Relationship Banking?.With Your Regulator

Relationship Banking ?.With Your Regulator
by Regional Examiner K. Paul Qualls, Oklahoma State Banking Department

If your regulator isn't applying the type of approach outlined below,
perhaps it should be!
At the height of the oil bust in the region where I'm located, and, coincidentally, at the onset of bank closures associated with the mid 1980s, the relationship between a bank and its regulator was less than enthusiastic or amiable. In fact, an air of common distrust seemed to prevail upon the entire relationship and, unfortunately, this air was not wholly unfounded.

Speculated oil prices never materialized and the economy within the oil region struck a dry hole. Banks were struggling to collect loans, dispose of collateral received through foreclosure proceedings, and augment decreasing capital levels impacted by the losses incurred in the disposal of collateral. Simultaneously, bankers were daunted by the challenge of conforming to the sometimes ambiguous demands of the regulators, who, themselves were struggling to meet the challenges brought on by deteriorating bank conditions and avoid the devastation incurred in the savings and loan industry.

Credit review became an exercise in viability prognostication due to the poor initial underwriting, nonexistent repayment structure and the absence of timely, substantiated loan documentation. Although implored by the banking community, benefit of doubt concerning credit quality was not easily conceded from the regulatory body. In some instances, where doubt existed, the worse case scenario was assumed on the part of the regulator, and any disparity between the loan balance and suspect collateral value was immediately sacrificed on the alter of regulatory burden. Hence, the foundations of a tenuous and apprehensive relationship were laid due to the economics of that period.

Fortunately, time and earnings have helped soothe many of the wounds inflicted during the bust era. Overall, banking conditions since the mid 1980's have significantly improved through sustained earnings performance, increased capital levels and improved asset quality via enhanced credit underwriting and securitization. This new era has also brought about the merging and consolidation of the superbanks, interstate banking and competition from non-banking financial institutions into the once-exclusive banking arena. This new era has, in addition, experienced a generally upbeat economy supported to a large degree by the availability of credit and, more recently, historically low interest rates. What impact these phenomena will have on the future of banking remains uncertain at this point.

Will banks again be faced with the same challenges of the mid-1980s or has management learned from the mistakes of the past?

This conundrum has been the catalyst for a complete paradigm shift in the philosophy of bank examinations on the behalf of the regulatory agency I represent (the Oklahoma State Banking Department) for the past ten years. In the past, regulatory philosophy was one of reactive approach, in which a bank was allowed to deteriorate until it demonstrated significant risk to the insurance fund or capital levels reached critical mass. Then the regulators would initiate a series of sincere, but laggard administrative actions against bank management to correct identified weaknesses and, ultimately, close the bank. Now the Oklahoma State Banking Department has transitioned to a more proactive philosophy in which we assess the significant areas of risk and focus on those identified areas rather than painting each examination with a broad brush. Resultantly, those banks with sound risk management practices including the identifying, monitoring and controlling of risk are examined differently than those that fail to incorporate even the most basic tenets of risk management.

We are employing this new proactive examination philosophy on many fronts. First, we have created and are currently utilizing three separate examination techniques, which enable us to fulfill our responsibilities as the primary regulators of all state-chartered banks in Oklahoma. The proactive programs employed include the A.C.E. Procedures, which is an acronym for Accelerated, Customized Examination. This examination process is utilized for only the elite banks within the state. This process reduces time actually spent within the bank and narrows the examination focus to only those areas of inherent risk.

Second, the Department introduced a new examination report format, which eliminates the reiteration of comments throughout the report and centralizes them on the Examiner's Comments and Conclusions pages. Third, a Central Point of Contact Program has been implemented which appoints a seasoned examiner to monitor a specific group of banks to observe any dramatic changes within the banks' financial condition. This program also provides banks a contact person within the department to field questions relating to bank regulation or clarification of banking issues identified at the previous examination. In turn, this program allows an examiner to become more acquainted with a bank's operations, its personnel and its unique strengths and weaknesses. With this understanding, any future examination should be uniquely tailored for the bank. Fourth, our Department offers a loan officer training program which is designed to explain to loan officers why and when examinations take place and how the examination is conducted, primarily in the area of loan review.

At the core of this paradigm shift in examination philosophy is an attempt to have a better understanding of all state-chartered banks and the risks that each present to the safekeeping of communal funds, a better understanding of the individuals dedicated to managing the identified risks, and a better understanding of the adequacy of the policies and practices promulgated by the bank's Board of Directors. With customized examination procedures, a more simplistic report format, a more thorough understanding via developed contacts between the banks and the Department, and education opportunities, the foundations of a new relationship between bankers and regulators are hopefully being developed. The success of this new philosophy will rest upon the bankers willingness to trust the regulators to not overreact in a given situation, and reciprocally, regulators trusting bankers to tell the truth, the whole truth and nothing but the truth, especially in the area of asset quality. The ultimate goal of both parties involved is the continued viability of the bank, for neither party, nor a community, wins if a bank is closed.

First published on BankersOnline.com 1/27/03