Insider Problems Are Indicative of Poor Conclusions On the basis of our analysis of the 175 banks that failed in 1990 and 1991 in which insider problems were identified by FDIC investigators, we found poor bank management and inadequate board oversight were the predominant reasons for the failures. We also found that a pattern of repeated insider violations and noncompliance with enforcement actions are clearly symptomatic of broader management and board failures. In 10 of the 13 relatively healthy banks we reviewed, examiners found insider violations, deficiencies in bank management and boards of directors, and failures of bank management and boards to respond to repeated regulatory criticisms. It is critical that violations and problems are corrected before they jeopardize a bank's financial viability. The correction of these violations and problems is particularly critical because the same problems, although more severe, led to most of the 175 bank failures with insider problems in 1990 and 1991. Chapter 4 The Extent of Insider Lending at Failed and Open Banks FDIC's Professional In pursuit of one of our objectives, we attempted to determine the overall extent of insider lending at failed and open banks. We initially attempted to do this for the 286 banks that failed in 1990 and 1991. We did so by obtaining information on the extent of insider lending from investigators' PCRS and other materials (e.g., loan lists developed by examiners and the minutes from meetings of boards of directors). Because FDIC's database of the assets of failed banks did not allow us to estimate the amount of insider lending at such banks, we attempted to identify manually insider lending at 10 judgmentally selected failed banks. We were able to estimate the amount of insider lending at 8 of these 10 banks. However, because of some uncertainties of the data we do not know if these estimates are valid. For open banks, we used bank call report data to estimate insider lending. These data became available in March 1993. The March data show the aggregate amount of insider lending at all open banks to be $24 billion. A primary function of FDIC investigators is to determine whether there are sufficient sources of recovery to warrant the pursuit of a claim against those responsible after a bank has failed. To fulfill this function, investigators do not necessarily have to develop or have a complete accounting of or comprehensive data on the extent of losses stemming from insider problems. In discussions with senior DOL and Professional Liability Section (PLS) officials, we were told that in most cases, investigators do not treat insider loans differently from loans to others. It is not necessary for investigators to tie losses sustained by the bank directly to insiders or their interests. Instead, investigators need only to establish that it was the management or oversight of the insiders that either led to or failed to avert the bank's losses for PLS to establish grounds for a negligence claim. In pursuing potential claims, DOL works with PLS to establish the extent of losses stemming from the negligence of those involved with the management of a bank. In general, FDIC investigators and attorneys seek to determine at what point those associated with the bank may reasonably have been expected to recognize the deficiencies that led to the bank's losses. For example, a claim against a bank's outside directors may result if the post-failure investigation discloses that a deficiency that was identified in a regulatory examination or bank audit report remained uncorrected and resulted in the bank suffering further losses. The Extent of Insider Lending at Failed and FDIC's Database After determining the primary reasons for a bank's failure, DOL investigators may develop a target loan list consisting of loan losses that stem from deficiencies identified in the bank's lending practices. If, for example, a bank was criticized by its primary regulator for having a loan concentration in commercial real estate development but took no corrective action and later failed, investigators would review the bank's loan losses and compile a target loan list consisting of commercial real estate loans that were extended or renewed after the bank had been criticized for the concentration. If losses were substantial enough, a claim against outside directors may be warranted. The case against the directors is not changed substantially if some of the losses involved insider loans. Therefore, DOL investigators generally do not establish the extent of lending to insiders. After determining that investigators do not often develop complete After numerous attempts by DOL and our staff, we were unable to complete 'Bank Supervision: OCC's Supervision of the Bank of New England Was Not Timely or Forceful (GAO/GGD-91-128, Sept. 1991). The Extent of Insider Lending at Failed and dollars. This amount represented approximately 18 percent of the Madison loans of $10,000 or more listed on LAMIS. As this amount was in line with the level of insider lending activity identified by occ shortly before Madison's failure, we believe our approach resulted in a reasonable estimate of the insider lending activity at this bank. However, the manual manipulations required to come up with this Identifying Insider Until recently, only very limited data on lending to insiders were available. We believed examination reports might also provide data on the extent of insider lending at open banks. In our review of open bank examinations, however, we found examiners generally did not document the extent of lending to insiders. In their review of loans to insiders, examiners typically attempt to identify violations of Regulation O, such as loans with preferential terms. However, unless the amount of lending to insiders is considered a problem, examiners are unlikely to document the extent of insider loans in the examination report. In addition, we attempted to use call report data to estimate the overall level of insider lending. Before March 1993, call reports required banks to report insider lending only for officers and principal shareholders and their related interests but not for directors. As of the March 1993 call report, the requirements were changed so that banks would also report aggregate insider lending to directors. As of March 1993, the aggregate amount of insider lending was reported as $24 billion, with an average 2SEC's definitions for insiders and related interests differs somewhat from those in Regulation O. For example, SEC includes family relationships in its definition of related interests. The Extent of Insider Lending at Failed and The New Requirement May aggregate amount per bank of $2 million within a range of no insider lending to $623 million. Historically, it often takes several reporting cycles for new data to be reliably reported by banks. As banks become more familiar with new call report requirements, future reports should more accurately reflect aggregate insider lending activity. Because of the lack of data on loans to directors in prior call reports, we contacted the organization responsible for requiring changes in the call reports, the Federal Financial Institutions Examination Council, to determine the impetus behind this change. We were told the addition of data on loans to directors was advocated by the Federal Reserve to address changes to Regulation O required under FDICIA. FDICIA established an aggregate lending limit on loans to insiders. It also required directors to adhere to the same individual limit on loans to individuals and their related interests that had previously applied only to executive officers and principal shareholders. The addition of this requirement will make available to regulators and the public the total amount of insider lending at banks if banks accurately report the amounts of loans to officers, directors, and major shareholders. To respond to the new requirement, banks must have or develop systems to collect and maintain this information. Accuracy in call report data is required under provisions 12 U.S.C. 1817 and 12 U.S.C. 161, and banks are instructed to maintain the records needed to generate the figures they provided in the call reports. We further discuss reporting requirements in chapter 5. Conclusions Until recently there was no comprehensive source of data for identifying the total amount of lending to bank insiders. Therefore, we were not able to determine the extent of insider lending for our failed bank analysis. As of March 1993, the aggregate amount of insider lending at open banks was reported as $24 billion. The new requirement for additional reporting of insider lending on call reports has the potential to provide an accounting of all insider loans. However, as a solution, it is dependent on the accuracy of the information reported by banks and the diligence of examiners to ensure accurate bank reporting. Agency Comments and Our Evaluation In its comments on a draft of this report (see app. IX), the Federal Reserve said that our inability to quantify the specific amount of insider lending |