This memorandum represents the Division of Supervision and Consumer Protection's (DSC) response to the draft report entitled, The FDIC’s Industrial Loan Company Deposit Insurance Application Process (Assignment No. 06-009) (“Draft Report”) prepared by the FDIC’s Office of Inspector General (OIG). The evaluation findings state that "FDIC has implemented a comprehensive process and procedures for reviewing, investigating, and approving deposit insurance applications" and that "[t]he Corporation's monitoring processes provide a reasonable supervisory approach to help ensure that ILCs adhere to the conditions imposed upon them, including those associated with business plans." DSC concurs with the findings and the recommendations in the Draft Report. We agree that issuing clarifying instructions and/or emphasizing certain expectations with respect to our deposit insurance application policies and procedures will further enhance our processes. In DSC's view, the Draft Report's recommendations are not unique to ILCs, but are applicable to all applications for deposit insurance. DSC's proposed actions to address each recommendation, as discussed below, will further strengthen our review and processing procedures for deposit insurance applications for all institutions.

     The review and investigation of chartering and deposit insurance applications for new institutions are coordinated between the FDIC and the applicable state chartering agency. The processing of applications is performed in accordance with Sections 5 and 6 of the Federal Deposit Insurance Act (FDI Act), Part 303.20-25 (Deposit Insurance) of the FDIC Rules and Regulations, and the FDIC Statement of Policy on Applications for Deposit Insurance. The FDIC's analysis and processing of applications for deposit insurance are conducted under the same guidelines for all applicants. Applications that present unique characteristics, such as special purpose, foreign owned, nonbank, boutique, and niche type banks are also subject to review by DSC headquarters, which acts on such applications.

     The Draft Report contains six recommendations. The recommendations, along with DSC's response to each, are detailed below.

OIG Recommendation

1. "Require that pre-filing meetings be documented and that DSC include the results of the pre-filing meetings in the application material submitted to examiners responsible for conducting field investigations of deposit insurance applications."

DSC Response

     DSC strongly encourages bank organizers to meet with the chartering authority and the FDIC prior to filing an application. When conducted, it is common practice for the DSC participant(s) to document the meeting in a file memorandum. Although encouraged, pre-filing meetings are not a prerequisite to the filing of an application, and some applicants have filed with little, if any, prior communications with the chartering authority or the FDIC. Nevertheless, DSC's experience has shown that pre-filing meetings are an effective forum for discussing information requirements and identifying potential problems, and that they can facilitate application processing and reduce unnecessary delays.

     DSC agrees that it would be beneficial to document the FDIC's participation in pre-filing meetings and include the results of the meeting in the application material submitted to examiners responsible for conducting field investigation of deposit insurance applications. By year-end 2006, DSC will issue instructions requiring such documentation.

OIG Recommendation

2. "Develop and issue clarifying policy or guidance regarding the need for, and importance of, conditions associated with deposit insurance applications. Such policy or guidance should address:

• the relative importance of conditions in ensuring the safe and sound operation of financial institutions, including ILCs,
• policy regarding circumstances wherein conditions should be imposed,
• definitions of conditions and types of conditions,
• discussion of the FDIC's ability to enforce violations of condition,
• DSC's position regarding imposing conditions that are similar in nature to state-imposed conditions, and
• DSC's position on imposing conditions when an application addresses a supervisory concern."

DSC Response

     The FDIC has the authority to impose conditions in connection with the approval of an application for deposit insurance and to enforce such conditions. While some conditions or limitations may be time-specific, others impose continuing requirements or restrictions and must be satisfied on an ongoing basis, even beyond an institution's initial years of operation. Conditions that impose ongoing requirements remain in effect so long as the FDIC determines that the condition is necessary to ensure the safe-and-sound operation of the institution.

     DSC's guidance with regard to conditions in deposit insurance orders addresses the need to impose, in every case, the conditions relating to the findings on the statutory factors in Section 6 of the FDI Act. Guidance also addresses the use of nonstandard conditions, and situations that may warrant the imposition of prudential conditions. The FDIC evaluates each proposal on a case-by-case basis and imposes the conditions (standard, nonstandard, and prudential) necessary to address the unique characteristics of each business plan. Such flexibility in designing and imposing conditions is essential to the FDIC's deposit insurance approval process. In DSC's experience, the type of charter under which an institution is organized, in and of itself, is not a determinant of risk; however, certain proposals may present unique characteristics warranting the imposition of additional conditions.

     By June 30, 2007, DSC will review its policies and guidance regarding the need for, and importance of, conditions associated with deposit insurance applications. Based on the results of the review, we will determine where clarifying guidance should be developed and issued to address the recommendation.

OIG Recommendation

3. "Emphasize to regional and field officials the need to obtain and document the applicant's written agreement to non-standard conditions."

DSC Response

     Documentation of an applicant's agreement, in writing, to any condition, other than a standard condition, is required for DSC to act under delegated authority from the FDIC Board of Directors to approve an application for deposit insurance. In situations where applicants do not agree in writing to nonstandard conditions, the FDIC Board will act on applications for deposit insurance.

     When processing applications for deposit insurance, FDIC Case Managers must complete an investigation report titled, "Summary of Investigation - Proposed New Bank" (Report) that requires them to verify and respond whether or not the applicant has agreed, in writing, to any condition, other than a standard condition. Additionally, DSC's Case Manager Procedures Manual states, "If nonstandard conditions are appropriate and not agreed to by the applicant, the application must be sent to the Washington Office." DSC is confident, because of its review and approval processes, that the required documentation was obtained in each of the cases cited in the Draft Report. We accept responsibility for these technical exceptions and we will take action to prevent future exceptions.

     By year-end 2006, DSC will emphasize the need to obtain and document the applicant's agreement, in writing, to nonstandard conditions.

OIG Recommendation

4. "Emphasize to regional and field officials the need to document evidence that the ILC has complied with all conditions stated in the deposit insurance order."

DSC Response

     DSC procedures require applicants to provide the FDIC with evidence that conditions in deposit insurance orders have been satisfied. Once deposit insurance is approved, the applicant is provided the order, and deposit insurance becomes effective only after the FDIC receives satisfactory evidence of the applicant's compliance with, or definite and certain arrangements to comply with, the conditions in the order. In practice, evidence of compliance with conditions is often obtained prior to the issuance of the order and in a progressive fashion throughout the deposit insurance application process. In such cases, DSC has historically considered receipt of documentary evidence at any time during the process to satisfy the applicant's documentation commitment.

     The Draft Report also cites instances where documentation received from an applicant did not address all conditions in the order. Orders for deposit insurance typically contain conditions that must be satisfied immediately, as well as conditions that may require an applicant's future compliance. Examples of such prospective conditions include those requiring prior FDIC approval for future changes in management or ownership, the requirement for an annual audit, notification of a proposed material change to the business plan, etc. Like other conditions, DSC verifies an institution's compliance with these conditions during onsite visitations or examinations.

     DSC concurs that obtaining evidence of a bank's compliance with, or definite and certain arrangements to comply with, the conditions stated in the order provides positive confirmation that the applicant has addressed or understands the FDIC's concerns or requirements for obtaining deposit insurance. By year-end 2006, DSC will clarify the documentation expectations in this regard.

OIG Recommendation

5. "Issue guidance to (a) clarify corporate expectations for deposit insurance investigations in reviewing the statutory factors Convenience and Needs of the Community to be Served and Risk to the Fund in evaluating the possible impact of an applicant's proposed line of business on existing financial institutions in the community and the Deposit Insurance Fund, (b) emphasize that examiners should document the basis for their conclusions in the Convenience and Needs of the Community to be Served area in the Report of Investigation."

DSC Response

     DSC's guidance regarding the consideration and evaluation of the statutory factor Convenience and Needs of the Community to be Served requires examiners to assess external factors including the demographic, economic, and competitive factors in the community to be served and to evaluate those factors in relation to the applicant's business plan. As described in the FDIC's Statement of Policy on Deposit Insurance Applications (SOP), "[t]he essential considerations in evaluating this factor are the deposit and credit needs of the community to be served, the nature and extent of the opportunity available to the applicant in that location, and the willingness and ability of the applicant to serve those financial needs." The SOP also discusses the importance of defining the community to be served and services to be offered, and the significance of the proposed bank's efforts to comply with the Community Reinvestment Act.

     In assessing the proposed market under the Convenience and Needs of the Community to be Served statutory factor, examiners solicit the opinions of the organizers of the applicant, the management of existing institutions, and when necessary, the views of representative business and professional persons and citizens in the community. The results of these surveys are documented in the Report of Investigation.

     The assessment of the statutory factor Risk to the Fund focuses on an applicant's business plan to determine any unsound activities, practices, or other issues. The SOP states that the factor is intended to be interpreted broadly in order to capture any undue risk to the insurance fund posed by a proposed institution. As such, the factor does not define specific risks to be considered or otherwise limit the range of issues that may be considered in making a supervisory determination. The FDIC may find that, in exceptional cases, any particular element of a proposal may pose undue risk to the insurance fund.

     By June 30, 2007, DSC will clarify corporate expectations for reviewing the statutory factors Convenience and Needs of the Community to be Served and Risk to the Fund in deposit insurance investigations and emphasize that examiners should document the basis for their conclusions in the Convenience and Needs of the Community to be Served area in the Report of Investigation.

OIG Recommendation

6. "Emphasize that examiners should address in 6-month visitations and ROEs for the first-, second-, and third-year examinations, each condition in the order granting deposit insurance and the status of each condition to provide case managers sufficient information to determine an ILC's adherence to the order granting deposit insurance."

DSC Response

     DSC's Risk Management Manual of Examination Policies (Manual) contains instructions for addressing conditions and calls for a separate page entitled Compliance with Ongoing Conditions for orders granting approval for deposit insurance. The instructions discuss the required format and frequency of documenting an institution's compliance, as well as how examiners should document compliance for provisions of a continuing nature.

     By year-end 2006, DSC will re-emphasize and clarify how examiners should address conditions in deposit insurance approval orders and the status of conditions in visitations and in reports of examination.