The CHAIRMAN. Did you want to add anything, Mr. Sinclair? Mr. SINCLAIR. No. I will be glad to answer any questions you might have.

The CHAIRMAN. Very good. What day is today? March 26, 1976. It's a day that will live in memory, in my memory, for a long time. I think this is the first time I can recall that the American Bankers Association has supported legislation which can be viewed as, in a sense, against their interests, that is, restrictive. You supported SBIC legislation which, of course, was very helpful to banks and supported legislation limiting State taxation of banks, but I don't mean to be critical of the ABA because I think this time you have come up with a very good and sound position, although you obviously have, as you would expect, some concern about the degree to which this would have a restrictive effect, and I think you have made some very helpful points.

I think if we wrote into the law all of your proposals we might have a problem with an effective bill providing full enforcement. The committee should certainly debate it and you have made a fine record on it.

Let me ask you about this insider loan problem which I think you have properly pointed to as one that is a problem, however you look at it. You recommend a liberalization of section 23A which restricts loan transactions between a bank and its affiliates. Don't we need a restriction in the ability of banks to fund activities of their affiliates? For example, I understand that the principal reason for the failure of the Hamilton National Bank recently were transactions between a holding company affiliate and the lead bank in the holding company. Another example is the Federal Reserve takes the position that 23A does not even apply to the swap transactions between a holding company advised REIT and the bank subsidiary of the holding

company.

Don't we need restrictions in the ability of a bank to fund activities of their affiliates?

Mr. TERRY. We already have restrictions in both the Federal Reserve Act as well as the Board's regulations concerning loan transactions between banks and their affiliates. What we refer to in our testimony are the transactions between affiliated banks of a bank holding company. Section 23A serves to force a bank holding company, which is a system of related banks, to go outside of its own system in order to efficiently use the excess funds and securities generated in any one of the banks. In other words, under existing law, we are unduly restricted in two areas, Federal funds transactions between affiliated banks and the pledging of securities.

The CHAIRMAN. How much of a handicap is that?

Mr. TERRY. First, it's an operational handicap, because it doesn't permit the most efficient utilization of affiliated bank funds and securities. But also it's a problem that could conceivably lead to some unsound banking practices because there are other ways to avoid the problem, for example, the shifting of assets from one bank to another as a means of balancing excess cash in one against a cash deficit in the other. I think the use of Federal funds would be much simpler and less risky and much more easily measurable way of managing the cash positions of various affiliated banks and a holding company.

The CHAIRMAN. Mr. Sinclair, in the statement that we have from you you say that the committee should give consideration to the interest of the primary supervisors from the State chartered banks. Do you have any specific recommendations in this regard for strengthening the dual banking system?

Mr. SINCLAIR. Mr. Chairman, with your permission, I'd like Mr. Terry to respond.

The CHAIRMAN. All right. Let me come back to Mr. Terry on that one. Do you want me to repeat the question?

Mr. TERRY. Please; if you would.

The CHAIRMAN. You say the committee should give consideration to the interest of the primary supervisors of the State-chartered banks. Do you have any specific recommendations in this regard for strengthening the dual banking system, for strengthening the State examiners, giving them more authority?

Mr. TERRY. Not specifically; while I can only speak for Tennessee and not try to globalize on the other 49 States, but in Tennessee we have a very effective State banking department and I don't think that anything is currently needed from the Federal level to either strengthen or improve it.

The CHAIRMAN. Let me see if I understand. What was the reason that you pointed out that we should give consideration to the interests of the primary supervisors of State-chartered banks?

Mr. TERRY. Simply to insure that in the interpretation of S. 2304 the wording of the bill recognizes that, whatever rights are given to Federal regulatory agencies under this bill, they would not totally usurp the present rights and responsibilities of State bank commissions in their role as the primary supervisor of State-chartered banks. The CHAIRMAN. You feel that the bill needs specific language to safeguard that State authority?

Mr. TERRY. No; Mr. Chairman, we are only trying to encourage the committee in its wording to recognize this and take care that the language could not be interpreted as usurping the basic authority of the States over State-chartered banks.

The CHAIRMAN. All right. Then, Mr. Sinclair, do you want to comment?

Mr. SINCLAIR. Well, I wanted to comment about the bank-director situation in a smaller town.

The CHAIRMAN. Yes. We'd like advice on that. You probably have experience as a vice president of the Salem bank.

Mr. SINCLAIR. I think the loan and aggregation provisions of S. 2304 probably affect directors much more so than officers because, as you pointed out, executive officers are already restricted from borrowing from their banks. But in a survey of our area I found that in very small towns, say less than 1,500 people, it really wouldn't present too much of a problem because there outside bank directors tend not to have large outside credit demands. But in towns, say from 2,500 or so up to 50,000 the proposal would be a problem. As a result, I think it would unduly restrict the choice of directors which would impose hardships on the banks.

The CHAIRMAN. Well, it would change it and maybe it would make a hardship, but let's think about that for a minute. I'm thinking of a town in Wisconsin of about 10,000 and there are two or three very

successful businessmen there who have some holdings and undoubtedly are the principal borrowers from the bank. Supposing those men would not serve as directors. Why would that make the quality of the bank's performance any less? Wouldn't it be possible to get other people in the community who perhaps didn't have the same wealth or the same substantial business experience who might be helpful too? What I'm concerned about is that you're buying a degree of success, all right, but that may not because you can sell farm implements, for example, or because you can operate and manufacture fishing rods doesn't necessarily mean that you can give sound advice as a director of a bank. It doesn't mean that you can't; but it doesn't mean that you could. I just haven't been convinced as yet that this kind of limitation would seriously handicap the banks. I'm inclined to support Governor Holland's view. He thinks this would be an insignificant handicap. Maybe I'm wrong.

Mr. SINCLAIR. Well, Senator, It's been my experience that when looking around in a small community for people who can serve on a bank board and really give sound business judgment and advice, it's generally the sparkplugs in the community, the people who are innovative and that initiate projects. In numbers they are usually limited, very limited. And, I know in our own case under the proposed limitations we would undoubtedly lose a couple of good directors.

The CHAIRMAN. Well, in your experience as a bank officer, you really find that these fellows are that vital-that their advice is that essential?

Mr. SINCLAIR. I certainly do, Mr. Chairman.

The CHAIRMAN. I can see why it's good business. If you get a director he's more likely to borrow from you than go to the next town and borrow from them.

Mr. SINCLAIR. And, in small towns, its not an easy chore to go from one town to another to borrow. It's pretty hard to do in a lot of cases.

In addition, to speculate, I wonder how many projects-for instance in a case where a director started a subdivision development in our area and his combined loans would have put him over the limit, even though it was a separate corporation-in many cases I doubt if you had these restrictions, we would ever have had that subdivision started.

The CHAIRMAN. Now that's the kind of thing that has me a little concerned. It's kind of a REIT, a subdivision development, a real estate operator. Wouldn't it be better if you were dealing at arm's length? The banks have gotten into so much trouble with those things. Wouldn't it be better if your subdivision developer were not a director of the bank and the bank would, it seems to me, in most circumstances, more likely to cut him off if he got out of line.

Mr. SINCLAIR. Perhaps, but then you probably wouldn't have the subdivision; people wouldn't have some badly needed houses or jobs they really need, because he probably wouldn't have access to the funds.

The CHAIRMAN. If he's got a good proposition, I don't know why the bank wouldn't be just as anxious to lend to him if he's a director

or not.

Mr. SINCLAIR. Exactly, that's what I mean. He would have the choice of either going ahead with his project or, if he valued his seat

4

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on the bank board, which most directors do, simply forget development of the subdivision.

The CHAIRMAN. I see what you mean. Here you have a man that's director of a bank who's a man of substance and he's interested in developing housing in the community and he has a choice of either-if he's going to borrow substantially above the limitation we have in the bill here, he has the choice of getting off the board and developing his project or staying on the board and forgetting the project. Mr. SINCLAIR. That's right.

The CHAIRMAN. That's a good point. Would you then support the two-thirds provision of the Comptroller as a substitute? What he suggested in 1917 was that he would require a two-thirds vote if an insider should borrow money-two-thirds vote of the directors, instead of a majority vote.

Mr. SINCLAIR. Rather than have an absolute limitation, I would prefer the two-thirds approval requirement, because if a loan application can't stand up under a two-thirds vote, then I'd say it was questionable anyway. If you didn't have the limitation but you impose the two-thirds vote requirement, I wouldn't see any objection. Could I make an additional comment?

The CHAIRMAN. Yes.

Mr. SINCLAIR. Mr. Chairman, I'm sure you're aware, based on your observation of banks, that the bank management in many cases helps pick out proposed directors. So I'm wondering if in some of the failed banks, even if the proposed limitations were in place would they have solved the problem? It seems to me that where you have dishonest management, they tend to pick directors that are going to go along with things, and if this avenue is sealed I'm just wondering if they wouldn't find some other route to go. I'm just questioning whether imposing this penalty on the honest people, the people who are trying to do a good job in the small towns of America, would really stop the dishonesty that's occurred in just a few isolated

instances.

The CHAIRMAN. I'm not sure that I follow you. I asked the advice of the staff on that. Are you saying the bank management should not have any input in the selection of directors? Obviously not.

Mr. SINCLAIR. What I was trying to point out is I'm not sure putting all these restrictions on directors would help solve what I think you're trying to solve, and that's the insider transactions that would cause a bank to fail.

The CHAIRMAN. Well, in view of the fact that about half the failures have been the result of these, what would you suggest? Do you just think the actions taken by the FDIC to date are enough?

Mr. SINCLAIR. I think that the recent actions taken by both the Comptroller and the FDIC in adopting insider regulations should go a long way to curbing any problems. I think these regulatory actions should at least be tried before stringent legislation is put into effect. The CHAIRMAN. Would that have prevented the San Diego bank failure?

Mr. SINCLAIR. I'm not that familiar with the San Diego situation. It's a lot different situation and climate than we are out in Salem. THE CHAIRMAN. Well, thank you gentlemen very, very much. Mr. TERRY. I have one matter for the record, Mr. Chairman.

Today the atmosphere in the board room of a bank, I believe, is changed considerably from several years ago. There's a lack of that club atmosphere today. Bank directors are aware of their obligations as they have never been before because of the responsibility, liability, and duty that's placed on them in serving as a bank director.

I think that we need to take great caution in the industry to see that we preserve this source of talent for our banks and one of the requirements that I found our directors want today is that we not surround them with incompetent people on the board. They want to share the responsibility of being a bank director with equally competent people, and I think that we, in terms of public policy, certainly have a trade-off between recognizing the abuses of a handful of bank directors and the great contribution to bank safety, and depositors' safety, made by the vast majority of bank directors serving in the United States on the boards of our 14,000 banks.

For that reason, I would urge the committee that, based on the actions of a few, we not make service as a bank director so restrictive that one day we find ourselves with a new level of mediocrity sitting on the boards of our banks.

The CHAIRMAN. How do we get them to take action in cases where they need it? You say that you want to eradicate the dishonest people and prevent the kind of mistakes that were made in the past.

Mr. TERRY. I think you have properly given cease and desist powers to the regulators and now in S. 2304 you're giving them the additional flexibility they need to make cease and desist and other supervisory tools work.

The CHAIRMAN. They have had that since 1966 and we have had four of the biggest failures in our history and we have had a number of other failures in the last few years, and the situation with problem banks is developing.

M. TERRY. If my memory serves me, the regulators—at least the Federal Reserve in the bank holding company area have had cease and desist powers for only about 1 year and after passage of S. 2304, we will have a very effective remedy for dealing with problems-or potential problems-situations.

The CHAIRMAN. All right, sir. Once again, thank you very, very much. I want to again commend you on your constructive support of the bill.

Mr. TERRY. Thank you, Mr. Chairman.

[Whereupon, at 12:10 p.m., the hearing was adjourned.]