WASHINGTON - A little-noticed section in the House version of the regulatory relief bill would exempt many larger banks from a 1991 requirement that they maintain an audit committee composed exclusively of outside directors.

That provision prompted a protest from the Clinton administration, which sees it as a blow to safety and soundness.

"It would permit an institution's management to dominate the audit committee of its board of directors, and thus undermine an important safeguard of bank integrity," said Treasury Secretary Robert E. Rubin soon after the relief package cleared the House Banking Committee.

The audit committee requirement was enacted in 1991 in response to the savings and loan crisis and troubles in the banking industry.

The Federal Deposit Insurance Corp. Improvement Act of 1991 mandated that every bank above a size set by the FDIC ($500 million in assets is the current threshold) must have an independent audit committee composed entirely of outside directors to review the bank's financial statements and audits with management and accountants.

"The point was making sure there wasn't any conflict of interest," said Diane Casey, regulatory director at the accounting firm of Grant Thornton in Washington.

The regulatory relief bill sponsored by Rep. Doug Bereuter, R-Neb., would exempt banks deemed by regulators to be "well capitalized and well managed" from all audit committee requirements.

Banks that do not meet these standards but which "face hardships in retaining competent (outside) directors on their internal audit committees" could get by with a majority rather than an entirety of outside directors if regulators agreed.

These changes would affect "only a handful" of closely held small to midsize banks, said Kate Barr, senior vice president and compliance officer at Riverside Bank in Minneapolis and chairman of the American Bankers Association's compliance committee.

Large banks already have boards composed almost entirely of outside directors, she said.

The audit changes were not on the priority list of either the ABA or the Independent Bankers Association of America. They did, however, bring a complaint from the American Institute of Certified Public Accountants, which wrote to Rep. Bereuter asking him to keep the "hardship" provision but do away with the blanket exemption for well-capitalized, well-managed banks.

The FDIC Improvement Act "kind of went in one direction and took away the regulatory flexibility," said Ms. Casey, a former bank industry lobbyist. "There's a balance and the pendulum has swung, but we went from one extreme to the other."

Still, she added, "at this point it's premature for any financial institutions to make plans to change the composition of audit committees, because this bill has a long way to go."

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