WASHINGTON — It’s show time for federal banking regulators.

With the economy softening faster than expected and bad loans blitzing bank profits, the Federal Reserve Board and the Office of the Comptroller of the Currency are center stage, trying to keep banks safe while also warding off a recession.

So far, the critics are applauding.

“The bankers will always growl and complain, but in the long run the examiners are more right than wrong,” said Kevin M. Blakely, group executive vice president at KeyCorp in Cleveland. “Most of the folks that I talk to, my counterparts at other banks, say, yes, the regulators are tough. Have they gone over the line? No.”

The regulators’ performance has also benefited from a stark contrast with the credit crunch of the early 1990s: The banking industry is unquestionably better insulated against losses this time around.

At $521.2 billion, the industry’s capital is more than double what it was 10 years ago. Reserves as a percentage of noncurrent loans are significantly higher as well. Today banks have an average of $1.61 of reserves for every $1 of bad loans, compared with 73.1 cents in 1990, according to Federal Deposit Insurance Corp. statistics.

Still, after harping on credit quality for five years, the folks responsible for a safe and sound banking system realize that they must temper their warnings or risk a backlash that could result in a recession. Government officials are determined to avoid a repeat of the early 1990s, when tough talk by then-Comptroller of the Currency Robert L. Clarke was widely blamed for causing a national liquidity crisis that crushed the economy.

No one — from Fed Chairman Alan Greenspan on down — wants to earn “the regulator from hell” label that was slapped on Mr. Clarke.

Mr. Greenspan surprised his colleagues at the other agencies last month when he became the first federal regulator since 1994 to ease off credit quality warnings. While understated, his point was clear: Bankers should keep lending.

“It is important that the response of management to these” credit quality “concerns not be overdone,” he said.

Noting a rise in problem loans is natural after a strong economy has stoked competition and emboldened borrowers, Mr. Greenspan added: “Though lenders will be viewing new transactions with greater caution than they did a couple of years ago, both bankers and their supervisors should now guard against allowing the pendulum to swing too far the other way by adopting policy stances that cut off credit to borrowers with credible prospects.”

Bankers were thrilled, though a little nervous that their two most important regulators seemed to be reading from different scripts.

The Comptroller’s Office has focused on credit quality like politicians on potholes since 1995, and is not about to ease up. Agency officials contend they are not risking a credit crunch because the warnings have been slow and gradual — “a toothache-like pain,” as one put it. They also insist they do not disagree with Mr. Greenspan, but it’s clear they question his motives.

Taking questions just days after Mr. Greenspan’s speech, Comptroller John D. Hawke Jr. said he agreed regulators must not overreact.

“We are keenly aware of what happened 10 years ago, when bank supervision was characterized by a long period of forbearance in the face of deteriorating conditions, followed by a ‘gangbusters’ type reaction when the problems could no longer be ignored,” he said. “We have tried very hard to maintain a reasoned and carefully modulated approach to dealing with the signs of deterioration in credit quality.”

Then he let this zinger fly: “Our job is to ensure the health of the banking system. We do not have responsibility for macroeconomic policy.”

Of course, the Fed does have that duty, and free-lending banks help the economy grow.

Former FDIC Chairman L. William Seidman said the Fed clearly faces a conflict of interest. “His advice in terms of the economy is appropriate, but I don’t know as a bank regulator whether you tell bankers the same thing,” Mr. Seidman said.

Fed officials declined interview requests, but there is less to this split than meets the eye. Both agencies want banks to make the good loans and avoid the bad ones. But no one denies that the tone from top-level regulators has an impact on examiners and how they value loans.

For instance, examiners from around the country are here this week for a biennial meeting, and will hear from Senior Deputy Comptroller E. Wayne Rushton, an agency veteran who was on the front lines during the last credit crunch. He’s been practicing to ensure his manner is just right — not too harsh, not too soft.

“When we meet with our examiners we rehearse it before we talk to them,” Mr. Rushton said in an interview. “It is so easy for any regulator, when they have all of their staff in, to look a little funny or have the wrong tone of voice. Then the troops go back out in the field and think, ‘They must want us to bust some ankles,’ and they do it for six months before we find out about it, and by then the damage is done.

“We’re taking every precaution to see that that doesn’t happen.”

The real test lies ahead: How will examiners judge credits over the next few quarters?

“How this comes out does have a lot to do with how regulators react,” said former Comptroller Eugene Ludwig. “If people overreact, then things could get nasty.”

His advice: Don’t change loan evaluation standards, and if changes are necessary, apply them only prospectively. “Regulators ought to be looking forward, not backward,” he said. “What they shouldn’t be doing, and there is always a human tendency to do this, is looking back on old decisions and becoming more restrictive.”

So far, regulators have been “pretty balanced,” according to Allen W. Sanborn, president of RMA, the trade association of bank loan and credit officers. “Over the next 12 months, it will be clearly important that the regulators maintain that balance, because the economy is going to be shakier,” he said. “And it is important for bankers to recognize challenges and get to work on them.”

Most experts agree the economy is far from credit starved. True, highly leveraged borrowers are finding it difficult to get credit, and even solid borrowers are paying more or being forced to accept tougher terms. But cash is still available.

And barring a big disruption in the economy, most people expect the banking industry to weather this storm. Energy — supply, pricing, and the mess in California — is the big “if” in most minds.

Beyond the banking industry’s bigger capital cushion, experts point to a slew of other factors that reduce the odds that a wave of bad loans will trigger a credit crunch.

Edward Crutchfield, former chairman of First Union Corp., said the banking business and its supervision are more sophisticated, bank risks are spread more geographically, and earnings streams are more diversified, with noninterest income accounting for more than half of all revenues at some companies. “You didn’t have that kind of counterbalance 10 years ago,” Mr. Crutchfield said.

Bankers are generally thought to be more nimble and more willing to face up to problem loans today.

“Bankers have much better risk management processes today, and we don’t have this huge concentration in commercial real estate,” Mr. Sanborn said.

Communication among bankers and the regulators is better, too.

For example, RMA sponsors meetings every quarter between loan officers and Fed and OCC staff. As the head of RMA’s regulatory relations council, Mr. Blakely led such a group of bankers last month.

The regulators “are genuinely trying to do the right thing,” Mr. Blakely said. If a banker encounters an overzealous examiner, federal regulators want to hear about it, he said. “You are being encouraged to call the ombudsman or call D.C. That’s no baloney, and it’s different than from ‘90.”

Back in 1990 the government was still busy cleaning up after hundreds of failed thrifts when record numbers of banks went under. Regulators had little choice but to crack down.

“There was tremendous political pressure being put on the agencies by Capitol Hill,” said Mr. Blakely, who was deputy comptroller for special supervision until mid-1990. “The regulators were in a no-win position back then.”

To be sure, no one knows how many bad loans lurk in bank portfolios. With so many years of economic bliss, some lenders are untested. “You’ve got a gap in the skill levels of these bankers,” one regulator said. “Most of these lenders were playing Nintendo in the last downturn.”

Loan losses are expected to continue to eat away at revenues as banks boost loan loss reserves and nonperforming assets grow. Loan concentration and growth is another concern. Commercial and industrial loans topped $1 trillion last year, compared with $621 billion in 1990. Home equity loans hit $123 billion in 2000, up from $59.3 billion 10 years ago, FDIC statistics show.

Clearly, mistakes have already been made, particularly in large syndicated credits.

The amount of these loans classified by regulators increased for the second consecutive year, to 3.3% in 2000 from 1.3% in 1998. But that is still far from the peak hit in 1991, when examiners classified 10% of syndicated loans.

Particularly disconcerting is how quickly large borrowers are getting into trouble. For instance, Xerox Corp. recently drew down an $8 billion line of credit and is now selling assets to repay the debt. The syndicated loan data compiled by the federal agencies showed borrowers have used about a third of $1.95 trillion of commitments. Of this 8% was classified last year, up from 5.3% in 1999. But again, the picture was much darker in 1991, when 18% of credit lines were classified.

While things are likely to get worse before they get better, most experts say they are confident that disaster does not loom.

Take Jim Chessen, chief economist at the American Bankers Association. “Are there going to be some loan problems? Sure,” he said. “Is it more than the industry can handle? No way.”

Mr. Rushton agreed with his assessment. “As long as everybody stays calm and there is not any cataclysmic event, I think we’re going to be just fine,” he said. “Qualified, credit-worthy borrowers are going to obtain credit whenever they need it from whomever they want to borrow it from.”



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