A performance audit of the State Banking Department

              STATE OF ARIZONA
OFFICE OF THE
AUDITOR GENERAL
A PERFORMANCE AUQlT
OF THE
STATE BANKING DEPARTMENT
OCTOBER 1983
A REPORT TO THE
ARIZONA STATE LEGISLATURE
REPORT 83- 21
DOUGLAS R. NORTON. CPA
AUDITOR GENERAL
STATE OF ARIZONA
OFFICE OF THE
AUDITOR GENERAL
October 26, 1983
Members of the Arizona Legislature
The Honorable Bruce Babbitt, Governor
M r . Walter C. Madsen, Superintendent
State Banking Department
Transmitted herewith is a report of the Audit or General, A Performance
Audit of t h e S t a t e Banking Department. This report is i n response t o a
January 18, 1982, resolution of the Joint Legislative Oversight
Committee. The performance audit was conducted as a part of the Sunset
Review set f o r t h i n A. R. S. $ 941- 2351 through 41- 2379.
The blue pages present a summary of the report; a response from t h e S t a t e
Banking Department is found on the yellow pages preceding the appendices.
My s t a f f and I w i l l be pleased t o discuss o r c l a r i f y items i n the report.
Respectfully submitted,
~ u d i t o rG eneral
Enclosure
Staff: William Thomson
Steve H. Thacker
Mark Fleming
U r s C. Bauder
Addie L. Ceballos
Sylvia Forte '
Nancy Love11
Jerome E. Miller
1 1 1 WEST MONROE SUITE 600 PHOENIX. ARIZONA 85003 ( 602) 255- 4385
OFFICE OF THE AUDITOR GENERAL
A PERFORMANCE AUDIT OF THE
STATE BANKING DEPARTMENT
A REPORT TO THE
ARIZONA STATE LEGISLATURE
REPORT 83- 21
TABLE OF CONTENTS
SUMMARY
INTRODUCTION AND BACKGROUND
SUNSET FACTORS
FINDING I
Licensing small loan companies is not necessary
t o protect consumers.
CONCLUSION
RECOMMENDATIONS
FINDING I1
Although the State Banking Department needs t o
strengthen supervision of four types of e n t e r p r i s e s ,
two others do not require departmental regulation.
CONCLUSION
FINDING I11
Oversight of f i n a n c i a l i n s t i t u t i o n s is adequate
but the Department can improve u t i l i z a t i o n of
its examiners.
CONCLUSION
RECOMMENDATIONS
FINDING I V
The c o n f l i c t of i n t e r e s t s t a t u t e f o r Banking
Department employees is unnecessarily r e s t r i c t i v e .
CONCLUSION
Page
i
1
7
15
RE COMMENDATIONS
OTHER PERTINENT INFORMATION
AREAS FOR FURTHER AUDIT WORK
AGENCY RESPONSE TO AUDITOR GENERAL'S REPORT
APPENDIX I
St a t e and Federal regulatory requirements f o r loan
companies i n Arizona
APPENDIX I1
L e g i s l a t i v e Council Opinion on r e g u l a t i o n of small
loan companies
LIST OF TABLES
PAGE
TABLE 1 - State- chartered Financial I n s t i t u t i o n s
TABLE 2 - Federally Chartered I n s t i t u t i o n s i n Arizona
TABLE 3 - Licensed F i n a n c i a l E n t e r p r i s e s , May 31, 1983
TABLE 4 - Banking Department Expenditures and Revenues,
F i s c a l Years 1981- 82 through 1983- 84
TABLE 5 - Types and Number of Licensed F i n a n c i a l E n t e r p r i s e s ,
May 31, 1983
TABLE 6 - Enterprise Examinations, F i s c a l Years 1980- 81
through 1982- 83
TABLE 7 - Estimated Costs f o r Routine Examinations of Financial
E n t e r p r i s e s
TABLE 8 - Compliance with Examination Requirements, Fiscal
Years 1978- 79 through 1982- 83
TABLE 9 - Regulatory Powers of Superintendent of Banks,
1979 and 1983
TABLE 10 - S t a t u s of Recommendations on Ability t o Regulate
Collect ion Agencies
LIST OF FIGURES
FIGURE 1 - Number of Licensed Small Loan Companies,
F i s c a l Years 1978- 79 through 1982- 83
FIGURE 2 - Trend i n Small Loan Industry P r o f i t s VS
t h e Amount of Consumer Loans, F i s c a l Years
1978- 79 through 1981- 82
The Office of the Auditor General has conducted a performance audit of the
State Banking Department i n response t o a January 18, 1982, resolution of
the Joint Legislative Oversight Committee. This performance audit was
conducted as a part of the Sunset Review s e t f o r t h i n Arizona Revised
Statutes ( A. R. S. ) § § 41- 2351 through 41- 2379.
The State Banking Department, created by the Legislature i n 1922,
supervises State- licensed financial i n s t i t u t i o n s and enterprises. The
Governor appoints the Superintendent of Banks, who oversees a l l
operations. The Department charters and examines banks, savings and loan
associations, c r e d i t unions, t r u s t companies and small loan companies.
The Department also l i c e n s e s f i n a n c i a l e n t e r p r i s e s and investigates
p o t e n t i a l mismanagement of the enterprises. The Department does not have
j u r i s d i c t i o n over federally chartered banks, savings and loans and c r e d i t
unions. A variety of Federal agencies have r e s p o n s i b i l i t y for federally
chartered i n s t i t u t i o n s .
Licensing Small Loan Companies Is
Not Necessary t o Protect Consumers ( see pages 15- 25)
Protecting consumers does not r e q u i r e l i c e n s i n g small loan companies.
Arizona s t a t u t e s authorize the Banking Department t o license consumer
finance companies but do not require any small loan companies t o obtain a
license from the Department. Loan companies may determine the extent t o
which they w i l l be subject t o departmental regulation by deciding whether
or not t o seek a license. Because companies choosing t o be licensed are
subject t o more regulatory requirements than unlicensed companies, the law
provides an economic incentive f o r companies t o not be licensed. As a
r e s u l t , many small loan companies i n Arizona have discontinued t h e i r
licenses i n recent years.
Although borrowing money poses some r i s k , consumers can assume the
resl. onsibility f o r protecting themselves i f they have s u f f i c i e n t
information t o evaluate terms offered by lenders. However, existing
disclosure requirements do not provide the borrower with s u f f i c i e n t
information t o permit comparisons among lenders. Although State law and
Federal truth- in- lending regulations establish requirements governing
loans, n e i t h e r r e q u i r e lenders t o inform borrowers about these legal
requirements. As a r e s u l t , consumers may be unable t o compare charges
against requirements t o determine i f they are being treated f a i r l y .
The Legislature should consider amending A. R. S. 544- 1201 - e t - seq t o 1)
incorporate provisions of Federal truth- in- lending regulations i n t o State
law, 2) require a l l lenders t o f u l l y inform each borrower about State and
Federal requirement s concerning allowable charges and met hod s of computing
i n t e r e s t r a t e s , and 3) s p e c i f i c a l l y authorize the Attorney General t o
enforce a l l State laws governing loans. The Legislature should also
consider amending A. R. S. $ 6- 601 et t o remove a l l licensing
requirements for small loan companies including i n t e r e s t r a t e limitations
placed on these companies. The Banking Department should prepare an
informat ion brochure which in£ oms consumers about legal requirements
governing loans.
Changes Needed i n Regulation of
Financial Enterprises ( see pages 27- 37)
Two of the six enterprises under the supervision of the Banking
Department, motor vehicle dealers and sales finance companies, pose
limited harm t o consumers. Continued licensing is not required f o r these
enterprises because consumers can adequately protect themselves i f the
Legislature strengthens truth- in- lending s t a t u t e s as recommended i n
Finding I. The Legislature should consider amending A. R. S. 544- 281 - e t seq
t o delete a l l licensing requirements for motor vehicle dealers and sales
finance companies and t o empower the Attorney General t o investigate
violations of the Motor Vehicle Time Sales Disclosure Act.
In c o n t r a s t , the remaining four enterprises can create serious financial
harm t o individuals and businesses who use t h e i r services. Banking
Department regulation is necessary t o protect consumers who have l i t t l e
recourse f o r protecting thenselves against f i n a n c i a l losses from mortgage
brokers, escrow agents, c o l l e c t i o n agents and debt management companies.
However, t h e Department does not routinely examine these e n t e r p r i s e s and
t h u s l a c k s an e f f e c t i v e means f o r deterring p o t e n t i a l fraud and abuse.
The Department should develop procedures t o implement routine examinat ions
of a sample of f i n a n c i a l e n t e r p r i s e s each year. Audit work a t each
enterprise should focus on a valid sample of p r i o r i t y transactions and
document s .
The Department Can Improve U t i l i z a t i o n
of Its Examiners ( see pages 39- 44)
Although t h e Banking Department adequately supervises f i n a n c i a l
i n s t i t u t i o n s , it can improve the u t i l i z a t i o n of its professional s t a f f .
The Department should review examination procedures used by other s t a t e s
and Federal agencies t o determine the f e a s i b i l i t y of increasing the
efficiency of examination procedures. The Department should develop a
personnel management system which provides accurate estimates of s t a f f
resources needed f o r examinat ions.
The Conflict of I n t e r e s t Statute f o r Banking Department
Employees Is Unnecessarily R e s t r i c t i v e ( see pages 45- 47)
The law prohibiting Banking Department employees from holding loans a t
i n s t i t u t i o n s regulated by the Department is more s t r i n g e n t than necessary
t o prevent c o n f l i c t s of i n t e r e s t . The prohibition may l i m i t the
Department's a b i l i t y t o a t t r a c t qualified s t a f f or cause hardship t o new
employees. Less r e s t r i c t i v e requirements w i l l reduce the p o t e n t i a l
hardship without increasing the r i s k of c o n f l i c t s of i n t e r e s t . The
Legislature should consider amending A. R. S. $ 6- 113 t o 1) allow
professional s t a f f t o r e t a i n loans with e n t i t i e s regulated by the
Department i f the loan existed prior t o employment with t h e Department and
the employee continues t o amortize the loan under its o r i g i n a l terms and
2) require that each employee f u l l y d i s c l o s e a l l loans with e n t i t i e s
regulated by the Department and the terms of such loans a t the t i m e of
i n i t i a l employment. The Department should e s t a b l i s h a policy of not
assigning personnel t o examine i n s t i t u t i o n s from which they hold a
preexisting loan.
iii
INTRODUCTION AND BACKGROUND
The Office of the Auditor General has conducted a performance audit of t h e
S t a t e Banking Department i n response t o a January 18, 1982, r e s o l u t i o n of
t h e J o i n t L e g i s l a t i v e Oversight Committee. This performance audit was
conducted as a part of the Sunset Review set f o r t h i n Arizona Revised
S t a t u t e s ( A. R. S.) $ 541- 2351 through 41- 2379.
The S t a t e Banking Department, created by t h e L e g i s l a t u r e i n 1922,
supervises State- licensed f i n a n c i a l i n s t i t u t i o n s and e n t e r p r i s e s . The
Governor appoints t h e Superintendent of Banks, who oversees a l l
operat ions. The Department c h a r t e r s and examines banks, savings and loan
a s s o c i a t i o n s , c r e d i t unions, t r u s t companies and small loan companies.
The Department a l s o l i c e n s e s f i n a n c i a l e n t e r p r i s e s and i n v e s t i g a t e s
p o t e n t i a l mismanagement of t h e e n t e r p r i s e s . The Department does not have
j u r i s d i c t i o n over f e d e r a l l y chartered banks, savings and loans and c r e d i t
unions. A v a r i e t y of Federal agencies have r e s p o n s i b i l i t y f o r f e d e r a l l y
chartered i n s t i t u t i o n s .
Development of Banking Department R e s p o n s i b i l i t i e s
The r o l e of t h e Banking Department has changed s i g n i f i c a n t l y since 1922.
The a s s e t s of State- chartered f i n a n c i a l i n s t i t u t i o n s have grown
s u b s t a n t i a l l y although t h e number of banks has decreased. Through its
insurance of deposits at State- chartered i n s t i t u t i o n s , t h e Federal
government now s h a r e s o v e r s i g h t r e s p o n s i b i l i t y with t h e Department. In
a d d i t i o n , t h e Arizona L e g i s l a t u r e h a s made t h e Department responsible f o r
supervising a number of f i n a n c i a l e n t e r p r i s e s .
Financial I n s t i t u t i o n s - Financial i n s t i t u t i o n s have changed s i g n i f i c a n t l y
s i n c e t h e Department ' s beginning. Banks have shown t h e g r e a t e s t
transformation i n numbers and a s s e t s . I n 1922, Arizona had 58
Stat e- chart ered banks with a s s e t s of $ 54.9 m i l l i o n and 4 State- chartered
savings and loan a s s o c i a t i o n s with a s s e t s of $ 1.4 million. There were
a l s o 22 n a t i o n a l banks chartered by t h e Federal government. A t t h a t time,
banks were small community u n i t s . Branch banking and growth of statewide
banks did not begin u n t i l t h e l a t e 1930s.
The 1920s and 1930s were a d i f f i c u l t time for Arizona banks. Numerous
State- chartered banks f a i l e d . By t h e e a r l y 1930s bank f a i l u r e s became SO
numerous t h a t t h e Superintendent of Banks opened special liquidating
o f f i c e s throughout the State. This greatly reduced the number of banks.
Arizona now has fewer banks. In recent years the number of
State- chartered savings and loan associations and c r e d i t unions has
decreased. However, the a s s e t s of Arizona's State- chartered financial
i n s t i t u t i o n s have grown s u b s t a n t i a l l y s i n c e the 1920s. Assets now t o t a l
i n b i l l i o n s of d o l l a r s rather t h a n m i l l i o n s ( Table 1).
TABLE 1
STATE CHARTERED FINANCIAL INSTITUTIONS
5 p e of Date of Number of Number of Assets a
I n s t i t u t i o n Report Home Offices Branches ( In Millions)
Banks 6/ 30/ 83 30 225 $ 5,382
Savings and Loan
Associations 6/ 30/ 83 6
Credit Unions 12/ 31/ 82 63 - 0- 45 5
Trust Companies 8/ 30/ 83 15 10 2,572
Consumer Finance
Companies 6/ 30/ 82 150
Source : State Banking Department
* Consumer loans accounted for $ 106 million of t o t a l a s s e t s .
In addition t o these S t a t e- chartered i n s t i t u t i o n s , a number of federally
chartered financial i n s t i t u t i o n s a l s o operate and represent some of the
S t a t e ' s largest banks and savings and loan associations i n Arizona ( Table
2). However, the State Banking Department does not have j u r i s d i c t i o n over
federally chartered i n s t i t u t i o n s .
TABLE 2
FEDERALLY CHARTERED INSTITUTIONS I N ARIZONA
5 p e of Date of Number of Number of Assets
I n s t i t u t i o n Report Home Off i c e s Branches ( In Millions)
Banks 6130183 3 392 $ 11,932
Savings and Loan
Associations 6/ 30/ 83
Credit Unions 12/ 31/ 82 67 N/ A 716
Source : St a t e Banking Department and National Credit Union Administ r a t ion
The Federal Role - The f i n a n c i a l c r i s i s created by the Great Depression
brought Federal agencies i n t o t h e supervision of State- chart ered
i n s t i t u t i o n s . In 1933, the Legislature required Stat e- chartered banks t o
insure t h e i r accounts with the Federal Deposit Insurance Corporation
( FDIC) which was established i n 1933 t o protect depositors against bank
f a i l u r e . In 1960 the Legislature required State- chart ered savings and
loan associations t o o b t a i n s i m i l a r Federal insurance and i n 1977
St a t e- chart ered c r e d i t unions were required t o carry insurance on accounts
with the National Credit Union Administrat ion ( NCUA) .
As a r e s u l t of these changes, both the State Banking Department and
Federal agencies a r e involved i n oversight of state- chartered banks,
savings and loan associations and c r e d i t unions. To protect t h e i r
i n t e r e s t ( insurance) i n State- chartered i n s t i t u t i o n s , Federal agencies now
also oversee the functional operations of these f i n a n c i a l i n s t i t u t i o n s .
Federal agencies and the Department conduct joint examinations, and A. R. S.
$ 6- 128 allows the Department t o accept Federal examination reports i n l i e u
of S t a t e examinat ions.
During the past 5 years, the Banking Department conducted 28 a u d i t s of
Stat e- chart ered i n s t i t u t i o n s using its own examiners and 24 j o i n t a u d i t s
with Federal agencies. Federal agencies made 15 examinations on t h e i r
own. The Department devoted over 4,400 s t a f f days t o examinations during
the period, while the Federal agencies spent almost 4,800 s t a f f days.
F i n a n c i a l E n t e r p r i s e s - Legislation enacted since the 1950s has added
f i n a n c i a l e n t e r p r i s e s t o t h e Banking Department ' s r e s p o n s i b i l i t i e s .
Enterprises a r e a c t i v i t i e s under the j u r i s d i c t i o n of the Department which
involve f i n a n c i a l t r a n s a c t i o n s but are not i n s t i t u t i o n s under Arizona
law. These a c t i v i t i e s include c o l l e c t i o n agencies, escrow agents, debt
management companies, mortgage brokers, mot o r v e h i c l e d e a l e r s and s a l e s
finance companies. The Department is responsible f o r licensing,
investigating complaints and examining 1,427 f i n a n c i a l e n t e r p r i s e s ( Table
3). Unlike requirements f o r examining f i n a n c i a l i n s t i t u t i o n s , State law
does not require a specific frequency of examination f o r enterprises.
TABLE 3
LICENSED FINANCIAL ENTERPRISES, MAY 31, 1983
Ent e r ~ r i s e
Collection Agencies
Debt Management Companies
Escrow Agents
Mortgage Brokers
Motor Vehicle Dealers
Sales Finance Companies
Total
Number of
Home Off i c e s
Number of
Branches
Source: State Banking Department
Budget and Personnel
Although t h e Department operating budget i s appropriated from the General
Fund, it c o l l e c t s f e e s from the industry f o r examinations, licenses,
applications and investigations. The r e c e i p t s go i n t o t h e General Fund.
Revenues from fees and expenditures a r e shown i n Table 4.
TABLE 4
BANKING DEPARTMENT EXPENDITURES AND REVENUES,
FISCAL YEARS 1981- 82 THROUGH 1983- 84
Expenditures
General Fund :
FTE posit ions
Actual Est imat ed Approved
1981- 82 1982- 83 Budget 1983- 84
Personal services $ 740,100 $ 692,900
Employ ee- relat ed expenses 144,700 139,700
Professional and out side
services 4,500 2,500
Travel 51,100 53,500
Other operating expenses 42,500 35,000
Equipment 700 5 00 Lump sum
Total $ 983,600 $ 924,100 $ 1,181,400
Revenues $ 1,087,100 $ 1.159.500 $ 1,600,000
Source: Compiled by Auditor General s t a f f from Joint Legislative Budget
Committee Appropriat ions Report and Banking Department budget requests.
In addition, t h e Department has a $ 50,000 revolving fund derived from
c i v i l penalties assessed against i n s t i t u t i o n s and e n t e r p r i s e s . The
purpose of the fund is t o meet investigation and prosecution expenses.
During 1983 the Department purchased data processing equipment f o r use i n
conducting investigations.
The Department had 32 positions during 1982- 83. The 1983- 84 budget
authorizes an additional nine examiners, three of which w i l l concent r a t e
t h e i r e f f o r t s on investigations. The Department is organized i n t o f i v e
divisions. Four divisions a r e i n Phoenix: Banking, Savings and Loans,
Licensing and Financial Enterprises and Consumer Affairs and
Administrative Services. Two examiners work out of a f i f t h division
located i n Tucson.
Audit Scope and Purpose
Our audit focuses on t h e a b i l i t y of t h e State Banking Department t o
perform d u t i e s a s outlined by s t a t u t e . The a u d i t r e p o r t presents findings
and recommendations i n four major areas:
The need f o r Banking Department regulation of small loan companies,
The effectiveness of f i n a n c i a l enterprise regulation,
The adequacy of Departmental oversight of f i n a n c i a l i n s t i t u t i o n s
and the efficiency of its personnel u t i l i z a t i o n , and
Conflict of i n t e r e s t s t a t u t e s .
In addit ion, we developed information on i n t e r s t a t e banking, Banking
Department work- space need s and implementat ion of recommendat ions made i n
the 1979 Auditor General performance audit on regulation of collection
agencies. The s e c t i o n " Other Pertinent Information" presents t h i s
informat ion.
Due t o time c o n s t r a i n t s , we were unable t o address a l l p o t e n t i a l issues
i d e n t i f i e d during our preliminary audit work. The section " Areas f o r
Further Audit Work" describes t h e s e p o t e n t i a l issues.
The Auditor General and s t a f f express appreciation t o the Superintendent
of Banking and Department employees f o r t h e i r cooperation and assistance
during the audit.
SUNSET FACTORS
In accordance with A. R. S. $ 41- 2354, the Legislature should consider the
following 11 f a c t o r s i n determining whether the Banking Department should
be continued or terminated .
Objective and purpose i n establishing t h e Agency
Although Banking Department s t a t u t e s contain no e x p l i c i t statements of
l e g i s l a t i v e i n t e n t , A. R. S. $ 6- 110 s t a t e s t h e Department w i l l
". . . have charge of the execution of the laws of t h e s t a t e r e l a t i n g
t o f i n a n c i a l i n s t i t u t i o n s and enterprises." The Superintendent
describes the Department's purpose a s one of protecting the public
welfare by " protecting the f i n a n c i a l a s s e t s of t h e c i t i z e n s of
Arizona." This is accomplished by 1) l i c e n s e requirements, 2)
examinations, and 3) resolution of consumer complaints.
The Department has r e s p o n s i b i l i t y f o r two areas of f i n a n c i a l a c t i v i t y ,
i n s t i t u t i o n s and e n t e r p r i s e s . A. R. S. $ 6- 181 s t a t e s that regulation of
banks provides f o r the safe and sound conduct of banks and t h e
protect ion of i n t e r e s t s of depositors , f i d u c i a r y b e n e f i c i a r i e s and the
public. A. R. S. s6- 181 may apply t o other i n s t i t u t i o n s such a s c r e d i t
unions and savings and loan associations. In recent y e a r s t h e s e
i n s t i t u t i o n s have become more l i k e banks, offering similar services
and performing l i k e functions. Consumer protection is the primary
f a c t o r f o r regulating f i n a n c i a l enterprises. Although s t a t u t e s do not
declare a specific purpose f o r regulating e n t e r p r i s e s , Department
o f f i c i a l s contend that laws regarding e n t e r p r i s e s protect the public
from abusive practices such a s fraud, misrepresentation and
embezzlement.
2. The effectiveness with which the Agency has met its objective and
purpose and the efficiency with which it has operated
Banking s t a t u t e s mandate periodic examinations of f i n a n c i a l
i n s t i t u t i o n s but not e n t e r p r i s e s . The Department appears t o be
e f f e c t i v e l y meeting the s t a t u t o r y requirements f o r examining
i n s t i t u t i o n s with the exception of t r u s t companies. In the case of
t r u s t s , the Department recognizes the problem and is taking action t o
improve f u t u r e compliance ( see pages 39- 41).
The Superintendent has authority t o perform examinations of licensed
e n t e r p r i s e s but is not mandated t o do so. Presently the Department
examines e n t e r p r i s e s when t h e r e a r e indications of problems o r i l l e g a l
a c t i v i t i e s . Although t h i s approach meets the s t a t u t o r y requirements,
it provides limited oversight of enterprise operat ions. The
Department needs t o improve supervision of e n t e r p r i s e s by examining a
sample of e n t e r p r i s e s each y e a r ( s e e pages 33- 36).
The Department can also improve its efficiency i n the use of
personnel. The Department should: 1) i n v e s t i g a t e the p o t e n t i a l f o r a
revised audit scope t o reduce personnel requirements and 2) develop a
personnel management system t o more accurately estimate work load and
s t a f f needs ( see pages 41- 44).
The extent t o which the Agency has operated i n t h e public i n t e r e s t
The Banking Department operates i n the public i n t e r e s t by protecting
t h e f i n a n c i a l a s s e t s of t h e c i t i z e n s through the following a c t i v i t i e s :
Investigating new applicants. The Department performs a
background check on each applicant f o r i n s t i t u t i o n charters
and most enterprise licenses. Based on the outcome of the
investigation, the department issues or denies the application.
Examining i n s t i t u t i o n s and enterprises. The Department
performs regular examinat ions of f i n a n c i a l i n s t i t u t i o n s t o
determine the soundness of operat ions and t o prevent abusive
practices. The Department currently examines e n t e r p r i s e s only
when problems occur. Routinely examining e n t e r p r i s e s would
more adequately serve the public i n t e r e s t ( see pages 33- 37).
Investigating unlicensed a c t i v i t i e s . When unlicensed
a c t i v i t i e s a r e suspected, the Department w i l l i n v e s t i g a t e . I f
the i n v e s t i g a t i o n confirms the suspicions, the Department
requires the operator t o obtain a license or cease operation
and may take appropriate l e g a l action.
Resolving consumer complaints. The Division of Consumer
Af f a i r s and Administrative Services i n v e s t i g a t e s and resolves
consumer complaints. A consumer complaint may lead t o a
f u l l - s c a l e i n v e s t i g a t i o n or examinat ion, i f warranted.
4. The extent t o which r u l e s and regulations promulgated by t h e Agency
are consistent with t h e l e g i s l a t i v e mandate
The Department has broad rule- making authority a s s t a t e d i n A. R. S.
$ 6- 123. The Attorney General has approved t h e Department ' s current
r u l e s and regulations and c e r t i f i e d t h a t they are consistent with the
s t a t u t e s . A review of the rules and regulations showed t h a t they
focus on licensing/ renewal requirements and operating procedures. The
Department's regulations a r e consistent with t h e mandate t o promote
sound operations and t o protect the consumer.
The Department is currently promulgating rules and regulations f o r two
types of f i n a n c i a l enterprises, escrow agents and mortgage brokers.
Because of s t a t u t o r y changes made during the 1983 Legislative session,
t h e Department is also repealing some savings and loan association
regulations t o maintain consistency with t h e new law.
5. The extent t o which the Agency has encouraged input from the public
before promulgating its rules and regulations and the extent t o which
it has informed the public a s t o its actions and t h e i r expected impact
on the public
The Banking Department has encouraged public input f o r proposed
revisions i n its rules and regulations but provides l i t t l e information
t o the public about its actions. The Department appears t o be
complying with the Administrative Procedures Act. The Department is
currently i n the process of repealing four r u l e s and regulations. As
required by law, the Department has sent the proposal t o interested
p a r t i e s f o r comment. However, public information is limited . The
Department seldom issues newsletters or press releases t o inform the
public of Department a c t i v i t i e s . The Superintendent c i t e s s t a t u t o r y
requirements ( A. R. S . 96- 129) t o preserve c o n f i d e n t i a l i t y of
information a s reason for not actively providing information t o the
public .
The Department's reluctance t o inform the public of its a c t i v i t i e s and
areas of r e s p o n s i b i l i t y may diminish its effectiveness. The
Department's Assistant Attorney General told us t h a t t h e public does
not always r e a l i z e that the Banking Department regulates operations
other than banks. For example, a representative of the Better
Business Bureau said she thought the Department regulated only banks
and collection agencies. Consequently, complaints may not reach the
Department.
6 . The extent t o which the Agency has been able t o investigate and
resolve complaints within its j u r i s d i c t i o n
The Department appears t o have responded adequately t o complaints .
During f i s c a l year 1982- 83, 799 complaints were f i l e d . We sampled 100
of these complaints and found t h a t t h e Department handled them i n a
timely manner, with i n i t i a l action generally taken within two days.
Complaints were resolved within 18 days on the average. Twenty- nine
complaints were resolved i n the consumer's favor and fifty- one were
resolved i n the institution/ enterprisels favor . Only f i v e of the
sampled complaints investigated violated Arizona Revised Statutes.
The remaining cases are i n l i t i g a t i o n or have not been resolved i n
e i t h e r party's favor.
7. The extent t o which the Attorney General or any other applicable
agency of State government has the authority t o prosecute actions
under enabling l e g i s l a t i o n
The Attorney General has t h e a u t h o r i t y t o prosecute actions concerning
a l l Department s t a t u t e s . The Superintendent indicates t h a t the
Department has a complete range of d i s c i p l i n a r y options including the
a b i l i t y t o 1) remove o f f i c e r s and d i r e c t o r s of any licensee, 2) issue
memoranda of understanding, 3) issue cease and d e s i s t orders, and 4)
seek c i v i l penalties through court action.
The Attorney General's o f f i c e reported that as of April 30, 1983, six
cases were i n l i t i g a t i o n and two cases were a t the administrative
hearing level. The o f f i c e a l s o reported t h a t from July 1, 1982, t o
April 30, 1983, three judgments and eight cease and d e s i s t orders were
issued i n cases involving unlicensed o r i l l e g a l a c t i v i t i e s . Civil
p e n a l i t i e s t o t a l e d $ 232,000 i n these cases.
8. The extent t o which the Agency has addressed d e f i c i e n c i e s i n the
enabling s t a t u t e s which prevent it from f u l f i l l i n g its s t a t u t o r y
mandate
The Department frequently attempts t o c l a r i f y or strengthen s t a t u t e s
through minor amendments. The Department has proposed several changes
i n recent Legislative sessions such as revising c r e d i t union laws and
regulating individual retirement accounts . The Department has also
proposed new l e g i s l a t i o n i n a n t i c i p a t i o n of future needs or i n
reaction t o current problems. For example, during the 1983 session
the Department sought and obtained j u r i s i d i c t i o n over f i n a n c i a l
holding companies with the passage of Senate B i l l 1320.
9. The extent t o which changes are necessary i n the laws of the Agency t o
adequately comply with the f a c t o r s l i s t e d i n the Sunset laws
Based on our audit work, we recommend the Legislature consider making
the following changes i n t h e Banking Department s t a t u t e s :
Amend A. R. S. $ 6- 601 - e t seq t o remove a l l licensing
requirements f o r small loan companies and a l l i n t e r e s t r a t e
l i m i t a t i o n s placed on these companies ( see page 24).
a Amend A. R. S. $ 44- 1201 - et 3 t o require a l l lenders t o f u l l y
inform each borrower about a l l State and Federal requirements
concerning allowable charges and methods of computing
i n t e r e s t r a t e s ( see page 25).
Amend A. R. S. $ 44- 1201 - e t seq t o e x p l i c i t l y empower the
Attorney General t o enforce a l l State laws regulating lending
a c t i v i t i e s ( see page 25).
Amend A. R. S. $ 44- 281 - e t seq t o d e l e t e a l l licensing
requirements f o r mot o r v e h i c l e dealers and sales finance
companies and t o empower the Attorney General t o i n v e s t i g a t e
violations of the Motor Vehicle Time Sales Disclosure Act
( see page 37).
a Amend A. R. S. $ 6- 101 t o d e l e t e reference t o $ 44- 281 - e t seq
from the d e f i n i t i o n of " T i t l e . " This change would make
Banking Department s t a t u t e s no longer applicable t o motor
vehicle d e a l e r s and sales finance companies ( see page 37).
Amend A. R. S. $ 6- 113 t o
a. Allow professional s t a f f t o r e t a i n loans with e n t i t i e s
regulated by the Department i f 1) the loan existed
prior t o employment with the Department and 2) the
employee continues t o amortize the loan under its
original t e r n s and
b. Require t h a t each employee f u l l y d i s c l o s e a l l loans
with e n t i t i e s regulated by the Department and the terms
of such loans a t t h e time of i n i t i a l employment ( see
page 47).
10. The extent t o which the termination of the k e n c v would sirrnificantlv
harm the public health, safety or welfare
Termination of t h e Banking Department would harm the public by
increasing its exposure t o deceptive practices of f i n a n c i a l
e n t e r p r i s e s and reducing Arizona' s c o n t r o l over f i n a n c i a l
i n s t i t u t i o n s . The Banking Department is the only State regulatory
authority responsible f o r e n t e r p r i s e s which pose economic r i s k s t o
consumers. The Department shares oversight of f i n a n c i a l i n s t i t u t i o n s
with a variety of Federal agencies and some overlap e x i s t s . However,
the Department's chartering and examination of f i n a n c i a l i n s t i t u t i o n s
allow S t a t e a u t h o r i t i e s t o c o n t r o l t h e development and operation of
these very important economic a c t i v i t i e s .
11. The extent t o which t h e l e v e l of regulation exercised by the Agency is
appropriate and whether less or more s t r i n g e n t l e v e l s would be
appropriate
Banking Department regulation of f i n a n c i a l i n s t i t u t i o n s is
appropriate . The Department meets s t a t u t o r y requirements f o r
examinations. However, some regulation is not needed. The
Legislature should consider eliminating State licensing of consumer
finance companies, motor vehicle dealers and s a l e s finance companies.
None of these a c t i v i t i e s pose extensive harm t o individual consumers
which cannot be addressed through other less r e s t r i c t i v e methods.
Strengthening laws which require lenders t o inform borrowers about
charges, i n t e r e s t and loan requirements would adequately protect
consumers ( see pages 24- 26 and 37).
Regulation of four types of e n t e r p r i s e s is not adequate. Mortgage
brokers, escrow agents, c o l l e c t i o n agents and debt management
companies can pose s i g n i f i c a n t f i n a n c i a l harm t o consumers. However,
t h e Banking Department does not routinely examine t h e s e e n t e r p r i s e s .
To deter p o t e n t i a l fraud and abuse, the Department needs t o e s t a b l i s h
procedures t o examine a random sample of f i n a n c i a l e n t e r p r i s e s each
y e a r ( s e e page 37).
FINDING I
LICENSING SMALL LOAN COMPANIES IS NOT NECESSARY TO PROTECT CONSUMERS.
Protecting consumers does not r e q u i r e l i c e n s i n g small loan companies.
Licensing is voluntary and the regulated portion of the loan industry is
steadily shrinking. Further, consumer harm has been minimal. With
s u f f i c i e n t information, consumers can adequately protect themselves when
borrowing money from a l l lenders.
Recent changes i n t h e s t a t u t e s governing money lenders i n Arizona have
created a confusing, inconsistent regulatory environment. Prior t o 1980,
usury s t a t u t e s limited i n t e r e s t r a t e s t o 12 percent. Companies wishing t o
exceed t h i s l i m i t could make loans with i n t e r e s t up t o 36 percent i f the
company obtained a l i c e n s e from the Banking Department and complied with
s t a t u t e s and regulations governing such loans. The 1980 Legislature
removed i n t e r e s t r a t e s from a l l loans except those made by licensed
companies. As a r e s u l t , t h e loan industry is divided i n t o licensed and
unlicensed segments, each of which is subject t o a variety of regulations
often a t a company's own discretion.*
Small Loan Companies A r e
Not Reauired t o Be Licensed
Arizona s t a t u t e s authorize the Banking Department t o license consumer
finance companies but do not require any small loan company t o obtain a
license from t h e Department. The Banking Department i n t e r p r e t s the
s t a t u t e s a s requiring only those companies which a d v e r t i s e " consumer loan"
services t o be licensed. Therefore, loan companies may determine the
extent t o which they w i l l be subject t o Departmental regulation by
deciding whether or not t o seek a license. Because companies choosing t o
be licensed are subject t o more regulatory requirements than unlicensed
* Appendix I describes the regulatory requirements f o r both licensed and
unlicensed loan companies.
companies, t h e law provides an economic incentive f o r companies not t o be
l i c e n s e d . As a r e s u l t , t h e number of licensed s m a l l loan companies i n
Arizona h a s d e c l i n e d i n r e c e n t y e a r s .
Licensing Requirements A r e Not Mandatory - Arizona law does not require
s m a l l loan companies t o obtain a l i c e n s e . An Arizona L e g i s l a t i v e Council
Opinion, issued August 23, 1983, s t a t e s t h a t A. R. S. t i t l e 6, chapter 5,
a r t i c l e 1 does not require anyone making a consumer loan t o be licensed by
the S t a t e . More s p e c i f i c a l l y , t h e L e g i s l a t i v e Council Opinion noted :
" Under t h e Arizona consumer loan a c t , A. R. S. s e c t i o n
6- 602, subsection A s t a t e s t h a t it is unlawful f o r a
person t o make a consumer loan and charge and c o l l e c t
i n t e r e s t at a r a t e higher than t h e general usury r a t e
unless t h e person f i r s t obtains a l i c e n s e . Since i n
Arizona t h e general usury r a t e is t h e rate s e t by t h e
marketplace, i . e . , t h e r e is no longer a prescribed
l i m i t , A. R. S. s e c t i o n 6- 602 has no e f f e c t i n requiring
a consumer lender t o become licensed." *
Banking Department Requires Some Licenses - Although t h e s t a t u t e s do not
r e q u i r e l i c e n s i n g f o r small loan companies, t h e Banking Department requires
some loan companies t o b e l i c e n s e d . The Department i n t e r p r e t s A. R. S.
$ 96- 601 and 6- 602 t o require companies which a d v e r t i s e or represent t h e i r
s e r v i c e s as " consumer loans" t o obtain a l i c e n s e . A. R. S. $ 6- 601 defines
consumer loans a s those i n amounts of $ 10,000 or less and A. R. S. $ 6- 602.~.
states, " Any person . . . who a d v e r t i s e s f o r , s o l i c i t s o r holds himself out
as w i l l i n g t o make o r procure a consumer loan is presumed t o be i n the
business prescribed i n t h i s subsection." Based on t h e Department's
i n t e r p r e t a t i o n , only those companies which choose t o represent t h e i r
s e r v i c e s as " consumer loans" a r e required t o be licensed. Companies
representing t h e i r s e r v i c e s under other terms such a s " personal loans" a r e
not required t o be licensed. However, based on t h e L e g i s l a t i v e Council
Opinion, t h e Department's a u t h o r i t y t o require any loan company t o be
licensed may be quest ionable.
* See Appendix I1 f o r t h e f u l l t e x t of t h e L e g i s l a t i v e Council Opinion.
16
Licensed and Unlicensed Companies Subject t o Different Regulatory
Requirements - Licensed and unlicensed small lenders are subject t o
d i f f e r e n t regulatory requirements. A l l loan companies must adhere t o the
Federal truth- in- lending requirements of Regulation Z. However, those
companies which e l e c t t o be licensed a r e a l s o subject t o additional
requirements of Arizona law.
Federal Regulation Z-- truth i n lending-- establishes disclosure
requirement s f o r both licensed and unlicensed small loan companies.
Truth- in- lending regulations require the c r e d i t o r t o provide the borrower
with specific information about the loan i n an i n i t i a l disclosure
statement ( see Figure 1 ) . Truth i n lending seeks t o inform the borrower
of i n t e r e s t charge calculations and r a t e s t o allow consumers t o make
comparisons among d i f f e r e n t sources.
In addition t o t h e Federal regulations, Arizona law places c e r t a i n
r e s t r i c t i o n s on loans made by licensed companies. These provisions
include:
- i n t e r e s t r a t e l i m i t a t i o n s ( A. R. S. $ 6- 622),
- allowable charges ( A. R. S. $ 6- 628),
- annual examinations ( A. R. S. $ 6- 122), and
- disclosure requirements ( A. R. S. $ 6- 621).
These s t a t u t e s delineate maximum i n t e r e s t charges and specify other
charges that companies may assess against borrowers. They also mandate
that consumers receive a copy of the s t a t u t e s which specify t h e i n t e r e s t
r a t e limitations.* The s t a t u t e s a l s o require the Banking Department t o
examine each licensed company annually. However, only the consumer loan
portion of a l i c e n s e e ' s business is bound by these requirements.
Licensees may also offer loans i n greater amounts under the authority of
A. R S. $ 44- 1201 - e t seq.
* Licensees are not required t o disclose which financing charges or
types of insurance a r e permitted for consumer loans.
As i l l u s t r a t e d i n Figure 1, unlicensed companies conduct t h e i r lending
a c t i v i t i e s e n t i r e l y under the a u t h o r i t y of t h e usury s t a t u t e s A. R. S.
§ 44- 1201 - e t 3. T hese companies may charge whatever i n t e r e s t r a t e s the
marketplace w i l l bear.* Other charges which may be assessed t h e consumer
are s p e c i f i e d i n A. R. S. $$ 44- 1205. A. 3 and 44- 1205. B. These loans are
bound only by the Federal t r u t h- in- lending d i s c l o s u r e requirements.
Unlicensed companies are not e x p l i c i t l y required t o reveal what financing
charges or c r e d i t - r e l a t e d insurance p o l i c i e s a r e permitted i n the usury
s t a t u t e s .
Reduction of Licensed Companies and Consumer Loans - The number of
licensed small loan companies and amount of consumer loans has decreased.
Since 1980 Arizona's usury s t a t u t e s have provided an economic incentive
f o r companies t o choose not t o be licensed. P r i o r t o t h a t year licensed
companies could charge higher i n t e r e s t on t h e i r l o a n s t h a n unlicensed
companies. The law now provides the o p p o s i t e i n c e n t i v e : companies which
a r e not licensed face no l i m i t s on t h e i r i n t e r e s t charges while licensed
companies may charge only t h e i n t e r e s t allowed by law.
The number of l i c e n s e s decreased by approximately 34 percent between
f i s c a l years 1978- 79 and 1982- 83 ( Figure 1). However, many of these
companies remain i n business making loans. For example, 6 of the 18
companies i n Phoenix which surrendered l i c e n s e s during 1981- 82 were l i s t e d
i n t h e February 1983 Yellow Pages and s t i l l make small loans. In
a d d i t i o n , the majority of the small loan companies l i s t e d i n those same
Yellow Pages were unlicensed a s of June 30, 1983. This reduction of
l i c e n s e e s has occurred statewide.
* A. R. S. $ § 13- 2301 and 13- 2302 i n d i c a t e an annual percentage r a t e
which exceeds 45 percent could be considered an e x t o r t i o n a t e
extension of c r e d i t .
FIGURE 1
NUMBER OF LICENSED SMALL LOAN COMPANIES,
FISCAL YEARS 1978- 79 THROUGH 1982- 83
Source : Banking Department records
Moreover, " consumer loans" appear t o comprise an increasingly smaller
portion of the licensed companies' t o t a l lending a c t i v i t i e s . As
i l l u s t r a t e d i n Figure 2, t h e licensed small loan companies have remained
p r o f i t a b l e , d e s p i t e a reduction i n the amount of money loaned a s " consumer
loans." Total consumer loans decreased by 23 percent between 1978 and
1982, but t o t a l p r o f i t s on a l l loans almost t r i p l e d . Thus, licensees
appear t o be deemphasizing consumer loans i n t h e i r asset bases and
concentrating on other types of loans.
FIGURE 2
TREND I N SMALL LOAN INDUSTRY PROFITS VS THE AMOUNT OF
CONSUMER LOANS, FISCAL YEARS 1978- 79 THROUGH 1981- 82
Millions
of
Dollars
b-\ I Total Consumer Loans
Total Net Earnings
Source : Banking Department records
Arizona r e g u l a t e s loans i n two very d i f f e r e n t ways. The L e g i s l a t u r e h a s
prescribed i n t e r e s t r a t e l i m i t a t i o n s f o r consumer loans and directed the
Banking Department t o supervise the a c t i v i t i e s of companies making these
loans. At the same time, however, no company is required t o submit t o
Departmental r e g u l a t i o n and the law does not l i m i t i n t e r e s t r a t e s on other
loans which c o n s t i t u t e t h e majority of loan a c t i v i t y . As a r e s u l t ,
r e g u l a t i o n is i n c o n s i s t e n t .
Although borrowing money poses some r i s k , consumers can assume t h e
r e s p o n s i b i l i t y f o r protecting themselves i f they have s u f f i c i e n t
information. However, existing disclosure requirements do not provide t h e
borrower with s u f f i c i e n t information t o permit comparisons among lenders.
Strengthening e x i s t i n g d i s c l o s u r e requirements, supported by a consumer
brochure, could provide the consumer with information necessary t o make
knowledgeable c r e d i t decisions.
Rationale f o r Licensing - Occupational and professional licensing and
regulation seek t o prevent s i g n i f i c a n t harm t o the public which may r e s u l t
from the unrestricted practice of p a r t i c u l a r occupation. The Council of
State Governments has published c r i t e r i a f o r assessing the p o t e n t i a l f o r
harm i n a given occupation. Based on these c r i t e r i a , the S t a t e should
regulate a p a r t i c u l a r occupation i f
@ t h e unlicensed practice of an occupation poses a serious r i s k t o
the consumer's l i f e , health o r o r economic well- being;
the p o t e n t i a l users of the occupational service cannot be expected
t o possess the knowledge needed t o properly evaluate the
q u a l i f i c a t i o n s of those offering services; and
the benefits t o the public c l e a r l y outweigh any potentially
harmful e f f e c t s such a s a decrease i n the a v a i l a b i l i t y of
services, higher c o s t s of goods and services and r e s t r i c t i o n s on
optimum u t i l i z a t i o n of personnel.
In the case of small loan companies the amount and likelihood of harm
coupled with consumers ' p o t e n t i a l s t o evaluate the services indicate
licensing is not necessary.
Harm t o Consumers - Although borrowing money may e n t a i l some r i s k f o r the
consumer, the r i s k is minimal. The Banking Department examines each small
loan company annually, but these examinations have i d e n t i f i e d few
problems. In addition, the Department receives r e l a t i v e l y few complaints
about small loan companies, and there has been no indication of widespread
harm caused by t h e unlicensed companies.
Department examinations of licensed companies reveal few violations of
s t a t u t e s . During examinat ions, Department s t a f f i d e n t i f y a r e a s of
noncompliance ( recorded a s e r r o r s ) with A. R. S. s6- 601 et seq. In f i s c a l
7-
year 1982- 83, the Banking Department found no e r r o r s i n approximately 57
percent of the companies examined. Furthermore, the majority of companies
where e r r o r s were i d e n t i f i e d had three or fewer e r r o r s .
The Department receives r e l a t i v e l y few complaints about small loan
companies. Only 3 percent of a sample of approximately 100 complaints f o r
1982- 83 were made against small loan companies." Other regulated e n t i t i e s
a t t r a c t e d a much higher l e v e l of complaints ( c o l l e c t i o n agencies, 29
percent ; mortgage companies, 25 percent). Complaints against the small
loan companies involved questions about the appropriateness of a company's
actions and disagreements over f i n a l disposition of the loan. The
Department found no v i o l a t i o n and took no action on any of the three
complaints .
F i n a l l y , t h e f a c t cannot be ignored t h a t a s u b s t a n t i a l proportion of the
loan industry is not licensed-- including many companies which were
formerly licensed under the small loan company s t a t u t e s . Since the 1980
changes i n the usury s t a t u t e s , consumers have been obtaining loans from a
largely unregulated industry with l i t t l e evidence of harm. Thus, there is
no evidence t o suggest t h a t consumers would be a t greater r i s k by removing
what are currently voluntary licensing provisions.
* During 1981- 82, the Department received 44 complaints against small
loan companies, 8 percent of the year's t o t a l complaints.
Consumer Information Not Adequate - Although r i s k s a r e minimal,
requirements do not ensure t h a t consumers w i l l have s u f f i c i e n t informat ion
t o evaluate t erms offered by lenders and make knowledgeable decisions.
Both S t a t e and Federal r e g u l a t i o n s seek t o inform consumers about loan
requirements. But n e i t h e r r e q u i r e s l e n d e r s t o inform borrowers about many
of these requirements. For example, A. R. S. $ 6- 628 p r o h i b i t s l i c e n s e d l o a n
companies from passing a l l but c e r t a i n charges t o consumers. However, the
law does not r e q u i r e l e n d e r s t o inform borrowers of t h e prohibition. The
Federal truth- in- lending r e g u l a t i o n is d e f i c i e n t i n t h e same manner.
Lacking informat ion about l e g a l requirements, consumers may be unable t o
compare charges against requirements and may be unaware t h a t they are
being overcharged.
Strengthened l o a n d i s c l o s u r e requirements coupled with a consumer brochure
can enable t h e consumer t o assume t h e r e s p o n s i b i l i t y of s e l f - p r o t e c t i o n .
The L e g i s l a t u r e should strengthen S t a t e d i s c l o s u r e requirements and make
them applicable f o r - a l l lenders. Lenders should be required t o d i s c l o s e
a l l Federal and S t a t e requirements f o r loan t r a n s a c t i o n s . In t h i s way,
consumers would be aware of t h e p e r t i n e n t information about i n t e r e s t
charges and c a l c u l a t i o n s , which financing charges a r e permitted by the
S t a t e and those insurance p o l i c i e s which may be sold a s a condition of the
loan. A consumer brochure d e t a i l i n g 1 ) t h e s p e c i f i c l i m i t a t i o n s placed on
small lenders and 2) consumer r i g h t s and means of recourse from unfair
p r a c t i t i o n e r s would f u r t h e r assist the consumer i n making decisions.
Equipped with s u f f i c i e n t information, t h e consumer can compare terms among
lenders. Providing consumers with information d e t a i l i n g which i n t e r e s t
and financing charges a r e permitted by law would allow the public t o
compare a c t u a l charges against what is authorized by law and t h e p r i c e s of
v a r i o u s f i n a n c i n g charges among d i f f e r e n t s m a l l loan companies.
Providing consumers with s u f f i c i e n t inf ormat ion t o compare loan t erms and
i n t e r e s t r a t e s would a l s o eliminate the need f o r t h e i n t e r e s t rate
l i m i t a t i o n s i n A. R. S. $ 6- 622. With adequate in£ ormat ion, consumers could
judge i n t e r e s t charges f o r themselves along w i t h o t h e r charges levied by
lenders.
Also, with adequate disclosure requirements, consumers would continue t o
have recourse even i f small loan companies a r e no longer licensed. If
problems occur, complaints against small loan companies could still be
brought t o t h e a t t e n t i o n of the Attorney General's Office or the Federal
Trade Commission. However, Arizona law must contain comprehensive
disclosure requirements which apply t o - a l l lenders to ensure t h a t S t a t e
control is maintained, and the Attorney General's Office w i l l have f u l l
j u r i s d i c a t i o n over the loan industry.
Freeing Department Resources - Eliminating licensure would also f r e e
Department s t a f f for o t h e r d u t i e s . The Banking Department ' s oversight of
licensed small loan companies requires processing license documents,
conducting examinat ions, compiling the Consumer Finance Companies ' Annual
Report and resolving complaints. Relieving the Department of t h i s
regulatory function would f r e e up approximately 1.3 professional staff
positions. In addition, the industry would save approximately $ 46,500 i n
annual examination fees.
CONCLUSION
Licensing small loan companies is not necessary t o protect consumers.
Because Arizona's s t a t u t e s on licensing small loan companies are not
mandatory, the majority of the small loan industry is unregulated.
Lending a c t i v i t i e s can pose some r i s k t o the consumer but strengthening
existing truth- in- lending requirements can allow the consumers t o protect
themselves.
RECOMMENDATIONS
1. The Legislature should consider amending:
a. A. R. S. 36- 601 - e t - seq t o remove a l l licensing requirements for
small loan companies and a l l i n t e r e s t r a t e limitations placed on
these companies,
b. A. R. S. $ 44- 1201 - et - seq t o require a l l lenders t o f u l l y inform
each borrower about State and Federal requirements concerning
allowable charges and methods of computing i n t e r e s t r a t e s , and
c. A. R. S. $ 44- 1201 - e t - seq t o e x p l i c i t l y empower the Attorney General
t o enforce a l l State laws regulating lending a c t i v i t i e s .
2. The Banking Department should prepare a brochure t o inform consumers
about legal requirements governing disclosure of information about
loan charges and i n t e r e s t .
FINDING I1
ALTHOUGH THE STATE BANKING DEPARTMENT NEEDS TO STRENGTHEN SUPERVISION OF
FOUR TYPES OF ENTERPRISES, TWO OTHERS DO NOT REQUIRE DEPARTMENTAL
REGULATION .
Changes are needed i n the regulation of Arizona's f i n a n c i a l enterprises.
Two types of e n t e r p r i s e s , motor vehicle dealers and s a l e s finance
companies, pose limited harm t o consumers and do not need t o be regulated
by the Banking Department. Four o t h e r e n t e r p r i s e s now under the
Department's j u r i s d i c t i o n do c r e a t e f i n a n c i a l r i s k s and require
regulation. However, the Department does not adequately supervise these
e n t e r p r i s e s and needs t o examine them on a regular b a s i s .
Financial e n t e r p r i s e s a r e businesses under the j u r i s d i c t i o n of the Banking
Department which involve f i n a n c i a l transactions but are not i n s t i t u t i o n s
under the law. Arizona law defines s i x types of f i n a n c i a l enterprises:
mortgage brokers, escrow agents, c o l l e c t ion agencies , debt management
companies, mot or vehicle d e a l e r s and s a l e s finance companies. Over 1,400
e n t e r p r i s e s conduct business i n Arizona and t h e i r operations encompass a
wide range of f i n a n c i a l a c t i v i t i e s ( Table 5). Although these a c t i v i t i e s
are under the supervision of the Banking Department, Arizona law does not
mandate a specific examination schedule a s is the case f o r f i n a n c i a l
i n s t i t u t i o n s .
Need f o r Regulation
Two of the s i x e n t e r p r i s e s under the supervision of the Banking
Department, mot or vehicle d e a l e r s and s a l e s finance companies, pose
limited harm t o consumers. Continued regulation is not required f o r these
e n t e r p r i s e s because consumers can adequately protect themselves i f the
Legislature strengthens existing truth- in- lending s t a t u t e s . In c o n t r a s t ,
the remaining four e n t e r p r i s e s can c r e a t e serious f i n a n c i a l harm t o
individuals and businesses who use t h e i r services. Banking Department
regulation is necessary t o protect consumers who have l i t t l e recourse f o r
protecting themselves against f i n a n c i a l losses from mortgage brokers,
escrow agents, c o l l e c t i o n agents and debt management companies.
2 7
TAELE 5
TYPES AND NUMBER OF LICENSED FINANCIAL ENTERPRISES
MAY 31, 1983
Home
Offices Branches
Motor Vehicle Dealers
S e l l on a noncash b a s i s t h r e e or more
motor vehicles a t r e t a i l i n any year
Sales Finance Companies
Purchase r e t a i l installment contracts f o r
motor vehicles from one or more r e t a i l s e l l e r s ;
a l s o a r e t a i l s e l l e r who c r e a t e s and holds
motor vehicle installment contracts which exceed
a t o t a l aggregate of outstanding indebtedness
of $ 25,000
Mortgage Brokers
Receive compensat ion for negotiating a
mortgage loan; a mortgage loan is any
loan secured by a mortgage or deed of
t r u s t on r e a l e s t a t e
Escrow Agents
Hold it ems of value ( property, money,
or evidence of t i t l e or possession) for
another u n t i l f u l f i l l m e n t of a condition
a t which time items are delivered t o a third
Collect ion Agencies
Collect claims owed t o another party ;
also any person who i n the process
of collecting debts occurring i n the operation
of his own business, uses any name other than his
own which would i n d i c a t e t h a t a third person is
collecting such debts
Debt Management Companies
As agent of a debtor, d i s t r i b u t e payment
of obligations t o debtor's creditors
Total
Source: Compiled by Auditor General staff from Arizona Revised Statutes and
State Banking Department records.
Licensing Not Needed f o r Two Enterprise Categories - Continued licensing
of motor vehicle d e a l e r s and s a l e s finance companies is unnecessary.
These businesses pose limited harm t o consumers. Arizona law provides
adequate information t o allow consumers t o protect themselves i n dealing
with these businesses.
Although motor vehicle dealers who sell on contract are one of t h e largest
, enterprise categories, the Department receives few complaints. Only 1 of
the 100 1982- 83 complaints we reviewed involved t h i s a c t i v i t y ; only 7 of
the 573 complaints during the previous f i s c a l year were about motor
v e h i c l e d e a l e r s . The individual harm is usually small and r e s u l t s from
dealers f a i l i n g t o accurately inform consumers about i n t e r e s t charges.
S a l e s f i n a n c e companies purchase installment contracts from motor vehicle
dealers and i n some cases actually w r i t e c o n t r a c t s . The p o t e n t i a l harm is
similar t o t h a t of motor vehicle dealers i f the finance company writes the
contract. If the company purchases t h e c o n t r a c t , t h e dealer who
o r i g i n a l l y wrote the contract c r e a t e s the p o t e n t i a l harm. Only 1 of the
100 complaints we reviewed f o r 1982- 83 was made against a sales finance
company. The complainant alleged t h a t the company fraudulently attempted
t o c o l l e c t debts and repossess automobiles. The Banking Department found
no v i o l a t i o n of law and took no action against the company.
Licensing motor vehicle d e a l e r s and s a l e s finance companies does not
appear t o be an e f f e c t i v e means of protecting consumers. Because s t a t u t e s
do not authorize i n v e s t i g a t i o n fees f o r these e n t e r p r i s e s , the Banking
Department makes only minimal investigations of applicants f o r licenses.
A l l applicants during the f i r s t seven months of 1983 were approved. Thus,
licensing does not appear t o pose a meaningful b a r r i e r t o unscrupulous
persons. Equally important, consumers may borrow funds from other
sources, such a s unlicensed small loan companies ( see pages 15- 26) which
make loans f o r similar purposes. As a r e s u l t , licensing does not appear
necessary t 0 protect consumers.
Arizona law and Federal regulations provide an e f f e c t i v e alernative t o
licensing and regulation by the Banking Department. The Motor Vehicle
Time Sales Disclosure Act ( A. R. S. 544- 281 - e t - seq ) e s t a b l i s h e s requirements
and prohibitions f o r motor vehicle contracts. For example, the law
requires t h a t contracts be i n writing and warn consumers not t o sign i f
any provisions are l e f t blank. In addit ion, Federal t ruth- in- lending
regulations, enforced by the Federal Trade Commission, require lenders t o
d i s c l o s e contract terms and charges t o a l l borrowers. Thus, the law
o f f e r s consumers some means t o protect themselves against a l l businesses
which make vehicle loans.
Strengthening Arizona law as recommended i n Finding I ( see pages 24- 26)
w i l l enable consumers t o decide f o r themselves about mot or vehicle
contracts. Authorizing the Attorney General t o i n v e s t i g a t e v i o l a t i o n s of
the Motor Vehicle Time Sales Disclosure Act w i l l provide consumers with
adequate recourse i f problems occur.* By taking t h e s e a c t i o n s , the
Legislature w i l l eliminate the need t o regulate mot or vehicle dealers and
s a l e s finance companies beyond the requirements applicable t o a l l lenders.
Continued Regulation Needed f o r Four Enterprise Categories - In contrast
t o the two e n t e r p r i s e s discussed above, continued regulation is needed for
the remaining four enterprise categories. The primary need f o r regulating
mortgage brokers, escrow agents, collection agencies and debt management
companies a r i s e s from the large sums of money these e n t e r p r i s e s hold i n
t r u s t . Combined with complex operating procedures at the various
e n t e r p r i s e s , these t r u s t funds provide opportunities f o r fraud and abuse.
MORTGAGE BROKERS AND ESCROW AGENTS offer the most dramatic examples of
need f o r regulation. Although the Department lacks specific information
on the s i z e s of these companies, one o f f i c i a l estimated that a large
brokerage company can exceed $ 100 million i n loans per year. Recent
Departmental investigations have revealed cases involving major fraud.
* According t o the Banking Department ' s Assistant Attorney General, the
Attorney General can now investigate such violations only a t the
Superintendent ' s request.
Example 1
A mortgage broker concealed adverse information about property f o r
which c l i e n t s were lending money. The company also concealed
reports of unsatisfactory c r e d i t ratings on potential borrowers,
misrepresented it s services i n advertisement s, misrepresented
charges, made unauthorized charges t o customers and concealed
charges. A two- year investigation resulted i n more than $ 825,000
r e s t i t u t i o n t o borrowers and lenders and payment t o the State of
over $ 200,000 i n c i v i l penalties and attorney fees.
Other investigations of mortgage brokers have resulted i n r e s t i t u t i o n s of
$ 5,400 and $ 7,600 f o r similar violations. Department o f f i c i a l s a n t i c i p a t e
that a current investigation w i l l identify over $ 1 million i n losses. In
a similar manner, escrow agents can also harm consumers.
Example 2
An escrow agency handled an account involving several i l l e g i t i m a t e
land sales and t r a n s f e r s . Although the agency knew or should have
known of the fraudulent practices, it did not disclose the
information t o the lenders. The Banking Department obtained a
consent judgment against the company and its president which
resulted i n $ 25,000 i n r e s t i t u t i o n for seven victims and $ 20,000 i n
c i v i l penalties and attorney f e e s . Legal act ions against three
other individuals f o r consumer fraud, Banking Act violations and
racketeering are pending.
Example 3
An escrow agent embezzled funds and f a i l e d t o provide promised
services. The Department expects its investigation of t h i s case t o
r e s u l t i n r e s t i t u t i o n of $ 60,000 t o $ 70,000.
Two c u r r e n t i n v e s t i g a t i o n s of escrow agencies involve larger examples of
fraud. In one case the Banking Department has i d e n t i f i e d an estimated
$ 700,000 i n p o t e n t i a l claims. A second investigation involves losses
which a Department o f f i c i a l estimates t o be i n the " low t o mid s i x figure
range. 11
Mortgage brokers and escrow agents harm consumers by f a i l i n g t o properly
discharge t h e i r t r u s t r e s p o n s i b i l i t i e s and misleading persons who seek
t h e i r services. Almost half ( 47 percent) of the 100 complaints we
reviewed were made against these two enterprise categories. Because the
fraudulent a c t i v i t i e s are of t e n i n t e r n a l and highly complex, p o t e n t i a l
victims are not i n a position t o adequately protect themselves.
COLLECTION AGENCIES also pose a t h r e a t t o consumers, both c r e d i t o r s and
debtors. The Department is c u r r e n t l y i n v e s t i g a t i n g a case where a
c o l l e c t ion agency commingled funds paid by debtors and fraudulently
misappropriated some $ 40,000.
In addit ion t o f i n a n c i a l fraud , c o l l e c t ion agency practices may t h r e a t en
debtors. For example, the Department found one agent who s o l i c i t e d sexual
favors i n r e t u r n f o r more l i b e r a l payment terms. Collection agencies may
also harass debtors by repeatedly c a l l i n g them, threatening l e g a l a c t i o n
when no grounds e x i s t and using rude and abusive language. As a r e s u l t ,
c o l l e c t i o n agencies were the s i n g l e l a r g e s t t a r g e t of complaints we
reviewed ( 29 percent).
DEBT MANAGEMENT COMPANIES can harm consumers by misappropriating funds
i n t h e i r t r u s t . Debt management companies a s s i s t individuals i n managing
t h e i r finances. The individuals w i l l usually turn over a portion of t h e i r
income t o the company which i n turn pays the individuals' c r e d i t o r s . Two
of the six debt management companies are nonprofit. The remaining four
companies are p r o f i t oriented and usually charge an i n i t i a l fee and a
percentage of the funds they handle on behalf of the individual c l i e n t .
Debt management companies manage account s through t r u s t funds i n t o which
they deposit c l i e n t funds. The companies then pay c l i e n t s ' c r e d i t o r s from
the t r u s t funds. As with the other enterprises, t r u s t funds held by debt
management companies offer the potential f o r fraud . The Banking
Department investigated one case involving embezzlement a t a debt
management company during 1982- 83. The Department's investigation
resulted i n $ 6,200 r e s t i t u t i o n and a $ 10,000 c i v i l penalty.
Although four of six enterprises pose f i n a n c i a l r i s k t o consumers, the
Banking Department does not routinely examine enterprises. Because other
regulatory a c t i v i t i e s , such as licensing, do not necessarily screen out
unscrupulous persons, the Department ' s f a i l u r e t o routinely examine
enterprises means that it lacks an effective means f o r deterring i l l e g a l
and unethical practices of mortgage brokers, escrow agents, debt
management companies and c o l l e c t ion agencies.
Regulatory A c t i v i t i e s - The Department regulates enterprises i n several
ways. Each enterprise must obtain a license. Principal owners of
mortgage brokerages, escrow agencies, collection agencies and debt
management companies must submit personal h i s t o r i e s and fingerprints.
Persons applying for motor vehicle dealer and s a l e s finance company
licenses must also submit personal h i s t o r i e s , but the Department only
f i n g e r p r i n t s applicants who indicate criminal records. Although the
licensing investigation may screen out persons with known criminal
records, the Department denies few applications. Between January and July
of 1983 only 14 applicants out of 247 ( 6 percent) f a i l e d t o qualify for a
license. The Department also investigates complaints, but i n most
instances Department a c t i o n c o n s i s t s of sending a form l e t t e r t o the
enterprise. Although recurring complaints against a p a r t i c u l a r e n t e r p r i s e
may r e s u l t i n a special investigation, the extent of Banking Department
control of enterprises through licensing and complaint investigation is
r e l a t i v e l y limited .
The f i n a l method of r e g u l a t i o n is examination. S t a t e law does not mandate
a s p e c i f i c examination schedule f o r e n t e r p r i s e s . Rather, t h e
Superintendent may examine these e n t i t i e s at h i s d i s c r e t i o n . Despite
t h e i r p o t e n t i a l f o r d e t e r r i n g fraud and abuse, e n t e r p r i s e examinat ions a r e
very infrequent.
Infrequent Examinations - The Banking Department has examined very few
e n t e r p r i s e s i n recent years. During f i s c a l years 1980- 81 through 1982- 83
t h e Department conducted 29 examinations or i n v e s t i g a t i o n s , l e s s than 2
percent of the licensed e n t e r p r i s e s ( Table 6). Thus, t h e odds of being
examined are only s l i g h t l y more than 1 i n 100 over a 3- year period.
TABLE 6
ENTERPRISE EXAMINATIONS, FISCAL YEARS
1980- 81 THROUGH 1982- 83
Enterprise
Number of Average Number Percent
Examinat ions of E n t e r p r i s e s Examined
Mortgage Brokers 12
Escrow Agent s 2
Collection Agencies 7
Debt Management Companies 1
Motor Vehicle Dealers/
Sales Finance Companies - 7
Total 2 9
The limited number of examinat ions reduces the e f f e c t i v e n e s s of t h e
Department's oversight. Departmental o f f i c i a l s maintain t h a t t h e
Department lacks adequate s t a f f t o r o u t i n e l y examine e n t e r p r i s e s .
Currently, a n i n v e s t i g a t i o n occurs only when t h e Department has reason t o
suspect problems. As a r e s u l t , i n v e s t i g a t o r s may examine a l l records f o r
a m u l t i y e a r p e r i o d . In two cases, i n v e s t i g a t i o n s took two years t o
complete. While t h e Department ' s approach appears adequate f o r
i n v e s t i g a t i n g suspected problems, t h e r e l a t i v e in£ requency of examinat ions
o f f e r s l i t t l e d e t e r r e n t against fraud and abuse.
Routine Examinations Would
Im~ rove Protect ion
The Banking Department can i n c r e a s e consumer protect ion against fraud i n
f i n a n c i a l e n t e r p r i s e s by developing procedures t o conduct systematic ,
e f f e c t i v e examinations of these e n t i t i e s on a routine basis. Such routine
examinations would be a " spot check" of e n t e r p r i s e s selected randomly and
i n s u f f i c i e n t numbers t o d e t e r p o t e n t i a l wrongdoing. These examinations
would focus on key documents and procedures most l i k e l y t o identify
problems. Routine examinat ions would not replace in- depth investigations
but, r a t h e r , would i d e n t i f y e n t e r p r i s e s f a i l i n g t o comply with legal
requirements.
The Banking Department can develop e f f e c t i v e procedures t o ensure
systematic examination of mortgage brokers, escrow agents, c o l l e c t i o n
agents and debt management companies based on three principles :
Identifying a random sample of e n t e r p r i s e s i n each category f o r
examinat ion. The Department would commit resources t o examine
a l l e n t e r p r i s e s selected f o r each year's sample. Problems
i d e n t i f i e d would be f u r t h e r investigated by t h e Department ' s
e x i s t i n g s p e c i a l investigations team.
Establishing p r i o r i t y areas f o r audit work. The Department
should focus on transactions and documents which provide the
c l e a r e s t indications of compliance with the law ( t r u s t accounts
and unified f i n a n c i a l statements, f o r example) .
a Sampling key documents. To promote efficiency the Department
should review a sample of key documents a t each enterprise under
examinat ion. Relatively simple s t a t i s t i c a l methods are available
t o ensure that sample documents are representative of a l l such
records a t an enterprise.
The cost of implementing r o u t i n e e n t e r p r i s e examinations w i l l depend on
t h e s i z e of t h e sample chosen. A 10 percent sample of e n t e r p r i s e s
( excluding motor vehicle d e a l e r s and s a l e s finance companies) would
require approximately 3.6 FTE p o s i t ions ; an 8 percent sample would require
2.9 FTEs ( Table 7). I f a r o u t i n e examination d i s c l o s e d s e r i o u s problems,
t h e Department could then conduct a d e t a i l e d i n v e s t i g a t i o n s i m i l a r t o
those it now conducts. Although a d d i t i o n a l s t a f f would be required t o
conduct routine examinat ions, our a u d i t work i n Finding I i n d i c a t e s t h a t
the Department can provide 1.3 p r o f e s s i o n a l FTE p o s i t ions by reassigning
e x i s t i n g personnel ( see page 24).
TABLE 7
ESTIMATED COSTS FOR ROUTINE EXAMINATIONS OF FINANCIAL ENTERPRISES ( 1)
- -
Number of Examinations
Sample Size
8 Percent 10 Percent
Hours Required 5,200 6,560
FTEs Required 2.9 3.6
Assumptions: a) motor vehicle d e a l e r s and s a l e s finance companies
excluded, b) 80 s t a f f hours per e n t e r p r i s e , and c ) FTEs based on
1,800 d i r e c t hours per y e a r .
CONCLUSION
The p o t e n t i a l f o r fraud and abuse i n many f i n a n c i a l e n t e r p r i s e s c r e a t e s a
c l e a r need f o r regulation. However, because f i n a n c i a l harm is limited,
strengthened truth- in- lending requirements would provide adequate
protection f o r persons dealing with motor vehicle d e a l e r s and sales
finance companies. On the other hand mortgage brokers, escrow agents,
c o l l e c t i o n agents and debt management companies require more extensive
surveillance than the Banking Department currently provides. The
Department can provide e f f e c t i v e oversight of these f i n a n c i a l e n t e r p r i s e s
by conducting routine examinat ions.
RECOMMENDATIONS
1. The Legislature should consider amending :
a. A. R. S. $ 44- 281 - e t 3 t o d e l e t e a l l licensing requirements f o r
motor vehicle dealers and sales finance companies and t o empower
the Attorney General t o i n v e s t i g a t e v i o l a t ions of the Mot or
Vehicle Time Sales Disclosure Act and
b. A. R. S. $ 6- 101 t o d e l e t e reference t o $ 44- 281 - et - seq from the
d e f i n i t i o n of " Title. " This change would make Banking Department
s t a t u t e s no longer applicable t o motor vehicle dealers and sales
finance companies.
2. The Department should develop procedures t o implement rout ine
examinations f o r a sample of f i n a n c i a l e n t e r p r i s e s each year. Audit
work a t each enterprise should focus on a valid sample of p r i o r i t y
t r a n s a c t i o n s and documents.
FINDING I11
OVERSIGHT OF FINANCIAL INSTITUTIONS IS ADEQUATE BUT THE DEPARTMENT CAN
IMPROVE UTILIZATION OF ITS EXAMINERS-The
Banking Department adequately supervises Stat e- chart ered financial
i n s t i t u t i o n s but can improve the use of its examiners. The Department has
met or exceeded statutory requirements f o r examining i n s t i t u t i o n s i n
recent years. However, revising examination procedures and improving
personnel management could increase depart mental efficiency .
Examination and Follow- up
A c t i v i t i e s Are Adeauate
The Banking Department adequately supervises State- chartered financial
i n s t i t u t i o n s . Our review of Department records f o r a f ive- year period
shows t h a t the Department has largely complied with statutory requirements
for examining i n s t i t u t i o n s and i n most cases e f f e c t i v e l y followed up on
problems i d e n t i f i e d during examinat ions. Although we found some
shortcomings, they were not major and are being corrected.
I n s t i t u t i o n s and Supervisory Responsibility - Arizona law defines f i v e
types of Stat e- chart ered f i n a n c i a l i n s t i t u t i o n s : banks, savings and loan
associations, t r u s t companies, c r e d i t unions and small loan companies.
The Department monitors the performance and conditions of these
i n s t i t u t i o n s through periodic examinations. Arizona s t a t u t e s require the
Department t o examine these i n s t i t u t i o n s on a regular b a s i s . The required
schedule is: 24 months f o r banks and savings and loan associations, every
12 months f o r t r u s t companies and c r e d i t unions and each f i s c a l year f o r
small loan companies.
Federal agencies such as the Federal Deposit Insurance Corporation and the
Federal Savings and Loan Insurance Corporation examine State- chartered
i n s t i t u t i o n s . Arizona law requires Stat e- chart ered banks, savings and
loan associations and c r e d i t unions t o carry Federal deposit insurance.
This p r o t e c t s depositor funds up t o a s p e c i f i e d d o l l a r amount i f an
i n s t i t u t i o n f a i l s . As a r e s u l t , a l l State- chartered i n s t i t u t i o n s are
subject t o Federal r e g u l a t i o n and examination. A. R. S. $ 6- 128 allows the
Banking Department t o p a r t i c i p a t e j o i n t l y with Federal agencies when
conducting examinations. This s e c t i o n a l s o permits t h e Superintendent t o
accept Federal examination r e p o r t s i n l i e u of a S t a t e examination.
Examinations - Our review of examination records shows t h a t t h e Department
met s t a t u t o r y examinat ion requirements f o r banks, savings and loan
a s s o c i a t i o n s , c r e d i t unions and small loan companies. Table 8 shows t h a t
f o r banks and savings and loan a s s o c i a t i o n s , the average examination
frequency was twice a s o f t e n as required by law during f i s c a l years
19 78- 79 through 1982- 83. The Department met requirements f o r examinat ions
of c r e d i t unions each calendar year during t h i s same period. Every small
loan company was examined during f i s c a l year 1982- 83 as required by
s t a t u t e . Federal agencies which share oversight r e s p o n s i b i l i t y with the
Banking Department of ten examine t h e i n s t i t u t i o n s j o i n t l y with t h e
Department and consider Arizona's examinations t o be comparable t o t h e i r
own.
TABLE 8
I n s t i t u t i o n
COMPLIANCE WITH EXAMINATION REQUIREMENTS,
FISCAL YEARS 1978- 79 THROUGH 1982- 83
Statutory Average Time Between
Requirement Examinat ions ( 1)
Banks 24 months
Savings and Loans 24 months
Credit Unions each calendar year
Trust 12 months
Small Loan Companies each f i s c a l year
11.6 months
10.7 months
12.5 months
13.6 months
( 2)
( 1 ) I n c l u d e s Federal agency and j o i n t Federal/ State examinat ions. A. R. S.
§ 6- 128 allows t h e Superintendent t o accept Federal examinations i n
l i e u of S t a t e examinations.
( 2) Due t o t h e l a r g e number of small loan companies, we reviewed only one
year of examination data. We found t h a t t h e Department examined each
s m a l l loan company during f i s c a l year 1982- 83.
In c o n t r a s t , the Department has not examined any t r u s t companies since May
1982 when its t r u s t examiner died. However, Federal agencies conducted
s i x examinations and one j o i n t l y with the State. As a r e s u l t t h e
Department was able t o meet examination requirements f o r a l l but two t r u s t
companies. The Department has hired an individual t o begin training as a
t r u s t examiner who w i l l begin work i n October 1983.
Follow- up - The Department's follow- up of problems i d e n t i f i e d during
examinations appears adequate. The Department a c t s t o resolve problems
using l e t t e r s , telephone c a l l s and unscheduled examinations t o ensure t h a t
i n s t i t u t i o n s correct problems. The only noticeable lack of consistent
follow- up occurred i n one c r e d i t union. The c r e d i t union operated f o r
four years under an order t o s t o p d e c l a r i n g dividends i n excess of
earnings. Although examiners noted the same problem during three of the
l a s t four examinations, the Department was reluctant t o close the c r e d i t
union a s long as i t s c a p i t a l remained s u f f i c i e n t and its Federal insurance
was not i n jeopardy. Until recently closure was the Department's only
option i n such matters. The 1983 Legislature authorized the Department t o
remove personnel responsible f o r such violations. The Superintendent
believes t h a t t h i s authority w i l l provide a c r e d i b l e means of ensuring
compliance .
The Department Can Improve the
Use of Professional S t a f f
Although supervision of f i n a n c i a l i n s t i t u t i o n s is adequate, the Department
can more e f f i c i e n t l y u t i l i z e its professional personnel. The Department
may be able t o improve s t a f f u t i l i z a t i o n by investigating procedures
developed by other agencies f o r increasing a u d i t e f f i c i e n c y . Developing
an accurate personnel management system would a l s o contribute t o more
e f f i c i e n t use of personnel.
Efficiency of I n s t i t u t i o n a l Examinat ions - The Department may be able t o
increase the efficiency of i n s t i t u t i o n a l examinations. Although most
f i n a n c i a l regulatory agencies follow procedures very similar t o Arizona's,
approaches used by two organizations suggest that the Department may be
able t o reduce examination t i m e without s a c r i f i c i n g e f f e c t i v e oversight.
The Department examines f i n a n c i a l i n s t i t u t i o n s t o determine i f they are
f i n a n c i a l l y sound. The standard examination is b a s i c a l l y t h e same for a l l
i n s t i t u t i o n s and is very d e t a i l e d . For example, examiners t y p i c a l l y
review 80 percent of each i n s t i t u t i o n ' s loans.
The Department's detailed examination appears unnecessary compared t o the
process used by other agencies. The United S t a t e s Comptroller of the
Currency and the Virginia Bureau of Financial I n s t i t u t i o n s have developed
procedures that suggest the Banking Department can ensure f i n a n c i a l
soundness with a l e s s detailed examination of some i n s t i t u t i o n a l a s s e t s .
Both agencies have changed from procedures similar t o Arizona's t o methods
t h a t they believe provide adequate oversight i n a more e f f i c i e n t manner.
The Comptroller of the Currency bases the scope of its examination on a
bank's f i n a n c i a l condition a s indicated by the previous examination. For
banks with higher ratings Comptroller s t a f f w i l l review information
supplied by t h e i n s t i t u t i o n s . Unless t h i s review i d e n t i f i e s problems, the
Comptroller w i l l allow the maximum t i m e allowed by policy ( 18 months) t o
elapse before examining an i n s t i t u t i o n . When the examination takes place,
it is limited to a review of the bank's f i n a n c i a l report and a small
number of loans. Banks with lower ratings, on the other hand, are
examined more frequently and t o a greater extent than higher rated banks.
The Virginia Bureau of Financial I n s t i t u t i o n s is changing its supervisory
procedures i n a similar manner. The Bureau c o l l e c t s information from
i n s t i t u t i o n s and from other sources and reviews it t o i d e n t i f y p o t e n t i a l
problems. The review focuses on i n t e r n a l c o n t r o l s , a s s e t s which are
subject t o influences beyond the i n s t i t u t i o n ' s control, previous
examinations and i n s t i t u t i o n a l f i n a n c i a l statements t o identify problems.
The extent t o which t h i s review i d e n t i f i e s any problems determines the
scope of. the Bureau's subsequent examination.
Because these examination procedures are r e l a t i v e l y new, experience with
them is limited. However, the procedures may offer opportunities f o r
s t a f f savings that could be used t o meet the growing r e s p o n s i b i l i t i e s of
the Banking Department. ( For example, the number of banks has grown from
13 i n 1978 t o 30 i n 1983, and beginning i n 1983 the Department is
responsible f o r supervising bank holding companies and i n t e r n a t i o n a l
banks.) Much of the information used by the Comptroller and Virginia is
now available t o the Department or can be readily obtained from the
i n s t i t u t i o n s or out side sources. The Department should review the
experiences of other s t a t e s ' and Federal agencies t o determine i f such
procedures are applicable t o Departmental a c t i v i t i e s .
Manpower Planning - The Banking Department l a c k s a c c u r a t e information f o r
estimating personnel requirements. A c t i v i t y r e p o r t s submitted by
examiners do not provide s u f f i c i e n t information t o departmental managers
t o allow them t o estimate resources necessary t o examine i n s t it ut ions.
Without accurate a c t i v i t y reporting the Department w i l l be unable t o
e f f i c i e n t l y implement changes i n examination procedures.
The Department does not systematically plan f o r i n s t i t u t i o n a l
examinat ions. Departmental managers informally project manpower
requirements based on previous years' experiences. However, the data base
f o r these projections is limited. Department examiners do not report t h e i r
time by a c t i v i t y . Rather, examiners report time only i n terms of
individual i n s t i t u t i o n s ( i . . , banks, savings and loan associations).
Thus, the Banking Department can only project time required f o r existing
examination procedures a s a whole; the Department cannot estimate the
impact of any procedural changes on personnel requirements f o r
examinations.
The Department needs t o develop a personnel management system which
provides accurate estimates of personnel needed t o conduct examinations.
Improved reporting of examiners' a c t i v i t i e s and time would provide a more
accurate basis f o r estimating s t a f f requirements and developing agency
budgets . Review and analysis of time reports would generate the
information a manager needs t o estimate the time required f o r specific
a c t i v i t i e s a t each i n s t i t u t i o n . I n addition, time reports would identify
problems such a s high use of professional s t a f f f o r c l e r i c a l duties.
CONCLUSION
Although t h e Banking Department adequately supervises f i n a n c i a l
i n s t i t u t i o n s , it can improve the u t i l i z a t i o n of its professional s t a f f .
The Department may be able t o improve efficiency of i n s t i t u t i o n a l
examinations by revising examination procedures. In addition, a personnel
management system w i l l improve Departmental budget estimates.
RE COMMENDATIONS
1. The Department should review examination procedures used by other
s t a t e s and Federal agencies t o determine the f e a s i b i l i t y of increasing
the efficiency of examination procedures.
2. The Department should develop a personnel management system which
provides accurate estimates of s t a f f resources needed f o r
examinations. The system should report time spent by individual
examiners on major a c t i v i t i e s a t each i n s t i t u t i o n .
FINDING I V
THE CONFLICT OF INTEREST STATUTE FOR BANKING DEPARTMENT EMPLOYEES IS
UNNECESSARILY RESTRICTIVE.
The s t a t u t o r y p r o h i b i t i o n on c e r t a i n loans t o Banking Department employees
is more s t r i n g e n t than necessary t o prevent c o n f l i c t s of i n t e r e s t . The
p r o h i b i t i o n may l i m i t the Department's a b i l i t y t o a t t r a c t q u a l i f i e d s t a f f
or cause hardship t o new employees. Less r e s t r i c t i v e requirements w i l l
reduce the p o t e n t i a l hardship without increasing t h e r i s k of c o n f l i c t s of
i n t e r e s t .
Department Employees May Not Have
Loans from Regulated I n s t i t u t i o n s
Arizona law p r o h i b i t s a l l Banking Department employees from holding loans
at i n s t i t u t i o n s regulated by the Department. A. R. S. $ 6- 113 provides t h a t
no Banking Department employee s h a l l
". . . Be indebted, d i r e c t l y or i n d i r e c t l y , as
borrower, accommodation endorser, surety or guarantor
t o any . . . f i n a n c i a l i n s t i t u t i o n or e n t e r p r i s e . . .
[ under t h e j u r i s d i c t i o n of the Department I."
The provision is intended t o eliminate p o t e n t i a l c o n f l i c t s of i n t e r e s t by
reducing i n c e n t i v e s f o r c o l l u s i o n between Banking Department s t a f f and
regulated f i n a n c i a l i n s t i t u t i o n s or e n t e r p r i s e s .
TO comply with t h i s requirement new employees holding loans with regulated
e n t i t i e s must d i v e s t themselves of t h e loans. The employees must e i t h e r
refinance t h e l o a n s w i t h a n i n s t i t u t i o n not regulated by t h e Department ( a
n a t i o n a l bank o r f e d e r a l l y c h a r t e r e d s a v i n g s and loan a s s o c i a t i o n , f o r
example) or pay it o f f . A l l Department s t a f f , including c l e r i c a l
personnel, must comply with t h i s s t a t u t e .
A Less R e s t r i c t i v e S t a t u t e W i l l
Effectively Prevent Conflicts of -
I n t e r e s t
The prohibition against holding any loans with regulated e n t i t i e s may
prevent prospective employees from accepting p o s i t i o n s with the
Department. However, the Legislature can prevent p o t e n t i a l c o n f l i c t s of
i n t e r e s t among Banking Department personnel without prohibiting a l l loans
from State- regulated e n t i t i e s .
Persons accepting employment with the Department may encounter f i n a n c i a l
hardships i n complying with the law. Refinancing may r e s u l t i n penalty
charges, procurement fees and higher i n t e r e s t r a t e s . The cost of
refinancing , especially of older housing loans with low i n t e r e s t r a t e s ,
may prevent qualified candidates from accepting a position with the
Department. Six of twenty- one employees had t o refinance loans when they
began working f o r the Department. Two employees paid prepayment
penalties. I n t e r e s t r a t e s on a bank card and auto loans increased by as
much a s 10 percent f o r a t h i r d employee, and t h e i n t e r e s t r a t e f o r one
employee's home mortgage went up by approximately 1 percent.
The 1983- 84 appropriations act allows the Department t o hire nine new
examiners. Candidates with industry experience a r e preferred. However,
the Department may encounter d i f f i c u l t y f i l l i n g the positions. According
t o a Department o f f i c i a l , one prospective candidate decided t o not
continue interviewing rather than refinance an existing loan.
Less r e s t r i c t i v e controls used by other s t a t e s ' and Federal agencies
e f f e c t i v e l y address p o t e n t i a l c o n f l i c t of i n t e r e s t s i t u a t i o n s without
requiring employees t o d i v e s t e x i s t i n g loans. These controls would allow
Department employees t o r e t a i n loans from regulated e n t i t i e s under c e r t a i n
conditions without creating a c o n f l i c t of i n t e r e s t . If a loan existed
prior t o employment with the Department and the employee continued t o pay
it under the o r i g i n a l terms, a loan from a regulated e n t i t y would offer no
incentive f o r an examiner t o compromise h i s or her o b j e c t i v i t y .
The Federal Deposit Insurance Corporation ( FDIC) and Federal Home Loan
Bank Board ( FHLBB) have functions similar t o the Banking Department but
allow t h e i r employees t o have loans from regulated i n s t i t u t i o n s . The FDIC
permits its employees t o r e t a i n loans existing prior t o employment
provided t h a t they f u l l y disclose the loans when they begin work. The
employees may not change the terms of the existing loans, nor may they
obtain new loans from regulated agencies. The FHLBB allows employees t o
obtain r e s i d e n t i a l loans from regulated i n s t i t u t i o n s . Employees must
d i s c l o s e the loan, provide a statement from the lender t h a t t h e employee
received no p r e f e r e n t i a l treatment and make payments so a s t o avoid any
penalties o r l a t e charges.
CONCLUSION
The s t a t u t e prohibiting c e r t a i n loans t o Banking Department employees is
unnecessarily r e s t r i c t i v e . It may l i m i t the Department's a b i l i t y t o
a t t r a c t qualified s t a f f and c r e a t e hardship t o new employees. The
Legislature can l e s s e n e x i s t i n g r e s t r i c t i o n s without r i s k t o the
Department ' s i m p a r t i a l i t y .
RECOMMENDATIONS
1. The Legislature should consider amending A. R. S. $ 6- 113 t o
a. Allow professional s t a f f t o r e t a i n loans with e n t i t i e s regulated
by the Department i f t h e loan existed prior t o employment with
the Department and the employee continues t o amortize the loan
under its o r i g i n a l terms and
b. Require t h a t each employee f u l l y disclose a l l loans with e n t i t i e s
regulated by the Department and the terms of such loans a t the
time of i n i t i a l employment.
2. The Banking Department should e s t a b l i s h a policy of not assigning
personnel t o examine i n s t i t u t i o n s from which they hold a preexisting
loan.
OTHER PERTINENT INFORMATION
During the audit we developed pertinent information i n t h e following three
areas: 1) i n t e r s t a t e banking, 2) Banking Department o f f i c e space needs,
and 3) the s t a t u s of previous performance a u d i t f i n d i n g s on the regulation
of the c o l l e c t i o n industry.
INTERSTATE BANKING
Although a number of s t a t e s have enacted or considered l e g i s l a t i o n t o
allow out- of- state bankholding companies t o operate within t h e i r
boundaries, " i n t e r s t a t e banking" involves much uncertainty and
speculation. Nine s t a t e s allow some f om of i n t e r s t a t e banking. S t a t u t e s
i n some of these s t a t e s permit only limited operations while other s t a t e s
allow a f u l l range of services. The d i f f e r e n t provisions i n these s t a t e
laws r e f l e c t t h e varying purposes each s t a t e seeks i n permitting
out- of- state banks t o operate.
Federal Law Allows S t a t e s t o
Restrict I n t e r s t a t e Banking
Under existing Federal law each s t a t e may prohibit i n t e r s t a t e banking.
T i t l e 12, § 1842( d) of the United States Code prohibits a bank holding
company from acquiring " a l l o r s u b s t a n t i a l l y a l l " a s s e t s of a bank outside
of the state where it p r i n c i p a l l y operated on July 1, 1966, unless
s p e c i f i c a l l y authorized by a s t a t e . Arizona law defines banking a s taking
deposits subject t o payment on request ( A. R. S § 6- 201. B.) and prohibits any
one " except a national banking association with i t s principal place of
business i n t h i s s t a t e . . ." from engaging i n banking business without a
permit from the Arizona Banking Department ( A. R. S. $ 6- 201. A. ) . State law
( A. R. S. 96- 204. A. l) f u r t h e r requires that applicants f o r State bank
charters be Arizona corporations. Department policy l i m i t s out- of- state
ownership of Arizona banks t o 20 percent. Thus, a l l banks operating i n
Arizona must be domiciled within the State i f they wish t o take deposits.
Arizona law a f f e c t s national banks as well a s State- chartered banks
because Federal law recognizes State primacy i n t h i s area. As a r e s u l t ,
i n t e r s t a t e banking is not permitted i n Arizona. The prohibition does not
mean t h a t out- of- state banks are not a c t i v e i n the State. Several large
banks, such a s Citibank and Chase Manhattan operate loan companies i n
Arizona. Arizona businesses and individuals may also seek loans from
out- of- state banks i f they wish. However, A. R. S. s6- 201. A. prohibits such
banks from accumulating c a p i t a l by taking deposits i n Arizona. Thus,
out- of- state banks must finance loans with t h e i r own c a p i t a l brought i n t o
the State.
The s t a t u t e barring i n t e r s t a t e banking i n Arizona has been i n e f f e c t since
at l e a s t 1922. Although no specific documentation of intent is available,
the purpose of t h i s law appears t o be t o ensure that Arizona's c a p i t a l
remains within the State t o promote its economy and growth. Without such
a s t a t u t e , an out- of- state bank could accumulate c a p i t a l by taking
deposits from Arizonans and then using the c a p i t a l i n another s t a t e or
foreign country. According t o the S t a t e Banking Superintendent, the
prohibition also allows the Department t o exercise greater control over
banks because they w i l l be owned by Arizona corporations.
Some States Allow I n t e r s t a t e Banking
I n recent y e a r s , s e v e r a l s t a t e s have enacted l e g i s l a t i o n t o permit some
form of i n t e r s t a t e banking. As of Pay 1983, nine s t a t e s permitted
out- of- state bank holding companies t o acquire or e s t a b l i s h banks within
t h e i r borders. Another 10 s t a t e s were considering similar l e g i s l a t i o n .
Two s t a t e s , Delaware and South Dakota, claim t h a t i n t e r s t a t e banking has
created new employment opportunities and increased tax revenues.
I n t e r s t a t e banking has increased c a p i t a l a v a i l a b i l i t y i n Maine, according
t o that s t a t e ' s superintendent of banking.
An analysis of i n t e r s t a t e banking i n the nine s t a t e s reveals that there
are three types of i n t e r s t a t e banking laws: 1) full- service banking, 2)
limited operations, and 3) a q u i s i t i o n of troubled banks. Of the three
types only the f i r s t allows a f u l l range of s e r v i c e s a c r o s s s t a t e l i n e s .
The remaining approaches l i m i t bank a c t i v i t i e s within the host s t a t e .
Full Service I n t e r s t a t e Banking - Full- service banking allows banks t o
offer a complete range of s e r v i c e s a c r o s s s t a t e l i n e s . S t a t e s use two
approaches t o full- service banking: regional and national banking.
Regional banking permits i n t e r s t a t e banking among s t a t e s i n a given area
of the country. The s i x New England s t a t e s are developing l e g i s l a t i o n t o
allow banks within the region t o conduct i n t e r s t a t e business. One of
these s t a t e s , Maine, also extends the i n v i t a t i o n nationally. Besides
Maine only two other s t a t e s , Alaska and New York, allow national
f ull- service banking. Even where s t a t e s i n v i t e out- of - s t a t e banks t o
acquire i n s t i t u t i o n s , there are some r e s t r i c t ions. For example, Maine
requires t h a t the entry of an out- of- state bank r e s u l t s i n a net c a p i t a l
increase t o the s t a t e . In addition, most s t a t e s allowing n a t i o n a l o r
r e g i o n a l f u l l - s e r v i c e operations require t h a t the out- of- state bank's home
s t a t e extend s i m i l a r p r i v i l e g e s t o banks i n the s t a t e where it seeks t o
operate.
Interviews with banking o f f i c i a l s i n New York and Maine show that the two
s t a t e s seek d i f f e r e n t goals from full- service i n t e r s t a t e banking on a
national basis. New York's law allows its banks t o take advantage of
similar l e g i s l a t i o n i n other s t a t e s . As the n a t i o n ' s major banking
center, i n t e r s t a t e banking benefits t h e many large banks headquartered i n
New York by allowing them t o expand i n t o new markets. Maine, on the other
hand, seeks t o import c a p i t a l and banking services not available t o the
s t a t e . I n t e r s t a t e banking o f f e r s out- of- state banks a market i n which t o
expand t h e i r operations while making additional c a p i t a l available t o
Maine's businesses. Although Maine was among the f i r s t s t a t e s t o permit
i n t e r s t a t e banking, the f i r s t acquisition of a Maine bank by an
out- of- state bank took place i n May 1983. The acquisition resulted i n an
infusion of new c a p i t a l by the acquiring bank according t o Elaine's banking
superintendent.
Limited Operations - Several s t a t e s s p e c i f i c a l l y l i m i t the a c t i v i t i e s of
i n t e r s t a t e banks operating within t h e i r borders. The most common
r e s t r i c t i o n is t o l i m i t the out- of- state bank t o one o f f i c e f o r the
purpose of e s t a b l i s h i n g a national c r e d i t card operation. South Dakota
and Delaware pioneered t h i s concept i n 1981. Virginia and Nebraska
enacted similar l e g i s l a t i o n i n 1983. In most cases, these s t a t e s enhance
t h e i r a t t r a c t i v e n e s s a s a locat ion f o r such operat ions by emphasizing
economic incentives ( no l i m i t on i n t e r e s t r a t e s or low taxes) and
geographic and l o g i s t i c advantages.
The p o t e n t i a l f o r a t t r a c t i n g economic development is largely responsible
f o r much of the i n t e r e s t i n i n t e r s t a t e banking. Delaware, according t o
its banking superintendent, has a t t r a c t e d 11 bank c r e d i t o r wholesale
operations which have produced 1,500 d i r e c t jobs and increased s t a t e tax
r e c e i p t s from banking from $ 2.2 million i n 1981- 82 t o an estimated $ 7.5
million i n 1983- 84. South Dakota has a t t r a c t e d one out- of- state bank and
900 new jobs according t o o f f i c i a l s i n t h a t s t a t e .
S t a t e s seeking bank operations impose a variety of r e s t r i c t i o n s on the
out- of- state banks t o protect t h e i r own banks from competition from the
l a r g e r out- of- state banks. Delaware and Virginia impose specific
r e s t r i c t i o n s on the out- of- state banks: number of o f f i c e s , minimum c a p i t a l
and employment requirements and a p r o h i b i t i o n a g a i n s t s o l i c i t i n g local
business. Banks deciding t o operate i n these s t a t e s must agree t o these
terns i n order to g a i n t h e s t a t e ' s approval of its entry i n t o t h e s t a t e .
South Dakota r e l i e s on the limited a t t r a c t i o n of its f i n a n c i a l markets t o
r e s t r i c t operations of outside banks. Regardless of the method, o f f i c i a l s
i n these s t a t e s c l e a r l y indicate that they want t o a t t r a c t the jobs
created by bank operations without increasing competition with in- state
banks.
Troubled Banks - One s t a t e , Washington, allows out- of- state banks t o
acquire banks which are experiencing f i n a n c i a l d i f f i c u l t i e s . This
l e g i s l a t i o n allowed the Bank of America t o acquire the SeaFirst Bank which
was close t o bankruptcy i n 1983. One other s t a t e , Oregon, is considering
similar l e g i s l a t i o n . This type of i n t e r s t a t e banking provides a means f o r
rescuing troubled banks when no i n - s t a t e i n s t i t u t i o n is w i l l i n g o r able t o
do so.
I n d u s t r i a l Banks Would Permit
I n t e r s t a t e Banking i n Arizona
In addition t o the methods discussed above, establishing i n d u s t r i a l banks
would allow out- of- state banks t o take deposits i n Arizona. The Federal
prohibition against i n t e r s t a t e banking does not include i n d u s t r i a l banks
such as those authorized by A. R. S. s6- 331 through 6- 338. T i t l e 12,
$ 18- 42( d) of the U. S. Code applies only t o banks which accept demand
deposits ( checking accounts) and make commercial loans. I n d u s t r i a l banks
i n Arizona may not accept demand deposits. Thus, the Banking Department
has no authority t o deny an out- of- state bankholding company permission t o
open an i n d u s t r i a l bank simply because the holding company is not located
i n Arizona. Existing State law, however, imposes r e s t r i c t i o n s on
i n d u s t r i a l banks which offer l i t t l e incentive f o r t h e i r creations.
I n d u s t r i a l banks may not make loans i n excess of $ 1,000 and i n t e r e s t may
not exceed 10 percent. As a r e s u l t , Arizona has no i n d u s t r i a l banks.
The 1983 Legislature considered changes i n State law which would have
increased the a t t r a c t i v e n e s s of i n d u s t r i a l banking and would have created
opportunities for out- of- state banks t o t a k e d e p o s i t s i n Arizona. Senate
B i l l ( SB) 1219 would have removed the l i m i t s on loan amounts and i n t e r e s t
r a t e s f o r i n d u s t r i a l banks, thus enhancing t h e i r a t t r a c t i v e n e s s . The
Legislature did not pass the b i l l . Enactment of such l e g i s l a t i o n would
permit t h e c r e a t i o n of i n d u s t r i a l banks owned by non- Arizona banks or
investors. However, SB 1219 did not r e s t r i c t the movement of c a p i t a l held
by i n d u s t r i a l banks. As a r e s u l t , the b i l l offered no protection against
taking deposits i n Arizona f o r use outside the State.
Does Arizona Need I n t e r s t a t e Banking?
I n t e r s t a t e banking v a r i e s considerbly from s t a t e t o s t a t e , depending on
each s t a t e ' s goals. Deciding whether or not Arizona should permit
i n t e r s t a t e banking w i l l depend on what goals the Legislature hopes t o
achieve. Banking o f f i c i a l s and regulators do not agree on t h i s question.
Representatives of l a r g e r Arizona banks support the idea of i n t e r s t a t e
banking i n Arizona. They say that such deregulation w i l l increase
services and lower prices through competition. These bankers acknowledge
that t h e competition may drive smaller banks out of business or force them
t o merge,* but maintain that t h i s is due t o the greater efficiency of
l a r g e r banks.
Representatives of one New York bank which has moved i n t o i n t e r s t a t e
operations also suggest that i n t e r s t a t e banking would benefit Arizona by
increasing competition within the State. The out- of - s t a t e banks could
a l s o provide employment opportunities by locating operations centers i n
Arizona. Although one representative noted t h a t no law prohibits
out- of - s t a t e banks from e s t a b l i s h i n g operations centers, Arizona law
l i m i t s t h e i r p o t e n t i a l f o r offering other f i n a n c i a l services.
The president of one small bank, on the other hand, claims that the
disappearance of smaller, l o c a l l y oriented banks w i l l r e s u l t i n l e s s
service t o many Arizona c i t i z e n s and communities. Large banks would be
more attuned t o national markets and less l i k e l y t o meet local needs
according t o the president of one small bank. This banker also disputed
the benefits of competition from i n t e r s t a t e banking by predicting that
banking would become more concentrated and l e s s competitive a f t e r the
i n i t i a l period of adjustment .
* The Superintendent of Banking suggests that some smaller Arizona banks
would be bought a t p r o f i t a b l e terms by l a r g e r out- of- state banks a s . a
means of gaining entrance i n t o t h e Arizona market.
The Banking Superintendent and one Arizona economist questioned the
benefit of i n t e r s t a t e banking. Both think permitting out- of- state banks
t o t a k e d e p o s i t s i n Arizona would provide l i t t l e benefit t o Arizonans.
Existing State and national banks provide 800 branches f o r business and
can add more branches anywhere i n t h e S t a t e because Arizona permits
statewide branching. They also maintain that Arizona does not lack
c a p i t a l f o r economic growth. The Superintendent also noted that Arizona
need not allow out- of- state banks t o take deposits t o a t t r a c t bank
operations centers and promote job growth. He added t h a t as a p r a c t i c a l
matter, however, banks w i l l seek deposit authority i n return f o r the
p o t e n t i a l jobs they w i l l bring.
A representative f o r the Conference of State Banking Superintendents
( CSBS) also expressed reservations about the benefits of i n t e r s t a t e
banking. CSBS supports s t a t e authority t o e i t h e r permit or r e s t r i c t
i n t e r s t a t e banking. However, the representative noted t h a t growing s t a t e s
such as Arizona are a t t r a c t i v e investments which may not need i n t e r s t a t e
banking t o enhance t h i s a t t r a c t i v e n e s s . He said that any s t a t e which
considers i n t e r s t a t e banking must c a r e f u l l y d e f i n e its intended objectives
and d r a f t l e g i s l a t i o n accordingly.
Our review of other s t a t e s ' experiences with i n t e r s t a t e banking confirms
the CSBS observation that i n t e r s t a t e banking l e g i s l a t i o n needs t o be
p r e c i s e l y d r a f t e d . Of the f i v e s t a t e s we contacted, a l l placed some
r e s t r i c t i o n s on out- of- state banks. Only New York has a r e l a t i v e l y
u n r e s t r i c t e d law. Other s t a t e s impose requirements which vary i n
r e s t r i c t i v e n e s s t o ensure that i n t e r s t a t e banking achieves its desired
purpose.
The decision t o authorize i n t e r s t a t e banking, and i n what form, w i l l r e s t
on the Legislature's estimate of Arizona's economic climate. If Arizona
needs t o a t t r a c t additional employment opportunities, banking services or
c a p i t a l or d e s i r e s t o increase competition i n the industry, i n t e r s t a t e
banking may be a desirable option. If Arizona can benefit from the growth
generated by its large banks expanding i n t o out- of- state markets, an
i n t e r s t a t e banking law may contribute t o t h i s expansion. Any l e g i s l a t i o n
t o authorize i n t e r s t a t e banking should c a r e f u l l y d e f i n e the desired
objectives and e s t a b l i s h provisions t o ensure achievement of those
objectives. I f , on the other hand, Arizona's economy w i l l not benefit
from such opportunities, then i n t e r s t a t e banking may not be advisable.
OFFICE SPACE NEEDS
Our observations during the course of the audit suggest t h a t space is a
c r i t i c a l problem. Although f u r t h e r audit work is necessary t o ascertain
the extent of space problems, it appears t h a t space is not adequate f o r
existing s t a f f . In addition, State planning guidelines may not be
appropriate f o r Banking Department need s.
E x i s t i m S ~ a c eI s
Not Adequate
Banking Department personnel do not have adequate work space. Although
most examiners spend the majority of t h e i r t i m e i n the f i e l d , a t l e a s t
seven examiners are i n the o f f i c e each workday. Currently some examiners
share o f f i c e space with division c h i e f s or work i n a f i l e room. Examiners
frequently share desks and small t a b l e s f o r workspace. In one case a
division chief shares h i s desk with an examiner. Another examiner has a
c h a i r and a clipboard f o r h i s work area.
The Banking Department also l a c k s p r i v a t e o f f i c e space. Although each
d i v i s i o n chief has a separate o f f i c e , he shares it with one or two
examiners. If a division chief meets with individuals t o discuss
c o n f i d e n t i a l matters, any examiners who are present must find another area
i n which t o work and may have limited or no access t o resource material i n
the c h i e f ' s o f f i c e . One d i v i s i o n chief shares h i s o f f i c e with the
Department's computer, various materials and records and two examiners.
In the future computer training also w i l l take place i n t h i s o f f i c e .
St orage space also appears t o be inadequate. The Department maintains
records f o r each of the 2400 licensed i n s t i t u t i o n s and enterprises. The
most current records are located i n the o f f i c e . F i l e cabinets and boxes
cover almost every wall. The basement storage area is f u l l and the
Department must rent a n a d d i t i o n a l 400 t o 450 square f e e t of space t o
st ore materials.
S t a t e Space Guidelines May Not
Meet D e ~ a rmt e nt Needs
Current guidelines f o r agency o f f i c e space may not be appropriate f o r the
Banking Department. The Division of Property Management within the
Department of Administration estimates the basic space requirement t o be
125 square f e e t per FTE position. This f i g u r e includes a small arriount of
storage and corridor space. Using t h i s c r i t e r i o n , the Banking Department
requires between 2,500 and 2,625 square f e e t of space.* The Department
has 2,360 square f e e t plus 140 square f e e t f o r storage.
However, the property management guidelines do not take i n t o account f i e l d
personnel who are i n t h e o f f i c e infrequently or exceptional storage
requirements. To account f o r such needs the Department assesses each
agency individually. The crowding observed during our audit work strongly
suggests that space is not adequate. Further research is necessary t o
determine whether the property management guidelines provide adequate work
and storage space f o r an agency such as the Banking Department.
* Based on 20 and 21 FTE positions. Although the Banking Department has
over 30 employees, we estimated space requirements using a lower
number t o account f o r the f a c t that many employees are usually working
i n the f i e l d .
STATUS OF 1979 AUDIT FINDINGS ON REGULATION OF THE COLLECTION INDUSTRY
The June 1979 Performance Audit Report, The Collection Agency Advisory
Committee and the Regulation of the Collection Industry i n Arizona,
presented four findings regarding r e g u l a t i o n of c o l l e c t i o n agencies. Of
t h e four findings, the L e g i s l a t u r e and t h e Department f u l l y implemented
two, took no a c t i o n on one and made changes o t h e r t h a n t h o s e recommended
i n one.
Finding : The Superintendent of Banks Needs
Additional Regulatory Authority t o
Adeauatelv Police t h e Collect ion Industrv .
The L e g i s l a t u r e implemented a l l recommendations made i n t h i s finding. The
Superintendent received a d d i t i o n a l powers t o regulate the c o l l e c t i o n
industry. Table 9 compares t h e Superintendent's powers i n 1979 t o h i s
c u r r e n t a u t h o r i t y . The Superintendent ' s a u t h o r i t y over c o l l e c t i o n
agencies is now comparable t o h i s a u t h o r i t y over the other i n d u s t r i e s
under h i s j u r i s d i c a t i o n .
TABLE 9
REGULATORY POWERS OF SUPERINTENDENT OF BANKS, 1979 and 1983
Regulatory Powers of Superintendent 1979 1983
May i n i t i a t e i n v e s t i g a t i o n i n t o f i n a n c i a l
records of l i c e n s e e
May i s s u e cease and d e s i s t orders
May order removal of corporate o f f i c e r
May i s s u e temporary r e s t r a i n i n g order
May apply t o s u p e r i o r c o u r t f o r
enforcement of h i s a c t i o n s
May revoke or suspend l i c e n s e s
May i s s u e w r i t t e n warnings
Attorney General may bring l e g a l
a c t i o n a t request of Superintendent
May assume a c t i v e c o n t r o l of business
No
Yes
Yes
Yes
Yes
Yes
~ e s ( 2 )
Yes
Yes
Yes
Y e s
Yes
( 1) The Superintendent had t h e r e s p o n s i b i l i t y t o appoint a CPA f o r
i n v e s t i g a t i o n . However, the 1979 audit did not consider t h i s as
" regulatory a u t h o r i t y . "
( 2) The Superintendent has t h e r i g h t t o go t o court t o seek a temporary
r e s t r a i n i n g order but the issuance of the order is at t h e d i s c r e t i o n
of t h e court. Temporary r e s t r a i n i n g orders a r e court orders.
Finding : The S t a t e Banking Department
Needs t o Expand It s Regulatory
Authority over Collection Activity .
The Department h a s t a k e n no a c t i o n on t h i s finding. This finding
recommended amending t h e s t a t u t e s t o permit t h e Banking Department t o
l i c e n s e i n d i v i d u a l c o l l e c t o r s . Although t h e Department supports t h e
recommendation and has considered such a c t i o n , no l e g i s l a t i o n has been
introduced t o e f f e c t t h e recommendation. The Department continues t o
l i c e n s e only t h e r e s p o n s i b l e p a r t y of a c o l l e c t i o n agency, not i n d i v i d u a l
c o l l e c t o r s .
Finding : Financial Information Submitted
by Collection Agencies Is Not a Valid
I n d i c a t i o n of Financial Responsibility.
The Department has implemented t h i s finding. The a u d i t recommended use of
a f i n a n c i a l form which provided information similar t o one used by
Nebraska. The Department adopted a new f i n a n c i a l statement form i n
December 1979. This form is s i m i l a r t o the one recommended but requires
more information.
Finding : Changes Needed t o Enhance
t h e Superintendent of Banks' A b i l i t y
t o Regulate t h e Collect ion Industry.
T h i s f i n d i n g c i t e d four areas f o r improvement ( Table 10). The only change
i n t h e s e a r e a s concerned the examination of c o l l e c t i o n agencies. The
Auditor General recommended t h a t t h e Legislature amend A. R. S. 932- 1052 t o
authorize the use of Banking Department examiners f o r routine examinations
and t o require l i c e n s e e s t o pay examination f e e s . Although t h e s p e c i f i c
recommendation was not followed, the same r e s u l t s were achieved. The
L e g i s l a t u r e repealed A. R. S. 932- 1052 and amended T i t l e 6 t o include
s32- 1001 - e t seq thereby giving the Banking Department f u l l a u t h o r i t y t o
l i c e n s e and examine c o l l e c t ion agencies.
TABLE 10
STATUS OF RECOMMENDATIONS ON ABILITY TO
REGULATE COLLECTION AGENCIES
Recommendat ions Status Comment s
Amend s t a t u t e s t o incorporate No Change S t a t u t e s w e r e not amended; the
provisions of Federal Consumer provisions a r e i n the Depart-
Credit Protection Act ment rules and regulations a s
they were a t time of audit
Amend A. R. S. $ 32- 1025 t o include No Change Statutes were not amended
a $ 5 per day penalty fee
Amend A. R. S. $ 32- 1052 t o authorize Change A. R. S. $ 32- 1052 was repealed
use of bank examiners t o routinely and T i t l e 6 was amended t o
examine c o l l e c t ion agencies and include A. R. S. $ 32- 1001 - e t t o r e q u i r e l i c e n s e e s t o pay seq thereby giving the
examinat ion fees Banking Department f u l l
authority t o license and
examine c o l l e c t i o n agencies
Inform public of Banking No Change The specific methods recom-
Department ' s role i n mended were not implemented
regulating c o l l e c t i o n agencies
through public service
announcement s
AREAS FOR FURTHER AUDIT WORK
During the course of the a u d i t , we i d e n t i f i e d several p o t e n t i a l issues
which we were unable t o complete due t o t i m e c o n s t r a i n t s . We have l i s t e d
these issues as areas f o r f u r t h e r audit work. These include as follows:
iJould the adoption of a uniform licensing procedure f o r a l l
e n t e r p r i s e s be more e f f i c i e n t and equitable than individual
requirements?
Does t h e present f e e s t r u c t u r e f o r licensing and examining
i n s t i t u t i o n a l e n t e r p r i s e s cover a l l costs of regulation?
e To what extent w i l l changes i n Federal laws governing the provision of
f i n a n c i a l services a f f e c t the Banking Department's a b i l i t y t o
e f f e c t i v e l y regulate i n s t i t u t i o n s and enterprises?
Should a l l Department a c t i v i t i e s be funded through a revolving fund
supported by fees collected from regulated e n t i t i e s ?
Should persons who purchase receivables from the original c r e d i t o r s
and c o l l e c t these accounts a s t h e i r own be required t o comply with
regulations similar t o those governing c o l l e c t i o n agencies?
STATBEA NKINDGE PARTMENT
ROOM 1 0 1 COMMERCE BUILDING
1 6 0 1 WEST JEFFERSON
PHOENIX. ARIZONA 85007
WALTER C. MADSEN
SUPERINTENDENT OF BANKS
October 25, 1983
Douglas A. Norton, Auditor General
Auditor General's Office
111 West Monroe, Suite 600
Phoenix, Arizona 85003
Dear Mr. Norton:
I have received a copy of the revised preliminary d r a f t of
the performance audit of t h e S t a t e Banking Department. This
response is directed towards the summary of Sunset Factors,
Findings I through IVY and comments concerning t h e o t h e r a r e a s
discussed i n the report.
SUMMARY
Licensing Small Loan Com~ anies Not Necessarv t o Protect Consumers
While Arizona has no usury laws which makes regulation of small
loan companies somewhat superfluous, complete deregulation does
contain some hazards. While looking at implementing various
consumer protection laws and disclosure requirements, we should
also consider the i n present laws that allow industry choice of
licensing. We should r e q u i r e l i c e n s i n g for a l l or none.
The recommended regulatory authority for the Attorney General can
best be dealt with by t h a t o f f i c e , however, i f t h i s r e s p o n s i b i l i t y
is assumed, some exemption for f i n a n c i a l i n s t i t u t i o n s should be
considered.
Changes Needed i n Regulation of Financial Enterprises
The recommendation to no longer license motor v e h i c l e d e a l e r s , and
sales finance companies is workable, however, the lack of consumer
complaints and problems may be the r e s u l t of few examinations and
l i t t l e consumer awareness as much as any perceived limited harm to
consumers. As noted, the department does not routinely examine
f i n a n c i a l e n t e r p r i s e s , and such a program is d e f i n i t e l y needed.
Before the s t a t i s t i c a l examination program can be implemented,
additional s t a f f i n g and o f f i c e space w i l l be required.
TELEPHONE
( 602) 255- 4421
Mr. Norton
Page 2
October 25, 1983
The Department Can Improve U t i l i z a t i o n of Its Examiners
The department can and w i l l review examination procedures used by
other states and Federal agencies which might increase our e f f i -
ciency. Top- down examination techniques used by the Comptroller
of the Currency are now used by the department i n larger i n s t i t u -
tions, however, the large number of new companies now operating
i n Arizona d i c t a t e a closer review program - a t l e a s t u n t i l such
time as a proven successful track record is i n place. The depart-ment
w i l l work at developing a program for accurately forecasting
s t a f f i n g needs for examinations.
The Conflict of I n t e r e s t Statute for Banking Department Employees
Is Unnecessarily Restrictive
The recommendation for amending A. R. S. Section 6- 133 is appropriate
with the two provisions discussed i n t h e r e p o r t included. Consider-ation
should be given t o exempting a l l c l e r i c a l employees from
A. R. S. Section 6- 113, because they have no d i r e c t contact with any
licensees.
SUNSET FACTORS
1. Objective and purpose i n establishing the Agency
No comment.
2. The effectiveness with which the Agency has met its objective and
purpose and the efficiency with which it has operated
More e f f e c t i v e regulation and oversight of f i n a n c i a l enterprises
can be accomplished only through increased s t a f f i n g , and consider-ation
should be given t o making examinations mandatory. There is
no question t h a t more supervision of enterprises is needed, and a
" Sample" examination program can be implemented with adequate
s t a f f i n g .
The department w i l l