Alert January 03, 2012

FSOC Issues Report on Federal Banking Agencies’ Implementation of Prompt Corrective Action

As required by Section 202(g)(4) of the Dodd-Frank Act, the Financial Stability Oversight Council (the “FSOC”) issued a report (the “FSOC Report”) to Congress concerning the implementation of prompt corrective action (“PCA”) by the federal banking agencies (the “Agencies”). In June 2011 the General Accountability Office (“GAO”) issued a report (the “GAO Report”) under Section 202(g)(1)-(3) of the Dodd-Frank Act in which it evaluated, among other things, the effectiveness of PCA in resolving insured depository institutions at the lowest cost to the FDIC’s Deposit Insurance Fund (“DIF”). The GAO study concluded that the existing PCA

“did not prevent widespread losses to the DIF, and…losses to the DIF as a result of the failure of banks that were subjected to PCA enforcement actions before failure were comparable as a percentage of assets to the losses of failed banks that were not subjected to PCA enforcement actions.”

The GAO Report also found that “[c]apital can lag behind other indicators of bank health.” In addition to capital, the GAO Report suggested that other PCA triggers be considered by the FSOC and the Agencies, including indicators of earnings, asset quality, liquidity, reliance on unstable funding and sector loan concentrations.

The FSOC Report states that the FSOC will provide a forum for the Agencies to discuss enhancements to the PCA framework and to evaluate non-capital related PCA triggers. The FSOC concluded that the following five principles should be used in developing potential enhancements to the PCA framework:

“(1) PCA triggers should be objective to provide predictability.

(2) PCA triggers and accompanying corrective action should serve to reduce the likelihood and cost of bank failures, and accordingly must be carefully designed not to speed a bank’s descent into an otherwise avoidable failure.

(3) PCA triggers should be based on broadly applicable financial metrics that do not discriminate against banks in particular size categories, geographies or business models. For example, the PCA framework should be cognizant of the differences in asset-type, concentration, and risk management for community banks when compared to larger financial institutions.

(4) PCA should complement a supervisory approach that encourages banks to improve their condition before severe automatic supervisory actions are required.

(5) Measures used in PCA should continue to have an automatic element that can provide a backstop to the existing supervisory framework, with an aim of ensuring prompt action to reduce the likelihood and cost of bank failures.”