Evaluation of Prompt Regulatory Action Implementation

The OIGs of the Board, the FDIC, and the Treasury conducted a review of the prompt regulatory action (PRA) provisions of the Federal Deposit Insurance Act (FDI Act).  The PRA provisions of the FDI Act (section 38, Prompt Corrective Action (PCA), and section 39, standards for safety and soundness) require federal financial regulators to institute a system of regulatory actions when an institution fails to meet minimum capital levels or certain safety and soundness standards. 

These provisions were intended to increase the likelihood that regulators would respond promptly and forcefully to minimize losses to the Deposit Insurance Fund (DIF) when federally insured banks fail.  Our work focused on the following objectives:

• Determining the purpose of and circumstances that led to the PRA provisions (FDI Act sections 38 and 39) and lessons learned from the savings and loan crisis in the 1980s;

• Evaluating to what extent PCA and the safety and soundness standards were a factor in bank failures and problem institutions during the curren crisis;

• Assessing whether these provisions prompted federal regulators to act more quickly and more forcefully to limit losses to the DIF, in light of findings and lessons learned from the saving and loan crisis and regulators' use of PRA provisions in the current crisis; and

• Determining whether there are other non-capital measures that provide leading indication of risks to the DIF that should be considered as part o the PRA provisions.

We found that PRA provisions were appropriately implemented and helped strengthen oversight to a degree. More specifically, we found that

• Regulators implemented PCA appropriately;
  
• Inherent limitations associated with PCA's capital-based framework and the sudden and severe economic decline impacted PCA's effectiveness;
  
• Regulators identified deficiencies prior to declines in PCA capital categories;
  
• Regulators used other enforcement actions to address safety and soundness concerns before under capitalization, but after financial decline occurred;
  
• Regulators made limited use of section 39 to address asset quality and management deficiencies identified; and
  
• Critically undercapitalized institutions were closed promptly, but overall losses were significant.

To improve the effectiveness of the PRA framework and to meet the section 38 and 39 goals of identifying problems early and minimizing losses to the DIF, we recommended that the FDIC, the Board, and the OCC agency heads review the matters for consideration presented in this report and work through the FSOC to determine whether the PRA legislation or implementing regulations should be modified. The matters for consideration were (1) develop specific criteria and corresponding enforcement actions for non-capital factors, (2) increase the minimum PCA capital levels, and (3) continue to refine the deposit insurance system for banks with assets under $10 billion to assess greater premiums commensurate with risk-taking.

Each of the agency responses to our draft report and the identified planned actions addressed the intent of the recommendation. The Board's written response concurred with the general findings in the report and noted that the Board

• has initiated a process that addresses the OIGs' recommendation to develop criteria and corresponding enforcement actions for non-capital factors;  
• will continue to consider the recommendation noted in the OIGs' report to increase the minimum PCA capital levels; and
• will defer to the FDIC on changes in deposit insurance premiums, but the Board will submit views if solicited by the FDIC.