Board of Governors of the Federal Reserve System

LISCC Program Supervisory Cycle

On an annual cycle, the LISCC Program engages in supervisory prioritization and planning, executes planned supervisory events to support evaluations of each firm's practices and capabilities, and synthesizes that information into an annual assessment of each firm (see figure 2).⁵

Supervisory Prioritization and Planning

The LISCC Program supervisory cycle begins with prioritization and planning. The goal of supervisory planning is to identify a body of work that will inform supervisory assessments and support the assignment of supervisory ratings at the end of the annual cycle.⁶ Supervisory planning aligns supervisory activities to the size, complexity, systemic importance, and dynamic nature of the firms in the LISCC portfolio. Like other supervisory programs and portfolios at the Federal Reserve, the LISCC Program considers applicable statutes, regulations, guidance, policies, and procedures as it designs its supervisory strategies.

The prioritization and planning process is designed to maximize information sharing and joint plan development across DSTs and LISCC portfolio programs. Key steps in supervisory planning include (1) sharing information and views across the LISCC Program of firm-level strategic developments, current risk drivers and levels, and forward-looking risk trends; (2) developing areas of focus for the coming year based on relevant information contained in planning documents developed by the portfolio programs and DSTs; and (3) determining supervisory events consistent with those areas of focus. LISCC supervisory plans are developed and approved for all firms simultaneously, to ensure that the most material risks to the firms, both individually and collectively, and the financial system are incorporated.

At the heart of LISCC Program supervisory plans are horizontal examinations, which help to inform supervisory assessments by providing a broad perspective. Particular attention is paid to the scope of horizontal examinations, both the focus of the work and which firms are included for each horizontal exam, as well as the balance between horizontal and firm-specific work with respect to each firm. Monitoring and risk identification also figure prominently in supervisory plans, given the wide range of activities engaged in by LISCC firms and their constantly changing risk profiles. Given each LISCC firm's structure, international footprint, and breadth of activities, the LISCC Program will consider and sometimes participate in supervisory work that other prudential regulatory and supervisory authorities are conducting at LISCC firms.

When appropriate, the LISCC Program coordinates with the Large and Foreign Banking Organization (LFBO) Program to identify joint horizontal examinations and monitoring efforts across the LISCC and LFBO portfolios, leveraging subject matter experts and risk specialists from LISCC and LFBO. These joint supervisory activities are identified, discussed, proposed, and approved jointly during supervisory planning.

The LISCC Program's governance of supervisory prioritization and planning is designed to incorporate multiple perspectives, align with the LFI ratings framework, and balance consistency across the portfolio with flexibility to ensure appropriate firm-specific supervisory coverage. The OC ultimately endorses a single LISCC Program supervisory plan for all firms in the portfolio.

The supervisory plan may be adjusted over the course of the year due to changes in market conditions, emerging gaps or risks, shifts in supervisory priorities, and/or changes in available supervisory resources. Material changes to the supervisory plan must be approved by the OC chair.

Supervisory Events and Execution

There are two types of supervisory events: monitoring and examinations. This section describes the purpose, approach, and governance of each event type.

Monitoring

The purpose of monitoring is to maintain supervisory awareness of each firm's strategies, activities, and risk profile; to identify emerging risks; and to ensure that the LISCC Program is focused on the most relevant and high-priority areas. Monitoring in the LISCC Program is distinct from examinations and verification of remediated supervisory findings. In general, supervisory assessments, such as findings or ratings, are derived from examinations, including remediation verification, and not from monitoring.

Monitoring LISCC firms is challenging due to their size, complexity, range of activities, geographic reach, and dynamic nature. To meet this challenge, the LISCC Program takes a network approach in which MAP, a dedicated monitoring function, coordinates with teams across the program, other Federal Reserve System functions, and other stakeholders to collect, synthesize, and share information. The objective is to harness the collective knowledge base of the LISCC Program. Monitoring activities range from routine ongoing meetings and review of routine firm-submitted internal management reports to more focused point-in-time or periodic reviews, including informal data requests.

The most routine form of monitoring consists of recurring meetings with firms (for example, meetings with the heads of material business lines, treasury function, independent risk management, or internal audit). Recurring meetings are augmented with analysis of internal management reports. The intelligence gleaned from monitoring is made available to all LISCC Program staff and informs their views on a range of topics. Monitoring is used to identify and better understand issues and developments that may require additional engagement with a firm or group of firms, for instance, through the identification of an emerging risk, a noteworthy trend, an outlier, or a concentration across multiple firms.

As needed, the LISCC Program may augment its routine monitoring with more intensive engagement, ranging from narrow, quick engagements with a small number of firms to deeper investigations of emerging risks across the entire LISCC portfolio. Information derived from these types of monitoring activities helps examiners better understand issues and risks and may be leveraged to inform supervisory planning or to refine and focus supervisory exams.

Monitoring activities generally do not result in supervisory communications to firms, as they are not assessment oriented. Rather, they help to inform and highlight areas where more supervisory work, such as examinations, may be warranted.

Examinations

The purpose of an examination, or exam, is to evaluate the safety and soundness of a firm's practices or its capabilities in a particular area, including its appropriateness of capital and liquidity levels and compliance with applicable laws and regulations.⁷ Exams may be conducted exclusively by the Federal Reserve, or jointly with another regulatory agency. There are three types of exams in the LISCC Program: horizontal exams (both common scope and common teams), firm-specific exams, and remediation verification exams. All exams follow a similar progression from commencement to completion.

Horizontal Exams

Horizontal exams are a hallmark of the LISCC Program. A horizontal exam is an examination of two or more firms focused on a discrete area. A horizontal exam may be conducted by a single "common team," by multiple teams (typically DSTs) using a shared "common scope," or by a hybrid of the two. A horizontal exam may include LISCC firms only, or a combination of LISCC and non-LISCC firms. Ultimately, the approach to a specific horizontal exam depends on a range of factors. In some cases, the scope of a horizontal exam as applied to a particular firm may be tailored to incorporate relevant firm-specific factors.

Horizontal exams enable the LISCC Program to better understand the level of risk across firms and how it is changing, survey the range and maturity of risk-management practices across the examined firms, and more accurately differentiate the risk profile of individual firms and the implications for each firm's approach to risk management.

Firm-Specific Exams

The LISCC Program recognizes that cross-firm perspective and context are helpful and, in some cases, necessary to assess a firm's safety and soundness. Nevertheless, a firm-specific examination approach is used, for instance, when activities to be examined are not as material for other firms or supervisory expectations and the industry range of practice are well understood, eliminating the need for a cross-firm perspective. A firm-specific examination is conducted at a single firm and is often focused on a business line or some other discrete activity and usually involves transaction testing.

Remediation Verification Exams

The purpose of remediation verification exams is to assess whether a firm's remediation of a supervisory finding is effective and whether the relevant supervisory finding can be closed.

All LISCC portfolio programs and the DSTs have a role in tracking open supervisory findings, with intentional overlap so that the LISCC Program maintains a comprehensive view of findings by firm and by LISCC portfolio program. Supervisors meet regularly with a firm regarding its progress in remediating supervisory findings. Supervisors also meet with the firm's internal audit department to understand its assessment of the effectiveness of the firm's remediation. Once a firm's internal audit department has deemed a supervisory issue to be remediated, examiners will schedule an exam to verify the effectiveness of remediation.

The outcome of a remediation verification exam is either to close a supervisory finding if the remediation is found to be effective, or leave the finding open if the remediation is found not to be effective or proven sustainable. Either way, the outcome will be communicated to the firm through a supervisory letter (see the "Supervisory Communications" section). If a firm is notified that a supervisory finding will remain open because its remediation efforts are found not to be effective, the firm would be required to provide a revised action plan and timeline outlining the remediation approach to address the outstanding gap(s). Depending on the materiality of an unremediated supervisory finding, additional supervisory or enforcement actions may be warranted.

Examination Governance and Process

All examinations follow a similar governance and process. Each exam will have a sponsoring LISCC portfolio program. For exams covering topics that cross LISCC portfolio programs, the sponsoring portfolio program leadership will leverage the multidiscipline nature of the LISCC Program and include leaders from other relevant portfolio programs in the governance and oversight of the examination.

Before commencing an examination, supervisors draft a scope memo setting out the context and rationale for the exam and listing explicit objectives to be accomplished, procedures to be observed, and questions to be answered. The objectives drive the work that examiners will then conduct in order to assess risk, the sufficiency of related risk-management activities, and their impact on the safety and soundness of the firm.

In developing a scope memo, supervisory teams are guided by a series of written policies and procedures, guidance, and manuals that describe supervisory expectations and provide direction to the teams in structuring their work at the firms. These publicly available materials include the Bank Holding Company Supervision Manual and the Commercial Bank Examination Manual (see "Appendix A: Supervisory and Examination Resources"), and Supervision and Regulation Letters, commonly known as SR Letters, that address significant policy and procedural matters related to the Federal Reserve System's supervisory responsibilities.⁸

Scope memos are vetted by the appropriate portfolio program leadership, which generally includes the related program co-chairs and/or steering committee. This review helps to ensure that relevant risks are identified; examination objectives and planned activities are well designed to thoroughly assess the risk and controls of the areas being reviewed; and the exam will effectively contribute to the annual assessment ratings.

Once the scope memo is approved by portfolio program leadership, a first-day letter (FDL) is drafted, reviewed, and sent to the financial institution. FDLs highlight the scope objectives and the materials requested to facilitate the start of the exam.

Once an examination has commenced, supervisors meet with firm management, conduct transaction testing, and review any additional materials requested—each with the purpose of understanding any risks posed by the examined activities, assessing the efficacy of the associated risk-management practices and internal controls, and completing the objectives set out in the scope memo.

At the conclusion of an exam, the team members' written evaluations are aggregated into a summary memo capturing key information, overall conclusions, and any divergent views.⁹ The summary memo serves as the document that facilitates discussions with key members of Board and LISCC Program leadership. These discussions include a vetting meeting where the exam team presents the outcome of the exam and any proposed supervisory findings. The vetting groups consist of experienced supervisors from across the LISCC Program who evaluate the concerns regarding safety and soundness raised by the supervisory findings. Often these discussions will compare and contrast similar issues at multiple firms to provide context on the level of risk and help differentiate the required risk management.

When supervisory findings reveal (1) a violation of law, rule, or regulation; (2) a violation of a condition imposed in writing by the Board; or (3) an unsafe or unsound practice, supervisors also consider whether issuance of an enforcement action, revisions to an existing enforcement action, and/or ratings changes are appropriate. The "Enforcement Actions" section describes enforcement actions in more detail.

After the examination results have been reviewed and approved by LISCC Program leadership, a formal exit meeting is held to provide firm management with an overview of the examination results. Supervisory letters are sent to the firm's senior management or board of directors, as appropriate, to communicate the key messages and findings from the examination (see the "Supervisory Communications" section).¹⁰

Annual Assessments

The LISCC Program's annual supervisory cycle culminates in the assignment of supervisory ratings for each firm.¹¹ The supervisory ratings assigned to a firm reflect the Federal Reserve's assessment of whether a firm has sufficient financial and operational strength and resilience to maintain safe and sound operations through a range of conditions, including stressful ones. Each firm is assigned three component ratings: capital planning and positions, liquidity risk management and positions, and governance and controls.¹² After assigning supervisory ratings, the Federal Reserve sends each LISCC firm an annual assessment letter that brings together supervisory messages issued over the course of the year and identifies common themes (see the "Supervisory Communications" section).¹³ For state member banks in the LISCC portfolio, capital, asset quality, management, earnings, liquidity, and sensitivity to market risk (CAMELS) ratings are also developed for the relevant bank subsidiaries.¹⁴

The DST and LISCC portfolio program teams play a critical role in developing supervisory ratings and annual assessment messages for each LISCC firm. The LISCC Program relies on the views of each relevant steering committee and the DST co-chairs throughout the ratings calibration process, culminating in a recommendation to the OC. The OC is responsible for vetting the proposed supervisory ratings and key messages included in the annual assessment. Once approved by the OC chair, the annual assessment letters are finalized and delivered to each recipient firm, and the firm-specific annual ratings and key messages are communicated by the DST lead examiner during a meeting with that firm's board of directors, with support from the OC chair or designee(s) as needed.

When assigning a rating and identifying supervisory issues requiring corrective action by a firm, the LISCC Program will also rely, to the fullest extent possible, on information and assessments from other relevant supervisors and regulators. The LISCC Program may also rely on information from a firm's internal audit or internal control functions if those functions perform effectively.

Supervisory Communications

The LISCC Program strives for communications that are clear, consistent, and appropriate for each LISCC firm. Clear communication between the LISCC Program and each supervised firm is critical to promote a shared understanding of the Federal Reserve's expectations and to promote the safe and sound operation of each LISCC firm. Communication occurs throughout the supervisory cycle.

At the start of an examination, a written communication (FDL) is delivered to each firm subject to the examination outlining the scope and timing of examination activities.

After an examination, the exam team synthesizes the conclusions into supervisory findings for a given firm in preparation for a vetting.

The draft supervisory letter is reviewed by senior leaders/stakeholders to ensure that

• conclusions reached during the post-exam process are appropriately reflected and conveyed in the letter;
• supervisory messages are clear and concise; and
• identified findings requiring firm remediation are consistent with applicable laws and regulations.

Following the vetting, supervisory findings are communicated formally in writing to the supervised firm. Each communication to the supervised firm includes the Confidential Supervisory Information Disclosure, which notes that the contents of the letter are subject to the rules of the Board regarding treatment and disclosure of confidential supervisory information. If the communication includes a material supervisory determination from examinations or other supervisory reviews, a disclosure on the appeals process for material supervisory determinations and the Board's Ombudsman policy is also included (see "Appendix B: Supervisory Communication Disclosures" for Confidential Supervisory Information and Material Supervisory Determination Disclosure language).

At the end of the annual supervisory cycle, each firm receives a letter communicating the firm's ratings. This annual assessment letter highlights key concerns that support the annual supervisory rating. Each DST leads the drafting of the annual assessment letter for its firm through an iterative process (see the "Annual Assessments" section) in which each letter is reviewed by senior representatives from each LISCC portfolio program and the DST co-chairs before it is presented to the OC for review and the OC chair for approval.

Enforcement Actions

The Federal Reserve may bring an enforcement action against any supervised institution regardless of size in response to a violation of law, rule, or regulation; a violation of a condition imposed in writing by the Board; or an unsafe or unsound practice.¹⁵ When determining the appropriate enforcement approach, LISCC supervisors, the Board's Legal Division, and other Federal Reserve stakeholders consider factors such as the severity and pervasiveness of the weaknesses at the institution and management's capacity to correct the weaknesses.

Enforcement actions are scaled to the severity of the firm's weaknesses or deficiencies. An informal enforcement action, in the form of a memorandum of understanding, can be appropriate for governance, risk management, and control weaknesses that are less severe. In the more serious cases, including when a firm fails to comply with an informal action, a firm may be subject to a formal enforcement action, such as a cease-and-desist order, which may also include civil money penalties.¹⁶

An enforcement action will be terminated after a firm has remediated the deficiencies that were identified in the enforcement action. As discussed in the "Remediation Verification Exams" section, the LISCC Program conducts specific supervisory events to verify the remediation of deficiencies. An enforcement action may be terminated at any time during the supervisory cycle. If a firm has complied with most provisions of an action, but significant deficiencies remain outstanding or have been newly identified, staff may recommend that the enforcement action be terminated and replaced with a new enforcement action or another supervisory measure.

In addition, under section 4(m) of the Bank Holding Company Act (BHC Act) of 1956, a financial holding company (FHC) or its depository institution that no longer meets FHC requirements because they are no longer well capitalized or well managed must enter into an agreement acceptable to the Federal Reserve to meet the requirements for FHC status.¹⁷ Other than as stipulated in the agreement, until it is again well capitalized and well managed, the FHC may not engage in any new section 4(k) activities or acquire control or shares of any company engaged in any activity under section 4(k) of the BHC Act without the prior written approval of the Board. When an institution corrects the conditions that caused it not to meet the FHC requirements, the section 4(m) agreement is terminated by operation of law.

The Board generally publishes all formal enforcement actions. An exception can be made if the Board determines that publication of the order or agreement would be contrary to the public interest. Section 4(m) agreements generally are not publicly disclosed because publication would convey the underlying supervisory ratings that gave rise to the 4(m) agreement, which constitute confidential supervisory information.

Title I Joint Agency Determination

Title I of the Dodd-Frank Act requires each LISCC firm to submit a resolution plan (i.e., a living will) to the Federal Reserve and to the FDIC at regular intervals for joint agency review. Joint agency determinations regarding whether there are shortcomings or deficiencies, as defined in the agencies' joint resolution plan rule, are made by the boards of both agencies and communicated via joint agency feedback letters.

Under the joint resolution plan rule, a firm that fails to remediate a deficiency must resubmit its resolution plan. If the agencies jointly determine that the revised plan does not adequately remedy the deficiencies, the agencies may apply certain requirements or restrictions to the firm and, in certain cases, may require the firm to divest certain businesses or assets.¹⁸

The LISCC RRP program is responsible for coordinating with the FDIC on the review and assessment of title I resolution plans submitted by LISCC firms. The vetting of title I findings is done jointly with the FDIC, while the staff recommendations to each agency's board are handled separately. The Federal Reserve staff makes suggestions to the Director of Supervision and Regulation (S&R Director) regarding the recommendations that will be advanced to the Board related to each LISCC firm's resolution plan.

Footnotes