Banking Supervision and Regulation
The Federal Reserve has supervisory and regulatory authority over a variety of financial institutions and activities with the goal of promoting a safe, sound, and stable banking and financial system that supports the growth and stability of the U.S. economy.
The Federal Reserve is the federal supervisor and regulator of all U.S. bank holding companies (BHCs), including financial holding companies and state-chartered commercial banks that are members of the Federal Reserve System. At the end of 2010, 2,193 banks were members of the Federal Reserve System and were operating 57,694 branches. These banks accounted for 34 percent of all commercial banks in the United States and for 71 percent of all commercial banking offices. In overseeing these organizations, the Federal Reserve seeks primarily to promote their safe and sound operation, including their compliance with laws and regulations.
The Federal Reserve also has responsibility for supervising the operations of all Edge Act and agreement corporations, the international operations of state member banks and U.S. BHCs, and the U.S. operations of foreign banking organizations. Furthermore, through the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), the Federal Reserve has been assigned additional responsibilities for additional institutions, including systemically important nonbank financial firms and systemically important financial utilities. In addition, the act transfers authority for consolidated supervision of more than 400 savings and loan holding companies (SLHCs) and their non-depository subsidiaries from the Office of Thrift Supervision (OTS) to the Federal Reserve, effective July 21, 2011.
The Federal Reserve exercises important regulatory influence over entry into the U.S. banking system, and the structure of the system, through its administration of the Bank Holding Company Act, the Bank Merger Act (with regard to state member banks), the Change in Bank Control Act (with regard to BHCs and state member banks), and the International Banking Act. The Federal Reserve is also responsible for imposing margin requirements on securities transactions. In carrying out its responsibilities, the Federal Reserve coordinates supervisory activities with the other federal banking agencies, state agencies, functional regulators (that is, regulators for insurance, securities, and commodities firms), and foreign bank regulatory agencies.
This report highlights several topics relevant to the Federal Reserve's supervisory and regulatory activities in 2010:
- safety and soundness
- supervisory policy
- supervisory information technology
- staff development
- regulation of the U.S. banking structure
- enforcement of other laws and regulations
During 2010, the U.S. banking system and financial markets improved further, continuing their recovery from the financial crisis that started in mid-2007.
Performance of bank holding companies. While a turnaround in BHC performance was evident during 2010, performance remains weak by historical standards, and the industry recovery could face challenges due to ongoing and elevated nonperforming asset levels. U.S. BHCs, in aggregate, reported earnings of $80.8 billion for the year ending December 31, 2010, compared to $12.9 billion for the full year 2009. Much of this improvement was due to lower loan loss provisioning and consequent reserve releases. The proportion of unprofitable BHCs, although down from 42 percent in 2009, remains high at 27 percent, which encompasses roughly 24 percent of industry assets. Nonperforming assets present a significant challenge to industry recovery, with the nonperforming asset ratio down only slightly to 4.1 percent of loans and foreclosed assets from 4.7 percent in 2009. Weaknesses were broad based, encompassing residential mortgages (first-lien), commercial real estate--especially non-owner nonfarm nonresidential and construction other than single-family--and commercial and industrial (C&I) loans. In 2010, an additional 73 BHCs that received funds from the U.S. Department of the Treasury's (Treasury) Troubled Asset Relief Program (TARP) repaid all funds received. As of year-end, 73 BHCs that received funds from Treasury's TARP repaid all funds received, and Treasury reports that approximately 82 percent of all distributed TARP's funds has been repaid.1 (Also see "Bank Holding Companies")
Performance of state member banks. Similar to BHCs, the turnaround at state member banks in 2010 was muted. As a group, state member banks reported a profit of $6.1 billion, up from aggregate losses totaling $4.6 billion in 2009, but low by historical norms. While earnings were up due largely to lower provisions ($17.7 billion versus $26.4 billion in 2009) and modest securities gains ($0.6 billion versus losses of $4.2 billion in 2009), almost a fifth of all state member banks continue to report losses. Mirroring trends at BHCs, the nonperforming assets ratio remained relatively unchanged at 4.3 percent of loans and foreclosed assets, reflecting both contracting loan balances and ongoing weaknesses in asset quality. Growth in problem loans slowed during 2010, but weakness encompassed nonfarm nonresidential lending, residential mortgages, and C&I loans. The number of foreclosed properties continued to increase, particularly those associated with construction and land development and one- to four-family residential lending. The risk-based capital ratios for state member banks improved during 2010 in the aggregate, and the percent of state member banks deemed well capitalized under prompt corrective action standards increased moderately to 97 percent from 95 percent at year-end 2009. In 2010, 18 state member banks with $8.5 billion in assets failed, with losses of $1.4 billion according to Federal Deposit Insurance Corporation (FDIC) estimates. (Also see "State Member Banks".)
Impact of the Dodd-Frank Act. One of the most prominent events of 2010 was the passage of the Dodd-Frank Act. The Dodd-Frank Act closed a gap in the regulatory framework by subjecting designated systemically important nonbank financial institutions to prudential regulation and consolidated supervision and by providing a mechanism for orderly resolution in the event of the failure of such an institution. A key aspect the Dodd-Frank Act is a set of enhanced standards for all systemically important financial institutions. Other elements of the act included creation of a Financial Stability Oversight Council,2 limits on certain types of proprietary trading, establishment of financial sector concentration limits, development of risk-retention requirements for securitizations, and improved oversight of over-the-counter (OTC) derivatives activity. In 2010, the Federal Reserve began the process of implementing elements of the Dodd-Frank Act through several proposed rulemakings (see "Capital Adequacy Standards"). For more detail on the impact of Dodd-Frank, see "Savings and Loan Holding Company Transfer"and "Federal Legislative Developments".
Capital adequacy. In addition, during 2010, the Federal Reserve was instrumental in augmenting standards related to capital adequacy of banking institutions. Federal Reserve staff worked proactively with the other federal banking agencies and with banking supervisors from other Basel Committee member countries to finalize a comprehensive and far-reaching reform package for internationally active banking organizations, issued in December 2010. This package aims to strengthen global capital and liquidity regulations, to be implemented in various stages in the coming years. In addition, the Federal Reserve worked with other U.S. banking agencies to issue for comment proposed rules to revise their market-risk capital rules, consistent with changes made at the Basel Committee level. Also, the Federal Reserve began implementing some of the provisions of the Dodd-Frank Act related to capital adequacy. (See "Supervisory Policy".)
Other policy initiatives. Other key policy initiatives included guidelines for evaluating proposals by large BHCs to undertake capital actions in 2011. The guidelines outlined the criteria to be used by supervisors when evaluating any capital distribution proposal (see "Capital Adequacy Standards"). The Federal Reserve and other banking agencies also issued policy statements on underwriting standards for small business loans originated under the Treasury's Small Business Lending Fund (SBLF) Program. The agencies also issued guidelines for funding and liquidity risk management, appraisals, and incentive compensation. (See box 1 and "Other Policy Issues").
Box 1. Incentive Compensation
In June 2010, the Federal Reserve issued final supervisory guidance aimed at ensuring that incentive compensation arrangements at financial organizations take into account risk and are consistent with safe and sound practices (Guidance on Sound Incentive Compensation Policies at www.federalreserve.gov/newsevents/press/bcreg/20100621a.htm). Importantly, the other federal banking agencies--the Office of the Comptroller of the Currency, the OTS, and the FDIC--joined the Federal Reserve in adopting the guidance, ensuring that the principles embedded in the guidance will apply to all banking organizations regardless of their federal supervisor.
The interagency guidance is principles-based, recognizing that the methods used to achieve appropriately risk-sensitive compensation arrangements likely will differ significantly across and within organizations. Importantly, the interagency guidance is oriented to the risk-taking incentives created by incentive compensation arrangements and not the level or amount of incentive compensation. Because improperly structured compensation arrangements for both executive and non-executive employees may pose safety-and-soundness risks, the guidance applies not only to top-level managers, but also to other employees who have the ability to materially affect the risk profile of an organization, either individually or as part of a group.
The guidance adopted by the federal banking agencies is based on three key principles: (1) incentive compensation arrangements at a banking organization should provide employees incentives that appropriately balance risk and financial results in a manner that does not encourage employees to expose their organizations to imprudent risk; (2) these arrangements should be compatible with effective controls and risk management; and (3) these arrangements should be supported by strong corporate governance, including active and effective oversight by the organization's board of directors. These principles, and the guidance more generally, are consistent with the Principles for Sound Compensation Practices issued in April 2009 by the Financial Stability Board and associated implementation standards.
The Board, in cooperation with other regulatory agencies, also conducted two supervisory initiatives designed to spur and monitor progress toward improved arrangements, identify emerging best practices, and advance the state of practice more generally in the industry. The first initiative, a horizontal review of incentive compensation practices at large complex banking organizations, will be completed in early 2011. This review has involved a multidisciplinary group of over 150 individuals, all of the banking agencies, and multiple project phases. Supervisory teams reviewed existing incentive compensation practices and related risk-management and corporate governance processes, evaluated plans and timetables for enhancements, and conducted more detailed reviews of a few specific business lines. Supervisors have observed and encouraged real, positive change in the incentive compensation practices of these banking organizations.
Additionally, the agencies incorporated oversight of incentive compensation arrangements into the regular examination process for smaller organizations. These reviews will be tailored to take account of the size, complexity, and other characteristics of these banking organizations.
Federal Reserve staff will prepare a report sometime after the conclusion of the 2010 bonus season, in consultation with the other federal banking agencies, on trends and developments in compensation practices at banking organizations. (For information on rulemaking/guidance required under the Dodd-Frank Act on incentive-based compensation, see "Changes to Banking Regulation and Supervision"in the "Federal Legislative Developments" chapter.)Return to text
Bank examinations and inspections. In light of supervisory lessons learned, the Federal Reserve began augmenting its processes for conducting examinations and inspections as needed. A prominent example is the enhanced approach to supervision of the largest, most complex organizations that takes a macroprudential and multidisciplinary approach to supervision, making greater use of the broad range of skills of the Federal Reserve staff to promote financial stability. (Also see "Examinations and Inspections" below and table 1.)
|State member banks|
|Total assets (billions of dollars)||1,697||1,690||1,854||1,519||1,405|
|Number of examinations||912||850||717||694||761|
|By Federal Reserve System||722||655||486||479||500|
|By state banking agency||190||195||231||215||261|
|Top-tier bank holding companies|
|Large (assets of more than $1 billion)|
|Total assets (billions of dollars)||15,986||15,744||14,138||13,281||12,179|
|Number of inspections||677||658||519||492||566|
|By Federal Reserve System1||654||640||500||476||557|
|By state banking agency||23||18||19||16||9|
|Small (assets of $1 billion or less)|
|Total assets (billions of dollars)||991||1,018||1,008||974||947|
|Number of inspections||3,340||3,264||3,192||3,186||3,449|
|By Federal Reserve System||3,199||3,109||3,048||3,007||3,257|
|By state banking agency||141||155||144||179||192|
|Financial holding companies|
1. For large bank holding companies subject to continuous, risk-focused supervision, includes multiple targeted reviews. Return to table
- Safety and Soundness
- Supervisory Policy
- Supervisory Information Technology
- Staff Development
Safety and Soundness
To promote the safety and soundness of banking organizations, the Federal Reserve conducts on-site examinations and inspections, conducts off-site surveillance and monitoring, and takes enforcement and other supervisory actions as necessary. The Federal Reserve also provides training and technical assistance to foreign supervisors and minority-owned and de novo depository institutions.
Examinations and Inspections
The Federal Reserve conducts examinations of state member banks, the U.S. branches and agencies of foreign banks, and Edge Act and agreement corporations. In a process distinct from examinations, it conducts inspections of BHCs and their nonbank subsidiaries. Whether an examination or an inspection is being conducted, the review of operations entails
- an evaluation of the adequacy of governance provided by the board and senior management, including an assessment of internal policies, procedures, controls, and operations;
- an assessment of the quality of the risk-management and internal control processes in place to identify, measure, monitor, and control risks;
- an assessment of the key financial factors of capital, asset quality, earnings, and liquidity; and
- a review for compliance with applicable laws and regulations.
Table 1 provides information on examinations and inspections conducted by the Federal Reserve during the past five years.
The Federal Reserve uses a risk-focused approach to supervision, with activities directed toward identifying the areas of greatest risk to banking organizations and assessing the ability of the organizations' management processes to identify, measure, monitor, and control those risks. Key aspects of the risk-focused approach to consolidated supervision of the largest institutions (see box 2) supervised by the Federal Reserve include
- developing an understanding of each organization's legal and operating structure, and its primary strategies, business lines, and risk-management and internal control functions;
- developing and executing a tailored supervisory plan that outlines the work required to maintain a comprehensive understanding and assessment of each institution, incorporating reliance to the fullest extent possible on assessments and information developed by other relevant domestic and foreign supervisors and functional regulators;
- maintaining continual supervision of these organizations--including through meetings with banking organization management and analysis of internal and external information--so that the Federal Reserve's understanding and assessment of each organization's condition remains current;
- assigning to each organization a supervisory team composed of Reserve Bank staff who have skills appropriate for the organization's risk profile; and
- promoting Systemwide and interagency information-sharing through automated systems and other mechanisms.
Box 2. Large Bank Supervision
The Dodd-Frank Act closed critical gaps in the regulatory framework by ensuring systemically important nonbank financial institutions would be subject to consolidated supervision and by providing a mechanism for orderly resolution in the event of the failure of such an institution. But, the crisis of 2008 also highlighted the critical importance of effective supervision of all systemically important institutions to reduce the potential for a destabilizing collapse of a troubled financial institution.
Well in advance of the passage of the Dodd-Frank Act, the Federal Reserve established an internal working group to enhance the effectiveness of the conduct of its supervisory activities. The working group, which comprised senior officials from the Board of Governors and the Reserve Banks, was charged with identifying key areas for improving supervision, as well as with laying out the actions necessary to effect those improvements. The working group identified needed improvements in each of three critical supervisory activities:
- the identification of key risks and vulnerabilities;
- the design and execution of the appropriate supervisory responses to these risks and concerns; and
- effective communication from supervisors to institutions about the risks and vulnerabilities that have been identified and related remedial requirements.
In response, to improve risk identification of both safety-and-soundness issues at individual institutions and broader risks to the financial system, the Federal Reserve is incorporating a more macroprudential orientation. To enhance the design and execution of supervisory activities, such as horizontal examinations and stress tests, we are adopting a multidisciplinary approach supported by rigorous quantitative analysis. Further, to facilitate greater agility and effectiveness in our supervisory responses, our corporate governance for large bank supervision now involves more senior and centralized System expertise.
The structure and governance of large bank supervision has been reorganized to support these objectives. The Large Institution Supervision Coordinating Committee (LISCC) was established as a multidisciplinary group of senior Federal Reserve officials to provide strategic and policy direction for supervisory activities, to ensure that systemic risk concerns are fully integrated in supervisory planning, and to facilitate improved consistency and quality of supervision. Through the LISCC, an expansive breadth of expertise from within the Federal Reserve System--in the research divisions, markets group, and clearing and settlement functions-- informs and complements the work of our supervisors. A multidisciplinary Operating Committee has been implemented to support the LISCC at the staff level. Like the LISCC, the Operating Committee incorporates participation from specialized skills from across the System in all phases of supervision for the most complex institutions.
Increased use of data-driven modeling and forecasting techniques, such as in the stress testing of low-probability, high-impact events, will allow supervisors to better anticipate and mitigate systemic risks. These tools are being used to assess potential risks and to support supervisors' assessment of an institution's internal capital assessment practices. Under this framework, the Federal Reserve will increase its use of horizontal examinations and scenario analysis, extend its focus to macroprudential issues, and increase cooperation with primary and functional supervisors.Return to text
For other sized banking organizations, the risk-focused consolidated supervision program provides that examination and inspection procedures are tailored to each banking organization's size, complexity, risk profile, and condition. The supervisory program for an institution, regardless of its asset size, entails both off-site and on-site work, including development of supervisory plans, pre-examination visits, detailed documentation, and preparation of examination reports tailored to the scope and findings of the examination.
State Member Banks
At the end of 2010, 829 state-chartered banks (excluding nondepository trust companies and private banks) were members of the Federal Reserve System. These banks represented approximately 13 percent of all insured U.S. commercial banks and held approximately 14 percent of all insured commercial bank assets in the United States. The guidelines for Federal Reserve examinations of state member banks are fully consistent with section 10 of the Federal Deposit Insurance Act, as amended by section 111 of the Federal Deposit Insurance Corporation Improvement Act of 1991 and by the Riegle Community Development and Regulatory Improvement Act of 1994. A full-scope, on-site examination of these banks is required at least once a year, although certain well-capitalized, well-managed organizations having total assets of less than $500 million may be examined once every 18 months.3 The Federal Reserve conducted 722 exams of state member banks in 2010.
Bank Holding Companies
At year-end 2010, a total of 5,464 U.S. BHCs were in operation, of which 4,844 were top-tier BHCs. These organizations controlled 5,443 insured commercial banks and held approximately 99 percent of all insured commercial bank assets in the United States. Federal Reserve guidelines call for annual inspections of large BHCs and complex smaller companies. In judging the financial condition of the subsidiary banks owned by holding companies, Federal Reserve examiners consult examination reports prepared by the federal and state banking authorities that have primary responsibility for the supervision of those banks, thereby minimizing duplication of effort and reducing the supervisory burden on banking organizations. Inspections of BHCs, including financial holding companies, are built around a rating system introduced in 2005. The system reflects the shift in supervisory practices away from a historical analysis of financial condition toward a more dynamic, forward-looking assessment of risk-management practices and financial factors. Under the system, known as RFI but more fully termed RFI/C(D), holding companies are assigned a composite rating (C) that is based on assessments of three components: Risk Management (R), Financial Condition (F), and the potential Impact (I) of the parent company and its nondepository subsidiaries on the subsidiary depository institution. The fourth component, Depository Institution (D), is intended to mirror the primary supervisor's rating of the subsidiary depository institution.4 Noncomplex BHCs with consolidated assets of $1 billion or less are subject to a special supervisory program that permits a more flexible approach.5 In 2010, the Federal Reserve conducted 654 inspections of large BHCs and 3,199 inspections of small, noncomplex BHCs.
Financial Holding Companies
Under the Gramm-Leach-Bliley Act, BHCs that meet certain capital, managerial, and other requirements may elect to become financial holding companies and thereby engage in a wider range of financial activities, including full-scope securities underwriting, merchant banking, and insurance underwriting and sales. As of year-end 2010, 430 domestic BHCs and 43 foreign banking organizations had financial holding company status. Of the domestic financial holding companies, 34 had consolidated assets of $15 billion or more; 101, between $1 billion and $15 billion; 68, between $500 million and $1 billion; and 227, less than $500 million.
Savings and Loan Holding Company Transfer
The Dodd-Frank Act transfers authority for consolidated supervision of SLHCs and their non-depository subsidiaries from the OTS to the Federal Reserve, effective July 21, 2011. The overriding principles include securing an orderly transfer of information and knowledge (see box 3), ensuring that there are no gaps in holding company supervision, and providing the thrift industry with information on a flow basis so as to increase certainty and minimize unnecessary disruption during the transition period.
Box 3. Interagency Coordination of the Savings and Loan Holding Company Transfer
The Federal Reserve is engaged in a range of activities to implement the transfer of consolidated supervision of SLHCs from the OTS. Federal Reserve staff is working closely with the OTS, whose staff is providing valuable information, expertise, and consultation during this transition period. Additionally, the Federal Reserve is working with staff at the Office of the Comptroller of the Currency and the FDIC in light of the critical role that these primary federal regulators play in contributing to the Federal Reserve's knowledge of consolidated holding companies.Return to text
Any company that controls a depository institution should be held to appropriate prudential standards, including those for capital, liquidity, and risk management. As such, the Federal Reserve intends to create an oversight regime for thrift holding companies that is consistent with, and is as rigorous as, the supervisory regime applicable to BHCs. Consequently, the Federal Reserve intends, to the greatest extent possible, taking into account any unique characteristics of SLHCs and the requirements of the Home Owners' Loan Act (HOLA), to carry out supervisory oversight of SLHCs on a comprehensive consolidated basis, consistent with the established approach to BHC supervision.6 To this end, Federal Reserve staff is reviewing all elements of its BHC supervision program to determine whether and how to incorporate SLHCs into the program, consistent with HOLA. The program includes
- understanding the structure of holding companies and material activities of these companies,
- evaluating risks posed by nonbanking activities in a holding company structure,
- imposing prudential standards on a consolidated basis, and
- assessing the consumer compliance risk profile for holding companies.
As the Federal Reserve develops plans for other aspects of the Dodd-Frank Act, it will extend these existing approaches to the supervisory programs for SLHCs, as appropriate.
The Dodd-Frank Act gives the Federal Reserve the authority to require grandfathered unitary SLHCs that conduct activities other than financial activities to establish an intermediate holding company over all, or a portion of, the financial activities. The Federal Reserve has established a working group to consider the issues associated with this authority and its potential advantages to effective supervision of such grandfathered companies. The Federal Reserve will implement this authority only after a proposed rule has been published for notice and public comment.
The Federal Reserve anticipates that all regulations, as appropriate, relating to (1) supervision of SLHCs and nondepository institution subsidiaries of SLHCs; (2) transactions with affiliates; (3) extensions of credit to executive officers, directors, and principal shareholders; and (4) tying arrangements will continue and will be enforceable by the appropriate agency. A working group is conducting an analysis of OTS and Federal Reserve regulations and guidance documents to determine policy or technical differences and to assess whether there are any gaps. The Federal Reserve will decide which OTS regulations should be amended after the transfer date, in conjunction with a broad assessment of the holding company standards to be applied to SLHCs and other policy considerations. The Federal Reserve will make changes, when necessary, to any transferred OTS regulations after public notice and opportunity for comment.
The Federal Reserve and the OTS are engaged in detailed discussions on the range of operational issues that they need to address during the transition period. In addition to detailed briefings on legal and regulatory issues, the OTS staff has provided information on its holding company program and on current supervisory issues. The agencies signed a memorandum of understanding (MOU) to facilitate the sharing of confidential supervisory information during the transition. This will allow the Federal Reserve to become familiar with the condition of each SLHC coming under its jurisdiction and to identify resource requirements needed on the transfer date. The Federal Reserve will integrate SLHCs into its existing programs that align institutions with institutional portfolios based on their size and complexity. For instance, smaller, noncomplex SLHCs will be supervised in the Community Banking Organization portfolio while larger, more complex SLHCs will be supervised in the Regional or Large Banking Organization portfolios. The Federal Reserve Board has assigned each SLHC to a responsible Reserve Bank.7 To facilitate the transition process, and pursuant to the MOU, examiners from the Federal Reserve are joining certain OTS examinations prior to the transfer date to gather information and learn about the OTS supervisory process. Discussions are well under way about the orderly transition of the caseload from the OTS to the Reserve Banks.
The Federal Reserve supervises the foreign branches and overseas investments of member banks, Edge Act and agreement corporations, and BHCs (including the investments by BHCs in export trading companies). In addition, it supervises the activities that foreign banking organizations conduct through entities in the United States, including branches, agencies, representative offices, and subsidiaries.
Foreign Operations of U.S. Banking Organizations
In supervising the international operations of state member banks, Edge Act and agreement corporations, and BHCs, the Federal Reserve generally conducts its examinations or inspections at the U.S. head offices of these organizations, where the ultimate responsibility for the foreign offices lies. Examiners also visit the overseas offices of U.S. banks to obtain financial and operating information and, in some instances, to test their adherence to safe and sound banking practices and compliance with rules and regulations or to evaluate an organization's efforts to implement corrective measures. Examinations abroad are conducted with the cooperation of the supervisory authorities of the countries in which they take place; for national banks, the examinations are coordinated with the Office of the Comptroller of the Currency (OCC). At the end of 2010, 53 member banks were operating 567 branches in foreign countries and overseas areas of the United States; 31 national banks were operating 508 of these branches, and 22 state member banks were operating the remaining 59. In addition, 18 nonmember banks were operating 26 branches in foreign countries and overseas areas of the United States.
Edge Act and Agreement Corporations
Edge Act corporations are international banking organizations chartered by the Board to provide all segments of the U.S. economy with a means of financing international business, especially exports. Agreement corporations are similar organizations, state chartered or federally chartered, that enter into agreements with the Board to refrain from exercising any power that is not permissible for an Edge Act corporation. Sections 25 and 25A of the Federal Reserve Act grant Edge Act and agreement corporations permission to engage in international banking and foreign financial transactions. These corporations, most of which are subsidiaries of member banks, may (1) conduct a deposit and loan business in states other than that of the parent, provided that the business is strictly related to international transactions, and (2) make foreign investments that are broader than those permissible for member banks. At year-end 2010, 51 banking organizations, operating 10 branches, were chartered as Edge Act or agreement corporations. These corporations are examined annually.
U.S. Activities of Foreign Banks
The Federal Reserve has broad authority to supervise and regulate the U.S. activities of foreign banks that engage in banking and related activities in the United States through branches, agencies, representative offices, commercial lending companies, Edge Act corporations, commercial banks, BHCs, and certain nonbanking companies. Foreign banks continue to be significant participants in the U.S. banking system. As of year-end 2010, 173 foreign banks from 52 countries operated 205 state-licensed branches and agencies, of which six were insured by the FDIC, and 50 OCC-licensed branches and agencies, of which four were insured by the FDIC. These foreign banks also owned eight Edge Act and agreement corporations and two commercial lending companies. In addition, they held a controlling interest in 55 U.S. commercial banks. Altogether, the U.S. offices of these foreign banks at the end of 2010 controlled approximately 17 percent of U.S. commercial banking assets. These 173 foreign banks also operated 92 representative offices; an additional 54 foreign banks operated in the United States through a representative office.
State-licensed and federally licensed branches and agencies of foreign banks are examined on-site at least once every 18 months, either by the Federal Reserve or by a state or other federal regulator. In most cases, on-site examinations are conducted at least once every 12 months, but the period may be extended to 18 months if the branch or agency meets certain criteria.
In cooperation with the other federal and state banking agencies, the Federal Reserve conducts a joint program for supervising the U.S. operations of foreign banking organizations. The program has two main parts. One part involves examination of those foreign banking organizations that have multiple U.S. operations and is intended to ensure coordination among the various U.S. supervisory agencies. The other part is a review of the financial and operational profile of each organization to assess its general ability to support its U.S. operations and to determine what risks, if any, the organization poses through its U.S. operations. Together, these two processes provide critical information to U.S. supervisors in a logical, uniform, and timely manner. The Federal Reserve conducted or participated with state and federal regulatory authorities in 465 examinations in 2010.
Compliance with Regulatory Requirements
The Federal Reserve examines institutions for compliance with a broad range of legal requirements, including anti-money-laundering (AML) and consumer protection laws and regulations, and other laws pertaining to certain banking and financial activities. Most compliance supervision is conducted under the oversight of the Board's Division of Banking Supervision and Regulation, but consumer compliance supervision is conducted under the oversight of the Division of Community and Consumer Affairs. The two divisions coordinate their efforts with each other and also with the Board's Legal Division to ensure consistent and comprehensive Federal Reserve supervision for compliance with legal requirements.
The Treasury regulations implementing the Bank Secrecy Act (BSA) generally require banks and other types of financial institutions to file certain reports and maintain certain records that are useful in criminal, tax, or regulatory proceedings. The BSA and separate Board regulations require banking organizations supervised by the Board to file reports on suspicious activity related to possible violations of federal law, including money laundering, terrorism financing, and other financial crimes. In addition, BSA and Board regulations require that banks develop written BSA compliance programs and that the programs be formally approved by bank boards of directors. The Federal Reserve is responsible for examining institutions for compliance with applicable AML laws and regulations and conducts such examinations in accordance with the Federal Financial Institutions Examination Council (FFIEC) Bank Secrecy Act/Anti-Money Laundering Examination Manual.8
The Federal Reserve conducts specialized examinations of banking organizations in the areas of information technology, fiduciary activities, transfer agent activities, and government and municipal securities dealing and brokering. The Federal Reserve also conducts specialized examinations of certain nonbank entities that extend credit subject to the Board's margin regulations.
Information Technology Activities
In recognition of the importance of information technology to safe and sound operations in the financial industry, the Federal Reserve reviews the information technology activities of supervised banking organizations as well as certain independent data centers that provide information technology services to these organizations. All safety-and-soundness examinations include a risk-focused review of information technology risk-management activities. During 2010, the Federal Reserve continued as the lead agency in four interagency examinations of large, multiregional data processing servicers, and it assumed leadership in one additional examination late in the year.
The Federal Reserve has supervisory responsibility for state member banks and state member nondepository trust companies that reported $53.1 trillion and $36.5 trillion of assets, respectively, as of year-end 2010. These assets were held in various fiduciary and custodial capacities. On-site examinations of fiduciary and custodial activities are risk-focused and entail the review of an organization's compliance with laws, regulations, and general fiduciary principles, including effective management of conflicts of interest; management of legal, operational, and reputational risk exposures; and audit and control procedures. In 2010, Federal Reserve examiners conducted 111 on-site fiduciary examinations, excluding transfer agent examinations, of state member banks.
As directed by the Securities Exchange Act of 1934, the Federal Reserve conducts specialized examinations of those state member banks and BHCs that are registered with the Board as transfer agents. Among other things, transfer agents countersign and monitor the issuance of securities, register the transfer of securities, and exchange or convert securities. On-site examinations focus on the effectiveness of an organization's operations and its compliance with relevant securities regulations. During 2010, the Federal Reserve conducted on-site transfer agent examinations at seven of the 38 state member banks and BHCs that were registered as transfer agents.
Government and Municipal Securities Dealers and Brokers
The Federal Reserve is responsible for examining state member banks and foreign banks for compliance with the Government Securities Act of 1986 and with the Treasury regulations governing dealing and brokering in government securities. Twelve state member banks and six state branches of foreign banks have notified the Board that they are government securities dealers or brokers not exempt from the Treasury's regulations. During 2010, the Federal Reserve conducted six examinations of broker-dealer activities in government securities at these organizations. These examinations are generally conducted concurrently with the Federal Reserve's examination of the state member bank or branch.
The Federal Reserve is also responsible for ensuring that state member banks and BHCs that act as municipal securities dealers comply with the Securities Act Amendments of 1975. Municipal securities dealers are examined, pursuant to the Municipal Securities Rulemaking Board's rule G-16, at least once every two calendar years. Of the 10 entities that dealt in municipal securities during 2010, seven were examined during the year.
Securities Credit Lenders
Under the Securities Exchange Act of 1934, the Board is responsible for regulating credit in certain transactions involving the purchase or carrying of securities. As part of its general examination program, the Federal Reserve examines the banks under its jurisdiction for compliance with Board Regulation U (Credit by Banks and Persons other than Brokers or Dealers for the Purpose of Purchasing or Carrying Margin Stock). In addition, the Federal Reserve maintains a registry of persons other than banks, brokers, and dealers who extend credit subject to Regulation U. The Federal Reserve may conduct specialized examinations of these lenders if they are not already subject to supervision by the Farm Credit Administration (FCA) or the National Credit Union Administration (NCUA).
At the end of 2010, 531 lenders other than banks, brokers, or dealers were registered with the Federal Reserve. Other federal regulators supervised 178 of these lenders, and the remaining 353 were subject to limited Federal Reserve supervision. The Federal Reserve exempted 153 lenders from its on-site inspection program on the basis of their regulatory status and annual reports. Thirty-four inspections were conducted during the year.
The Federal Reserve has enforcement authority over the banking organizations it supervises and their affiliated parties. Enforcement actions may be taken to address unsafe and unsound practices or violations of any law or regulation. Formal enforcement actions include cease-and-desist orders, written agreements, prompt corrective action directives, removal and prohibition orders, and civil money penalties. In 2010, the Federal Reserve completed 264 formal enforcement actions. Civil money penalties totaling $33,010 were assessed. As directed by statute, all civil money penalties are remitted to either the Treasury or the Federal Emergency Management Agency. Enforcement orders and prompt corrective action directives, which are issued by the Board, and written agreements, which are executed by the Reserve Banks, are made public and are posted on the Board's website (www.federalreserve.gov/apps/enforcementactions/).
In addition to taking these formal enforcement actions, the Reserve Banks completed 639 informal enforcement actions in 2010. Informal enforcement actions include MOU and board of directors resolutions. Information about these actions is not available to the public.
Surveillance and Off-Site Monitoring
The Federal Reserve uses automated screening systems to monitor the financial condition and performance of state member banks and BHCs in the period between on-site examinations. Such monitoring and analysis helps direct examination resources to institutions that have higher-risk profiles. Screening systems also assist in the planning of examinations by identifying companies that are engaging in new or complex activities.
The primary off-site monitoring tool used by the Federal Reserve is the Supervision and Regulation Statistical Assessment of Bank Risk model (SR-SABR). Drawing mainly on the financial data that banks report on their Reports of Condition and Income (Call Reports), SR-SABR uses econometric techniques to identify banks that report financial characteristics weaker than those of other banks assigned similar supervisory ratings. To supplement the SR-SABR screening, the Federal Reserve also monitors various market data, including equity prices, debt spreads, agency ratings, and measures of expected default frequency, to gauge market perceptions of the risk in banking organizations. In addition, the Federal Reserve prepares quarterly Bank Holding Company Performance Reports (BHCPRs) for use in monitoring and inspecting supervised banking organizations. The BHCPRs, which are compiled from data provided by large BHCs in quarterly regulatory reports (FR Y-9C and FR Y-9LP), contain, for individual companies, financial statistics and comparisons with peer companies. BHCPRs are made available to the public on the National Information Center (NIC) website, which can be accessed at www.ffiec.gov .
Federal Reserve analysts use Performance Report Information and Surveillance Monitoring (PRISM), a querying tool, to access and display financial, surveillance, and examination data. In the analytical module, users can customize the presentation of institutional financial information drawn from Call Reports, Uniform Bank Performance Reports, FR Y-9 statements, BHCPRs, and other regulatory reports. In the surveillance module, users can generate reports summarizing the results of surveillance screening for banks and BHCs. During 2010, four major upgrades to the web-based PRISM application were completed.
The Federal Reserve works through the FFIEC Task Force on Surveillance Systems to coordinate surveillance activities with the other federal banking agencies.
Training and Technical Assistance
The Federal Reserve provides training and technical assistance to foreign supervisors and minority-owned and de novo depository institutions.
International Training and Technical Assistance
In 2010, the Federal Reserve continued to provide technical assistance on bank supervisory matters to foreign central banks and supervisory authorities. Technical assistance involves visits by Federal Reserve staff members to foreign authorities as well as consultations with foreign supervisors who visit the Board or the Reserve Banks. The Federal Reserve, along with the OCC, the FDIC, and the Treasury, was an active participant in the Middle East and North Africa Financial Regulators' Training Initiative, which is part of the U.S. government's Middle East Partnership Initiative. The Federal Reserve also contributes to the regional training provision under the Asia Pacific Economic Cooperation Financial Regulators' Training Initiative.
In 2010, the Federal Reserve offered a number of training courses exclusively for foreign supervisory authorities, both in the United States and in a number of foreign jurisdictions. Federal Reserve staff also took part in technical assistance and training missions led by the International Monetary Fund (IMF), the World Bank, the Asian Development Bank, the Basel Committee on Banking Supervision (Basel Committee), and the Financial Stability Institute.
The Federal Reserve is also an associate member of the Association of Supervisors of Banks of the Americas (ASBA), an umbrella group of bank supervisors from countries in the Western Hemisphere. The group, headquartered in Mexico,
- promotes communication and cooperation among bank supervisors in the region;
- coordinates training programs throughout the region with the help of national banking supervisors and international agencies; and
- aims to help members develop banking laws, regulations, and supervisory practices that conform to international best practices.
The Federal Reserve contributes significantly to ASBA's organizational management and to its training and technical assistance activities.
Initiatives for Minority-Owned and De Novo Depository Institutions
The Partnership for Progress program is a Federal Reserve System program created to preserve and promote minority-owned, woman-owned, and de novo depository institutions (MBOs). Launched in 2008, the program seeks to help these institutions compete effectively in today's marketplace by offering them a combination of one-on-one guidance and targeted workshops on topics of particular relevance in terms of starting and growing a bank in a safe and sound manner. In addition, training and information on resources are provided through an extensive public website (www.fedpartnership.gov ). Designated Partnership for Progress coordinators serve as local program contacts in each of the 12 Reserve Bank Districts and at the Board to answer questions and coordinate assistance for institutions requesting guidance.
The Board Oversight Committee is committed to further enhancing support for MBOs who are facing increasing marketplace challenges, as many operate in some of the hardest hit regions and are adversely impacted by the recent recession and sluggish economic recovery. The Board also appointed a new national coordinator to lead the program. The program district coordinators and the Board Oversight Committee will conduct two program conferences annually to discuss the program activities, meet with MBO bankers and industry experts, and report/coordinate the program Systemwide initiatives.
During 2010, the Federal Reserve hosted a variety of workshops and seminars including
- an information session for Federal Reserve examination staff on the condition of minority banks and the application of the Partnership for Progress program;
- a series of seven seminars on Community Development Financial Institutions (CDFI) programs and Small Business Lending programs;
- a workshop on Financial Intelligence for Developing Executives to increase expertise in analyzing financial data and performance metrics;
- presentations on the New Markets Tax Credits Program (NMTC) at the National Interagency Community Reinvestment Conference in New Orleans, in partnership with the CDFI Fund;
- a presentation on NMTCs at the National Bankers Association Legislative Regulatory Conference; and
- a series of advanced NMTC webinars as part of a collaborative interagency effort.
The seminars on the NMTC and CDFI programs helped minority bankers to better understand how these programs can be used as a source of funding. Along with the FDIC, OCC, and OTS, the Federal Reserve sponsored the NMTC guidance program.
The Federal Reserve participated in the FDIC Investor Series to share information with minority bankers and investors interested in purchasing bank assets or starting banks.9 The Federal Reserve also participated in the National Bankers Association (NBA) Annual Convention to discuss priorities for the NBA and minority banks during 2011 and possible program initiatives to improve support for minority banks.
Additionally, the Federal Reserve coordinates its efforts with those of the other agencies through participation in an annual interagency conference for minority depository institutions. For the federal bank regulatory agencies, the conference provides an opportunity to meet with senior managers from minority-owned institutions and gain a better understanding of the institutions' unique challenges and opportunities. Finally, the agencies offer training classes and sessions on emerging banking issues.
Business Continuity/Pandemic Preparedness
In 2010, the Federal Reserve continued its efforts to strengthen the resilience of the U.S. financial system in the event of unexpected disruptions, including focused supervisory efforts to evaluate the resiliency of the banking institutions under its jurisdiction. The Federal Reserve revised, jointly with other regulatory agencies, its analysis of firms subject to the Interagency Paper on Sound Practices to Strengthen the Resilience of the U.S. Financial System (Sound Practices paper).10 Subsequently, the Federal Reserve notified firms with business lines falling within the parameters of the Sound Practices paper of the resiliency requirements and began meeting with those firms to assess their implementation plans and timeframes for implementation.
The Federal Reserve, together with other federal and state financial regulators, is a member of the Financial Banking Information Infrastructure Committee (FBIIC), which was formed to improve coordination and communication among financial regulators, enhance the resiliency of the financial services sector of U.S. critical infrastructures and key resources, and promote the public/private partnership. The FBIIC has established emergency communication protocols to maintain effective communication among members in the event of an emergency. The members of the FBIIC will convene by conference call no later than 90 minutes following the first public report of an event to share situational and operational status reports. As a member of FBIIC, the Federal Reserve is then responsible for establishing and maintaining communication with the institutions for which they have primary supervisory authority and for ensuring coordination between public affairs and media relations staff.
The Federal Reserve's supervisory policy function, carried out by the Board, is responsible for developing guidance for examiners and banking organizations as well as regulations for banking organizations under the Federal Reserve's supervision. The Board, often in conjunction with the other federal banking agencies, issues rulemakings, public SR letters, and other policy statements and guidance in order to carry out its supervisory policy function. Federal Reserve staff also participate in supervisory and regulatory forums, provide support for the work of the FFIEC, and participate in international forums such as the Basel Committee, the Financial Stability Board, the Joint Forum, and the International Accounting Standards Board.
Capital Adequacy Standards
In 2010, the Board issued several rulemakings and guidance documents related to capital adequacy standards, including several joint proposed rulemakings with the other federal banking agencies to address provisions of the Dodd-Frank Act.
- In response to the Dodd-Frank Act's requirement to remove references to, or requirements of reliance on, the use of credit ratings in federal regulations, the federal banking agencies issued an advanced notice of proposed rulemaking (ANPR) seeking comment on alternatives to the use of credit ratings in the risk-based capital rules. The ANPR (1) describes how the agencies' risk-based capital standards currently reference ratings; (2) sets forth the factors the agencies will consider in assessing potential alternatives to the use of credit ratings; and (3) describes briefly, and requests comment on, potential alternatives to the use of credit ratings. The ANPR is available at www.gpo.gov/fdsys/pkg/FR-2010-08-25/
- The federal banking agencies issued for comment a notice of proposed rulemaking (NPR) to amend the advanced approaches capital adequacy framework, consistent with certain provisions of the Dodd-Frank Act. The proposed rule would require a banking organization operating under the advanced approaches framework to meet, on an ongoing basis, the higher of the generally applicable and the advanced approaches minimum risk-based capital standards. The NPR is available at http://edocket.access.gpo.gov/2010/pdf/2010-32190.pdf .
- In order to implement certain market risk-related changes to the Basel Accord, the Board, the OCC, and the FDIC issued for comment an NPR to revise their market-risk capital rules. The proposed revisions would (1) better capture positions for which the market-risk capital rules are appropriate, (2) reduce procyclicality in market-risk capital requirements, (3) enhance the rules' sensitivity to risks that are not adequately captured by the current regulatory measurement methodologies, and (4) increase market discipline through enhanced disclosures. The NPR is available at http://edocket.access.gpo.gov/2011/pdf/2010-32189.pdf .
- The federal banking agencies issued a statement clarifying the risk weight for claims on, or guaranteed by, the FDIC. The statement is available at www.federalreserve.gov/boarddocs/srletters/2010/sr1004a1.pdf.
- The Federal Reserve issued guidelines for evaluating proposals by large BHCs to undertake capital actions in 2011 in a revised temporary addendum to SR letter 09-4, "Dividend Increases and Other Capital Distributions for the 19 Supervisory Capital Assessment Program Firms." The guidelines state that any capital distribution proposal will be evaluated on the basis of a number of criteria including, for example, the firm's ability to absorb losses over the next two years under several scenarios, the firm's plans to meet Basel III capital requirements, and the firm's plans to repay U.S. government investments, if applicable. The guidelines are available at www.federalreserve.gov/boarddocs/srletters/2009/SR0904_Addendum.pdf.
In 2010, Board and Reserve Bank staff conducted supervisory analyses of a number of complex capital issuances, private capital investments, and novel transactions to determine their qualification for inclusion in regulatory capital and consistency with safety and soundness. For certain transactions, staff required banking organizations to make changes necessary for instruments to satisfy these criteria.
Board staff participated in making determinations regarding tier 1 qualification of capital issuances arising from the review of applications for private capital investments in banking organizations, including banking organizations in severely impaired condition. The focus of these analyses is compliance with the Board's capital standards for inclusion in tier 1 capital, as well as consistency with safety and soundness to ensure that the terms of such private investments do not (1) impede prudent action by issuing banking organizations to address financial problems or (2) impair the Federal Reserve's ability to take appropriate supervisory action.
Board staff also continued in 2010 to work closely with the Treasury and the other federal banking agencies in making determinations related to the tier 1 capital eligibility of capital instruments issued to Treasury under the Community Development Financial Institutions Program and securities issued to the Small Business Lending Fund, initiated by Congress in 2010.
International Guidance on Supervisory Policies
As a member of the Basel Committee, the Federal Reserve participates in efforts to advance sound supervisory policies for internationally active banking organizations and improve the stability of the international banking system. (See box 4 for a list of Basel Committee publications on risk-management practices.)
Box 4. Risk Management
The Federal Reserve contributed to supervisory policy papers, reports, and recommendations issued by the Basel Committee during 2010 and aimed at improving the supervision of banking organizations' risk-management practices. Publications during 2010 included
- Sound practices for back testing counterparty credit risk models (final document, issued in December at www.bis.org/publ
- Report and recommendations of the Cross-border Bank Resolution Group (final document, issued in March at www.bis.org/publ/bcbs169.htm );
- Operational risk-supervisory guidelines for the Advanced Measurement Approaches (consultative paper, issued in December at www.bis.org/publ/bcbs184.htm ); and
- Range of methodologies for risk and performance alignment of remuneration (consultative paper, issued in October at www.bis.org/publ/bcbs178.htm ).
During 2010, Federal Reserve staff worked proactively with the other federal banking agencies and with banking supervisors from Basel Committee member countries to finalize a comprehensive and far-reaching reform package for internationally active banking organizations. On December 16, 2010, the Basel Committee issued "Basel III: A global regulatory framework for more resilient banks and banking systems," with the overarching goal of increasing the resiliency of the banking system by strengthening global capital and liquidity regulations. International implementation of Basel III is scheduled to begin January 1, 2013, and certain aspects are subject to transitional arrangements.
Basel III increases the quantity and quality of the regulatory capital base in several ways. Importantly, it establishes a new minimum common equity tier 1 to risk-weighted assets ratio of 4.5 percent. This is the first time that the risk-based capital framework will include an explicit capital standard based on tangible common equity, which is the highest form of capital. To instill market confidence in the regulatory capital framework, common equity tier 1 is subject to strict eligibility criteria, and regulatory deductions from capital are taken from common equity tier 1. Regulatory deductions include deferred tax assets associated with net operating losses, all intangible assets (except mortgage servicing rights), and defined benefit pension fund assets to which the banking organization does not have unfettered and unrestricted access. Mortgage servicing rights, deferred tax assets associated with timing differences, and significant investments in unconsolidated financial firms are subject to a strict individual and aggregate limit of 10 percent and 15 percent of common equity tier 1, respectively; amounts above these limits must be deducted from common equity tier 1.
Basel III tightens the criteria for tier 1 eligibility to ensure that all tier 1 capital can absorb losses on a going concern basis--those instruments that no longer qualify as tier 1 capital will be phased-out over an agreed-upon timeframe and either included in tier 2 capital or fully excluded from regulatory capital. Instruments that no longer qualify as tier 2 capital will be phased-out from regulatory capital. Under Basel III, the minimum tier 1 to risk-weighted assets ratio is increased from 4 percent to 6 percent, while the total capital to risk-weighted assets ratio remains at 8 percent.
Basel III introduces a series of measures to promote the buildup of capital buffers in good times that can be drawn upon in periods of stress. It requires banking organizations to hold a capital conservation buffer composed of common equity tier 1 above the regulatory minimum levels. The capital conservation buffer is calibrated at 2.5 percent of risk-weighted assets to enable banking organizations to maintain capital levels above the minimum requirements throughout a significant sector-wide downturn. Under Basel III, banking organizations that fail to maintain this 2.5 percent capital conservation buffer will face mandatory regulatory restrictions on the percentage of earnings that they can pay out in the form of capital distributions or employee discretionary bonus payments. Together, the minimum capital requirements plus the capital conservation buffer translate into 7 percent common equity tier 1, 8.5 percent tier 1, and 10.5 percent total capital to risk-weighted assets ratio requirements.
Subject to national discretion, Basel III also introduces a countercyclical capital buffer that fluctuates between 0 and 2.5 percent of risk-weighted assets that could be triggered when a relevant measure indicative of steep credit expansion hits a specified threshold. The countercyclical buffer would effectively work as an extension of the capital conservation buffer and should contribute to a more stable banking system by helping to dampen economic and financial shocks.
Moreover, Basel III strengthens capital requirements for counterparty credit-risk exposures arising from banking organizations' derivatives and securities financing activities. The reforms also provide market participants with incentives to move OTC derivative contracts to central counterparties, helping reduce systemic risk across the financial system.
Basel III introduces an international leverage ratio designed to contain the buildup of excessive on- and off-balance-sheet leverage in the banking system and to safeguard against attempts to arbitrage the risk-based capital requirements. The leverage ratio will be subject to a parallel run period, during which the Basel Committee will test a minimum tier 1 to quarterly average on- and off-balance-sheet assets ratio of 3 percent. U.S. banking organizations have long been subject to a simple leverage ratio, but most banks outside the United States have not. Adoption of an international leverage ratio should help to put U.S. banking organizations on a more level playing field with their foreign bank peers.
Basel III adopts a global minimum liquidity standard for internationally active banking organizations that includes a 30-day liquidity coverage ratio requirement underpinned by a longer-term structural liquidity ratio (the net stable funding ratio). The liquidity coverage ratio promotes short-term resiliency by ensuring that banking organizations have sufficient high-quality liquid assets to survive an acute stress scenario lasting for one month, whereas the net stable funding ratio was designed to capture structural liquidity mismatches and to promote resiliency over a longer-term horizon. The framework also includes a common set of monitoring metrics to assist supervisors in identifying and analyzing liquidity risk trends at both the banking organization and systemwide levels.
The Board, along with the other federal banking agencies, expects to issue during 2011 an interagency NPR describing how the agencies intend to implement Basel III in the United States, followed by an interagency final rule in 2012.
In 2010, the Federal Reserve continued to participate in the Joint Forum--an international group of supervisors of the banking, securities, and insurance industries established to address varied issues crossing the traditional borders of these sectors, including the regulation of financial conglomerates. The Joint Forum operates under the aegis of the Basel Committee, the International Organization of Securities Commissions, and the International Association of Insurance Supervisors. National supervisors of these three sectors, who are members of the Joint Forum's founding organizations, work together to carry out the responsibilities of the Joint Forum.
The Joint Forum, through its founding organizations, issued a report in 2010 that reviewed developments in modeling risk aggregation and suggested improvements to the current modeling techniques used by complex firms to aggregate risks. During the year, the Federal Reserve also contributed to Joint Forum projects that will result in the issuance of reports or papers in the near future.
Financial Sector Assessment Program
Beginning in 2009 and extending into 2010, the Federal Reserve and other banking agencies underwent a Financial Sector Assessment Program (FSAP) review. The FSAP is a joint IMF and World Bank program designed to promote national and international financial stability and growth and to help strengthen the financial systems of member countries. The IMF views the FSAP as an integral part of their national assessments.
The Division of Banking Supervision and Regulation led an interagency effort to prepare for, and respond to, the IMF's assessment of the effectiveness of U.S. banking supervision. As part of this review, the Federal Reserve and other federal banking agencies jointly prepared a self assessment against the Basel Core Principles for Effective Banking Supervision (BCPs). For each principle and associated criteria, the self assessment includes a summary of applicable legal and regulatory provisions and a description of how the principles are put into practice, with specific citations regarding procedures. The U.S. BCP self assessment was made public in August of 2009 on Treasury's website (www.treasury.gov ).
Based on the self assessment and several weeks of on-site work, the IMF concluded that the U.S. banking agencies were compliant with 96 percent of the BCPs, which are effectively best practices for banking supervision. The IMF's recommendations for improvement incorporated a number of initiatives already in process, including conducting stress tests; joining international efforts to initiate supervisory colleges for large, globally active U.S. banks; and directing large banks to improve their ability to aggregate risks across legal entities and product lines to identify risk concentrations and correlations.
The Federal Reserve strongly endorses sound corporate governance and effective accounting and auditing practices for all regulated financial institutions. Accordingly, the Federal Reserve's supervisory policy function is responsible for monitoring major domestic and international proposals, standards, and other developments affecting the banking industry in the areas of accounting, auditing, internal controls over financial reporting, financial disclosure, and supervisory financial reporting.
Federal Reserve staff interact with key constituents in the accounting and auditing professions, including standard-setters, accounting firms, the financial services industry, accounting and financial sector trade groups, and other financial sector regulators. The Federal Reserve also participates in the Basel Committee's Accounting Task Force, which represents the Basel Committee at international meetings on accounting, auditing, and disclosure issues affecting global banking organizations. These efforts help inform our understanding of current domestic and international practices and proposed standards and our formulation of policy positions based on the potential impact of changes in standards or guidance (or other events) on the financial sector. As a consequence, Federal Reserve staff routinely provide informal input to standard-setters, as well as formal input through public comment letters on proposals, to ensure appropriate and transparent financial statement reporting.
During 2010, addressing challenges related to financial sector accounting and reporting remained a priority for Federal Reserve staff. Issues during the year included fair value accounting, accounting for impairment in securities and other financial instruments, and accounting for asset securitizations and other off-balance-sheet items. As discussed below, to address these and other issues, the Federal Reserve participated in activities arising from general market conditions and in support of efforts related to financial stability.
Federal Reserve staff participated in a number of discussions with accounting and auditing standard-setters. In response to requests for comment, staff
- provided comment letters to the Financial Accounting Standards Board (FASB) on proposals related to the accounting for financial instruments, derivative instruments, hedging activities, troubled debt restructurings, and leases; and
- provided a comment letter on the International Accounting Standards Board's (IASB's) financial instrument impairment proposal and contributed to the development of numerous other comment letters related to accounting and auditing matters that were submitted to the IASB and the International Auditing and Assurance Standards Board through the Basel Committee.
Federal Reserve staff participated in the development and issuance of a Risk Retention report to Congress on the potential impact of credit-risk retention requirements on securitization markets. The report was required by the Dodd-Frank Act and highlights the potential interaction between risk retention, accounting standards, and regulatory capital requirements. Federal Reserve staff also participated in other supervisory activities to assess additional interactions between accounting standards and regulatory reform efforts.
The Federal Reserve issued supervisory guidance to financial institutions and supervisory staff on accounting matters, as appropriate, and participated in a number of supervisory related activities. For example, Federal Reserve staff
- issued guidance to address supervisory considerations relating to business combinations and other acquisitions when the fair value of net assets acquired exceeded the acquisition price;
- participated in activities related to structured finance, derivatives, trust preferred securities, new capital instruments, and loan participations;
- developed and participated in a number of domestic and international training programs to educate supervisors about new and emerging accounting and reporting topics affecting financial institutions; and
- supported the efforts of the Reserve Banks in financial institution supervisory activities related to financial accounting, auditing, reporting, and disclosure.
The Federal Reserve supports the concept of achieving a single widely accepted set of high-quality global accounting standards. Federal Reserve staff provided input to the Securities and Exchange Commission (SEC) on issues related to the convergence of U.S. generally accepted accounting principles and International Financial Reporting Standards (IFRS), including challenges that would need to be addressed before establishing a date for U.S. companies to utilize IFRS. The Federal Reserve supported the efforts of the FASB and the IASB to continue toward the achievement of converged standards, which should help to improve comparability of financial reporting across national jurisdictions and promote more efficient capital allocation. Given the Federal Reserve's unique perspectives on the challenges facing financial institutions and our role in the financial markets, staff participated on the joint FASB and IASB Financial Crisis Advisory Group. Federal Reserve staff also participated on the FASB's Valuation Resource Group, which was created to assist the FASB in matters involving valuation for financial reporting purposes.
The Federal Reserve works with the other federal banking agencies to develop guidance on the management of credit risk; to coordinate the assessment of regulated institutions' credit risk; and to ensure that institutions properly identify, measure, and manage credit risk.
Lending to Creditworthy Small Businesses
In February 2010, the Federal Reserve, along with the other banking agencies, issued guidance to examiners that reinforced the message that institutions should strive to meet the credit needs of creditworthy small business borrowers and that the supervisory agencies will not hinder those efforts.11 This guidance directs examiners and bankers alike to be mindful of the effects of excessive credit tightening on the broader economy. As a general matter, the Federal Reserve does not expect examiners to adversely classify loans based solely on a decline in collateral value where, for example, the borrower has stable revenue streams and demonstrates the ability to repay the loan. To this end, we implemented training for examiners and conducted outreach to the banking industry to underscore this expectation. The 2010 guidance is the latest in a series of actions taken by the Federal Reserve and the other banking agencies to support sound bank lending and the credit intermediation process.
In an effort to encourage prudent commercial real estate (CRE) loan workouts, the Federal Reserve led the development of interagency guidance issued in October 2009 regarding CRE loan restructurings and workouts.12 In January 2010, the Federal Reserve launched a comprehensive Systemwide training initiative to further underscore our expectations regarding CRE. These initiatives themselves build off of guidance that the Federal Reserve and other federal banking agencies issued in November 2008 to encourage banks to meet the needs of creditworthy borrowers, in a manner consistent with safe and sound banking practices, and to take a balanced approach in assessing a borrower's ability to repay.13 Achieving this balance will not always be easy. That is why we have emphasized to both bankers and our examiners the importance of careful analysis of the circumstances of individual borrowers.
In addition to our outreach to banks and bank examiners, the Federal Reserve has conducted a number of forums in 2010 to better understand the difficulties faced by small businesses. In mid-November, the Board and the Federal Reserve Bank of San Francisco, in conjunction with the Small Business Administration, held small business forums in San Francisco and Los Angeles. We then conducted a series of meetings on small business access to credit hosted by the Reserve Banks, followed by a capstone event at the Board of Governors.
Interagency Appraisal and Evaluation Guidelines
In December 2010, the Federal Reserve, FDIC, NCUA, OCC, and OTS jointly issued the revised Interagency Appraisal and Evaluation Guidelines14 that replaces the 1994 Interagency Appraisal and Evaluation Guidelines and reflects consideration of comments received on the November 2008 proposal to revise the guidelines. The new guidelines clarify the agencies' long-standing expectations for an institution's appraisal and evaluation program. The core principles of the 1994 guidelines are retained in the new guidelines. Further, the new guidelines clarify the agencies' expectations for an institution's collateral valuation function, considering changes in appraisal practices and technologies since 1994. The new material in the 2010 guidelines is based largely on guidance documents that the agencies have issued over the past several years regarding independence in the appraisal and evaluation functions, appraisals for residential tract development lending, and revisions to Uniform Standards of Professional Appraisal Practice. There is also an expanded discussion on the conditions under which an institution's real estate-related transactions might be exempted from the agencies' appraisal regulations.
Shared National Credit Program
In September 2010, the Federal Reserve and the other federal banking agencies released summary results of the 2010 annual review of the Shared National Credit (SNC) Program. The agencies established the program in 1977 to promote the efficient and consistent review and classification of shared national credits. A SNC is any loan or formal loan commitment--and any asset, such as other real estate, stocks, notes, bonds, and debentures taken as debts previously contracted--extended to borrowers by a supervised institution, its subsidiaries, and affiliates. A SNC must have an original loan amount that aggregates to $20 million or more and either (1) is shared by three or more unaffiliated supervised institutions under a formal lending agreement or (2) a portion of which is sold to two or more unaffiliated supervised institutions, with the purchasing institutions assuming their pro rata share of the credit risk.
The 2010 SNC review was based on analyses of credit data as of December 31, 2009, provided by federally supervised institutions. The SNC portfolio totaled $2.5 trillion, with 8,292 credit facilities to approximately 5,600 borrowers. From the previous period, the dollar volume of the portfolio declined by $362 billion or 12.6 percent, and the number of credits declined by 663, or 7.4 percent. Although the 2010 review found that credit quality improved from the previous period, the volume and percentage of criticized and classified assets remained high.15 Criticized assets declined by $194 billion to $448 billion, a 30 percent decline from 2009 findings. Criticized assets represented 17.8 percent of the portfolio, compared with 22.3 percent in the 2009 review. Classified credits declined by $142 billion, a 31.8 percent decline. Classified credits represented 12.1 percent of the portfolio, compared with 15.5 percent in the 2009 review. Credits rated special mention (or potentially weak) declined by $52 billion to $143 billion, a 26.7 percent decline. Special mention credits represented 5.7 percent of the portfolio, compared with 6.8 percent in the 2009 review. The reduction in the level of criticized and classified assets is attributed to improved borrower operating performance, debt restructurings, bankruptcy resolutions, and greater borrower access to bond and equity markets. Industry groups demonstrating significant improvement in credit quality included automotive, materials and commodities, and finance and insurance.
Continuing the trend from 2008, the number of credits originated in 2009 declined compared with prior years, but observed underwriting standards were generally satisfactory and improved over prior years. Performance of the SNC portfolio remained influenced by its significant exposure to credits originated in 2006 and 2007 that are characterized by weak underwriting standards. Refinancing risk within the portfolio is also significant, with nearly 67 percent of criticized commitments maturing between 2012 and 2014.
Compliance Risk Management
The Federal Reserve works with international and domestic supervisors to develop guidance that promote compliance with BSA/AML and counter terrorism laws.
Bank Secrecy Act and Anti-Money-Laundering Compliance
In 2010, the Federal Reserve continued to actively promote the establishment and maintenance of effective BSA/AML compliance risk-management programs. For example, the Federal Reserve issued guidance in April 2010 providing BHCs and their nonbank subsidiaries more flexibility in filing Suspicious Activity Reports (SARs). This additional flexibility permits these entities to file the type of SAR form that is most applicable to their business activities. Also, Federal Reserve supervisory staff participated in several interagency projects designed to clarify regulatory expectations, including developing and issuing guidance on (1) beneficial ownership, (2) sharing SARs, and (3) examination procedures for monitoring compliance with the Unlawful Internet Gambling Enforcement Act.
The Federal Reserve currently chairs the FFIEC BSA/AML working group, which is a monthly forum for the discussion of pending BSA policy and regulatory matters, and participates in the Treasury-led BSA Advisory Group, which includes representatives of regulatory agencies, law enforcement, and the financial services industry and covers all aspects of the BSA. Since 2009, the FFIEC BSA/AML working group meetings have included, on a quarterly basis, the SEC, the Commodity Futures Trading Commission, the Internal Revenue Service, and the Office of Foreign Assets Control (OFAC) in order to share and discuss information on BSA/AML examination procedures and general trends more broadly.
The FFIEC BSA/AML working group also is responsible for updating the FFIEC BSA/AML Examination Manual (Manual). The FFIEC created and publicly released the Manual as part of its ongoing commitment to provide current and consistent guidance on risk-based policies, procedures, and processes for banking organizations to comply with the BSA and safeguard their operations from money laundering and terrorist financing.
In 2009 and 2010, the Federal Reserve chaired the drafting group that updated the Manual; a revised version was issued in April 2010. Among the significant modifications to the Manual are the following: streamlined and reorganized procedures for reviewing BSA/AML compliance programs; a new section on reviewing bulk currency shipments; a reorganized discussion of suspicious activity monitoring and reporting; updated requirements for Currency Transaction Report exemptions; clarification of expectations for determining the severity of regulatory violations; and updated discussions of recent developments in electronic banking, Automated Clearing House transactions, prepaid cards, cover payments, and third-party processor customers.
The Federal Reserve and other federal banking agencies continued during 2010 to regularly share examination findings and enforcement proceedings with the Financial Crimes Enforcement Network under the interagency MOU that was finalized in 2004, and with the Treasury's OFAC under the interagency MOU that was finalized in 2006.
International Coordination on Sanctions, Anti-Money Laundering, and Counter-Terrorism Financing
The Federal Reserve participates in a number of international coordination initiatives related to sanctions, money laundering, and terrorism financing. For example, the Federal Reserve has a long-standing role in the U.S. delegation to the intergovernmental Financial Action Task Force (FATF) and its working groups, contributing a banking supervisory perspective to formulation of international standards on these matters. In 2010, the Federal Reserve actively contributed to the development of a FATF typologies report that addressed the use of new payment methods to launder money. Also, the Federal Reserve continued to participate in a subcommittee of the Basel Committee that focuses on AML and counter-terrorism financing issues.
Banks' Securities Activities
In 2010, the Federal Reserve continued to provide examiner training on Regulation R, which implemented certain key exceptions for banks from the definition of the term "broker" under section 3(a) (4) of the Securities Exchange Act of 1934, as amended by the Gramm-Leach-Bliley Act. Regulation R was adopted jointly by the Board and the SEC, with a compliance date for most banks of January 1, 2009, for most aspects of the regulation, and January 1, 2011 for certain trust and fiduciary activity-related aspects of the regulation.
Other Policy Issues
In 2010, the Board approved guidance and policy statements on a number of issues.
- The agencies issued a statement on underwriting standards for small business loans originated under the Treasury's SBLF Program. Pursuant to the Small Business Jobs Act of 2010, the Secretary of the Treasury is authorized to purchase up to $30 billion in preferred stock and other financial instruments from eligible financial institutions to increase the availability of credit for small businesses that qualify for the program. The statement is available at www.federalreserve.gov/boarddocs/srletters/2010/sr1017a1.pdf.
- The federal banking agencies, in conjunction with the Conference of State Bank Supervisors (CSBS), released supervisory guidance in March 2010 on their expectations for sound funding and liquidity risk-management practices. This policy statement, adopted by each of the agencies, summarizes the principles of sound liquidity risk management issued previously and, when appropriate, supplements them with the "Principles for Sound Liquidity Risk Management and Supervision" (issued in September 2008 by the Basel Committee on Banking Supervision). The policy statement emphasizes the importance of cash-flow projections; diversified funding sources; stress testing; a cushion of liquid assets; and a formal, well-developed contingency funding plan as primary tools for measuring and managing liquidity risk. The guidance is available at www.federalreserve.gov/newsevents/press/bcreg/20100317a.htm.
- The federal banking agencies, along with the NCUA and the FFIEC State Liaison Committee, issued an advisory reminding depository institutions of supervisory expectations for sound practices in managing interest-rate risk. The advisory reiterated the importance of effective risk-management practices related to interest-risk exposures and described interest-rate-risk management techniques used by effective risk managers. The advisory is available at www.federalreserve.gov/newsevents/press/bcreg/20100107a.htm.
- The federal banking agencies issued guidance reminding institutions of supervisory expectations on sound practices for managing risks associated with funding and credit concentrations arising from correspondent relationships with other financial institutions. The guidance is available at www.federalreserve.gov/newsevents/press/bcreg/20100430a.htm.
- The federal banking agencies issued supervisory guidance related to bargain purchases and acquisitions assisted by the FDIC and the NCUA. The guidance was issued primarily to address supervisory considerations relating to bargain purchase gains and the impact such gains have on the application approval process. The guidance is available at www.federalreserve.gov/boarddocs/srletters/2010/SR1012a1.pdf.
- The federal banking agencies, the NCUA, and the CSBS issued an interagency statement to assist financial institutions and their customers affected by the explosion and oil spill related to the Deepwater Horizon Mobile Offshore Drilling Unit in the Gulf of Mexico. The statement encouraged financial institutions to consider measures to assist creditworthy borrowers affected by the Gulf oil spill and stated that examiners would consider the unusual circumstances of banks and credit unions in affected areas when determining the appropriate supervisory response to safety-and-soundness issues. The interagency statement is available at www.federalreserve.gov/newsevents/press/bcreg/20100714a.htm.
- The federal banking agencies, together with the FCA and the NCUA, issued jointly developed rules requiring mortgage loan originators who are employees of institutions regulated by these agencies to meet the registration requirements of the Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (the S.A.F.E. Act). The S.A.F.E. Act requires these agencies to jointly develop and maintain a system for registering residential mortgage loan originators using the National Mortgage Licensing System and Registry. The Federal Reserve also issued guidance that discussed S.A.F.E. Act requirements and implementation considerations. The rules are available at www.federalreserve.gov/newsevents/press/bcreg/20100728a.htm.
The Federal Reserve's supervisory policy function is also responsible for developing, coordinating, and implementing regulatory reporting requirements for various financial reporting forms filed by domestic and foreign financial institutions subject to Federal Reserve supervision. Federal Reserve staff members interact with other federal agencies and relevant state supervisors, including foreign bank supervisors as needed, to recommend and implement appropriate and timely revisions to the reporting forms and the attendant instructions.
Bank Holding Company Regulatory Reports
The Federal Reserve requires that U.S. BHCs periodically submit reports that provide information about their financial condition and structure. This information is essential to formulating and conducting bank regulation and supervision. It is also used in responding to requests by Congress and the public for information about BHCs and their nonbank subsidiaries. Foreign banking organizations also are required to periodically submit reports to the Federal Reserve.
- FR Y-9 series reports--the FR Y-9C, FR Y-9LP, and FR Y-9SP--provide standardized financial statements for BHCs on both a consolidated and a parent-only basis. The reports are used to detect emerging financial problems, to review performance and conduct pre-inspection analysis, to monitor and evaluate risk profiles and capital adequacy, to evaluate proposals for BHC mergers and acquisitions, and to analyze a holding company's overall financial condition.
- Nonbank subsidiary reports--the FR Y-11, FR 2314, FR Y-7N, and FR 2886b--help the Federal Reserve determine the condition of BHCs that are engaged in nonbank activities and also aid in monitoring the number, nature, and condition of the companies' nonbank subsidiaries.
- The FR Y-8 report provides information on transactions between an insured depository institution and its affiliates that are subject to section 23A of the Federal Reserve Act; it is used to monitor bank exposures to affiliates and to ensure banks' compliance with section 23A of the Federal Reserve Act.
- The FR Y-10 report provides data on changes in organization structure at domestic and foreign banking organizations.
- The FR Y-6 and FR Y-7 reports gather additional information on organization structure and shareholders from domestic banking organizations and foreign banking organizations, respectively; the information is used to monitor structure so as to determine compliance with provisions of the Bank Holding Company Act and Regulation Y and to assess the ability of a foreign banking organization to continue as a source of strength to its U.S. operations.
During 2010, a number of revisions to the FR Y-9C report were implemented. The revisions included items to identify other-than-temporary impairment losses on debt securities; additional items for unused credit card lines and other unused commitments and a related additional item for other loans; reformatting of the schedule that collects information on quarterly averages; additional items for assets covered by FDIC loss-sharing agreements; and clarification of the instructions for unused commitments.
Also effective December 2010, the FR Y-9C and FR Y-9SP were revised to collect new footnote items associated with the Treasury's Community Development Capital Initiative program.
In 2010, the Federal Reserve proposed the following revisions to the FR Y-9C for implementation in 2011: (1) break out by loan category of other loans and leases that are troubled debt restructurings for those that (a) are past due 30 days or more or in nonaccrual status or (b) are in compliance with their modified terms and clarify reporting of restructured troubled debt consumer loans; (2) break out other consumer loans into automobile loans and all other consumer loans in several schedules; (3) break out commercial mortgage-backed securities issued or guaranteed by U.S. government agencies and sponsored agencies; (4) create a new Schedule HC-V, Variable Interest Entities, for reporting major categories of assets and liabilities of consolidated variable interest entities (VIEs); (5) break out loans and other real estate owned (OREO) information covered by FDIC loss-sharing agreements by loan and OREO category; (6) break out life insurance assets into data items for general account and separate account life insurance assets; (7) add new data items for the total assets of captive insurance and reinsurance subsidiaries; (8) add new income statement items for credit valuation adjustments and debit valuation adjustments included in trading revenues (for BHCs with total assets of $100 billion or more); (9) revise reporting instructions in the areas of construction lending, one- to four-family residential mortgage banking activities, and maturity and repricing data; and (10) collect expanded information on the quarterly-averages schedule.
Commercial Bank Regulatory Financial Reports
As the federal supervisor of state member banks, the Federal Reserve, along with the other banking agencies (through the FFIEC), requires banks to submit quarterly Call Reports. Call Reports are the primary source of data for the supervision and regulation of banks and the ongoing assessment of the overall soundness of the nation's banking system. Call Report data provide the most current statistical data available for evaluating institutions' corporate applications, identifying areas of focus for both on-site and off-site examinations, and considering monetary and other public policy issues. Call Report data, which also serve as benchmarks for the financial information required by many other Federal Reserve regulatory financial reports, are widely used by state and local governments, state banking supervisors, the banking industry, securities analysts, and the academic community.
During 2010, the FFIEC implemented revisions to the Call Report. The revisions included (1) items to identify other-than-temporary impairment losses on debt securities; (2) additional items for unused credit card lines and other unused commitments and a related additional item for other loans; (3) new items pertaining to reverse mortgages; (4) an additional item on time deposits and revisions to reporting of brokered deposits; and (5) additional items for assets covered by FDIC loss-sharing agreements. In addition, revisions were made to change the reporting frequency of the number of certain deposit accounts from annually to quarterly; to eliminate an item for internal allocations of income and expense from foreign offices; to clarify the instructions for unused commitments; and to change the reporting frequency of loans to small businesses and small farms from annually to quarterly.
Also during 2010, the FFIEC proposed the following revisions to the Call Report for implementation in 2011: (1) break out by loan category of other loans and leases that are troubled debt restructurings for those that (a) are past due 30 days or more or in nonaccrual status or (b) are in compliance with their modified terms and clarify reporting of restructured troubled debt consumer loans; (2) break out other consumer loans into automobile loans and all other consumer loans in several schedules; (3) break out commercial mortgage-backed securities issued or guaranteed by U.S. government agencies and sponsored agencies; (4) add a new memorandum item for the estimated amount of nonbrokered deposits obtained through the use of deposit listing service companies; (5) break out existing items for deposits of individuals, partnerships, and corporations into deposits of individuals and deposits of partnerships and corporations; (6) create a new Schedule HC-V, Variable Interest Entities, for reporting major categories of assets and liabilities of consolidated VIEs; (7) break out loans and OREO information covered by FDIC loss-sharing agreements by loan and OREO category; (8) break out life insurance assets into data items for general account and separate account life insurance assets; (9) add new data items for the total assets of captive insurance and reinsurance subsidiaries; (10) add new income statement items for credit valuation adjustments and debit valuation adjustments included in trading revenues (for banks with total assets of $100 billion or more); (11) change reporting frequency from annually to quarterly for the data reported in Schedule RC-T, Fiduciary and Related Services, on collective investment funds and common trust funds; and (11) revise reporting instructions in the areas of construction lending, one- to four-family residential mortgage banking activities, and maturity and repricing data.
In addition, during 2010, the FFIEC proposed several revisions to the Report of Assets and Liabilities of U.S. Branches and Agencies of Foreign Banks (FFIEC 002) to (1) collect additional detail on trading assets, (2) revise the reporting instructions in Schedule E for reporting of time deposits of $100,000 or more, and (3) expand the data collected on Schedule Q, Financial Assets and Liabilities Measured at Fair Value.
Supervisory Information Technology
The Federal Reserve's supervisory information technology function, carried out by the Board's Division of Banking Supervision and Regulation and the Reserve Banks under the guidance of the Subcommittee on Supervisory Administration and Technology, works to identify requirements and set priorities for information technology initiatives in the supervision and regulation (S&R) business line.
In 2010, the supervisory information technology function (1) developed an Application Portfolio framework and established an application architecture repository for all of the supervisory applications; (2) deployed simplified and secure single sign-on for most S&R applications; (3) identified and implemented technology infrastructure improvements to shift information technology investments to more efficient computing platforms and technologies; (4) researched and provided infrastructure in support of workgroup team collaboration and workflow automation to efficiently share technology demand across infrastructure assets; (5) conducted Systemwide architecture blueprint workshops to shift from building custom systems to adopting light technologies and shared solutions; and (6) established a technology community plan to exchange best practices, case studies, and allow for proactive sharing of knowledge and improve technical problem solving.
National Information Center
The National Information Center (NIC) is the Federal Reserve's comprehensive repository for supervisory, financial, and banking-structure data. It is also the main repository for many supervisory documents. NIC includes (1) data on banking structure throughout the United States as well as foreign banking concerns; (2) the National Examination Desktop, which enables supervisory personnel as well as federal and state banking authorities to access NIC data; (3) the Banking Organization National Desktop, an application that facilitates secure, real-time electronic information-sharing and collaboration among federal and state banking regulators for the supervision of banking organizations; and (4) the Central Document and Text Repository, which contains documents supporting the supervisory processes.
Within the NIC, the supporting systems have been modified over time to extend their useful lives and improve business workflow efficiency. During 2010, work continued on upgrading the entire NIC infrastructure to provide easier access to information, a consistent Federal Reserve enterprise information data repository, a comprehensive metadata repository, and uniform security across the Federal Reserve System. Comprehensive testing was performed and implementation began in May 2010. Application developers began to transition their applications to use the new infrastructure, and all applications are expected to be completed during 2011. Also during the year, numerous programming changes were made to NIC applications in support of business needs and to converge and streamline supervisory applications where possible. A system of record was created for exam/inspection dates, including the calculation of the start dates for institutions supervised by the Federal Reserve System and transmitting those requirements to a work scheduling system. Another system of record was created for tracking issues resulting from examinations.
The NIC also supports the Shared National Credit Modernization project (SNC Mod), a multiyear, interagency, information technology development effort to improve the efficiency and effectiveness of the systems that support the SNC Program. SNC Mod focuses on a complete rewrite of the current legacy systems to take advantage of modern technology to enhance and extend the system's capabilities. The primary focus during 2010 was the development of a set of examination support tools (SNCnet) to be used by the interagency teams of examiners during the annual SNC examination. The new SNCnet system will be used during the execution of the 2011 SNC exam.
Finally, the Federal Reserve participated in a number of technology-related initiatives supporting the supervision function as part of FFIEC task forces and interagency committees. These efforts support standardized data collections and cross agency information sharing. Work in this area will continue to be important as the agencies work through the implementation of the Dodd-Frank Act.
The Federal Reserve's staff development program is responsible for the ongoing development of nearly 2,605 professional supervisory staff to ensure that they have the skills necessary to meet their evolving supervisory responsibilities. The Federal Reserve also provides course offerings to staff at state banking agencies. Training activities in 2010 are summarized in table 2.
Examiner Commissioning Program
The Examiner Commissioning Program (ECP) involves approximately 22 weeks of instruction. Individuals move through a combination of classroom offerings, self-paced assignments, and on-the-job training over a period of two to five years. Achievement is measured by two professionally validated proficiency examinations: the first proficiency exam is required of all ECP participants, and the second proficiency exam is offered in two specialty areas--(a) safety and soundness and (b) consumer compliance. A third specialty, in information technology, requires that individuals earn the Certified Information Systems Auditor certification offered by the Information Systems Audit Control Association. In 2010, 227 examiners passed the first proficiency exam and 87 passed the second proficiency exam (69 in safety and soundness and 18 in consumer compliance).
|Number of enrollments||Instructional time
(approximate training days) 1
|Number of course
|Federal Reserve personnel||State and federal banking agency personnel|
|Federal Reserve System||1,464||279||395||79|
|The Options Institute2||9||6||3||1|
1. Training days are approximate. System courses were calculated using five days as an average, with FFIEC courses calculated using four days as an average. Return to table
2. The Options Institute, an educational arm of the Chicago Board Options Exchange, provides a three-day seminar on the use of options in risk management. Return to table
Continuing Professional Development
Other formal and informal learning opportunities are available to examiners, including other schools and programs offered within the System and FFIEC-sponsored schools. System programs are also available to state and federal banking agency personnel. The Rapid Response® program, introduced in 2008, offers System and state personnel 60-90 minute teleconference presentations on emerging issues or urgent training needs associated with implementation or issuance of new laws, regulations, or guidance.
- Regulation of the U.S. Banking Structure
- Enforcement of Other Laws and Regulations
Regulation of the U.S. Banking Structure
The Federal Reserve administers five federal statutes that apply to BHCs, financial holding companies, member banks, and foreign banking organizations--the Bank Holding Company Act, the Bank Merger Act, the Change in Bank Control Act, the Federal Reserve Act, and the International Banking Act.
In administering these statutes, the Federal Reserve acts on a variety of proposals that directly or indirectly affect the structure of the U.S. banking system at the local, regional, and national levels; the international operations of domestic banking organizations; or the U.S. banking operations of foreign banks. The proposals concern BHC formations and acquisitions, bank mergers, and other transactions involving bank or nonbank firms. In 2010, the Federal Reserve acted on 699 proposals representing 1,366 individual applications filed under the five statutes. Many of these proposals involved banking organizations in less than satisfactory financial condition.
Bank Holding Company Act
Under the Bank Holding Company Act, a corporation or similar legal entity must obtain the Federal Reserve's approval before forming a BHC through the acquisition of one or more banks in the United States. Once formed, a BHC must receive Federal Reserve approval before acquiring or establishing additional banks. Also, BHCs generally may engage in only those nonbanking activities that the Board has previously determined to be closely related to banking under section 4(c)(8) of the Bank Holding Company Act. Depending on the circumstances, these activities may or may not require Federal Reserve approval in advance of their commencement.
When reviewing a BHC application or notice that requires prior approval, the Federal Reserve may consider the financial and managerial resources of the applicant, the future prospects of both the applicant and the firm to be acquired, the convenience and needs of the community to be served, the potential public benefits, the competitive effects of the proposal, and the applicant's ability to make available to the Federal Reserve information deemed necessary to ensure compliance with applicable law. In the case of a foreign banking organization seeking to acquire control of a U.S. bank, the Federal Reserve also considers whether the foreign bank is subject to comprehensive supervision or regulation on a consolidated basis by its home-country supervisor. In 2010, the Federal Reserve acted on 312 applications and notices filed by BHCs to acquire a bank or a nonbank firm, or to otherwise expand their activities, including proposals involving private equity firms.
A BHC may repurchase its own shares from its shareholders. When the company borrows money to buy the shares, the transaction increases the company's debt and decreases its equity. The Federal Reserve may object to stock repurchases by holding companies that fail to meet certain standards, including the Board's capital adequacy guidelines. In 2010, the Federal Reserve acted on three stock repurchase proposals by a BHC.
The Federal Reserve also reviews elections submitted by BHCs seeking financial holding company status under the authority granted by the Gramm-Leach-Bliley Act. BHCs seeking financial holding company status must file a written declaration with the Federal Reserve. In 2010, 12 domestic financial holding company declarations and one foreign bank declaration were approved.
Bank Merger Act
The Bank Merger Act requires that all proposals involving the merger of insured depository institutions be acted on by the relevant federal banking agency. The Federal Reserve has primary jurisdiction if the institution surviving the merger is a state member bank. Before acting on a merger proposal, the Federal Reserve considers the financial and managerial resources of the applicant, the future prospects of the existing and combined organizations, the convenience and needs of the community(ies) to be served, and the competitive effects of the proposed merger. The Federal Reserve also must consider the views of the U.S. Department of Justice regarding the competitive aspects of any proposed bank merger involving unaffiliated insured depository institutions. In 2010, the Federal Reserve approved 96 merger applications under the act.
Change in Bank Control Act
The Change in Bank Control Act requires individuals and certain other parties that seek control of a U.S. bank or BHC to obtain approval from the relevant federal banking agency before completing the transaction. The Federal Reserve is responsible for reviewing changes in the control of state member banks and BHCs. In its review, the Federal Reserve considers the financial position, competence, experience, and integrity of the acquiring person; the effect of the proposed change on the financial condition of the bank or BHC being acquired; the future prospects of the institution to be acquired; the effect of the proposed change on competition in any relevant market; the completeness of the information submitted by the acquiring person; and whether the proposed change would have an adverse effect on the Deposit Insurance Fund. A proposed transaction should not jeopardize the stability of the institution or the interests of depositors. During its review of a proposed transaction, the Federal Reserve may contact other regulatory or law enforcement agencies for information about relevant individuals. In 2010, the Federal Reserve approved 133 change in control notices related to state member banks and BHCs, including proposals involving private equity firms.
Federal Reserve Act
Under the Federal Reserve Act, a member bank may be required to seek Federal Reserve approval before expanding its operations domestically or internationally. State member banks must obtain Federal Reserve approval to establish domestic branches, and all member banks (including national banks) must obtain Federal Reserve approval to establish foreign branches. When reviewing proposals to establish domestic branches, the Federal Reserve considers, among other things, the scope and nature of the banking activities to be conducted. When reviewing proposals for foreign branches, the Federal Reserve considers, among other things, the condition of the bank and the bank's experience in international banking. In 2010, the Federal Reserve acted on new and merger-related branch proposals for 584 domestic branches and granted prior approval for the establishment of seven new foreign branches.
State member banks must also obtain Federal Reserve approval to establish financial subsidiaries. These subsidiaries may engage in activities that are financial in nature or incidental to financial activities, including securities-related and insurance agency-related activities. In 2010, no financial subsidiary application was approved.
Overseas Investments by U.S. Banking Organizations
U.S. banking organizations may engage in a broad range of activities overseas. Many of the activities are conducted indirectly through Edge Act and agreement corporation subsidiaries. Although most foreign investments are made under general consent procedures that involve only after-the-fact notification to the Federal Reserve, large and other significant investments require prior approval. In 2010, the Federal Reserve approved 51 applications and notices for overseas investments by U.S. banking organizations, many of which represented investments through Edge Act or agreement corporations.
International Banking Act
The International Banking Act, as amended by the Foreign Bank Supervision Enhancement Act of 1991, requires foreign banks to obtain Federal Reserve approval before establishing branches, agencies, commercial lending company subsidiaries, or representative offices in the United States.
In reviewing proposals, the Federal Reserve generally considers whether the foreign bank is subject to comprehensive supervision or regulation on a consolidated basis by its home-country supervisor. It also considers whether the home-country supervisor has consented to the establishment of the U.S. office; the financial condition and resources of the foreign bank and its existing U.S. operations; the managerial resources of the foreign bank; whether the home-country supervisor shares information regarding the operations of the foreign bank with other supervisory authorities; whether the foreign bank has provided adequate assurances that information concerning its operations and activities will be made available to the Federal Reserve (if deemed necessary to determine and enforce compliance with applicable law); whether the foreign bank has adopted and implemented procedures to combat money laundering; whether the home country of the foreign bank is developing a legal regime or is participating in multilateral efforts to address money laundering; and the foreign bank's record in complying with U.S. law. In 2010, the Federal Reserve approved nine applications by foreign banks to establish branches, agencies, or representative offices in the United States.
Public Notice of Federal Reserve Decisions
Certain decisions by the Federal Reserve that involve an acquisition by a BHC, a bank merger, a change in control, or the establishment of a new U.S. banking presence by a foreign bank are made known to the public by an order or an announcement. Orders state the decision, the essential facts of the application or notice, and the basis for the decision; announcements state only the decision. All orders and announcements are made public immediately; they are subsequently reported in the Board's weekly H.2 statistical release. The H.2 release also contains announcements of applications and notices received by the Federal Reserve upon which action has not yet been taken. For each pending application and notice, the related H.2A release gives the deadline for comments. The Board's website (www.federalreserve.gov) provides information on orders and announcements as well as a guide for U.S. and foreign banking organizations that wish to submit applications.
Enforcement of Other Laws and Regulations
The Federal Reserve's enforcement responsibilities also extend to the disclosure of financial information by state member banks and the use of credit to purchase and carry securities.
Financial Disclosures by State Member Banks
State member banks that are not members of BHCs and that issue securities registered under the Securities Exchange Act of 1934 must disclose certain information of interest to investors, including annual and quarterly financial reports and proxy statements. By statute, the Board's financial disclosure rules must be substantially similar to those of the SEC. At the end of 2010, 13 state member banks were registered with the Board under the Securities Exchange Act.
Under the Securities Exchange Act, the Board is responsible for regulating credit in certain transactions involving the purchasing or carrying of securities. The Board's Regulation T limits the amount of credit that may be provided by securities brokers and dealers when the credit is used to purchase debt and equity securities. The Board's Regulation U limits the amount of credit that may be provided by lenders other than brokers and dealers when the credit is used to purchase or carry publicly held equity securities if the loan is secured by those or other publicly held equity securities. The Board's Regulation X applies these credit limitations, or margin requirements, to certain borrowers and to certain credit extensions, such as credit obtained from foreign lenders by U.S. citizens.
Several regulatory agencies enforce the Board's securities credit regulations. The SEC, the Financial Industry Regulatory Authority, and the Chicago Board Options Exchange examine brokers and dealers for compliance with Regulation T. With respect to compliance with Regulation U, the federal banking agencies examine banks under their respective jurisdictions; the FCA and the NCUA examine lenders under their respective jurisdictions; and the Federal Reserve examines other Regulation U lenders.
1. The TARP statistics only include those BHCs that did not participate in the Supervisory Capital Assessment Program in 2009. Return to text
2. The Federal Reserve is a member of this newly formed council. Return to text
3. The Financial Services Regulatory Relief Act of 2006, which became effective in October 2006, authorized the federal banking agencies to raise the threshold from $250 million to $500 million, and final rules incorporating the change into existing regulations were issued on September 21, 2007. Return to text
4. Each of the first two components has four subcomponents: Risk Management-- (1) Board and Senior Management Oversight; (2) Policies, Procedures, and Limits; (3) Risk Monitoring and Management Information Systems; and (4) Internal Controls. Financial Condition-- (1) Capital, (2) Asset Quality, (3) Earnings, and (4) Liquidity. Return to text
5. The special supervisory program was implemented in 1997 and modified in 2002. See SR letter 02-01 for a discussion of the factors considered in determining whether a BHC is complex or noncomplex (www.federalreserve.gov/boarddocs/srletters/2002/sr0201.htm). Return to text
6. See SR letter 08-9/CA 08-12, which sets forth the holding company supervision, "Consolidated Supervision of Bank Holding Companies and the Combined U.S. Operations of Foreign Banking Organizations" (www.federalreserve.gov/boarddocs/srletters/2008/SR0809.htm). Return to text
7. See SR letter 05-27/CA letter 05-11, "Responsible Reserve Bank and Inter-District Coordination," (www.federalreserve.gov/boarddocs/srletters/2005/SR0527.htm). Return to text
8. The FFIEC is an interagency body of financial regulatory agencies established to prescribe uniform principles, standards, and report forms and to promote uniformity in the supervision of financial institutions. The Council has six voting members: the Board of Governors of the Federal Reserve System, the FDIC, the National Credit Union Administration, the OCC, the OTS, and the chair of the State Liaison Committee. Return to text
9. The FDIC Investor Series was held at events in Atlanta, Harlem, Houston, Los Angeles, Miami, and San Francisco. Return to text
10. The population under review included core clearing and settlement organizations and firms that play a critical role in financial markets and are subject to resiliency guidelines issued in April 2003 (www.federalreserve.gov/boarddocs/srletters/2003/sr0309.htm). Return to text
11. See Interagency Statement on Meeting the Credit Needs of Creditworthy Small Business Borrowers, (February 2010), www.federalreserve.gov/newsevents/press/bcreg/20100205a.htm. Return to text
12. See Policy Statement on Prudent Commercial Real Estate (CRE) Loan Workouts, (October 2009), www.federalreserve.gov/newsevents/press/bcreg/20091030a.htm. Return to text
13. See Interagency Statement on Meeting the Needs of Creditworthy Borrowers (November 2008), www.federalreserve.gov/newsevents/press/bcreg/20081112a.htm. Return to text
14. See SR letter 10-16, www.federalreserve.gov/boarddocs/srletters/2010/sr1016.htm. Return to text
15. Criticized assets are composed of special mention and classified assets. Special mention assets are loans and securities that exhibit potential weakness but are not classified. Classified assets are loans and securities that exhibit well-defined weaknesses or a distinct possibility of loss. Return to text