Supervisory and examination procedures today show evidence of lessons learned from the bank and thrift crises of the 1980s and early 1990s. These procedures are the primary basis used by the federal regulatory agencies to assess the risks that banks and thrifts assume and to take actions that are needed to maintain a safe and sound banking system and protect the deposit insurance funds. Excessive Regulatory Forbearance Contributed to Problems of Thrifts and Banks and Insurance Fund Losses

Banks and thrifts failed during the 1980s for several reasons. The second law, the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), was enacted, in part, because of concerns that the exercise of regulatory discretion during the 1980s did not adequately protect the safety and soundness of the banking system or minimize insurance fund losses. FDICIA contains several safety and soundness provisions based on a simple principle: if a depository institution fails to operate in a safe and sound manner, it should be subject to timely and forceful supervisory response, including, if necessary, prompt closure. FDICIA mandates annual on-site examinations of insured banks and thrifts. However, section 39, as implemented, appears to do little to reduce regulatory discretion. Insufficient review of loan quality and loan loss reserves: Effective loan quality assessment is important, because loans generally make up the majority of bank and thrift assets and involve the greatest risk. Regulators Have Made Significant Efforts to Improve Examinations

Regulators have made a number of changes in an effort to improve their examinations since the bank and thrift crises of the late 1980s, and I would like to highlight some that seem most significant. A Changing Banking Environment Has Prompted Greater Emphasis on Risk Management and Internal Controls

One of the most significant efforts at improvement involves changes in examinations to account for a dynamic banking environment in which institutions can rapidly reposition their portfolio risk exposures. Examiners were instructed in 1996 to give greater emphasis to the adequacy of an institution’s risk management processes, including its internal controls when evaluating management under the CAMEL system. In our report on the operations of foreign bank organizations in the United States, we noted deficiencies in the internal controls of these organizations.
Why GAO Did This Study

GAO discussed bank and thrift supervision and examination.

What GAO Found

GAO noted that: (1) bank supervision and examination today show evidence of lessons learned from the bank and thrift crises of the 1980s and early 1990s; (2) these procedures are the primary basis for federal regulatory agencies to assess the risks that banks and thrifts assume and to take actions to maintain a safe and sound banking system and protect deposit insurance funds; (3) one critical lesson of the earlier crises was that excessive regulatory forbearance contributed to the extent of the crises; (4) the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) based regulatory practices on a simple principle: if a depository institution fails to operate in a safe and sound manner, it should be subject to timely and forceful supervisory response, including, if necessary, prompt closure; (5) FDICIA also required that banks reform their corporate governance and accounting practices and that the regulatory agencies improve their supervision of insured banks and thrifts; (6) in a November 1996 report, however, GAO noted that questions remain about the effectiveness of FDICIA's trip-wire provisions which are intended to limit regulatory discretion; (7) as implemented, the trip-wire that enables regulatory action at the early stage of problems in a bank does little to limit regulatory discretion; (8) in several reports in the early 1990s, GAO also noted limitations in the safety and soundness examinations conducted by the regulatory agencies; (9) the limitations included a lack of comprehensive internal control assessments, insufficient review of loan quality and loan loss reserves, weaknesses related to insider lending, and insufficient assessment of bank subsidiaries; (10) regulators have made a number of changes in an effort to improve their examinations; (11) the changes respond, in part, to the dynamic banking environment in which institutions can rapidly reposition risk exposures; (12) to ensure that banks and thrifts have the managerial ability and internal control structure to effectively manage risk, the examination process is evolving to put greater emphasis on risk management and internal controls; and (13) in its recent report on foreign banking organizations operating in the United States, GAO noted that regulators have begun to put greater emphasis on risk management processes and operational controls in examinations of these organizations.