Seal of the Board of Governors of the Federal Reserve System

WASHINGTON, D. C.  20551


SR 91-17 (FIS)
July 22, 1991


SUBJECT: Application and Supervision Standards for De Novo State Member Banks

                        SR 88-10 was issued on April 19, 1988 to establish application and supervision standards for de novo state member banks.  Attached are measures that are being adopted to strengthen further our application and supervisory efforts regarding de novos and converted banks.  This letter supersedes SR 88-10 and becomes effective immediately.

                        Should you have any questions, please contact Jack Jennings (202-452-3053) or Cheryl Taylor (202-452-2536) regarding supervisory issues; or John Russell (202-452-2466) or Beverly Evans (202-452-2573) regarding applications matters.

Richard Spillenkothen
Deputy Associate Director

Cross References:   AD 87-20 (FIS) (7/8/87)
SR 88-8 (STR) (FIS) (3/18/88)
SR 88-8(a) (STR) (FIS) (3/18/88)
Supersedes: SR 88-10 (STR) (FIS) (4/19/88)


Application and Supervision Standards for De Novo State Member Banks


                        For purposes of this policy a de novo bank is defined as a state member bank that has been in operation for five years or less.  This policy also extends to commercial banks that have been in existence for less than five years and subsequently convert to membership.  Thrifts, Edge Act Companies and industrial banks that are converting to membership, irrespective of their length of existence, are subject to the de novo policy because they have not demonstrated operating stability as a commercial bank.  These institutions will hereafter be referred to as converted banks for purposes of this policy.  The policy is being extended to de novo banks through the fifth year of existence because experience indicates that pronounced problems often surface during the fourth and fifth years of operations for new banks.  These problems are frequently the result of inexperienced management, management and director changes, director dissension or lack of involvement and poor lending practices during the early years.  

De Novo Bank Subsidiaries of Bank Holding Companies with Assets Greater than $1 Billion

                        De novo state member bank subsidiaries of holding companies are subject to this policy.  However, the de novo examination frequency guidelines may be waived for de novo subsidiaries of large bank holding companies (consolidated assets greater than $1 billion) if, in the opinion of the Reserve Bank, the parent company and its subsidiary banks are in satisfactory condition, and the parent is considered to be a source of strength to the bank subsidiaries.  Notwithstanding, such subsidiary state member banks would be expected to maintain capital in conformance with the de novo policy guideline.

Notice of Application to FDIC    

                        In accordance with existing procedures, the Reserve Bank should notify the FDIC when it receives membership applications for de novo banks and thereby allow the FDIC the opportunity to provide material comments that could affect the Board's consideration of the application.  The appropriate Regional Office of the FDIC should be sent one copy of the de novo bank membership application at the time of filing in final form.  In addition, the Reserve Bank should provide a copy of letters received from the FDIC to the applicant if the letter is adverse in nature or presents material information not already clearly in the record.

Capital Standards

                        Initial capital in a de novo state member bank should be reasonable in relation to State law, its location, business plan and competitive environment.  At a minimum, however, a de novo bank must maintain a tangible Tier 1 leverage ratio of 9 percent for the first three years of operations.  (The 9 percent Tier 1 leverage ratio, which excludes loan loss reserves, is generally consistent with the former 10 percent primary capital guideline, which included loan loss reserves.)  The applicant must provide projections of asset growth and earnings performance that reasonably support the bank's ability to maintain this ratio without reliance on additional capital injections.  This policy also applies to newly converted commercial banks through the third year of existence and generally to other types of institutions that become Federal Reserve members (e.g., industrial banks, thrift, and Edge Act Companies) for a three year period beginning from the date following consummation.  Any exceptions to this policy for converted banks should be discussed with Board staff.  Even though a 9 percent tangible leverage ratio is not required after year three, de novo banks are expected to maintain capital ratios commensurate with ongoing safety and soundness concerns and, generally, well in excess of regulatory minimums.

Outside Directors

                         Directors with prior banking experience provide a de novo institution with additional managerial strength. Accordingly, the board of directors of a de novo bank normally should include at least two outside directors with prior banking-related experience.  This recommendation also applies to de novo state member bank subsidiaries of large holding companies.  In such cases the outside directors for the bank could be drawn from the parent company management or board.  This guideline may be waived if, in the opinion of the Reserve Bank, it will be difficult to find outside directors with prior banking experience, as may be the case for institutions located in rural areas.

Qualifications and Notification Requirements of Senior Management Officials and Directors

                        In accordance with procedures enumerated in SR-88-8 (STR) (3/18/88), each proposed director of a de novo bank is subject to a "name check".  In addition, pursuant to Section 914 of FIRREA which amended Regulation Y, any insured depository institution that has been in operation for less than two years shall notify the Reserve Bank at least 30 days before the proposed addition of any individual to the board of directors or the employment, promotion or transfer of any individual as a senior executive officer.  The Reserve Bank must state either a "no objection" or "disapproval" of the individual by the end of the 30-day period beginning on the date the notification is accepted.

                        In those instances where there is a conflict between the System's need to verify an official's qualifications and a request that a present employer not be contacted, appropriate and reasonable steps should be taken to satisfy the System's need to know.  Although Reserve Banks have delegated authority to make these decisions, they are encouraged to consult with Board staff when necessary.  If it is decided that information is available through alternative means, it may not be necessary to contact present employers.  In those cases where it is deemed necessary to contact present employers, the applicant should be given notice of the decision before the contact is made.

Meeting with the Board of Directors

                        Reserve Banks should advise applicants of all membership requirements when an application is initially filed. In addition, prior to approval, Reserve Bank staff should meet with the full board of directors to discuss applicable statutes, regulations, policies, and supervisory procedures and to become better acquainted with the organizers.  After an application is approved, but before the bank is opened, the Reserve Bank should meet with the directorate to reiterate the System's expectations for newly formed institutions.  The Reserve Bank should again apprise the directors of their individual and group responsibilities, particularly as they apply to Regulation O and Sections 23A and 23B of the Federal Reserve Act.  Directors should also be made aware of their fiduciary responsibilities and the need for adherence to sound operating policies, including the written policies reviewed and found satisfactory by Reserve Bank staff.

Approval Letters

                        With the passage of FIRREA, a cease and desist order can be issued and civil money penalties can be assessed for noncompliance with written conditions that are incorporated in an approval order or letter which grants membership to a bank.   Accordingly, conditions imposed are to be incorporated in the approval letter.  It should be stressed to the organizers and directors that conditions imposed during the application process are legally binding and subject to enforcement.

Cash Flows to a BHC Parent

                        Under the current small one bank holding company policy, de novo banks are restricted from providing funds for servicing the parent's debt until the bank receives two consecutive CAMEL ratings of "1" or "2", based on full scope examinations, and, in the judgment of the Reserve Bank, can be expected to continue operating on a sound basis.  An exception to this prohibition is tax payments that are made in accordance with the Board's policy under Regulation Y.  Consequently, if debt is included in a small bank holding company's formation application (debt to equity ratio is not to exceed 1:1), the applicant must clearly indicate how this debt will be serviced from sources other than the de novo bank, such as contributions from principals.

Written Policies

                        In the application process organizers of de novo banks are required to submit copies of the proposed bank's business plan, Community Reinvestment Act policy, investment policy, asset/liability management policy, and loan policy (including the percentage of the loan account allocated to commercial, installment, real estate and agricultural loans).  It is recommended that these policies be reviewed by the Reserve Bank supervision or other appropriate staff prior to accepting the application.  Likewise, any employment agreements, compensation packages and management fee arrangements should also be reviewed to determine their consistency with applicable policies.

Examination Frequency

                        The Reserve Bank should conduct a limited-scope examination at the end of the de novo bank or converted bank's first quarter of operation.  The examiner should review, at a minimum:  the minutes of board of directors' meetings; management information and control systems; the loan portfolio, including underwriting standards, concentrations, transactions with insiders, etc.; the sources of the bank's deposits; and compliance with reporting requirements on large currency transactions.  Also, the examiner should review major expenditures, including salaries, compensation packages and other related benefits; compare operating results for consistency with projections in the application; and determine whether the business and operating plans are consistent with those presented in the application and whether they need modification.  Upon completion of the limited-scope examination, a written report should be submitted to the board of directors and to the Board (Attn:  BS&R Clearing Unit for transmittal to...).  A CAMEL rating would normally not be assigned after this initial examination.  In order to better assess the condition of the bank and the parent bank holding company in the context of the application, it is suggested that Reserve Bank application staff also participate in the initial examination when possible.  

                        After the bank has been in operation for a further six-month period, the Reserve Bank should conduct a full-scope examination.  At six-month intervals, thereafter, full-scope examinations should be conducted until the bank receives two consecutive CAMEL composite ratings of "1" or "2" and, in the judgment of the Reserve Bank, can be expected to continue operating on a sound basis.  However, when a bank's composite rating declines to a CAMEL "3" (after two consecutive composite ratings of "2" or better) at anytime during the first five years of operation, the Reserve Bank should, thereafter, conduct a full-scope examination at six-month intervals until the composite rating improves to a "2" or better for two consecutive examinations.  When the bank has received two consecutive CAMEL composite ratings of two or better and Reserve Bank staff is of the opinion that the bank will continue to operate on a sound basis, the standard examination schedule may be followed.

Surveillance Tracking System

                        As part of the monitoring process, the Reserve Bank should establish appropriate programs for tracking the financial performance of a de novo and converted state member bank for the first five years of operation.  One feature of the tracking system should include the comparison of the bank's quarterly results with the projections in the application.  In addition, an ongoing reporting system should be required from approval to actual opening date to track any non-financial occurrences in the interim such as additions to or deletions from the board of directors or changes made to written policies reviewed and found acceptable by Reserve Bank staff.

Other Considerations

Diversification of the Directorate

  • Experience has shown that when a bank's directorate is composed of persons with a variety of professional expertise, overall managerial guidance is strengthened.  Accordingly, diversification of the board of directors should be strongly encouraged.  

Annual Outside Audits

  • De novos and converted banks should be strongly encouraged to have annual outside audits for at least the first five years of operation.

Supervisory Action

  • Given the rapid deterioration experienced by some de novo banks, a timely supervisory response to address problem areas is particularly important.  When weaknesses are first detected, prompt supervisory action should be taken by the Reserve Bank.  If these weaknesses aren't immediately corrected, or if they could lead to serious problems, formal enforcement action should be initiated.  


                        Board staff requests that de novos and converted banks be identified on summary form F.R. 1418 and on the cover of the examination report.  Quarterly surveillance data on such banks are to be submitted to the applicable District Review Analysts at the Board.

SR letters | 1991