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entitled 'Industrial Loan Corporations: Recent Asset Growth and 
Commercial Interest Highlight Differences in Regulatory Authority' 
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Report to the Honorable James A. Leach, House of Representatives: 

September 2005: 

Industrial Loan Corporations: 

Recent Asset Growth and Commercial Interest Highlight Differences in 
Regulatory Authority: 

[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-05-621]: 

GAO Highlights: 

Highlights of GAO-05-621, a report to the Honorable James A. Leach, 
House of Representatives: 

Why GAO Did This Study: 

Industrial loan corporations (ILC) emerged in the early 1900s as small 
niche lenders that provided consumer credit to low and moderate income 
workers who were generally unable to obtain consumer loans from 
commercial banks. Since then, some ILCs have grown significantly in 
size, and some have expressed concern that ILCs may have expanded 
beyond the original scope and purpose intended by Congress. Others have 
questioned whether the current regulatory structure for overseeing ILCs 
is adequate. 

This report (1) discusses the growth and permissible activities of ILCs 
and other insured depository institutions, (2) compares the supervisory 
authority of the FDIC with consolidated supervisors, and (3) describes 
ILC parents’ ability to mix banking and commerce. 

What GAO Found: 

The ILC industry has experienced significant asset growth and has 
evolved from one-time, small, limited purpose institutions to a diverse 
industry that includes some of the nation’s largest and more complex 
financial institutions. Between 1987 and 2004, ILC assets grew over 
3,500 percent from $3.8 billion to over $140 billion. In most respects, 
ILCs may engage in the same activities as other depository institutions 
insured by the FDIC and thus may offer a full range of loans, including 
consumer, commercial and residential real estate, small business, and 
subprime. ILCs are also subject to the same federal safety and 
soundness safeguards and consumer protection laws that apply to other 
FDIC-insured institutions. Therefore, from an operations standpoint, 
ILCs pose similar risks to the bank insurance fund as other types of 
insured depository institutions. 

Parents of insured depository institutions that provide similar risks 
to the bank insurance fund are not, however, being overseen by bank 
supervisors that possess similar powers. ILCs typically are owned or 
controlled by a holding company that may also own other entities. 
Although FDIC has supervisory authority over an insured ILC, it has 
less extensive authority to supervise ILC holding companies than the 
consolidated supervisors of bank and thrift holding companies. 
Therefore, from a regulatory standpoint, these ILCs may pose more risk 
of loss to the bank insurance fund than other insured depository 
institutions operating in a holding company. For example, FDIC’s 
authority to examine ILC affiliates and take certain enforcement 
actions against them is more limited than a consolidated supervisor. 
While FDIC asserted that its authority may achieve many of the same 
results as consolidated supervision, and that its supervisory model has 
mitigated losses to the bank insurance fund in some instances, FDIC’s 
authority is limited to a particular set of circumstances and may not 
be used at all times. Further, FDIC’s authority has not been tested by 
a large ILC parent during times of economic stress. 

An exemption in federal banking law currently allows ILC parents to mix 
banking and commerce more than the parents of other depository 
institutions. Three of the six new ILC charters approved during 2004 
were for commercial firms, and one of the largest retail firms recently 
applied for an ILC charter. While some industry participants assert 
that mixing banking and commerce may offer benefits from operational 
efficiencies, empirical evidence documenting these benefits is mixed. 
Federal policy separating banking and commerce focuses on the potential 
risks from integrating these functions, such as the potential expansion 
of the federal safety net provided for banks to their commercial 
entities. GAO finds it unusual that a limited ILC exemption would be 
the primary means for mixing banking and commerce on a broader scale 
and sees merit in Congress more broadly considering the advantages and 
disadvantages of a greater mixing of banking and commerce. 

What GAO Recommends: 

GAO is not recommending executive action but believes Congress should 
consider strengthening the regulatory oversight of ILCs and more 
broadly consider the advantages and disadvantages of a greater mixing 
of banking and commerce by ILCs or other financial institutions. In 
commenting on a draft of this report, the Board agreed with both the 
findings and matters for congressional consideration. FDIC agreed with 
one of the findings but generally believed that no changes were needed 
in its supervisory approach. 

www.gao.gov/cgi-bin/getrpt?GAO-05-621. 

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Richard J. Hillman at 
(202) 512-8678 or hillmanr@gao.gov. 

[End of section] 

Contents: 

Letter: 

Results in Brief: 

Background: 

ILCs Have Grown Significantly and Are No Longer Small, Limited Purpose 
Institutions: 

ILC Business Lines and Regulatory Safeguards Are Similar to Other 
Insured Financial Institutions: 

FDIC's Supervisory Authority Over ILC Holding Companies and Affiliates 
Is Not Equivalent to Consolidated Supervisors' Authority: 

FDIC Actions May Help Mitigate Potential Risks, but Supervision of ILC 
Holding Companies and Affiliates Has Only Been Tested on a Limited 
Basis in Relatively Good Economic Times: 

ILCs May Offer Commercial Holding Companies a Greater Ability to Mix 
Banking and Commerce Than Other Insured Depository Institution, but 
Views on Competitive Implications Are Mixed: 

Recent Legislative Proposals May Increase the Attractiveness of 
Operating an ILC: 

Conclusions: 

Matters for Congressional Consideration: 

Agency Comments and Our Evaluation: 

Appendixes: 

Appendix I: Objectives, Scope, and Methodology: 

Appendix II: Comments from the Board of Governors of the Federal 
Reserve System: 

Appendix III: Comments from the Federal Deposit Insurance Corporation: 

Appendix IV: GAO Contact and Staff Acknowledgments: 

Tables: 

Table 1: Comparison of Permissible Activities Between State Nonmember 
Commercial Banks and ILCs in a Holding Company Structure: 

Table 2: The Extent of Selected FDIC Authorities: 

Table 3: Affiliate Related Examination Procedures: 

Table 4: Comparison of Examination Resources and Organizational 
Structure of State Banking Supervisory Office: 

Table 5: Causes of Material ILC Failures and FDIC's Response to 
Failures and Other Industry Conditions: 

Figures: 

Figure 1: Number and Total Assets of ILCs: 

Figure 2: Percentage of ILC Assets Held by Individual States: 

Figure 3: Percentage of Estimated FDIC Insured Deposits Held by ILCs: 

Figure 4: Comparison of Explicit Supervisory Authorities of the FDIC, 
Board, and OTS: 

Abbreviations: 

BHC Act: Bank Holding Company Act: 

Board: Board of Governors of the Federal Reserve System: 

CEBA: Competitive Equality Banking Act: 

CIBA: Change in Bank Control Act: 

CSBS: Conference of State Banking Supervisors: 

FDI Act: Federal Deposit Insurance Act: 

FDIC: Federal Deposit Insurance Corporation: 

FDIC-IG: Federal Deposit Insurance Corporation Office of Inspector 
General: 

FFIEC: Federal Financial Institutions Examination Council: 

Fund: Bank Insurance Fund: 

GLBA: Gramm Leach Bliley Act: 

HOLA: Home Owners Loan Act: 

IAP: Institution-Affiliated Party: 

ILC: Industrial Loan Corporation: 

IT: information technology: 

NCUA: National Credit Union Association: 

Nevada DFI: Nevada Division of Financial Institutions: 

NOW: Negotiable Order of Withdrawal: 

OCC: Office of the Comptroller of the Currency: 

OTS: Office of Thrift Supervision: 

QTL: Quality Thrift Lender: 

SEC: Securities and Exchange Commission: 

Treasury: Department of the Treasury: 

Utah DFI: Utah Department of Financial Institutions: 

Letter September 15, 2005: 

The Honorable James A. Leach: 
House of Representatives: 

Dear Mr. Leach: 

Industrial loan corporations (ILC), also known as industrial banks, are 
state-chartered financial institutions that emerged in the twentieth 
century to provide consumer credit to low and moderate income workers 
who were generally unable to obtain consumer loans from commercial 
banks. Over the past 10 years, ILCs have experienced significant asset 
growth, and these one-time, small niche lenders have evolved into a 
diverse industry that includes some large, complex financial 
institutions. In addition, some commercial entities are increasingly 
interested in owning ILCs. For example, three large commercial entities 
were granted approval to open ILCs in 2004, and one of the largest 
retail enterprises recently applied for an ILC charter. As a result, 
some have expressed concerns that ILCs may be expanding beyond the 
original scope and purpose intended by Congress. 

ILCs are typically owned or controlled by a holding company that may 
also own other entities, and concerns have also been expressed that the 
current regulatory structure for overseeing ILCs in holding companies 
may not provide adequate protection against the potential risks that 
holding companies and nonbank affiliates may pose to an ILC. The 
regulation of the safety and soundness of ILCs rests with the Federal 
Deposit Insurance Corporation (FDIC) and the ILC's respective state 
regulator. Under the Bank Holding Company Act (BHC Act), the Board of 
Governors of the Federal Reserve System (Board) generally supervises 
bank holding companies and has established a consolidated supervisory 
framework for assessing the risks to a depository institution that 
could arise because of their affiliation with other entities in a 
holding company structure. For example, the Board may generally examine 
holding companies and their nonbank subsidiaries, subject to some 
limitations, to assess, among other things, the nature of the 
operations and financial condition of the holding company and its 
subsidiaries; the financial and operations risks within the holding 
company system that may pose a threat to the safety and soundness of 
any depository institution subsidiary of such holding company; and the 
systems for monitoring and controlling such risks. Thus, consolidated 
supervisors take a systemic approach to supervising holding companies 
and nonbank subsidiaries of depository institutions. However, holding 
companies of ILCs operate under an exception to the BHC Act, and most 
are not subject to Board oversight. Moreover, FDIC has not been given 
consolidated supervisory authority over ILC holding companies. FDIC 
has, however, employed what some term as a "bank-centric" supervisory 
approach that primarily focuses on isolating the insured institution 
from potential risks posed by holding companies and affiliates, rather 
than assessing these potential risks systemically across the 
consolidated holding company structure. 

Another area of concern about ILCs is the extent to which they can mix 
banking and commerce through the holding company structure. The policy 
separating banking and commercial activity was largely a reaction to 
the perception that banks, especially those in a larger conglomerate 
organization, had a disproportionate amount of economic power in the 
period leading up to the stock market crash of 1929. The BHC Act 
maintains the historical separation of banking from commerce by 
generally restricting bank holding companies to banking-related or 
financial activities.[Footnote 1] The BHC Act also allows ILC holding 
companies, including nonfinancial institutions such as retailers and 
manufacturers, and other institutions to avoid consolidated supervision 
and activities restrictions. While some industry participants have 
stated that mixing banking and commerce may offer benefits from 
operational efficiencies, the policy of separating banking and commerce 
was based primarily on the potential risks that combining these 
activities may pose to the federal safety net for insured depository 
institutions, as well as the potential for more conflicts of interest 
and the potential increase in economic power exercised by large 
conglomerate enterprises. Currently ILC holding companies and companies 
that own or control other types of insured depository institutions and 
other nondepository institutions, such as unitary thrifts, are 
permitted to mix banking and commerce to varying degrees. However, some 
believe that ILCs may be the entities that offer the greatest ability 
to mix these activities. 

Currently, FDIC-insured banks, including ILCs, are not permitted to 
offer interest-bearing business checking accounts. Over the past 
several years, there have been repeated legislative proposals to repeal 
this prohibition and some have stated that this prohibition is 
unnecessary and outdated. Recent legislative proposals would grant 
insured depository institutions, including many ILCs, the ability to 
pay interest on business checking accounts and branch into other states 
through establishing new branches--known as de novo branching. Some 
have questioned whether these proposals would give ILCs a competitive 
advantage in the marketplace or essentially place ILCs on par with 
commercial banks. 

This report responds to your March 4, 2004, request for a review of 
several issues related to ILCs. Specifically you asked us to (1) 
describe the history and growth of the ILC industry; (2) describe the 
permissible activities and regulatory safeguards for ILCs as compared 
with other insured financial institutions; (3) compare FDIC's 
supervisory authority over ILC holding companies and affiliates with 
the consolidated supervisors' authority over holding companies and 
affiliates; (4) describe recent changes FDIC made to its supervisory 
approach of the risks that holding companies and affiliates could pose 
to ILCs and determine whether FDIC's bank-centric supervisory approach 
protects the ILC from all the risks that holding companies and nonbank 
affiliates may pose to the ILC; (5) determine whether the ILC charter 
allows for a greater mixing of banking and commerce than other types of 
insured depository institutions, and whether this possibility has any 
competitive implications for the banking industry; and (6) determine 
the potential implications of granting ILCs the ability to pay interest 
on business checking accounts and operate de novo branches nationwide. 

To describe the history and growth of the ILC industry, we analyzed 
data, including information on ILC assets and estimated insured 
deposits for the time period 1987-2004. To describe the permissible 
activities of and regulatory safeguards for ILCs, we reviewed federal 
and state legislation, regulations, and guidance regarding ILCs and 
banks. We also interviewed management from various ILCs and spoke with 
officials from FDIC; the Board; and state supervisory officials from 
California, Nevada, and Utah that are responsible for the safety and 
soundness of insured institutions. We focused on ILCs and bank 
supervisors in these three states because they comprise over 99 percent 
of the ILC industry assets. We also analyzed FDIC data on ILCs from 
1987-2004. To compare FDIC's supervisory authority over ILC holding 
companies and affiliates with the consolidated supervisors' authority 
over holding companies and affiliates, we reviewed and analyzed 
legislation and regulations that govern the supervision of insured 
depository institutions, including ILCs and their holding companies, 
banks and their holding companies, and thrifts and their holding 
companies. We also compared agency examination manuals and guidance, 
interviewed officials regarding the FDIC's, the Board's, and the Office 
of Thrift Supervision's (OTS) supervisory approaches and supervisory 
authorities, and spoke with state and FDIC regional staff responsible 
for conducting examinations. We focused our comparison primarily on the 
Board's authorities relating to the consolidated supervision of bank 
holding companies and the FDIC's supervision of ILCs, their holding 
companies, and affiliates from a safety and soundness perspective. 
However, because OTS also supervises similar institutions with similar 
risks, we also reviewed OTS' supervisory authority with respect to 
thrifts and savings and loan holding companies. To describe what recent 
changes FDIC has made to its supervisory approach of the risks that 
holding companies and their nonbank subsidiaries could pose to ILCs and 
determine whether FDIC's bank-centric supervisory approach protects the 
ILC from all the risks that holding companies and those subsidiaries 
may pose to the ILC, we reviewed and synthesized relevant supporting 
documents and the information from the two FDIC-Inspector General (FDIC-
IG) material loss reviews related to ILCs. Where appropriate, after 
conducting our own due diligence review, we also relied upon the work 
of the FDIC-IG's September 30, 2004, report on limited charter 
depository institutions, including ILCs, that provided information on 
FDIC's guidance and procedures for supervising limited-charter 
depository institutions, including ILCs, and summarized recent actions 
regarding these institutions.[Footnote 2] To determine whether the ILC 
charter allows for a greater mixing of banking and commerce than other 
types of insured depository institutions, and whether this possibility 
has any competitive implications for the banking industry and to 
determine the potential implications of granting ILCs the ability to 
pay interest on business checking accounts and operate de novo branches 
nationwide, we reviewed academic and other studies, relevant laws, and 
other documents, interviewed management from several ILCs, and hosted a 
panel of experts made up of academics, economists, industry 
practitioners, and independent consultants. See appendix I for 
additional details on our objectives, scope, and methodology. 

During this review, we did not assess the extent to which regulators 
effectively implemented consolidated supervision or any other type of 
supervision. Rather, we focused on the respective federal regulators' 
authorities to determine whether there were any inherent limitations in 
these authorities. We conducted our work in Washington, D.C; Los 
Angeles, California; San Francisco, California; Las Vegas, Nevada; and 
Salt Lake City, Utah; between May 2004 and August 2005 in accordance 
with generally accepted government auditing standards. 

Results in Brief: 

ILCs began in the early 1900s as small, state-chartered, loan companies 
that primarily served the borrowing needs of industrial workers unable 
to obtain noncollateralized loans from banks. Since then, the ILC 
industry has experienced significant asset growth and has evolved from 
small, limited purpose institutions to a diverse industry that includes 
some of the nation's largest and more complex financial institutions 
with extensive access to the capital markets. Most notably, between 
1987 and 2004, ILC assets grew over 3,500 percent from $3.8 billion to 
over $140 billion, while the number of ILCs declined about 46 percent 
from 106 to 57. The amount of estimated insured deposits in the ILC 
industry has also grown significantly; however, these deposits 
represent less than 3 percent of the total estimated insured deposits 
in the Fund for all banks. This growth in the ILC industry has been 
concentrated in three states--California, Nevada, and Utah. In 2004, 6 
ILCs were among the 180 largest financial institutions in the nation 
with $3 billion or more in total assets, and one institution had over 
$66 billion in total assets. 

With one exception contained in federal and one state's banking laws, 
ILCs in a holding company structure may generally engage in the same 
activities as FDIC-insured depository institutions. Also, FDIC-insured 
ILCs must comply with the same federal requirements as other FDIC- 
insured depository institutions. For these two reasons, ILCs pose risks 
to the Fund similar to those posed by other FDIC-insured institutions 
from an operations standpoint.[Footnote 3] Like other FDIC-insured 
depository institutions, ILCs may offer a full range of loans such as 
consumer, commercial and residential real estate, and small business 
loans. Further, like a bank, an ILC may also "export" its home-state's 
interest rates to customers residing elsewhere. However, because of 
restrictions in federal and California state banking law, most ILCs do 
not accept demand deposits.[Footnote 4] As a result, many ILCs offer 
Negotiable Order of Withdrawal (NOW) accounts--similar in some respects 
to demand deposits and are, therefore, able to offer a service similar 
to demand deposits without their holding companies being subject to 
supervision under the BHC Act.[Footnote 5] While most ILC holding 
companies are not subject to supervision under the BHC Act, ILCs 
generally are subject to the same federal regulatory safeguards that 
apply to commercial banks and thrifts, such as federal restrictions 
governing transactions with affiliates and laws addressing terrorism 
financing, money laundering, and other criminal activities by bank 
customers. 

FDIC's supervisory authority over the holding companies and affiliates 
of ILCs is more limited than the authority that consolidated 
supervisors have over the holding companies and affiliates of banks and 
thrifts. For example, FDIC's authority to examine an affiliate of an 
insured depository institution is limited to examinations necessary to 
disclose fully the relationship between the institution and any 
affiliate and the effect of the relationship on the institution. 
Relationships generally include arrangements involving some level of 
interaction, interdependence, or mutual reliance between the ILC and 
the affiliate, such as a contract, transaction, or the sharing of 
operations. When a relationship does not exist, any reputation or other 
risk presented by an affiliate that could impact the institution may 
not be detected. In contrast, consolidated supervisors, subject to 
functional regulation restrictions, generally are able to examine the 
holding company and any nonbank subsidiary regardless of whether the 
subsidiary has a relationship with the affiliated insured 
bank.[Footnote 6] FDIC officials told us that with its examination 
authority, as well as its abilities to impose conditions on or enter 
into agreements with an ILC holding company in connection with an 
application for federal deposit insurance, terminate an ILC's deposit 
insurance, enter into agreements during the acquisition of an insured 
entity, and take enforcement measures, FDIC can protect an ILC from the 
risks arising from being in a holding company as effectively as the 
consolidated supervision approach. However, with respect to the holding 
company, these authorities are limited to particular sets of 
circumstances and are less extensive than those possessed by 
consolidated supervisors of bank and thrift holding companies. 

While FDIC's bank-centric supervisory approach has undergone various 
enhancements designed to help mitigate the potential risks that FDIC- 
examined institutions, including ILCs in a holding company structure, 
can be exposed to by their holding companies and affiliates, questions 
remain about whether FDIC's supervisory approach and authority over BHC 
Act-exempt holding companies and their nonbank subsidiaries address all 
risks to the ILC from these entities. FDIC revised the guidance for its 
risk-focused examinations to, among other things, provide additional 
factors that might be considered in assessing a parent company's 
potential impact on an insured depository institution affiliate. In 
addition, FDIC's monitoring and application processes may also help to 
mitigate risks to ILCs with foreign holding companies and affiliates. 
FDIC has provided some examples where its supervisory approach 
effectively protected the insured institution and mitigated losses to 
the Fund. However, FDIC's supervision of large rapidly growing ILCs and 
FDIC's authority over ILC holding companies and nonbank subsidiaries, 
including the risks that these entities could pose to the ILC, has been 
refined during a period of time described as the "golden age of 
banking" and has not been tested during a time of significant economic 
stress or by a large, troubled ILC. 

Because most ILC holding companies and their subsidiaries are exempt 
from business activity limitations that generally apply to the holding 
companies and affiliates of other types of insured depository 
institutions, ILCs may provide a means for mixing banking and commerce 
more than ownership or affiliation with other insured depository 
institutions. During our review, we identified other instances where 
the mixing of banking and commerce previously existed, or currently 
exists on a limited basis, such as unitary thrift holding companies, 
certain "nonbank banks" in a holding company, and activities permitted 
under GLBA, such as merchant banking and grandfathered, limited 
nonfinancial activities by securities and insurance affiliates of 
financial holding companies.[Footnote 7] However, federal law 
significantly limits the operations and product mixes of these entities 
and activities as compared with ILC holding companies. Additionally, 
with the exception of a limited, credit-card-only bank charter, 
ownership or affiliation with an ILC is today the only option available 
to nonfinancial, commercial firms wanting to enter the insured banking 
business. Three of the six new ILC charters approved by FDIC during 
2004 are owned by nonfinancial, commercial firms, and one of the 
nation's largest retailers recently filed an application to own an ILC. 
The policy generally separating banking and commerce is based primarily 
on potential risks that integrating these functions may pose such as 
the potential expansion of the federal safety net provided for banks to 
their commercial holding companies or affiliates, potential increase in 
conflicts of interest, and the potential increase in economic power 
exercised by large conglomerate enterprises. While some industry 
participants state that mixing banking and commerce may offer benefits 
from operational efficiencies, empirical evidence documenting these 
benefits is mixed. 

Recent legislative proposals to allow insured depository institutions, 
including certain ILCs, to offer NOW accounts to business customers and 
the ability to de novo branch will expand the availability of products 
and services that insured depository institutions, including ILCs, 
could offer and may make the ownership of ILCs increasingly attractive, 
particularly to commercial entities. FDIC-insured depository 
institutions, including ILCs, are currently prohibited from offering 
interest-bearing business checking accounts. Recent legislative 
proposals would remove the current prohibition on paying interest on 
demand deposits and allow insured depository institutions, including 
all or some ILCs, to offer interest-bearing business NOW checking 
accounts. This would, in effect, expand the availability of products 
and services that insured depository institutions, including most ILCs, 
could offer. ILC advocates we spoke with stated that including ILCs in 
these legislative proposals maintains the current relative parity 
between ILC permissible activities and those of other insured bank 
charters. However, Board officials, as well as some industry observers 
we spoke with, told us that granting grandfathered ILCs the ability to 
pay interest on business NOW accounts represents an expansion of powers 
for ILCs, which, they stated, could further blur the distinction 
between ILCs and traditional banks. Another recent legislative proposal 
would allow banks and most ILCs (those included in a grandfather 
provision) to de novo branch by removing states' authority to prevent 
them from doing so. Board officials we spoke with told us that, if 
enacted, these proposals could increase the attractiveness of owning an 
ILC, especially by private sector financial or commercial holding 
companies that already operate existing retail distribution networks. 

To better ensure that supervisors of institutions with similar risks 
have similar authorities, we are asking Congress to consider various 
options such as eliminating the current exclusion for ILCs and their 
holding companies from consolidated supervision, granting FDIC similar 
examination and enforcement authority as a consolidated supervisor, or 
leaving the oversight responsibility of small, less complex ILCs with 
the FDIC, and transferring oversight of large, more complex ILCs to a 
consolidated supervisor. In addition, we are asking Congress to more 
broadly consider the advantages and disadvantages of mixing banking and 
commerce to determine whether continuing to allow ILC holding companies 
to engage in this activity significantly more than the holding 
companies of other types of financial institutions is warranted or 
whether other entities should be permitted to engage in this level of 
activity. 

We provided a draft of this report to the Board, FDIC, OTS, and SEC for 
review and comment. Each of these agencies provided technical comments 
that were incorporated as appropriate. In written comments, the 
Chairman of the Board of Governors of the Federal Reserve System (see 
app. II) concurred with the report's findings and conclusions and 
stated that "consolidated supervision provides important protections to 
the insured banks that are part of a larger organization, as well as 
the federal safety net that supports those banks" and that the report 
"properly highlights the broad policy implications that ILCs raise with 
respect to maintaining the separation of banking and commerce." In 
written comments from the Chairman of the Federal Deposit Insurance 
Corporation (see app. III), FDIC concurred that from an operations 
standpoint, ILCs do not appear to have a greater risk of failure than 
other types of insured depository institutions but generally believed 
that no changes were needed in its supervisory approach over ILCs and 
their holding companies and disagreed with the matters for 
congressional consideration. Specifically, FDIC's disagreements 
generally focused on three primary areas--whether consolidated 
supervision of ILC holding companies is necessary to ensure the safety 
and soundness of the ILC; that FDIC's supervisory authority may not be 
sufficient to effectively supervise ILCs and insulate insured 
institutions against undue risks presented by external parties; and the 
impact that consolidated supervision of ILCs and their holding 
companies would have on the marketplace and the federal safety net. 
However, we believe that consolidated supervision offers broader 
examination and enforcement authorities that may be used to understand, 
monitor, and when appropriate, restrain the risks associated with 
insured depository institutions in a holding company structure. We 
continue to be concerned that FDIC's bank-centric approach has only 
been tested on a limited basis in relatively good economic times, and 
our report identifies additional tools that consolidated supervisors 
may use to help ensure the safety and soundness of insured depository 
institutions. Further, the report does not advocate an expansion of the 
federal safety net. Rather, this report advocates that ILCs and their 
holding companies be regulated in a similar manner as other insured 
depository institutions and their holding companies. 

Background: 

Today, five federal agencies oversee federally insured depository 
institutions and consolidated supervised entities: Office of the 
Comptroller of the Currency, Board of Governors of the Federal Reserve, 
Federal Deposit Insurance Corporation, Office of Thrift Supervision, 
and the National Credit Union Association. Many of those institutions 
are state chartered and are subject to state regulation. The specific 
regulatory configuration depends on the type of charter the banking 
institution chooses--commercial bank, thrift, credit union, or 
industrial loan company. To achieve their safety and soundness goals, 
bank regulators establish capital requirements, conduct on-site 
examinations and off-site monitoring to assess a bank's financial 
condition, and monitor compliance with banking laws. Regulators also 
issue regulations, take enforcement actions, and close banks they 
determine to be insolvent. In addition, federal regulators oversee 
compliance with and enforce consumer protection laws such as those 
requiring fair access to banking services and privacy protection. 

The FDIC was created as an independent agency in 1933 to preserve and 
promote public confidence in the financial system by (1) insuring 
deposits in banks and thrift institutions for up to certain amounts 
(currently $100,000); (2) identifying, monitoring, and addressing risks 
to the Fund; and (3) limiting the effect on the economy and the 
financial system when a bank or thrift institution fails. Today, FDIC 
directly examines and supervises 5,272 insured, state-chartered banks, 
which, according to FDIC, is more than half of all institutions in the 
banking system. FDIC is the primary federal supervisor of state- 
chartered institutions that do not join the Federal Reserve System, 
including ILCs. In addition, FDIC is the backup supervisor for the 
remaining insured banks and thrift institutions. As of December 31, 
2004, 3 of the top 16 largest insured institutions supervised by FDIC 
were ILCs. ILCs are also monitored at the state level and are subject 
to state and federal supervision in the same manner as state nonmember 
banks. 

The Board was founded by Congress in 1913 and currently has the 
following four general areas of responsibility: (1) conducting the 
nation's monetary policy by influencing the money and credit conditions 
in the economy in pursuit of full employment and stable prices; (2) 
supervising and regulating banking institutions to ensure the safety 
and soundness of the nation's banking and financial system and to 
protect the credit rights of consumers; (3) maintaining the stability 
of the financial system and containing systemic risk that may arise in 
financial markets; and (4) providing certain financial services to the 
government, the public, financial institutions, and foreign official 
institutions, including playing a major role in operating the nation's 
payments system. Today, the Board is the primary supervisor of 919 
state-chartered member banks and 5,863 bank holding companies, and has 
direct oversight of bank holding companies and their affiliates. 

The Office of the Comptroller of the Currency (OCC), established in 
1863 as a bureau of the Department of the Treasury (Treasury), is 
responsible for chartering, supervising, and regulating all national 
banks. OCC's mission is to ensure a stable and competitive national 
banking system through (1) ensuring the safety and soundness of the 
national banking system; (2) fostering competition by allowing banks to 
offer new products and services; (3) improving the efficiency and 
effectiveness of OCC supervision, including reducing regulatory burden; 
and (4) ensuring fair and equal access to financial services for all 
Americans. OCC also supervises the federal branches and agencies of 
foreign banks. Currently, OCC supervises 1,906 national banks. 

OTS was established as a bureau of the Treasury in 1989. Its mission is 
to supervise savings associations and their holding companies in order 
to maintain their safety and soundness and compliance with consumer 
laws and to encourage a competitive industry that meets America's 
financial services needs. OTS is the primary federal supervisor of all 
federally chartered and many state-chartered thrift institutions, which 
includes savings banks and savings and loan associations. Currently, 
OTS regulates and supervises 886 thrifts[Footnote 8]--some of which, 
like ILCs, are owned by a commercial holding company--and has direct 
oversight of the thrift, the thrift holding company and its 
subsidiaries, and its affiliates. 

The National Credit Union Administration (NCUA) is an independent 
federal agency that charters and supervises federal credit unions and 
operates the National Credit Union Share Insurance Fund, which insures 
the savings in all federal and many state-chartered credit unions. 
Currently, NCUA regulates and supervises 9,128 credit unions. 

In addition, the Securities and Exchange Commission has consolidated 
supervisory oversight of certain financial conglomerates, known as 
consolidated supervised entities, which are large, internationally 
active securities firms. Certain of these consolidated supervised 
entities own one or more large ILCs, although their primary line of 
business is the global securities market. 

Bank Holding Companies: 

The BHC Act of 1956, as amended, contains a comprehensive framework for 
the supervision of bank holding companies and their nonbank 
subsidiaries. Bank holding companies are companies that own or control 
an FDIC-insured bank or other depository institution that meets the 
definition of "bank" in the BHC Act. Generally, any company that 
acquires control of an insured bank or bank holding company is required 
to register with the Board as a bank holding company. Regulation under 
the BHC Act entails, among other things, consolidated supervision of 
the holding company by the Board, as well as restrictions on the 
activities of the holding company and its affiliates to those 
activities that are closely related to banking or, for qualified 
financial holding companies, activities that are financial in nature. 
The BHC Act defines "control" of an insured bank flexibly to include 
ownership or control of blocs of stock, the ability to elect a board 
majority, or other management control.[Footnote 9] The Board's bank 
holding company supervision manual states that a bank holding company 
structure may offer advantages. For example, a bank holding company 
structure allows entities to avoid some regulatory constraints such as 
limitations on geographic areas they can serve. In addition, a bank 
holding company structure may increase an organization's financial 
flexibility by allowing the combined firm to avoid selected 
restrictions on the types of assets acquired, and types of liabilities 
that can be issued by the combined entity. 

The Board's bank holding company supervision manual states that the 
holding company structure can adversely affect the financial condition 
of a bank subsidiary through exposing the bank to various types of 
risk. The reasons these risks occur cover a variety of circumstances, 
including poor risk management, poor bank management, and poor asset 
quality. For example, a holding company or its subsidiary with poor 
risk management procedures may take on excessive investment or market 
risks and fail. This failure of the holding company or affiliate can 
impair the insured institution's access to financial markets. In 
another example, a holding company with a poorly managed bank can 
initiate adverse intercompany transactions with the insured bank or 
impose excessive dividends on the insured bank.[Footnote 10] Adverse 
intercompany transactions may include charging above market prices for 
products or services, such as information technology (IT) services, 
provided to the insured institution by an affiliate or requiring the 
insured institution to purchase poor quality loans at above market 
prices from an affiliate. Such loans may place the insured institution 
at higher risk of loss. Other types of risk that holding companies and 
affiliates can pose to insured institutions include operations or 
reputation risks. Operations risk is the potential that inadequate 
information systems, operations problems, breaches in internal 
controls, or fraud will result in unexpected losses. From a practical 
standpoint, insured depository institutions, including ILCs, may be 
susceptible to operations risk when they are dependent on or share in 
the products or services of a holding company or its subsidiaries, such 
as IT services or credit card account servicing. If these entities 
ceased their operations, there could be an adverse impact on the 
insured institution. Reputation risk is the potential that negative 
publicity regarding an institution's or affiliate's business practices, 
whether true or not, could cause a decline in the customer base, costly 
litigation, or revenue reductions. Operations or reputation risks that 
impact the holding company can also affect affiliates throughout the 
corporate structure. 

The Board's Regulation Y contains a provision stating that a bank 
holding company shall serve as a source of strength to its subsidiary 
banks and shall not conduct its operations in an unsafe and unsound 
manner.[Footnote 11] According to the Board, as part of this policy, a 
bank holding company should stand ready to use its available resources 
to provide adequate funds to its subsidiary bank during periods of 
financial stress or adversity and should maintain the financial 
flexibility and capital raising capacity to obtain additional resources 
for assisting its affiliate. According to this doctrine, a bank holding 
company should not withhold financial support from an affiliate bank in 
a weakened or failing position when it is in a position to provide the 
support. According to the Board, a bank holding company's failure to 
assist a troubled or failing subsidiary bank would generally be 
considered an unsafe and unsound practice and may result in a violation 
of Regulation Y. Consequently, such a failure would generally result in 
a cease and desist order or other enforcement action as authorized 
under banking law. 

Historical Policies Governing Separation of Banking and Commerce: 

The policy separating banking and commercial activity was first 
codified in provisions of the Banking Act of 1933 that generally are 
referred to as the Glass-Steagall Act. Glass-Steagall was largely a 
reaction to the perception that banks, and in particular banks that 
were part of larger conglomerate organizations, such as the J. P. 
Morgan and John D. Rockefeller entities of the era, wielded a 
disproportionate amount of economic power in the period leading up to 
the stock market crash of 1929. Among other things, Glass-Steagall 
generally prohibited banks from owning corporate stock for their own 
accounts and also limited affiliations between banks and securities 
firms. An immediate outcome of Glass-Steagall was that the Morgan, 
Rockefeller, and other complex business combinations with financial 
firms of the period were split into separate banking and nonbanking 
parts. Since then, Congress and banking supervisors have generally 
reaffirmed the long-standing policy of separating banking and commerce. 
For example, the BHC Act of 1956 generally prohibited bank holding 
companies from owning or controlling entities that were not banks 
unless, among other things, the Board determined that the entity's 
activities were "so closely related to the business of banking . . . as 
to be a proper incident thereto…."[Footnote 12] In 1970, Congress 
amended the BHC Act to broaden the Board's authority to determine when 
an activity is sufficiently related to banking but restricted bank 
holding companies to the business of banking remained a controlling 
principle of the act.[Footnote 13] In 1999, the GLBA amended the BHC 
Act by, among other things, relaxing the distinction between separating 
banking and commerce to permit qualified bank holding companies--known 
as financial holding companies--to engage in a wider range of financial 
activities, such as insurance underwriting and securities brokerage. By 
restricting bank holding companies to activities that are financial in 
nature, GLBA generally reaffirmed the separation of banking from 
nonfinancial, commercial industries. In addition, in the GLBA, Congress 
also ended the unitary thrift provision that allowed commercial firms 
to acquire control of a single savings association. 

ILCs Have Grown Significantly and Are No Longer Small, Limited Purpose 
Institutions: 

ILCs began in the early 1900s as small, state-chartered loan companies 
that served the borrowing needs of industrial workers that were unable 
to obtain noncollateralized loans from commercial banks. Since then, 
the ILC industry has experienced significant asset growth and has 
evolved from small, limited purpose institutions to a diverse group of 
insured financial institutions with a variety of business models. Most 
notably, from 1987 to 2004, ILC assets have grown over 3,500 percent 
from $3.8 billion to over $140 billion, while the number of ILCs 
declined about 46 percent from 106 to 57. In 2004, 6 ILCs were among 
the 180 largest financial institutions in the nation with $3 billion or 
more in total assets, and one institution had over $66 billion in total 
assets. During this time period, most of the growth occurred in the 
state of Utah while the portion of ILC assets in other states declined-
-especially in California. According to Utah officials, ILCs grew in 
that state because its laws are "business friendly," and the state 
offers a large, well-educated workforce for the financial services 
industry. Some ILCs have evolved into large, complex financial 
institutions with extensive access to capital markets. 

ILCs Have Evolved Over Time: 

ILCs, also known as industrial banks, are state-chartered financial 
institutions that emerged from the Morris Plan banks of the early 20th 
century to provide consumer credit to low and moderate income workers. 
Generally, these workers were unable to obtain noncollateralized 
consumer loans from commercial banks. Since many state laws prevented 
these banks from accepting deposits, the banks issued certificates of 
investment or indebtedness often referred to as thrift certificates and 
avoided using the term "deposit." Initially, the FDIC determined that 
ILCs were not eligible to be insured. 

Over time, FDIC policy regarding ILC's eligibility for deposit 
insurance changed. Insurance was initially granted on a case by case 
basis. However, the Garn-St. Germain Depository Institutions Act of 
1982 made all ILCs eligible for federal deposit insurance.[Footnote 14] 
This act also authorized federal deposit insurance for thrift 
certificates, a primary funding source for ILCs at the time.[Footnote 
15] Subsequently, some states required ILCs to obtain FDIC insurance as 
a condition of keeping their charters. As a result, FDIC insured most 
ILCs, and they were subject to safety and soundness supervision by the 
FDIC in addition to the supervision they received from their respective 
states. 

In 1987, Congress passed the Competitive Equality Banking Act (CEBA), 
which also impacted the ILC industry.[Footnote 16] One purpose of CEBA 
was to close a provision in the BHC Act under which commercial firms 
were able to own "nonbank banks." These institutions had some 
characteristics of banks but did not meet the BHC Act's definition of a 
bank. Prior to CEBA, the BHC Act defined "bank" to mean an institution 
that both accepted demand deposits and engaged in the business of 
making commercial loans. Nonbank banks generally were limited purpose 
institutions that did not both accept demand deposits and make 
commercial loans. By avoiding the BHC Act definition of a bank, 
commercial firms that owned or controlled those institutions were able 
to provide certain banking services across state lines. Additionally, 
these firms were not subject to supervision by the Board as a bank 
holding company. CEBA prohibited new nonbank banks and more stringently 
defined "banks" under the BHC Act to include institutions insured by 
the FDIC. This new definition of a "bank" contained exceptions that 
allow entities that own or control certain types of insured 
institutions to avoid Board regulation as a bank holding company. One 
of these exceptions applies to ILCs chartered in states that on March 
5, 1987, had in effect or under consideration a statute requiring ILCs 
to be FDIC insured. An ILC chartered in those states is exempt from the 
definition of "bank" in the BHC Act if it satisfies one or more of the 
following conditions:[Footnote 17]

* The ILC does not accept demand deposits that may be withdrawn by 
check or similar means for payment to third parties. 

* The ILC has total assets of less than $100 million. 

* Control of the ILC was not acquired by any company after August 10, 
1987. 

Since the passage of CEBA, the ILC industry has changed significantly 
and is currently a diverse group of insured financial institutions with 
a variety of business models. The majority of the 57 active ILCs, as of 
December 31, 2004, are owned and operated by financial services firms, 
such as the ILCs owned by Merrill Lynch, USAA Savings Bank, and 
American Express. These ILCs are complex financial institutions with 
extensive access to capital markets. Other ILCs are part of a business 
organization whose activities are conducted within the financial arm of 
a larger corporate organization that is not necessarily financial in 
nature, such as the ILCs owned by GE Capital Financial and GMAC 
Commercial Mortgage Bank. In addition, other ILCs directly support the 
holding company organizations' commercial activities, such as the ILCs 
owned by BMW and Volkswagen. Additionally, some ILCs are smaller, 
community-focused, stand-alone institutions such as Golden Security 
Bank and Tustin Community Bank. 

ILCs Have Experienced Significant Asset Growth: 

The total assets of the ILC industry have increased significantly since 
1987. As shown in figure 1, although the total number of ILCs has 
decreased by nearly half, from 106 to 57, as of December 31, 2004, the 
total assets in the ILC industry have grown by over 3,500 percent, 
increasing from $3.8 billion in 1987 to over $140 billion in 2004. In 
2004, 6 ILCs were among the 180 largest financial institutions in the 
nation with $3 billion or more in total assets, and one institution had 
over $66 billion in assets. This significant growth in ILC assets was 
primarily concentrated in a few large ILCs owned by financial services 
firms. For example, as of December 31, 2004, 6 ILCs owned 85 percent of 
the total assets for the ILC industry with aggregate assets totaling 
over $119 billion and collectively controlled about $64 billion in FDIC-
insured deposits. 

Figure 1: Number and Total Assets of ILCs: 

[See PDF for image] 

[End of figure] 

Today, the vast majority of ILC assets are located in California, 
Nevada, and Utah. Although seven states have active ILCs, three states 
charter more than half, or 49, of the active ILCs that own over 99 
percent of the ILC industry's assets, as shown by figure 2. The state 
of Utah has experienced the largest amount of ILC asset growth. As of 
December 31, 2004, there were 29 ILCs, representing 82 percent of the 
ILC industry assets, with headquarters in Utah. According to officials 
at the Utah Department of Financial Institutions, ILC growth in Utah 
occurred because other state laws are not as "business friendly" as 
Utah. These officials also stated that Utah has state usury laws that 
are more desirable than many other states, and the state offers a large 
well-educated workforce for the financial institutions industry. 

Figure 2 also shows that the portion of ILC assets in states other than 
Utah declined significantly. Moreover, California had the largest 
decline in the number of ILCs during this time period. According to 
state banking regulators in California, the decline in the number of 
ILCs was partially due to a state law passed in 1985 requiring all 
thrifts and loans, including ILCs, to obtain federal insurance in order 
to accept deposits. Because many ILCs were unable to get approval from 
FDIC, they were liquidated. Another reason these officials gave for the 
decline in ILCs in California was that the ILC industry in California 
experienced similar failures as the banking and savings and loan 
industries in the late 1980s and early 1990s. While these failures and 
law changes accounted for much of the decline in the assets held by 
California ILCs, these officials also stated that California's laws are 
less favorable to business, which may also have restricted the growth 
of the ILC industry in that state. 

Figure 2: Percentage of ILC Assets Held by Individual States: 

[See PDF for image] 

[A] The other category may consist of as many as nine states in some 
years. In 1987, states in this category included Arizona, Colorado, 
Florida, Hawaii, Minnesota, Nebraska and West Virginia. In 2004, this 
category included Colorado, Hawaii, and Minnesota. 

[End of figure] 

Figure 3 shows that, although the total amount of estimated insured 
deposits in the ILC industry has grown by over 500 percent since 1999, 
these deposits represent less than 3 percent of the total estimated 
insured deposits in the bank insurance fund for all banks. The 
significant increase in estimated insured deposits since 1999 was 
related to the growth of a few ILCs owned by financial services firms. 
For example, at the end of 2004, the largest ILC, owned by an 
investment bank, had over $40 billion in FDIC insured deposits. 

Figure 3: Percentage of Estimated FDIC Insured Deposits Held by ILCs: 

[See PDF for image] 

[End of figure] 

ILC Business Lines and Regulatory Safeguards Are Similar to Other 
Insured Financial Institutions: 

Federal banking law permits FDIC-insured ILCs to engage in the same 
activities as other insured depository institutions. However, because 
of restrictions in California state law and in order to qualify for 
exemption from the BHC Act, most ILCs, which are owned by non-BHC Act 
holding companies, may not accept demand deposits. Banking laws in 
California, Nevada, and Utah have undergone changes that generally 
place ILCs on par with traditional banks. Thus, like other FDIC-insured 
depository institutions, ILCs may offer a full range of loans such as 
consumer, commercial and residential real estate, and small business 
loans. Further, like a bank, ILCs may "export" their home-state's 
interest rates to customers residing elsewhere. In addition, ILCs 
generally are subject to the same federal regulatory safeguards that 
apply to commercial banks and thrifts, such as federal restrictions 
governing transactions with affiliates and laws addressing terrorism, 
money laundering, and other criminal activities by bank customers. 

ILCs Are Permitted to Engage in Most Banking Activities: 

Under the Federal Deposit Insurance Act (FDI Act), FDIC insured 
institutions, including ILCs, generally are permitted to engage only in 
activities as principal that are permissible for a national bank, 
although the FDIC may approve of an additional activity if it 
determines that the activity would pose no significant risk to the bank 
insurance fund (Fund), and the institution complies with applicable 
federal capital standards. During our review, we did not identify any 
banking activities that were unique to ILCs that other insured 
depository institutions were not permitted to do. Table 1 shows that, 
like other insured depository institutions, ILCs are permitted to offer 
a wide variety of loans including consumer, commercial and residential 
real estate, small business, and subprime.[Footnote 18] Like other FDIC-
insured state charters, an ILC may charge its customers the interest 
rates allowed by the laws of the state where the ILC is located, no 
matter where the customers reside.[Footnote 19] In effect, this permits 
ILCs offering credit cards to charge their state's maximum allowable 
interest rates in other states.[Footnote 20] A primary difference 
between ILCs and other FDIC-insured depository institutions is that, to 
remain exempt from the BHC Act, ILCs must be chartered in the 
grandfathered states and generally do not accept demand deposits if 
their total assets are $100 million or more. 

Table 1: Comparison of Permissible Activities Between State Nonmember 
Commercial Banks and ILCs in a Holding Company Structure: 

Permissible activities: Ability to offer full range of loans, 
including: consumer; commercial real estate; residential real estate; 
small business, and; subprime; 
State nonmember commercial bank: Yes; 
Industrial loan corporation: Yes. 

Permissible activities: Ability to export interest rates; 
State nonmember commercial bank: Yes; 
Industrial loan corporation: Yes. 

Permissible activities: Ability to offer full range of deposits 
including demand deposits; 
State nonmember commercial bank: Yes; 
Industrial loan corporation: Yes, except in California; However, BHC 
Act-exempt ILCs may offer demand deposits if either the ILC's assets 
are less than $100 million or the ILC has not been acquired after 
August 10, 1987. 

Source: FDIC. 

Note: This table was adapted from FDIC's Supervisory Insights, Summer 
2004. According to the FDIC officials, Supervisory Insights was 
published in June 2004, by FDIC to provide a forum to discuss how bank 
regulation and policy is put into practice in the field, share best 
practices, and communicate emerging issues that bank supervisors are 
facing. This inaugural issue described a number of areas of current 
supervisory focus at the FDIC, including the ILC charter. According to 
FDIC officials, Supervisory Insights should not be construed as 
regulatory or supervisory guidance. 

[End of table]

As discussed previously, in order to maintain an exemption from the BHC 
Act, most ILCs with assets of $100 million or more may not accept 
demand deposits that the depositor may withdraw by check or similar 
means for payment to third parties. Representatives from some ILCs told 
us that because demand deposits are an important, often primary source 
of cost-effective funding for some depository institutions, 
restrictions on ILCs' ability to accept demand deposits is a limitation 
of the ILC charter. However, federal regulation does not restrict ILCs' 
use of NOW accounts. NOW accounts are similar to demand deposits but 
give the depository institution the right to require at least 7 days 
written notice prior to withdrawal. In addition, NOW accounts can be 
FDIC insured. Some ILCs use NOW accounts as a source of funding, 
particularly those institutions owned by investment banking/brokerage 
firms. Further, some ILCs finance their operations through sources 
other than FDIC insured deposits and use commercial paper, brokered 
deposits.[Footnote 21]

Based on an analysis of the permissible activities of ILCs and other 
insured depository institutions, we and the FDIC-IG found that, from an 
operations standpoint, ILCs do not appear to have a greater risk of 
failure than other types of insured depository institutions. FDIC 
officials have reported that, like other insured depository 
institutions, the risk of failure and loss to the deposit insurance 
fund from ILCs is not related to the type of charter the institution 
has. Rather, these officials stated that this risk depends on the 
institution's business plan and the type of business that the entity is 
involved in, management's competency to run the bank, and the quality 
of the institution's risk-management process. Further, FDIC officials 
stated that FDIC's experience does not indicate that the overall risk 
profile of ILCs is different from that of other types of insured 
depository institutions, and ILCs do not engage in more complex 
transactions than other institutions. 

Some State Banking Laws Have Evolved to Make ILCs More Like Banks: 

Despite initial state limitations on certain permissible activities of 
ILC charters, the laws of the states we reviewed have essentially 
placed ILCs on par with other FDIC-insured state banks. For example, 
officials in California told us that ILCs originally were chartered to 
serve various niche lending markets. However, these officials stated 
that, over time, changes were made to California laws governing ILCs 
because these entities sought to be more competitive with other 
financial institutions and engage in different types of lending 
activities not specified in the charter law. According to these 
officials, in October of 2000, the California legislature revised the 
ILC charter law that contained a variety of outdated and artificial 
lending restrictions. California officials also stated that, at that 
time, ILCs were brought under the state banking laws and, with the 
exception of the restriction against accepting demand deposits, ILCs 
became subject to the same laws and regulations, as well as standards 
for safe and sound lending practices, as commercial banks. According to 
these officials, the laws that were no longer applicable to ILCs 
contained restrictions on, among other things, the: 

* type of security for an ILC loan,

* amount of loans that could be made out-of-state,

* loan-to-value ratios on loans,[Footnote 22] and: 

* amount of loans that had to be collateralized by real estate. 

Officials at the Utah Department of Financial Institutions (Utah DFI) 
told us that, since 1985, ILCs chartered in Utah have generally been 
able to conduct the same permissible activities as state chartered 
commercial banks. In addition, since at least 1997, Utah ILCs have been 
permitted to use the term "bank" in their name. 

ILCs Must Comply with Federal Requirements Applicable to Other Insured 
Institutions: 

ILCs are subject to federal safety and soundness safeguards and 
consumer protection laws that apply generally to FDIC-insured 
institutions. These include restrictions on transactions between an 
insured institution and its affiliates under sections 23A and 23B of 
the Federal Reserve Act that are designed to protect the insured 
depository institution from adverse transactions with holding companies 
and affiliates. Sections 23A and 23B generally limit the dollar amount 
of loans to affiliates and require transactions to be done on an "arms- 
length" basis.[Footnote 23] Specifically, section 23A regulates 
"covered transactions" between a bank and its affiliates and permits an 
institution to conduct these transactions with its affiliates so long 
as the institution limits the aggregate amount of covered transactions 
with a particular affiliate to not more than 10 percent of the bank's 
capital stock and surplus and, with all of its affiliates, to 20 
percent of the institution's capital stock and surplus.[Footnote 24] 
Section 23B essentially imposes the following four restrictions: (1) a 
requirement that the terms of affiliate transactions be comparable to 
terms of similar nonaffiliate transactions; (2) a restriction on the 
extent that a bank may, as a fiduciary, purchase securities and other 
assets from an affiliate; (3) a restriction on the purchase of 
securities where an affiliate is the principal underwriter; and (4) a 
prohibition on agreements and advertising providing or suggesting that 
a bank is responsible for the obligations of its affiliates. 

Examples of other regulatory safeguards that ILCs must comply with 
include provisions of the following Board regulations: 

* Regulation O, which governs the extension of credit by a depository 
institution to an executive officer, director, or principal shareholder 
of the institution;[Footnote 25]

* Regulation D, which sets reserves a depository institution must hold 
against deposits;[Footnote 26]

* Regulation Q, which generally prohibits the payment of interest on 
demand deposits;[Footnote 27] and: 

* Regulation F, which requires that banks establish policies and 
procedures to prevent excessive exposure to any individual 
correspondent bank.[Footnote 28]

In addition to these safeguards, ILCs must also comply with Bank 
Secrecy Act, Anti-Money Laundering, and Community Reinvestment Act 
requirements. Further, ILCs, like other insured depository 
institutions, are subject to consumer protection laws and must comply 
with federal regulations such as the Board's: 

* Regulation B, which implements the Equal Credit Opportunity Act's 
antidiscrimination provisions;[Footnote 29]

* Regulation Z, which implements the Truth in Lending Act requirements 
relating to disclosures and other consumer protections;[Footnote 30] 
and: 

* Regulation CC, which implements the Expedited Funds Availability Act, 
including the Act's requirements regarding the limits on the length of 
time that a hold may be placed on funds deposited into an account, 
including a NOW account.[Footnote 31]

FDIC's Supervisory Authority Over ILC Holding Companies and Affiliates 
Is Not Equivalent to Consolidated Supervisors' Authority: 

Because most ILCs exist in a holding company structure, they are 
subjected to risks from the holding company and its subsidiaries, 
including adverse intercompany transactions, operations, and reputation 
risk, similar to those faced by banks and thrifts existing in a holding 
company structure. However, FDIC's authority over the holding companies 
and affiliates of ILCs is not as extensive as the authority that 
consolidated supervisors have over the holding companies and affiliates 
of banks and thrifts. For example, FDIC's authority to examine an 
affiliate of an insured depository institution exists only to disclose 
the relationship between the depository institution and the affiliate 
and the effect of that relationship on the depository institution. 
Therefore, any reputation or other risk from an affiliate that has no 
relationship with the ILC could go undetected. In contrast, 
consolidated supervisors, subject to functional regulation 
restrictions, generally are able to examine a nonbank affiliate of a 
bank or thrift in a holding company regardless of whether the affiliate 
has a relationship with the bank. FDIC officials told us that with its 
examination authority, as well as its abilities to impose conditions on 
or enter into agreements with an ILC holding company in connection with 
an application for federal deposit insurance, terminate an ILC's 
deposit insurance, enter into agreements during the acquisition of an 
insured entity, and take enforcement measures, FDIC can protect an ILC 
from the risks arising from being in a holding company as effectively 
as with the consolidated supervision approach. However, we found that, 
with respect to the holding company, these authorities are limited to 
particular sets of circumstances and are less extensive than those 
possessed by consolidated supervisors of bank and thrift holding 
companies. As a result, FDIC's authority is not equivalent to 
consolidated supervision of the holding company. 

FDIC and Consolidated Supervisors Use Different Supervisory Approaches: 

With some exceptions, companies that own or control FDIC insured 
depository institutions are subject to a consolidated--or top-down-- 
supervisory approach that is aimed at assessing the financial and 
operations risks within the holding company structure that may pose a 
threat to the safety and soundness of the depository institution. 
Consolidated supervision is widely recognized throughout the world, 
including Asia, Europe, and in North America, as an accepted approach 
to supervising organizations that own or control financial institutions 
and their affiliates. The European Union also requires consolidated 
supervision for financial institutions operating in its member states, 
and this approach is recognized by the Basel Committee as an essential 
element of banking supervision.[Footnote 32] According to this 
committee, consolidated supervision "includes the ability to review 
both banking and nonbanking activities conducted by the banking 
organization, either directly or indirectly (through subsidiaries and 
affiliates), and activities conducted at both domestic and foreign 
offices. Supervisors need to take into account that nonfinancial 
activities of a bank or group may pose risks to the bank. In all cases, 
the banking supervisors should be aware of the overall structure of the 
banking organization or group when applying their supervisory methods."

In contrast to the top-down approach of bank consolidated supervision, 
which focuses on depository institution holding companies, FDIC's 
supervision focuses on depository institutions. FDIC's authority 
extends to affiliates of depository institutions under certain 
circumstances, thus FDIC describes its approach to examining and taking 
supervisory actions concerning depository institutions and their 
affiliates (including holding companies), as bank-centric or bottom-up. 
According to FDIC officials, the objective of this approach is to 
ensure that the depository institution is insulated and isolated from 
risks that may be posed by a holding company or its subsidiaries. This 
objective is similar to the objectives of consolidated supervision. 
While FDIC officials assert that the agency's bank-centric approach can 
go beyond the insured institution, as discussed later in this report, 
this approach is not as extensive as the consolidated supervisory 
approach in assessing the risks a depository institution faces in a 
holding company structure. 

Consolidated Supervisors Have More Explicit Supervisory Authority Over 
Holding Company Affiliates than FDIC: 

As consolidated supervisors, the Board and OTS have authority to 
examine bank and thrift holding companies and their nonbank 
subsidiaries in order to assess risks to the depository institutions 
that could arise because of their affiliation with other entities in a 
consolidated structure. The Board and OTS may examine holding companies 
and their nonbank subsidiaries, subject to some limitations,[Footnote 
33] to assess, among other things, the nature of the operations and 
financial condition of the holding company and its subsidiaries; the 
financial and operations risks within the holding company system that 
may pose a threat to the safety and soundness of any depository 
institution subsidiary of such a holding company; and the systems for 
monitoring and controlling such risks.[Footnote 34] The Board's 
examination authority is limited to certain circumstances, such as 
where the Board "has reasonable cause to believe that such subsidiary 
is engaged in activities that pose a material risk to an affiliated 
depository institution" or the Board has determined that examination of 
the subsidiary is necessary to inform the Board of the systems the 
company has to monitor and control the financial and operational risks 
within the holding company system that may threaten the safety and 
soundness of an affiliated depository institution.[Footnote 35] OTS's 
examination authority with respect to holding companies is subject to 
the same limitation.[Footnote 36] Also, the focus of Board and OTS 
examinations of all holding company nonbank subsidiaries must, to the 
fullest extent possible, be limited to subsidiaries that could have a 
materially adverse effect on the safety and soundness of a depository 
institution affiliate due to either the size, condition, or activities 
of the subsidiary or the nature or size of transactions between the 
subsidiary and any affiliated depository institution.[Footnote 37]FDIC 
examinations of affiliates having a relationship with an institution 
are not subject to the same limitations where the examination is to 
determine the condition of the institution for insurance 
purposes.[Footnote 38]

As a result of their authority, consolidated supervisors take a 
systemic approach to supervising depository institution holding 
companies and their nonbank subsidiaries. Consolidated supervisors may 
assess lines of business, such as risk management, internal control, 
IT, and internal audit across the holding company structure in order to 
determine the risk these operations may pose to the insured 
institution. These authorities enable consolidated supervisors to 
determine whether holding companies that own or control insured 
depository institutions, as well as holding company nonbank 
subsidiaries, are operating in a safe and sound manner so that their 
financial condition does not threaten the viability of their affiliated 
depository institutions.[Footnote 39] Thus, consolidated supervisors 
can examine a holding company subsidiary to determine whether its size, 
condition, or activities could have a materially adverse effect on the 
safety and soundness of the bank even if there is no direct 
relationship between the two entities. Although the Board's and OTS's 
examination authorities are subject to some limitations, as previously 
noted, both the Board and OTS maintained that these limitations do not 
restrict the supervisors' ability to detect and assess risks to an 
insured depository institution's safety and soundness that could arise 
solely because of its affiliations within the holding company. 

The Board's and OTS' consolidated supervisory authorities also include 
the ability to require holding companies and their nonbank subsidiaries 
to provide reports in order to keep the agencies informed about matters 
that include the holding company's or affiliate's financial condition, 
systems for monitoring and controlling financial and operations risks, 
and transactions with affiliated depository institutions.[Footnote 40] 
These authorities are subject to restrictions designed to encourage the 
agency to rely on reports made to other supervisors, publicly available 
information, and externally audited financial statements. The Board 
requires that bank holding companies provide annual reports of the 
company's operations for each year that it remains a bank holding 
company; OTS has the authority to require an independent audit of, 
among other things, the financial statements of a holding company, at 
any time.[Footnote 41] According to Board's and OTS' examination 
manuals, examiners may also use additional reports of holding company 
and affiliate activities that are not publicly available, such as the 
holding company's financial statements, budgets and operation plans, 
various risk management reports, and internal audit reports. 

In addition to examination authority, as consolidated supervisors, the 
Board and OTS have instituted standards designed to ensure that the 
holding company serves as a source of strength for its insured 
depository institution subsidiaries. The Board's regulations for bank 
holding companies include consolidated capital requirements that, among 
other things, can help protect against a bank's exposure to risks 
associated with its membership in the holding company.[Footnote 42] The 
OTS does not impose consolidated regulatory capital requirements on 
thrift holding companies. Although there is no specific numerical 
requirement (ratio), OTS's policy is that regulated holding companies 
should have an adequate level of capital to support their risk profile. 
OTS examiners are instructed to consider all aspects of an 
organization's risk profile, on a case by case basis, to determine if 
capital is adequate with respect to both the holding company and its 
affiliate thrift. 

In addition to consolidated capital requirements, the Board has, by 
regulation, instituted the "source of strength" doctrine, which states 
that a bank holding company shall serve as a source of financial and 
managerial strength to its subsidiary banks.[Footnote 43] According to 
Board officials, the source of strength doctrine can be invoked to 
require a bank holding company to take affirmative action, for example, 
by providing capital infusions to an affiliate depository institution 
in financial distress, in order to enhance the safety and soundness of 
the institution. Some banking experts have expressed concern that the 
Board's authority to require a transfer of assets from the holding 
company to a troubled affiliate bank is unclear.[Footnote 44] In 
amendments to the BHC Act and FDI Act enacted as part of GLBA, Congress 
indicated its understanding that the Board has such authority.These 
amendments refer to (1) limiting the Board's authority to require the 
transfer of funds or other assets to a subsidiary bank by bank holding 
companies or affiliates that are insurance companies or are registered 
as brokers, dealers, investment companies or investment advisers; (2) 
granting the Board authority to require a functionally regulated 
subsidiary of a holding company to provide capital or other funds or 
assets to a depository institution affiliate of the holding company; 
and (3) prohibiting a bank holding company from engaging in expanded 
activities as a financial holding company unless, among other things, 
all of its depository institutions are well capitalized.[Footnote 45] 
The third of these provisions suggests that the Board has authority to 
order the holding company to maintain the bank's capital as a condition 
of its status as a financial holding company. OTS officials stated that 
OTS has the same authority as the Board with respect to requiring a 
capital infusion. 

The Board and OTS also have enforcement authority over holding 
companies and their nonbank subsidiaries which, among other things, 
allows the agencies to order the termination of any activity, or 
ownership, or control of any noninsured subsidiary, if there is 
reasonable cause to believe that the continuation of the activity or 
ownership or control of the uninsured affiliate constitutes a serious 
risk to the financial safety, soundness, or stability of an affiliated 
insured depository institution.For example, if a subsidiary exposed the 
holding company to reputation risk that constituted a serious risk to 
the financial safety and soundness of an affiliated bank, these 
authorities could be used to force the holding company to divest of the 
subsidiary in order to prevent any negative impact from spreading to 
the insured institution.[Footnote 46]

In contrast to the consolidated supervisory approaches of the Board and 
OTS, FDIC's authority does not specifically address the circumstances 
of an ILC holding company or its nonbank subsidiaries except in the 
context of a relationship between the ILC and an entity affiliated with 
it through the holding company structure. Specifically, FDIC's 
authority to examine state nonmember banks, including ILCs, includes 
the authority to examine some, but not all, affiliates of the ILC in a 
holding company structure. Under section 10(b) of the FDI Act, FDIC 
may, in the course of examining an institution, examine "the affairs of 
any affiliate of (the) institution as may be necessary to disclose 
fully--( i) the relationship between such depository institution and 
any such affiliate; and (ii) the effect of such relationship on the 
depository institution."[Footnote 47] FDIC's use of this authority to 
determine the condition of an institution for insurance purposes is not 
limited by the functional regulation restrictions that apply to 
examinations by the Board and OTS.[Footnote 48] Also, according to FDIC 
officials, FDIC can use its subpoena and other investigative 
authorities to obtain information from any affiliate, as well as any 
nonaffiliate, to determine compliance with applicable law and with 
respect to any matter concerning the affairs or ownership of an insured 
institution or any of its affiliates.[Footnote 49] According to FDIC 
officials, such an investigation would be triggered by concerns about 
the insured institution. 

Because FDIC does not regulate institutions affiliated with depository 
institutions on a consolidated basis, it has no direct authority to 
impose consolidated supervision requirements, such as capital levels 
and reporting obligations, on ILC holding companies. However, FDIC does 
have authorities that it can use for certain purposes to address risk 
to depository institutions in a holding company structure. For example, 
FDIC can initiate an enforcement action against an insured ILC and, 
under appropriate circumstances, an affiliate that qualifies as an 
institution-affiliated party (IAP) of the ILC if the ILC engages in or 
is about to engage in an unsafe or unsound practice.[Footnote 50] An 
ILC affiliate is an IAP if, among other things, it is a controlling 
stockholder (other than a bank holding company), a shareholder who 
participates in the conduct of the affairs of the institution, or an 
independent contractor who knowingly or recklessly participates in any 
unsafe or unsound practices.[Footnote 51] However, FDIC's ability to 
use this authority to, for example, hold an ILC holding company 
responsible for the financial safety and soundness of the ILC is less 
extensive than application of the source of strength doctrine by the 
Board or OTS under consolidated supervision. As we will discuss later, 
FDIC officials assert that FDIC can use its supervisory power over an 
ILC under certain circumstances to achieve similar results as under 
consolidated supervision. 

Figure 4 compares some of the differences in explicit supervisory 
authority between FDIC and consolidated supervisors, specifically the 
Board and OTS. The table shows that in two of the eight areas FDIC has 
examination authority with respect to ILC affiliates that have a 
relationship with the ILC, as do the Board and OTS. However, we 
identified six areas where FDIC's explicit authority with respect to 
ILC holding company affiliates is not as extensive as the explicit 
authorities of consolidated supervisors to examine, impose capital- 
related requirements on, or take enforcement actions against holding 
companies and affiliates of an insured institution. In general, FDIC's 
supervisory authority over holding companies and affiliates of insured 
institutions depends on the agency's authority to examine certain 
affiliates and its ability to enforce conditions of insurance and 
written agreements, to coerce conduct based on the prospect of 
terminating insurance, and to take enforcement actions against a 
holding company or affiliate that qualifies as an IAP.[Footnote 52]

Figure 4: Comparison of Explicit Supervisory Authorities of the FDIC, 
Board, and OTS: 

[See PDF for image] 

[A] FDIC may examine an insured institution for interaffiliate 
transactions at any time and can examine the affiliate when necessary 
to disclose the transaction and its effect on the insured institution. 

[B] The authority that each agency may have regarding functionally 
regulated affiliates of an insured depository institution is limited in 
some respects. For example, each agency, to the extent it has the 
authority to examine or obtain reports from a functionally regulated 
affiliate, is generally required to accept examinations and reports by 
the affiliates' primary supervisors unless the affiliate poses a 
material risk to the depository institution or the examination or 
report is necessary to assess the affiliate's compliance with a law the 
agency has specific jurisdiction for enforcing with respect to the 
affiliate (e.g., the Bank Holding Company Act in the case of the 
Board). These limits do not apply to the Board with respect to a 
company that is itself a bank holding company. These restrictions also 
do not limit the FDIC's authority to examine the relationships between 
an institution and an affiliate if the FDIC determines that the 
examination is necessary to determine the condition of the insured 
institution for insurance purposes. 

[C] FDIC may take enforcement actions against institution-affiliated 
parties of an ILC. A typical ILC holding company qualifies as an 
institution-affiliated party. FDIC's ability to require an ILC holding 
company to provide a capital infusion to the ILC is limited. In 
addition, FDIC may take enforcement action against the holding company 
of an ILC to address unsafe or unsound practices only if the holding 
company engages in an unsafe or unsound practice in conducting the 
affairs of the depository institution. 

[D] FDIC maintains that it can achieve this result by imposing an 
obligation on an ILC holding company as a condition of insuring the 
ILC. FDIC also maintains it can achieve this result as an alternative 
to terminating insurance. FDIC officials also stated that the prospect 
of terminating insurance may compel the holding company to take 
affirmative action to correct violations in order to protect the 
insured institution. According to FDIC officials, there are no examples 
where FDIC has imposed this condition on a holding company as a 
condition of insurance. 

[E] In addition to an enforcement action against the holding company of 
an ILC in certain circumstances (see footnote b), as part of prompt 
corrective action the FDIC may require any company having control over 
the ILC to (1) divest itself of the ILC if divestiture would improve 
the institution's financial condition and future prospects, or (2) 
divest a nonbank affiliate if the affiliate is in danger of becoming 
insolvent and poses a significant risk to the institution or is likely 
to cause a significant dissipation of the institution's assets or 
earnings. However, the FDIC generally may take such actions only if the 
ILC is already significantly undercapitalized. 

[End of figure] 

While FDIC's Authority is Less Extensive Than Consolidated Supervision, 
FDIC Officials Assert Its Authority Could Achieve Similar Results: 

Although FDIC's authority over an insured ILC permits FDIC to take 
certain measures with respect to some ILC holding company affiliates 
under certain circumstances, this authority is not equivalent to 
consolidated supervision of the holding company. However, FDIC 
officials stated that it can adequately protect an ILC from the risks 
arising from being in a holding company without adopting a consolidated 
supervision approach. The officials stated that FDIC has various 
authorities, including the following: 

* examining certain ILC affiliates that have a relationship with the 
ILC;

* imposing requirements on an ILC holding company in connection with an 
application for deposit insurance, as a condition of insuring the ILC;

* terminating deposit insurance or entering into written agreements 
with the holding company to correct conditions that would warrant 
termination of the ILC's insurance;

* obtaining written agreements from the acquiring entity in connection 
with a proceeding to acquire an ILC; and: 

* taking enforcement measures against ILCs and certain ILC affiliates. 

FDIC may be able to use these authorities in many instances to 
supervise ILCs and their holding company and affiliates. However, 
because these authorities can be used in connection with concerns about 
a particular ILC only under specific circumstances, they do not provide 
FDIC with a comprehensive supervisory approach designed to detect and 
address the ILC's exposure to all risks arising from its affiliations 
in the holding company, such as reputation risk from an affiliate that 
has no relationship with the ILC. These limitations are most 
significant with respect to existing ILC holding companies that are not 
subject to conditions or written agreements made in connection with the 
ILC's application for insurance and whose ILCs are not currently 
financially troubled or exposed to risks from relationships with their 
affiliates. 

Table 2 provides a summary of what FDIC officials told us about their 
authority over holding companies and affiliates of insured depository 
institutions and our analysis of the limitations of these authorities. 

Table 2: The Extent of Selected FDIC Authorities: 

FDIC authority: Examine certain ILC affiliates[A]; 
Extent of authorities: Only to determine whether the affiliate has a 
relationship with the ILC and, if so, to disclose the effect of the 
relationship on the ILC. The authority does not extend to determining 
how the affiliate's involvement in the holding company alone might 
threaten the safety and soundness of the ILC. 

FDIC authority: Impose conditions on or enter into agreement with an 
ILC holding company in connection with an application for deposit 
insurance; 
Extent of authorities: Only in connection with an application for 
deposit insurance and cannot be used to unilaterally impose conditions 
on an ILC holding company after the application has been approved. 

FDIC authority: Terminate deposit insurance; 
Extent of authorities: Only if certain notice and procedural 
requirements (including a hearing on the record before the FDIC Board 
of Directors) are followed after FDIC determines that:  
* the institution, its directors or trustees have engaged in unsafe or 
unsound practices; 
* the institution is in an unsafe or unsound condition; or; 
* the institution, its directors or trustees have violated an 
applicable legal requirement, condition of insurance, or written 
agreement between the institution and FDIC. 

FDIC authority: Obtain written agreements from the acquiring entity in 
connection with a proceeding to acquire an ILC[B]; 
Extent of authorities: Could be used if grounds for disapproval exist 
with respect to the acquirer. 

FDIC authority: Take enforcement actions against ILC affiliates[C]; 
Extent of authorities: Only if an affiliate is an IAP; and only if the 
IAP engages in an unsafe or unsound practice in conducting the business 
of the ILC or has violated a legal requirement. If the IAP is 
functionally regulated, FDIC's enforcement grounds are further limited. 

Source: GAO analysis of the supervisory authorities stated by FDIC 
officials. 

[A] FDIC's ability to examine ILC affiliates is limited by the meaning 
of the term "relationship," which is unclear in situations where the 
ILC and the affiliate do not engage in transactions or share 
operations. In this respect, FDIC's authority is less extensive than 
consolidated supervision because (1) the examination authority of 
consolidated supervisors does not depend on the existence of a 
relationship and (2) without a relationship, FDIC generally needs the 
consent of the affiliate to conduct an examination of its operations. 

[B] FDIC's ability to obtain written agreements from the acquiring 
entity in connection with a proceeding to acquire an ILC is limited 
because certain types of risks, such as reputation risk, could be 
unrelated to any of the grounds for disapproval of a CIBA notice. 
Moreover, this ability would not be related to concerns arising after 
the acquisition is made. Further, some experts stated that it is 
unlikely that FDIC could require capital-related commitments from a 
financially strong, well managed commercial enterprise that seeks to 
acquire an ILC. 

[C] In accordance with 12 U.S.C. §§1848a, 1831v(a), FDIC's authority to 
take action against a functionally regulated IAP is limited to where 
the action is necessary to prevent or redress an unsafe or unsound 
practice or breach of fiduciary duty that poses a material risk to the 
insured institution and the protection is not reasonably possible 
through action against the institution. 

[End of table]

FDIC's Examination Authority Is Less Extensive Than a Consolidated 
Supervisor: 

FDIC officials stated that its examination authority is sufficient to 
address any significant risk to ILCs from holding companies and 
entities affiliated with the ILC through the holding company structure. 
For example, FDIC officials told us that it has established effective 
working relationships with ILC holding companies and has conducted 
periodic targeted examinations of some ILC holding companies and 
material affiliates that have relationships with the ILC, which 
includes those affiliates that are providing services to or engaging in 
transactions with the ILC. FDIC officials also told us that these 
targeted reviews of holding companies and affiliates help to assess 
potential risks to the ILC and include the following: 

* assessing the holding company's value-at-risk model used at its 
affiliate banks;[Footnote 53]

* assessing the internal control and review processes developed at the 
holding company level and understanding how those processes are applied 
to the bank, including how the holding company's internal audit 
function is designed, scoped, and implemented with respect to the bank;

* reviewing information about the holding company's asset quality and 
its processes for analyzing risk such as: stress testing, review of 
commercial, industrial, and international loans and country risk 
ratings, and loan underwriting procedures developed at the holding 
company level and implemented at the bank; and: 

* assessing IT systems and controls related to the bank. 

The scope of FDIC's general examination authority may be sufficient to 
identify and address many of the risks that holding company and 
affiliate entities may pose to the insured ILC. However, FDIC's general 
examination authority is less extensive than a consolidated 
supervisor's. Because FDIC can examine an ILC affiliate only to 
determine whether it has a relationship with the ILC and, if so, to 
disclose the effect of the relationship on the financial institution, 
FDIC cannot examine ILC affiliates in a holding company specifically to 
determine how their involvement in the holding company alone might 
threaten the safety and soundness of the ILC. When there is no 
relationship between the ILC and the affiliate, FDIC generally would 
need the consent of the affiliate to conduct an examination of its 
operations. According to its officials, FDIC could use its subpoena 
powers and other authorities under section 10(c) of the FDI Act to 
obtain information, but the use of these powers appears to be limited 
to examinations or investigations relating to the insured depository 
institution.[Footnote 54] In contrast, the examination authorities of 
the Board and OTS focus on the operations and financial condition of 
the holding company and its nonbank subsidiaries and specifically on 
financial and operations risks within the holding company system that 
can threaten the safety and soundness of a bank subsidiary.[Footnote 
55] To the extent that an affiliate's size, condition, or activities 
could expose the depository institution to some type of risk, such as 
reputation risk, where no direct relationship with the bank exists, the 
consolidated supervisory approach is more able to detect the 
exposure.[Footnote 56] FDIC's authority does not permit it to examine 
an affiliate based solely on its size, condition, or activities. 
However, FDIC officials told us that it is unlikely that any serious 
risk could come from an affiliate that does not have a relationship 
with the insured institution. According to these officials, there have 
been no bank failures in the United States from reputation risk in the 
past 20 years. We agree that the most serious risk to an ILC would come 
from holding companies or affiliates that have a relationship with the 
ILC. However, the possibility that risks could come from affiliates 
with no relationship with the ILC cannot be overlooked. While no recent 
bank failures may have resulted from reputation risk, it continues to 
attract the attention of the FDIC and the Board. 

Unlike the specific examination authority of the Board, the full extent 
of FDIC's examination authority over affiliates is unclear because 
there is no established definition of the term "relationship" in the 
context of FDIC's examination authority. Further, we are not aware of 
any judicial or legislative clarification of this term as it relates to 
FDIC examinations. According to FDIC officials, determining whether a 
relationship exists can be routine in cases where an insured 
institution and an affiliate engage in a transaction or share 
operations. However, in less obvious cases, the determination might 
involve circumstances that may be unique or unprecedented. 

However, both the Board and FDIC officials, as well as an expert we 
interviewed, generally agreed that the term connotes an arrangement in 
which there exists some level of interaction, interdependence or mutual 
reliance between the ILC and the affiliate, such as a contract, 
transaction, or the sharing of operations. Board officials expressed 
the view that the term has a limiting effect on affiliate examinations. 
FDIC officials told us that its use of this authority to examine ILC 
holding companies or entities affiliated with an insured institution in 
a holding company has never been challenged. 

FDIC's Authority to Impose Conditions or Written Agreements Can Be Used 
in Certain Circumstances: 

FDIC officials also stated that it can use its authority to approve 
applications for deposit insurance as a means of requiring an ILC 
holding company to adopt commitments, operations and procedures that 
enhance the safety and soundness of the ILC. When reviewing an 
application for insurance, FDIC must consider the following seven 
statutory factors:[Footnote 57]

* financial history and condition of the depository institution,

* adequacy of the institution's capital structure,

* future earnings prospects of the institution,

* general character and fitness of the institution's management,

* risk the institution presents to the deposit insurance fund,

* convenience and needs of the community to be served by the 
institution, and: 

* whether the institution's corporate powers are consistent with the 
FDI Act. 

FDIC officials stated that because its primary mission is to protect 
the bank insurance fund, the FDIC's incidental powers and other 
authorities under the FDI Act authorize the FDIC to impose conditions 
on insurance where those conditions are warranted by the statutory 
factors.[Footnote 58] Under its enforcement authority, FDIC can 
initiate proceedings against an IAP for violation of a condition 
imposed in writing by FDIC in connection with the granting of any 
application or request by the depository institution or any written 
agreement with the agency.[Footnote 59] In March 2004, FDIC issued 
guidance that identified nonstandard conditions that might be imposed 
when approving applications for deposit insurance involving financial 
institutions to be owned by or significantly involved in transactions 
with commercial or financial companies. For example, among other 
things, FDIC can require that the majority of ILC management be 
independent of its holding company and affiliates, and that all 
arrangements to share management staff, personnel, or resources with 
the holding company or any affiliate be governed by written contracts 
giving the bank authority to govern its own affairs. FDIC officials 
told us that the approval of insurance could be conditioned upon the 
holding company's adhering to prescribed capital levels, adopting a 
capital maintenance plan for the ILC, and/or other measures such as 
submitting reports about affiliates to FDIC. For example, FDIC's policy 
is to favor capital commitments from holding companies of applicants 
for insurance.[Footnote 60] However, FDIC officials were unable to 
provide examples where FDIC has imposed conditions on an application 
for insurance that required the holding company to provide specific 
reports of operations, financial condition, and systems of monitoring 
risk at the holding company and affiliates. Although FDIC officials and 
examiners told us that no ILC holding company has refused to provide 
all of the reports and supporting documents that the examiners needed, 
our review found that FDIC examiners rely upon information about 
holding company and affiliate operations that is voluntarily provided 
by ILC holding companies during the course of an examination to assess 
the various types of risk from the holding company and affiliate 
operations, including various types of nonpublic information such as 
asset quality and loan underwriting. Further, FDIC officials told us 
that it has never imposed capital requirements on a holding company; 
rather, officials gave an example where a legally enforceable agreement 
to maintain a certain level of capital was obtained from the holding 
company. In addition to imposing conditions, FDIC could, according to 
its officials, enter into a written agreement with the holding company 
of an institution to establish a supervisory system similar to 
consolidated supervision. For example, the agreement could call for the 
holding company to correct conditions at the affiliate that presents 
risks to the ILC, provide reports about affiliates, or even a capital 
infusion into the ILC. According to FDIC officials, whether to impose 
capital and reporting requirements as conditions on insurance or 
achieve the same result through agreements with the holding company 
depends upon the circumstances of the application for insurance. 

FDIC's authority does not permit it to impose conditions on an ILC 
holding company after the application has been approved. Should the ILC 
face risks from the holding company that are not adequately covered by 
insurance conditions or a written agreement with the holding company 
and do not arise from any relationship that the ILC has with an 
affiliate, FDIC would have to resort to some other means to achieve 
corrective action by the holding company, such as persuading the 
holding company to take action to avoid termination of the depository 
institution's insurance. FDIC officials also referred to procedures 
under the prompt corrective action (PCA) provisions of the FDI Act for 
undercapitalized institutions that can require action by a holding 
company, such as a guarantee to maintain the depository institution's 
capital at prescribed levels and divestiture of a significantly 
undercapitalized institution or any affiliate.[Footnote 61] FDIC's PCA 
authority cannot be used unless the institution violates capital 
standards and is triggered only by a bank's capital deficiency. In 
contrast, under consolidated supervision, capital and reporting 
requirements are imposed on holding companies of depository 
institutions to address the potential for risks arising from the 
holding company system. Moreover, consolidated supervision requirements 
can address risks that might not be discernible at a particular point 
in time, whereas FDIC can exercise its authorities only under certain 
circumstances, such as when an application for insurance is granted. 

FDIC's Authority to Terminate Insurance Can Be Exercised in Certain 
Circumstances: 

FDIC officials stated that, even if conditions or agreements were not 
established in connection with the issuance of an ILC's insurance, the 
prospect of terminating an institution's insurance can serve to compel 
the holding company to take measures to enhance the safety and 
soundness of the ILC. Under the FDI Act, FDIC can initiate an insurance 
termination proceeding only if certain notice and procedural 
requirements are followed after a determination by the FDIC that (1) an 
institution, its directors, or trustees have engaged in or are engaging 
in an unsafe or unsound practice; (2) an institution is in an unsafe or 
unsound condition; or (3) the institution, its directors, or trustees 
have violated an applicable legal requirement, a condition imposed in 
connection with an application by the depository institution, or a 
written agreement between the institution and FDIC.[Footnote 62] In 
addition, termination proceedings must be conducted in a hearing on the 
record, documented by written findings in support of FDIC's 
determination, and are subject to judicial review.[Footnote 63] FDIC 
officials told us that if the grounds for termination exist, FDIC can 
provide the holding company of a troubled ILC with an opportunity to 
avoid termination by agreeing to measures that would eliminate the 
grounds for termination. These measures could include an agreement to 
infuse capital into the ILC or provide reports about the holding 
company and its affiliates. According to FDIC officials, the prospect 
of terminating insurance is usually sufficient to secure voluntary 
corrective action by a holding company to preclude the occurrence of an 
unsafe or unsound practice or condition or restore the institution to a 
safe and sound financial condition. FDIC officials stated that FDIC has 
notified insured institutions that it intended to terminate deposit 
insurance 184 times. Between 1989 and 2004, FDIC initiated formal 
proceedings to terminate deposit insurance in 115 of these cases 
because necessary corrections were not immediately achieved. In 94 of 
these 115 instances, corrective actions were taken, and the deposit 
insurance was not terminated. For the remaining 21 of the 115 cases, 
FDIC terminated deposit insurance. FDIC officials told us that, after 
terminating deposit insurance, 17 of these institutions implemented 
appropriate corrective actions, and the insurance was subsequently 
reinstated. 

As demonstrated by the number of institutions that took measures to 
enhance the safety and soundness of the insured depository institution, 
the threat of insurance termination has been an effective supervisory 
measure in many instances. However, FDIC's ability to use the 
possibility of insurance termination to compel the holding company to 
enhance the safety and soundness of the insured institution is limited. 
For example, because the statutory grounds for termination relate to 
the condition of the institution and practices of its directors or 
trustees, the prospect of termination would not be based solely on the 
condition or operations of an institution's affiliate. While conditions 
could exist in the holding company that might threaten the holding 
company and thereby indirectly threaten an ILC, these conditions would 
not serve as grounds for termination of insurance unless they caused 
the institution to be in an unsafe or unsound condition. Further, 
unlike the consolidated supervision approach, FDIC insurance 
termination authority does not give it power to require a holding 
company or any of its nonbank affiliates to change their operations or 
conditions in order to rehabilitate the ILC. The extent to which FDIC 
could enter into an agreement with a holding company would depend on 
whether the holding company has an incentive to retain the 
institution's insured status and/or the resources to take the action 
FDIC seeks. 

In Certain Circumstances, FDIC May Enter Into Agreements in Connection 
with the Acquisition of an Insured Institution: 

FDIC officials also stated that if an entity sought to acquire an ILC, 
the regulatory process for such a transaction could afford FDIC an 
opportunity to seek an agreement from the prospective acquirer relating 
to matters such as capital maintenance, examinations, and reporting. 
Provisions of the Change In Bank Control Act (CIBA) set forth the 
reasons for which FDIC can disapprove the proposed acquisition of an 
insured ILC.[Footnote 64] These include proposed acquisitions where (1) 
the financial condition of the acquiring company might jeopardize the 
financial stability of the depository institution; (2) the competence, 
experience, or integrity of the acquirer or proposed management 
personnel do not satisfy statutory standards; and where (3) FDIC 
determines that the acquisition would have an adverse effect on the 
deposit insurance fund. According to FDIC officials, it could use the 
prospects of disapproval on these or other grounds to force a potential 
acquirer to enter agreements that would address potential risks to an 
ILC arising from its presence in a holding company. FDIC officials 
described an instance where officials obtained an agreement from an 
acquirer to correct potential problems even before issuing disapproval 
of the CIBA notice to address the acquirer's request to avoid negative 
publicity. 

FDIC's ability to reach an agreement in connection with an acquisition 
appears to be helpful in mitigating some of the risks that could arise 
at this time. However, FDIC's ability to obtain agreements in 
connection with a CIBA notice is limited when a prospective acquirer of 
an ILC does not trigger the statutory concerns described above. For 
example, some experts we talked with said it is unlikely that FDIC 
could use its CIBA authority to require capital-related commitments 
from a financially strong, well-managed commercial enterprise that 
seeks to acquire an ILC. Moreover, certain types of risk to a 
depository institution that can arise from its affiliations in a 
holding company, such as reputation risk arising from an affiliate of 
the acquirer, could be unrelated to any of the grounds for disapproval 
set forth in CIBA or could arise after the acquisition has been 
approved. 

FDIC's Authority to Take Enforcement Actions Is Less Extensive Than a 
Consolidated Regulator: 

FDIC officials also stated that it can use its enforcement authority to 
compel certain institution affiliated parties of ILCs (a group that 
typically would include the ILC's holding company) to take measures 
relating to the safety and soundness of the ILC. However, FDIC has no 
enforcement authority over ILC affiliates that are not IAPs, and its 
ability to require an IAP to infuse capital into a troubled ILC appears 
to be limited. As discussed previously, FDIC has no authority to take 
action against an ILC affiliate whose activities weaken the holding 
company, and potentially the ILC, unless the affiliate is an IAP. If 
grounds for an enforcement action exist, FDIC can initiate an action 
against the insured institution or an IAP to obtain, among other 
things, a cease and desist order or civil money penalties.[Footnote 65]

FDIC officials told us that it could use its enforcement authority, 
under appropriate circumstances, to require an ILC holding company to 
take action necessary to protect or restore the safety and soundness of 
its affiliate insured institution, which action could include 
transferring capital into the institution or making a guarantee to do 
so. However, FDIC's ability to impose such requirements against a 
functionally regulated affiliate is limited.[Footnote 66] Moreover, 
FDIC's authority to require an asset transfer in an administrative 
enforcement action may be limited. In a decision interpreting OTS' 
authority to require a holding company to comply with a written 
condition requiring the company to maintain the net worth of a savings 
bank affiliate, the District of Columbia Circuit Court (Court) held 
that OTS had no authority to require an asset transfer absent proof of 
the holding company's unjust enrichment or reckless disregard of its 
legal obligations.[Footnote 67] In that decision, the Court observed 
that this same provision governs enforcement actions by other federal 
banking agencies, including FDIC. According to this decision, FDIC has 
no authority to require an ILC holding company to transfer assets to a 
troubled ILC solely because of the ILC's unsafe or unsound condition, 
unless the condition is the result of the holding company's use of the 
ILC for unjust enrichment or reckless disregard of a legal obligation 
to make the transfer. The Court's decisions in these cases also may 
limit the authority of the Board and OTS to require an asset transfer 
without proving unjust enrichment or reckless disregard of a legal 
requirement. In this regard, a bank holding company's reckless 
disregard of its obligation to maintain the financial safety and 
soundness of a subsidiary bank might satisfy the Court's requirements 
for a capital infusion. 

FDIC Actions May Help Mitigate Potential Risks, but Supervision of ILC 
Holding Companies and Affiliates Has Only Been Tested on a Limited 
Basis in Relatively Good Economic Times: 

FDIC's bank-centric, supervisory approach has undergone various 
modifications to its examination, monitoring, and application 
processes, designed to help mitigate the potential risks that FDIC- 
examined institutions, including ILCs in a holding company structure, 
can be exposed to by their holding companies and affiliates. For 
example, FDIC revised the guidance for its risk-focused examinations 
to, among other things, provide additional factors that might be 
considered in assessing a holding company's potential impact on an 
insured depository institution affiliate. These changes may further 
enhance FDIC's ability to supervise the potential risks that holding 
companies and affiliates can pose to insured institutions in a holding 
company structure, including ILCs. In addition, FDIC's application 
process may also help to mitigate risks to ILCs with foreign holding 
companies and affiliates. While FDIC has provided some examples where 
its supervisory approach effectively protected the insured institution 
and mitigated losses to the bank insurance fund, questions remain about 
whether FDIC's supervisory approach and authority over BHC Act-exempt 
holding companies and affiliates addresses all risks to the ILC from 
these entities. Further, FDIC's supervision of large, rapidly growing 
ILCs and authority over BHC Act-exempt holding companies and nonbank 
affiliates has been refined during a period of time described as the 
"golden age of banking" and has not been tested during a time of 
significant economic stress or by a large, troubled ILC. 

FDIC Examination and Monitoring Procedures May Help to Mitigate Risks 
to ILCs from Holding Companies and Affiliates: 

According to FDIC, its process for conducting safety and soundness 
examinations for ILCs is risk-focused and generally the same as for 
other banks under its oversight. These officials believed that an 
examiner's ability to exercise judgment to determine the depth of 
review in each functional area is crucial to the success of the risk- 
focused supervisory process. FDIC officials and examiners told us that, 
at every examination, FDIC reviews an institution's relationships with 
affiliated entities. According to FDIC's Supervisory Insights, in an 
examination of a depository institution with affiliates, including an 
ILC, FDIC examiners assess the bank's corporate structure, the bank's 
interactions with affiliates--which include a review of intercompany 
transactions and interdependencies--as well as the financial risks that 
may be inherent in the affiliate relationship. Once each on-site 
examination is initiated, the FDIC requests information from bank 
management to obtain items that serve as the starting point for 
reviewing the institution's relationships with affiliated entities. The 
requested information may include items such as the following: 

* a list of officers and directors of affiliates, including 
organizational chart, if available;

* a list of affiliated organizations and their financial statements as 
of the financial statement date, or most recent date available;

* the most recent annual report, SEC 10-K report, and/or SEC 10-Q 
report (annual and quarterly financial filings to the SEC);

* a tax allocation agreement with the holding company;

* contracts for all business relationships with affiliates that provide 
services to the ILC; and: 

* the fee structure of transactions with the holding company and/or 
affiliates. 

FDIC's examination manual notes that an institution's relationship with 
its affiliates is an important part of the analysis of the condition of 
the bank itself. The manual further states that, because of common 
ownership or management, transactions with affiliates may not be 
subject to the same sort of objective analysis by bank management that 
is used to analyze transactions between independent parties and that 
affiliates offer an opportunity to engage in types of business 
endeavors that are prohibited for the bank itself, yet may impact the 
condition of the bank. In March 2004, the FDIC updated the Related 
Organizations section of its examination manual to, among other things, 
expand the discussion of management's fiduciary responsibilities to 
ensure that an insured depository institution maintains a separate 
corporate existence from its affiliates; to provide additional factors 
that might be considered in assessing a holding company's potential 
impact on an insured depository institution affiliate, such as the 
independence of the bank's management from the holding company; and to 
emphasize examiners' authority under Section 10(b) and (c) of the FDI 
Act to examine affiliates of state nonmember banks, if deemed 
warranted. 

Table 3 lists some of the examination procedures performed during a 
review of an institution with affiliates, including ILCs. 

Table 3: Affiliate Related Examination Procedures: 

Assessing the bank's corporate structure. 

Reviewing intercompany transactions to determine how the bank interacts 
with the affiliates. 

Reviewing the interdependencies of the bank and affiliates. 

Evaluating any financial risks that may be inherent in the 
relationship. 

Reviewing the current written business plan and evaluating any changes. 

Reviewing any arrangements of shared management or employees. 

Reviewing services provided to an affiliate to determine whether the 
same terms and conditions are in place as would be for nonaffiliated 
entities. 

Reviewing the services purchased from an affiliate to determine whether 
the same terms and conditions are similar to those that would be 
applied to a nonaffiliated entity. 

Assessing whether written agreements are in place for all service 
relationships. 

Reviewing relevant documents to determine whether the bank has a 
contingency plan for all critical business functions performed by 
affiliated companies. 

Source: FDIC. 

Note: Adapted from Supervisory Insights, June 2004. 

[End of table]

While the FDIC lacks specific authority to require that holding 
companies serve as a source of strength to affiliate financial 
institutions, FDIC officials told us that examination activities to 
assess the holding company's source of strength to the insured 
institution are performed at each examination. The examination manual 
also states that a sound, well-managed holding company can be a source 
of strength for unit banks and provide strong financial support because 
of its greater ability to attract and shift funds from excess capital 
areas to capital deficient areas. Moreover, the examination manual 
states that, when the financial condition of the holding company or its 
nonbanking affiliates is tenuous, pressures can be exerted on the 
affiliate bank by payment of excessive dividends, investing in high 
risk assets, purchase and/or trade of high quality assets for 
affiliates lower quality assets, purchase of unnecessary services, or 
payment of excessive management or other fees. 

In its recent report on FDIC's approach to supervising limited-charter 
institutions,including ILCs, the FDIC-IG recommended that FDIC further 
revise its examination manual and policies to expand the discussion of 
the source of strength provided to an affiliate bank by the managerial 
and financial capabilities of the holding company and provide guidance 
and procedures to examiners for analyzing the holding company's source 
of strength. FDIC officials told us that, in December 2004, FDIC 
further revised its manual to include more specific suggestions for 
analyzing whether a holding company, including a holding company of an 
ILC, may serve as a potential "source of strength." Currently, FDIC's 
manual provides specific guidance to examiners on: (1) measuring the 
ability of the holding company to cover its interest expense; (2) 
testing the holding company's cash availability to meet not only 
interest expenses, but also operating expenses, taxes, shareholders 
dividends, and debt maturities; and (3) assessing the risk to a bank 
through the use of dual-employee arrangements. FDIC officials told us 
that if the management or financial capacity of the holding company 
provides a significant source of strength to the ILC, this finding 
would typically be incorporated into the summary examination report. 
The FDIC-IG's report also stated that establishing uniform and complete 
policies and procedures for assessing a bank's corporate structure or 
relationships with affiliated entities, including the holding company, 
should help ensure that examiners adequately identify risks that may be 
inherent in the ILC-holding company relationship. The FDIC-IG concluded 
that FDIC could further improve its examination policies and procedures 
by (1) including specific procedures for examiners to follow in 
assessing dual-manager and dual-employee arrangements; (2) clarifying 
procedures with respect to reviewing business plans, operating budgets, 
or strategic planning documents to ensure that procedures are 
consistently applied; and (3) requiring examiners to calculate and 
provide financial ratios in the summary examination report, especially 
for ILCs. The report further states that, in the absence of Board 
holding company reports, these ratios could provide examiners with 
important insights about the impact that affiliates are having on the 
ILC. 

Other aspects of FDIC's examination approach also help mitigate the 
risk that holding companies and affiliates may pose to insured 
institutions, including ILCs. For example, some ILCs are included in 
FDIC's Large State Nonmember Bank Onsite Supervision or "Large Bank" 
and Dedicated Examiner programs and receive continuous supervision. The 
Large Bank program provides an on-site presence at depository 
institutions through visitations and targeted reviews throughout the 
year as opposed to the traditional annual point-in-time examination. 
State nonmember banks with total assets of $10 billion or more are 
eligible. Institutions that do not meet the asset threshold can qualify 
for the Large Bank program based upon their size, complexity, and risk 
profile. Some of the major areas covered in the targeted reviews can 
include: capital markets activities, lending, risk management, 
operations, internal controls and audit, management supervision, 
capital, earnings, and liquidity. Three ILCs that represent nearly 75% 
of total ILC assets are currently part of the Large Bank program. In 
addition, according to the FDIC-IG report, the FDIC established the 
Dedicated Examiner program in 2002 to appoint eight dedicated examiners 
to work closely with the primary federal supervisors of the eight 
largest insured depository institutions in the United States. Currently 
there are three holding companies that are monitored as part of the 
Dedicated Examiner program and, together, they own a total of four 
ILCs. These dedicated examiners work with examination staff from the 
Board, OTS, and OCC to obtain real-time access to information about the 
risk and trends in these organizations. According to FDIC officials, 
currently dedicated examiners for two of the three holding companies 
had not been assigned. 

Examiners also use Call Report[Footnote 68] data to monitor the 
condition of financial institutions and assist in prioritizing on-site 
safety and soundness examination efforts. In addition, according to 
FDIC officials and examiners we spoke with, examiners often obtain 
information, including holding company financial reports and monthly 
board of directors' meeting minutes, voluntarily provided by ILC 
management that can assist an examiner's ability to assess risks to the 
ILC. This documentation can include information regarding existing and 
planned transactions and contracts with its holding company and 
affiliates and can further assist in an examiner's ability to identify 
and assess potential risks to the ILC stemming from these 
relationships. 

FDIC also works with state banking supervisors to examine ILCs, 
including assessing the risks that ILC holding companies and affiliates 
may pose to the insured institution. In May 2004, FDIC jointly 
developed recommended practices for state and federal supervisors to 
communicate and coordinate the planning and execution of supervisory 
activities.[Footnote 69] Recommendations included: involving both the 
state and federal banking supervisors in meetings with bank management 
and directors; sharing reports produced through off-site monitoring or 
targeted supervisory activities; discussing and preparing supervisory 
plans at least once during the examination cycle, or more frequently, 
as appropriate; and jointly discussing, coordinating, and executing all 
corrective action plans such as memoranda of understanding and cease 
and desist orders. 

In addition, FDIC established a goal, as part of its 2004 Performance 
Plan, to develop an on-site examination program for nonbank holding 
companies. The program would establish procedures for examination of a 
nonbank or commercial holding company that owns an insured institution, 
beyond what is currently done to determine the holding company's 
potential effect on the insured institution. According to FDIC 
officials, a preliminary draft outline of the examination program had 
been provided to FDIC's legal and management divisions for comment in 
September 2004. FDIC officials also told us that proposals for the 
program are still being drafted. At this time, it is too early to 
determine how this program will enhance FDIC's ability to protect an 
insured depository institution from the potential risks that holding 
company and affiliate entities may pose. 

FDIC's Application Process May Help to Mitigate Risks to ILCs from 
Foreign Holding Companies and Affiliates: 

As previously discussed, FDIC's authority to impose conditions on a 
holding company is limited to the circumstances previously discussed. 
However, its application process may help mitigate potential risks to 
ILCs from foreign holding companies. For example, deposit insurance 
applications from foreign owners are subject to the same approval and 
review processes as all other applications. While foreign banking 
organizations chartered in the European Union are already subject to 
consolidated supervision, FDIC officials told us that not all foreign- 
owned ILC holding companies are designated as foreign banking 
organizations (as defined by the Board) and, therefore, are not subject 
to consolidated supervision in their home country. According to FDIC, 
currently, only one of the five foreign-owned ILCs is owned by a 
foreign banking organization that is subject to comprehensive 
consolidated supervision in its home country. We reviewed an order 
approving an application for insurance from a foreign holding company 
of an ILC in which FDIC indicated that the proposed ownership structure 
presented some concerns because it had potential to present supervisory 
concerns similar to those posed by chain banking organizations[Footnote 
70] and because part of the "chain" was located in another country and 
not subject to U.S. supervision. According to FDIC, chain banks present 
opportunities to shift low- quality assets and other funds between 
banks to avoid being detected by supervisors and auditors. FDIC's 
concerns were mitigated, in part, because of its ability to review 
publicly available information about the publicly traded holding 
company and the foreign bank affiliates' location in countries that 
appeared to have adequate supervisory regimes. 

In addition, FDIC may impose conditions in foreign applications for 
deposit insurance when it is deemed necessary to insulate the ILC. For 
example, we reviewed an order approving an application for deposit 
insurance from a foreign holding company of an ILC in which FDIC 
imposed several conditions, including the following: 

* requiring the holding company to establish a designated agent in the 
United States, prior to receiving deposit insurance;

* entering into a written agreement with FDIC whereby the holding 
company agrees to be subject to United States Court jurisdiction on 
domestic banking issues;

* prohibiting the bank from engaging in any transactions with non-U.S. 
affiliates without the prior written approval of the regional Director 
of the FDIC; and: 

* requiring the holding company to obtain and maintain current 
financial information on any non-U.S. financial affiliate prior and 
subsequent to entering into any transactions with the non-U.S. 
financial affiliate and making the information available for examiner 
review at the holding company's main office in the United States. 

State Supervisors Contribute to ILC Supervision, but Resources Vary: 

The state chartering authorities also play a role in supervising ILCs 
and their holding companies and affiliates. The states of California, 
Nevada, and Utah collectively supervise 49 of the 57 active, FDIC- 
insured ILCs. Like FDIC, they examine transactions and agreements that 
the ILCs may have with their holding companies and affiliates for 
compliance with sections 23A and 23B of the Federal Reserve Act. In 
addition, according to these state banking supervisors, they have 
authority to conduct examinations of holding companies and affiliates, 
although the scope of these authorities varies.[Footnote 71] Utah 
officials also maintain that the Commissioner of Financial Institutions 
can, under general supervisory authority over financial institution 
holding companies, impose capital requirements on the holding company 
in order to protect the insured institution.[Footnote 72] We also found 
that FDIC has written, formal information sharing agreements with all 
three states and has an agreement to accept examination reports 
prepared by California on alternate examination years and to conduct 
examinations jointly with Nevada and Utah. 

Table 4 compares the examination resources and organizational structure 
of the state banking supervisory offices in all three states. As shown 
in the table, more than half of the institutions supervised by the 
state of Utah are ILCs while this percentage is significantly less in 
California and Nevada. 

Table 4: Comparison of Examination Resources and Organizational 
Structure of State Banking Supervisory Office: 

(Dollars in billions). 

California Department of Financial Institutions; 
Total number of insured institutions supervised: 190; 
Number of ILCs supervised: 15; 
Total ILC assets: $13.7; 
Number of examination staff: 120; 
Organizational structure: Reports directly to the state Business, 
Transportation and Housing Agency. 

Nevada Division of Financial Institutions; 
Total number of insured institutions supervised: 29; 
Number of ILCs supervised: 5; 
Total ILC assets: $10.2; 
Number of examination staff: 12; 
Organizational structure: Reports directly to the state Department of 
Business and Industry. 

Utah Department of Financial Institutions; 
Total number of insured institutions supervised: 56; 
Number of ILCs supervised: 29; 
Total ILC assets: $115.0; 
Number of examination staff: 33; 
Organizational structure: Reports directly to the Governor of Utah. 

Sources: GAO and FDIC data. 

Note: All data reported are as of December 31, 2004. 

[End of table]

Table 4 also demonstrates that the supervisory resources available in 
each state and the organizational structure of each banking supervisory 
office vary. Further, the number of examination staff per regulated 
entity is similar for California and Utah while Nevada has fewer 
examiners per institution supervised. Additionally, Utah has 
supervisory oversight over almost half of the active ILCs, 29 out of 
the 57, and employs 33 examiners that are responsible for examining 56 
state-supervised banking institutions, including ILCs. The Utah DFI 
reports directly to the state Governor. The Utah DFI recently provided 
ILCs in its jurisdiction the opportunity to voluntarily submit to 
continuous supervision by FDIC and Utah state supervisors, as part of 
FDIC's Large Bank program.[Footnote 73] As a result, according to Utah 
officials, 4 ILCs have volunteered to participate.[Footnote 74] 
California has supervisory oversight over 190 state-supervised banking 
institutions, including 15 ILCs and employs 120 examiners. The 
California Department of Financial Institutions reports directly to the 
state Business, Transportation and Housing Agency. Nevada has 
supervisory oversight over 29 state-supervised banking institutions, 
including 5 ILCs, and currently employs 12 examiners. As of the time of 
our review, the Nevada Division of Financial Institutions (Nevada DFI) 
was not accredited, largely due to limited staff resources. As a 
result, the Nevada DFI is unable to examine insured depository 
institutions without partnership with FDIC or other federal 
supervisors.[Footnote 75] The Nevada DFI reports directly to the state 
Department of Business and Industry. 

Questions Exist Regarding Whether the Bank-Centric Approach Addresses 
All Risks to the ILC: 

Officials from the FDIC and the Board disagree over whether the bank- 
centric approach to supervision, without the added components of the 
consolidated supervisory approach, effectively identifies all of the 
potential risks that holding companies and ILC may pose to the ILC. 
FDIC officials told us that its current supervisory approach focuses 
not only on the insured institution but also on the risks that holding 
companies and affiliates could pose to an insured institution in a 
holding company structure. FDIC notes in Supervisory Insights that its 
experience with ILCs reinforces the agency's position that effective 
bank-level supervision is essential in safeguarding institutions from 
risk posed by holding companies. However, officials from the Board told 
us that the bank-centric approach alone was not sufficient to protect 
banks from all the risks that holding company and affiliate entities 
could pose. These officials stated that consolidated supervision of 
holding companies is essential to ensuring the safety and soundness of 
institutions, like ILCs, that exist in a holding company structure. 

According to FDIC officials, consolidated supervision of the holding 
company is not a superior method for protecting the insured entity; 
rather, these officials stated that the primary source of strength for 
the holding company is usually the insured institution. FDIC officials 
told us that its bank-centric approach is not limited in its focus and 
that examiners have access to whatever they need in order to assess 
potential risks to the insured institution. As noted previously, FDIC 
officials provided examples of where examiners conducted targeted 
reviews of selected operations of the holding company and material 
affiliates of several ILCs. In addition, officials stated that the bank-
centric approach has effectively mitigated losses to the bank insurance 
fund stemming from troubled banks. For example, FDIC officials told us 
about its efforts to protect Conseco Bank--an insured ILC whose assets, 
at one point, totaled $3 billion--from operations and reputation risk 
from its parent company that eventually filed for bankruptcy after 
experiencing financial difficulty from acquiring a business with a poor 
loan portfolio. In this instance, FDIC, the state supervisor, and the 
bank developed a mutually agreed upon plan to protect Conseco Bank by 
implementing policies that placed more control in the hands of bank 
management. For example, the plan prohibited the bank from paying 
dividends to any affiliate, including the parent, and required Conseco 
Bank to sell its problem loans to the parent. Also, since loan 
servicing for Conseco Bank was provided by an affiliate of the parent, 
the agreement required the parent to sell the loan servicing affiliate 
to Conseco Bank to improve the independence and continuity of the 
bank's operations. The FDIC and state supervisor closely monitored 
Conseco Bank throughout the parent's bankruptcy proceedings. 
Eventually, Conseco Bank was marketed and ultimately sold for full 
value with no loss to the Fund. 

FDIC told us of three other examples where its bank-centric approach 
effectively managed the risks being posed by holding companies and 
their subsidiaries to ILCs that were troubled. In one example, the FDIC 
established a written agreement with the ILC prohibiting it from paying 
dividends to its holding company or its affiliates without FDIC 
approval or engaging in transactions covered under the limitations set 
forth in sections 23A and 23B of the Federal Reserve Act. In two other 
examples, FDIC enforced corrective actions that were applicable to the 
ILC, as well as the holding company and the ILC's affiliates. 
Specifically, in one instance, a cease and desist order to end unsafe 
and unsound banking practices and enforce sections 23A and 23B 
transaction limits were applicable to the ILC, as well as the holding 
company and its subsidiary organizations. In the other example, FDIC 
entered into a written agreement with the ILC because of declines in 
its asset quality, as well as a capital and liquidity assurance 
agreement with the holding company. As a result, the holding company 
provided the ILC with a capital infusion and purchased its low quality 
assets. None of these troubled ILCs failed and no losses were incurred 
by the Fund. 

According to the FDIC-IG, two recent ILC failures, Pacific Thrift and 
Loan in 1999 and Southern Pacific Bank in 2003, resulted in material 
losses to the Fund totaling more than $105 million.[Footnote 76] As a 
result of the failures, the FDIC-IG made several recommendations to 
revise FDIC's supervisory approach, which FDIC implemented. According 
to FDIC officials, other conditions in the banking industry that 
occurred at the same time of the ILC failures were also contributing 
factors to the changes that FDIC made to its supervisory approach. 
Specifically, since 1999, FDIC has, among other things, modified its 
risk focused examination procedures; issued guidance to examiners on 
topics such as risk from examining subprime lending programs and real 
estate lending standards; and hosted a symposium to discuss the lessons 
learned from these failures. According to FDIC, both failures were 
generally the result of ineffective risk management and poor credit 
quality. Table 5 provides a summary of the causes of the ILC failures 
and a description of the various corrective actions that FDIC officials 
told us were taken in response to the failures and other conditions in 
the banking industry that occurred during the same time period. 

Table 5: Causes of Material ILC Failures and FDIC's Response to 
Failures and Other Industry Conditions: 

Name of ILC, (year of failure), assets at closing: Pacific Thrift & 
Loan; Woodland Hills, Calif. (1999);  
Total assets: $117.6 million at closing; 
Cause of failure: 
* Poor corporate governance; 
* Poor risk management; 
* Lack of risk diversification; 
* Annual financial statement audit did not identify the actual 
financial condition of the bank; 
* Inappropriate accounting for estimated future revenue from high risk 
assets; 
* Auditors did not provide a written report of internal control 
weaknesses to the bank audit committee and examiners; 
* Auditors did not provide examiners access to workpapers and 
supporting documentation; 
Amount of loss to the fund: $42 million; (as of 01/01/02); 
FDIC's response:  
*  Modified risk focused examination procedures; 
* Issued internal guidance on: 
* subprime lending programs, and; 
* real estate lending standards; 
* Modified guidance for examining high-risk residual assets (e.g., 
Modifications to Capital Markets Examination handbook, specifically 
mortgage derivative securities, asset-backed securities, structured 
notes, and securitization)[A]; 
* Issued a proposed rule to revise risk-based capital requirements 
(e.g., Financial Institution. 

Name of ILC, (year of failure), assets at closing: Southern Pacific 
Bank; Torrance, Calif. (2003);  
Total assets: $1.1 billion at closing; 
Cause of failure: 
* Poor corporate governance; 
* Poor risk management; 
* Lack of risk diversification; 
* Annual financial statement audit did not identify the actual 
financial condition of the bank; 
* Auditors did not provide a written report of internal control 
weaknesses to the bank audit committee and examiners; 
Amount of loss to the fund: $63.4 million; (as of 12/31/04); 
FDIC's response: 
* Letter, Capital Treatment of Residual Interest in Asset 
Securitizations, issued 9/2000); 
* Hosted a symposium for FDIC regional management on "Lessons Learned" 
from bank failures; 
* Required that contracts with third parties providing audit services 
include a provision to provide examiners access to audit workpapers and 
supporting materials. 

Sources: GAO, FDIC, and FDIC-IG. 

Note: This table is based on information from FDIC-IG's material loss 
reviews and interviews with and documentation from FDIC. 

[A] Mortgage derivative and asset backed securities refer to securities 
created from securitized assets. Structured notes are debt securities 
whose principal and interest payments vary according to specific 
formulas or as a result of changes in exchange rates or equity and 
commodity prices, they may also contain derivatives or financial 
contracts based on, or derived from, an underlying market, such as 
stocks, bonds, or currencies. 

[End of table]

Board officials told us that they had a different view of the FDIC-IG 
reports concerning the two ILC failures that resulted in material 
losses to the bank insurance fund. According to Board officials, the 
lack of consolidated supervision at the holding company level 
contributed to the problems that impacted the ILCs. For example, these 
officials stated that the failure of Pacific Thrift and Loan was, in 
part, due to problems at the holding company level that were affecting 
the bank. To support their view, Board officials highlighted that the 
FDIC-IG reported that the holding company accumulated more debt than 
could be supported by the dividends it received from the ILC, thereby 
allowing the ILC to generate loans without reliable and stable funding 
sources. Officials from the Board stated that, as a result, the holding 
company implemented an aggressive high-risk strategy to boost 
profitability and pay these debt instruments, which resulted in 
significant losses and the holding company's inability to raise enough 
capital to help the ILC. Board officials told us that, because the 
holding company of Pacific Thrift and Loan was exempt from the BHC Act, 
no federal supervisor had examined the holding company, and the 
regulatory capital requirements that would have limited the borrowings 
of the holding company did not apply. While the lack of federal 
supervision of the holding company was not explicitly stated as a cause 
of failure in the FDIC-IG's material loss review of Pacific Thrift and 
Loan, the FDIC-IG's review discusses this matter in detail. Board 
officials told us that the ability to see a broader picture of, and 
take enforcement action against, the holding company would have enabled 
FDIC to identify and correct problems at the holding company before the 
ILC failed. Further, the FDIC-IG's material loss review recommended 
that FDIC remind its examiners of the agency's authority to examine 
holding companies and affiliates. Subsequently, FDIC examiners 
performed two on-site visitations of the holding company of Southern 
Pacific Bank, before it failed in 2003, to determine the overall 
condition of the holding company and its ability to support the ILC. 

Board officials told us that the bank-centric approach alone is not 
sufficient to assess all the risks that a holding company and 
affiliates can pose to an insured financial institution. Board 
officials also stated that consolidated supervision has a long, 
successful history of assessing the potential risks that holding 
company and affiliate organizations may pose to insured depository 
institutions. According to Board officials, in order to understand the 
risks within a holding company structure and how they are dispersed, 
bank supervisors must assess risks across business lines, by legal 
entity, and on a consolidated basis. Board officials note that 
consolidated supervision provides its examiners with both the ability 
to understand the financial strength and risks of the overall holding 
company--especially operations and reputation risk--and the authority 
to address significant management, operations, capital, and other 
deficiencies throughout the organization before these deficiencies pose 
a danger to affiliate insured banks and the bank insurance fund. 

Further, Board officials stated that focusing supervisory efforts on 
transactions covered by sections 23A and 23B will not cover the full 
range of risks that insured institutions are exposed to from holding 
companies and their subsidiaries. Board officials told us that sections 
23A and 23B violations most often occur in smaller organizations, and 
the risks posed by large organizations are more often related to other 
issues such as internal controls and computer systems problems. These 
officials stated that FDIC would likely not be able to detect these 
problems in a large holding company unless it was able to supervise the 
entire organization on a consolidated basis. In addition, Board 
officials stated that operations and reputation risk cannot be 
effectively assessed by focusing on sections 23A and 23B limitations. 
Board officials told us, for example, that these risks could come from 
a lending affiliate in the holding company that has loans outstanding 
to the same borrower as the ILC, but the affiliate does not do any 
business with the ILC. If this lending affiliate engaged in improper 
lending practices, it could impact the reputation of the holding 
company and ultimately affect the ILC. Further, the lending limits of 
both the ILC and the affiliate could be within an acceptable range, 
based upon a review of each individual organization's financial 
statements. However, based upon a consolidated view of the holding 
company's financial statement, the amount of loans from the ILC and the 
affiliate to the borrower could expose the consolidated entity to risk 
from a concentration of credit, which could ultimately impact the ILC. 
According to Board officials, it is unclear whether the FDIC's bank- 
centric approach would be able to detect either condition given that 
the ILC does not do business or otherwise have a relationship with the 
lending affiliate. 

In our 1995 testimony to the House Committee on Banking and Financial 
Services, we presented our views on the need for consolidated 
supervision of bank holding companies. Based upon our work evaluating 
the effectiveness of bank supervision and examination during the 1980s 
and 1990s, we discussed specific safeguards that are necessary to 
protect: 

against undue risks.[Footnote 77] These safeguards included a 
comprehensive regulation of financial services holding companies on 
both a functional and consolidated basis. We stated that an umbrella 
supervisory authority needs to exist to adequately assess how risks to 
insured banks may be affected by risks in the other components of the 
holding company structure. In addition, we also stated that capital 
standards for both insured banks and financial services holding 
companies that adequately reflect all major risks, including market and 
operations risk, were a necessary safeguard. Because our past work on 
failed banks and thrifts found that capital can erode quickly in times 
of stress, we stated that supervisors should also be required to 
conduct periodic assessments of risk management systems for all the 
major components of the holding company, as well as for the holding 
company itself. 

Our belief in the importance of consolidated supervision and 
consolidated capital standards is partly based on the fact that most 
bank holding companies are managed on a consolidated basis, with the 
risks and returns of various components being used to offset and 
enhance one another. In addition, past experience has shown that, 
regardless of whether regulatory safeguards--such as sections 23A and 
23B limitations--are set properly, even periodic examinations cannot 
ensure that regulatory safeguards can be maintained in times of stress. 
However, the consolidated supervisory approach is flexible enough to 
account for and recognize the contagion or systemic risks inherent in a 
holding company structure. Further, it appears that, in some instances, 
FDIC also embraces this concept. For example, in an order approving a 
foreign organization's application for deposit insurance in January 
2004, FDIC expressed concerns over the difficulty of monitoring foreign 
affiliates that were not subject to U.S. supervision.[Footnote 78] The 
order states that FDIC has embraced the concept of effective, 
comprehensive, consolidated supervision. 

FDIC's Supervisory Model and Authority Over BHC Act-Exempt Holding 
Companies and Nonbank Affiliates Has Been Tested on a Limited Basis in 
Relatively Good Economic Times: 

Although there have been material losses to the bank insurance fund 
resulting from two ILC failures in the past 6 years, the remaining 19 
ILC failures occurred during the banking crisis in the late 1980s and 
early 1990s. Most of these ILCs were small California Thrift and 
Savings and Loan companies that, according to FDIC, had above-average 
risk profiles. FDIC's analysis of bank failures during this time period 
indicates that California experienced deteriorating economic conditions 
and a severe decline in the real estate industry, which contributed to 
the failure of 15 ILCs in that state. As previously discussed, FDIC has 
since implemented changes to its supervisory approach and has told us 
about some recent examples where, according to FDIC, its supervisory 
approach--including its influence and authority as the provider of 
deposit insurance--has effectively protected the insured institution 
and prevented losses to the Fund. However, all of the ILCs that failed 
since the late 1980s, as well as those ILCs that became troubled and 
FDIC took corrective action, were relatively small in size compared 
with some of the large ILCs that currently dominate the industry. FDIC 
has not provided any examples where its supervisory approach was used 
to mitigate potential losses from troubled ILCs that would qualify for 
supervision under its Large Bank program. 

As previously discussed, because FDIC has established positive working 
relationships with ILC holding companies, examiners are able to obtain 
information about holding company and affiliate operations, supplied by 
ILC holding companies on a voluntary basis, from large, complex ILCs. 
According to examiners we spoke with, this information enhances FDIC's 
ability to monitor the potential risks posed by holding companies and 
affiliates to the insured ILC and, in some instances, this information 
is not publicly available. Further, according to FDIC, its requests for 
information about holding company and affiliate organizations have not 
been challenged in court. Therefore, it is not clear whether FDIC would 
be able to successfully obtain needed information about holding company 
and affiliate organizations in the absence of consent by the holding 
company or affiliate. 

FDIC's supervisory model and authority over BHC Act-exempt ILC holding 
companies and affiliates has emerged during a time when banking has not 
confronted an adverse external environment. FDIC Chairman Donald Powell 
has described the past decade as a "golden age" of banking. The past 10 
years can be characterized by stable economic growth, which has 
contributed to strong industry profitability and capital positions. 
During the past 7 years, only 35 financial institutions protected by 
the Fund have failed, and FDIC has reported that insured institutions' 
earnings for 2004 set a new record for the fourth consecutive year and 
that the industry's equity capital ratio is at its highest level since 
1938.[Footnote 79] In contrast, 1,373 financial institutions protected 
by the Fund failed between 1985 and 1992 due to, among other things, 
poor management and poor lending practices. How FDIC's supervisory 
approach would fare for large, troubled ILCs during an adverse external 
environment is not clear. 

ILCs May Offer Commercial Holding Companies a Greater Ability to Mix 
Banking and Commerce Than Other Insured Depository Institution, but 
Views on Competitive Implications Are Mixed: 

Because most ILC holding companies and their subsidiaries are exempt 
from business activity limitations that generally apply to the holding 
companies and affiliates of other FDIC-insured depository institutions, 
ILCs may provide a greater means for mixing banking and commerce than 
ownership or affiliation with other insured depository institutions. 
During our review, we found other more limited instances where the 
mixing of banking and commerce previously existed or currently exists, 
such as unitary thrift holding companies, certain "nonbank banks," and 
certain activities permitted under GLBA, such as merchant banking and 
grandfathered, limited nonfinancial activities by securities and 
insurance affiliates of financial holding companies. However, federal 
law significantly limits the operations and product mixes of these 
entities and activities as compared with ILCs. Additionally, with the 
exception of a limited credit-card-only bank charter, ownership or 
affiliation with an ILC is today the only option available to 
nonfinancial, commercial firms wanting to enter the insured banking 
business. The policy generally separating banking and commerce is based 
primarily on potential risks that integrating these functions may pose, 
such as the potential expansion of the federal safety net provided for 
banks to their commercial entities, potential increased conflicts of 
interest, and the potential increase in economic power exercised by 
large conglomerate enterprises. While some industry participants state 
that mixing banking and commerce may offer benefits from operational 
efficiencies, empirical evidence documenting these benefits is mixed. 

ILC Charter May Offer Commercial Holding Companies More Opportunity to 
Mix Banking and Commerce Than Other Insured Depository Institution 
Charters: 

ILC holding companies and their affiliates may be able to mix banking 
and commerce more than other insured depository institutions because 
the holding companies and affiliates of ILCs are not subject to 
business activity limitations that generally apply to insured 
depository institution holding companies. Except for a limited category 
of firms, such as grandfathered unitary thrift holding companies and 
companies that own limited purpose credit card banks (CEBA credit card 
banks), entities that own or control insured depository institutions 
generally may engage, directly or through subsidiaries, only in 
activities that are financial in nature.[Footnote 80] Because of a 
provision in the BHC Act excluding certain ILCs from the act's 
coverage, an entity can own or control a qualifying ILC without facing 
the activities restrictions imposed on bank holding companies and 
nonexempt thrift holding companies. As a result, the holding companies 
and affiliates of some ILCs and other subsidiaries are allowed to 
engage in nonfinancial, commercial activities. Today, nonfinancial, 
commercial firms in the automobile, retail, and energy industries, 
among others, own ILCs. According to the FDIC officials, as of December 
31, 2004, 9 ILCs with total assets of about $3 billion directly support 
their parent's commercial activities. However, these figures may 
understate the total number of ILCs that mix banking and commerce 
because 5 other ILCs are owned by commercial firms that were not 
necessarily financial in nature. Because these corporations, on a 
consolidated basis, include manufacturing and other commercial lines of 
business with the financial operations of their ILC, we determined that 
these entities also mixed banking and commerce. Thus, we found that, as 
of December 31, 2004, approximately 14 of the 57 active ILCs were owned 
or affiliated with commercial entities, representing about $9.0 
billion, (about 6.4 percent) and $4.6 billion (about 6.2 percent) of 
total ILC industry assets and estimated insured deposits, 
respectively.[Footnote 81]

During our review, regulators and practitioners we spoke with 
highlighted other, more limited, historical exceptions to the policy 
generally separating banking and commerce, such as unitary thrift 
holding companies and "nonbank banks"--both of which at one time 
allowed for instances where insured banks could be owned by or 
affiliated with nonfinancial, commercial firms. Regulators also 
provided us with other current examples of limited mixed banking and 
commerce in the financial system, such as the merchant banking 
operations of financial holding companies and CEBA credit card banks, 
which offer limited opportunities to attract insured deposits and no 
commercial lending opportunities, but are permitted to be owned by or 
affiliated with commercial firms. However, because of the wide variety 
of products and services that ILCs offer and the continued availability 
of this charter type in certain states,[Footnote 82] ILCs may offer 
commercial holding companies a greater opportunity to mix banking and 
commerce than these other exempted insured depository institutions and 
currently more limited situations of mixed banking and commerce. 
Additionally, with the exception of the more limited CEBA credit card 
only bank charter, ownership or affiliation with an ILC is today the 
only option available to nonfinancial, commercial firms wanting to 
enter the insured banking business. 

Unitary thrift holding companies or unitary savings and loan holding 
companies are firms that own or control a single FDIC-insured thrift or 
savings and loan and typically own or control other subsidiaries. The 
Savings and Loan Holding Company Act of 1967 (HOLA) established the 
regulatory framework for unitary thrift holding companies. Unitary 
thrift holding companies were at one time permitted to own one thrift 
association and engage, without limitation, in other activities, 
including commercial activities, as long as the thrift complied with 
requirements intended to maintain its function as a thrift.[Footnote 
83] In 1999, as previously discussed, GLBA prohibited new unitary 
thrift holding companies from being chartered after May 4, 
1999.[Footnote 84] GLBA also "grandfathered" existing unitary thrift 
holding companies and limited the existing commercial powers of a 
unitary thrift holding company to the owners at that time. Thus, after 
this date, new owners of a unitary thrift would be unable to engage in 
commercial, nonfinancial activities. While many of the original 
commercial owners of unitary thrift holding companies have since sold 
their insured thrifts, several "grandfathered" commercially owned or 
affiliated unitary thrift holding companies remain active. As of 
December 31, 2004, there were 17 commercially owned or affiliated 
unitary thrift holding companies representing $38.7 billion in assets 
and $15.0 billion in estimated insured deposits. 

Officials from the OTS highlighted several limitations of unitary 
thrift holding companies that made this charter more restrictive in its 
ability to mix banking and commerce than ILCs. These limitations for 
unitary thrift holding companies include the following: 

* prohibitions on lending to commercial affiliates of the insured 
thrift;[Footnote 85]

* restrictions on commercial lending to 20 percent of assets, provided 
any amount over 10 percent is in small business lending;[Footnote 86] 
and: 

* restrictions under the qualified thrift lender test (QTL), including 
holding at least 65 percent of its assets in qualified thrift 
investments, which are primarily mortgage related assets.[Footnote 87]

OTS officials told us that the restrictions on extending credit to 
commercial affiliates in the unitary thrift holding company structure 
prevents a unitary thrift holding company from using the insured thrift 
to fund nonbanking activities of the holding company. Unlike qualified 
thrifts, ILCs are not subject to restrictions on extending credit to 
commercial affiliates, limitations on the amount of commercial lending 
activity they can engage in, or restrictions on the mix of assets in 
their loan portfolios. 

A similar, but even more limited, historical exception to the policy 
generally separating banking and commerce was, at one time, granted to 
"nonbank banks"--generally financial institutions that either accepted 
demand deposits or made commercial loans but did not engage in both 
activities. Because the BHC Act defined a bank as a firm that did both 
of these activities, a company could own or control a "nonbank bank" 
and avoid federal supervision as a bank holding company. Similar to 
ILCs, the owners and affiliates of "nonbank banks" were able to mix 
banking and commerce prior to 1987 when CEBA was enacted. In effect, 
CEBA ended the ability to mix banking and commerce through the "nonbank 
bank" charter, because activity limitations on bank holding companies 
limit the holding companies' ability to own a bank and commercial 
affiliates. CEBA grandfathered the organizations that acquired a 
nonbank bank prior to March 5, 1987, provided that the organization did 
not undergo a change in control after that date and the organization 
and its nonbank bank abide by various restrictions contained in the BHC 
Act. Currently, only eight grandfathered nonbank banks remain in 
existence. 

In addition to these historical exemptions, other more limited 
opportunities to mix banking and commerce currently exist, such as 
merchant banking and portfolio investing by the securities and 
insurance affiliates of financial holding companies and CEBA credit 
card only banks. Merchant banking refers to the practice where a 
financial institution makes a passive equity investment in a 
corporation with a view toward working with company management and 
operating partners to enhance the value of the equity investment over 
time. Merchant banking can result in ownership of significant portions 
of a firm's equity. GLBA relaxed long-standing restrictions on the 
merchant banking activities of banking organizations by permitting 
qualified financial holding companies to own and operate merchant 
banking entities. However, GLBA contains several provisions that are 
designed to distinguish merchant banking investments from the more 
general mixing of banking and commerce.[Footnote 88] For example, 
merchant banking investments may only be held for a period of time to 
enable the resale of the investment, and the investing financial 
holding company may not routinely manage or operate the commercial firm 
except as necessary or required to obtain a reasonable return on the 
investment on resale.[Footnote 89] Similarly, CEBA credit card banks, 
which are exempt from the BHC Act, offer limited opportunities to mix 
banking and commerce because they can be owned by or affiliated with 
nonfinancial, commercial firms but, because of the nature of their 
charter, are limited scope banking entities. CEBA credit card banks are 
FDIC-insured institutions whose only business is credit cards. A CEBA 
credit card bank is not allowed to offer demand deposits or NOW 
accounts, can accept only "jumbo deposits" ($100,000 minimum), may have 
only one office that accepts deposits, and cannot make any commercial 
loans.[Footnote 90]

Industry practitioners we spoke with also highlighted examples of 
commercial firms providing bank-like services through finance 
subsidiaries, such as the credit card operations of selected retailers 
or the financing subsidiaries of manufacturing firms--often referred to 
as captive finance subsidiaries because their business operations 
generally focus on providing credit to support the sale of a holding 
company or affiliate's products. For example, selected manufacturers of 
furniture, tractors, boats, and automobiles may offer credit through 
financing subsidiaries. However, banking regulators told us that 
captive financing subsidiaries are generally limited scope operations 
that must rely on the capital markets, their commercial holding 
companies, or banks for funding, and may not offer insured deposits. 
Banking regulators also stated that insured depository institutions 
generally can offer a broader range of banking services and can attract 
insured deposits as an attractive source of funding. Because the 
noninsured finance subsidiaries of commercial firms are not permitted 
to offer insured deposits, noninsured finance subsidiaries do not 
represent risk to the federal bank insurance fund. 

Additionally, several developed countries allow greater mixing of 
banking and commerce than the United States. For example, in European 
countries there are generally no limits on a nonfinancial, commercial 
firm's ownership of a bank. However, the European Union has mandated 
consolidated supervision. Japan has allowed cross-ownership of 
financial services firms, including banks and commercial firms, 
permitting development of industrial groups or keiretsu that have 
dominated the Japanese economy. These groups generally included a major 
or "lead" bank that was owned by other members of the group, including 
commercial firms, and that provided banking services to the other 
members. The experience of these nations provides some empirical 
evidence of the effects of increased affiliation of banking and 
commercial businesses, particularly pointing to the importance of 
maintaining adequate credit underwriting standards for loans to 
affiliated commercial businesses. Problems in Japan's financial sector, 
notably including nonperforming loans, often to commercial affiliates 
of the banks, have contributed in part to the persistent stagnation of 
the Japanese economy beginning in the 1990s. However, important 
differences between the financial and regulatory systems of these 
nations and the United States, and limitations in research into the 
effects of these affiliations, limit many direct comparisons. 

Mixing Banking and Commerce Presents Both Risks and Potential Benefits: 

The mixing of banking and commerce can potentially come about in many 
different forms. For example, banks may want to enter nonfinancial 
activities, and commercial firms may want to enter banking. A bank may 
also want to take an equity stake in a commercial firm, or a commercial 
firm may want to make an ownership investment in a bank. The forms of 
mixing banking and commerce differ depending on the firms' and banks' 
motivations. In the ILC industry, mixing banking and commerce has 
primarily been in the form of commercial, nonfinancial firms owning and 
operating insured banks. 

The policy generally separating banking and commerce is based primarily 
on limiting the potential risks that may result to the financial 
system, the deposit insurance fund, and taxpayers. As discussed more 
fully below, we have previously reported that the potential risks that 
may result from greater mixing of banking and commerce[Footnote 91] 
include the (1) expansion of the federal safety net provided for banks 
to their commercial entities, (2) increased conflicts of interest 
within a mixed banking and commercial conglomerate, and (3) increased 
economic power exercised by large conglomerate enterprises. However, 
generally the magnitudes of these risks are uncertain and may depend, 
in part, upon existing regulatory safeguards and how effectively 
banking regulators monitor and enforce these safeguards. 

The federal government provides a safety net to the banking system that 
includes federal deposit insurance, access to the Federal Reserve's 
discount window, and final riskless settlement of payment system 
transactions. According to Federal Reserve officials, the federal 
safety net in effect provides a subsidy to commercial banks and other 
depository institutions by allowing them to obtain low-cost funds 
because the system of federal deposit insurance shifts part of the risk 
of bank failure from bank owners and their affiliates to the federal 
bank insurance fund and, if necessary, to taxpayers. The system of 
federal deposit insurance can also create incentives for commercial 
firms affiliated with insured banks to shift risk from commercial 
entities that are not covered by federal deposit insurance to their 
FDIC-insured banking affiliates. As a result, mixing banking and 
commerce may increase the risk that the safety net, and any associated 
subsidy, may be transferred to commercial entities. The potential 
transfer of risks among insured banks and uninsured commercial 
affiliates could result in inappropriate risk-taking, misallocation of 
resources, and uneven competitive playing fields in other industries. 
As noted by regulators and practitioners we spoke with, these risks may 
be mitigated by regulatory safeguards between the bank and their 
commercial affiliates. For example, requirements for arms-length 
transactions and restrictions on the size of affiliate transactions 
under sections 23A and 23B of the Federal Reserve Act are a regulatory 
safeguard designed to protect an insured institution from adverse 
intercompany transactions. However, during times of stress, these 
safeguards may not work effectively--especially if managers are 
determined to evade them. 

The mixing of banking and commerce could also add to the potential for 
increased conflicts of interest and raise the risk that insured 
institutions may engage in anticompetitive or unsound practices. For 
example, some have stated that, to foster the prospects of their 
commercial affiliates, banks may restrict credit to their affiliates' 
competitors, or tie the provision of credit to the sale of products by 
their commercial affiliates. Commercially affiliated banks may also 
extend credit to their commercial affiliates or affiliate partners, 
when they would not have done so otherwise. For example, when a bank 
extends credit to an affiliate, customers, or suppliers of an 
affiliate, the credit judgment could be influenced by that 
relationship. While current regulatory safeguards are designed to 
mitigate this possibility, advocates of continued separation highlight 
that the potential for more frequent misallocation of credit 
opportunities is greater in a merged banking and commercial 
environment. These advocates have stated that increased conflicts of 
interest could result in greater numbers of loans to commercial 
affiliates with favorable terms, relaxed underwriting standards, 
preferential lending to suppliers and customers of commercial 
affiliates, and ultimately increased risk exposure to the federal bank 
insurance fund. Additionally, some have also stated that mixing banking 
and commerce could promote the formation of very large conglomerate 
enterprises with substantial amounts of economic power. If these 
institutions were able to dominate some markets, such as the banking 
market in a particular local area, they could impact the access to bank 
services and credit for customers in those markets. 

Other industry observers have stated that there are potential benefits 
from mixed banking and commerce, including allowing banks, their 
holding companies, and customers to benefit from potential increases in 
the scale of operations, which lowers the average costs of production 
known as economies of scale, or from potential reductions in the cost 
of producing goods that share common inputs, known as economies of 
scope, and enhanced product and geographic diversification. Because 
banks incur large fixed costs when setting up branches, computer 
networks, and raising capital, these institutions may benefit from the 
selected economies of scale and scope that could result from 
affiliations with commercial entities. For example, we were told 
combined entities may be able to generate operating efficiencies by 
sharing computer systems or accounting functions. Mixed banking and 
commercial entities may also benefit from product synergies that result 
from affiliation. For example, firms engaged in both the manufacturing 
and financing of automobiles may be able to increase sales and reduce 
customer acquisition costs by combining manufacturing and financing. 
Other incentives for affiliations between banking and commercial firms 
include enhanced product and geographic diversification, which could 
contribute to reduced risk to the combined entity. Additionally, one 
FDIC staff wrote that increased mixing of banking and commerce may help 
U.S. banks with regard to global competition with several other 
countries that have fewer restrictions than the United States. 
Advocates have also stated that some of these potential revenue and 
cost synergies may be passed on to consumers through lower prices for 
banking or commercial services. 

Divergent Views Exist About the Competitive Implications of Mixed 
Banking and Commerce: 

Continued market interest by commercial firms in mixed banking and 
commerce may indicate that at least some participants believe that 
operational efficiencies and cost synergies may be realized from mixing 
banking and commerce. For example, three of the six new ILC charters 
approved by FDIC after June 30, 2004, are owned by nonfinancial, 
commercial firms. Additionally, recent press reports and conversations 
we had with federal banking regulators indicate one of the nation's 
largest retailers has expressed continuing interest in owning an 
insured depository institution. However, during our search of academic 
and other literature, we were unable to identify any conclusive 
empirical evidence that documented operational efficiencies from mixing 
banking and commerce. One primary factor in the lack of empirical 
evidence may be that, because of the policy generally separating 
banking and commerce, few institutions are available for study. 

However, product synergies between banking and commercial firms may 
exist in certain industries. For example, several automobile 
manufacturers own or operate captive financing affiliates that 
generally provide credit to borrowers at competitive rates to 
facilitate the commercial holding company's efforts to sell 
automobiles. Some of these affiliates are insured depository 
institutions while others rely on the capital markets, their commercial 
holding companies, or banks for funding. Additionally, other regulators 
and practitioners noted that commercially affiliated insured depository 
institutions might benefit from access to existing commercial holding 
company or affiliate customers. For example, insured banks owned or 
affiliated with commercial firms may be able to attract deposits or 
potential credit card customers through targeted marketing to the 
commercial holding company or affiliate customers. Industry observers 
we spoke with also told us that commercially affiliated banks might 
benefit from stronger brand recognition and, in instances where banks 
are owned by retailers, the banks may benefit from being located in 
stores that keep longer hours of operation. Furthermore, as discussed 
previously, combined firms may generate efficiencies from the sharing 
of fixed costs, such as computer systems or accounting functions. 

One OTS official and industry practitioners we talked with were less 
convinced of potential economic efficiencies from mixing banking and 
commerce and suggested that these firms might not have a competitive 
advantage over other businesses. For example, an OTS official we talked 
with provided us with instances where the commercial owners of insured 
banks operating under the "nonbank bank" exemption had subsequently 
sold their insured banking subsidiaries because these firms may not 
have been able to realize expected operational efficiencies from mixed 
banking and commerce. For instance, a published study we reviewed noted 
that, in the late 1980s, a large retailer's efforts to cross market its 
traditional product line and financial services failed to generate 
expected synergies. The study highlighted the management challenges 
associated with linking the conglomerate's insurance, securities, real 
estate, retail, and catalog businesses. The study also mentioned 
difficulties managing accurate customer information and division 
management concerns about other divisions pursuing their customers as 
reasons for the conglomerate's inability to capture expected synergies. 
Further, the study noted the financial services centers operating 
inside the traditional retailer's stores generally proved unprofitable. 
Eventually, the retailer cited in the study abandoned its 
diversification strategy and sold its financial services business. 
Similarly, a practitioner we spoke with stated that success in the 
banking industry may require skill sets that are different from the 
expertise and business practices in commercial sectors of the economy. 

While there is little direct research assessing the competitive effects 
of mixing banking and commerce, the incentives to mix banking and 
commerce may in some way be linked to research indicating that 
operational efficiencies may result from merging two banks. According 
to this research, there is a general expectation that operational 
efficiencies may be realized from scale and scope economies within the 
banking industry. For example, merging two banks can result in gains 
from the closing of redundant branches, consolidating systems and back 
offices, and marketing products, such as credit cards, to broader 
customer bases. Some of these same operational efficiencies--such as 
the marketing of credit cards to a broader customer base--would 
presumably be available to mixed banking and commercial firms as well. 
However, empirical studies have not found clear evidence that bigger is 
necessarily better in banking. For example one study noted that while 
large banking operations were regarded as advantageous, the conclusions 
in academic literature on economies of scale and scope within merged 
banks are mixed. Our own independent review of academic literature 
reached similar conclusions. Some studies documented economies of scale 
and scope in banking, but others were less conclusive. Additionally, 
while some recent studies we reviewed suggested that recent advances in 
information technology may be contributing to greater opportunities for 
economies of scale and scope within the banking industry, these studies 
do not provide conclusive evidence on the competitive implications of 
mixing banking and commerce. 

The mixed findings on scale and scope economies within academic 
literature we reviewed are in many ways consistent with market activity 
post GLBA. Because GLBA removed several restrictions on the extent to 
which conglomerates could engage in banking and nonbanking financial 
activities, such as insurance and securities brokerage, some analysts 
had expected that conglomeration would intensify in the financial 
services industry after GLBA. However, as yet, this does not seem to 
have happened. The reasons vary. Many banks may not see any synergies 
with insurance underwriting. Additionally, it may be that many mergers 
are not economically efficient, the regulatory structure set up under 
GLBA may not be advantageous to these mergers, or, it is simply too 
soon to tell what the impact will be. Further, a general slowdown 
occurred in merger and acquisition activity across the economy in the 
early 2000s, which may also be a contributing factor to the pace of 
industry conglomeration post GLBA. 

Recent Legislative Proposals May Increase the Attractiveness of 
Operating an ILC: 

FDIC-insured banks, including ILCs, are currently not permitted to 
offer interest-bearing business checking accounts. Recent legislative 
proposals would remove the current prohibition on paying interest on 
demand deposits and, separately, authorize insured depository 
institutions, including most ILCs, to offer interest-bearing business 
NOW accounts.[Footnote 92] This would, in effect, expand the 
availability of products and services that insured depository 
institutions, including those ILCs, could offer. ILC advocates we spoke 
with highlighted that including ILCs in these legislative proposals 
maintains the current relative parity between ILC permissible 
activities and those of other insured bank charters. However, Board 
officials and some industry observers we spoke with told us that 
granting grandfathered ILCs the ability to offer business NOW accounts 
represents an expansion of powers for ILCs, which could further blur 
the distinction between ILCs and traditional banks. Another legislative 
proposal, introduced but not passed in the last congressional session, 
would allow banks and most ILCs (those included in a grandfathered 
provision) to branch into other states through establishing new 
branches--known as de novo branching--by removing states' authority to 
prevent them from doing so.[Footnote 93] Board officials we spoke with 
told us that, if enacted, these proposals could increase the 
attractiveness of owning an ILC, especially by private sector financial 
or commercial holding companies that already operate existing retail 
distribution networks. 

As previously discussed, in order to remain exempt from the definition 
of a bank under the BHC Act, most ILCs may not accept demand deposits, 
if their total assets are $100 million or more. However, ILCs are not 
restricted from offering NOW accounts, which are insured deposits that, 
in practice, are similar to demand deposits. Current federal banking 
law prohibits insured depository institutions from paying interest on 
demand deposits and does not authorize insured depository institutions 
to offer NOW business checking accounts. According to a Treasury 
official, the prohibition on paying interest on demand deposits, 
including those maintained by businesses, was enacted in the 1930s 
because of concerns about the solvency of the nation's banks and the 
belief that limiting competition among banks would reduce bank 
failures. This ban was designed to protect small rural banks from 
having to compete for deposits with larger institutions that could 
offer higher interest rates and use the deposits to make loans to stock 
market speculators and deprive rural areas of financing. 

There have been repeated legislative proposals to repeal this 
prohibition. Supporters of these efforts have stated that the 
prohibition on paying interest on demand deposits, including those 
maintained by businesses, is an unnecessary and outdated law that 
unfairly affects small businesses. According to these supporters, small 
businesses tend to bank at smaller institutions that do not offer sweep 
accounts which, in effect, circumvent the ban on interest bearing 
demand accounts, because their deposit balances may not qualify for 
these accounts at larger institutions.[Footnote 94] The most recent 
legislative proposals would repeal section 19(i) of the Federal Reserve 
Act and section 18(g) of the FDI Act, which, together with other 
federal laws, effectively prohibit the payment of interest on demand 
deposits, including business checking accounts.[Footnote 95] This would 
allow insured depository institutions to pay interest on their demand 
deposits, including those maintained by businesses, although it would 
not remove the BHC Act provision exempting larger ILCs from the 
definition of a bank on the condition, among others, that they do not 
accept demand deposits. Separate provisions of this legislative 
proposal would allow qualified ILCs (which would include ILCs owned or 
controlled by a commercial firm where the ILC obtained deposit 
insurance prior to October 1, 2003, and did not undergo a change in 
control after September 30, 2003) to offer business NOW accounts. Going 
forward, other ILCs could offer business NOW accounts, provided that 
their state supervisors determine that at least 85% of their holding 
company and affiliated entities' gross revenues were from activities 
that were financial in nature or incidental to a financial activity in 
at least three of the prior four calendar quarters. In effect, this 
amendment would make it difficult for nongrandfathered ILCs owned by 
commercial enterprises to offer interest bearing business NOW accounts. 
ILC advocates we spoke with highlighted that if other insured banks are 
permitted to offer interest bearing demand deposit accounts to 
businesses, granting ILCs the ability to offer interest bearing 
business NOW accounts maintains the current relative parity between ILC 
permissible activities and those of other insured bank charters. 
Officials at the Board have opposed ILCs being able to offer interest 
bearing business NOW accounts, unless ILC holding companies were 
subjected to consolidated supervision and the same activity 
restrictions applied to the holding companies of most other insured 
depository institutions, because doing so would further enable ILCs to 
become the functional equivalent of full-service banks and expand their 
operations beyond the historical function of ILCs and the terms of 
their exemption in current banking law. 

Federal banking law permits insured state banks and ILCs to expand on 
an interstate basis by acquiring another institution, provided that 
state law does not expressly prohibit an interstate merger.[Footnote 
96] However, banks and ILCs are not permitted to branch in another 
state without having an established charter in that state and without 
acquiring another bank--known as de novo branching--unless the host 
state enacted legislation that expressly permitted this 
practice.[Footnote 97] Currently, only 17 states have enacted this 
legislation. According to proponents of de novo branching, current 
restrictions make it difficult for small banks seeking to operate 
across state lines and puts banks at a disadvantage compared with 
savings associations, which are permitted to establish interstate de 
novo branches. A proponent also stated that de novo branching would 
benefit small banks near state borders to better serve customers by 
establishing new branches across state lines and would increase 
competition by providing banks with a less costly method for offering 
their services in new locations. 

According to a Utah state bank supervisory official we spoke with, ILCs 
in some states have the ability to establish branches in certain other 
states through reciprocal branching agreements. For example, this 
official stated that ILCs in Utah have reciprocity agreements with 17 
other states and are able to branch, without federal de novo branching 
authority, into these 17 states. However, this Utah state supervisory 
official and industry practitioners told us that many ILC business 
models do not rely on retail branching to conduct their business 
operations. For example, currently only two Utah ILCs have branches, 
and they have only two branches each. According to Board officials, 
granting ILCs unrestricted de novo branching authority in other states 
may increase the relative attractiveness of ILCs as compared with other 
financial institution charters. These officials highlighted that 
reduced restrictions on nationwide branching may increase private 
sector interest in ILC ownership by financial or commercial holding 
companies that operate retail distribution networks. However, according 
to at least one industry expert we spoke with, the effects of the 
consequences of de novo branching may be overstated and not likely to 
result in major changes in the ILC industry. 

Conclusions: 

ILCs have significantly evolved from the small, limited purpose 
institutions that existed in the early 1900s. In particular, the ILC 
industry has grown rapidly since 1999 and, in 2004, six ILCs were among 
the 180 largest financial institutions with $3 billion or more in total 
assets, and one institution had over $66 billion in assets. Because of 
the significant recent growth and complexity of some ILCs, the industry 
has changed since being granted an exemption from consolidated 
supervision in 1987, and some have expressed concerns that ILCs may 
have expanded beyond the original scope and purpose intended by 
Congress. 

The vast majority of ILCs have corporate holding companies and 
affiliates and, as a result, are subject to similar risks from holding 
company and affiliate operations as banks and thrifts and their holding 
companies. However, unlike bank and thrift holding companies, most ILC 
holding companies are not subject to federal supervision on a 
consolidated basis. Although FDIC has supervisory authority over an 
insured ILC, it does not have the same authority to supervise ILC 
holding companies and affiliates as a consolidated supervisor. While 
the FDIC's authority to assess the nature and effect of relationships 
between an ILC and its holding company and affiliates does not directly 
provide for the same range of examination authority, its cooperative 
working relationships with state supervisors and ILC holding company 
organizations, combined with its other bank regulatory powers, has 
allowed the FDIC, under limited circumstances, to assess and address 
the risks to the insured institution and to achieve other results to 
protect the Fund against ILC-related risks. However, we are concerned 
that insured institutions providing similar risks to the Fund are not 
being overseen by bank supervisors that possess similar powers. 

FDIC has responded appropriately to the challenges it faces supervising 
the ILC industry by implementing significant enhancements to its 
examiner guidance designed to mitigate the risks that could be posed to 
insured depository institutions, including ILCs, from various sources, 
such as holding companies and affiliates. Within the scope of its 
authority, FDIC has demonstrated that its supervisory approach has, in 
some instances, effectively mitigated losses to the Fund. Some have 
even stated that, from a safety and soundness perspective, FDIC's 
approach is an effective alternative to the Board's bank holding 
company supervision, given that FDIC has successfully mitigated losses 
to the Fund posed by some troubled institutions. However, the Board 
disagrees and stated that FDIC's approach, without the aid of 
consolidated supervision, cannot effectively assess all the risks to a 
depository institution posed by the holding company and affiliates of 
an ILC. Moreover, the extent of some of FDIC's authorities over ILC 
holding companies and affiliates is not clear. For example, it is 
unclear under what circumstances FDIC could compel ILC affiliates to 
provide information about their operations when these affiliates do not 
have a relationship with an ILC. As a result, absent a cooperative 
working relationship, FDIC's supervisory approach may not be able to 
identify or address all potential risks to the insured institution. It 
is also unclear how effective the FDIC's approach would be if the ILC 
industry incurred widespread and significant losses or if a large 
complex ILC were to become troubled. As a result of differences in 
supervision, we and the FDIC-IG have found that, from a regulatory 
standpoint, ILCs in a holding company structure may pose more risk of 
loss to the Fund than other types of insured depository institutions in 
a holding company structure. 

Although federal banking law may allow ILC holding companies to mix 
banking and commerce to a greater extent than holding companies of 
other types of depository institutions, we were unable to identify any 
conclusive empirical evidence that documented operational efficiencies 
from mixing banking and commerce, and the views of bank regulators and 
practitioners were mixed. Including ILCs in recent legislative 
proposals to offer business checking accounts and operate de novo 
branches nationwide maintains the current relative parity between ILC 
permissible activities and those of other insured bank charters. These 
legislative proposals may make the ILC charter more attractive and 
encourage future growth. However, the potential risks from combining 
banking and commercial operations remain, including the potential 
expansion of the federal safety net provided for banks to their 
commercial entities, increased conflicts of interest within a mixed 
banking and commercial conglomerate, and increased economic power 
exercised by large conglomerate enterprises. In addition, we find it 
unusual that this limited exemption for ILCs would be the primary means 
for mixing banking and commerce on a broader scale than afforded to the 
holding companies of other financial institutions. Because it has been 
a long time since Congress has broadly considered the potential 
advantages and disadvantages of mixing banking and commerce and given 
the rapid growth of ILC assets and the potential for increased 
attractiveness of the ILC charter, it would be useful for Congress to 
review the ILC holding company's ability to mix banking and commerce 
more than other types of financial institutions and whether the holding 
companies of other financial institutions should be permitted to engage 
in this level of activity. 

Matters for Congressional Consideration: 

Consolidated supervision is a recognized method of supervising an 
insured institution, its holding company, and affiliates. While FDIC 
has developed an alternative approach that it claims has mitigated 
losses to the bank insurance fund, it does not have some of the 
explicit authorities that other consolidated supervisors possess, and 
its oversight over nonbank holding companies may be disadvantaged by 
its lack of explicit authority to supervise these entities, including 
companies that own large and complex ILCs. To better ensure that 
supervisors of institutions with similar risks have similar 
authorities, Congress should consider various options such as 
eliminating the current exclusion for ILCs and their holding companies 
from consolidated supervision, granting FDIC similar examination and 
enforcement authority as a consolidated supervisor, or leaving the 
oversight responsibility of small, less complex ILCs with the FDIC, and 
transferring oversight of large, more complex ILCs to a consolidated 
supervisor. 

The long-standing policy of separating banking and commerce has been 
based primarily on mitigating the potential risk that combining these 
operations may pose to the Fund and the taxpayers. GLBA reaffirmed the 
general separation of banking from commerce and providing financial 
services from nonfinancial commercial firms. However, under federal 
banking law, the ILC charter offers commercial holding companies more 
opportunity to mix banking and commerce than other insured depository 
institution charters. Congress should also be aware of the potential 
for continued expansion of large commercial firms into the ILC 
industry--especially if ILCs are granted the ability to de novo branch 
and offer interest bearing business checking accounts. In recent years, 
this policy issue has been addressed primarily through exemptions and 
provisions to existing laws rather than assessed on a comprehensive 
basis. Thus, Congress should more broadly consider the advantages and 
disadvantages of mixing banking and commerce to determine whether 
continuing to allow ILC holding companies to engage in this activity 
more than the holding companies of other types of financial 
institutions is warranted or whether other financial or bank holding 
companies should be permitted to engage in this level of activity. 

Agency Comments and Our Evaluation: 

We provided a draft of this report to the Board, FDIC, OTS, and SEC for 
review and comment. Each of these agencies provided technical comments 
that were incorporated as appropriate. In written comments, the 
Chairman of the Board of Governors of the Federal Reserve System (see 
app. II) concurred with the report's findings and conclusions. 
Specifically, the Chairman stated that "consolidated supervision 
provides important protections to the insured banks that are part of a 
larger organization, as well as the federal safety net that supports 
those banks." The Chairman also wrote that our report "properly 
highlights the broad policy implications that ILCs raise with respect 
to maintaining the separation of banking and commerce."

In written comments from the Chairman of the Federal Deposit Insurance 
Corporation (see app. III), FDIC concurred with one of the report's 
findings but generally believed that no changes were needed in its 
supervisory approach over ILCs and their holding companies and 
disagreed with the matters for congressional consideration. 
Specifically, the FDIC concurred that from an operations standpoint, 
ILCs do not appear to have a greater risk of failure than other types 
of insured depository institutions. However, FDIC's disagreements 
generally focused on three primary areas--whether consolidated 
supervision of ILC holding companies is necessary to ensure the safety 
and soundness of the ILC; that FDIC's supervisory authority may not be 
sufficient to effectively supervise ILCs and insulate insured 
institutions against undue risks presented by external parties; and the 
impact that consolidated supervision of ILCs and their holding 
companies would have on the marketplace and the federal safety net. 

First, in its comments about consolidated supervision for ILCs and 
their holding companies, FDIC stated that its bank-centric supervision, 
enhanced by sections 23A and 23B of the Federal Reserve Act and the 
Prompt Corrective Action provisions of the FDIC Improvement Act, is a 
proven model for protecting the deposit insurance funds, and no 
additional layer of consolidated federal supervision of ILC holding 
companies is necessary. As stated in our report, we agree that FDIC's 
approach has effectively mitigated the risk of loss to the Fund in some 
instances. However, FDIC's approach has only been tested on a limited 
basis in relatively good economic times. FDIC also expressed concern 
that our report did not include a comparison of the effectiveness and 
cost of FDIC's bank-centric approach with the effectiveness and cost of 
consolidated supervision. As stated in our report, the scope of this 
review did not include an assessment of the extent to which regulators 
effectively implemented consolidated supervision or any other type of 
supervision. Rather, we focused on the respective regulators' 
authorities to determine whether there were any inherent limitations in 
these authorities. Consolidated supervision is widely recognized 
nationally and throughout the world as an accepted approach to 
supervising organizations that own or control financial institutions 
and their affiliates, and we are not aware of any empirical evidence, 
or a reliable method of gathering such evidence, that could be used to 
draw meaningful conclusions about the costs and benefits of either 
supervisory approach. Further, during our review we did not become 
aware of any significant concerns over the cost of consolidated 
supervision. While we recognize that consolidated supervision would 
likely pose some additional cost to ILC holding companies, determining 
the extent of this cost would be speculative, depending on the scope of 
coverage of consolidated supervision (including whether current ILC 
parents would be grandfathered or whether ILCs below some size 
threshold would be exempt). Further, we believe that as one considers 
any additional costs, consideration should also be given to the 
benefits obtained from the enhanced supervisory tools and authorities 
that ILC regulators could use to better protect the Fund. 

Further, FDIC believes that no additional layer of consolidated federal 
supervision of ILC holding companies is necessary and asserts that the 
report inappropriately repeated assertions by the Board which 
speculated that excessive debt at the parent of Pacific Thrift and Loan 
(PTL), an ILC, caused PTL to engage in higher-risk strategies that 
resulted in the ILC's failure. FDIC further stated that these 
assertions were not supported by the FDIC-IG's material loss review. We 
disagree that the information presented in the report is not supported 
by the FDIC-IG's review of PTL. As we report, the IG did not 
specifically identify PTL's excessive debt as a cause of failure. The 
IG found that inappropriate valuation of PTL's residual assets (i.e., 
the assets that PTL retained after it packaged and sold loans) 
ultimately caused the collapse of the bank. As FDIC notes, it and the 
other bank regulators have subsequently tightened rules for this 
valuation. However, the collapse of PTL was not purely an issue of 
inappropriate accounting. The IG found that while PTL's parent "was 
incurring monumental amounts of debt, no federal agency was present to 
regulate these activities. The major problem with the borrowing 
arrangement was whether or not [the parent] had the financial 
wherewithal to repay the debt on a stand-alone basis without relying on 
PTL for financial support." The IG's report also stated that PTL's new 
"management team immediately implemented an expansionary program of 
originating and selling subprime mortgage loans…without regard to 
adequate policies, programs, and controls [which] resulted in serious 
shortcomings." We believe that one of the significant benefits of 
consolidated supervision is that it may better position a regulator to 
obtain an earlier awareness of possible problems within a holding 
company structure that could have an impact on the insured bank than 
does the FDIC's bank-centric approach. Had there been a greater 
regulatory presence at the holding company, potentially, problems at 
PTL may have been identified earlier or averted. Further, the Board's 
view of all of the contributing factors to PTL's failure is necessary 
to have a balanced discussion of this event. 

Second, FDIC commented that it does not need any additional supervisory 
authority and has an excellent track record of identifying potential 
problems at nonbank subsidiaries and taking appropriate corrective 
action. FDIC further stated that the report too narrowly interpreted 
its examination authority. We agree that within the scope of its 
authority, FDIC has demonstrated that its supervisory approach has, in 
some instances, effectively mitigated losses to the Fund. However, we 
disagree that the report narrowly interprets FDIC's various authorities 
and continue to believe that consolidated supervision offers broader 
examination and enforcement authorities that may be used to understand, 
monitor, and, when appropriate, restrain the risks associated with 
insured depository institutions in a holding company structure. 
Further, as stated in the report, consolidated supervisors can compel 
holding companies and nonbank subsidiaries to provide key financial and 
operational reports and can impose consolidated or parent-only capital 
requirements that are important tools used to help ensure the safety 
and soundness of an insured depository institution. We continue to be 
concerned that FDIC's bank-centric approach relies on voluntary 
participation by regulated and unregulated entities to provide this key 
information, and that this approach has only been tested during a 
favorable economic environment. The ILC industry is growing rapidly and 
some ILCs are becoming increasingly complex. Thus, we believe it is 
important for the Congress to consider whether insured institutions 
providing similar risks to the Fund should also be overseen by bank 
supervisors that uniformly possess similar powers. 

Third, in its comments, FDIC also stated that consolidated supervision 
of ILCs and their holding companies would result in greater federal 
involvement with commercial parents and nonbank subsidiaries. While we 
agree that more commercial entities would be subject to federal 
oversight, we disagree with FDIC's comment that such oversight "would 
represent a new level of government intrusion in the marketplace" and 
would "radically restructure" the federal government's role relative to 
commercial firms. Subjecting commercial ILC holding companies to 
consolidated supervision currently would affect a relatively small 
number of firms that chose to own and operate ILCs and provide them 
with a similar level of oversight afforded to other firms owning 
insured depository institutions. In so doing, consolidated supervision 
could better ensure that there is sufficient regulatory authority to 
effectively supervise these entities. Our report, however, raises 
oversight concerns with not only commercial holding company ownership 
of ILCs, but also discusses the development of a small number of more 
complex ILCs owned by financial-oriented holding companies that are 
currently exempt from consolidated supervision. At this time, it is 
more so because of the advent of these larger institutions--which 
increases the potential risk to the Fund--rather than commercial 
ownership of ILCs, that we believe this lack of consolidated 
supervision merits additional congressional scrutiny. 

FDIC further stated that such supervision may call into question the 
individual accountability of insured institutions owned by large 
organizations to manage their own capital and could lead to an 
unintended expansion of the federal safety net to these entities. We 
disagree that consolidated supervision would have this effect since 
many institutions currently manage their capital, and regulators assess 
its adequacy on a consolidated basis. Further, the report does not 
advocate an expansion of the federal safety net. Rather, this report 
advocates that ILCs and their holding companies be regulated in a 
similar manner as other insured depository institutions and their 
holding companies. 

Historically, limited charter entities such as ILCs and nonbank banks 
were exempt from consolidated supervision. However, ILCs have evolved 
from small, limited purpose institutions and are exempt from business 
activity limitations that generally apply to the holding companies and 
affiliates of other FDIC-insured depository institutions offering 
similar services. Further, ILCs may provide a greater means for mixing 
banking and commerce than ownership of or affiliation with other 
insured depository institutions. Given the changes and growth in the 
ILC industry, we see less distinction now between ILC holding companies 
and other holding companies owning insured depository institutions, and 
it is unclear why a different regulatory approach would be used to 
supervise ILCs. As a result, we continue to believe that Congress 
should consider various options such as eliminating the current 
exclusion for ILCs and their holding companies from consolidated 
supervision, granting FDIC similar examination and enforcement 
authority as a consolidated supervisor, or leaving the oversight 
responsibility of small, less complex ILCs with the FDIC, and 
transferring oversight of large, more complex ILCs to a consolidated 
supervisor. 

As agreed with your office, unless you publicly announce the contents 
of this report earlier, we plan no further distribution until 30 days 
from the report date. At that time we will send copies of this report 
to the Chairman and Ranking Minority Member of the Senate Committee on 
Banking, Housing, and Urban Affairs; Chairman and Ranking Minority 
Member of the House Committee on Banking, Housing, and Urban Affairs; 
and other congressional committees. We also will send copies to the 
Federal Deposit Insurance Corporation, the Board of Governors of the 
Federal Reserve, the Office of the Comptroller of the Currency, the 
Office of Thrift Supervision, the Securities and Exchange Commission, 
and make copies available to others upon request. In addition, the 
report will be available at no charge on the GAO Web site at 
[Hyperlink, http://www.gao.gov]. 

This report was prepared under the direction of Dan Blair, Assistant 
Director. If you or your staff have any questions regarding this 
report, please contact me at (202) 512-8678 or [Hyperlink, 
hillman@gao.gov]. Contact points for our Offices of Congressional 
Relations and Public Affairs may be found on the last page of this 
report. Key contributors are acknowledged in appendix IV. 

Sincerely yours,

Signed by: 

Richard J. Hillman: 
Managing Director, Financial Markets and Community Investment: 

[End of section]

Appendixes: 

Appendix I: Objectives, Scope, and Methodology: 

To describe the history and growth of the industrial loan corporation 
(ILC) industry, we analyzed Federal Deposit Insurance Corporation 
(FDIC) Call Report and Statistics on Depository Institutions (SDI) data 
on ILCs including total assets and estimated insured deposits from 1987 
through 2004 to determine the (1) number of ILCs by year and by state, 
(2) total ILC industry assets by year and by state, and (3) ILC 
industry estimated insured deposits as a percentage of total estimated 
insured deposits by year. Prior to using the Call Report and SDI data, 
we assessed its reliability by (1) reviewing existing information about 
both data systems (2) interviewing agency officials knowledgeable of 
both data systems to discuss the sources of the data variables and the 
controls in place to ensure the accuracy and integrity of the data, and 
(3) performing various electronic tests of the required data elements. 
Based on our work, we determined that the data from both the Call 
Report and SDI systems were sufficiently reliable for the purposes of 
this report. 

To describe the permissible activities and regulatory safeguards for 
ILCs as compared with state nonmember banks, we reviewed federal and 
state legislation, regulations, and other guidance regarding ILCs and 
banks. We interviewed state bank regulators from the Utah Department of 
Financial Institutions, the California Department of Financial 
Institutions, and the Nevada Financial Institutions Division. We 
focused on ILCs and regulators in these three states because over 99 
percent of the ILC industry assets exist in these states. We also 
interviewed key management officials of various ILCs in these states 
that were representative of the various sizes and business strategies, 
including: large businesses with activities that were predominantly 
within the financial services sector; businesses that were primarily 
credit card operations; captive financing arms of commercial holding 
companies; and a small, community-oriented banking institution. In 
addition, we interviewed management officials from the headquarters of 
FDIC, as well as field staff from FDIC's San Francisco Regional Office 
and the FDIC Salt Lake City Field Office that are responsible for the 
supervision of ILCs located in California, Nevada, Utah, and other 
states. We also interviewed officials from the Board of Governors of 
the Federal Reserve (Board). 

To compare FDIC's supervisory authority over ILC holding companies and 
affiliates with the consolidated supervisors' authority over holding 
companies and affiliates, we analyzed legislation and regulations that 
govern the supervision of insured depository institutions, including 
ILCs and their holding companies, banks and their holding companies, 
and thrifts and their holding companies. We focused our comparison from 
a safety and soundness perspective primarily on the Board's 
consolidated supervision of bank holding companies and their affiliates 
because these entities may pose similar risks to insured depository 
institutions as ILCs that exist in a holding company structure. 
However, because the Office of Thrift Supervision (OTS) also supervises 
similar entities that pose similar risks to insured depository 
institutions, we also reviewed OTS' supervisory authority. We also 
interviewed state banking regulators in California, Nevada, and Utah, 
as well as officials headquartered in the offices of the FDIC, the 
Board, and OTS who are knowledgeable of the supervisory approach and 
authorities of these agencies. 

To determine recent changes FDIC has made to its supervisory approach 
for the risks that holding companies and affiliates could pose to ILCs 
and whether differences in supervision and regulatory authorities pose 
additional risk to the Fund, we interviewed knowledgeable FDIC 
officials and obtained documentation regarding revised agency guidance 
on safety and soundness examination procedures. We also compared agency 
examination manuals and other guidance; interviewed agency officials 
regarding the supervisory approach and supervisory authority of FDIC, 
the Board and OTS; and spoke with state and FDIC regional staff 
responsible for conducting examinations. Additionally, we synthesized 
and relied, as appropriate, upon information from the FDIC Inspector 
General (FDIC-IG) September 30, 2004, report entitled, The Division of 
Supervision and Consumer Protection's Approach for Supervising Limited- 
Charter Depository Institutions because this report provided 
information on FDIC's guidance and procedures for supervising limited 
charter depository institutions, including ILCs, and summarized various 
recent actions that FDIC had taken. Prior to relying on the FDIC-IG's 
report, we performed various due diligence procedures that provided a 
sufficient basis for relying upon their work including obtaining 
information about the other auditors' qualifications and independence; 
reviewing the other auditors' external quality control review report; 
and determining the sufficiency, relevance, and competence of the other 
auditors' evidence by reviewing the audit report, audit program and 
documentation. We also reviewed and synthesized information from the 
FDIC-IG's material loss reviews of Pacific Thrift and Loan and Southern 
Pacific Bank, two failed ILCs. To determine what actions FDIC had taken 
as a result of these material loss reviews and any other conditions 
existing in the banking industry at that time, we interviewed FDIC 
management about the status of recommendations made by the FDIC-IG in 
the material loss reviews. 

To determine whether ILCs allow for greater mixing of banking and 
commerce than other insured depository institutions and whether this 
possibility has any competitive implications, as well as to determine 
the implications of granting ILCs the ability to pay interest on 
business checking accounts and operate de novo branches nationwide, we 
reviewed and synthesized academic, bank regulator, and other studies 
and literature about the historic policy of mixing banking and 
commerce, potential economies of scale and scope in the banking 
industry, and academic literature on mixed banking and commerce in 
other countries. We also interviewed and reviewed studies from 
academics who have published on the subject of regulatory and 
competitive issues in the banking industry. Additionally, we reviewed 
applicable laws and legislative proposals, press reports, and other 
documents. Furthermore, we assessed the degree to which other 
depository institutions are able to mix banking and commerce, such as 
unitary thrifts, "nonbank banks," merchant banks, and captive finance 
subsidiaries. In addition, we reviewed applicable laws and regulations 
and interviewed federal banking regulators from the FDIC, Federal 
Reserve, and OTS. We also interviewed state banking regulators in Utah, 
California, and Nevada and key management officials from several ILCs 
in California, Nevada, and Utah, as well as representatives from the 
Independent Community Bankers Association. 

Finally, to more fully understand (1) the significance of the 
differences between consolidated supervision of bank and thrift holding 
companies and FDIC's supervision of ILCs and the potential risks that 
their holding company and affiliate organizations may pose to the ILC, 
(2) the potential for greater mixing of banking and commerce by ILC 
holding companies as compared with other types of depository 
institutions, and (3) the potential advantages and disadvantages of 
granting ILCs the ability to pay interest on business checking accounts 
and open de novo branches nationwide, we hosted a panel of experts. The 
panel members were selected from a list of well-known and knowledgeable 
officials from the FDIC and the Board, academics, economists, industry 
practitioners, and independent consultants. The panel participants were 
selected to ensure a robust discussion of divergent views on issues 
facing the ILC industry and bank regulators. 

[End of section]

Appendix II: Comments from the Board of Governors of the Federal 
Reserve System: 

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM: 

WASHINGTON, DC 20551: 

ALAN GREENSPAN: 
CHAIRMAN: 

August 19, 2005:
Mr. Richard Hillman: 
Director:
Financial Markets and Community Investment: 
United States Government Accountability Office: 
Washington, D.C. 20548: 

Dear Mr. Hillman: 

The Board appreciates the opportunity to review and comment on the 
Government Accountability Office's (GAO) draft report concerning 
industrial loan companies (GAO-05-621). The Board concurs with and 
strongly supports the GAO's conclusions. 

ILCs are state-chartered, FDIC-insured banks that were first 
established in the early 1900s to meet the borrowing needs of local 
industrial workers. Your report notes that the ILC industry has changed 
dramatically in recent years. As the report states, the laws of some 
states "have essentially placed ILCs on par with other FDIC-insured 
state banks" in terms of permissible powers. In addition, the total 
assets held by ILCs have grown by more than 3,500 percent between 1987 
and 2004, and six ILCs are now among the largest 180 banking 
organizations in the country. 

A special exemption in current law, however, allows any company, 
including a commercial firm or foreign bank, to acquire an ILC in a 
handful of states (principally Utah, California, and Nevada) and avoid 
the consolidated supervisory requirements and activity restrictions 
that apply to the corporate owners of other types of insured banks 
under the federai Bank Holding Company Act (BHC Act). Consolidated 
supervision provides important protections to the insured banks that 
are part of a larger organization as well as the federal safety net 
that supports those banks. For this reason, the BHC Act and other 
federal law grant the Board broad authority to examine and obtain 
reports from bank holding companies and their subsidiaries, establish 
consolidated capital requirements for bank holding companies, and take 
supervisory or enforcement action against a bank holding company or its 
nonbank subsidiaries to address unsafe or unsound practices before 
these practices pose a danger to an affiliated bank. 

The report also notes that current legislative proposals that would 
grant exempt ILCs the authority to open de novo branches on an 
interstate basis, or offer interest-bearing checking accounts to 
business customers, would make it increasingly attractive for companies 
to establish ILCs, rather than other types of insured banks, and thus 
avoid consolidated supervision. In addition, because ILCs are exempt 
from the definition of "bank" in the BHC Act, a foreign bank may 
acquire an FDIC-insured ILC without meeting the requirement in the BHC 
Act that the foreign bank be subject to comprehensive supervision on a 
consolidated basis in its home country. Congress established this 
comprehensive, consolidated supervision requirement in 1991 for foreign 
banks seeking to enter the banking business in the United States 
following the collapse of Bank of Commerce and Credit International 
(BCCI). 

Your report also properly highlights the broad policy implications that 
ILCs raise with respect to maintaining the separation of banking and 
commerce. Because Congress has closed the so-called "nonbank bank" and 
unitary thrift loopholes, the ILC exemption is now the primary means by 
which commercial firms may control an FDIC-insured bank engaged in 
broad lending and deposit-taking activities. We believe it is important 
for the Congress to decide, after a full and careful evaluation, 
whether broader mixings of banking and commerce should be allowed for 
all banking organizations, rather than allowing the nation's policy on 
banking and commerce to be decided de facto through the exploitation or 
expansion of an exemption available only to one type of institution 
chartered in certain states. 

Board staff has separately provided GAO staff technical and correcting 
comments on the draft report. We hope that these comments are helpful. 

Thank you again for your efforts on this important matter. 

Sincerely, 

Signed by: 

Alan Greenspan: 

[End of section]

Appendix III: Comments from the Federal Deposit Insurance Corporation: 

FEDERAL DEPOSIT INSURANCE CORPORATION, 
Washington DC 20429: 

DONALD E. POWELL: 
CHAIRMAN: 

August 29, 2005: 

Mr. Richard Hillman, Director:
Financial Markets and Community Investment: 
U.S. General Accounting Office:
441 G Street, N.W.: 
Washington, D.C. 20548: 

Dear Mr. Hillman: 

Thank you for the opportunity to comment on the draft report entitled 
Industrial Loan Corporations: Recent Asset Growth and Commercial 
Interest Highlights Differences in Regulatory Authority (GAO-05-621). 
Your report does not recommend executive action. However, we welcome 
this opportunity to respond to the report and address the Matters for 
Congressional Consideration that you have raised. 

The Federal Deposit Insurance Corporation agrees with the report's 
finding that "from an operations standpoint, industrial loan 
corporations (ILCs) do not appear to have a greater risk of failure 
than other types of insured depository institutions." The report also 
documents the FDIC's legal and supervisory authorities to address risks 
to insured ILCs that may be posed by affiliated entities. The report 
nevertheless recommends that Congress consider strengthening (the 
report's term) the regulation of parent companies of ILCs by subjecting 
them to the same consolidated supervision as is currently applied to 
bank holding companies. The FDIC believes these suggested changes in 
regulation are unnecessary from a safety and soundness perspective, and 
would inappropriately change the relationship between the federal 
banking agencies and the non-bank sector of the U.S. economy. 

As outlined in more detail in this letter, the FDIC does not believe 
that consolidated supervision of an TLC's corporate owner is necessary 
to ensure the safety and soundness of the ILC itself. The FDIC 
disagrees with the GAO's finding that our regulatory authorities may 
not be sufficient to effectively supervise, regulate, or take 
enforcement action to insulate insured institutions against undue risks 
presented by external parties. We believe the GAO's finding is founded 
on a misinterpretation of the legal basis underlying the regulatory 
authorities of both the FDIC and the Federal Reserve Board of Governors 
(Federal Reserve). The core of each banking agency's statutory mandate 
for supervision is preserving the safety and soundness of insured 
depository institutions. We believe the record shows the FDIC's 
authorities are as effective in achieving this goal as are the 
authorities of consolidated supervisors. 

The FDIC also believes consolidated supervision of ILC parents would 
change the relationship between the federal banking agencies and the 
non-bank sector of the U.S. economy in undesirable ways. This includes 
the potential for an unintended expansion of the federal banking safety 
net, and the costs of imposing bank-like regulation on a greater share 
of U.S. economic activity. The GAO bases its recommendations in part on 
the idea that ILCs benefit from an uneven competitive playing held, 
since their parent companies are not subject to the same type of 
consolidated supervision that applies to other corporate owners of 
insured banks. As noted by a number of panelists at a symposium the GAO 
convened to assist in the preparation of this report, however, there 
are reasons why commercial and other non-bank owners of insured banks 
should not be subject to consolidated banking agency supervision. 
Commercial firms and entities such as broker- dealers are, and should 
remain, outside the scope of the federal banking safety net. Imposing 
activity restrictions and other aspects of bank-like regulation on 
firms that historically have not been subject to such regulation has 
costs, and these costs need to be weighed against any perceived safety-
and-soundness benefits to insured entities. 

The necessity of consolidated federal supervision of all large 
conglomerates that own banks is a new idea. In March, 1997, Federal 
Reserve Chairman Alan Greenspan told Congress-

.. we would hope that should the Congress authorize wider activities 
for financial services holding companies that it recognize that a bank, 
which is a minor part of such an organization (and its associated 
safety net), can be protected through adequate bank capital 
requirements and the application o^ Sections 23A and 2313 of the 
Federal Reserve Act. The case is weak, in our judgment, for umbrella 
supervision of a holding company in which the bank is not the dominant 
unit and is not large enough to induce systemic problems should it 
fail. [NOTE 1] [Emphasis added]. 

More recently, proponents of consolidated supervision appear to have 
moved away from the views expressed by Chairman Greenspan and toward a 
more absolute claim that the safety and soundness of an insured 
financial institution requires the consolidated, top-down supervision 
of its corporate owner. This approach, which the GAO endorses, is based 
on the idea that supervisors should mirror business processes used in 
the private sector. Enterprise risk management processes, used by a 
number of large banking organizations, are characterized by a 
centralized approach, to risk management throughout the conglomerate. 
Enterprise risk management, as used in these firms, is essentially a 
tool to better manage private profits and safeguard the interests of 
holding company shareholders. However, its use as a model on which 
federal bank supervisors would base their efforts to safeguard 
individual insured banks within large conglomerates is as yet unproven. 
Indeed, by appearing to promote the operation. of insured entities in 
conglomerates more as integrated parts of a broader organization, and 
less as insulated entities, consolidated supervision going forward 
could have the unintended effect of extending the scope of the safety 
net, rather than containing it. 

For these reasons, the FDIC believes that a supervisory approach that 
focuses on insulating the insured financial institution and the federal 
safety net from external risks (the bank-centric approach) is an 
appropriate supervisory model for ILCs and their parent companies. 

NOTE 1: Testimony of Chairman Alan Grccnspan before the Subcommittee on 
Capital Markets, Securities and Government Sponsored Enterprises of the 
Committee on Banking and Financial Services, U.S. House of 
Representatives, March 19, 1997. 

The remainder of this letter provides further discussion of the track 
record of supervision, the practical significance of differences in 
agencies' supervisory authorities, certain issues related to banking 
agency supervision of commercial firms, and the scope of the federal 
banking safety net. 

The Track Record of Supervision: 

Surprisingly, in recommending one mode of supervision over another, the 
report attempts no comparison of how these methodologies have fared in 
protecting the deposit insurance funds, or their relative costs and 
benefits. Not only does the report attempt no systematic study of these 
issues, it ignores opportunities for relevant comparisons. For example, 
while acknowledging that the FDIC successfully insulated from failure 
the insured ILC of a large, bankrupt, commercial parent company, the 
report does not provide similar examples where a large bank holding 
company failed without any losses to its insured subsidiaries. 

In the absence of any factual comparison of how various models of 
holding company supervision have fared in protecting the deposit 
insurance funds, the GAO report looks to a single ILC failure, Pacific 
Thrift and Loan (PTL), and repeats assertions by representatives of the 
Federal Reserve who speculate that excessive debt at PTL's parent 
caused the bark to engage in higher-risk strategies that resulted in 
the bank's failure. The assertions, however, are not supported by the 
FDIC Inspector General's Material Loss Review finding that, "PTL's 
overly optimistic valuation assumptions resulted in inflated values 
that were unrealizable" PTL did not fail as a result of parent company 
debt, and neither the Federal Reserve nor the GAO presents any evidence 
that an examination of the parent company by a consolidated supervisor 
would have prevented the failure of this insured institution. The 
Federal Reserve's assertions in this case are all the more surprising 
in view of the fact that it joined the FDIC and other bank regulators 
in responding to the failure of PTL and other non-ILC institutions by 
tightening the rules for valuations of residual assets, not by taking 
any action to address problems with excessive parent company debt. 

The FDIC believes that bank-centric supervision, as applied by the 
National Bank Act and the FDI Act, and enhanced by Sections 23A and 23B 
of the Federal Reserve Act and the Prompt Corrective Action provisions 
of the FDIC Improvement Act, is a proven model for protecting the 
deposit insurance funds, and no additional layer of consolidated 
federal supervision of ILC parents is necessary. 

The Legal Authority for Supervision: 

The FDIC's supervisory philosophy of insulating the insured ILC, bank, 
or thrift, is rooted in the absolute accountability of insured 
institution boards of directors for the governance of their 
institutions. Transaction testing at the insured entity, traced as 
needed through parent companies and affiliates, is intended to ensure 
that undue parent company influence is not being exercised. Important 
bank functions are evaluated onsite, whether at the bank or, where 
those functions are outsourced to affiliates, at those entities. 
Identifying and addressing inappropriate influence by affiliated 
entities is included in the scope of every examination, but the degree 
of insulation the FDIC requires increases substantially as identified 
risk increases, and can reach the point where the bank is completely 
walled off from its affiliates with all major decisions requiring FDIC 
approval. 

One of the central themes of the report is that the FDIC's authority to 
examine an affiliate of an insured depository institution is so 
restricted that reputation risk from an affiliate that has no direct 
relationship with the ILC could go undetected. Contrary to GAO.'s legal 
interpretation, the FDIC's affiliate examination authority is not 
dependent upon the existence of any particular kind of relationship, 
nor is it limited to discrete transactions between an ILC and its 
affiliate. The FDIC does not agree that its examination authority is 
properly interpreted so narrowly. In actual application, even in 
problem-institution or failure cases, the FDIC has always been able to 
exercise its examination authority broadly enough to fulfill its 
supervisory duties. 

The GAO report points to perceived limitations on the FDIC's 
supervisory authority that might prevent it from exercising authority 
over certain non-banking affiliates. Yet, a careful reading of the 
report reveals that the authorities of consolidated supervisors are 
subject to almost identical limitations. Furthermore, the GAO report 
acknowledges an additional power available to the FDIC alone: "[als 
demonstrated by the number of institutions that took measures to 
enhance the safety and soundness of the insured depository institution, 
the threat of insurance termination has been an effective supervisory 
measure in many instances."

Whether in the case of a consolidated supervisor or the FDIC, the 
financial institution supervisor must rely on knowledge of a potential 
problem at a non-bank subsidiary and have some reason to believe that 
problem may adversely affect the insured depository institution before 
the supervisor can take direct action. The FDIC has an excellent track 
record of doing so even without the consolidated supervisory powers 
itemized in the report. In terms of the relevant goal of safeguarding 
the federal banking safety net, any conclusion that the FDIC's 
affiliate examination authority is less effective in practice than that 
of consolidated supervisors is not supported by the historical record. 

Issues Associated with Banking-Agency Supervision of Commercial 
Enterprises: 

Consolidated supervision implies that a federal banking regulator would 
oversee the commercial parent and its affiliates, and that commercial 
activities increasingly would be subject to regulation designed for 
banks. The potential result of implementing the GAO's recommendation 
would be that federal banking regulators may exercise supervisory 
oversight over large sectors of the U.S_ economy. This would represent 
a new level of government intrusion in the marketplace - in fact, it 
would amount to a radical restructuring of the longstanding role of the 
federal government relative to commercial firms. Such an approach also 
would raise significant concerns about legal separateness, corporate 
governance, and the unwarranted expansion of the federal safety net. 

It should also be noted that consolidated supervision of a large, 
commercial organization is subject to certain practical constraints. 
The legal structures of many of these companies are intentionally 
segregated, with some large companies having hundreds of subsidiaries. 
Many financial holding companies are similarly diverse. An individual 
review of each subsidiary would be extremely time-consuming and would 
be unlikely to yield information useful to the effective supervision of 
the subsidiary bank. As a result, consolidated supervisors have tended 
to focus on a high-level review as the only time-effective, practical 
approach to the supervision of these entities. The argument that 
consolidated supervision of a company such as General Electric would 
benefit bank regulators by improving familiarity with a non-bank 
affiliate, such as the consumer electronics division of the company, is 
not compelling from either a logistical or a risk identification 
standpoint. 

The Consolidated Supervision Approach May Extend the Federal Safety 
Net: 

In the United States, the federal safety net is provided to insured 
banks, not their holding companies and affiliates. Preventing the 
federal safety net from supporting risks taken outside insured banks 
has been the most often-stated reason for the existence of bank holding 
company supervision. 

Recently, however, the Federal Reserve endorsed the concept of 
enterprise-wide supervision, founded on the principle that government 
supervision must mirror the manner in which companies are managed_ The 
FDIC is concerned that some aspects of this new supervisory approach 
may detract from achieving the traditional goal of preventing insured 
entities from supporting risks taken in parents or affiliates. Under an 
enterprise-wide supervision approach, it appears that the supervisory 
vision of an insured bank as an independent entity may be supplanted by 
a supervisory vision of an insured bank as an integrated component of a 
larger organization. Enterprise supervision by holding company 
management, and the top-down approach to Basel II advocated by the 
Federal Reserve, have the potential to call into question the 
individual accountability of insured institutions owned by large 
organizations to manage their own capital. 

A supervisory goal of insulating an insured bank from risks taken by an 
affiliate is fundamentally different from a supervisory goal of 
integrating that bank with its affiliates, Integration downplays the 
risk-management responsibilities of insured entities operating in 
financial conglomerates. A supervisory regime that in any way supports 
the idea that insured banks are not fully accountable for their own 
risk management, combined with a capital regime that promotes the 
concept that an insured institution's risk should be measured together 
with its affiliates, effectively expands the federal safety net. 

The regulatory approach of the FDIC focuses on -the insured entity and 
the importance of maintaining corporate separateness. The consolidated 
supervision model proposed by the GAO for consideration by Congress not 
only endangers these legal-entity distinctions, but also raises the 
possibility of extending the federal safety net beyond the insured 
entity. To the extent banks are integrated and managed as departments 
of their holding company, especially if regulators by means of their 
supervisory methodology are actively promoting this approach, there is 
a danger that the bank could be held liable for the debts or conduct of 
an affiliate. This piercing of the corporate veil seems far more likely 
under an "integration" philosophy of supervision than it does under an 
"insulation" philosophy. 

Conclusion: 

Congress must ensure that a financial regulatory framework is in place 
that adequately controls the potential cost of the federal banking 
safety net. This includes deciding how arrangements involving the 
ownership of banks by commercial firms should be regulated. 

The GAO report articulated one vision of such regulation-consolidated 
banking agency supervision of the commercial parent. We are concerned 
with such an approach, and we believe the federal safety net is best 
protected in such situations by a bank-centric regulatory approach. 
that focuses on bank insulation, corporate separateness, and the legal 
accountability of bank directors and officers. 

The FDIC believes these issues will be an important subject for public 
policy debate in the years ahead. We stand ready to provide the GAO, 
Congress and other interested persons with any information we can in 
order to contribute to an appropriate resolution of these important 
questions. 

Sincerely, 

Signed by: 

Donald E. Powell: 

[End of section]

Appendix IV: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

Richard J. Hillman (202) 512-8678: 

Staff Acknowledgments: 

The following individuals made key contributions to this report: 

Dan Blair, Assistant Director Heather Atkins Rudy Chatlos Jordan Corey 
Tiffani Humble James McDermott Marc Molino David Pittman Rhonda Rose 
Paul Thompson. 

(250202): 

FOOTNOTES

[1] As amended by the Gramm-Leach-Bliley Act (GLBA), the BHC Act 
restricts the activities of bank holding companies to activities 
"closely related to banking" that were permitted by the Federal Reserve 
Board as of November 11, 1999. However, bank holding companies that 
qualify as financial holding companies can engage in additional 
activities defined in GLBA as activities that are "financial in 
nature," as well as activities that are incidental to or complementary 
to financial activity. Pub. L. No. 106-102 §§ 102, 103, codified at 12 
U.S.C. § 1843(c)(8), (k) (2000 & Supp. 2004). 

[2] The Division of Supervision and Consumer Protection's Approach for 
Supervising Limited-Charter Depository Institutions (FDIC Office of 
Inspector General Report No. 2004-048, Sept. 30, 2004). 

[3] Under 12 U.S.C 1831a(a), FDIC-insured state banks, a group that 
includes ILCs, may not engage as principal in any activity that is not 
permissible for a national bank unless the FDIC has determined that any 
additional activity would pose no significant risk to the deposit 
insurance fund and the bank is in compliance with applicable federal 
capital standards. 

[4] California law prohibits industrial banks from accepting demand 
deposits. Cal. Financial Code § 105.7 (Deering 2002). Section 2c(2)(H) 
of the BHC Act exempts ILCs that satisfy certain criteria from the act. 
The exemption applies to ILCs organized under the laws of states which, 
on March 5, 1987, had or were considering laws to require FDIC 
insurance for ILCs and includes ILCs with assets of $100 million or 
more that do not accept demand deposits that may be withdrawn by check 
or similar means for payment to third parties. 12 U.S.C. § 
1841(c)(2)(H). The vast majority of ILCs exist in a holding company 
structure, and these ILCs' assets account for 99 percent of total ILC 
industry assets. 

[5] NOW accounts are deposit accounts that give the depository 
institution the right to require at least 7 days written notice prior 
to withdrawal and have other characteristics set forth in Federal 
Reserve Regulation D. 12 C.F.R. § 204.2(b)(3) (2004). Under the Federal 
Deposit Insurance Act, NOW accounts may be offered to individuals and 
nonprofit organizations and for the deposit of public funds. 12 U.S.C. 
§ 1832 (2000). 

[6] For purposes of this report, the term "bank" refers to insured 
depository institutions, including ILCs and thrifts. The Federal 
Deposit Insurance Act defines the term "bank" to include ILCs. 12 
U.S.C. § 1813(a). 

[7] Unitary thrift holding companies are generally any company that 
owns a single thrift. Merchant banking refers to the practice where a 
financial institution makes a passive equity investment in a 
corporation with a view toward working with company management and 
operating partners to enhance the value of the equity investment over 
time. Federal banking law contains several provisions that are designed 
to distinguish merchant banking investments from the more general 
mixing of banking and commerce. 

[8] We use the term thrift to refer to savings and loan associations. 
According to OTS, these institutions provide various financial services 
to consumers and small to mid-sized businesses in their communities and 
offer an array of deposit instruments including checking, savings, 
money market, and time deposits. Thrifts' lending activities are 
primarily focused on residential lending, including first mortgage 
loans, home equity loans, and loans secured by multifamily residences. 
They also provide loans for other consumer needs such as for autos, 
education, and home improvements. In addition, thrifts provide 
community businesses with working capital loans, loans secured by 
commercial property, and construction loans. 

[9] Any one of the following circumstances will trigger coverage by the 
BHC Act: (1) Stock ownership --Where the company owns, controls or has 
the power to vote 25 percent or more of any class of the voting 
securities of a bank or bank holding company (either directly or 
indirectly or acting through one or more other persons); (2) Ability to 
elect a board majority--Where the company controls the election of a 
majority of the directors or trustees of a bank or bank holding 
company; or (3) Effective control of management-Where the Board 
determines, after notice and opportunity for hearing, that the company 
directly or indirectly exercises a controlling influence over the 
management or policies of a bank or bank holding company. For purposes 
of this last provision, Congress expressly presumed that any company 
that directly or indirectly owns, controls, or has power to vote fewer 
than 5 percent of any class of voting securities of a specific bank or 
bank holding company does not have the requisite control. See 12 U.S.C. 
§ 1841(a). 

[10] As discussed more fully later in this report, federal law 
restricts transactions between an insured depository institution and 
its bank holding company affiliates. 

[11] 12 C.F.R. § 225.4 (2004). 

[12] Bank Holding Company Act of 1956, Pub. L. No. 84-511 § 4. 

[13] See Board of Governors of the Federal Reserve System v. Investment 
Company Institute, 450 U.S. 46, 72, n. 51 (1980). 

[14] Depository Institutions Act of 1982, Pub. L. No. 97-320 § 703. 

[15] Id. 

[16] Pub. L. No. 100-86. 

[17] 12 U.S.C. § 1841(c)(2)(H). According to the FDIC, at the time of 
the 1987 CEBA exemption six states--California, Colorado, Hawaii, 
Minnesota, Nevada, and Utah--had statutes in effect or under 
consideration requiring their ILCs to have federal deposit insurance. 
However, because the exemption for ILCs is in the BHC Act, the Board 
has primary responsibility for determining which states are 
grandfathered by the BHC Act. Only ILCs chartered in "grandfathered" 
states are eligible for the ILC exemption from the BHC Act. 

[18] Subprime loans are a type of lending that relies on risk-based 
pricing to serve borrowers who cannot obtain credit in the prime 
market. 

[19] See 12 U.S.C. § 1831d(a); see also, FDIC General Counsel's Opinion 
No. 11, Interest Charges by Interstate State Banks, 63 Fed. Reg. 27282 
(May 18, 1998). 

[20] Nevada and Utah do not cap the interest rates credit card 
companies can charge. Their usury laws, similar to Delaware and South 
Dakota, are considered desirable for credit card entities. 

[21] Commercial paper generally is a short-term, unsecured promissory 
note issued primarily by highly rated corporations. Many companies use 
commercial paper to raise cash needed for current transactions and find 
it to be a lower-cost alternative to bank loans. Brokered deposits are 
generally deposits obtained by a deposit broker and are considered rate-
sensitive because consumers are able to withdraw them quickly and 
without notice. 

[22] Loan-to-value ratios are a lending risk ratio calculated by 
dividing the total amount of the mortgage loan by the appraised value 
of the property or the purchase price of the property. 

[23] Section 18(j) of the FDI Act extends the provisions of sections 
23A and 23B of the Federal Reserve Act to state nonmember banks. 12 
U.S.C. § 1828(j). 

[24] Covered transactions are specifically described in section 23A 
(b)(7)(A) through (E) but generally consist of making loans to an 
affiliate; purchasing securities issued by an affiliate; purchasing 
nonexempt assets from an affiliate; accepting securities issued by an 
affiliated company as collateral for any loan; and issuing a guarantee, 
acceptance, or letter of credit on behalf of (for the account of) an 
affiliate. Section 23A also lists several types of transactions that 
are specifically exempted from its provisions. Under the BHC Act, as 
amended by GLBA, a depository institution controlled by a financial 
holding company is prohibited from engaging in covered transactions 
with any affiliate that engages in nonfinancial activities under the 
special 10-year grandfather provisions in the GLBA. 12 U.S.C. § 1843 
(n)(6). 

[25] See 12 C.F.R. § 337.3 (2005). 

[26] See 12 C.F.R. Part 204. 

[27] See 12 C.F.R. Part 329. 

[28] See 12 C.F.R. Part 206. 

[29] See 12 C.F.R. Part 202. 

[30] See 12 C.F.R. Part 226. 

[31] See 12 C.F.R. Part 229. 

[32] The Basel Committee on Banking Supervision, established in 1974, 
is composed of representatives from the central banks or supervisory 
authorities of various countries in Europe, North America, and Asia. 
This committee has no formal authority but seeks to develop broad 
supervisory standards and promote best practices in the expectation 
that each country will implement the standards in ways most appropriate 
to its circumstances. Implementation is left to each nation's 
regulatory authorities. 

[33] See 12 U.S.C. § 1831v(b). 

[34] See 12 U.S.C. §§ 1844(c)(2)(A), 1467a. 

[35] See 12 U.S.C. § 1844(c)(2)(B). 

[36] See 12 U.S.C. §§ 1467a(b)(4), 1831(a). 

[37] See 12 U.S.C. §§ 1844(c)(2)(C), 1831v(a). 

[38] See 12 U.S.C. § 1831v(b). 

[39] See "Framework for Financial Holding Company Supervision," Letter 
from the Division of Banking Supervision and Regulation, Board of 
Governors of the Federal Reserve System, to the Officer in Charge of 
Supervision and Appropriate Supervisory Staff at Each Federal Reserve 
Bank and to Financial Holding Companies (August 15, 2000). 

[40] See 12 U.S.C. §§ 1844(c)(1), 1467a(b)(2), 1844(c)(1)(B), 
1831v(a)(1). 

[41] 12 C.F.R. § 225.5(b) (Board); 12 C.F.R. § 562.4(a) (OTS). 

[42] 12 C.F.R. Part 225, Appendices B & C. 

[43] See 12 C.F.R. § 225.4(a). 

[44] The concern is based upon differing views about the effect of the 
Supreme Court's ruling in Board of Governors v. MCorp. Financial, Inc., 
502. U.S. 32 (1991). In MCorp, the Court reversed a federal circuit 
court's holding that federal courts had jurisdiction to consider and 
enjoin an administrative action by the Board alleging MCorp's violation 
of the Board's source of strength regulation. The Court observed that 
MCorp ultimately could seek judicial review of the validity of the 
source of strength regulation and its application "if and when the 
Board finds that MCorp has violated that regulation." 502 U.S. at 43- 
44. The judicial action subsequently was dismissed for lack of 
jurisdiction. MCorp. Financial v. Board of Governors, 958 F.2d 615 (5TH 
Cir. 1992). Questions about the validity and enforcement of the 
regulation were unresolved. 

[45] See, e.g., 12 U.S.C. §§ 1844(g), 1831v(a)(2), and 1843(l), 
respectively. 

[46] See 12 U.S.C. § 1818(b)(3) (enforcement authority regarding 
nonbank subsidiaries includes authority to impose cease and desist 
orders for unsafe or unsound practices); see also, 12 U.S.C. § 1467(g) 
(OTS enforcement authority regarding thrift holding companies); 12 
C.F.R. § 225.4(b) (Board regulation providing for divestiture of 
holding company affiliates); 12 U.S.C. § 1467a(g)(5) (OTS divestiture 
authority). 

[47] See 12 U.S.C. 1820(b)(4)(A). 

[48] See 12 U.S.C. 1831v(b). 

[49] See 12 U.S.C. § 1820(c). 

[50] FDIC has no authority to take action against an ILC affiliate 
whose activities weaken the holding company, and potentially the ILC, 
unless the affiliate is an IAP and the IAP participated in conducting 
the ILC's business in an unsafe or unsound manner, violated a legal 
requirement or written condition of insurance, or otherwise engaged in 
conduct subject to enforcement. See 12 U.S.C. § 1818(b). 

[51] See 12 U.S.C. § 1813(u). 

[52] In addition to these authorities, we note that measures under the 
prompt corrective action provisions of the FDI Act based on an 
institution's undercapitalized status include a parental capital 
maintenance guarantee and the possibility of divestiture of a 
significantly undercapitalized depository institution or any affiliate. 
See 12 U.S.C. § 1831o. These measures apply equally to all FDIC insured 
institutions and their respective regulators. 

[53] Value-at-risk is an estimate of the potential losses that might 
occur in a portfolio due to changes in market rates, based on a 
specified period of time during which the rates change, and at a 
specified probability level. For example, a firm may generate a value 
at risk estimate for a 10-day period at 99 percent probability and 
arrive at a figure of $1 million. This means that 99 percent of the 
time it would expect its losses during a 10-day move of rates to be 
less than $1 million. 

[54] See 12 U.S.C. § 1820(c). 

[55] See, for example, the focus of bank holding company examinations 
as prescribed in the BHC Act. 12 U.S.C. § 1844(c)(2). 

[56] See 12 U.S.C. 1844(c)(1)(C) (Board examinations, to fullest extent 
possible, are to be limited to examinations of holding company 
subsidiaries whose "size, condition, or activities" could adversely 
affect the affiliated bank's safety and soundness or where the nature 
and size of transactions between the affiliate and the bank could have 
that effect.)

[57] See 12 U.S.C. §§ 1815(a)(4), 1816. 

[58] FDIC's incidental powers are set forth at 12 U.S.C. 
1819(a)(Seventh). 

[59] See 12 U.S.C. § 1818(b)(1). 

[60] FDIC's Policy Statement on Applications for Deposit Insurance 
provides, in pertinent part, that: Where the proposed depository 
institution will be a subsidiary of an existing bank or thrift holding 
company, the FDIC will consider the financial and managerial resources 
of the parent organization in assessing the overall proposal and in 
evaluating the statutory factors prescribed in section 6 of the Act. . 
. . If the applicant (for deposit insurance) is being established as a 
wholly owned subsidiary of an eligible holding company, . . . the FDIC 
will consider the financial resources of the parent organization as a 
factor in assessing the adequacy of the proposed initial capital 
injection. In such cases, the FDIC may find favorably with respect to 
the adequacy of capital factor, when the initial capital injection is 
sufficient to provide for a Tier 1 leverage capital ratio of at least 8 
percent at the end of the first year of operation, based on a realistic 
business plan, or the initial capital injection meets the $2 million 
minimum capital standard set forth in this Statement of Policy, or any 
minimum standards established by the chartering authority, whichever is 
greater. The holding company shall also provide a written commitment to 
maintain the proposed institution's Tier 1 leverage capital ratio at no 
less than 8 percent throughout the first 3 years of operation. See 67 
Fed. Reg. 79276-79278 (Dec. 27, 2002). 

[61] See 12 U.S.C. § 1831o(e)(2)(C), (f)(I)(ii). 

[62] The procedural requirements include notifying the appropriate 
federal or state banking supervisor of FDIC's determination for the 
purpose of securing a correction by the institution. 12 U.S.C. § 
1818(a)(2)(A). 

[63] See 12 U.S.C. § 1818(a)(3),(5). 

[64] FDIC's authority in connection with the acquisition of an insured 
institution is set forth at 12 U.S.C. §§ 1817(j). 

[65] Grounds for an enforcement action against an IAP include the 
occurrence or potential occurrence of an unsafe or unsound practice by 
the insured institution caused by the IAP's conducting the business of 
the institution or the violation of a law, regulation or other 
regulatory requirements by the institution or IAP. See 12 U.S.C. § 
1818(b)(1). 

[66] See 12 U.S.C. §§ 1831v, 1848a. 

[67] Wachtel v.Office of Thrift Supervision, 982 F.2d 581 (D. Cir. 
1993) (OTS lacks authority to require majority shareholder of a savings 
and loan to inject capital into the institution pursuant to a written 
agreement where OTS failed to prove unjust enrichment.); see also, 
Rapaport v. Office of Thrift Supervision, 59 F.3d 212 (1995). 

[68] All commercial banks insured by the FDIC and all FDIC-supervised 
savings banks are required to submit quarterly Call Reports. The Call 
Report contains a variety of financial information that shows a bank's 
condition and income and is used for multiple purposes including 
assessing the financial health and risk of the institution. 

[69] FDIC jointly developed the recommended practices as documented by 
the State Federal Working Group Supervisory Agreement together with the 
Board and the Conference of State Banking Supervisors. 

[70] According to FDIC, a chain banking organization is a group of two 
or more banks or savings and loan associations and/or their holding 
companies that are controlled directly or indirectly by an individual 
or company acting alone or through or in concert with any other 
individual or company. The linkage of several banks or holding 
companies into a chain creates a concentration of banking resources 
that can be susceptible to common risks including poor loan 
participation practices, common deficiencies in lending and/or 
investment policies, domineering or absentee ownership, insider abuses, 
or other self-serving practices. Further, FDIC has noted that chain 
banking organizations do not have to report financial information on a 
consolidated basis, thereby making offsite monitoring difficult. 

[71] Under Nevada Law, the Commissioner of Financial Institutions has 
authority to examine ILC affiliates for limited purposes. Nev. Rev. 
Stat. § 677.440 (2004). The laws of Utah and California provide for 
full examinations of ILC affiliates. Utah Code Ann. §§ 7-1-314, 7-1-510 
(2004); Cal. Fin. Code § 3704 (2004). 

[72] See Utah Code Ann. § 7-1-510. 

[73] FDIC's Large Bank program provides an onsite presence at 
depository institutions through visitations and targeted reviews 
throughout the year as opposed to the traditional annual point-in-time 
examination. FDIC Regional Directors or their designees are to 
determine which institutions qualify for the program, however FDIC 
guidance indicates that all state nonmember banks with total assets of 
$10 billion or more should be considered. 

[74] Four Utah ILCs are eligible to participate in the Large Bank 
program. As of the date of this report, FDIC has approved three of 
these ILCs and the fourth is awaiting approval to participate. 

[75] In June 1995, the Federal Financial Institutions Examination 
Council (FFIEC) issued guidelines for federal supervisors to use to 
determine whether to rely upon state examinations. The guidelines 
stipulate that the federal banking agencies will "accept and rely on 
State reports of examination in all cases in which it is determined 
that State examinations enable the Federal banking agencies to 
effectively carry out their supervisory responsibilities." According to 
FFIEC and FDIC criteria, the FDIC should consider the adequacy of state 
budgeting and examiner staffing in determining reliance placed on state 
examinations. In addition to FFIEC criteria, FDIC uses a number of 
other factors, including the state bank supervisor's accreditation 
through the Conference of State Bank Supervisors (CSBS). CSBS is the 
professional association of state banking departments responsible for 
chartering, regulating, and supervising the nation's state chartered 
banks. 

[76] From 1985 through year-end 2003, a total of 21 ILCs failed, 
including those discussed above. The other 19 failures did not result 
in material losses to the bank insurance fund; therefore, the FDIC-IG 
did not conduct a review. A material loss review by the Inspector 
General of the principal federal regulator of a failed institution is 
required when the estimated loss to the bank or savings association 
insurance funds exceeds the greater of $25 million or 2 percent of the 
institution's total assets at the time the FDIC was appointed receiver. 
These 19 ILCs were operated as finance companies, and their average 
total assets were $23 million. According to FDIC, most of the failures 
were small California ILCs that failed during the banking crisis of the 
late 1980s and early 1990s. 

[77] For the 1995 testimony, see Financial Regulation: Modernization of 
the Financial Services Regulatory System (GAO/T-GGD-95-121, Mar. 15, 
1995). In addition to this testimony, other GAO products present 
similar views on consolidated supervision. See, for example, Separation 
of Banking and Commerce (GAO/OCE/GGD-97-61R); the U.S. Bank Oversight: 
Fundamental Principles for Modernizing Structure (GAO/T-GGD-96-117, May 
2, 1996); Bank Oversight Structure: U.S. and Foreign Experience May 
Offer Lessons for Modernizing U.S. Structure (GAO/GGD-97-23, Nov. 20, 
1996); Bank Powers: Issues Related to Repeal of the Glass-Steagall Act 
(GAO/GGD-88-37, Jan. 22, 1988). 

[78] In Re: Toyota Financial Savings Bank Henderson, Nevada, 
Application for Federal Deposit Insurance, Federal Deposit Insurance 
Corporation, January 2004. 

[79] Equity capital or financing is money raised by a business in 
exchange for a share of ownership in the company. Financing through 
equity capital allows a business to obtain funds without incurring debt 
or without having to repay a specific amount of money at a particular 
time. The equity capital ratio is calculated by dividing total equity 
capital by total assets. 

[80] See 12 U.S.C. §§ 1843, 1467a(c). As previously discussed, 
grandfathered unitary thrift holding companies are not subject to these 
activities restrictions. Limited purpose credit card banks also are 
exempt from the BHC Act. See 12 U.S.C. § 1841(c)(2)(F). 

[81] When determining the current levels of mixed banking and commerce 
within the ILC industry, we considered only ILCs owned or affiliated 
with explicitly nonfinancial, commercial firms. Because some owners and 
operators of ILCs are engaged in business activities that are generally 
financial in nature, but still may not meet the statutory requirements 
of a qualified bank or financial holding company, officials from the 
Federal Reserve Board noted that they interpret the level of mixed 
banking and commerce among ILCs may be greater than 6.4 percent of 
industry assets and 6.2 percent of industry estimated insured deposits. 

[82] In 2003, California and Colorado enacted laws restricting 
ownership or control of ILCs to financial firms. As a result, greater 
mixed banking and commerce for the holding company's affiliates of ILCs 
is not available to owners of California and Colorado ILCs. 

[83] In 1967, Congress enacted the current version of the Savings and 
Loan Holding Company Act, Pub. L. No. 90-255, 82 Stat. 5 (1968). In 
that legislation, Congress permitted unitary thrift holding companies 
to engage in nonthrift business. 

[84] Pub. L. No. 106-102 § 401 (1999). 

[85] See 12 U.S.C. § 1468(a). 

[86] See 12 U.S.C. § 1464(c)(2)(A). 

[87] See 12 U.S.C. § 1467a(m). 

[88] In the GLBA, Congress authorized FHCs to engage in merchant 
banking activities through nondepository institution subsidiaries under 
specific conditions, thus allowing an FHC to acquire or control, 
directly or indirectly, any kind of ownership interest in any entity 
engaged in any kind of trade or business, subject to rules to be 
promulgated by the FRB and the Secretary of the Treasury. See H. Rep. 
No. 106-434 at 154. 

[89] See 12 U.S.C. § 1843(k)(4)(H). 

[90] See 12 U.S.C. § 1841(c)(2)(F). 

[91] GAO, Separation of Banking and Commerce, GAO/OCE/GGD-97-16R 
(Washington, D.C.: Mar. 17, 1997). 

[92] See H.R. 1224, 109TH Cong. § 3 (2005). 

[93] H.R. 1375 108TH Cong. § 401(b) (2004). This bill would permit de 
novo interstate branching by ILCs subject to the grandfathering 
provisions described later in our discussion of legislative proposals 
to permit interest-bearing business checking accounts. 

[94] Generally, sweep accounts use computers to analyze customer 
accounts and automatically transfer funds at the end of each day to 
higher-interest earning money market accounts. 

[95] H.R. 1224 § 3. See 12 U.S.C. §§ 371a, 1828(g), 1832. 

[96] See 12 U.S.C. §§ 1831u. 

[97] See 12 U.S.C. § 1828(d). 

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