I. Management's Discussion and Analysis
Operations of the Corporation Ė The Year in Review
As the FDIC marked its 70th anniversary in 2003, it continued to ensure the stability of the nationís financial services industry Ė the Corporationís original mandate in 1933. Much has changed for the FDIC over seven decades, including the tools it uses to conduct bank examinations, the way it markets failed bank assets, and the manner in which it assesses risk to the deposit insurance funds. However, what has remained constant are the reliability of deposit insurance and the publicís confidence in the FDIC and the nationís financial system.
During 2003, the FDIC continued to strive to meet the challenges of an ever-evolving banking industry Ė challenges associated with globalization, advances in technology and industry consolidation. The FDIC provided leadership on important economic and policy issues, working to enact deposit insurance reform legislation, and holding symposia for policymakers, regulators and others to engage in dialogue on significant public policy concerns. It also continued to monitor emerging risks to the deposit insurance funds, while improving its internal operations to better meet the challenges of the future.
Highlights of the Corporationís 2003 accomplishments are presented below for each of its three major business linesĖInsurance, Supervision and Consumer Protection, and Receivership Management.
The FDIC insures bank and savings
association deposits. As insurer, the
FDIC must continually evaluate how
changes in the economy, the financial
markets and the banking system
affect the adequacy and the viability
of the deposit insurance funds. During
2003, the FDIC sought to enhance
its risk analysis and management,
promote sound public policies, and
resolve failed institutions in a timely
Enhanced Risk Analysis and Management
The FDIC employs a robust, integrated risk analysis process that was strengthened by several initiatives in 2003. The Risk Analysis Center (RAC) was established in March. Located at the FDICís headquarters in Washington, DC, the RAC brings together economists, bank examiners, financial analysts, and others involved in assessing risks to the banking industry and the insurance funds. Under the auspices of the RAC, individuals from these various disciplines work together to monitor and analyze economic, financial, regulatory and supervisory trends, and their potential implications for the continued financial health of the banking industry and the deposit insurance funds. Comprehensive solutions are developed to address risks identified during this process.
The principle of a coordinated approach to analyzing and addressing risks also extends to Regional Risk Committees (RRCs), which have operated for a number of years, but were formally chartered in January 2003. Each of the FDICís six regional offices has an RRC that meets regularly, engaging individuals from various disciplines to analyze and address the unique risks facing the region.
Art Murton, Mike Zamorski, Mitchell Glassman, Chairman Powell officially open the RAC.
In January 2003, the National Risk Committee (NRC) was chartered to provide a forum for executive leadership to consider and coordinate risk management activities across the FDIC. The RAC and RRCs provide data and reports to the NRC to support policy and resource allocation decisions of the NRC. Among other things, the NRC is responsible for ensuring that the FDIC takes appropriate actions to address identified risks and that these risks and FDIC's actions are effectively communicated to internal and external audiences.
Improved Financial Risk Management Practices
In 2003, the FDIC hired an independent, outside consultant to review the FDICís financial risk management practices. This review focused particularly on the methodology and processes used by the inter-divisional Financial Risk Committee (FRC), which is responsible for recommending quarterly the amount of the BIF and SAIF contingent liability for anticipated bank and thrift failures. The final report, Strengthening Financial Risk Management at the FDIC, reflects the FDICís commitment to ensuring that our methods and procedures remain effective and represent industry best practices. The report provided meaningful suggestions to enhance the overall accuracy, robustness and transparency of the FDICís contingent loss-reserving process. It also laid out a road map to follow in developing next-generation tools and organizational practices for managing risk at the FDIC.
The consultantís recommendations span three overlapping time periods (Horizons 1, 2, and 3). The FDIC implemented Horizon 1 recommendations in September 2003. The results of the implementation of these recommendations are reflected in our audited 2003 financial statements. The Horizon 1 recommendations include:
Limiting subjective deviations from average expected failure rates to a range around the recent, historical average, and developing explicit guidelines for when the FRC may elect to deviate from the average,
Incorporating the asset and liability compositions of failing banks and thrifts into expected loss rates, and
Adopting a set of more formal operating procedures for the FRC.
The FDIC will implement Horizon 2 recommendations throughout 2004. The Horizon 2 recommendations include:
Accelerating development of a new integrated model for financial risk management. The FDIC has already developed a prototype loss distribution model that will be the centerpiece of the integrated fund model and will be used by the FRC in 2004 to establish the contingent liability for anticipated failures. A paper describing the prototype model was presented at the Finance and Banking: New Perspectives conference in December 2003, and
Building a more integrated risk management organization by enhancing outputs, operations and feedback mechanisms of the FRC and RAC.
Horizon 3 improvements include building capabilities such as real-time risk management, programs for hedging or reinsurance, and the ability to rapidly conduct scenario analyses. The FDIC will annually assess whether to implement Horizon 3 capabilities.
FDIC Center for Financial Research
The Corporation established the Center for Financial Research (CFR) in late 2003 to promote research that would provide meaningful insights into developments in deposit insurance, the financial services sector, prudential supervision, risk measurement and management, regulatory policy and related topics that are of interest to the FDIC, the financial services industry, academia and policymakers. The CFR will be a partnership between the FDIC and the academic community with prominent scholars actively engaged in overseeing and directing its research program. The CFR will carry out its mission through an agenda of research, analysis, forums and conferences that encourages and facilitates an ongoing dialogue that incorporates industry, academic and public-sector perspectives. The CFR will support high-quality original research by sponsoring relevant research program lines and soliciting rigorous analysis of the issues within five program areas. These programs will be under the leadership of program coordinators who are drawn largely from the outside academic community. Input will also be obtained from six prominent economists who will serve as Senior Fellows.
The CFR will sponsor a Visiting Research Fellows Program to provide support for residence scholars for defined time periods. The CFR will also organize visits and encourage interaction and collaboration between outside scholars and FDIC staff on subjects of mutual interest.
New International Capital Standards
The FDIC continues to actively participate in the Basel Committee on Banking Supervisionís (BCBS) efforts to update and revise the 1988 Basel Capital Accord. Such revisions are necessary to align capital standards with advances in banksí risk measurement and management practices, while continuing to assure that these banks maintain adequate capital reserves. In addition to the BCBS, the FDIC is active on a number of global supervisory groups, including the Capital Task Force, the Accord Implementation Group, the Risk Management Group, and various subgroups and task forces that seek to enhance risk management practices.
The FDIC invested significant resources on several fronts during 2003 to ensure that the new capital rules, when final, will be compatible with the Corporationís roles as both deposit insurer and supervisor. Significant work has been performed, both internationally and domestically, to assure that the new Accord is implemented efficiently, that effective supervisory oversight will continue, and that these new rules will not create unintended and potentially harmful consequences.
Ensuring the adequacy of capital requirements under the new Accord was the FDIC's main priority during 2003. The FDIC published a study suggesting that over time and on average, risk-based capital requirements under the new Accord would probably decline substantially relative to the 1988 Accord. In 2004, the FDIC will seek to ensure that any reductions in capital requirements reflect bank risk profiles rather than specific statistical modeling assumptions. The BCBS has established a goal of issuing a final rule in mid-2004, with implementation slated for January 2007.
Deposit Insurance Reform
The FDIC continued to give priority attention to enactment of comprehensive deposit insurance reform legislation throughout 2003. Legislation containing major elements of the deposit insurance reform proposals developed by the FDIC over the past three years was introduced in both the House of Representatives and the Senate. FDIC Chairman Powell testified in support of deposit insurance reform proposals on February 26 before the Senate Banking Committee and on March 4 before the House Financial Services Committee.
The FDIC's recommendations, which were summarized in the testimony, include:
Merging the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF).
Granting the FDIC's Board of Directors the flexibility to manage a combined deposit insurance fund. Under the present system, statutorily-mandated methods of managing the size of the BIF and SAIF may cause large premium swings and could force the FDIC to charge the highest premiums during difficult economic times when the industry can least afford it. Currently, safer institutions subsidize riskier institutions unnecessarily while new entrants and growing institutions avoid paying premiums. To correct these problems, the FDIC recommended that the Congress give the Board of Directors the discretion to:
Manage the combined fund within a range.
Price deposit insurance according to risk at all times and for all insured institutions.
Grant a one-time initial assessment credit to recognize institutionsí past contributions to the fund and create an ongoing system of assessment credits to prevent the fund from growing too large.
Indexing deposit insurance coverage to ensure that basic account coverage is not eroded over time by inflation.
The House passed H.R. 522, the Federal Deposit Insurance Reform Act of 2003, on April 2 by a vote of 411 to 11. Although the Senate Banking Committee held a hearing on deposit insurance reform in February, it did not act on a deposit insurance bill during the year. Enactment of deposit insurance reform will remain a priority of the FDIC during 2004.
FFIEC Central Data Respository The FDIC provided leadership for a new interagency initiative with the Federal Reserve Board and the Office of the Comptroller of the Currency under the auspices of the FFIEC, to consolidate the collection, editing and publication of quarterly bank financial reports into a Central Data Repository (CDR). The CDR will be implemented during the fourth quarter of 2004 and will be accessible to regulators, financial institutions and the public. This initiative will be undertaken in cooperation with the industry and will employ cutting-edge technology based on the Extensible Business Reporting Language (XBRL) standard to define data standards and streamline the collection and validation of the data. The first reports are expected to be filed under the new system beginning with the September 2004 Call Report.
Future of Banking Study
The FDIC conducted a study on the future of banking during 2003 that focused on underlying trends in the economy and the banking industry, and their implications for different sectors of the industry and for bank regulators in the future. FDIC analysts explored policy issues that included the mixing of banking and commerce, regulatory reorganization, consumer privacy, the role of banks in light of the increased importance of non-bank competitors, and the potential effects of financial services industry consolidation on small business and local economies. As part of the study, FDIC analysts met with representatives from the banking industry and the regulatory community throughout the year to discuss their views on the direction of the industry. The results of the study will be presented at a conference in 2004 and published following this conference. The FDICís Advisory Committee on Banking Policy, formed in 2002 to provide advice and recommendations relating to the FDICís mission, will also be reviewing the study.
Reduced Regulatory Burden
Determined to cut red tape and reduce regulatory burden are (l to r),
OTS Director James Gilleran, Jim McLaughlin of the American Bankers
Association, Harry Doherty of Americaís Community Bankers,
FDIC Vice Chairman John Reich and Ken Guenther of the Independent
Community Bankers of America.
On June 3, 2003 under the leadership of FDICís Vice Chairman John Reich, the federal thrift and bank regulatory agencies launched a cooperative, three-year effort to review all of their regulations (129 in all) that impose some burden on the industry. The purpose of the review, which is mandated by the Economic Growth and Regulatory Paperwork Reduction Act of 1996 (EGRPRA), is to identify and eliminate any regulatory requirements that are outdated, unnecessary or unduly burdensome. As a former community banker, Vice Chairman Reich understands bankersí concerns regarding the extent of regulatory burden and believes that, with the assistance of bankers, meaningful changes can be made. For the purposes of this review, the agencies categorized their regulations into 12 separate groups. Every six months, new groups of regulations will be published for comment, giving bankers and others an opportunity to identify regulatory requirements they believe are no longer needed. The agencies will then analyze the comments and propose amendments to their regulations where appropriate.
On June 15, 2003, the agencies issued the first three groups of regulations for comment: Applications and Reporting, Powers and Activities, and International Banking. During the 90-day comment period, 17 letters were received containing more than 150 individual recommendations for burden reduction. Staff is reviewing and analyzing all of these recommendations with an eye towards reducing regulatory burden wherever possible. If necessary, legislative changes may be proposed.
As a part of the regulatory burden reduction effort, the FDIC hosted five banker outreach meetings during 2003 to facilitate industry awareness of the EGRPRA project and to listen to bankersí comments, complaints and suggestions on regulatory burden. These meetings were attended by more than 250 bankers. Chairman Powell, Vice Chairman Reich, Federal Reserve Board Governor Mark Olson and Comptroller John D. Hawke were featured speakers at the meetings. Project staff from each of the federal banking regulatory agencies as well as regional representatives of the major industry trade groups attended each of the meetings. Outreach sessions were held in Orlando, St. Louis, Denver, San Francisco and New York.
Ten major regulatory issues emerged from the outreach sessions that appeared to be of the greatest concern to bankers:
Bank Secrecy Act, including Suspicious Activity Reports (SARs) and Currency Transaction Reports (CTRs)
USA PATRIOT Act and ďKnow Your CustomerĒ Requirements
Withdrawal Limits on Money Market Deposit Accounts (Regulation D)
Home Mortgage Disclosure Act (HMDA)
Community Reinvestment Act (CRA)
Truth-in-Lending Act (Regulation Z) and the Real Estate Settlement Procedures Act (RESPA)
Three-Day Right of Rescission
Extensions of Credit to Insiders (Regulation O)
The EGRPRA project will give particular attention to these concerns as it moves forward.
The FDIC maintains an interagency Web site on EGRPRA: www.egrpra.gov. This site contains the agendas and discussion topics from the outreach meetings, as well as a summary of the issues raised and potential solutions offered by the participants. Comments received during the first comment period are also posted on the Web site.
Resolution of Failed Institutions
During 2003, the FDIC resolved three financial institution failures. These failed institutions had a total of $1.10 billion in assets and $908.6 million in deposits. Within one business day after each failure, the FDIC had issued payout checks to insured depositors, or worked with open institutions to ensure that depositors had access to their insured funds. (See the accompanying table on page 18 for details about liquidation activities.)