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Are Bank Directors Always to Blame for Their Bank Failing?

 

Jan 30 - The Material Loss Reviews conducted by the federal banking agencies’ Inspectors General always seem to blame directors for the failure of their banks. But a summary report issued by the American Association of Bank Directors finds that many of the Material Loss Reviews are flawed and cannot be relied on.

In reviewing a sample of Material Loss Reviews of failed banks, AABD found one constant throughout – the bank failure was always determined to be the fault of the failed bank’s board of directors. But could that possibly be true?

“The AABD review found that the sampled MLRs were so flawed in their methodology and assumptions as to render their findings unreliable,” David Baris, AABD executive director, said.

Federal law requires the appropriate Office of Inspector General among the federal banking agencies to ascertain why a failed bank’s problems resulted in material loss to the Deposit Insurance Fund.  The performance audits by the IG offices are conducted under standards to require the audit “to obtain sufficient, appropriate evidence to provide a reasonable basis for its finding and conclusions based on its audit objectives.” Can the audit meet this standard if it does not include in its review the views and input of the directors and officers of the failed bank?

“It looks like the MLRs only tell one side of the story,” Baris said. “The IG offices interviewed representatives of the banking agencies in charge of the failed banks and let them comment on the draft report, but the former directors and executive officers of the bank were not afforded the same courtesy.”

“Many of the MLRs we reviewed seem to suggest that the worsening of the economy, in some cases residential real estate prices falling by more than 50%, was a condition, not a cause of the bank failure. This defies logic.”

“In most of the banks that ultimately failed, the bank examiners considered management and the bank to be highly or satisfactorily rated at least up to two years prior to failure. It wasn’t until loan losses mounted did the examiners conclude that bank directors and management were to blame for deficient loan underwriting and loan administration. The MLRs assume that the later assessment of the board and management is correct and the earlier assessment is incorrect without substantiating that assumption.”

The accuracy of the MLRs is important for many reasons. The banking agencies rely on the MLR findings to formulate policy and rules, and the FDIC considers the findings to help decide whether to sue former directors of failed banks. Congress receives the MLRs, relying on their accuracy in its legislative and investigative duties.

Because the MLRs are public, the reputation of the board and management of the failed bank is at stake.

The AABD report makes a series of recommendations to the Inspectors General, including inviting directors and executive officers to review the documents on which the IG office is relying, to be interviewed, and to comment on the draft report; reflecting the comments of the directors and officers in the final report; and posting comments from former directors and officers on already issued MLRs.

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