Bank Regulation:

Modified Prompt Corrective Action Framework Would Improve Effectiveness

GAO-11-612: Published: Jun 23, 2011. Publicly Released: Jun 23, 2011.

Additional Materials:

Contact:

Angela N. Clowers
(202) 512-3000
contact@gao.gov

 

Office of Public Affairs
(202) 512-4800
youngc1@gao.gov

More than 300 insured depository institutions have failed since the current financial crisis began in 2007, at an estimated cost of almost $60 billion to the deposit insurance fund (DIF), which covers losses to insured depositors. Since 1991, Congress has required federal banking regulators to take prompt corrective action (PCA) to identify and promptly address capital deficiencies at institutions to minimize losses to the DIF. The Dodd-Frank Wall Street Reform and Consumer Protection Act requires GAO to study federal regulators' use of PCA. This report examines (1) the outcomes of regulators' use of PCA on the DIF; (2) the extent to which regulatory actions, PCA thresholds, and other financial indicators help regulators address likely bank trouble or failure; and (3) options available to make PCA a more effective tool. GAO analyzed agency and financial data to describe PCA and DIF trends and assess the timeliness of regulator actions and financial indicators. GAO also reviewed relevant literature and surveyed expert stakeholders from research, industry, and regulatory sectors on options to improve PCA.

Although the PCA framework has provided a mechanism to address financial deterioration in banks, GAO's analysis suggests it did not prevent widespread losses to the DIF--a key goal of PCA. Since 2008, the financial condition of banks has declined rapidly and use of PCA has grown tenfold. However, every bank that underwent PCA because of capital deficiencies and failed in this period produced a loss to the DIF. Moreover, these losses were comparable as a percentage of assets to the losses of failed banks that did not undergo PCA. While regulators and others acknowledged PCA's limitations, regulators said that the PCA framework provides benefits, such as facilitating orderly closures and encouraging banks to increase capital levels. PCA's triggers limit its ability to promptly address bank problems, and although regulators had discretion to address problems sooner, they did not consistently do so. Since the 1990s, GAO and others have noted that the effectiveness of PCA, as currently constructed, is limited because of its reliance on capital, which can lag behind other indicators of bank health. That is, problems with the bank's assets, earnings, or management typically manifest before these problems affect bank capital. Once a bank falls below PCA's capital standards, a bank may not be able to recover regardless of the regulatory action imposed. GAO tested other financial indicators, including measures of asset quality and liquidity, and found that they were important predictors of future bank failure. These indicators also better identified those institutions that failed and did not undergo the PCA process during the recent crisis. Although regulators identified problematic conditions among banks well before failure, the presence and timeliness of enforcement actions were inconsistent. For example, among the banks that failed, more than 80 percent were on a regulatory watch list for more than a year, on average, before bank failure. However, GAO's analysis of regulatory data and material loss reviews showed that actions to address early signs of deterioration were inconsistent and, in many cases, regulators either took no enforcement action or acted in the final days before an institution was subject to PCA or failed. Without an additional early warning trigger, the regulators risk acting too late, thereby limiting their ability to minimize losses to the DIF. Most stakeholders (23 of 29) GAO surveyed agreed that PCA should be modified and identified three top options to make it more effective. The first option--incorporating an institution's risk profile into PCA capital categories--would add a measure of risk to the capital category thresholds beyond the existing risk-weighted asset component. The second option was increasing the capital ratios that place banks in PCA capital categories. The third most popular option was including another trigger for PCA, such as asset quality or asset concentration. Each option has advantages and disadvantages. For example, while an additional trigger could account for other factors often found to precede capital deterioration, it might be difficult to implement. Although stakeholders supported these broad options, they cautioned that the manner in which any option was crafted would determine its success. GAO recommends that the bank regulators consider additional triggers that would require early and forceful regulatory action to address unsafe banking practices as well as the other options identified in the report to improve PCA. The regulators generally agreed with the recommendation.

Status Legend:

More Info
  • Review Pending-GAO has not yet assessed implementation status.
  • Open-Actions to satisfy the intent of the recommendation have not been taken or are being planned, or actions that partially satisfy the intent of the recommendation have been taken.
  • Closed-implemented-Actions that satisfy the intent of the recommendation have been taken.
  • Closed-not implemented-While the intent of the recommendation has not been satisfied, time or circumstances have rendered the recommendation invalid.
    • Review Pending
    • Open
    • Closed - implemented
    • Closed - not implemented

    Recommendations for Executive Action

    Recommendation: To improve the effectiveness of the PCA framework, the heads of the Federal Reserve, FDIC, and OCC should consider additional triggers that would require early and forceful regulatory actions tied to specific unsafe banking practices and also consider the other two options--adding a measure of risk to the capital category thresholds and increasing the capital ratios that place banks into PCA capital categories--identified in this report to improve PCA. In considering such improvements, the regulators should work through the Financial Stability Oversight Council to make recommendations to Congress on how PCA should be modified.

    Agency Affected: Federal Deposit Insurance Corporation

    Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: To improve the effectiveness of the PCA framework, the heads of the Federal Reserve, FDIC, and OCC should consider additional triggers that would require early and forceful regulatory actions tied to specific unsafe banking practices and also consider the other two options--adding a measure of risk to the capital category thresholds and increasing the capital ratios that place banks into PCA capital categories--identified in this report to improve PCA. In considering such improvements, the regulators should work through the Financial Stability Oversight Council to make recommendations to Congress on how PCA should be modified.

    Agency Affected: Department of the Treasury: Office of the Comptroller of the Currency

    Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: To improve the effectiveness of the PCA framework, the heads of the Federal Reserve, FDIC, and OCC should consider additional triggers that would require early and forceful regulatory actions tied to specific unsafe banking practices and also consider the other two options--adding a measure of risk to the capital category thresholds and increasing the capital ratios that place banks into PCA capital categories--identified in this report to improve PCA. In considering such improvements, the regulators should work through the Financial Stability Oversight Council to make recommendations to Congress on how PCA should be modified.

    Agency Affected: Federal Reserve System

    Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Jun 18, 2014

    Apr 29, 2014

    Apr 7, 2014

    Jan 8, 2014

    Dec 11, 2013

    Nov 14, 2013

    Oct 29, 2013

    Sep 6, 2013

    Jul 18, 2013

    Looking for more? Browse all our products here