Safe and Sound Banking Teveia R. Barnes Commissioner State of California Department of Financial Institutions Sustainable Banking Seminar Stanford University April 3, 2013 April 3, 2013Safe & Sound Banking - Stanford CEE 244A 1

DFI as Prudential Regulator  Ensure Safe and Sound Banking  Promote public confidence in the health of the regulated institutions  Benefits of a healthy financial services system  Implement policy by administering the law  Managing the chartering and regulatory process April 3, 2013Safe & Sound Banking - Stanford CEE 244A 2

Changes Among State Banks 2012 # $ Thousands State Banks & Total Assets as of 1/1/ ,593,744 # Failed00 # Merged out of business(9) (1,890,267) # Converted to national charter00 # Ceased doing business(1)(25,902) # Opened00 # Converted to state charter21,173,470 State banks that acquired other banks233,066 State banks that did not acquire other banks17419,447,297 State Banks & Total Assets as of 12/31/ ,331,408 Net change:(8)18,737,664 April 3, 2013Safe & Sound Banking - Stanford CEE 244A 3

Changes Among State Banks 2012 April 3, 2013Safe & Sound Banking - Stanford CEE 244A 4

Changes Among State Banks 2005 – 2012 #$ Thousands State Banks & Total Assets as of 1/1/ ,470,243 # Failed(23)(33,137,711) # Merged out of business(63)(24,766,060) # Converted to national charter(2)(4,456,770) # Ceased doing business(4)(7,808,923) # Opened7157,649,244 # Converted to state charter1016,979,061 State banks that acquired other banks2369,909,822 State banks that did not acquire other banks10743,492,502 State Banks & Total Assets as of 12/31/ ,331,408 Net change (11)117,861,165 April 3, 2013Safe & Sound Banking - Stanford CEE 244A 5

Changes Among State Banks April 3, 2013Safe & Sound Banking - Stanford CEE 244A 6

Regulation Encompass  Granting of licenses to conduct banking business in the State  Approval of bank mergers, acquisitions, consolidations, changes in articles and bylaws and the sale of securities  Conducting periodic examinations  Review and analysis of periodic reports  Issuance and enforcement of supervisory and other regulatory actions  Rendering counsel and advice on banking issues and/or problems  Closure and liquidation April 3, 2013Safe & Sound Banking - Stanford CEE 244A 7

Examination & Supervision of Banks  Bank examination is the foundation of bank supervision  Bank supervision  Evaluation of the abilities of bank management  Supervision used to strengthen or replace management  Management demonstrates the inability to effectively direct the activities of the bank or  Continued viability of the bank is threatened April 3, 2013Safe & Sound Banking - Stanford CEE 244A 8

Bank Examinations  Findings the field examination, DFI is in a position  to determine whether the bank is being operated in a safe and sound manner,  to prescribe necessary corrective actions, and  to formulate specific supervisory actions for the bank, if needed.  The extent of the corrective actions required or supervisory advice given varies from bank to bank. April 3, 2013Safe & Sound Banking - Stanford CEE 244A 9

CAMELS April 3, 2013Safe & Sound Banking - Stanford CEE 244A 10

CAMELS RATINGS  The specific areas of a bank that are evaluated include:  Capital Adequacy  Asset Quality  Management  Earnings  Liquidity and Funds Management  Sensitivity to Market Risk  Each of the components is rated on a scale of "1" through "5" in ascending order of performance deficiency. A rating of "1" represents the highest and "5" the lowest and most critically deficient level of operating performance.  Component/Composite rating: /2  CAMEL RATINGS OF A BANK ARE CONFIDENTIAL April 3, 2013Safe & Sound Banking - Stanford CEE 244A 11

Bank Ratings CAMELS 1 Composite  COMPOSITE 1  Sound institutions in almost every respect  Any critical findings are a minor in nature and can be handled in a routine manner.  These banks are resistant to external economic and financial disturbances  Capable of withstanding the vagaries of business conditions  Rating "1" indicates strong performance. It is the highest rating and is indicative of performance that is significantly higher than average April 3, 2013Safe & Sound Banking - Stanford CEE 244A 12

Bank Ratings CAMELS 2 Composite  COMPOSITE 2  Fundamentally sound institutions but may reflect modest weakness correctable in the normal course of business.  Stable and also able to withstand business fluctuations quite well; however, areas of weakness could develop into conditions of greater concern.  Rating "2" reflects satisfactory performance.  Performance that is average or above; it includes performance that adequately provides for the safe and sound operation of the bank. April 3, 2013Safe & Sound Banking - Stanford CEE 244A 13

Bank Ratings CAMELS 3 Composite  COMPOSITE 3  Combination of weaknesses ranging from moderately severe to unsatisfactory.  Only nominally resistant to the onset of adverse business conditions and could easily deteriorate if concerted action is not effective in correcting the areas of weakness.  Vulnerable and require special supervisory attention.  Rating "3" represents performance that is flawed to some degree; as such it is considered fair. April 3, 2013Safe & Sound Banking - Stanford CEE 244A 14

Bank Ratings CAMELS 4 Composite  COMPOSITE 4  Immoderate volume of asset weaknesses, or a combination of other conditions that are unsatisfactory.  Unless prompt corrective action is taken, the bank could reasonably develop into a situation that could impair future viability.  A potential for failure is present. Banks in this category require close supervisory attention and financial surveillance  Rating "4" refers to marginal performance and is significantly below average; if left unchecked, such performance could threaten the viability of the institution. April 3, 2013Safe & Sound Banking - Stanford CEE 244A 15

Bank Ratings CAMELS 5 Composite  COMPOSITE 5  Volume and character of weaknesses are such as to require urgent aid from the shareholders or other sources  Require immediate corrective action and constant supervisory attention. The probability of failure is high for these banks  Rating "5" is considered unsatisfactory. It is the lowest rating and is indicative that performance is critically deficient and in need of immediate remedial attention.  Such performance by itself, or in combination with other weaknesses, threaten the viability of the institution. April 3, 2013Safe & Sound Banking - Stanford CEE 244A 16

Safe and Sound Banking  Banks that are operated in a safe and sound manner, have management that exhibit a clear understanding of or has delineated the following:  mission, vision, and values;  impact of the environment on the organization;  culture;  strengths, weaknesses, opportunities, and threats;  goals to be accomplished in the future; and  how those goals will be reached through strategies, objectives, responsibilities and time-lines. April 3, 2013Safe & Sound Banking - Stanford CEE 244A 17

Safe and Sound Banking  With an understanding of the environment the institution is operating in, management may then develop:  the products and services the bank is willing to provide;  an organizational design and the roles that are needed by the organization;  a risk management framework supported by strong policies and procedures;  performance goals; and  the resources needed to reach those goals April 3, 2013Safe & Sound Banking - Stanford CEE 244A 18

Examination Trends 19 April 3, 2013Safe & Sound Banking - Stanford CEE 244A

Enforcement Actions  Board Resolutions  Voluntary representation by the bank board to take specific future actions to improve bank’s condition  Memorandum of Understanding (MOU)  Lowest level of enforcement action  Two party informal agreement between the bank and the regulator, usually implemented when the bank’s condition has fallen to less than satisfactory.  This agreement defines what specific steps, and when they will be taken.  This action may be “joint” with other regulators. April 3, 2013Safe & Sound Banking - Stanford CEE 244A 20

Enforcement Actions  Regulatory Agreements (Written Agreement)  Contract between the bank and the Commissioner.  Any breach on the part of the bank may result in a Cease & Desist Order, and/or allow the Commissioner to enforce the breached term.  This action may be “joint” with other regulators. April 3, 2013Safe & Sound Banking - Stanford CEE 244A 21

Enforcement Actions  Cease & Desist Orders (C&D) or Consent Orders  C&D Order may be a unilateral action of the Commissioner, or the final order may be issued with the written consent of the respondent bank.  C&D Orders set forth goals, which must be achieved in a short time frame.  Suspension or Removal of Officers, Directors, Employees  May provide for an immediate removal order under certain specific circumstances. April 3, 2013Safe & Sound Banking - Stanford CEE 244A 22

Civil Money Penalties (CMP)  DFI has authority to impose civil money penalties against banks for acts that violate certain provisions of the Financial Code.  The penalty is based on a three tier system and penalty amount subject to specific findings and certain conduct standards. April 3, 2013Safe & Sound Banking - Stanford CEE 244A 23

Enforcement Actions in 2012  24 state chartered banks that were the subject of enforcement actions:  6 Cease and Desist orders  3 Board Resolutions  15 Memorandums of Understanding  34 state chartered banks enforcement actions were lifted:  12 Cease and Desist Orders  4 Board Resolutions  18 Memorandums of Understanding. April 3, 2013Safe & Sound Banking - Stanford CEE 244A 24

Enforcement Actions in 2012 April 3, 2013Safe & Sound Banking - Stanford CEE 244A 25