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Remarks by
Sandra Pianalto
President and Chief Executive Officer
Federal Reserve Bank of Cleveland
Ohio Bankers Day
Columbus, Ohio
Wednesday, April 9, 2003
I am pleased to have the opportunity to talk with you today about Ohio's banking
industry and some of its aspects that have my heightened attention. I will
conclude with some thoughts about how we can continue to work together to
keep Ohio's banking industry strong.
These are challenging times for our great nation.
We are in the middle of a war, and our economy's performance
is more sluggish than we would like it to be. But I can tell
you that I am deeply committed to doing all that I possibly
can to help ensure the strength of our nation's economy and
the continued well-being of the banking industry.
Before I turn to those areas of banking that
have my heightened attention, I want to start with some good
news. Overall, Ohio's commercial banks, thrift institutions,
and savings banks are sound and performing well. In fact,
Ohio's banking companies as a group realized record earnings
last year. When you stop to consider the weakened economy,
heightened competition, and sluggish business loan demand,
this performance is exceptional. We can attribute this growth
to a substantial influx of core deposits and a healthy increase
in earning assets. A rebound in noninterest income growth,
a containment of noninterest expenses, and an increase in
security gains also bolstered earnings. Largely as a result
of these earnings gains, capital levels for most banking
companies also rose in the last year.
Looking beyond Ohio, one of the barometers
we use to gauge the health of the banking system as a whole
relates to the number of problem banking companies and banking
failures. Right now, that barometer is rising.
Nationwide, the number of companies on the
FDIC's Problem Bank List has increased steadily since 1999,
going from a low of 79 companies to 136 by year-end 2002.
While this trend warrants some concern, even the current
level compares favorably with the more than 1,000 problem
banking companies back in 1991, when the industry experienced
a rash of problem institutions following a recession and
a downturn in credit quality. Meanwhile, the 11 bank and
thrift failures we saw nationwide in 2002 represented the
largest number of failures since 1994. Again, to keep things
in perspective, however, almost 10 times that many institutions
failed in 1991.
All things considered, then, today's banking
environment in Ohio is relatively good. But you as bankers
and I as a supervisor must not let our guard down or the
picture could change in a hurry. So let's turn now to the
list of areas that have my heightened attention: credit quality,
internal controls, the accuracy and transparency of financial
information, and corporate governance.
First on my list is credit quality. On a positive
note, the levels of noncurrent loans and leases and credit
losses for Ohio banks compare favorably with national averages.
Noncurrent loans and leases represented 1.33% of total loans
and leases for Ohio banks, which compares favorably with
a national average of 1.37%. In addition, Ohio banks experienced
a net charge-off ratio of 0.92% of total loans and leases,
compared with a national average of 0.97%. Nevertheless,
measures of credit quality remain relatively weak, both here
in Ohio and nationwide. Given the soft economy, some credit
deterioration is to be expected. However, we've seen particular
problems in credit quality in commercial and industrial loan
portfolios, especially among some of the larger banking companies
in Ohio. On top of that, Ohio continues to have an elevated
level of personal bankruptcy filings, and the state has seen
record-high levels of consumer debt. As a result of all this,
continued attention is needed to manage credit risk in all
loan portfolios.
Another area that deserves our heightened attention
is internal controls. Our examiners have found lapses in
operational procedures and internal controls that have led,
at best, to inadvertent errors resulting in some loss to
the financial institution or, at worst, to opportunities
for fraudulent activity both inside and outside the institution.
These losses could easily have been avoided with the proper
checks and balances in place, adequate segregation of duties,
and strong internal controls — all fundamental elements
of safe and sound banking practices.
Unfortunately, these operational deficiencies
have not been limited to backroom operations. They have also
manifested themselves in the front office and have led to
the third area requiring heightened attention, namely, the
lack of financial reporting accuracy and transparency. What
I mean by that is that instances of questionable reporting
practices or misinterpretation of accounting standards have
not been confined to notable examples in the energy and telecommunications
industries. Stock analysts, institutional investors, and
individual shareholders alike are subjecting the information
that companies report to much greater scrutiny, and the sensitivity
to errors in reporting, whether intentional or otherwise,
is at its highest level. This lack of accuracy and transparency
in financial reporting can quickly turn into legal problems
and put a company's reputation at risk.
And now let me turn to the fourth area deserving
of heightened attention, corporate governance. Although the
term “corporate governance” is bandied about quite
a bit, it means different things to different people. One
of the best explanations I've found comes from the Basel
Committee on Banking Supervision, which defines corporate
governance as “the system by which businesses are directed
and by which controls are implemented.” In other words,
corporate governance encompasses all of the systems and processes
that provide accountability and responsibility for risk management
and internal controls in a banking organization. The cornerstone
of effective corporate governance is an active and involved
board of directors. It includes the independence of directors,
the role of board committees (including the audit committee),
clear corporate strategies, and a system that ensures adherence
to policies and laws and regulations.
A robust, enterprise-wide, risk-management
system that is appropriate for the size and complexity of
the banking organization is a critical aspect of effective
corporate governance. All banking organizations, regardless
of their size, need to focus on corporate governance. The
failure of Oakwood Deposit Bank last year shows that even
community banks can suffer when corporate governance breaks
down. A strong corporate governance process is critical to
maintaining the strong reputations you have worked so hard
to build.
Now that I have laid out the four areas that
have my heightened attention, I would like to focus on how
we can work together in the future. First and foremost, I
do not want you to go away from here today worrying that
the Federal Reserve is going to be taking a harder line in
the examination process. I want to emphasize that our standards
for compliance with laws, regulations, and prudent banking
practice remain the same. Our expectations of you also remain
the same.
We recognize that risk is a significant component
of the business you are in. Certainly, we don't expect banks
to stop taking risks. What we want to do is work with you
to strengthen your risk management processes to avoid or
minimize repercussions to your organizations. It's our challenge
to adapt our approach to examinations to help ensure that
financial institutions manage their risks effectively.
The real focus of our examination process has
been, and will continue to be, understanding the processes
and systems you have in place to help you understand and
manage your risks — and then making sure those processes
are working the way you designed them. We will continue to
do transaction testing to confirm the credibility and reliability
of the procedures that are in place. Consistent with our
own risk-focused approach to examinations, we will conduct
this testing in those areas where we believe there is the
greatest risk to the banking organization — generally
speaking, the ones I have mentioned: credit quality, internal
controls, financial reporting, and corporate governance.
And where there is significant risk — or evidence that
would indicate a need for a closer look-we will conduct more
testing or comprehensive reviews to affirm the integrity
and reliability of the processes in place.
We will also continue to evolve from single,
point-in-time examinations toward a more continuous approach
to supervision. We've found that this approach is mutually
beneficial in that it increases the timeliness with which
we can respond. In addition, it allows us to do more of the
work “off site,” that is, in our offices, not yours.
The shift to more “real-time” supervision has also
done a lot to improve communications. You've probably noticed
that when you talk to someone at the Fed, it is typically
someone you know. Assigning one person to maintain contact
with an institution allows relationships to develop and tends
to increase openness and the two-way sharing of information.
That is how we will work with you in our supervisory
role. Now I'd like to talk about how we can work with you
through our outreach programs. As most of you know, through
our Banker Education program, we offer seminars and workshops
designed to provide bankers with timely information about
current and upcoming issues affecting the banking industry.
In addition to that, during the past year our examiners began
traveling to banks to meet with presidents and boards of
directors outside of the examination process. These meetings,
which we refer to as our Tailored Director's Program, give
us the opportunity to have a direct dialogue with bank leaders
on issues that are particularly important to them.
I hope that you will agree that our ideas for
adding value to our relationship don't happen in a vacuum.
Many of our best ideas come from you. I plan to meet regularly
with bankers all over the District. You will be receiving
invitations to join me for meetings in communities throughout
the District. You also have our standing offer to hold your
board meetings in our Bank.
Your comments and suggestions are important
to me. They help us at the Federal Reserve Bank of Cleveland
add value to the services we provide you. And the information
you share with me about your bank and your business customers
lets me add to the information I share with the members of
the Federal Open Market Committee. So let's keep listening
to each other — and learning from each other. Let's
keep in touch. I am committed to building on the spirit of
dialogue and trust we already have, in order to help ensure
the ongoing strength of your institutions and continued public
confidence in our nation's financial system. I look forward
to serving Ohio's banking industry and I particularly look
forward to working with you.
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