Examination and Supervision of the US Dual Banking System

Introduction to the Dual Banking System and Supervision

• Speaker Profile: Tommy Gatlin

  • Affiliation: Tommy Gatlin works with the Office of the Commissioner of Banks in North Carolina ($NCCoB$).
  • Experience: He has been with the commission for approximately $17$ years. He started as a loan reviewer and served as a team supervisor for a couple of years. He has held his current role as a review examiner for about one year.
  • Professional Background: Prior to joining the regulatory side, Gatlin worked in the banking industry for $10$ years. His previous employers include the old Wachovia Bank, First Union Bank, and Centura Bank.

• Definition of the Dual Banking System

  • Core Meaning: In the United States, the banking system is "dual" because banks are regulated by two sets of authorities: federal regulators and state regulators.
  • Choice of Charter: Banks have the autonomy to choose which charter to pursue. This decision is made by bank management, not the regulators.

The Three Federal Regulatory Agencies

• Office of the Comptroller of the Currency ($OCC$)

  • Role: The primary and only regulator for nationally chartered banks.
  • Exclusivity: The $OCC$ is not involved in the regulation of state-chartered banks.

• Federal Reserve Bank ($FRB$)

  • Role: Acts as a primary federal regulator for certain state-chartered banks that choose to be members of the Federal Reserve System.

• Federal Deposit Insurance Corporation ($FDIC$)

  • Dual Role: The $FDIC$ acts as an insurance company for deposits and also serves as a regulatory agency. For the majority of state-chartered banks in North Carolina, the $FDIC$ is the primary federal regulator.

State Regulatory Authorities

• Every state has its own regulatory agency, though names vary:
  • North Carolina: North Carolina Office of the Commissioner of Banks.
  • Tennessee: Department of Financial Institutions.
  • South Carolina: Office of the Commissioner of Banking.
  • Virginia: Bureau of Financial Institutions.
• Reciprocity and Jurisdiction:
  • Banks are regulated by the state where they are chartered. For example, Pinnacle Bank is chartered in Tennessee; therefore, the Tennessee regulator oversees them, even if they operate branches in North Carolina.
  • States often have agreements to facilitate cross-state business, but one state's regulator generally will not oversee another state’s bank.

National vs. State Charters

• National Banks:
  • Regulated exclusively by federal law and the $OCC$.
  • Often exempt from certain state-specific laws, which can make branching across state lines easier if the $OCC$ approves.
• State-Chartered Banks:
  • Regulated by both state law/regulators and a primary federal regulator (either the $FDIC$ or the $FRB$).
  • Advantage: Access to regulators who are geographically closer to the bank’s operations.
• Size Misconceptions:
  • A bank does not need to be large to be a national bank, nor small to be state-chartered.
  • As of March $31$, $9$ of the largest $25$ banks in the country were state-chartered.
  • $3$ of the $10$ largest banks in the country are state-chartered (e.g., Truist is chartered in North Carolina).
  • Small savings banks are often nationally chartered; size is not a dictating factor for the charter type.

Rationale for Heavy Bank Regulation

• Protection of Public Funds: Banks deal with people's money. Ensuring safety is paramount to maintaining economic stability.
• Economic Stability: The flow of money and public access to it is crucial for U.S. economic stability.
• Public Confidence: The banking system requires public trust to function. If people lack confidence, they will not deposit money, which prevents banks from lending.
• Conduit for Monetary Policy: The Federal Reserve ($FRB$) uses banks to implement monetary policy (promoting maximum employment, stable prices, and moderate long-term interest rates). Banks act as the conduit by reflecting interest rate changes in the market.
• $FDIC$ Insurance Requirements: To qualify for federal deposit insurance, banks must prove they are financially healthy to minimize potential losses to the insurer.

The Federal Deposit Insurance Corporation ($FDIC$)

• Historical Context: Created in $1933$ during the Great Depression to restore trust in the banking system.
• Insurance Limit: The standard insurance amount is currently $250,000$ per depositor. This limit was increased from $100,000$ in $2008$ during the financial crisis, initially as a temporary measure before becoming permanent.
• Exceptions: Most states require $FDIC$ insurance, but there are rare exceptions. The Bank of North Dakota is state-run and insured by the state of North Dakota rather than the $FDIC$.

The Supervision Program Structure

• 1. Off-Site Analysis and Monitoring:

  • Continuous Process: Performed regularly using several data tools.
  • Call Reports: Quarterly financial submissions including balance sheets, income statements, and schedules of assets/liabilities.
  • Uniform Bank Performance Report ($UBPR$): A tool that summarizes quarterly data into usable formats, performing ratio analysis on loan categories, past-due percentages, and income.
  • $SELF$ Evaluation Program (North Carolina): A monthly submission of financial info, less detailed than call reports, used to identify "red flags" via green, yellow, or red status indicators.
  • Other Inputs: $SEC$ filings, management changes (upper management and board members), and strategy shifts.

• 2. Risk-Focused Examinations:

  • Definition: Focuses on how management identifies, measures, aggregates, monitors, and attempts to control risk.
  • Types of Exams:
    • Safety and Soundness (Full Scope): Review of all operations and credit quality.
    • Information Technology ($IT$): Review of cybersecurity, software patching, and vendor management.
    • Trust Department: Conducted if the bank has a trust function.
    • Compliance and $CRA$: Federal exams (usually every couple of years) regarding the Community Reinvestment Act and fair lending laws.

Examination Frequency and Logistics

• Standard Frequency: Exams typically occur every $12$ months.
• Extensions: The interval can be extended to $18$ months if the bank meets specific criteria:
  • Total assets under $3,000,000,000$.
  • The bank is well-capitalized and well-managed.
  • There are no outstanding enforcement actions (e.g., $MOU$, Consent Orders, or Cease and Desist orders).
• Visitations: Additional, informal visits may occur if specific concerns arise between formal exams.
• Joint and Alternate Exams:
  • Banks under $1,000,000,000$: State and federal regulators ($FDIC/FRB$) usually alternate years.
  • Banks over $1,000,000,000$: Conducted as "Joint Exams" where both state and federal regulators are on-site simultaneously. They must agree on the final report and ratings.
  • Banks over $10,000,000,000$: Subjected to a continuous examination cycle with multiple targeted exams throughout the year, culminating in a year-end "roll-up" report.

The $CAMELS$ Rating System

• Definition: A standardized rating system used by all federal and state regulatory agencies.
• Components ($CAMELS$):
  • Capital Adequacy: Levels, trends, and access to new capital.
  • Asset Quality: Credit administration, loan allowance, and non-performing assets.
  • Management: Overall oversight and risk management.
  • Earnings: Consistency, quality, and composition of income.
  • Liquidity: Sources and uses of funds; ability to meet withdrawal demands.
  • Sensitivity to Market Risk: How interest rate changes affect the bank.
• Rating Scale ($1-5$):
  • $1$: Strong (least regulatory concern).
  • $2$: Satisfactory.
  • $3$: Needs Improvement (weaknesses identified; requires follow-up every $6$ months).
  • $4$: Deficient.
  • $5$: Critically Deficient (most regulatory concern).
• Composite Rating: An overall summary rating assigned to the bank. It correlates with individual component ratings but is not a simple mathematical average.
• Confidentiality: Bank ratings are strictly confidential by law. They are only shared with senior management and the Board of Directors to prevent market panic or impact on stock prices.

Asset Quality (AQ) and Credit Review

• Importance of AQ: Loans are usually the largest asset and the primary source of income. Poor asset quality leads to charge-offs, which deplete capital.
• Allowance for Credit Losses ($ACL$): Reserves set aside for possible losses. Regulators look at the adequacy of these levels based on asset quality trends.
• Other Real Estate Owned ($OREO$): Foreclosed properties. In North Carolina, banks generally cannot hold $OREO$ on their books for more than $5$ years without approval.
• Loan Review Scoping: Examiners cannot look at every loan. They focus on:
  • Largest commercial credits.
  • Regulation O ($Reg O$) loans: Loans to bank insiders (directors/executives) to ensure no preferential treatment.
  • Watch list and past-due loans.
  • Non-accrual loans.
  • Adversely classified loans from previous exams (to see if they improved or should be charged off).

Operations and Information Technology (IT) Review

• Anti-Money Laundering/Countering the Financing of Terrorism ($AML/CFT$): Includes compliance with the Bank Secrecy Act ($BSA$), risk assessments, and timely filing of Suspicious Activity Reports ($SARs$) and Currency Transaction Reports ($CTRs$).
• IT Components:
  • Cybersecurity assessments.
  • Timeliness of software patching to prevent data breaches.
  • Vendor management and third-party risk.
  • Electronic banking security.

Questions & Discussion

• Question (Audience): Regarding different state laws—do large banks have to change their laws/procedures every time they open in a new location?
• Response (Tommy Gatlin/Alex): Compliance departments work to smooth those differences. National banks have more ease branching via the $OCC$. State-chartered banks use agreements between states or acquire existing banks through holding companies to grow while maintaining compliance with non-discriminatory acquisition laws.
• Question (Audience): Regarding hours of operation—does a bank need approval to change business hours?
• Response: Banks must notify regulators of changes to business hours. If a temporary closure is needed (e.g., a hurricane), the Commissioner must be informed and/or approve the closure to ensure the bank remains accessible to the public as required.
• Question (Audience): Regarding automated rating systems—is a human bias removed when using software to assign credit ratings?
• Response: Automated systems help remove personal bias, such as a loan officer's close relationship with a client. However, exceptions always exist. The key is for management to justify and document why a rating might differ from the automated output. Regulators prefer seeing the credit department, rather than the loan officer, handle final ratings to ensure impartiality.