Insider Problems Are Indicative of Poor
Management Practices

exceeding loan limits. Further, when examiners cited a bank's failure to maintain records, they were about 2.7 times more likely to cite it for poor and/or negligent management. They also were 2.6 times more likely to cite it for passive and/or negligent boards than when they did not cite the Regulation O violation of failure to maintain records. Finally, when examiners cited a failure to obtain prior board approval, they were about 6.8 times more likely to cite a lack of board expertise than when they did not cite a failure to obtain prior board approval.

Table 3.1: the Likelihood That a Management Problem Is Cited Given That an Insider Violation Is Also Cited

Although the federal examiners cited these banks for insider violations and associated management problems, the banks still failed. On the basis of our analysis, we believe the failure of bank management to correct

'The odds ratios are derived as follows. We calculated the odds of being cited for dominant board member given that loans to insiders exceeding loan limits was also cited (16/66 = 0.24 odds). We then calculated the odds that dominant board member was cited when loans to insiders exceeding loan limits was not cited (5/88 = 0.06 odds). The final result is the ratio of the odds or 0.24/0.06 4.00. The other odds ratios were calculated in a similar manner.

=

Insider Problems Are Indicative of Poor
Management Practices

Negligent Management and
Inadequate Board
Oversight Were the Most
Significant Management
Deficiencies in the 1990 to
1991 Bank Failures

insider violations and problems with insiders indicate much broader problems related to management and inadequate board oversight.

Competent bank management is critical to the successful operation of a bank and must be performed in a manner that will ensure the bank's safety and soundness. According to FDIC's Manual of Examination Policies, the primary responsibility of bank management is to implement in the bank's day-to-day operations the policies and objectives established by the board of directors. FDIC defines the board of directors as the source of all authority and responsibility, including the formulation of sound policies and objectives of the bank, the effective supervision of its affairs, and the promotion of its welfare.

Additional responsibility has been placed on bank directors and officers through the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), which gave regulators additional authority to take enforcement actions against individual bank officers and directors when the gross negligence of those officers and directors threatens the financial safety of the bank. Bank directors and officers can be held personally liable, in certain instances, for their performance.

Our analysis of failed banks shows that both the FDIC investigators and the
federal examiners cited management and board deficiencies as the most
significant factors in the failure of the banks. As shown in table 3.2, the
most common management problems identified by both were a passive
and/or negligent board, loan losses due to lax lending practices, poor
and/or negligent management.

While it is apparent the examiners cited these management problems less
frequently than the FDIC investigators, some of the discrepancy may be due
to the differences in the timing and focus of their respective review
processes. Investigators clearly are to pursue management problems for
financial recoveries. However, bank examiners may be somewhat
reluctant to be critical of bank management and boards, particularly of
those managers and boards who assure examiners of their willingness and
ability to cooperate in addressing bank safety and soundness problems.
We discuss these issues further in chapter 5.

Table 3.2: Management and Insider Problems Cited by FDIC Investigators (Post-Failure) and by Examiners (When the Banks Were Open)

Insider Problems Are Indicative of Poor
Management Practices

Table 3.3: Insider Violations and Management Problems Found in the Open Banks as Identified by Bank Examiners

For example, an examiner cited a bank for poor management because the bank's management team did not provide the bank's board of directors with the necessary management reports about bank operations. Federal examiners also cited the bank's board of directors for inadequate oversight because the board failed to request the same reports from the bank's management.

Insider Problems Are Indicative of Poor
Management Practices

In another example, the examiners stated in an examination report that
the board of directors lacked an active involvement in the supervision of
the bank. In this case, the federal examiner identified 17 areas where the
board's attention was needed to evaluate or incorporate existing
committees or policies in its overall supervision of the bank. One of the
areas needing the board's attention was the development of and adherence
to an insider compliance program.

Problems of poor management and inadequate board oversight are not explicitly violations of banking laws and regulations; however, safety and soundness problems are and, therefore, federal examiners can take enforcement actions to compel bank management and directors to address potential safety and soundness problems. It is critical that a bank's management and board of directors work together as a team to ensure the financial viability of the bank.

Examiners Expressed
Concern Regarding Poor
Management-Related
Practices in Open Banks
With Insider Violations

From our review of examination reports for the 13 open and relatively healthy banks, we found instances when examiners expressed concern that poor management practices could lead to certain insider problems and/or insider violations. We found two banks where the examiners expressed concern over the banks' insufficient policies relating to loans to insiders and inadequate monitoring of insider activities. For example, in one of the banks, examiners found that the bank's internal controls to ensure the accuracy of the Regulation O recordkeeping requirements for loans to insiders needed to be improved. On the basis of his review of the bank's system, the examiner determined that the system did not account for insider loans from overdraft protection or installment loans. This bank had been previously cited for other Regulation O violations.

In another examination report, examiners expressed a concern over the interaction of a bank's management with two other banks. The examiner cited these relationships as having the potential for Regulation O violations and a possible conflict of interest involving a director and his business interests. However, no Regulation O violations were cited. In another example, an examiner found one bank with a tradition of lending money based on borrowers' character. The examiner determined that insider abuse could easily occur at this bank because of such lax lending practices. In all of the examples we have discussed, the examiners identified problems with management and board oversight and the potential for insider violations.