Financial Update (Fourth Quarter 2008)

Agencies Outline Expectations of Banks' Role in U.S. Economy

photo of lender and loan applicants In an effort to thaw out the nation's frozen credit markets, the U.S. Treasury Department, the Federal Deposit Insurance Corp. (FDIC), and the Federal Reserve recently issued a joint statement emphasizing their expectation that banking organizations will fulfill their "fundamental role" in the economy as sources of credit to business, consumers, and other creditworthy borrowers.

Provision of credit "essential"
The interagency statement, issued on Nov. 12, discussed the importance of banks' making credit available. "It is essential that banking organizations provide credit in a manner consistent with prudent lending practices," the statement said. "However, if underwriting standards tighten excessively or banking organizations retreat from making sound credit decisions, the current market conditions may be exacerbated, leading to slower growth and potential damage to the economy as well as the long-term interests and profitability of individual banking organizations."

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Banks should seek to strengthen capital position
Financial organizations should also undertake steps to shore up their capital planning and maintenance, the agencies noted. "Maintaining a strong capital position complements and facilitates a banking organization's capacity and willingness to lend and bolsters its ability to withstand uncertain market conditions," they said. Besides effective risk management, the agencies indicated that banks should recognize losses on their assets and activities in a timely manner, maintain sufficient loan-loss provisions, and adhere to prudent dividend policies.

Addressing the foreclosure crisis
The agencies also expect banking organizations to work with existing borrowers to avoid preventable foreclosures. "Given escalating mortgage foreclosures, the agencies urge all lenders and servicers to adopt systematic, proactive, and streamlined mortgage loan modification protocols and to review troubled loans," they said. "Systematic efforts to address delinquent mortgages should seek to achieve modifications that result in mortgages that borrowers will be able to sustain over the remaining maturity of their loan."

Compensation should be appropriate
Lastly, the statement discussed the importance of banks having well-designed compensation policies that do not jeopardize the health of the organization. "Management compensation practices should balance the ongoing earnings capacity and financial resources of the banking organization, such as capital levels and reserves, with the need to retain and provide proper incentives for strong management," according to the statement.

November 25, 2008