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The Big "One"
by Jeffrey K. Bagby,
Regional Examiner, Oklahoma State Banking Department
I don't blame you. I would desire a '1' rating also. When a regulatory body develops a measuring stick and applies it to your bank, the tendency is to strive for the top rung. That's natural. And it does have some marketing value (although your bank rating is supposed to be confidential). Curiously, word does get around which banks are '1' rated and those that - ahem - are not. The haves and the have-nots of a sort. It may not be a rigid class hierarchy, but the stigma can be hard to shed when the rating is less than desirable. I've lost count how many times bankers have asked me "what do I have to do to get a '1' rating?" Certainly there are and have been regulators that dole out '1' ratings like Olympic judges awarding gold medals. One every four years. But, quality may not rest solely in accomplishing this feat.
There are plenty of reasonable guidelines within the rating system that reflect a good solid bank. Regardless of who is looking, strong asset quality, earnings and capital are a plus. But therein lies a conundrum. How much capital is enough? Ask an examiner and you may NEVER feel like you have enough. If your bank is complying with the Federal rules governing capital ratios, and asset quality, liquidity and earnings are strong, the tendency to appease examiners should take a back seat to the needs of another important group. The stockholders. Unless the bank is small, family-owned, and very conservative minded, the stockholders are going to be concerned about maximizing their return on investment. When capital is 18%, the component rating may be a '1', but the bank's Return on Investment is going to suffer.
Let's be frank. If your bank's Tier 1 Leverage Capital ratio is in the six to seven percent range, a '1' rating for Capital is often hard to come by. But the long-range benefit to your bank, your stockholders and your customers may be much more positive with this philosophy. Financial intermediary is a challenging industry. The margins are thin for the bottom line and for making mistakes. Also, this is in a business that lives and dies on maintaining customers' faith in the system. That's where the FDIC made its mark. Bank's could do their business and rest easy that depositors would not draw their insured funds out due to fear of loss. Historically, deposit insurance has been very affordable for quality banks. The cost of insurance only affected banks when they deteriorated into the "troubled bank" ratings of '3' or worse.
But lately, there has been more rumblings from the depository insurer regarding the insurance fund and how premiums are paid. FDIC Chairman Donald E. Powell gave a speech on economic reform on 9/12/02. In that speech, he stated "I believe we should be able to better distinguish between our customers based on the risks they pose to the financial system. . . . .We know that institutions with a CAMELS rating of '2' are two and a half times more likely to fail than those with a '1' rating, for example. We should be able to make distinctions that are not arbitrary and that are truly reflective of our risk. As far as I am concerned, if you are a well-run institution with appropriate capital for your risk, you should be able to get your deposit insurance for a pittance. If you have a riskier business model, you should pay more. . . . .we will work constructively, with the industry, to design a pricing system that is both fair and that does not discriminate
against institutions on the basis of their size. I give you my word that we will work with you to make sure the new risk-based premium system for deposit insurance is both effective and fair."
If this reform initiative takes shape - it has been discussed for several years - then banks will have to brush up on their balancing act between regulators and stockholders. But, it can be done. Tighter capital ratios simply mean that management is accepting more risk. No problem. Just meet the exposure half way by employing proper controls to manage the added risk. Obviously, that's easy for an examiner to say on this side of the desk. But, there are plenty of banks that have proven the theory true. The positive result is solid asset quality, consistent earnings and happy stockholders. And, oh yes, maybe even the examiners will crack a smile.
Jeff Bagby is a Regional Examiner with the Oklahoma State Banking
Department. He has spent 17 years in bank regulation which includes a wide spectrum of knowledge and experience. In the early part of his career, the banking industry in the central region of the United States endured its most devastating era since the FDIC was established bringing with it numerous bank closures. In addition to writing examination reports and working with bank management, Jeff teaches Loan Officer Seminars which is aimed at revealing to bank lenders how and what an examiner looks for when reviewing loans.
Jeff received a B.B.A. from the University of Oklahoma in 1985 and is a graduate of the Conn Graduate School of Community Banking.
First published on BankersOnline.com 11/25/02
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