Bank and thrift year-2000 ratings slipped during the first quarter as institutions missed deadlines for taking remedial actions, federal regulators told lawmakers Tuesday.

Though nearly all financial institutions are on track to meet the Jan. 1, 2000, deadline, agency chiefs testified at a House Banking Committee hearing that an increasing number have fallen behind schedule on testing to ensure that renovated systems work properly.

Large national banks showed the steepest ratings decline. Among the 184 national banks with assets of more than $1 billion, the number rated "needs improvement"-the middle of three grades-rose to 12% as of March 31, from 8% at yearend.

By contrast, fewer than 3% of those with assets below $1 billion were judged "needs improvement."

Comptroller of the Currency John D. Hawke Jr. tried to put the figures into context.

"This decline in the ratings of large banks was not unanticipated, given the complexity" of their operations and the burden of inoculating vast computer systems, he testified.

Moreover, he said, 96% of all national banks were still rated "satisfactory," and not a single large national bank got an "unsatisfactory" grade. "Most problems banks have encountered during the testing phase are not serious," Mr. Hawke said.

Across the industry, the number of banks and thrifts deemed "unsatisfactory"-the worst rating-rose to 24 as of March 31, from 16 at yearend. During the same period, the number rated "needs improvement" crept to 313 from 304, and the total of institutions rated "satisfactory" fell to 10,042, from 10,095.

The next critical target date is June 30, when banks and thrifts are supposed to have tested and "substantially" installed their renovated computer systems.

This month, the Federal Deposit Insurance Corp. revealed that it does not expect any bank or thrift to fail due to year-2000 problems. None of the institutions on its projected failure list, which lists banks that could fail in the next two years, were singled out for year-2000 flaws.

Despite the falloff in first-quarter ratings, the House committee's leadership expressed cautious optimism about the industry's readiness.

Chairman Jim Leach, R-Iowa, said he was pleased that the vast majority of financial institutions have received "satisfactory" ratings. But he said that studies by private companies and government agency inspectors general raised questions about whether bank regulators are making accurate assessments.

"Are, indeed, some institutions being awarded a 'satisfactory' rating by their regulators without having met adequate standards of performance?" he asked.

Rep. John J. LaFalce, the ranking Democrat on the panel, concurred, saying he believes that different agencies, and even different examiners within single agencies, are applying terms like "satisfactory" differently.

Nevertheless, Rep. LaFalce expressed increasing optimism about the industry's ability to weather the Jan. 1, 2000, rollover. "Evidence mounts that the pesticides for the millennium bug are doing their job," he said.

Several agency chiefs said they are raising the heat on faltering banks.

FDIC Chairman Donna A. Tanoue said the agency will hit all state nonmember banks that have less than a "satisfactory" year-2000 rating with cease-and-desist or so-called "safety and soundness" orders. Up to now, the FDIC has generally used less severe enforcement actions.

Federal Reserve Board Governor Edward W. Kelley Jr. said the Fed- supervised banks with "unsatisfactory" or "needs improvement" ratings will be "placed on an intensified monthly monitoring plan."

He also said that two groups-the 50 largest bank holding companies and "financial institutions of special importance to key financial and payment systems"-would be contacted quarterly and monthly, respectively, due to their broad importance in the financial system.

Several regulators told lawmakers that, though they are neutral on the need for anti-liability legislation, no legislation should interfere with agency enforcement and penalty-assessing powers.

On the subject of credit risk, Mr. Kelley's statement said that the Fed is "beginning to see instances where credit standards and collateral requirements are being tightened" due to insufficient year-2000 reassurances from a customer or counterparty.

But in his prepared remarks, Mr. Hawke said national banks attempting such tightening "have met with limited success due to their lack of leverage with borrowers in the currently competitive lending environment."

Rep. Leach and bank regulators will assemble again Thursday in a summit on financial services to be hosted by the President's Council on Year-2000 Conversion. The meeting will feature panel discussions on contingency planning and customer awareness.

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