Banking Committee takes regulators to task for Continental Bank failure

Federal bank regulators were harshly criticized Tuesday by House Banking Committee members for lax supervision as legislators examined the role of banks and bank regulators.

The near-collapse and eventual federal bailout of Continental Illinois National Bank & Trust Company, once the nation's sixth-largest bank, have triggered much of the ongoing debate on the US banking system.

''This case presents an unfortunate combination of aggressive, decentralized (bank) management and timid regulatory aproaches,'' said Committee Chairman Fernand J. St Germain (D) of Rhode Island at the start of extended hearings on the Continental situation.

He accused the three federal agencies that regulate federal banks of an ''anything your heart desires approach'' to rescuing Continental.

At their peak, the public and private funds committed to the bailout topped $ 15 billion, Mr. St Germain said. And the total costs to the taxpayers could eventually be $2 billion to $3 billion.

The outcome of the debate over the adequacy of bank regulation as well as the separate issue of what services banks should be allowed to offer will affect consumers in a variety of ways.

It will influence, for example: the size of a bank, according to the size consumers feel is safest for their savings; the level of insurance on those savings; and whether the local bank will be allowed to provide a variety of financial services including securities, real estate, and insurance.

The issue of what service a bank can offer came up last week when the Senate passed Sept. 13 a deregulation bill broadening some banks' securities underwriting powers, but curtailing others. The bill limited banks' ability to sell insurance and operate across state lines. A House deregulation bill now is pending.

The failure of Continental Illinois has worsened the climate for broadening banks' powers, many observers say.

''Why should we trust bankers who cannot manage a loan portfolio to sell securities, insurance and real estate,'' said House Banking Committee member Stewart B. McKinney (R) of Connecticut.

In testimony early Tuesday, Kathleen Kenefick, a former Continental loan officer officer, told the committee that in July 1981 she had written a memo to her superiors warning about loans to Penn Square Bank of Oklahoma City.

Her memo warned that ''corrective action should be instigated quickly.'' Further, the memo charged, ''management of credit relationships has not consistently taken place'' while ''follow-up and accountability have been rare.'' The memo was ignored, she said.

When Penn Square failed on July 4, 1982, Continental Illinois was left holding about $1 billion in bad energy loans issued by the bank.

In August 1981 federal bank examiners from the Office of the Comptroller of the Currency found that billions of dollars' worth of loans had never gone through the bank's normal review process.

Still, the examination report that year said that the bank's internal systems were ''functioning well and accurately reporting ''to top bank management.''

Allan McCarte, a former bank examiner who handled the examination of Continental in 1981, told the Banking Committee he was not told by the controller's office that there were problems with Penn Square which could affect Continental.

Richard Kovarik, the bank examiner who supervised the examination of Continental in 1982, did not receive a copy of the Kenefick memo until three months after writing his report. Mr. Kovarik's report was written after the Penn Square problems were known. But his report said that previous criticism of bank controls ''was not as strong as it now appears it should have been.''

Top bank regulators will have a chance to defend themselves Wednesday when C. T. Conover, comptroller of the currency, will testify. In advance of his testimony, Mr. Conover has circulated a memo to reporters arguing that the regulators were helpless to prevent Continental's problems.

''Bank regulators do not and should not take over the management of any bank, '' the document says. Bank regulators also came under fire for apparently setting up a two-tier standard for protecting depositors and other bank creditors.

Although Continental's depositors and bondholders were assured of not losing any money, depositors and creditors at smaller troubled banks have lost savings above the $100,000-per-account limit on federal deposit insurance. That could cause both large and small accounts to leave small banks in favor of money-center banks.

''If the bailout program is to proceed on the basis of bank size, there may be a substantial impact on the small and medium-size institutions across the nation which have not enjoyed the automatic bailout features incorporated in the Continental case,'' St Germain said.

Some congressmen favor cutting the amount of insurance, for example to $40, 000 under one plan, and offering additional amounts at extra cost.