There was a time when bank directors were not expected to be very knowledgeable about banking laws and regulations, but those days are long gone. Over the past forty years they have increased exponentially, and banks' compliance burden has grown apace. Compliance failures can adversely affect a bank's overall CAMELS rating (This is an acronym for Capital, Assets, Management, Earnings, Liquidity, and Sensitivity to interest rate risk), result in assessment of monetary penalties by the bank's regulator, potential exposure to individual and class action damages, and damage to the bank's reputation. While directors are not on the front lines in their bank's compliance efforts, they have an important role to play. What is the nature of that role and how much do they need to know about laws and regulations that affect their bank? In a consumer compliance examination manual, the OCC stated: "The board of directors and management must recognize the scope and implications of laws and regulations that apply to their bank." An FDIC compliance manual states "The Board of directors of a financial institution is ultimately responsible for developing and administering a compliance management system that ensures compliance with federal consumer protection laws and regulations. To a large degree, the success of an institution's compliance management system is founded on the actions taken by its board and senior management." In October, 2011, the Consumer Financial Protection Bureau (CFPB), a new agency created under the Dodd-Frank Wall Street Reform And Consumer Protection Act (Dodd-Frank) published a Supervision and Examination Manual, in which it stressed the importance of board and management oversight of compliance. As was the case in the OCC's and FDIC's manuals, version 2 the CFPB manual, published in October 2012, states that the board is ultimately responsible for developing and administering a compliance management system that ensures compliance with Federal consumer financial laws and regulations, and calls upon the board and senior management to adopt clear policy statements regarding consumer compliance. It would be a good idea for directors to read a nine page section in the manual, captioned "Compliance Management Review."
All of the agencies emphasize the importance of training. The FDIC expressed this as follows: "Education of a financial institution's Board of Directors, management and staff is essential to maintaining an effective compliance program. Line management and staff should receive specific, comprehensive training in laws and regulations, and internal policies and procedures that directly affect their jobs." The CFPB. In its Manual states: "Education of an entity's board of directors, management and staff is essential to maintaining an effective compliance program. Board members should receive sufficient information to enable them to understand the entity's responsibilities and the commensurate resource requirements. Management and staff should receive specific, comprehensive training that reinforces and helps implement written policies and procedures. Requirements for compliance with Federal consumer financial laws, including prohibitions against unlawful discrimination and unfair, deceptive, and abusive acts and practices, should be incorporated into training for all relevant officers and employees, including audit personnel." With regard to examination manuals generally, they are published by all of the Federal bank regulators and compliance personnel should become familiar with them, as they indicate what the examiners will be looking for when they come calling on your bank.
While the compliance manuals do not distinguish between inside and outside directors, insofar as director education is concerned, it would be reasonable to expect the former to have a more in depth knowledge than the latter. In a Policy Statement concerning the Responsibilities of Bank Directors and Officers, to be discussed later, the FDIC drew that distinction in determining whether to bring an action against a director. As the FDIC pointed out, "An inside director is generally an officer of the institution, or a member of a control group. An inside director generally has greater knowledge of and direct day to day responsibility for the management of the institution." The FDIC Statement continued "By contrast, an outside director usually has no connection to the bank other than the directorship and, perhaps, is a small or nominal shareholder. Outside directors generally do not participate in the conduct of the day to day business operations of the institution." This should not mean that outside directors are absolved from any responsibility to learn about banking laws and regulations that pertain to the activities of their bank. Because of the pervasiveness of these laws and regulations, some knowledge of them is necessary to understand the business of banking. Moreover, as noted below and throughout this publication, there are times when they are required by law or regulation to review and approve policies and procedures relating to various matters, in which case it is essential that they understand the underlying law or regulation.
Although the compliance manuals cited focus on consumer protection laws and regulations, they constitute only a part, albeit a major part, of the total universe of laws and regulations that can affect the bank. An example of a major non-consumer law that warrants board attention is the federal Bank Secrecy Act, that is implemented through regulations of The Department of The Treasury and, to a lesser extent, the federal banking agencies. As will be discussed later, violations can result in criminal penalties. Banks are required to develop a written Bank Secrecy Act/Anti/Anti-Money Laundering compliance program that is approved by the board. Specific board approval or review is required in a number of other instances discussed herein, and they will be highlighted in bold type. Over time, additional approvals will no doubt be required and it is important that your compliance staff keep up with new approval requirements and coordinate with your corporate secretary to make sure they are appropriately calendared. Laws and regulations governing loans to insiders are of particular importance to directors, who are deemed insiders. As you will see, there are many other important laws and regulations with which banks must comply, and with which board members should have some familiarity. They should not be overlooked.
The information we are providing herein is not a substitute for director training, although, hopefully, its broad overview will help to give you a running start. We have tried to provide you with a broad overview of the current legal and regulatory landscape and to discuss with greater particularity matters requiring your specific approval or review. Where this is required, prior to the board meeting when the approval or review is an agenda item, you should be provided with an executive summary of the underlying law, regulation, or agency policy statement.
Although not falling within the realm of compliance, we thought a brief history of our banking system and a description of our current structure, would provide you with a context that might be helpful. In addition, as a director, you should have a basic understanding of how the Federal Reserve influences interest rates, a process that is widely misunderstood, even among bank directors. Following this, using a typical bank's financial statements as a roadmap, we will discuss in very broad brush fashion laws and regulations that pertain to the various components of the financial statements.
A LITTLE HISTORY
Although today, commercial banks and thrifts have many similarities and the general public tends to think of both as banks, without distinguishing between the two, commercial banks and thrifts each has had its own separate history, and so we will treat them separately herein.
Commercial Banks
Today, we have a dual system of banking, under which we have both state and federally chartered and regulated banks, but this was not always the case. In the early years of our country, banks were chartered by the states, and one had to petition the state legislatures to obtain a bank charter. The first bank chartered at the national level was the Bank of North America, chartered in 1781 by the Continental Congress. Because there were some doubts about the legal authority of the Continental Congress to charter a bank, it was re-chartered by the Pennsylvania Assembly in 1782. Pennsylvania repealed the charter in 1785 and then re-granted it in 1787. In 1791 the First Bank of The United States was chartered by Congress. The federal government held stock in the bank, along with private investors, and it served as fiscal agent for the United States. Its charter was limited in term to 20 years, and it was not renewed when it expired in 1811. In 1816 the Second Bank of the United States was chartered, also for a twenty year term, and it was not renewed. President Andrew Jackson vetoed the bill to reissue the charter and then transferred government funds to state chartered banks, which his critics referred to as "pet banks."
In 1846 Congress passed the Independent Treasury Act, under which public revenues would be retained in the Treasury Building and Sub-treasuries located in various cities. This Act completely separated the government from the banking system. An indispensable provision was the so called "specie clause" that provided:"...all duties, taxes, sales of public lands, debts, and sums of money accruing or becoming due to the United States, and also all sums due for postages or otherwise, to the General Post Office Department shall be paid in gold and silver coin only, or in Treasury notes issued under the authority of the United States...." The Act also provided that all disbursements on account of the United States shall be paid in gold and silver coin or in Treasury notes, if the creditor agrees to receive said notes in payment..." One of the Sub-treasury buildings stands on Wall Street today. In front of the building, there is an imposing statue of George Washington, who's first inauguration took place at that approximate location.
These early nationally chartered banks and the Independent Treasury Act gave rise to a controversy about the role of the Federal Government in our banking system, a controversy that continues to this day. The Federal Government at that time did not regulate banks. It wasn't until the passage of the National Currency Act in 1863, which created the Office of Comptroller of the Currency (OCC), that bank regulation was introduced at the federal level. (The Act was later re-enacted as the National Bank Act) This marked the beginning of our dual system. The Federal Reserve Act of 1913 created the Federal Reserve System, the Banking Act of 1933 created the Federal Deposit Insurance Corporation, and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 created the Consumer Financial Protection Bureau. These agencies will be discussed below.
Thrifts
The term "Thrift" is commonly used to describe savings and loan associations, sometimes called building and loan associations, and savings banks. There are both state and federally chartered thrifts. The thrift industry can trace its origins to 1816, when the Provident Institution for Savings in the Town of Boston was incorporated. The Philadelphia Savings Fund Society began business the same year, but was not incorporated until 1819. They were savings banks, owned by their depositors. Today, the Federal Deposit Insurance Act (FDIA) defines savings bank as "a bank, (including a mutual savings bank) which transacts its ordinary banking business strictly as a savings bank under state laws imposing special requirements on such banks governing the manner of investing their funds and conducting their business." The FDIA refers to state savings associations and federal savings associations. The latter are defined as any federal savings association or Federal savings bank chartered under the Home Owners Loan Act (HOLA).
The nation's first savings and loan association was the Oxford Provident Building Association, established in Frankford, Pennsylvania in 1831. It made home loans and offered savings deposits to its members. In the early days savings associations and savings banks were organized as mutuals, however, over the years, many have converted to a stock form of organization. Today, both the FDIC and the OCC have regulations applicable to mutual to stock conversions. In 1932, the Home Loan Bank Act was enacted. It created the Home Loan Bank System of 12 regional Federal Home Loan Banks. They are chartered specifically to carry out federal policy for enhancing the availability of credit for residential mortgages and community development finance. They provide funds in the form of advances to their member institutions. In 1933, Congress enacted the Homeowners Loan Act. It created the Federal Home Loan Bank Board, which was empowered to grant charters to federal savings associations and which established a regulatory system to promote home ownership. The Federal Savings and Loan Insurance Corporation (FSLIC) was created as part of the National Housing Act of 1934, to insure deposits at savings and loan associations.
The Office of Thrift Supervision (OTS) was created by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA). The powers of the Federal Home Loan Bank Board were transferred to the OTS. Also, the FDIC assumed FSLIC's responsibilities respecting the insurance fund, which was renamed the Savings Association Insurance Fund (SAIF). The Bank Insurance Fund (BIF), that insured deposits of commercial banks, continued to be administered by the FDIC separately, until 2006, when, pursuant to the Federal Deposit Insurance Reform Act of 2005, the two funds were merged into a single fund, called the Deposit Insurance Fund (DIF). The OTS had been a bureau within the Department of the Treasury, and had been headed by a Director, who was appointed by the President, with the Advice and Consent of the Senate. Under Dodd-Frank, the OTS became a Bureau within the OCC, which will remain part of the Department of the Treasury. The powers and responsibilities of the OTS have been transferred primarily, but not exclusively, to the OCC. The FDIC will supervise state chartered savings associations, and the Federal Reserve will supervise savings and loan holding companies. The Home Owners Loan Act remains in effect and will continue to be the statute governing federal savings associations. The thrift charter has been preserved, and the OCC is empowered to grant new charters for federal savings associations, including Federal savings banks., although since the thrift charter lost some of its unique advantages under Dodd-Frank, some thrifts will likely consider whether they should switch to a commercial bank charter. Any decision to switch charters should be an informed one, after carefully weighing the pros and cons.
THE CURRENCY PROBLEM
The need for a stable currency
Problems with currency played an important role in the evolution of our banking system. In the early days, currency consisted of circulating notes issued by individual commercial banks. Not infrequently, notes issued by banks located outside a particular area were not honored. Also, many banks issued more notes than they were able to redeem in specie. Notes issued by the First and Second Bank of the United States were more widely accepted, which gave them a competitive advantage. All of this made for an unstable currency. Passage of the National Currency Act helped to provide for a more stable currency in that circulating notes issued by national banks had to be backed 120% by United States government bonds. This feature served another purpose. It helped the government finance the Civil War. As will be explained below, our currency today consists of notes issued by Federal Reserve Banks. The National Currency Act, the name of which was later changed to the National Bank Act, created the Office of the Comptroller of the Currency. It provided for the chartering of national banks, and introduced federal supervision of banks for the first time. It was a free banking statute, meaning that anyone meeting specified criteria could apply for a bank charter, which opened up the process. The concept of free banking was first introduced at the state level in the 1838 by New York, but the practice of requiring petitions to state legislatures remained the rule in many states into the 1900s.
Making our currency elastic
Although the National Bank Act served to provide a more stable currency, it did not provide any elasticity. In other words, it could not expand and contract according to the needs of commerce. A series of financial panics resulted in passage of the Federal Reserve Act in 1913. The stated purpose of the Act was "to provide for the establishment of Federal Reserve Banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish more effective supervision of banking in the United States, and for other purposes." The Act introduced, for the first time, federal supervision over state chartered banks, but only over those that elected to join the Federal Reserve System. Then, as now, membership in the System was optional for state chartered banks, but mandatory for national banks.
The expanding role of the federal government
The Federal Reserve Act represented a big step forward in the evolution of our banking system, but some lingering problems remained. Bank panics continued to recur, and many state chartered banks remained beyond the reach of federal supervision. These problems were addressed in the Banking Act of 1933, which created the Federal Deposit Insurance Corporation (FDIC). Originally, the provisions respecting the FDIC were incorporated in the Federal Reserve Act, however, in 1950 it was separately enacted as the Federal Deposit Insurance Act (FDIA).
THE FEDERAL BANKING AGENCIES
The Office of Comptroller of the Currency (OCC)
The OCC is a Bureau of the Department of the Treasury. The Comptroller is appointed by the President, with the advice and consent of the Senate. The OCC determines applications for national bank charters and branches, issues rules and regulations affecting the activities and practices of national banks, and is authorized to take supervisory action against those that do not conform to laws and regulations, or otherwise engage in unsafe and unsound practices. The OCC also examines national banks, which are not subject to examination by state banking supervisors. Essentially, the authority of the OCC with respect to national banks is congruent with the authority of state bank supervisory agencies over state chartered banks. The National Bank Act, like typical state banking statutes, contains provisions relating to the organization of national banks, capital, stockholders, directors, branching, and sets forth the powers of national banks. As indicated above, as a result of Dodd-Frank, the OCC now also supervises federal savings associations.
The statute governing the activities of federal savings associations is the Home Owners Loan Act (HOLA), which was originally enacted in 1932.There are federal and state savings associations. While their powers are basically similar to those of commercial banks, Federal savings association's commercial lending authority is more limited. Under the HOLA, secured or unsecured loans for commercial, corporate, business, or agricultural purposes may not, in the aggregate, exceed 20 percent of the total assets of the Federal savings association, and amounts in excess of 10 percent of such total assets may be used only for small business loans, as that term is defined by the Director. OTS regulations that were outstanding at the time of the transfer of OTS powers to the OCC will remain in effect until they are repealed or modified by the OCC.
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