Financial Crisis News Center

OCC Publishes Economics Working Paper on Bank Executive Turnover

This story appeared in Bank Digest.

The OCC has published an economic working paper revisiting the topic of relative performance evaluation (RPE) of top management using a large panel of community banks. The paper shows that penalizing executives for poor performance arising from economic downturns is not necessarily inconsistent with the theory. The OCC's empirical results indicate that weak downturn-linked performance is strongly related to increased executive turnover. Furthermore, this relationship is more pronounced in better-governed banks, which are more likely to engage in value-enhancing disciplinary actions. The OCC's analysis suggests that executive dismissals during adverse economic conditions are not necessarily a result of bad luck; rather, the analysis implies that bad times are informative about management quality.

National Banks Notified of Risk Weights for FDIC Claims and Guarantees

This story appeared in Bank Digest.

National banks have been notified by the Office of the Comptroller of the Currency regarding a joint interagency statement clarifying the risk weights for claims on or guaranteed by the FDIC for purposes of banking organizations' risk-based capital requirements. The interagency statement was issued by the OCC, Federal Reserve Board, Federal Deposit Insurance Corp.

Basel Proposals Designed to Promote More Resilient Banking Sector

This story appeared in Bank Digest.

In a speech before the Institute of International Bankers' annual Washington conference on March 1, 2010, Comptroller of the Currency John C. Dugan discussed “efforts underway to guard against a recurrence of the financial crisis that did so much damage, not just to banks and financial services companies, but to consumers, businesses, and communities around the world.” Dugan predicted that “the central challenge to policymakers around the world in the next year” will be striking a balance between adopting reforms to prevent another financial “meltdown” and requiring banks to hold too much capital and liquidity, risking a “significant and suboptimal restriction of credit.” Dugan noted that international solutions are required and pointed to the Basel II framework, which is intended to promote a more resilient banking sector by strengthening the standards for capital, liquidity and risk management.

Senators Say SEC Action Falls Short of Solving Naked Short Selling Concern

By James Hamilton, J.D., LL.M., Principal Analyst, CCH Federal Securities Law Reporter; and CCH Derivatives Regulation Law Reporter.

Senators Ted Kaufman and Johnny Isakson said that the partial action taken by the SEC will neither provide investors with the same protections as the uptick rule nor address the enforcement issues surrounding the current naked short selling rule. The SEC voted 3-2 to require short sellers, if a company’s shares fall 10 percent in one day, to exceed the prevailing bid for the remainder of the trading day and the following day in short sales of that security.

While encouraged that the SEC took some action to protect investors from manipulative short selling, adding that the circuit-breaker/bid test rule is a step forward, the senators said it will be of limited use, helping only in the worst-case scenarios that could occur during a terrorist attack or financial crisis. The uptick rule worked for 70 years as a systemic check on predatory bear raids; they emphasized, and this approach will not provide investors with the same protections as an always-on bid test.

Thrifts Alerted to Policy Statement on Small Business Lending

This story appeared in Bank Digest.

The OTS has alerted thrifts that the Federal Reserve Board, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency, Conference of State Bank Supervisors and OTS have adopted the Policy Statement on Meeting the Credit Needs of Creditworthy Small Business Borrowers. The Statement addresses lending to creditworthy small business borrowers in the current economic environment.

Joint Agency Policy Statement Restates and Elaborates Supervisory Views on Small Business Lending

This story appeared in Bank Digest.

The Office of the Comptroller of the Currency, along with the Federal Reserve Board, Federal Deposit Insurance Corp., Office of Thrift Supervision and the Conference of State Bank Supervisors, have adopted the Policy Statement on Meeting the Credit Needs of Creditworthy Small Business Borrowers. The policy statement builds upon principles in existing guidance, including the November 2008 Statement on Meeting the Needs of Creditworthy Borrowers and the October 2009 Statement on Prudent Commercial Real Estate Loan Workouts.

The statement discusses principles of sound underwriting and risk management practices and notes that financial institutions should consider new lending opportunities on the basis of a comprehensive review of a borrower’s financial condition while maintaining prudent lending and concentration risk management standards. Financial institutions should apply the principles of the policy statement in accordance with their internal definitions of small business loans or as appropriate in their loan portfolios. Small business lending includes loans to small businesses and farms, such as working capital lines of credit, secured and unsecured term loans, as well as unsecured revolving credit.

Dugan Remarks on Securitization Market

This story appeared in Bank Digest.

Comptroller John C. Dugan, in a speech before the American Securitization Forum, commented that minimum underwriting standards could play a major role in reforming securitization markets. While noting that securitization played a major role in the financial crisis, Dugan also supported securitization as important to the economy because it “helps consumers and businesses by increasing the availability of credit on terms that might otherwise be unavailable.” Thus, he said, the securitization must be revived, but not without also “guarding against the kinds of abuses that fueled the crisis, such as creating incentives for lax underwriting of underlying assets; opaque and overly complex asset pools; credit rating failures; inadequate risk capture in both accounting standards and regulatory capital; and breakdowns in disclosure.” With regard to addressing lax underwriting standards, Dugan said, rather than rely on so-called “skin-in-the-game” requirements, minimum underwriting standards should be established directly by regulation.

Working Paper Examines Correlation in CDS Spread Changes

This story appeared in Bank Digest.

The OCC has released a working paper that examines the correlation in credit risk using credit default swap (CDS) data. The authors, Xiaoling Pu and Xinlei Zhao, found that the observable risk factors at the firm, industry and market levels and the macroeconomic variables cannot fully explain the correlation in CDS spread changes, leaving at least 30 percent of the correlation unaccounted for. This finding suggests that contagion is not only statistically but also economically significant in causing correlation in credit risk. The paper concluded it is important to incorporate an unobservable risk factor into credit risk models in future research. The authors also found that, consistent with some theoretical predictions, that the correlation is countercyclical and is higher among firms with low credit ratings than among firms with high credit ratings.

Comments on Incorporating Employee Compensation Into the Risk Assessments

By Gregg D. Killoren, J.D., CCH State Banking Law Reporter, Bank Digest and Individual Retirement Plans Guide.

The Federal Deposit Insurance Corp. will be issuing an Advance Notice of Proposed Rulemaking (ANPR) that asks for comment on whether employee compensation structures that increase a depository institution's risk should be considered in setting the institution's deposit insurance assessment. According to FDIC Chairman Sheila Bair, “A broad consensus of academic studies agrees that poorly designed compensation structures can misalign incentives and induce risk taking.” This can increase risk for the deposit insurance fund and increase losses in the financial system, Bair said. According to the FDIC's notice, the agency is not attempting to impose compensation limits. Instead, it is looking at how to incorporate into the deposit insurance assessment rates the effects of compensation programs that increase risks to the Deposit Insurance Fund.

Financial Regulation Report Issued by Joint Forum

This story appeared in Bank Digest.

National banks have been apprised of a report issued by the Joint Forum entitled Review of the Differentiated Nature and Scope of Financial Regulation—Key Issues and Recommendations. The report’s recommendations address five key areas: differences in regulation across the banking, insurance and securities sectors; supervision and regulation of financial groups; hedge funds; credit default swaps and financial guaranty insurance; and minimum underwriting standards for residential mortgages. Commenting on the report, Comptroller of the Currency and retiring Chair of the Joint Forum John C. Dugan noted that once the report’s recommendations are implemented certain regulatory gaps will be reduced and regulation of the financial system will be strengthened.