July 14, 2010 – Banking regulators agreed to give the FDIC expanded authority to conduct examinations of insured depository institutions that the FDIC does not directly supervise, under a new memorandum of understanding (MOU). The FDIC’s position is that it should have more than “backup authority” and be allowed to take a more active on-site presence in order to evaluate risks to the Deposit Insurance Fund.
The new agreement gives the FDIC expanded backup supervisory powers under certain circumstances. The FDIC can now conduct its own examination of institutions that it does not directly supervise when an institution may be at higher risk, when an institution is defined as “large” or when a large institution may represent systemic risk to the banking system. In the past, if the primary regulator of a banking institution gave the bank an acceptable rating, the FDIC could not conduct its own examination
According to the FDIC press release,
“The agreement reached today strikes that reasonable balance between preserving the role of the primary federal regulator and providing the FDIC with the information that is critical to meeting our statutory responsibilities,” she said. “The FDIC supports the role of the primary federal regulator and has no interest in infringing upon their authorities. However, the FDIC has needs that are separate and distinct from the primary federal regulator that must be met in order to satisfy our statutory responsibilities.”
For example, an Evaluation of Federal Regulatory Oversight of Washington Mutual Bank issued by the FDIC and Treasury Inspectors Generals in April criticized the existing MOU because it limited the FDIC’s ability to make its own independent assessment of risk to the Deposit Insurance Fund and required the FDIC to place unreasonable reliance on the work of the primary federal regulator.
In the case of Washington Mutual, the FDIC and the Office of Thrift Supervision (OTS) could not come to agreement on what regulatory actions should be taken. Washington Mutual later collapsed under the weight of billions of dollars of losses caused by lax lending standards. Apparently, the OTS viewed Washington Mutual as being less of a risk than the FDIC did which raises two interesting questions. How could the OTS and the FDIC have dramatically different risk assessments and which regulator will be right the next time? Washington Mutual did not collapse overnight – they failed after making unsound loans over a period of many years. Both regulators were blind to unsound lending practices until failure was imminent.
FDIC And Primary Regulator Both Failed In Exam Of Indy Mac Bank
The FDIC press release does not mention the failure of Indy Mac Bank in 2008, with over $10 billion in losses to the Deposit Insurance Fund. Indy Mac was examined by both the FDIC and the OTS (its primary regulator). The failure of Indy Mac was later reviewed by the Office of Inspector General (OIG) and they report that the FDIC identified Indy Mac as having a “highrisk” profile but then concluded that Indy Mac Bank “posed an ordinary or slightly more than ordinary level of risk to the insurance fund”. The OIG report states that the OTS “viewed growth and profitability as evidence that IMB management was capable, and OTS gave IMB favorable CAMELS ratings right up to the time it failed. Moreover, the OTS did not issue an enforcement action until June 2008, less than 2 weeks before IMB failed”. (See Regulators Were Blind to Risk In Biggest US Banking Failure).
Obviously, it wouldn’t have mattered what agreement the FDIC had with the primary regulator in the case of Indy Mac. Both regulators concluded that one of the most reckless lenders in the country was safe and sound right up until its collapse.
The report by the OIG provides scant assurance that future major banking failures will be prevented by regulators since current regulatory “reforms” basically keep intact the existing regulatory agencies – see Will Regulatory Reform Prevent Future Financial Crises?
The OTS and FDIC were not the only regulators oblivious to the risks of subprime, no doc and low doc mortgage lending. The entire regulatory apparatus consistently turned a blind eye to repeated warnings of lending excesses and abuses until the financial crisis was out of control.
Report by the Office of Inspector General (OIG) on Indy Mac Collapse
In its role as insurer, the FDIC identified and monitored risks that IMB presented to the Deposit Insurance Fund by participating with the OTS in on-site examinations of IMB in 2001, 2002, 2003, and again shortly before IMB failed in 2008 and through the completion of required reports and analysis of IMB based upon information from FDIC monitoring systems. FDIC risk committees also raised broad concerns about the impact that an economic slowdown could have on institutions like IMB that were heavily involved in securitizations and subprime lending. Nevertheless, FDIC officials consistently concluded that despite its highrisk profile, IMB posed an ordinary or slightly more than ordinary level of risk to the insurance fund. It was not until August 2007 that the FDIC began to understand the implications that the historic collapse of the credit market and housing slowdown could have on IMB and took additional actions to evaluate IMB’s viability.
The Treasury IG’s material loss report stated that although OTS conducted timely and regular examinations of IMB and provided oversight through offsite monitoring, its supervision of the thrift failed to prevent a material loss to the Deposit Insurance Fund. The Treasury IG reported that IMB’s high-risk business strategy warranted more careful and much earlier attention. The report further stated that OTS viewed growth and profitability as evidence that IMB management was capable, and OTS gave IMB favorable CAMELS ratings right up to the time it failed. Moreover, the OTS did not issue an enforcement action until June 2008, less than 2 weeks before IMB failed.