Edward W. Kelley, Jr., Member, Board of Governors of the Federal Reserve System.

I would like to thank you for the opportunity to discuss the issues of lender liability under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA), as well as the solutions to this problem proposed by S.651. The issues presented in this legislation are complex, and I commend the committee for undertaking to explore them fully at this time.

As an initial matter, we strongly support the purposes of CERCLA. We all wish to live in a clean and healthy environment; however, the costs of achieving this goal are substantial. The Environmental Protection Agency has estimated that the cleanup of the 1,200 priority sites alone may exceed $30 billion. The General Accounting Office has estimated that as many as 425,000 sites may need investigation and possibly cleanup.

In light of these potential costs, we have become concerned over the effect of recent court interpretations of CERCLA that have held lenders liable for the cost of the cleanup of hazardous substances found on a borrower's property. Despite an exemption in CERCLA designed to shield lenders from CERCLA liability, these decisions, in effect, place lenders in the role of policing the hazardous substance disposal activities of their borrowers. Lenders are often ill equipped to perform this function, and imposition of unlimited liability can be expected to reduce their willingness to provide credit to prospective borrowers in any business or area where there is a risk of CERCLA liability. A reduction in the availability of credit threatens the viability of these businesses and their ability to contribute to the cleanup of the environment. Consequently, we believe that the imposition of cleanup liability on lenders is counterproductive to long-term environmental goals and is contributing to an unnecessary and unwarranted constriction of credit availability to a wide range of otherwise creditworthy borrowers. We support the objectives of S.651 to limit lender liability for cleanup costs under CERCLA.

Under CERCLA, the owner or operator of a property may be held liable for the entire cost of cleaning up hazardous substances found on a site, regardless of whether they are responsible for the release of the hazardous substance. By its terms, CERCLA generally excludes secured lenders from this liability; however, recent court decisions have largely eroded the protection furnished by this exclusion. Courts have imposed lender liability under CERCLA when a lender secured by property forecloses on property or has "participated in the management" of its borrower by virtue of the rights reserved by the lender under its lending and security agreements with the borrower. With the average projected cost of remedying contamination at sites on the National Priority List climbing to more than $25 million dollars, liability in CERCLA cases may far exceed the amount of the lender's original loan.

Because of the erosion of the secured lender exemption, lenders to borrowers in businesses that are used or produce hazardous substances are faced with a dilemma. Lenders can actively attempt to police hazardous substance disposal by their borrowers, risking being found to have "participated in the management" of the borrower and therefore liable for potential cleanup costs, or they can ignore the borrower's activities and risk nonpayment of the loan. Further, these court decisions may discourage even normal loan collection practices out of concern that they will be found to constitute management.

Lenders already have adequate incentives to encourage their borrowers to engage in environmentally safe practices so that these borrowers will avoid CERCLA liability. However, lenders do not generally have the technical expertise to police the environmental aspects of a borrower's operations. Covenants in borrowing agreements that give lenders a voice in their borrower's activities are designed to ensure that the borrower acts prudently in financial matters and places a high priority on the repayment of the debt, not to permit the lender to substitute its judgment for that of the borrower's in technical aspects of the borrower's business.

Imposing affirmative liability for environmental cleanup costs on lenders because of the exercise of such covenants is likely to do little to prevent the pollution of the environment but is likely to interfere with the availability of credit to even prudent businesses that use hazardous substances, such as farmers, dry cleaners, service stations, and chemical and fertilizer producers. Credit is a necessity for the operation of commercial enterprises. Lenders, already reluctant to extend credit to borrowers that are subject to a high risk of CERCLA liability, will only be deterred further by the prospect of affirmative lender liability under CERCLA. Increased lender reluctance to provide funds to industries or areas that present a risk of CERCLA liability is likely to have a significant adverse effect on these industries or areas.

Lack of credit in these cases may also frustrate environmental interests. Companies that are unable to continue operating because they cannot obtain credit will not be able to make any contribution to the environmental cleanup costs. Consequently, the current thrust of court decisions imposing lender liability under CERCLA may actually frustrate the environmental goals of CERCLA and increase the cleanup costs that must be borne by the government.

While the Board does not have comprehensive data on lender losses because of CERCLA liability to date, clearly significant losses have already occurred. More important to the future is that data from the Federal Reserve Banks suggest that CERCLA liability is, in fact, affecting the availability of credit. Banks are developing environmental guidelines that often indicate that the lender should decline to make loans collateralized by real property when past uses may have resulted in contamination of the property or to make loans to businesses that may use or produce hazardous substances in their operations. In some cases it appears that banks are declining to make loans regardless of the safety of a borrower's handling of hazardous substances.

In addition, banks are examining property carefully before they foreclose on it and are sometimes walking away from their collateral to avoid environmental liability. This problem appears to be widespread and is not confined to industrial areas of the country or to particular types of businesses. Virtually every Federal Reserve Bank reported instances in which lenders had walked away from collateral, even when the collateral was the only source of repayment for the loan. The experience of walking away from collateral to avoid CERCLA liability is likely to cause lenders to become increasingly cautious about loans to many businesses or areas, even if no actual liability has been incurred under CERCLA. In carrying out its examination and supervisory activities, the Federal Reserve expects banking organizations to have policies and procedures in place to monitor and control the risks to which banking organizations are exposed. However, banks have experienced difficulty in determining the appropriate protective practices to minimize the potential for CERCLA liability. Lending institutions are at risk for hazardous waste liability whether they have ignored hazardous waste issues altogether or have actively attempted to monitor the safety of their borrowers' operations. The Board currently is developing guidelines for bank examiners to follow in determining whether a lending institution has adopted appropriate procedures and safeguards to recognize potential hazardous substance problems. Unfortunately, given the current state of the law, there is no clear guidance that we can provide as to how an institution can extend credit and still avoid liability.

Besides private sector liability, CERCLA raises significant issues concerning the funding of government operations. Many lending institutions that are potentially subject to CERCLA liability are federally insured through the bank and thrift insurance funds. Unlimited liability under CERCLA poses a potential threat to the capital and solvency of these institutions and in some cases could result in the costs of hazardous substance removal being borne by the bank and thrift insurance funds. We understand that the Federal Deposit Insurance Corporation (FDIC) has already incurred losses as a result of CERCLA.

Further, many agencies and instrumentalities of the federal government, such as Federal Reserve Banks, Federal Home Loan Banks, the Farm Credit System, and the Small Business Administration, are also lenders. Lender liability presents a threat to the ability of these organizations to carry out the missions assigned to them by the Congress. The Federal Reserve Banks fulfill important functions in providing adjustment credit and acting as a lender of last resort for depository institutions. In acting as lender of last resort, a Federal Reserve Bank may advance funds to a depository institution collateralized by the institution's loans, which may in turn be secured by real property. Should the institution fail, the FDIC, as receiver, would likely acquire the loans from the Reserve Bank and would be left holding the loans. In these cases, the FDIC would be exposed to lender liability to the same extent as the original lender. If the FDIC chose not to acquire the loans, however, the Reserve Bank would be subject to this exposure.

It is not appropriate to shift the risks and expenses of environmental clean-up costs from the funds allocated by the Congress for this purpose to the bank and thrift insurance funds or to governmental instrumentalities such as the Federal Reserve Banks. Federal agencies and instrumentalities have been charged by the Congress with particular responsibilities. Their funds are intended to be used to fulfill these responsibilities, not to cover the costs of hazardous substance removal.

We believe that the appropriate avenue for remedying these problems is legislation. While we commend the Environmental Protection Agency for its efforts to provide regulations to clarify the secured lender exemption, its efforts are necessarily limited by the current statutory provisions. We believe that greater certainty and protection for both public and private sector lenders will be provided by statutory amendments.

Any legislation to limit the application of CERCLA liability should apply to all lenders and should strive to delineate clearly those activities that will lead to CERCLA liability. S.651 presents a viable approach to reducing potential lender liability problems under CERCLA for both the private and public sectors. While this bill has several strong points, it does not cover all lenders and leaves unanswered questions as to what duties, if any, those lenders that are covered must perform to preserve the limitation on liability.

S.651 amends the Federal Deposit Insurance Act to limit the liability of mortgage lenders and federally insured depository institutions for the cost of hazardous substance removal. It appears that the liability of these lenders would be limited to the amount of the loan made by the lender or the actual benefit received by the lender from the cleanup of the property. S.651 also provides that mortgage lenders or insured depository institutions will not be liable for cleanup costs based on their unexercised capacity to influence the operations of a borrower.

However, under S.651 a lender would lose all benefit of the exemption if it caused or contributed to the release of hazardous wastes or failed to take reasonable steps to prevent continued release. It is not clear under what circumstances a lender would be considered to have caused or contributed to a release or what actions a lender must take to prevent a release. This stringent standard juxtaposed against the severe implications of being found responsible could be a serious inhibition to a lender's willingness to lend.

S.651 also specifically addresses the concerns of federal banking and lending agencies by providing protection for these entities and the next purchaser of the property by excluding them from liability for hazardous substance removal and exempting property held or sold by these agencies from certain CERCLA liens. The federal banking and lending agencies would also be exempted from CERCLA provisions requiring federal government entities that are owners or operators of facilities to provide warranties concerning the cleanup of any property before it can be sold.

These provisions would improve the ability of the federal banking and lending agencies to obtain repayment of their loans or to realize the value of real property and would limit the extent to which their funds are diverted to pay for hazardous substance cleanup costs. The extension of the broader agency immunity to subsequent purchasers should be particularly helpful in this regard by encouraging prospective purchasers to invest in properties that carry a risk of CERCLA liability.

S.651 also requires the federal bank regulatory agencies to promulgate regulations to require the institutions they supervise to adopt procedures for evaluating environmental risks associated with lending secured by property. We believe that the incentives arising from the risk that the borrower will be unable to repay its loan because of its own CERCLA liability are adequate to encourage lenders to evaluate environmental risks related to their borrower's property. Banks are already beginning to undertake these evaluations. Accordingly, we do not believe that it is necessary to add additional regulatory requirements in this area.

In closing, it is in the interests of the financial and environmental communities to find a balanced solution to the lender liability issue. If this issue is not resolved, we risk a reduction in the availability of credit to any industry, area, or borrower that appears to present a risk of liability for hazardous substance removal. We also risk imposing additional costs on the bank and thrift insurance funds to pay for environmental cleanup costs that would otherwise be met from the funds allocated by the Congress for that purpose. In light of these considerations, we believe that the environmental goals of CERCLA will be furthered rather than hampered by the provisions of S.651.