Officials of the American Bankers Association, the Saving & Community Bankers of America and the Association of Bank Holding Companies wrote the four federal depository regulatory agencies to urge that when the regulators adopt real estate lending standards under the Federal Deposit Insurance Corporation Improvement Act, they permit financial institutions to set standards and policies appropriate to each institution's operation. They argued against establishing specific uniform maximum standards. The agencies, however, ignored the advice and set specific loan-to-value ratios. (See story on Page 1.) Following is the comment letter.

We express our strong concern regarding adoption, pursuant to Section 304 of the Federal Deposit Insurance Corporation Improvement Act, of real estate lending standards that apply uniformly to all depository institutions. Inclusion in such a regulation of detailed loan-to-value ratio limits would have a negative effect on the nation's economy and all aspects of the development, financing, construction and the sale of residential and commercial real estate.

We understand that your agency, in concert with the other financial institution regulatory agencies, may issue such a proposal for public comment in the near future. The Board of Governors of the Federal Reserve System has already extensively discussed this issue and has options in establishing these standards: (1) specific uniform maximum loan-to-value ratio standards, or (2) individual lender loan-to-value ratio standards. We unanimously urge adoption of the approach in option two as the appropriate framework for real estate standards. This option reflects the uniqueness of each financial institution's market and loan products and provides the necessary flexibility to meet the needs of financial institutions and their customers consistent with safety and soundness considerations.

We make this recommendation based on a number of considerations. First, the strict maximum loan-to-value ratio standards are not necessary in the context of the other measures adopted by Congress for overseeing financial institutions' operations. The implementation and refinement of risk-based capital standards to take into account interest rate risk and concentration of credit risk imposes a capital system, which directly relates operating risk to the capital level.

Second, the new real estate appraiser state licensing and certification system, along with the strict adherence to the Uniform Standards of Professional Appraisal Practice, help ensure quality appraisals, further supporting the valuation of real estate collateral. The new requirement of annual on-site regulatory examinations also enhances the agencies' capabilities in monitoring financial institutions so as to more closely scrutinize an institution's real estate lending activity. The new accounting and auditing requirements will complement the agencies' monitoring efforts.

Third, the imposition of uniform maximum loan-to-value ratios fails to take into account the diversity of lending activity throughout the United States. Although often perceived as a national marketplace, real estate lending is actually better represented by regional activity that reflects the unique needs of different economies of various sections of our country. A national standard will not provide the flexibility needed to respond to these economies and markets. The approach contained in option two provides the flexibility that financial institutions need to prudently respond to these regional differences.

Fourth, the creation of rigid standards fails to recognize the necessary flexibility that is essential for certain specialized types of lending activity. Community development loans, loans to low-and moderate-income individuals, and small business loans in disadvantaged neighborhoods all require heightened banker sensitivity and creativity in fashioning loan products that will meet the needs of those communities. The imposition of rigid loan-to-value standards will only serve to thwart banker participation in these specialized programs. The approach in option two provides the flexibility needed to offer these products.

Finally, imposition of uniform standards may also serve as a deterrent to the overall economic recovery by discouraging financial institutions from lending on real estate. Regulatorily imposed loan-to-value limits will result in credit allocation to the loan categories subject to the least restrictive limits, thereby resulting in a misallocation of resources in the lending process that is unrelated to supply/demand factors. Furthermore, severe restrictions on depository institutions may encourage other financial intermediaries not subject to these inflexible standards to dominate this market vacated by financial institutions. The competitiveness of financial institutions will decline, which will likely, then, reduce their market share and restrict their ability to continue to serve their customers. The approach in option two will help to preserve the competitiveness of depository institutions within the bounds of prudence.

Because of these reasons, among others, we urge the adoption of the approach contained in option two as the most appropriate method of addressing the requirements of Section 304 of the Federal Deposit Insurance Corporation Improvement Act of 1991. Under this alternative, a financial institution would adopt lending policies and standards appropriate to its operation as determined by its board of directors. These policies would be subject to review by the examiners in keeping with general guidelines issued by the agencies. A financial institution's adherence to the guidelines would be tested by the examiners as a part of its regular examination, as would be institution's adherence to its policies be measured by its actual lending activity. Any general guidelines should provide sufficient flexibility so that a financial institution could make exceptions where justified by factors such as the creditworthiness of the borrower and supported by appropriate documentation and review. Indeed, perceived riskier loans could require special presale, preleasing or third-party guarantees, depending upon the circumstances. This flexibility is appropriately part of the credit underwriting process established to avoid excessive risk-taking.

In summary, we believe that the flexible guidelines allowing financial institutions to structure standards for their own institutions provides the better approach to the implementation of Section 304. We urge the agencies to focus on this approach as the basis for any proposal for public comment on the subject of real estate standards.

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