Part 1: Our Muddled Supervisory System

This series of articles won’t primarily be about how we ended up with the current bank dislocation. For the elevator summary, see What Just Happened to the Banking System.

Instead I want to focus on the the following question: Why do we find ourselves in similar situations on an average of about every seven years?

In order to sustain prudent supervision and proper regulation of the banking industry, the institutions that are charged with these duties need to be deconstructed and reformed along clarity of purpose and singularity of mission.

This statement assumes that these overseeing bodies currently aren’t that. Here’s how.

At present there are at least four “agencies” charged with bank overseeing banks:

• The FDIC
• The OCC
• The Federal Reserve
• & The CFPB
• Bonus regulator: The SEC has some regulatory and enforcement powers too, and shouldn’t be completely ignored. (Anyone remember an action against SunTrust for over reserving for loan losses?)

Briefly, each agency’s authority, funding source, and mission breaks down as follows:

• The FDIC insures all the banking system’s insured deposits; but it also has primary federal supervisory authority over state chartered banks that aren’t members of the Federal Reserve system (state nonmember banks). It is funded by deposit insurance assessments and does not charge examination fees. It’s mission is to maintain stability and public confidence in the nation’s financial system.
• The OCC has chartering and primary supervisory authority over National banks (and federal savings associations inherited by the deservedly defunct OTS), which are the largest and most systemically important banks amounting to about 80% of banking assets. It is funded by examination fees, which in aggregate (its budget) rise and fall depending on how many banks have the charters that it supervises. It’s mission statement has gotten more inspirational lately; but it used to be “Ensuring a Safe and Sound Federal Banking System for All Americans”
• The Federal Reserve has supervisory authority for over all BHCs, regardless of whether its subs are national banks, state “member” banks, or state “nonmember” banks. It also has primary Federal supervisory federal supervisory authority over state state member banks (recall the FDIC has the state nonmember banks). I know, it’s hard to keep straight. The Feds’ operations are financed primarily from the interest earned on the securities it acquires in the course of the Federal Reserve’s open market operations and by fees received for services provided to depository institutions such as check clearing, funds transfers, and automated clearinghouse operations, and — oh yea — “supervision fees.” “The Fed’s mission is to foster the stability, integrity, and efficiency of the nation’s monetary, financial, and payment systems so as to promote optimal macroeconomic performance.”

There are interesting things to say about the governance of each agency (interesting to me, at least…which maybe why I struggle at cocktail parties). For now, it’s only important to focus on the FDIC’s. The board of the FDIC consists of a presidential appointment, two members of the party in opposition to the one that appointed its chair, and the head of the OCC and the CFPB (also presidentially appointed positions). Already, on the face of it, this doesn’t sound like an efficient composition; but it’s worse than that.

Recall that recently Jelana McWilliams resigned as Chair of the FDIC because Democrats on the board were trying to pursue an agenda that she contends was off mission and ill-timed. So, there is some suspicion that the political composition of the board may influence its ability to pursue its mission (I’m being charitable).

Maybe even more important, the FDIC also has the authority to conduct special (backup) examination activities for institutions for which is not the primary federal regulator. Under this authority, the FDIC participates in examinations of certain IDIs that present heightened risk to the DIF and designated large, complex IDIs.

The problem with this is that there are a only a limited set of circumstances that allow the FDIC to exercise its backup authority. I can paraphrase these circumstances as roughly equating to, “a problem that is too late to fix has already occurred.”

Otherwise, “to make any special examination of any insured depository institution whenever the authority is limited to when the, “(FDIC) Board determines a special examination of any such depository institution is necessary to determine the condition of such depository institution for insurance purposes.”

Sounds great until you realize that the FDIC Board is rarely at full complement, and when it is, it is inherently conflicted. The point of backup authority is that there are times when others in the supervisory system aren’t doing the job of protecting the FDIC’s interests. Some of these parties are on the FDIC’s board.

In fact, during the GFC, there were a couple of times that the FDIC was prevented from exercising its backup authority.

Stayed tuned for the next installment: The FDIC Has an “Agency” Problem.