Commercial Bank Examination Manual October 2007 Update
The October 2007 update to the Commercial Bank Examination Manual has been published (supplement no. 28). The manual comprises the Federal Reserve System's regulatory, supervisory, and examination guidance for state member banks. The new supplement includes guidance on the following subjects:
- Sound Practices Concerning Elevated-Risk Complex Structured Financing Activities. This new section provides this January 11, 2007, interagency statement. The supervisory guidance was issued by the Federal Reserve Board and the other federal bank regulatory agencies (the agencies) to address risk-management principles that should help institutions to identify, evaluate, and manage the heightened legal and reputational risks that may arise from their involvement in complex structured financing transactions (CSFTs), particularly those that are defined as "elevated-risk CFSTs." (See SR letter 07-5 and 72 Federal Register 1372, January 11, 2007.)
- Statement on Subprime Mortgage Lending. A new section, "Subprime Mortgage Lending" sets forth the June 29, 2007, interagency guidance. The subprime statement was developed and issued by the agencies to address issues and questions related to certain adjustable-rate mortgage (ARM) products marketed to subprime borrowers. The statement emphasizes the need for institutions to have prudent underwriting standards and to provide consumers with clear and balanced information--so that both the institutions and consumers can assess the risks arising from certain ARM products that have discounted or low introductory rates. The subprime statement�s principles also are relevant to ARM products offered to nonsubprime borrowers. The statement applies to all banks and their subsidiaries as well as to bank holding companies and their nonbank subsidiaries. (See SR letter 07-12 and its attachment.)
- Examination Frequency Guidelines for State Member Banks. This section, "Examination Strategy and Risk-Focused Supervision," has been revised to accommodate changes to these examination frequency guidelines. The changes resulted from an interim rule, effective on April 10, 2007, that was jointly issued by the agencies. The interim rule implemented (1) section 605 of the Financial Services Regulatory Relief Act of 2006 (FSRRA), and (2) Public Law No. 109-473 (to be codified at 12 U.S.C. 1820(d)). The interim rule was adopted as final, without change, on September 11, 2007. (See 72 Federal Register, 54,347, September 25, 2007.) The rule permits federally insured depository institutions that have up to $500 million in total assets, and that meet certain other criteria, to qualify for an 18-month (rather than a 12-month) on-site examination cycle. The rule specifies, consistent with current practice, that a small insured depository institution meets the statutory "well managed" criteria for an 18-month examination cycle if the institution, besides having a CAMELS composite rating of 1 or 2, received a rating of 1 or 2 for the management component of the CAMELS rating at its most recent examination. (See SR letter 07-8 and its attachment, 72 Federal Register 17,798.)
- Interagency Guidance in Concentrations in Commercial Real Estate Lending, Sound Risk-Management Practices. The manual�s section 2103.1 (added with the May 2007 update to this manual) sets forth this supervisory guidance (effective December 12, 2006). The guidance, which was jointly issued by the agencies, is now supplemented with new sections setting forth the examination objectives, examination procedures, and an internal control questionnaire. The guidance was developed to reinforce sound risk-management practices for institutions with high and increasing concentrations of commercial real estate loans on their balance sheets. (See SR letter 07-1 and 71 Federal Register 74,580, December 12, 2006.)
- Reports of Examinations of Government Securities Activities. The "Other Types of Examinations" section has been revised to discuss the responsibilities of Reserve Bank staff in the examination and supervision of, and the reporting for, an institution�s compliance with the Government Securities Act. A Reserve Bank�s staff is required to report separately (to designated Board staff) the results of their reviews of government securities broker-dealer activities (and such broker-dealer�s related custodial activities). The optional reporting form, Summary Report of Government Securities Broker-Dealer and Custodial Activities, may be used for this purpose. (See the specific examination guidance and procedures in SR letters 06-8, 93-40, and 87-37. Also see SR letters 94-5, 90-1, and 88-26.)
- Direct Credit Substitutes Extended to Asset-Backed Commercial Paper Programs. This new section sets forth the March 2005 interagency guidance that is based on the Board�s adoption of the November 29, 2001, amended risk-based capital standards. The standards established a capital framework for banking organizations that are engaged in securitization activities. The guidance clarifies how banking organizations are to use internal ratings that they assign to asset pools purchased by their asset-backed commercial paper (ABCP) programs to appropriately risk weight any direct-credit substitutes (for example, guarantees) that are extended to such programs. An analytical framework is provided for assessing the broad risk characteristics of direct credit substitutes that a banking organization provides to an ABCP program it sponsors. The guidance also provides specific information on evaluating direct credit substitutes issued in the form of program-wide credit enhancements. There are examination objectives, examination procedures, and an internal control questionnaire included.
A more detailed summary of changes is included with the update package. The public may obtain the manual and the updates (including pricing information) from Publications Fulfillment, MS-127, Board of Governors of the Federal Reserve System, 20th and C Streets, N.W., Washington, DC 20551; telephone (202) 452-3244; or send a facsimile to (202) 728-5886.