WASHINGTON - The number of examiners at the Federal Deposit Insurance Corp. has shrunk in recent years, and the agency is reducing the amount of time they spend on exams.
Depending on whom you ask, the strategy is an admirable one that other bloated regulatory agencies should mimic or an inflexible one out of step with its peers'. Some current FDIC supervision employees have offered harsher criticism; they have warned lawmakers in anonymous letters that the new system is less rigorous and could lead to more failures.
On one point the FDIC and its critics agree - examiners are spending less time in banks.
While the number of banks the FDIC supervises fell 8% from 1999 to 2004, to 5,278, the number of examiners has decreased more quickly. The agency had 1,951 examiners as of August, or 15% fewer than it did five years earlier, because of attrition and retirements.
FDIC executives estimate the number of hours its examiners spend checking up on banks has fallen about 20% over the past five years.
The executives describe the reduction as a conscious, positive move toward more risk-based supervision and efficiency. Those are the goals of the 2-year-old Maximum Efficiency, Risk-Focused, Institution Targeted, or Merit, program - a streamlined look at small banks with strong supervisory ratings that sets benchmark hours for examiners that vary by asset size.
"Merit was developed by top examiners to ensure that examinations, primarily loan reviews, are sufficiently risk-focused," said Michael Zamorski, the FDIC director of supervision. "The program has operated successfully for two years and has allowed us to prioritize our resources on the greatest areas of risk."
The program is a departure from the procedures followed by the Office of Thrift Supervision, the Office of the Comptroller of the Currency, and the Federal Reserve System, all of which say they give examiners and their regional supervisors more leeway in directing the course of oversight.
"I'm afraid that a cap on the hours provides perverse disincentives for my examiners," said Tim Long, the OCC's senior deputy comptroller for midsize and community bank supervision. "They feel pressure that they have to leave when maybe their gut is telling them that there's something wrong in that bank."
Opponents of the FDIC's policy, including some of the agency's employees, describe the changes as dangerous, and they have begun writing letters to lawmakers. An unsigned letter the Senate Banking Committee received in August outlines alleged shortcomings in the system and decries the changes in supervision. The letter was also sent to the House Financial Services Committee.
In general, the state of FDIC supervision "is bad and deteriorating rapidly, while the direction is ill-planned and poorly conceived," according to the letter, which blamed in part FDIC Chairman Donald Powell's cost-cutting efforts.
FDIC officials said they were aware of the letter. "Various other letters have been floating around over the months - and people have a right to exercise their opinions," Mr. Zamorski said.
But it is "simply incorrect" to blame the program on Mr. Powell, according to Mr. Zamorski. He noted that it began under the previous chairman and is a natural result of regulators' emphasis on risk-based supervision starting in the 1990s.
At first the changes were focused on cutting out unnecessary parts of the exam, he said. "There are things we do and sometimes you stand back and you say, 'Why are we doing that?' and we say, 'Well, we did it that way before.' "
In subsequent rounds of revisions the FDIC created a new exam process for healthier banks. The Merit exams started in 2002 for banks that had a Camels supervisory rating of 1 or 2 (the best scores on a scale of five) in their two most recent exams, are well capitalized, and have stable management and ownership.
Participation was initially limited to banks with $250 million or less of assets, but in January the threshold was raised to $1 billion.
The recommended examination limits are 280 hours for banks with less than $50 million of assets, 429 hours for banks with $100 million to $150 million, and 475 hours for banks with $200 million to $250 million.
(The FDIC said it has no benchmarks for the bigger banks, though it keeps track of average exam times for planning purposes.)
FDIC officials said the most significant difference between a Merit exam and a traditional one is how much of a bank's loan portfolio the examiners check - typically between 15% and 30% for a Merit exam. For banks outside the Merit program, examiners on average review 48% of the dollar volume of loans, Mr. Zamorski said.
"The Merit exam is not a checklist," he said; examiners can look at more of a loan portfolio if their supervisor approves the request.
The FDIC estimates that about 1,800 banks will get a Merit exam this year.
In an e-mail to American Banker, an FDIC supervision employee wrote that the guidelines leave "a sense that there is enough flexibility in the program to assure we get a reasonable perspective" in Merit examinations. "However, in reality, there are no real flexibilities, because of the pressures and expectations that examiners WILL meet these minimum requirements AND do no more than these minimums."
The August letter to Congress said that many red flags go unchecked, unless the examiner "is willing to accept the wrath of management for exceeding budgeted hours."
Mark Schmidt, the FDIC's acting deputy director for exam oversight, said the goals are not fixed in stone, nor are they meant to discourage examiners from raising red flags. "That's only a starting point. Whenever examiners see something, they definitely have the ability to pick up the phone and call in and get that exam expanded if their request is justified."
He said he knew of no case in which an examiner with a reasonable concern had been prevented from pursuing it. "It just doesn't happen," he said.
One bank examined under the Merit program has failed, Mr. Schmidt said - and fraud was the cause. Some banks that received Merit exams have had their Camels ratings downgraded in subsequent exams, he said.
No matter what kind of exam a bank is given, deteriorations can happen after the examiners leave, and examiners do not focus on finding fraud, Mr. Schmidt said.
The OCC would not disclose the average number of hours its employees spend on bank exams, but it said it sets no general guidelines or maximums for how long examiners should take.
At the regional level, he said, assistant deputy comptrollers and their examiner staff develop supervisory plans for every bank they examine. During the planning process, the examiners look at the bank's risk level, including its business lines, Camels ratings, previous exam history, management, and strategic plans before determining what the exam will include and how long the examiners will be on site.
"You go back years and years ago, you look at what some agencies were doing, you say if a bank's under a hundred million dollars you can't spend more than, let's say, 75 days in it. That's what I have a problem with," he said.
However, if examiners want to significantly change the exam length, they talk with their supervisor first, Mr. Long said. Also, the OCC does not have guidelines for the amount of loans examiners need to look at, he said.
"I want them using their judgment," Mr. Long said. "I don't want them using some arbitrary model that compares an ag bank in Kansas with a growing community bank in inner-city Cleveland that's getting into leverage finance and all kinds of complex business lines."
The OTS said it has a similar policy and gives examiners - for thrifts of any size - flexibility to determine how long they will be on site. "Each institution varies," a spokesman said.
The Federal Reserve System's examiners work from the district banks, and the supervisory goals for institutions are set by examiners-in-charge and their district managers.
"The Federal Reserve does not have systemwide benchmarks linking examination hours with asset size or Camels ratings," a Fed spokesman said. "Instead, institution risk, complexity, management stability, asset quality, and several other risk factors are used to determine the right amount of time, staff, and skills needed for examinations."
Experts outside the FDIC said the changes were not cause for concern.
Neil Milner, the president of the Conference of State Bank Supervisors, said the Merit program is a good one, because it tries to put resources where the risks are.
For the kinds of banks that qualify for the program, "you pretty well know what you need to do when you get there," he said.
Exams are more efficient now than they were in the past, Mr. Milner said. He attributes that in part to technology - records that examiners once spent lots of time copying and reviewing by hand are now computerized.
In general, even if they spend less time on their exams, "the examiners are looking as much as they ever did before at the institutions," he said.
