Now for some supervisory lessons
1)Denovo bank charters – too many bank charters have been issued since 2000. Some states, like Georgia, have also had more than their share of new charters. This situation leads banks to fiercely compete for customers by pricing loans and deposits without regard to the cost of the institution to run effectively and adequately provide an acceptable return on equity. Mr. Lockhart also mentions the preponderance of failed institutions that deviated from their approved business plan. He went on to state that “regulators need to be more realistic in our assessment of proposed business plans and less tolerant of deviations from those plans”.
An example of the danger this represents to a young institution is detailed in the Material Loss Review for Hillcrest Bank in Naples, Florida. The institution failed on October 23, 2009, and the review was issued in May 2010. The Audit Results state “Hillcrest failed because it implemented a lending strategy in its first year of operation that resulted in loan concentrations in CRE…..The bank’s lending strategy constituted a deviation from the bank’s original business plan, and this change was not submitted in advance to the FDIC or the OFR for approval.”
When this banking crisis concludes and investors and misplaced bank management look to open a new institution we can expect tighter restrictions on denovo’s. The FDIC already issued enhanced supervisory procedures for newly insured institutions in FIL-50-2009.
2)Forward-looking assessments – this is for me the most interesting take away from this speech. Mr. Lockhart stated that regulators need to “broaden supervision from point-in-time solvency and compliance evaluation to include a more strategic, forward-looking, anticipatory, and holistic evaluation of the bank’s operating mix” and that the Fed is already working on incorporating a “horizontal” approach. I think there are some forward-looking elements currently present in the examination process but the regulators could do a far better job in this area. Regulators have access to the best statistical information available in the marketplace as well as any tool needed to incorporate this information into a “realistic as possible” future scenario for an individual institution or even a group or segment of regional institutions. Stress testing as an exercise will undoubtedly play a key role in risk management practices going forward.