If you are a bank regulator, the capital directive is a dream come true.
It is a simple way to force a bank with operating problems to raise new capital in a hurry. The bank's officers and directors face penalties if they fail to raise the capital. And the directive lacks the administrative hearings and court reviews that protect banks and bankers from other regulatory orders.
While the capital directive procedure has seldom been used since Congress authorized it in 1983, a recent federal appeals court ruling upholds the constitutionality of the procedure and will lead to increased use of capital directives against banks with capital problems.
Mechanics of process. The capital directive procedure allows FDIC and the Comptroller of the Currency to order any bank with less than minimum capital to increase it before a specified deadline. (Other institutions may receive such notices if regulators believe their activities warrant a higher-than-minimum capital ratio.) All it takes is two written notices from the regulators to the bank.
The only advance warning required is the first written notice, which tells of the decision to issue the directive. This notice includes the proposed capital increase and the proposed deadline for raising the money. After a short period during which the bank can submit a written response, the agency sends out the second notice, the directive - as proposed or as modified.
If the bank fails to raise the required additional capital by the specified deadline, the directive may be enforced by a federal court order. The enforcement sought by the regulators will likely include civil money penalties against bank officers and directors.
By contrast, most bank regulation is accomplished through informal persuasion by bank examiners. The next level of regulatory action is usually a memorandum of understanding or other written agreement negotiated with the bank. For more severe problems, the agencies may seek a cease and desist order, which can ultimately be enforced by a court.
Federal banking laws and the Administrative Procedure Act provide many procedural protections if the bank and the regulators cannot agree on the terms for an agreed order. These protections include a written notice of charges (like a court complaint) and a hearing (really a trial with live witnesses, held after the bank has some access to agency files on the bank) conducted by an independent administrative law judge.
The bank can get a review of the administrative decision by the banking agency's top echelons. If necessary, it can request a review by the United States Court of Appeals.
Historical view. The capital directive procedure was enacted by Congress as a direct result of cease and desist proceedings lost by the Comptroller of the Currency against the First National Bank of Bellaire, Texas. After lengthy and bitterly contested administrative proceedings, the Court of Appeals in New Orleans ruled in 1983 that the Bellaire bank was not required to comply with OCC capital guidelines. The court reasoned that the agency had failed to prove that the bank's lower capital ratio made it an unsafe or unsound institution.
This decision alarmed the regulators. It called into question their legal authority to regulate capital.
Congress responded immediately by including a section on bank capital in the International Lending Supervision Act of 1983. The capital section of the act applies to all banks (not just those making foreign loans), directs federal banking agencies to establish capital levels, clarifies that the agencies may declare inadequate capital to be an unsafe and unsound practice, and specifically provides for capital directives to individual banks as an alternative to the more complicated administrative proceedings for other unsafe and unsound practices.
The legislative history of the act refers to the Bellaire case and makes it clear that Congress intended to eliminate challenges to regulatory authority. …