Blind Spots - Jeff Bagby

Blind Spots
by Jeff Bagby, Regional Examiner, Oklahoma State Banking Department

You missed a spot. No, really. Right there next to the thingamabob. Hey, don't shoot the messenger! I'm just trying to help.

Whew! Some people just don't like constructive criticism?

Scratch that. No one enjoys correction. Or there would be people scheduling their vacations around trips to the dentist. But everyone has blind spots. Even bankers and their banks have blind spots. And guess who gets to point them out. Your civil servant. We're the government and we're here to help.

It is well within your power and prerogative to simply ignore the recommendations and suggestions made within the context of a Report of Examination or interim correspondence (at least write back and tell the regulators you read it, however). I've said it before, strong earnings, good asset quality and decent capital always trumps the lack of a branch closing policy or whatever your favorite irritating criticism may be. But some of those helpful hints and recommendations could benefit you. For you bankers that attempt to address every issue and dot every i, examiners might disclose some obscure or long forgotten matter that could actually affect your - gulp - bottom line.

Of course, regulators need to avoid the desire to justify or magnify their existence by criticizing loans or other matters more severely than is necessary. Back in the old days, some examiners - not from our organization mind you - received kudos from their supervisors for provoking angry correspondence from bankers stating the examiner was too tough or grossly unfair. This gave rise to a more defensive posture by bankers and a general unwillingness to agree with examiners just so regulators wouldn't get the upper hand in a combat situation. Thankfully, in the last ten years the environment and economy has improved, which has allowed more positive interaction between the two entities. Yet, blind spots emerge and fester.

We regulate a large number of family-owned banks that seat mostly family members on the board of directors. There are obvious benefits to family ownership. The level of trust between members of upper management is reasonably high, and most if not all the decision-makers are deeply committed financially. But, with every strength comes an equal and balancing weakness. That same high level of trust among family members can encourage lax controls on insider borrowing and insider deposit accounts.

One bank recently examined supports this viewpoint. A stockholder, director - family member - of a quality bank wanted a loan to his corporation to do a residential real estate development. The rub was, he is an attorney and likes to do his own title work. On his own loans. And the board - basically, his family - let him. This is a conservative, well-run bank. They have very few demerits when examined, yet they complained that this was excessive criticism. The family blind spot.

Another bank carries multi-million dollar unsecured loans to a selection of board members at below prime interest rates. The big money blind spot. Granted, if the borrower is strong and the bank would lend to anyone with those credentials at a most favorable rate, then good luck to you. But, it is self evident and better for loan portfolio preservation to believe that those type people are few and far between.

Often there is a time lag when it comes to acknowledging a blind spot. A recently examined institution was so infuriated over the examiners' aggressive efforts to expose a lingering weakness, the bank converted to a different regulator. But as the reality of their need to improve that area of the bank settled in, management began not only to correct the specific criticisms from the examination, they implemented a full culture change that has placed them on the intellectual forefront of internal audit procedures. In hindsight, it should have resulted in a positive solution for all entities. Could be - regulators have a few blind spots when it comes to their bedside manner?

At the other end of the forest are the bankers that have blind spots and don't want to know about them or deal with them. The chronic blind spots. Regulators point, whistle, and lose their voice disclosing vital warnings to the banker, but if no one is home the message is void. Criticisms in Reports of Examination become carbon copies of previous reports. Repeat violations are the norm rather than the exception. And composite ratings and enforcement actions begin to reflect their lack of action.

Thankfully, the banks in this category are rare. But they exist. At an actual bank, the board had been under a Cease and Desist Order (C&D) for six years. The chairman of the board was informed during the most recent examination that capital had fallen below the parameters set forth in the C&D. The capital level had gradually eroded due to regular operating losses, yet there was no discussion during the board meetings or any reference to marginal capital in the quarterly reports documenting management's efforts to comply with the C&D. When the chairman got wind of the infraction, he indicated that he did not know what the capital requirements were in the C&D.

This same bank had been criticized repeatedly for their inability to hire and retain a chief executive officer as well as comply with Bank Secrecy Act guidelines. Often, the recurring excuse for their lack of action was "this is the first time we've heard this criticism." Uh, no it isn't. We invite you to read an old examination at your earliest convenience.

Whether it's heeded or ignored, there is usually some merit to comments and criticisms in any regulatory examination. If you as the banker aggressively disagree with the findings of an examination, do your homework and prove us wrong. At the very least, that blind spot will get the attention it deserves.

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 11/13/03