against an insured 
depository institution in an impaired financial condition may serve as 
a powerful incentive for insured depository institutions to maintain 
strong capital positions. 

We very much appreciate the depth of the GAO's review of actual cases 
subject to PCA, and the opportunity to comment on the findings. The 
Federal Reserve has no comments on the portion of the report relating 
to the recent changes to the FDIC's deposit insurance system. 

Sincerely. 

Signed by: 

Roger T. Cole: 

[End of section] 

Appendix III: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

Yvonne D. Jones, (202) 512-8678 or jonesy@gao.gov: 

Acknowledgments: 

In addition to the contact named above, Kay Kuhlman, Assistant 
Director; Gloria Hernandez-Saunders; Wil Holloway; Tiffani Humble; 
Bettye Massenburg; Marc Molino; Carl Ramirez; Omyra Ramsingh; Barbara 
Roesmann; Cory Roman; and Christopher Schmitt made key contributions to 
this report. 

FOOTNOTES 

[1] Under the Federal Deposit Insurance Reform Act of 2005, title II, 
subtitle B of Pub. L. No. 109-171, 120 Stat. 4, 9-21 (2006), the Bank 
Insurance Fund and the Savings Association Insurance Fund, which 
insured deposits in banks and thrifts, respectively, were merged into a 
combined Deposit Insurance Fund effective March 31, 2006. Throughout 
this report we use "deposit insurance fund" to refer to both funds 
individually and collectively. 

[2] Pub. L. No. 102-242, 105 Stat. 2236 (1991). 

[3] Act of September 21, 1950, ch. 967, 64 Stat. 873 (1950). 

[4] 12 U.S.C. § 1831o. 

[5] Although section 38 authorizes several noncapital supervisory 
actions (such as restricting operational activities a regulator 
determines pose excessive risk to an institution), the discussion of 
noncapital supervisory actions in this report is limited to actions to 
dismiss officers and directors under section 38(f)(2)(F) and to 
reclassify an institution's capital category under section 38(g). 

[6] 12 U.S.C. § 1831p-1. 

[7] Federal Deposit Insurance Reform Act of 2005, Pub. L. No. 109-171, 
120 Stat. 9 (2006); Federal Deposit Insurance Conforming Amendments Act 
of 2005, Pub. L. No. 109-173, 119 Stat. 3601 (2006). 

[8] Pub. L. No. 109-173, 119 Stat. 3601 (2006). 

[9] GAO, Bank Supervision: Prompt and Forceful Regulatory Actions 
Needed, GAO/GGD-91-69 (Washington, D.C.: Apr. 16, 1991), and Bank and 
Thrift Regulation: Implementation of FDICIA's Prompt Regulatory Action 
Provisions, GAO/GGD-97-18 (Washington, D.C.: Nov. 21, 1996). 

[10] Problem institutions typically have severe asset quality, 
liquidity, and earnings problems that make them potential candidates 
for failure. FDIC reports the number of problem institutions on its 
problem institutions list on a quarterly basis. 

[11] In these six cases, regulators did not use PCA for reasons 
including the following: the institution suffering a onetime drop in 
reported capital information, the institution misreporting capital 
information, or the institution failing to meet one or more of the PCA 
capital ratios by a fraction of a percent. 

[12] Section 38(k) of FDIA requires the inspector general of the 
applicable federal regulator to issue reports on any depository 
institution whose failure results in a "material loss"--generally 
losses that exceed $25 million or 2 percent of the institution's 
assets, whichever is greater--to the deposit insurance fund. These 
material loss reports must assess why the institution's failure 
resulted in a material loss and make recommendations for preventing 
such losses in the future. 12 U.S.C. § 1831o(k). 

[13] Section 8(e) (codified at 12 U.S.C. § 1818(e)) gives regulators 
authority to permanently ban certain institution-affiliated individuals 
(including officers, directors, and shareholders of an institution) 
from participating in the conduct of the affairs of any federally 
regulated institution under certain circumstances involving egregious 
conduct on the part of the individuals. Section 8(b) (codified at 12 
U.S.C. 1818(b)) of FDIA gives regulators authority to order an 
institution to cease and desist from certain practices or violations. 

[14] Federal Deposit Insurance Corporation--Assessments, 71 Fed. Reg. 
41910 (2006) (proposed rule). Comments to the proposed rule making were 
due on September 22, 2006. Federal Deposit Insurance Corporation-- 
Assessments, 71 Fed. Reg. 69282 (2006) (final rule codified at 12 
C.F.R. § 327.9, 327.10 and Appendixes A, B, and C of Subpart A). 

[15] At each examination, examiners assign a supervisory CAMELS rating, 
which assesses six components of an institution's financial health: 
capital, asset quality, management, earnings, liquidity, and 
sensitivity to market risk. An institution's CAMELS rating is known 
directly only by the institution's senior management and appropriate 
regulatory staff. Regulators never publicly release CAMELS ratings, 
even on a lagged basis. 

[16] GAO/GGD-97-18. 

[17] Credit rating agencies, such as Moody's Investors Services, 
Standard & Poor's, and Fitch Ratings, evaluate an institution's ability 
to repay debt and then publish a rating reflecting their opinion on 
that institution's likelihood of default. 

[18] This report only addresses the extent to which regulators used 
sections 38 and 39 to address problems at banks and thrifts. Bank and 
thrift holding companies are excluded from all discussion and data. 
Under the dual federal and state banking system, state-chartered banks 
are supervised jointly by their state chartering authority and either 
FDIC or the Federal Reserve. OCC and OTS are operating bureaus under 
the Department of the Treasury. 

[19] Within these categories, we and others have identified and 
reported on several specific risks currently facing the industry, 
including the growth in alternative mortgage products and increasing 
concentrations of commercial real estate holdings among certain 
institutions. See GAO, Alternative Mortgage Products: Impact on 
Defaults Remains Unclear, but Disclosure of Risks to Borrowers Could Be 
Improved, GAO-06-1021 (Washington, D.C.: Sept. 19, 2006); Office of the 
Comptroller of the Currency, Board of Governors of the Federal Reserve 
System, and Federal Deposit Insurance Corporation, Concentrations in 
Commercial Real Estate Lending, Sound Risk Management Practices, 71 
Fed. Reg. 74585 (2006) (joint final guidance); and Office of Thrift 
Supervision, Concentrations in Commercial Real Estate Lending, Sound 
Risk Management Practices, 71 Fed. Reg. 75298 (2006) (final guidance). 

[20] All banks that FDIC insures must submit quarterly Call Reports, 
which contain a variety of financial information, including capital 
ratios, that show a bank's condition and income. Thrifts file similar 
reports, called Thrift Financial Reports. 

[21] Effective January 1, 1997, the Federal Financial Institutions 
Examination Council added the "S" component of the CAMELS rating; prior 
to 1997, the rating was known as CAMEL. 

[22] Noncompliance with an informal enforcement action can be addressed 
by a formal action under section 8 of FDIA. 

[23] PCA directives are formal actions that regulators issue to 
institutions that fail to meet minimum capital requirements. Directives 
require institutions to take one or more specified actions to return to 
required minimum capital standards. Regulators typically use directives 
to specify corrective actions for significantly and critically 
undercapitalized institutions, as the restrictions and requirements 
specified in section 38 for undercapitalized institutions are 
automatic. 

[24] Under section 38(f)(2)(F), regulators also may order a new 
election for an institution's board of directors or require the 
institution to employ qualified senior executive officers. 

[25] Pub. L. No. 103-325, 18 Stat. 2160, 2223-2224 (1994). 

[26] Interagency Guidelines Establishing Standards for Safety and 
Soundness, 60 Fed. Reg. 35680 (1995) (codified as amended as follows: 
FDIC--Appendix A to 12 C.F.R. pt. 364 (2006); Federal Reserve--Appendix 
D-1 to 12 C.F.R. pt. 208 (2006); OCC--Appendix A to 12 C.F.R. pt. 30 
(2006); and OTS--Appendix A to 12 C.F.R. pt. 570 (2006)). 

[27] 12 U.S.C. § 1831p-1(e). 

[28] We counted the institutions in each PCA capital category by 
quarter because institutions are required to report capital ratio 
information in quarterly Call and Thrift Financial Reports. As a 
result, the number of institutions in each category per year is more 
than the number of institutions reporting in each year because an 
institution could appear in more than one capital category in a year. 
Thus, the percentage of institutions in all five capital categories in 
a given year is more than 100 percent. 

[29] To determine those institutions that held capital in excess of the 
well-capitalized minimum, we first determined the number of 
institutions that were well capitalized for all four quarters of each 
calendar year, 1992 through 2005, and then calculated the average 
amount of leverage capital each of the institutions held during each 
calendar year. 

[30] Metropolitan Savings Bank, Pittsburgh, Pennsylvania, failed on 
February 2, 2007; however, because this failure occurred after we 
completed our audit work, we did not include this bank in our 
discussion of failed institutions. 

[31] Pub. L. No. 102-242 § 111(a), 105 Stat. 2236, 2240 (1991) 
(codified as amended at 12 U.S.C. § 1820(d)). Section 605 of the 
Financial Services Regulatory Relief Act of 2006, Pub. L. No. 109-351, 
120 Stat. 1966, 1981 (2006) amended section 10(d)(4)(A) of FDIA 
(codified at 12 U.S.C. § 1820(d)(4)(A)) to provide that for well- 
capitalized, well-managed institutions with total assets of less than 
$500 million that are not subject to an enforcement action or any 
change in control during the 12-month period in which a full-scope, on- 
site examination would be required, regulators are only required to 
conduct an on-site examination every 18 months. 

[32] Federal Deposit Insurance Corporation, History of the Eighties-- 
Lessons for the Future (Washington, D.C.: 1997). FDIC data include only 
those institutions that FDIC, the Federal Reserve, and OCC supervise. 
According to OTS data, the average number of days between examinations 
was 461 in 1989, the year OTS was formed, and down to 309 days by 1992. 

[33] With one exception, section 38 does not place restrictions on 
institutions that are well capitalized or adequately capitalized. 
Namely, all institutions, regardless of their capital level, are 
prohibited from paying dividends or management fees that would drop 
them into the undercapitalized category. Further, section 301 of FDICIA 
amended section 29 of FDIA (codified at 12 U.S.C. § 1831f) to allow 
adequately capitalized institutions to accept or renew brokered 
deposits only if they receive waivers from FDIC. (Brokered deposits are 
large-denomination deposits that a broker divides into smaller pieces 
to sell to multiple depository institutions on behalf of its 
customers.) Section 301 also imposes certain interest rate restrictions 
for brokered deposits accepted by institutions that are not well 
capitalized. 

[34] Any determination to take other action in lieu of receivership or 
conservatorship for a critically undercapitalized institution is 
effective for no more than 90 days. After the 90-day period, the 
regulator must place the institution in receivership or conservatorship 
or make a new determination to take other action. Each new 
determination is subject to the same 90-day restriction. If the 
institution is critically undercapitalized, on average, during the 
calendar quarter beginning 270 days after the date on which the 
institution first became critically undercapitalized, the regulator is 
required to appoint a receiver for the institution. Section 38 contains 
an exception to this requirement, if, among other things, the regulator 
and chair of the FDIC Board of Directors both certify that the 
institution is viable and not expected to fail. 

[35] GAO/GGD-97-18. Our 1996 report on the implementation of PCA found 
that regulators generally took prescribed enforcement actions under 
section 38, including obtaining and reviewing capital restoration plans 
from undercapitalized institutions and closing critically 
undercapitalized institutions within the required 90-day time frame. 

[36] Federal Deposit Insurance Corporation Office of the Inspector 
General, The Role of Prompt Corrective Action as Part of the 
Enforcement Process, Audit Report No. 03-038 (Washington, D.C.: Sept. 
12, 2003). 

[37] Institutions with CAMELS composite ratings of 4 or 5 are placed on 
the problem institutions list. When FDIC's Division of Resolution and 
Receivership becomes involved in the resolution of any institution, it 
places that institution on the resolution cases list. Institutions that 
are deemed likely to fail within 1 year are placed on the projected 
failure list. FDIC is responsible for maintaining each of the lists. 
Regulators also may maintain their own watch lists; however, we did not 
determine whether any of the institutions in our sample appeared on any 
of these lists. 

[38] Because we only examined enforcement-related documents for the 
four quarters prior to when these institutions became undercapitalized 
or worse by PCA standards, the number of institutions with prior 
enforcement action actually may be greater than 15. 

[39] The enforcement actions detailed in the following examples may not 
represent all the enforcement actions regulators took against these 
institutions because we only reviewed documents for the four quarters 
prior to the institutions becoming undercapitalized or worse. 

[40] Since 1992, 19 banks and thrifts failed with material losses. We 
excluded 4 of these institutions from our review because they either 
did not suffer from capital deficiencies that required the use of PCA 
or because their capital deficiencies predated the implementation of 
FDICIA. In one case (Southern Pacific Bank), the bank was selected as 
part of our sample of 24 institutions. 

[41] The FDIC IG made similar findings in its report on the 
effectiveness of PCA in preventing losses to the deposit insurance 
fund. See Federal Deposit Insurance Corporation Office of the Inspector 
General, The Effectiveness of Prompt Corrective Action Provisions in 
Preventing or Reducing Losses to the Deposit Insurance Funds, Audit 
Report No. 02-013 (Washington, D.C.: Mar. 26, 2002). 

[42] Typically, subprime loans are for persons with poor or limited 
credit histories and carry a higher rate of interest than prime loans 
to compensate for increased credit risk. Securitization is the process 
of selling to investors (public or private) asset-backed securities 
that represent an interest in the cash flow generated by the loans. 

[43] Residual assets are assets remaining after sufficient assets are 
dedicated to meet all senior debtholders' claims in full. 

[44] GAO, Bank Regulation: Analysis of the Failure of Superior Bank, 
FSB, Hinsdale, Illinois, GAO-02-419T (Washington, D.C.: Feb. 7, 2002). 

[45] FDIA does not define unsafe and unsound practice or condition-- 
such determinations are to be made by the appropriate regulator based 
on the facts and circumstances of each case. For purposes of the cease- 
and-desist authority under section 8(b)(8) of FDIA, an institution with 
a less-than-satisfactory rating (CAMELS 3, 4, or 5) for asset quality, 
management, earnings, or liquidity may be deemed by the appropriate 
federal regulator to be engaging in an unsafe and unsound practice. 

[46] Data were not available on the frequency with which regulators 
were able to informally persuade individuals to resign from 
institutions. 

[47] Under section 8(e) of FDIA, regulators must make three 
determinations to institute an action for removal or prohibition: 
misconduct, the effect of the misconduct, and the individual's 
culpability for the misconduct. Misconduct includes (1) violation of 
any law, regulation, or final section 8(b) order; (2) violation of any 
condition imposed in writing by the appropriate federal agency in 
connection with the grant of any application or other request by the 
institution; (3) violation of any written agreement between the 
institution and the appropriate federal agency; (4) engagement or 
participation in any unsafe or unsound practice; or (5) engagement in 
any act, omission, or practice that constitutes a breach of fiduciary 
duty. The regulator then must demonstrate that as a result of the 
individual's misconduct any of the following occurred: (1) the 
institution suffered or probably will suffer financial loss or other 
damage, (2) the interests of the institution's depositors have been or 
could be prejudiced, or (3) the individual in question received 
financial gain or other benefit as a result of his or her conduct. To 
assess culpability, regulators must determine whether the individual's 
conduct involved personal dishonesty or demonstrated a willful or 
continuing disregard for the safety and soundness of the institution. 

[48] The Federal Reserve has established safety and soundness standards 
under section 39, but has not used the enforcement mechanisms under the 
section to address deficiencies in favor of using other supervisory 
authorities. The following discussion about regulators use of section 
39 is therefore limited to FDIC, OCC, and OTS. 

[49] OCC was unable to segregate orders covering operations and 
management; compensation; and asset quality, earnings, and stock 
valuation from all cease-and-desist orders issued over the period. 
According to data obtained from OCC's Web site, the regulator issued 
240 cease-and-desist orders from 1995 through 2005. 

[50] See Assessments, 71 Fed. Reg. 69282, 69283-84 (2006). 

[51] These capital categories are different from the PCA capital 
categories discussed elsewhere in this report. Where PCA divides 
institutions into five capital categories, the previous insurance 
system used three. 

[52] Deposit Insurance Funds Act of 1996, title II, subtitle G of Pub. 
L. No. 104-208, § 2708(c), 110 Stat. 3009, 3009-497 (1996) (codified at 
12 U.S.C. § 1817(b)(2)(A)(v)). The repeal of section 1817(b)(2)(A)(v) 
was effective on January 1, 2007, the date that FDIC's final 
regulations under Section 2109(a)(5) of the Federal Deposit Insurance 
Reform Act of 2005 took effect. See Federal Deposit Insurance Reform 
Act of 2005, supra note 1, § 2104(e). The designated reserve ratio is 
the insurance fund's reserve level, expressed as a fraction of total 
estimated insured deposits. 

[53] According to FDIC officials, although most institutions paid no 
premiums in recent years, lower-risk institutions implicitly subsidized 
the premiums of higher-risk institutions--even when the premium rate 
charged to most institutions was zero, the activities of higher-risk 
institutions raised the chances of insurance fund losses and thus 
higher premiums for all institutions. 

[54] FDIC officials refer to the general method as the financial ratio 
method and the large-institution method as the debt rating method. 

[55] These data are only for banks and do not include thrifts. Also 
excluded are failures in which fraud was determined to be a primary 
contributing factor. 

[56] Subordinated debt is repayable only after other debts with higher 
claim priority have been satisfied. 

[57] According to FDIC, approximately 10 to 15 percent of the 120 
institutions with assets of at least $10 billion do not have available 
credit agency ratings. As with large institutions with credit agency 
ratings, FDIC may use other financial market information to evaluate 
these institutions' risk. 

[58] With some minor adjustments, premiums are assessed on total 
domestic deposits. 

[59] Section 2107(a) of the Federal Deposit Insurance Reform Act of 
2005 amended section 7(e)(3) of FDIA (codified at 12 U.S.C. § 
1817(e)(3)) to require that FDIC's Board provide by regulation a 
onetime premium credit to eligible banks and thrifts to offset future 
premiums based on certain previous payments into the deposit insurance 
fund. The aggregate amount of funds available for such onetime credits 
is capped at the amount FDIC could have collected if it had imposed an 
assessment of 10.5 basis points on the combined assessment base of the 
Bank Insurance Fund and the Savings Association Insurance Fund as of 
December 31, 2001. FDIC has calculated this amount to be approximately 
$4.7 billion. See One-Time Assessment Credit, 71 Fed. Reg. 61374, 61375 
(2006) (final rule). While their credits are drawn down, some 
institutions will pay lower premiums; however, when the credits are 
exhausted, all institutions will be assessed full premiums. 

[60] Federal Deposit Insurance Reform Act of 2005, §§ 2105 and 2107, 
120 Stat. 14 and 16 (2006). Section 2105 of the act amended section 
7(b)(3) of FDIA to require FDIC to establish by regulation the 
insurance fund's reserve level, known as the designated reserve ratio, 
within a range of 1.15 to 1.50 percent of insured deposits. If the 
reserve ratio exceeds 1.35 percent, but is not more than 1.50 percent, 
FDIC generally must rebate to institutions half of any amount above 
1.35 percent. If the reserve ratio exceeds 1.50 percent, FDIC must 
rebate all amounts in the fund above the 1.50 percent level. 

[61] FDIC omitted from design of its new system data on institutions 
insured by the former Federal Savings and Loan Insurance Corporation. 
FDIC officials told us they did so because the information was 
unavailable or deemed unreliable or unrepresentative. 

[62] Section 13 of FDIA (codified at 12 U.S.C. § 1823) authorizes FDIC 
to undertake various actions or provide assistance to a failing 
institution. FDIC is obligated to pursue a course of resolution that is 
the least costly to the insurance fund, except in cases involving 
systemic risk. 12 U.S.C. § 1823(c)(4). Under the "systemic risk" 
exception, if upon recommendation of FDIC's Board of Directors and the 
Board of Governors of the Federal Reserve System (in each case by a two-
thirds vote of the members of the boards), the Secretary of the 
Treasury, in consultation with the President, determines that pursuing 
the least costly alternative would have serious adverse effects on 
economic conditions or financial stability, then FDIC may take any 
action or provide any assistance authorized under section 13 that would 
avoid or mitigate such adverse effects. In such cases, the loss to the 
insurance fund arising from such action or assistance is recaptured by 
special assessment on all insured institutions. This assessment 
effectively amounts to a systemic risk premium. Because the assessment 
is not levied on insured deposits, but rather on nonsubordinated 
liabilities, the effect is to shift the burden to larger institutions-
-the institutions that pose the greatest systemic risks. 

[63] Section 2104(a)(2) of the Federal Deposit Insurance Reform Act 
(codified at 12 U.S.C. § 1817(b)(2)(D)) specifically prohibits barring 
an institution from obtaining the lowest premium solely because of 
size. Pub. L. No. 109-171, 120 Stat. 12. Large institutions generally 
pose the greatest systemic risk, so according to FDIC officials, 
charging a systemic risk premium could effectively amount to a 
surcharge based on size, improperly disqualifying them from the lowest 
rate. 

[64] A majority of comments submitted to FDIC in response to its 
initial proposal for the new insurance system addressed two issues: (1) 
the automatic assessment of de novo institutions at the ceiling rate (4 
basis points under the base rate schedule) in Risk Category I and (2) 
the possible treatment of Federal Home Loan Bank advances as volatile 
liabilities. FDIC's final rule relaxed treatment of de novo 
institutions and dropped volatile liabilities as a factor in the 
determination of premiums. Thirty-two organizations and individuals, 
including 6 we interviewed, provided comments to FDIC on issues and 
concerns with other aspects of FDIC's deposit insurance system. The 
comments of these institutions are reflected in our discussion. 

[65] According to FDIC, CAMELS ratings capture information on an 
institution's risk management practices that is not otherwise reflected 
in premium calculations. Under the new system, FDIC generally will 
consider an institution's ratings in each of the CAMELS components in 
determining risk. Each component will receive the following weight: C, 
25 percent; A, 20 percent; M, 25 percent; and E, L, and S, 10 percent 
each. 

[66] FDIC officials said that such changes were not within the scope of 
this redesign of the deposit insurance system. 

[67] Leverage capital is tier 1 capital computed without risk weights 
and in most cases closely matches an institution's reported tangible 
equity. If an institution's tangible equity is 2 percent or less, it is 
considered critically undercapitalized for PCA purposes. 

[68] For example, see GAO, Industrial Loan Corporations: Recent Asset 
Growth and Commercial Interest Highlight Differences in Regulatory 
Authority, GAO-05-621 (Washington, D.C.: Sept. 15, 2005), 87. In 
addition, we confirmed that no significant changes occurred to the way 
in which banks and thrifts report information on their financial 
condition and how FDIC maintains the data since the release of this 
report. 

[69] Pub. L. No. 102-242 § 111(a), 105 Stat. 2236, 2240 (1991) 
(codified as amended at 12 U.S.C. § 1820(d)). GAO, Bank Supervision: 
Prompt and Forceful Regulatory Actions Needed, GAO/GGD-91-69 
(Washington, D.C.: Apr. 16, 1991); GAO, Bank and Thrift Regulation: 
Implementation of FDICIA's Prompt Regulatory Action Provisions, GAO/ 
GGD-97-18 (Washington, D.C.: Nov. 21, 1996); Federal Deposit Insurance 
Corporation Office of the Inspector General, The Role of Prompt 
Corrective Action as Part of the Enforcement Process, Audit Report No. 
03-038 (Washington, D.C.: Sept. 12, 2003); and Federal Deposit 
Insurance Corporation, History of the Eighties--Lessons for the Future 
(Washington, D.C.: 1997). 

[70] GAO/GGD-91-69 and GAO/GGD-97-18. 

[71] Section 38(k) of FDIA requires the federal regulators' respective 
inspectors general to issue reports on each depository institution 
whose failure results in a "material loss"--losses that exceed $25 
million or 2 percent of an institution's assets, whichever is greater-
-to the insurance fund. These material loss reports must assess why the 
institution's failure resulted in a material loss and make 
recommendations for preventing such losses in the future. 

[72] Federal Deposit Insurance Corporation--Assessments, 71 Fed. Reg. 
41910 (2006) (proposed rule). Comments to the proposed rule making were 
due on September 22, 2006. Federal Deposit Insurance Corporation-- 
Assessments, 71 Fed. Reg. 69282 (2006) (final rule codified at 12 
C.F.R. pt. 327.9, 327.10 and Appendixes A, B, and C of Subpart A). 

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