Board of Governors of the Federal Reserve System

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 efficient financial system that supports the growth and stability of the U.S. economy.

The Federal Reserve carries out its supervisory and regulatory responsibilities and supporting functions primarily by

• collecting data, along with the other federal financial regulatory agencies, to monitor trends in the banking sector;

• engaging in supervisory activities that

  • promote the safety and soundness of individual institutions supervised by the Federal Reserve;
  • identify requirements and set priorities for supervisory information technology initiatives; and
  • meet evolving supervisory responsibilities through ongoing staff development; and
• developing regulatory policy (rulemakings, supervision and regulation letters, policy statements, and guidance), and regulating the U.S. banking and financial structure by acting on a variety of proposals.

Banking System Conditions

The financial condition of the U.S. banking system is generally strong. The strong economic trends of the last several years have contributed to improvements in the financial condition of banks. Two important measures of profitability—return on equity (ROE) and return on average assets (ROAA)—have seen steady gains over the past several years and ended the year near a 10-year high (figure 1).¹ Earnings for firms of all sizes have been bolstered by rising net interest income and the recent reduction in effective tax rates. Moderately rising interest rates have been positive for bank earnings and have helped drive increases in net interest income.

Firms have reported growth in loan volume coupled with lower nonperforming loan ratios. Loan growth remains robust, with total loan volume for the industry growing over 30 percent since 2013 (figure 2). Commercial and industrial (C&I) loans and non-residential real estate loans have experienced the strongest growth. Since 2013, the volume of C&I and non-residential real estate loans has grown by close to 50 percent. Residential real estate lending, which experienced structural changes over this period, exhibited tepid growth.

In recent quarters, nonbank finance companies are increasing their market share in new mortgage originations, and large banks are shifting their mortgage exposures from loans to securities. As a result, the banking industry's overall loan portfolio is shifting away from residential real estate loans toward C&I loans and consumer loans (figure 3).

The nonperforming loan ratio—one measure of asset quality—is generally improving or stable across the banking system (figure 4).² Currently, nonperforming loans as a share of total loans and leases are at or near a 10-year low. However, nonperforming consumer loans saw a slight increase in the second half of 2018.

Firms maintain reserves to provide a cushion against losses on loans and leases they are unable to collect. One important financial metric is the ratio of allowance for loan and lease losses (ALLL, which is the amount of reserves banks set aside to absorb losses related to troubled loans) to the volume of nonperforming loans and leases held by a bank, also known as the reserve coverage ratio (figure 5). A higher ratio generally indicates a better ability to absorb future loan losses.

Since 2013, as the volume of nonperforming loans has declined, the industrywide coverage ratio has improved considerably. While the entire industry has seen an improvement in this ratio, the largest firms have seen the greatest improvement. It is important to note that nonperforming loan status is a lagging indicator of loan losses and other factors are considered when estimating the allowance, such as changes in underwriting standards and changes in local or regional economic conditions.

As profitability and asset quality continue to improve, firms still maintain high levels of quality capital. Capital provides a buffer to absorb losses that may result from unexpected operational, credit, or market events. Since the financial crisis, the Federal Reserve has implemented new rules that have significantly raised the requirements for the quantity and quality of bank capital, particularly at the largest firms. As a result of the new requirements, capital levels have increased across the industry (figure 6).

Firms have also significantly bolstered their liquidity after coming under funding pressure during the financial crisis. The funding stresses faced by large banks during the financial crisis heavily influenced the subsequent U.S. regulatory framework for addressing funding and liquidity risk. The financial crisis demonstrated the need to ensure that banks hold enough fundamentally sound and reliable liquid assets to survive a stress scenario. Liquidity requirements put in place since the crisis have significantly increased aggregate levels of highly liquid assets (figure 7).

The banking industry remains concentrated, while the market share of the largest banking organizations has declined. Over the past few decades, as the banking system has grown, there has been a trend of increased bank consolidation. During the height of the financial crisis, and immediately after, as the financial system was strained, many banks merged with other institutions, or failed. Upon closing, the assets of these failed banks were sold to other, often larger, institutions, and the industry saw a wave of consolidation and growth of the largest institutions. In recent years, however, concentration has slowed by some measures. Even as the total volume of loans and leases has been growing, the distribution of those loans has spread to a broader section of the industry. The market share of loans for the 10 largest banking organizations has declined (figure 8).

Market indicators generally reflect stronger industry performance. The improvements in overall banking system conditions since the crisis are reflected in market indicators of bank health, such as the market leverage ratio and credit default swap (CDS) spreads. The market leverage ratio is a market-based measure of firm capital, and a higher ratio generally indicates investor confidence in banks' financial strength. Credit default spreads are a measure of market perceptions of bank risk, and a small spread reflects investor confidence in banks' financial health. Both measures are close to pre-crisis levels, despite increased market volatility in the fourth quarter of 2018 (figure 9).³

Supervisory Developments

In overseeing the institutions under its authority, the Federal Reserve seeks primarily to promote safety, soundness, and efficiency, including compliance with laws and regulations. For supervisory purposes, the Federal Reserve categorizes institutions into the groups described in table 1.

Table 1. Summary of organizations supervised by the Federal Reserve

Safety and Soundness

The Federal Reserve uses a range of supervisory activities to promote the safety and soundness of financial institutions and maintain a comprehensive understanding and assessment of each firm. These activities include horizontal reviews, firm-specific examinations and inspections, continuous monitoring and surveillance activities, and implementation of enforcement or 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, financial market utilities (FMUs), 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 holding companies and their nonbank subsidiaries. Whether an examination or an inspection is being conducted, the review of financial performance and operations entails

• analysis of financial condition, including capital, asset quality, earnings, and liquidity;
• an assessment of the risk-management and internal control processes in place to identify, measure, monitor, and control risks;
• an evaluation of the adequacy of governance, including oversight by the board and execution by senior management, which incorporates an assessment of internal policies, procedures, risk limits, and controls; and
• a review for compliance with applicable laws and regulations.

Consolidated Supervision

Consolidated supervision, a method of supervision that encompasses the parent company and its subsidiaries, allows the Federal Reserve to understand the organization's structure, activities, resources, risks, and financial and operational resilience. Working with other relevant supervisors and regulators, the Federal Reserve seeks to ensure that financial, operational, or other deficiencies are addressed before they pose a danger to the consolidated organization, its banking offices, or to the broader economy.⁴

Capital Planning and Stress Tests

Since the financial crisis, the Board has led a series of initiatives to strengthen the capital positions of the largest banking organizations. Two related initiatives are the Comprehensive Capital Analysis and Review (CCAR) and the Dodd-Frank Act stress tests (DFAST).

CCAR is a supervisory exercise to evaluate capital adequacy, internal capital planning processes, and planned capital distributions simultaneously at all bank holding companies (BHCs) with $100 billion or more in total consolidated assets and U.S. intermediate holding companies (IHCs).⁵ In CCAR, the Federal Reserve assesses whether these BHCs have sufficient capital to withstand highly stressful operating environments and be able to continue operations, maintain ready access to funding, meet obligations to creditors and counterparties, and serve as credit intermediaries. Capital is central to a BHC's ability to absorb losses and continue to lend to creditworthy businesses and consumers. Through CCAR, a BHC's capital adequacy is evaluated on a forward-looking, post-stress basis as the BHC is required to demonstrate in its capital plan how it will maintain, throughout a very stressful period, capital above minimum regulatory capital requirements.⁶ The 2018 CCAR results are available at https://www.federalreserve.gov/publications/files/2018-ccar-assessment-framework-results-20180628.pdf.

DFAST is a supervisory stress test conducted by the Federal Reserve to evaluate whether large BHCs and IHCs have sufficient capital to absorb losses resulting from stressful economic and financial market conditions. The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) also requires BHCs and other financial companies supervised by the Federal Reserve to conduct their own stress tests. Together, the Dodd-Frank Act supervisory stress tests and the company-run stress tests are intended to provide company management and boards of directors, the public, and supervisors with forward-looking information to help gauge the potential effect of stressful conditions on the capital adequacy of these large banking organizations. The 2018 DFAST results are available at https://www.federalreserve.gov/publications/files/2018-dfast-methodology-results-20180621.pdf.

State Member Banks

At the end of 2018, a total of 1,611 banks (excluding nondepository trust companies and private banks) were members of the Federal Reserve System, of which 794 were state chartered. Federal Reserve System member banks operated 53,339 branches, and accounted for 33 percent of all commercial banks in the United States and for 70 percent of all commercial banking offices. State-chartered commercial banks that are members of the Federal Reserve, commonly referred to as state member banks, represented approximately 17 percent of all insured U.S. commercial banks and held approximately 17 percent of all insured commercial bank assets in the United States.

Under 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, the Federal Reserve must conduct a full-scope, on-site examination of state member banks at least once a year.⁷ However, qualifying well-capitalized, well-managed state member banks with less than $3 billion in total assets are eligible for an 18-month examination cycle.⁸ The Federal Reserve conducted 321 examinations of state member banks in 2017. Table 2 provides information on examinations and inspections conducted by the Federal Reserve during the past five years.

Table 2. State member banks and bank holding companies, 2014–18

Bank Holding Companies

At year-end 2018, a total of 4,300 U.S. BHCs were in operation, of which 3,848 were top-tier BHCs. These organizations controlled 3,948 insured commercial banks and held approximately 94 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 with less than $100 billion in assets, including financial holding companies (FHCs), 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.⁹ Noncomplex BHCs with consolidated assets of $1 billion or less are subject to a special supervisory program that permits a more flexible approach.¹⁰ In 2018, the Federal Reserve conducted 533 inspections of large BHCs and 2,132 inspections of small, noncomplex BHCs.

In 2018, the Board adopted a new ratings framework for BHCs with $100 billion or more in assets, which was designed to align with the supervisory program for Large Institution Supervision Coordinating Committee (LISCC) firms and other large financial institutions. Under the system, known as LFI, these firms are assigned ratings for three separate components: Capital Planning and Positions; Liquidity Risk Management and Positions; and Governance and Controls. The Federal Reserve is using the new ratings framework to assign ratings to LISCC firms in 2019, and to other large financial institutions in 2020. (See box 1 for further explanation of the Board's newly adopted ratings system.)

Financial Holding Companies

Under the Gramm-Leach-Bliley Act, BHCs that meet certain capital, managerial, and other requirements may elect to become FHCs 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 2018, a total of 490 domestic BHCs and 44 foreign banking organizations had FHC status. Of the domestic FHCs, 25 had consolidated assets of $50 billion or more; 48, between $10 billion and $50 billion; 153, between $1 billion and $10 billion; and 264, less than $1 billion.

Savings and Loan Holding Companies

The Dodd-Frank Act transferred responsibility for supervision and regulation of SLHCs from the former Office of Thrift Supervision to the Federal Reserve in July 2011. At year-end 2018, a total of 379 SLHCs were in operation, of which 194 were top-tier SLHCs. These SLHCs control 203 depository institutions and include 16 companies engaged primarily in nonbanking activities, such as insurance underwriting (9 SLHCs), securities brokerage (3 SLHCs), and commercial activities (4 SLHCs). The 25 largest SLHCs accounted for more than $1.5 trillion of total combined assets. Approximately 91 percent of SLHCs engage primarily in depository activities. These firms hold approximately 20 percent ($331 billion) of the total combined assets of all SLHCs. The Office of the Comptroller of the Currency (OCC) is the primary regulator for most of the subsidiary savings associations of the firms engaged primarily in depository activities. Table 3 provides information on examinations of SLHCs for the past five years.

Table 3. Savings and loan holding companies, 2014–18

Several complex policy issues continue to be addressed by the Board, including those related to consolidated capital requirements for insurance SLHCs and issues pertaining to intermediate holding companies for commercial SLHCs. In June 2016, the Board issued an advance notice of proposed rulemaking (ANPR) inviting comment on conceptual frameworks for capital standards that could apply to companies with significant insurance activities.¹¹ A request for public comment on the adoption of the formal rating system for certain SLHCs closed on February 13, 2017. On November 9, 2018, the Board determined that it would apply the formal rating system to SLHCs that are depository in nature. The determination does not apply the formal rating system to SLHCs engaged in significant insurance or commercial activities. Additionally, SLHCs that are depository in nature and have $100 billion or more in consolidated assets will be rated under the RFI rating system until the Board applies the new rating system for large financial institutions.

Savings and loan holding companies primarily engaged in insurance underwriting activities. The Federal Reserve supervises 9 insurance SLHCs (ISLHCs), with $886 billion in estimated total combined assets, and $151 billion in thrift assets. Of the ten, three firms have total assets greater than $100 billion, four firms have total assets between $10 billion and $100 billion, and three firms have total assets less than $10 billion. With the exception of two ISLHCs, each of which owns a thrift subsidiary that comprises roughly half of the firm's total assets, thrift subsidiary assets for most ISLHCs represent less than 25 percent of total assets.

As the consolidated supervisor of ISLHCs, the Federal Reserve evaluates the organization's risk-management practices, the financial condition of the overall organization, and the impact of the nonbank activities on the depository institution. The Federal Reserve focuses supervisory attention on legal entities and activities that are not directly supervised or regulated by state insurance regulators, including intercompany transactions between the depository institution and its affiliates. The Federal Reserve relies to the fullest extent possible on the work of state insurance regulators as part of the overall supervisory assessment of ISLHCs. The Federal Reserve has been active in engaging with the state departments of insurance and the National Association of Insurance Commissioners (NAIC) on general insurance supervision matters.

Financial Market Utilities

FMUs manage or operate multilateral systems for the purpose of transferring, clearing, or settling payments, securities, or other financial transactions among financial institutions or between financial institutions and the FMU. Under the Federal Reserve Act, the Federal Reserve supervises FMUs that are chartered as member banks or Edge Act corporations and coordinates with other federal banking supervisors to supervise FMUs considered bank service providers under the Bank Service Company Act.

In July 2012, the FSOC voted to designate eight FMUs as systemically important under title VIII of the Dodd-Frank Act. As a result of these designations, the Board assumed an expanded set of responsibilities related to these designated FMUs that include promoting uniform risk-management standards, playing an enhanced role in the supervision of designated FMUs, reducing systemic risk, and supporting the stability of the broader financial system. For certain designated FMUs, the Board established risk-management standards and expectations that are articulated in the Board's Regulation HH. In addition to setting minimum risk-management standards, Regulation HH establishes requirements for the advance notice of proposed material changes to the rules, procedures, or operations of a designated FMU for which the Board is the supervisory agency under title VIII. Finally, Regulation HH also establishes minimum conditions and requirements for a Federal Reserve Bank to establish and maintain an account for, and provide services to, a designated FMU.¹²

The Federal Reserve's risk-based supervision program for FMUs is administered by the FMU Supervision Committee (FMU-SC). The FMU-SC is a multidisciplinary committee of senior supervision, payment policy, and legal staff at the Board of Governors and Reserve Banks who are responsible for, and knowledgeable about, supervisory issues for FMUs. The FMU-SC's primary objective is to provide senior-level oversight, consistency, and direction to the Federal Reserve's supervisory process for FMUs. The FMU-SC coordinates with the LISCC on issues related to the roles of LISCC firms in FMUs as well as the payment, clearing, and settlement activities of LISCC firms and the FMU activities and implications for financial institutions in the LISCC portfolio.

In an effort to promote greater financial market stability and mitigate systemic risk, the Board works closely with the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), both of which also have supervisory authority for certain FMUs. The Federal Reserve's work with these agencies under title VIII, including the sharing of appropriate information and participation in designated FMU examinations, aims to improve consistency in FMU supervision, promote robust FMU risk management, and improve regulators' ability to monitor and mitigate systemic risks.

Designated Nonbank Financial Companies

The Dodd-Frank Act requires the Board to apply enhanced prudential standards to the nonbank financial companies designated by the FSOC for supervision by the Board. There are currently no nonbank financial companies subject to Federal Reserve supervision.

In March 2019, the FSOC sought comment on proposed guidance to prioritize its efforts to identify, assess, and address potential risks and threats to U.S. financial stability through a process that emphasizes an activities-based approach. The proposed guidance indicated that the FSOC would pursue entity-specific determinations under the Dodd-Frank Act only if a potential risk or threat could not be addressed through an activities-based approach. This approach is intended to enable the FSOC to more effectively identify and address the underlying sources of risks to financial stability, rather than addressing risks only at a particular nonbank financial company that may be designated.

International Activities

The Federal Reserve supervises the foreign branches and overseas investments of state 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 resides. Examiners also visit the overseas offices of U.S. banking organizations 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. 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 OCC.

At the end of 2018, a total of 29 member banks were operating 322 branches in foreign countries and overseas areas of the United States; 14 national banks were operating 271 of these branches, and 15 state member banks were operating the remaining 51. In addition, 6 nonmember banks were operating 14 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 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 2018, out of 36 banking organizations chartered as Edge Act or agreement corporations, 3 operated 6 Edge Act and agreement branches. These corporations are examined annually.

U.S. activities of foreign banks. Foreign banks continue to be significant participants in the U.S. banking system. As of year-end 2018, a total of 140 foreign banks from 48 countries operated 155 state-licensed branches and agencies, of which 6 were insured by the Federal Deposit Insurance Corporation (FDIC), and 57 OCC-licensed branches and agencies, of which 4 were insured by the FDIC. These foreign banks also owned 8 Edge Act and agreement corporations. In addition, they held a controlling interest in 39 U.S. commercial banks. Altogether, the U.S. offices of these foreign banks controlled approximately 20 percent of U.S. commercial banking assets. These 140 foreign banks also operated 79 representative offices; an additional 36 foreign banks operated in the United States through a representative office. The Federal Reserve—in coordination with appropriate state regulatory authorities—examines state-licensed, non-FDIC-insured branches and agencies of foreign banks on site at least once every 18 months.¹³ 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. As part of the supervisory process, a review of the financial and operational profile of each organization is conducted to assess the organization's ability to support its U.S. operations and to determine what risks, if any, the organization poses to the banking system through its U.S. operations. The Federal Reserve conducted or participated with state and federal regulatory authorities in 468 examinations of foreign banks in 2018.

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 Supervision and Regulation (S&R), but consumer compliance supervision is conducted under the oversight of the Division of Consumer and Community Affairs (DCCA).¹⁴ 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.

Anti-Money-Laundering Examinations

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's (FFIEC's) Bank Secrecy Act/Anti-Money Laundering Examination Manual.¹⁵

Specialized Examinations

The Federal Reserve conducts specialized examinations of supervised financial institutions 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 2018, the Federal Reserve contributed to FFIEC information systems and technology policy and emerging technology issues, including prescribing principles and guidance for the examination of financial institutions and their technology service providers to promote uniformity in the supervision of these entities. The Federal Reserve chaired the FFIEC's IT Subcommittee of the Task Force on Supervision, the primary interagency group responsible for coordination across member agencies on information technology policy activities. The IT Subcommittee conducted a conference for IT examiners from all of the FFIEC member agencies, which highlighted current and emerging technology issues affecting supervised institutions and their service providers. Additionally, the Federal Reserve contributed updates to the IT Examination Handbook to incorporate a more enterprise-wide, risk-management approach to the assessment of information technology and related risks at supervised institutions in reflection of changes that have occurred in technology and the financial sector.

In October 2018, the Cybersecurity and Critical Infrastructure Working Group (CCIWG) published an interagency joint statement on Office of Foreign Assets Control (OFAC) sanctions to raise awareness that entities were targeting U.S. financial institutions with malicious software and services. Because of the nature of the claims under OFAC's Cyber-Related Sanctions Program, financial institutions were advised to assess the risk of having, or continuing to use, sanctioned entities' software and services. In recognition of National Cybersecurity Awareness Month, the CCIWG hosted a webinar on October 31, 2018, to announce free public and private sector resources to help financial institutions enhance their resilience.

Fiduciary Activities

The Federal Reserve has supervisory responsibility for state member banks and some nondepository trust companies, which hold assets 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 compliance risk exposures; the quality and level of earnings; the management of fiduciary assets; and audit and control procedures. In 2018, Federal Reserve examiners conducted 95 fiduciary examinations of state member banks and nondepository trust companies.

Transfer Agents

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 2018, the Federal Reserve conducted transfer agent examinations at two state member banks 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. Fourteen 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 2018, 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. Five entities supervised by the Federal Reserve that dealt in municipal securities were examined during 2018.

Securities Credit Lenders

Under the Securities Exchange Act of 1934, the Board is responsible for regulating credit in certain transactions involving the purchasing or carrying of securities. As part of its general examination program, the Federal Reserve examines the banks under its jurisdiction for compliance with the Board's Regulation U. 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).

Cybersecurity and Critical Infrastructure

The Federal Reserve collaborated with other financial regulators, the U.S. Treasury, private industry, and international partners to promote effective safeguards against cyber threats to the financial services sector and to bolster the sector's cyber resiliency. Throughout the year, Federal Reserve examiners conducted targeted cybersecurity assessments of the largest and most systemically important financial institutions (SIFIs), FMUs, and technology service providers (TSPs). The Federal Reserve worked closely with the OCC and FDIC to develop and implement improved examination procedures for the cybersecurity assessments of TSPs. Federal Reserve examiners also continued to conduct tailored cybersecurity assessments at community and regional banking organizations.

In October 2018, the Federal Reserve presented a webinar to examiners to inform them of internal resources to assist financial institutions in meeting their control objectives, regardless of whether they use the FFIEC Cybersecurity Assessment Tool, National Institute for Standards and Technology (NIST) Cybersecurity Framework, Financial Services Sector Specific Cybersecurity Profile, or any other methodology to assess their cybersecurity preparedness. Also, in December 2018, the Federal Reserve issued an advisory letter to examiners and other supervisory staff responsible for responding to cyber and security incidents at supervised institutions. The advisory letter formalizes roles, responsibilities, and process guiding S&R's response to cyber and security incidents, and implements a playbook to guide response actions and interdivisional communication during and after incidents.

In 2018, the Financial and Banking Information Infrastructure Committee (FBIIC) Harmonization Working Group (HWG), chaired by the Federal Reserve, analyzed the cyber terms and definitions used by the FBIIC agencies in published cyber-related laws, regulations, tools, and guidance. The HWG sought to identify instances of the FBIIC agencies using different definitions for the same cyber terms. Going forward, the agencies agreed to use NIST as the primary source of cyber terms and definitions in cyber-related regulations, tools and guidance. Also in 2018, representatives of the HWG conducted outreach to a number of financial institutions with multiple regulators to gather information that would help the HWG identify opportunities to improve regulatory harmonization and the coordination of cyber examinations.

The Federal Reserve actively participated in interagency groups, such as the FFIEC's CCIWG and the FBIIC to share information and collaborate on cybersecurity and critical infrastructure issues impacting the financial sector. In coordination with FBIIC members, the Federal Reserve collaborated with government and industry partners to plan and execute sector-wide and regional tabletop exercises focused on identifying areas where sector resiliency, information sharing, and public-private collaboration can be enhanced with respect to potential cybersecurity incidents. The exercises focused on tactical, strategic, operational, and financial stability considerations that tested both government and private sector processes and capabilities for addressing cyber incidents across the financial services sector.

In addition, the Federal Reserve was actively involved in international policy coordination to address cyber-related risks and efforts to bolster cyber resiliency. The Federal Reserve supported the Group of Seven (G-7) Fundamental Elements of Threat-led Penetration Testing and Third Party Cyber Risk Management in the Financial Sector and the development of incident coordination protocols to enhance international coordination and knowledge sharing. The Federal Reserve also supported the Financial Stability Board's (FSB's) cyber lexicon for the financial sector. Additional information about the FSB cyber lexicon is available at http://www.fsb.org/2018/11/cyber-lexicon/.

Enforcement Actions

The Federal Reserve has enforcement authority over the financial institutions 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 2018, the Federal Reserve completed 92 formal enforcement actions. Civil money penalties totaling $223,960,223 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 (https://www.federalreserve.gov/apps/enforcementactions/search.aspx).

In 2018, the Reserve Banks completed 62 informal enforcement actions. Informal enforcement actions include memoranda of understanding (MOU), commitment letters, and board of directors' resolutions.

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 offsite monitoring tool used by the Federal Reserve is the Supervision and Regulation Statistical Assessment of Bank Risk (SR-SABR) model. 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 https://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 2018, one major and five minor upgrades to the web-based PRISM application were completed to enhance the user's experience and provide the latest technology.

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 depository institutions.

International Training and Technical Assistance

In 2018, the Federal Reserve continued to provide training and technical assistance on 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 of Governors or the Reserve Banks.

The Federal Reserve offered a number of training programs for the benefit of foreign supervisory authorities, which were held both in the United States and in many foreign jurisdictions. Federal Reserve staff took part in technical assistance and training assignments led by the International Monetary Fund, the World Bank, and the Financial Stability Institute. The Federal Reserve also contributed to the regional training provided under the Asia-Pacific Economic Cooperation Financial Regulators Training Initiative. Other training partners that collaborated with the Federal Reserve during 2018 to organize regional training programs included the South East Asian Central Banks Research and Training Centre, the Caribbean Group of Banking Supervisors, the Reserve Bank of India, the Arab Monetary Fund, the European Central Bank, and the Association of Supervisors of Banks of the Americas.

Efforts to Support Minority-Owned Depository Institutions

The Federal Reserve System implements its responsibilities under section 367 of the Dodd-Frank Act primarily through its Partnership for Progress (PFP) program. Established in 2008, this program promotes the viability of minority depository institutions (MDIs) by facilitating activities designed to strengthen their business strategies, maximize their resources, and increase their awareness and understanding of supervisory expectations. In addition, the Federal Reserve continues to maintain the PFP website, which supports MDIs by providing them with technical information and links to useful resources (https://www.fedpartnership.gov). Representatives from each of the 12 Federal Reserve Districts, along with staff from the S&R and DCCA divisions at the Board of Governors, continue to offer technical assistance tailored to MDIs by providing targeted supervisory guidance, identifying additional resources, and fostering mutually beneficial partnerships between MDIs and community organizations. As of year-end 2018, the Federal Reserve's MDI portfolio consisted of 14 state member banks.

In 2018, the Federal Reserve System continued to support MDIs through the following activities:

• Staff of the PFP program organized the first biannual MDI Leadership Forum that took place April 19–20, 2018, in Washington, D.C. The MDI Leadership Forum will continue as a biannual opportunity for the Fed to host CEOs of a number of state-member-bank (SMB) MDIs to provide them with an opportunity to express their experiences and challenges and provide the PFP staff with an opportunity to improve our communication and outreach. In addition, it provides an opportunity for Federal Reserve staff to present on a number of pertinent supervision and regulation and consumer affairs topics. The conference was attended by senior level officers from SMB MDIs supervised by the Federal Reserve. During the course of the Leadership Forum, the senior level officers also had an opportunity to speak with the Vice Chairman of the Federal Reserve Board concerning issues particular to MDIs. The next Leadership Forum will take place in 2020.
• In April 2018, the Federal Reserve System, together with the other federal banking agencies sent representatives to present at the Native Banks Gathering II in Shawnee, Oklahoma. This gathering was a collaborative assembly of native-owned banks sponsored by the Citizen Potawatomi Nation, the Federal Reserve Bank of Minneapolis' Center for Indian Country Development, and the Board of Governors, in conjunction with the Office of Indian Energy and Economic Development, a division under the U.S. Department of Interior's Bureau of Indian Affairs. The Federal Reserve discussed "Banking in Indian Country" and provided "A Washington Perspective on the Banking Industry and the Opportunities of Minority-Owned Banks." The goal of the gathering was to familiarize native-owned banks with the Indian Loan Guarantee Program and to better understand opportunities for growth and diversification of portfolios for all Native American and Alaskan Native businesses. The gathering helped identify new growth strategies and ways to increase revenue streams to contribute to the nurturing of vital, strong economies in Indian Country.
• On August 27, 2018, the Federal Reserve Board of Governors and the Center for Indian Country Development at the Federal Reserve Bank of Minneapolis organized a peer-to-peer meeting for Native American banks, Native American credit unions, and Native American community development financial institutions. The meeting was held at the Flathead Reservation of the Confederated Salish and Kootenai Tribes, Polson, Montana, with the goal of the gathering being one of sharing best banking practices and developing networks to better serve the financial needs of Native Americans and their communities.
• P4P staff and a senior Board employee attended the annual National Bankers Association meeting in October 2018 in Washington, D.C., and hosted an exhibit table.
• System staff provided technical assistance to the industry through the presentation of commissioned research results on a webinar open to the MDI audience; provided examiner training via a Rapid Response Session educating Federal Reserve examiners on the mission of the P4P program.
• The Board of Governors co-sponsored the Forum for Minority Bankers with the Federal Reserve Banks of Kansas City (lead sponsor), Philadelphia, Richmond, Atlanta, Chicago, St. Louis, and Dallas. The forum is a national program that provides minority bank leaders with industry knowledge and professional development. The forum was held in September 2018 in Charlotte, North Carolina.

International Coordination on Supervisory Policies

As a member of several international financial standard-setting bodies, the Federal Reserve actively participates in efforts to advance sound supervisory policies for internationally active financial organizations and to enhance the strength and stability of the international financial system.

Basel Committee on Banking Supervision

During 2018, the Federal Reserve contributed to supervisory policy recommendations, reports, and papers issued for consultative purposes or finalized by the BCBS that are designed to improve the supervision of banking organizations' practices and to address specific issues that emerged during the financial crisis. Of note, the Federal Reserve contributed to the finalization of the capital requirements for market risk, the revised assessment methodology for global systemically important banking organizations, supervisory guidelines related to stress testing and fintech developments, and further updates to the Basel III disclosure requirements. The Federal Reserve also participated in ongoing international initiatives to track the progress of implementation of the BCBS framework in member countries.

Final BCBS documents issued in 2018 include

• Sound practices: Implications of fintech developments for banks and bank supervisors(issued in February and available at https://www.bis.org/bcbs/publ/d431.pdf).
• Progress report on adoption of the Basel regulatory framework(issued in April and October and available at https://www.bis.org/bcbs/publ/d440.pdf and https://www.bis.org/bcbs/publ/d452.pdf).
• Capital treatment for short-term "simple, transparent and comparable" securitizations (issued in May and available at https://www.bis.org/bcbs/publ/d442.pdf).
• Treatment of extraordinary monetary policy operations in the Net Stable Funding Ratio(issued in June and available at https://www.bis.org/bcbs/publ/d444.pdf).
• Global systemically important banks: revised assessment methodology and the higher loss absorbency requirements(issued in July and available at https://www.bis.org/bcbs/publ/d445.pdf).
• Pillar 3 disclosure requirements – regulatory treatment of accounting provisions(issued in August and available at https://www.bis.org/bcbs/publ/d446.pdf).
• Stress testing principles (issued in October and available at https://www.bis.org/bcbs/publ/d450.pdf).
• Cyber-resilience: Range of practices (issued in December and available at https://www.bis.org/bcbs/publ/d454.pdf).
• Pillar 3 disclosure requirements – updated framework(issued in December and available at https://www.bis.org/bcbs/publ/d455.pdf).
• Minimum capital requirements for market risk(issued in December and available at https://www.bis.org/bcbs/publ/d457.pdf).

Consultative BCBS documents issued in 2018 include

• Leverage ratio treatment of client cleared derivatives (issued in October and available at https://www.bis.org/bcbs/publ/d451.pdf).
• Revisions to the leverage ratio disclosure requirements(issued in December and available at https://www.bis.org/bcbs/publ/d456.pdf).

Financial Stability Board

In 2018, the Federal Reserve continued its participation in the activities of the FSB, an international group that helps coordinate the work of national financial authorities and international standard-setting bodies, and develops and promotes the implementation of financial sector policies in the interest of financial stability.

FSB publications issued in 2018 include

• Monitoring the technical implementation of the FSB total loss-absorbing capacity (TLAC) standard (issued in June and available at http://www.fsb.org/wp-content/uploads/P060618.pdf).
• Crypto-assets: Report to the G20 on the work of the FSB and standard-setting bodies (issued in July and available at http://www.fsb.org/wp-content/uploads/P160718-1.pdf).
• Incentives to centrally clear over-the-counter derivatives (issued jointly by the BCBS, the Committee on Payments and Market Infrastructures, and the International Organization of Securities Commissions in August and available at http://www.fsb.org/wp-content/uploads/P070818.pdf).

Committee on Payments and Market Infrastructures

In 2018, the Federal Reserve continued its active participation in the activities of the CPMI, a forum in which central banks promote the safety and efficiency of payment, clearing and settlement activities and related arrangements. In conducting its work on financial market infrastructure and market-related reforms, the CPMI often coordinated with the International Organization of Securities Commissions (IOSCO). Over the course of 2018, CPMI-IOSCO continued to monitor implementation of the Principles for Financial Market Infrastructures. Additionally, CPMI-IOSCO published a framework for supervisory stress testing of central counterparties as well as two additional reports as part of a series on critical, over-the-counter data elements. The CPMI also issued a report on cross border retail payments, released its final strategy on addressing the risk of wholesale payments fraud related to endpoint security, and, jointly with the Markets Committee, prepared a report on central bank digital currencies. Additional information is available at http://www.bis.org/.

International Association of Insurance Supervisors

The Federal Reserve continued its participation in 2018 in the development of international supervisory standards and guidance to ensure that they are appropriate for the U.S. insurance market. The Federal Reserve continues to participate actively in standard setting at the IAIS in consultation and collaboration with state insurance regulators, the NAIC, and the Federal Insurance Office to present a coordinated U.S. voice in these proceedings. The Federal Reserve's participation focuses on those aspects most relevant to financial stability and consolidated supervision.

In 2018, the IAIS issued for public consultation the revised text of five Insurance Core Principles (ICPs) as well as certain associated standards and guidance specific to supervision of internationally active insurance groups, and adopted revisions to one of these ICPs (covering change of control and portfolio transfers).¹⁶ The IAIS plans to adopt revisions to all of these ICPs by year-end 2019.¹⁷

The IAIS also issued a second version of its developing Insurance Capital Standard in July 2018.¹⁸ In addition, the IAIS issued several final and consultative reports as well as research reports in 2018.¹⁹

Papers and reports:

• Issues Paper on Index-based Insurances Particularly in Inclusive Insurance Markets (issued in June and available at https://www.iaisweb.org/page/supervisory-material/issues-papers/file/75169/issues-paper-on-index-based-insurances-particularly-in-inclusive-insurance-markets).
• IAIS and [Sustainable Insurance Forum] Issues Paper on Climate Change Risks to the Insurance Sector (issued in July and available at https://www.iaisweb.org/page/supervisory-material/issues-papers/file/76026/sif-iais-issues-paper-on-climate-changes-risk).
• Issues Paper on Increasing Digitalization in Insurance and its Potential Impact on Consumer Outcomes (issued in November and available at https://www.iaisweb.org/page/supervisory-material/issues-papers/file/77816/issues-paper-on-increasing-digitalisation-in-insurance-and-its-potential-impact-on-consumer-outcomes).
• Application Paper on the Use of Digital Technology in Inclusive Insurance (issued in November and available at https://www.iaisweb.org/page/supervisory-material/application-papers/file/77815/application-paper-on-the-use-of-digital-technology-in-inclusive-insurance).
• Application Paper on Supervision of Insurer Cybersecurity (issued in November and available at https://www.iaisweb.org/page/supervisory-material/application-papers/file/77763/application-paper-on-supervision-of-insurer-cybersecurity).
• Application Paper on the Composition and the Role of the Board (issued in November and available at https://www.iaisweb.org/page/supervisory-material/application-papers/file/77741/application-paper-on-the-composition-and-the-role-of-the-board).

Consultative papers:

• Holistic Framework for Systemic Risk in the Insurance Sector (issued in November and available at https://www.iaisweb.org/page/consultations/closed-consultations/2019/holistic-framework-for-systemic-risk-in-the-insurance-sector/file/77862/holistic-framework-for-systemic-risk-consultation-document).
• Application Paper on Proactive Supervision of Corporate Governance (issued in November and available at https://www.iaisweb.org/page/consultations/closed-consultations/2018/application-paper-on-proactive-supervision-of-corporate-governance/file/77733/draft-application-paper-on-proactive-supervision-of-corporate-governance).
• Application Paper on Recovery Planning (issued in November and available at https://www.iaisweb.org/page/consultations/closed-consultations/2018/application-paper-on-recovery-planning/file/77804/draft-application-paper-on-recovery-planning).

Accounting Policy

The Federal Reserve supports sound corporate governance and effective accounting and auditing practices for all regulated financial institutions. Accordingly, the Federal Reserve's accounting policy function is responsible for providing expertise in policy development and implementation efforts, both within and outside the Federal Reserve System, on issues affecting the banking and insurance industries in the areas of accounting, auditing, internal controls over financial reporting, financial disclosure, and supervisory financial reporting.

Federal Reserve staff regularly consult with key constituents in the accounting and auditing professions, including domestic and international standard-setters, accounting firms, accounting and financial sector trade groups, and other financial sector regulators to facilitate the Board's understanding of domestic and international practices; proposed accounting, auditing, and regulatory standards; and the interactions between accounting standards and regulatory reform efforts. The Federal Reserve also participates in various accounting, auditing, and regulatory forums in order to both formulate and communicate its views.

The Financial Accounting Standards Board (FASB) issued an accounting standard in 2016 that overhauls the accounting for credit losses with a new impairment model based on the Current Expected Credit Losses (CECL) methodology. CECL's implementation will affect a broad range of supervisory activities, including regulatory reports, examinations, and examiner training. During 2018, the Federal Reserve together with the other federal banking agencies continued to monitor the industry's implementation efforts, and provided comments on significant interpretations as observers of the FASB's Transition Resource Group and through outreach and routine discussions with standard setters and other stakeholders, as described above. During 2018, the Board, along with the OCC and FDIC issued a comment letter on the FASB's proposed codification improvements to financial instruments guidance on credit losses.

Other notable outreach efforts during 2018 include the Federal Reserve co-hosting a series of "Ask the Regulators" webinars in February and July on "Practical Examples of How Smaller, Less Complex Community Banks can Implement CECL" and "CECL Q&A for Community Institutions," respectively. In December 2018, the Board, along with the OCC and FDIC, issued a final rule that provides firms with the option to phase in the day-one adverse regulatory capital effects of CECL over a three-year period. Separately, in December 2018, the Board issued a statement on supervisory stress testing, announcing that it will maintain the current modeling framework for loan allowances in its supervisory stress test through 2021.

Federal Reserve staff continued to participate in meetings of the BCBS Accounting Experts Group and the IAIS Accounting and Auditing Working Group. These groups represent their respective organizations at international meetings on accounting, auditing, and disclosure issues affecting global banking and insurance organizations. Working with international bank supervisors, Federal Reserve staff contributed to the development of publications and a comment letter that were issued by the BCBS, including guidelines on identification and management of step-in risk and a comment letter to the International Auditing and Assurance Standards Board on the proposed auditing standard on identifying and assessing the risk of material misstatement. In collaboration with international insurance supervisors, Federal Reserve staff also made contributions to work related to enhancing IAIS standards on disclosures and drafting comment letters to standard setters on accounting and audit exposure documents.

Additionally, Federal Reserve staff provided their accounting and business expertise through participation in other supervisory activities during the past year. These activities included supporting Dodd-Frank Act initiatives related to stress testing of banks as well as various regulatory capital-related issues.

Credit-Risk Management

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 management practices; and to ensure that institutions properly identify, measure, and manage credit risk. The Federal Reserve jointly with other federal banking agencies develops and maintains a regulatory framework covering the use of real estate appraisals in federally related transactions engaged in by regulated institutions; a component in the management of credit risk.

Shared National Credit Program

The Shared National Credit (SNC) program is a key supervisory program employed by the Federal Reserve and the other federal banking agencies to ensure the safety and soundness of the financial system. SNC is a long-standing program used to assess credit risk and trends as well as underwriting and risk-management practices associated with the largest and most complex loans shared by multiple regulated financial institutions. The program also provides for uniform treatment and increased efficiency in shared credit risk analysis and classification.

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, which has the following characteristics: an original loan amount that aggregates to $100 million or more²⁰ 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.

At the end of 2018, the SNC portfolio totaled $4.4 trillion, with 8,567 credit facilities to 5,314 borrowers. Summary examination findings rate the overall risk in the SNC portfolio as moderate, given the asset quality outside of leveraged loans. The percentages of non-pass (aggregate special mention and classified) assets declined from 2017,²¹ largely due to improving conditions in the oil and gas sectors. Despite the improvement in the percentage of non-pass commitments, the overall level of criticized assets continued to be higher than observed in previous periods of economic expansion, such that losses could rise considerably in the event of an economic downturn. During prior cycles, non-investment-grade borrowers relied more heavily on the high-yield bond market to finance operations. Today, those borrowers, especially when controlled by financial sponsors, tend to favor the syndicated loan market for their financing needs. As a result, the current portfolio reflects a larger volume of riskier paper in aggregate.

Leveraged lending accounts for a substantial portion of the SNC portfolio and remains a key focus in the agencies' broader effort to evaluate overall safety and soundness of bank underwriting and risk-management practices. Risks associated with leveraged lending activities are building, as contrasted with the SNC portfolio overall. Leveraged loans with supervisory ratings below pass typically reflect borrowers with higher than average leverage levels and weaker repayment capabilities. The SNC review found that many leveraged loan transactions possess weakened transaction structures and increased reliance upon revenue growth or anticipated cost savings/synergies to support borrower repayment capacity. Weaknesses include the prevalence of covenant lite transactions, incremental facilities with limited lending restrictions, and loan agreement language which allows the removal of assets to unrestricted subsidiaries. Borrowers possess greater control over lending relationships and market dynamics are changing. Non-regulated entities have increased their participation in the leveraged lending market via both purchases of loans and/or direct underwriting and syndication of exposure. More leveraged lending risk is being transferred to these non-regulated entities.

For more information on the 2018 SNC review, visit the Board's website at https://www.federalreserve.gov/newsevents/pressreleases/bcreg20190125a.htm

Compliance Risk Management

The Federal Reserve works with international and domestic supervisors to develop guidance that promotes compliance with Bank Secrecy Act and anti-money-laundering compliance (BSA/AML) and counter-terrorism (CFT) laws.

Bank Secrecy Act and Anti-Money-Laundering Compliance

In 2018, the Federal Reserve continued to actively promote the development and maintenance of effective BSA/AML compliance risk-management programs, including developing supervisory strategies and providing guidance to the industry on trends in BSA/AML compliance. For example, the Federal Reserve supervisory staff participated in a number of industry conferences to continue to communicate regulatory expectations and policy interpretations for financial institutions.

The Federal Reserve is a member of 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. In October 2018, the Federal Reserve, in conjunction with the World Bank and International Monetary Fund, hosted the Seminar for Senior Bank Supervisors from Emerging Economies which was attended by representatives from over 45 foreign jurisdictions. That seminar included a discussion of anti-money-laundering developments for banks designed to promote information sharing and understanding of BSA/AML issues. In addition, the Federal Reserve participated in meetings during the year to discuss BSA/AML issues with delegations from Canada and Japan.

The Federal Reserve participates in the FFIEC BSA/AML working group, a monthly forum for the discussion of pending BSA policy and regulatory matters. In addition to the FFIEC agencies, the BSA/AML working group includes the Financial Crimes Enforcement Network (FinCEN) and, on a quarterly basis, the SEC, the CFTC, the Internal Revenue Service, and OFAC. The FFIEC BSA/AML working group is responsible for updating the FFIEC Bank Secrecy Act/Anti-Money Laundering Examination Manual. The FFIEC developed this manual as part of its ongoing commitment to provide current and consistent interagency guidance on risk-based policies, procedures, and processes for financial institutions to comply with the BSA and safeguard their operations from money laundering and terrorist financing. Throughout 2018, the Federal Reserve continued to regularly share examination findings and enforcement proceedings with FinCEN as well as with OFAC under the interagency MOUs finalized in 2004 and 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. 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 the formulation of international standards. The Federal Reserve participated in the development of FATF Guidance on Regulation of Virtual Assets published in October 2018.

The Federal Reserve also continues to participate in committees and subcommittees through the Bank for International Settlements. Specifically, the Federal Reserve actively participates in the AML Experts Group under the BCBS that focuses on AML and CFT issues as well as the CPMI. The Federal Reserve participated in the BCBS, CPMI, FATF, and FSB joint issuance welcoming the Correspondent Banking Due Diligence Questionnaire published by the Wolfsberg Group, as one of the industry initiatives that will help to address the decline in the number of correspondent banking relationships by facilitating due diligence processes.

Incentive Compensation

The Federal Reserve believes that supervision of incentive compensation programs at financial institutions can play an important role in helping safeguard financial institutions against practices that threaten safety and soundness, provide for excessive compensation, or could lead to material financial loss. The Federal Reserve along with the other federal banking agencies adopted interagency guidance oriented to the risk-taking incentives created by incentive compensation arrangements in June 2010. The guidance is based on the principles that incentive compensation arrangements at a banking organization should provide employees incentives that appropriately balance risk and financial results; be compatible with effective controls and risk management; and be supported by strong corporate governance.

Section 956 of the Dodd-Frank Act requires the Board, OCC, FDIC, SEC, NCUA, and FHFA to develop joint regulations or guidelines implementing disclosures and prohibitions concerning incentive-based compensation at covered financial institutions with at least $1 billion in assets. The agencies published a revised proposed rule in 2016.

Guidance on Guidance

The federal banking agencies issue various types of supervisory guidance, including interagency statements advisories, bulletins, policy statements, questions and answers, and frequently asked questions, to their respective supervised institutions. In September 2018, the Federal Reserve—along with other federal financial agencies—issued a statement confirming the proper role of this supervisory guidance. The statement clarified that unlike a law or regulation, supervisory guidance does not have the force and effect of law. Examiners cannot cite a financial institution for a violation of supervisory guidance as they would violation of a law or regulation. To ensure that supervisory guidance is properly applied, the Federal Reserve has taken several steps since issuance of the statement, including conducting several internal training sessions, providing internal examination materials, more closely reviewing draft supervisory communications to institutions, and coordinating with other federal banking agencies. The Federal Reserve remains committed to ensuring the proper role of guidance in the supervisory process going forward.

Regulatory Reports

The Federal Reserve and the other U.S. federal banking agencies have the authority to require banks and holding companies to submit information, on both a solo and a consolidated basis, on their financial condition, performance, and risks, at regular intervals. The Federal Reserve's data collections, reporting, and governance function is 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, state supervisors, and, as needed, foreign bank supervisors, to recommend and implement appropriate and timely revisions to the reporting forms and the attendant instructions.

Federal Reserve Regulatory Reports

The Federal Reserve requires that U.S. holding companies (HCs) periodically submit reports that provide information about their financial condition and structure.²² This information is essential to formulating and conducting financial institution regulation and supervision. It is also used to respond to information requests by Congress and the public about HCs and their nonbank subsidiaries. Foreign banking organizations also are required to periodically submit reports to the Federal Reserve. For more information on the various reporting forms, see https://www.federalreserve.gov/apps/reportforms/default.aspx.

During 2018, the following reporting forms had substantive revisions:

• FR Y-9C—to implement a number of burden-reducing revisions corresponding to Call Report revisions, as applicable. The revisions, effective June 2018, included deleting certain data items, consolidating existing data items into new data items, and adding new or raising existing reporting thresholds for certain data items. These changes affected approximately 28 percent of the data items collected for holding companies filing the FR Y-9C. Additionally, several reporting schedules were revised in response to changes in the accounting for equity securities, and changes to the definitions of reciprocal deposits brokered deposits and high volatility commercial real estate exposures. Effective September 2018, the reporting threshold was increased from $1 billion or more to $3 billion or more in total consolidated assets, as a result of section 207 of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) (box 2). EGRRCPA directed the Board to revise the Small Bank Holding Company Policy Statement (Policy Statement) to raise the total consolidated asset limit in the Policy Statement from $1 billion to $3 billion in total consolidated assets. As a result of this change, nearly 55 percent of holding companies filing the Y-9C quarterly report became eligible to file the significantly shorter semiannual FR Y-9SP report.
• FR Y-9LP and FR Y-9SP—to implement revisions in response to changes in the accounting for equity securities, effective March 2018. Effective September 2018, reporting thresholds on these forms were modified as a result of EGRRCPA section 207. The FR Y-9LP reporting threshold was increased to $3 billion or more in total consolidated assets (from $1 billion or more), and the FR Y-9SP threshold was increased to under $3 billion in total consolidated assets (from under $1 billion). As a result, nearly 55 percent of holding companies filing the FR Y-9LP quarterly reports became eligible to file the shorter semiannual FR Y-9SP report.
• FR Y-14—to modify several FR Y-14Q schedules to improve consistency of reported data and to enhance supervisory modeling. Additionally, various FR Y-14A, FR Y-1Q, and FR Y-14M schedules were revised to reflect current accounting standards, eliminate a sub-schedule, and streamline reporting. These changes were effective March 2018.
• FR Y-16—to discontinue this form and transfer the stress testing information collection for institutions with between $10 billion and $50 billion in total consolidated assets to an FFIEC collection.

FFIEC Regulatory Reports

The law establishing the FFIEC and defining its functions requires the FFIEC to develop uniform reporting systems for federally supervised financial institutions. The Federal Reserve, along with the other member FFIEC agencies, requires financial institutions to submit various uniform regulatory reports. This information is essential to formulating and conducting supervision and regulation and for the ongoing assessment of the overall soundness of the nation's financial system. During 2018, the following FFIEC reporting forms had substantive revisions:

• FFIEC 031, 041, and 051—to implement certain burden-reducing revisions to the FFIEC 031, FFIEC 041 and FFIEC 051 Call Reports. See section below on the Call Report Burden Reduction Initiative for more details. Additionally, several reporting schedules were revised in response to changes in the accounting for equity securities.
• FFIEC 002—to implement certain burden-reducing revisions corresponding to Call Report revisions, as applicable. Additionally, certain reporting information was revised in response to changes in the accounting for equity securities.
• FFIEC 016—to create a new, single FFIEC form to combine the agencies' three separate, yet identical, stress test forms for institutions with between $10 billion and $50 billion in total consolidated assets, with modifications to align the report form with burden-reducing changes made to other financial reports and to collect an institution's legal entity identifier if they already have one. The passage of EGRRCPA in 2018 eliminated the Dodd-Frank Act stress testing requirements for these firms and no data was collected on this form.

Call Report Burden Reduction Initiative

In 2018, the FFIEC concluded a multiyear initiative that began in 2015 to streamline and simplify regulatory reporting requirements for banking institutions, primarily community banks, and reduce their reporting burden. The objectives of this initiative were consistent with feedback the FFIEC received as part of the regulatory review conducted as required by the Economic Growth and Regulatory Paperwork Reduction Act of 1996 to reduce burden.

Through this initiative, the FFIEC implemented burden-reducing changes that removed or consolidated data items, added new or raised certain existing reporting thresholds, or reduced the frequency of reporting data items. Collectively, these changes affected approximately 51 percent of required data items for smaller, less complex institutions filing the FFIEC 051 Call Report, and 28 percent of required data items for all other institutions filing the FFIEC 031 and FFIEC 041 Call Reports, that were included in the Call Reports for December 31, 2016. Table 4 summarizes the overall number of changes finalized and implemented by Call Report form under the burden reduction initiative.

Table 4. Cumulative data items revised through June 30, 2018

Supervisory Information Technology

The Federal Reserve's supervisory information technology function established a new multiyear IT strategy focused on optimizing our technology spend, simplifying our IT environment and leveraging new or emerging technologies. High priority initiatives included: (1) the completion of the IT strategy, (2) establishing an Enterprise Information Management Program for the Supervision function, (3) developing a Records and Document Management Strategy, and (4) the successful investigation of new technology solutions to improve examiner efficiency while reducing burden for regulated institutions.

Supervisory and support tools. To support examiners and other supervisory staff, IT continues to manage tools to support the collection, use, and storage of supervisory data—both directly within the supervisory programs or to manage resources. There has been increased investment and growth in the advanced quantitative analysis platforms and toolsets, as well as and data visualization software to allow supervisory analysts to glean insights from supervisory data.

Streamlined data access and improved security. For the supervision function, IT continues to enhance its data-access process using a central tool established for managing and granting user access. This central tool provides assurance that user-access is established for important data, applications, and research that will be published externally. The resulting effect of this tool is enhanced prevention and detection controls that reduces information security risks.

IT has implemented information security policies, procedures, and practices designed to safeguard confidential information, including confidential supervisory information and personally identifiable information. A comprehensive, defense-in-depth approach leveraging multiple layers of security are implemented to protect confidential information. IT continually assesses the effectiveness of its information security programs and controls, and implements additional security measures as needed to further enhance the protection of confidential information.

Information sharing and external collaboration. IT provides a Federal Reserve business area representative to the FFIEC Task Force on Information Sharing, and representatives who lead both the Technical Working Group and the Path Forward Working Group, which focuses efforts to work with the business areas to increase capabilities for collaboration between the agencies.

The Federal Reserve exchanges approved regulatory interagency information with several external agencies, managed through interagency sharing agreements for specific data sets, and overseen by the IT area.

Document management. In addition to continued efforts to implement a document and records management strategy, IT continues to improve document tracking, storage, and access through the implementation of document management software. The software eliminates point-to-point interfaces between document management systems and systems uploading or referencing documents. The software also moves and tracks documents between management systems as the documents progress through their life cycle.

National Information Center

IT continues to be responsible for the delivery of the NIC, the Federal Reserve's authoritative source for supervisory, financial, and banking structure data as well as information on supervisory documents. The NIC includes (1) structure, financial, and supervisory data on banking structures throughout the United States and foreign banking concerns (2) national applications on various supervisory programs and the data they capture, (3) data collection processes, and (4) a platform for sharing of the information with external agencies and the public. Thousands of data points are updated on a daily basis and a public version of the data is made available through the NIC's website.

Staff Development

The Federal Reserve's staff development program supports the ongoing development of nearly 3,000 professional supervisory staff, ensuring that they have the requisite skills necessary to meet their evolving supervisory responsibilities. The Federal Reserve also provides course offerings to staff at state banking agencies. Training activities in 2018 are summarized in table 5.

Table 5. Training for banking supervision and regulation, 2018

Examiner Commissioning Program

An overview of the Federal Reserve System's Examiner Commissioning Program for assistant examiners is set forth in SR letter 17-6, "Overview of the Federal Reserve's Supervisory Education Programs."²³

Examiners choose from one of three specialty tracks: (1) safety and soundness, (2) consumer compliance, or (3) large financial institutions. On average, individuals move through a combination of classroom offerings, self-paced learning, virtual instruction, and on-the-job training over a period of two to three years. Achievement is measured by completing the required course content, demonstrating adequate on-the-job knowledge, and passing a professionally validated proficiency examination. In 2018, 58 examiners passed the proficiency examination (35 in safety and soundness and 23 in consumer compliance).

In 2018, the Board enhanced the consumer compliance proficiency examination by adding application-based questions designed to measure performance reflecting the level of knowledge and skills needed to effectively perform in an examiner-in-charge role. In addition, further learning units were released for the Large Financial Institutions Examiner Commissioning Program, which will continue to be developed and deployed in 2019.

Continuing Professional Development

Throughout 2018, the Federal Reserve System continued to enhance its continuing professional development program. Professional development and training content was developed to support several major supervision initiatives, including CECL, Divergent Views, Cybersecurity, and the LISCC program. Educational efforts specific to financial technology, including use cases and industry perspectives, were also delivered to a national supervision audience.

Regulatory Developments

Post-Crisis Framework

Regulatory policies implemented over the past decade have contributed significantly to improving the safety and soundness of banking organizations and the financial system so they are able to support the needs of the economy through good times and bad. Today, U.S. banking firms are significantly better capitalized and have much stronger liquidity positions. They rely less on short-term wholesale funding, which can evaporate quickly during periods of stress. The largest banking firms have also developed resolution plans that reduce the potential negative systemic impact that could result in the event of their failures.

As the regulatory framework has been strengthened, the Federal Reserve has also focused on the efficiency of financial institution supervision. Compliance burden should be minimized without compromising the safety and soundness gains that have been made in recent years. In addition, the Federal Reserve continues to tailor its regulations, ensuring that the rules vary with the risk of the institution.

In an effort to refine the post-crisis supervisory and regulatory framework, the Board promotes the principles of efficiency, transparency, and simplicity.

Efficiency involves two components. The first is related to methods: efficient methods tailor the requirements and intensity of regulations and supervision programs based on the asset size and complexity of firms. Efficient methods also minimize compliance burdens generally while achieving regulatory objectives. The second is related to goals: we have a strong public interest in an efficient financial system, just as we do in a safe and sound one. We include the efficient operation of the financial sector as one of the goals we seek to promote through our regulation and supervision.²⁴

Transparency is not only a core requirement for accountability to the public but also benefits the regulatory process by exposing ideas to a variety of perspectives. Similarly, transparent supervisory principles and guidance allow firms and the public to understand the basis on which supervisory decisions are made and allow firms the ability to respond constructively to supervisors (box 3).

Simplicity complements and reinforces transparency by promoting the public's understanding of the Board's regulatory and supervisory programs. Confusion and unnecessary compliance burden resulting from overly complex regulation do not advance the goal of a safe financial system.

Since the crisis, the Federal Reserve has substantially strengthened its supervisory programs for the largest institutions. The financial crisis made clear that policymakers needed to address more substantially the threat to financial stability posed by the largest and most complex banking organizations, in particular those considered systemically important. As a result, the Federal Reserve has strategically shifted supervisory resources to its large bank supervision programs. For SIFIs, LISCC was established in 2010 to oversee a national program for these firms.²⁵ An increased number of horizontal examinations were introduced, focusing on capital, liquidity, governance and controls, and resolution planning.²⁶ In addition, financial and management information collections from large institutions increased, giving supervisors more timely and better insight into firms' risk profiles and activities.

The Federal Reserve also enhanced its supervision programs for smaller institutions to address lessons learned during the crisis and has more recently focused on tailoring its supervisory expectations to minimize regulatory burden whenever possible without compromising safety and soundness. During the financial crisis of 2007–09, a large number of regional and community banks failed or experienced financial stress. Accordingly, the Federal Reserve took steps to improve its regional and community bank supervision programs to enhance expectations for examinations, particularly for those conducted at banks with significant concentrations of credit risk in particular loan segments or that relied significantly on less-stable funding sources.

As banking conditions have improved and regulators have gained more experience implementing the post-crisis regulatory regime, the Federal Reserve, along with other regulatory agencies, has recalibrated supervisory programs to ensure they are effectively and efficiently achieving their goals. As a result, the agencies have implemented several burden-reducing supervisory changes, including

• reducing the volume of financial data that smaller, less-risky banks must submit to the agencies each quarter,
• increasing the loan size under which regulations require banks to obtain formal real estate appraisals for commercial loans, and
• proposing changes to simplify regulatory capital rules.

In addition, the Federal Reserve has taken steps to reduce the amount of undue burden associated with examinations, including conducting portions of examinations offsite. There has also been an increased emphasis on risk-focusing examination activities, where more in-depth examinations are conducted for banks identified as high risk or in areas with high-risk activities, and less-intensive examinations are conducted at lower-risk banks, or in lines of businesses at banks that have historically been lower in risk.

U.S. Banking System Structure

The Federal Reserve acts on a variety of applications and notices 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 applications and notices concern BHC and SLHC formations and acquisitions, bank mergers, and other transactions involving banks and savings associations or nonbank firms. In 2018, the Federal Reserve acted on 1,356 applications filed under the six statutes.

In 2018, the Federal Reserve published its Semiannual Report on Banking Applications Activity, which provides aggregate information on proposals filed by banking organizations and reviewed by the Federal Reserve. The report includes statistics on the number of proposals that have been approved, denied, withdrawn, mooted, or returned as well as general information about the length of time taken to process proposals and common reasons for proposals to be withdrawn from consideration. The reports are available at https://www.federalreserve.gov/publications/semiannual-report-on-banking-applications-activity.htm

Public Notice of Federal Reserve Decisions and Filings Received

Certain decisions by the Federal Reserve that involve a BHC, SLHC, 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 are made public immediately and 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 provides information on orders and announcements (https://www.federalreserve.gov/newsevents/pressreleases.htm) as well as a guide for U.S. and foreign banking organizations that wish to submit applications (https://www.federalreserve.gov/bankinforeg/afi/afi.htm).

Other Laws and Regulation Enforcement Activity/Actions

The Federal Reserve issued the following rules and guidance in 2018 (table 6).

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

Under the Securities Exchange Act of 1934 and the Federal Reserve's Regulation H, certain state member banks are required to make financial disclosures to the Federal Reserve using the same reporting forms (such as Form 10K—annual report and Schedule 14A—proxy statement) that are normally used by publicly held entities to submit information to the SEC.²⁷ As most of the publicly held banking organizations are BHCs and the reporting threshold was recently raised, only two state member banks were required to submit data to the Federal Reserve in 2018. The information submitted by these two small state member banks is available to the public upon request and is primarily used for disclosure to the bank's shareholders and public investors.

Assessments for Supervision and Regulation

The Dodd-Frank Act directs the Board to collect assessments, fees, or other charges equal to the total expenses the Board estimates are necessary or appropriate to carry out the supervisory and regulatory responsibilities of the Board for BHCs and SLHCs with total consolidated assets of $50 billion or more and nonbank financial companies designated for Board supervision by the FSOC. As a collecting entity, the Board does not recognize the supervision and regulation assessments as revenue nor does the Board use the collections to fund Board expenses; the funds are transferred to the Treasury. The Board collected and transferred $564,081,227 in 2018 for the 2017 supervision and regulation assessment.

Securities Credit

Under the Securities Exchange Act of 1934, 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.

Table 6. Federal Reserve or interagency rulemakings/statements (proposed and final), 2018

Footnotes