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Average interest rates on loans to these insiders were below the average prime rate in periods of tight money and rapidly changing prime rates. Those would be 1970, 1973, 1974, and the early part of 1975.

The State-by-State comparison reveals that banks in Texas, Oklahoma, Illinois, Florida, Missouri, Tennessee, and Minnesota, none of which permit statewide branching, had the most loans and the largest dollar volume of loans to insiders of other banks.

Three-quarters of the banks reported outstanding loan balances to their own insiders, their business interests, and their families. These loans amounted to just over $10 billion which was about 2 percent of the total loans of all the insured commercial banks as of September 30, 1977. Most of these loans, I think about 80-odd percent, were to directors and their interests.

Similar to the results reported for loans to insiders of other banks, the average interest rate charged on fixed rate loans to insiders of the reporting banks was below the average prime rate during 1970 and 1973 and 1974 and, again, State-by-State comparison indicates that banks in Texas had the greatest concentration of loans to their own insiders.

Survey data on overdrafts indicated that the daily average dollar volume of overdrafts during September was $1.9 billion and the average daily number of overdrafts was 2 million. The amount of the average overdraft ranged from $248 at the smallest banks to $2,239 at the banks with $1 billion to $5 billion in assets. Twothirds of the reporting banks had no overdrafts to their own insiders during this 9-month period and 90 percent reported no overdrafts to insiders of other banks or to public officials. For those banks reporting large overdrafts, about 90 percent did not impose an interest charge. The percentage of overdrafts of insiders of the reporting banks that were charged interest increased with the size of the overdraft. No similar relationship can be observed for the overdrafts of insiders of other banks or public officials.

However, in cases where no interest charge was reported a fee may have been charged.

So far we have contacted by telephone 130 of the 191 banks reporting overdrafts of over $100,000. The telephone contacts revealed that 103 of these banks should not have been included in this survey, largely because of reporting errors or because the overdrafts reported were not really overdrafts. Of these 103 banks' overdrafts, 38 were covered before the midnight deadline, close of business deadline, covered by transfers from other accounts in the bank, resulted from delays in disbursing proceeds from loans that were already approved or resulted from computer error, and 65 reported, contrary to survey instructions, overdrafts of corporate interests of bank insiders. Only in 6 of the 130 banks contacted did the overdraft appear to involve abusive conduct. Even though the survey focused on the longest overdraft, about half of these overdrafts to insiders were cleared in 5 days or less. A smaller proportion of overdrafts to public officials were cleared in the same period. On the other hand, about 6 percent of the longest overdrafts to insiders had durations of more than 50 days, compared to 13 percent for those of public officials.

Finally, the survey results indicated that banks always or frequently waive overdraft fees for their own customers more often than they did for insiders of other banks and much more often than they did for public officials.

Now that concludes my summary of the statement by the staff and if I may I'd now like to get to some recommendations on proposed action that we have taken.

The FDIC plans to follow up on the survey results by identifying each State nonmember bank which reported anything in the survey that implies a possible abusive practice with respect to loans secured by the stock of other banks or bank holding companies or in loans to insiders of the lending bank or loans to insiders of other banks and overdrafts to insiders of the bank and insiders of other banks and to public officials. A list of these banks will be forwarded to the appropriate regional office with instructions to take whatever steps are necessary to determine whether the bank has in fact engaged in or is engaging in any of these practices. This list will include all those State nonmember banks identified in the survey which extended credit to their own insiders at rates of interest clearly below the average prime rate. The list will also include those banks on both ends of stock loan transactions which involve low interest rates and a demand deposit placed in the lending bank by the bank whose stock secured the loan.

In addition, in those cases where abusive practices exist, regional offices will be instructed to point out to the bank how correction can be and should be effected and then to insure that the correction is taken, and if necessary, formal enforcement action will be instituted to achieve that correction.

I would like to emphasize that the FDIC is now and has been deeply concerned about and responds vigorously to overreaching and abusive conduct by bank insiders. Although I do not believe that the data from the survey indicate basic weaknesses in the bank regulatory structure, I do believe that the law and public policy must evolve with the pace of changing times and events. To underscore that fact and the fact that we do intend to stick strictly to the existing framework in appropriate regulation we published on January 30 this year proposed amendments to our regulations dealing with insider transactions. Those regulations became effective May 30, 1976. Included in these proposed amendments are several substantive changes.

First, a new provision specifying that the FDIC will not tolerate any insider transaction that affords preferential treatment to an insider or person related to an insider that results in an economic detriment to the bank. The pu pose of that obviously is to make it clear that the approval by the bank board of directors does not legitimatize what would otherwise be an unsafe and unsound operation.

Second, a new provision would be added relating specifically to correspondent accounts. Each insider would be required to report in writing to the bank's board of directors all extensions of credit that are made by a financial institution with which the bank maintains a correspondent account and made for the purpose of enabling the insider to purchase carry or own a beneficial interest in securities issued by the bank or by its holding company or by

any other insured bank or holding company. The bank's board would be required to review at least annually all of the bank's correspondent accounts with other financial institutions to insure that these accounts are fair and in the best interest of the bank. As I testified before in support of S. 71, I do support the passage of certain amendments to the statutory powers of the Federal agencies, the most important of which I consider to be S. 71. Our cease and desist power under section 8(b) of the Federal Deposit Insurance Corporation Act would be much more effective, in my opinion, if it could be used directly against individuals or an individual who is responsible for the commission of the abusive practice.

I also favor the civil penalty provisions that are contained in S. 71, particularly the provision which authorizes the imposition of a monetary penalty against individuals and banks for the violation of a final cease and desist order.

Another desirable legislative provision is one which would allow the three Federal bank regulatory agencies to disapprove changes in bank control on the basis of standards expressed in the statute. Although I assume the power to disapprove changes in control would be used sparingly, this type of legislation, if properly employed, would enable the agencies to anticipate and avoid problems which at present they can only react to.

In summary, I would suggest that the most pressing legislative need at the moment is the passage of S. 71 which would significantly buttress the enforcement powers now held by the agencies. Thank you, Mr. Chairman.

[Complete statement follows:]



Mr. Chairman, I welcome the opportunity to provide my own comments and evaluation of the results of the survey on bank stock loans, loans to officials and major stockholders of other banks, loans to insiders of reporting banks and overdrafts. The survey represents a substantial undertaking by the federal banking agencies, and one which I feel provides some valuable insights into the dimensions and characteristics of insider lending and overdraft policies of commercial banks. I would like to summarize a few of the highlights. Only 902 insured commercial banks, 6.4 percent of all reporting banks, had loans secured by bank stock on their books as of September 30, 1977. A smaller percentage (4.2 percent) of insured nonmember banks reported bank stock loans. The survey revealed that bank stock lending is concentrated principally in unit banking states in the southwestern and central regions of the country. This is consistent with legitimate and understandable motives for borrowing to purchase bank stock. Unit banking States are generally characterized by a relatively large number of small banks. The ability to borrow against bank stock, with the stock serving as collateral, facilitates acquisition of an equity interest in local banks by small investors. Thus, the vehicle of bank stock lending helps preserve smaller, locally owned, independent institutions and thereby prevents further concentration of banking resources. In addition, by providing a source of liquidity to stockholders in small banks, bank stock loans more readily facilitate changes in ownership to bring new management to banks when necessary. While recognizing that there are benefits associated with bank stock lending, such loans also pose a potential for mischief and insider abuse. The insider abuse most commonly associated with bank stock loans involves the use of correspondent balances to compensate the correspondent bank for a loan extended on preferential terms to an insider of the depositing bank and which results in an economic detriment to that bank. To determine whether widespread abuses currently exist in bank stock lending, it is necessary to examine all the lending terms of stock loans in each time period. Comparisons between interest rates charged on the loans and the average prime rates during the year of the loan origination provide some indication

of the magnitude of preferential treatment extended to insiders of other banks in connection with bank stock loans. The survey showed that, since 1969, 7.4 percent of reported stock loans was made below the average prime rate. Moreover, since 1975, when most of these loans were made, the proportion was 1.9 percent.

The survey also showed that when a bank has a correspondent relationship with an institution whose stock is pledged by the borrower, the average size of the loan is larger and the interest rate charged is somewhat lower than when no correspondent relationship exists. However, it is not possible to conclude whether there are abuses of correspondent relationships without examining other information such as the timing of the establishment of the correspondent relationship and whether the amount of correspondent balances held are commensurate with the services provided. However, on balance, the survey data do not indicate to me that such abuses as may exist in bank stock lending are widespread in the banking system.

In my testimony before this committee on September 26, 1977, I commented on the extent of abuses relating to bank stock loans in insured nonmember banks. My remarks were based on a sample investigation of examination reports and a survey of banks under examination at that time. Because we found that only six banks out of 303, or 2 percent, demonstrated preferential practices involving correspondent balances, I concluded that such abuses may be an isolated phenomenon. The data from this larger, more complete survey reveals that 10 percent of the bank stock loans of nonmember institutions made to insiders of other banks was made at interest rates clearly below the average prime rate during the period of loan origination. The loans making up this 10 percent were extended both with and without a correspondent relationship. This additional evidence seems to support my earlier conclusion that correspondent abuses associated with bank stock lending, although perhaps greater than I suspected earlier, are not prevalent among insured nonmember banks.

It is important to bear in mind that abuses related to correspondent relationships are not limited to those abuses arising out of bank stock lending. The survey data provide some evidence of a link between insider lending in general and correspondent banking, that it, a pattern of systematically lower interest rates prevail on loans to insiders of other banks when the other bank has a correspondent relationship with the lending bank. This pattern holds true for state member, national and state nonmember banks.

Most of the fixed-rate loans to insiders of other banks with rates below the average prime rate were made during periods characterized by tight money and rapidly changing interest rates (1970, 1973, 1974, and the first half of 1975). Under conditions of great uncertainty, such as occurred during these periods, it might not have been unreasonable to make short-term loans at rates below prime to individuals with whom the lending bank has had business dealings for a long time. Nevertheless, special circumstances would still have to be demonstrated to satisfy me that preferential treatment did not exist in such cases. I might add that State nonmember banks charged higher rates (both fixed and floating rates) on loans to insiders over the time period of the survey than the national average as reported in the survey. This was true regardless of whether correspondent balances were maintained at the lending institution.

Overall, I find that the survey tables provide interesting and relevant, although as I have stated, incomplete information on insider lending. Because of the special caveats mentioned in the joint agency report, information in the portion of the survey dealing with overdrafts is not as revealing. What is apparent to me is that the volume of overdrafts is greater than I would have expected. Banks reported a daily average of 2 million overdrafts amounting to a daily average of approximately $1.9 billion. Based on 1976 estimates of the number and dollar volume of checks debited to the accounts of individuals and businesses, overdrafts represented 2 percent of the number but 13 percent of the dollar volume of daily checks. For reasons mentioned below, these figures may not reflect fairly the actual extent of overdraft.

In my September 26, 1977 testimony before this committee, I reported that of the 189 nonmember banks that were examined during the week beginning September 12, 1977, approximately 64 percent recorded overdrafts of insiders during the 90-day period preceding the examination date. By comparison, in the survey under discussion, about 44 percent of the 8,580 State nonmember banks reported overdrafts over $500, including 2,706 banks (31 percent) with overdrafts of their own insiders, 368 (4 percent) with overdrafts of insiders of other banks, and 735 (9 percent) with overdrafts of public officials. The larger overall percentage of banks in the 189 sample of state nonmember banks reporting overdrafts occurred because overdrafts of under $500 were included. Nevertheless, the percentage of nonmember banks reporting

overdrafts of insiders of other banks and public officials were about the same in both surveys.

Although overdrafts are permitted by a large percentage of banks, abuse or violations of law are not widespread. In our review of overdraft practices from a survey of 261 bank examination reports which we conducted last fall, we discovered that examiners criticize approximately 3 percent of all insured state nonmember banks for bank insider overdraft abuses. Furthermore, we noted that most overdrafts are not criticized because the insiders' accounts are seldom overdrawn for more than a few days, and overdrafts occur infrequently. Overdrafts that are substantial or persist over time are criticized in the examination report as a matter of course.

It is not possible to compare the size, duration and frequency of overdrafts on an individual basis from data reported in the survey tables. For this reason I am skeptical about how meaningful data in table 5A showing a substantial number of banks with large, free overdrafts of insiders are in addressing the question of overdraft abuses. Similarly, table 7, which appears to show a policy of leniency with regard to waiving fees and charges to insiders of the bank on their overdrafts, does not take account of the relationship between size and frequency of overdrafts for each person and the fee policy imposed. However, no real sense of the extent of potential abuses relating to overdrafts is possible without comparing bank overdraft policies for insiders and others. Such an inquiry extends beyond the scope of the special survey. These and other matters related to the survey will be explored by examiners. Examination procedures and the report of examination will be reviewed in light of the survey to determine what changes should be undertaken.


The issue of what constitutes abuse by insiders of their relationship with their financial institution evokes some disagreement. My own view and the predominant one at the FDIC is that insider conduct is abusive and constitutes an unsafe or unsound banking practice when an insider obtains a benefit which is not available to a noninsider otherwise similarly situated and which results in an economic detriment to the bank. Where a bank's board tolerates abusive conduct, unquestionably firm supervisory action should be taken. As the Supreme Court has stated, the broad visitational power of federal bank examiners is perhaps the most effective weapon of federal regulation of banking (see United States v. Philadelphia National Bank, 374 U.S. 321, 329 (1965)).

I would like to outline some of the steps that the FDIC has taken, and anticipates taking, to follow up on possible abusive practices indicated by the survey data. As a first step, the Corporation, in conjunction with the Comptroller of the Currency and the Federal Reserve System, undertook a telephone survey of those banks that reported large overdrafts. This was done because of the information gaps on overdrafts in the survey as was indicated in the joint agency staff report.

Originally, it was planned to contact all those banks that reported overdrafts of $50,000 and above. However, because of time constraints, the telephone calls actually made were limited to those banks reporting overdrafts of $100,000 or more. Of the 191 banks reporting such overdrafts, 130 were contacted.

Overall, the results of the telephone followup show that 102 of the 130 banks should not have been included in the survey on overdrafts, largely because of reporting errors or because the overdrafts reported were not, in my judgment, overdrafts.

Of the 130 banks contacted, 38 either had no exposure because the overdraft was covered in a timely fashion or because the bank was never obligated to pay the overdraft. It should be kept in mind that, in virtually every state, banks by statute, clearing house rule, or agreement have a certain period of time to return or dishonor a demand item without incurring a legal obligation to pay it. In 20 of the 38 banks, the facts ascertained from the telephone survey indicated that the overdrafts reported were covered within the generally accepted time frame in which the bank could have returned the item. This time frame is usually referred to as the "midnight deadline." Thus, the 20 banks were apparently never legally obligated to pay the overdrafts reported. In any event, even if they could be considered overdrafts, in all 20 cases they were outstanding only one day.

Of the remaining 18 banks, overdrafts in eight were covered by timely transfers from other bank accounts in the reporting bank, but were reported as overdrafts because of delays in posting the deposit to the customer's checking accounts; overdrafts in eight were the result of delays in disbursing loan proceeds of a prior already approved loan to the customer's checking account; and overdrafts in two

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