The Federal Reserve has supervisory and regulatory authority over a variety of financial institutions and activities. It works with other federal and state supervisory authorities to ensure the safety and soundness of supervised financial institutions and the stability of U.S. financial markets as a whole.
In 2006, U.S. banking organizations reported record earnings despite tight net interest margins resulting from a persistently flat yield curve and heightened competition for deposits and loans. Credit quality indicators remained historically strong, although nonperforming assets increased, particularly in residential real estate portfolios. For a second consecutive year, there were no failures of insured banks. Banking supervisors focused on banking activities that could prove vulnerable in the event of an economic downturn. In particular, the federal banking agencies during the year issued guidance for supervised financial institutions on extensions of credit for nontraditional residential mortgages and for commercial real estate. Delinquencies among loans of these and most other types remained low.
Federal Reserve staff continued to work throughout the year with the other federal banking agencies to prepare for U.S. implementation of the Basel II capital accord. 1 In September, the agencies issued a joint notice of proposed rulemaking (NPR) describing proposals for implementing the Basel II framework in the United States. In December, they issued an NPR proposing revisions to capital requirements for trading book positions subject to the market risk capital rule. The agencies are also developing Basel II supervisory guidance for examiners and the banking industry.
Under the NPR implementing Basel II, the new capital framework would be mandatory for large, internationally active banking organizations and optional for all others. Federal banking supervisors expect that the vast majority of banking organizations will remain subject to the existing risk-based capital framework (Basel I). To update Basel I and mitigate some of the consequences of the differences between Basel I and Basel II, the agencies in December issued an NPR proposing changes to the Basel I framework that would be optional for banking organizations not subject to Basel II.
The Federal Reserve is the federal supervisor and regulator of all U.S. bank holding companies, including financial holding companies formed under the authority of the 1999 Gramm-Leach-Bliley Act, and state-chartered commercial banks that are members of the Federal Reserve System. In overseeing these organizations, the Federal Reserve seeks primarily to promote their safe and sound operation, including their compliance with laws and regulations. 2
The Federal Reserve also has responsibility for supervising the operations of all Edge Act and agreement corporations, the international operations of state member banks and U.S. bank holding companies, and the U.S. operations of foreign banking companies.
The Federal Reserve exercises important regulatory influence over entry into the U.S. banking system, and the structure of the system, through its administration of the Bank Holding Company Act, the Bank Merger Act (with regard to state member banks), the Change in Bank Control Act (with regard to bank holding companies and state member banks), and the International Banking Act. The Federal Reserve is also responsible for imposing margin requirements on securities transactions. In carrying out these responsibilities, the Federal Reserve coordinates its supervisory activities with the other federal banking agencies, state agencies, functional regulators, and the bank regulatory agencies of other nations.
To promote the safety and soundness of banking organizations, the Federal Reserve conducts on-site examinations and inspections and off-site surveillance and monitoring. It also takes enforcement and other supervisory actions as necessary.
The Federal Reserve conducts examinations of state member banks, the U.S. branches and agencies of foreign banks, and Edge Act and agreement corporations. In a process distinct from examinations, it conducts inspections of bank holding companies and their nonbank subsidiaries. Whether an examination or an inspection is being conducted, the review of operations entails (1) an assessment of the quality of the processes in place to identify, measure, monitor, and control risks; (2) an assessment of the quality of the organization's assets; (3) an evaluation of management, including an assessment of internal policies, procedures, controls, and operations; (4) an assessment of the key financial factors of capital, earnings, liquidity, and sensitivity to market risk; and (5) a review for compliance with applicable laws and regulations. The table provides information on the examinations and inspections conducted by the Federal Reserve during the past five years.
|State member banks|
|Total assets (billions of dollars)||1,405||1,318||1,275||1,912||1,863|
|Number of examinations||761||783||809||822||814|
|By Federal Reserve System||500||563||581||581||550|
|By state banking agency||261||220||228||241||264|
|Top-tier bank holding companies|
|Large (assets of more than $1 billion)|
|Total assets (billions of dollars)||12,179||10,261||8,429||8,295||7,483|
|Number of inspections||566||501||500||454||439|
|By Federal Reserve System 1||557||496||491||446||431|
|By state banking agency||9||5||9||8||8|
|Small (assets of $1 billion or less)|
|Total assets (billions of dollars)||947||890||852||847||821|
|Number of inspections||3,449||3,420||3,703||3,453||3,726|
|By Federal Reserve System||3,257||3,233||3,526||3,324||3,625|
|By state banking agency||192||187||177||129||101|
|Financial holding companies|
1. For large bank holding companies subject to continuous, risk-focused supervision, includes multiple targeted reviews. Return to table
Inspections of bank holding companies, including financial holding companies, are built around a rating system introduced in 2005 that reflects the recent shift in supervisory practices for these organizations away from the 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 potential impact (I) of the parent company and its nondepository subsidiaries on the subsidiary depository institution. 3 The fourth component, depository institution (D), is intended to mirror the primary regulator's rating of the subsidiary depository institution.
In managing the supervisory process, the Federal Reserve takes a risk-focused approach that directs resources to (1) those business activities posing the greatest risk to banking organizations and (2) the organizations' management processes for identifying, measuring, monitoring, and controlling risks. The key features of the supervision program for large complex banking organizations (LCBOs) are (1) identifying those LCBOs that are judged, on the basis of their shared risk characteristics, to present the highest level of supervisory risk to the Federal Reserve System; (2) maintaining continual supervision of these organizations so that the Federal Reserve's assessment of each organization's condition is current; (3) assigning to each LCBO a supervisory team composed of Reserve Bank staff members who have skills appropriate for the organization's risk profile (the team leader is the System's central point of contact for the organization, has responsibility for only one LCBO, and is supported by specialists capable of evaluating the risks of LCBO business activities and functions); and (4) promoting Systemwide and interagency information-sharing through automated systems.
For other banking organizations, the risk-focused supervision program provides that examination procedures are tailored to each banking organization's size, complexity, and risk profile. As with the LCBOs, examinations entail both off-site and on-site work, including planning, pre-examination visits, detailed documentation, and examination reports tailored to the scope and findings of the examination.
At the end of 2006, 901 state-chartered banks (excluding nondepository trust companies and private banks) were members of the Federal Reserve System. These banks represented approximately 12 percent of all insured U.S. commercial banks and held approximately 14 percent of all insured commercial bank assets in the United States.
The guidelines for Federal Reserve examinations of state member banks are fully consistent with section 10 of the Federal Deposit Insurance Act, as amended by section 111 of the Federal Deposit Insurance Corporation Improvement Act of 1991 and by the Riegle Community Development and Regulatory Improvement Act of 1994. A full-scope, on-site examination of these banks is required at least once a year, although certain well-capitalized, well-managed organizations having total assets of less than $250 million may be examined once every eighteen months. The Financial Services Regulatory Relief Act of 2006, signed into law in October, authorized the federal banking agencies to raise the total asset threshold for certain institutions from $250 million to $500 million. Interim rules that will incorporate this change into existing regulations are being developed. The Federal Reserve conducted 500 exams of state member banks in 2006.
At year-end 2006, a total of 5,825 U.S. bank holding companies were in operation, of which 5,102 were top-tier bank holding companies. These organizations controlled 6,106 insured commercial banks and held approximately 96 percent of all insured commercial bank assets in the United States.
Federal Reserve guidelines call for annual inspections of large bank holding companies as well as 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. Noncomplex bank holding companies with consolidated assets of $1 billion or less are subject to a special supervisory program that permits a more flexible approach. 4 In 2006, the Federal Reserve conducted 557 inspections of large bank holding companies and 3,257 inspections of small, noncomplex bank holding companies.
Under the Gramm-Leach-Bliley Act, bank holding companies that meet certain capital, managerial, and other requirements may elect to become financial holding companies and thereby engage in a wider range of financial activities, including full-scope securities underwriting, merchant banking, and insurance underwriting and sales. The statute streamlines the Federal Reserve's supervision of all bank holding companies, including financial holding companies, and sets forth parameters for the supervisory relationship between the Federal Reserve and other regulators. The statute also differentiates between the Federal Reserve's relations with regulators of depository institutions and its relations with functional regulators (that is, regulators for insurance, securities, and commodities firms).
As of year-end 2006, 604 domestic bank holding companies and 44 foreign banking organizations had financial holding company status. Of the domestic financial holding companies, 38 had consolidated assets of $15 billion or more; 121, between $1 billion and $15 billion; 86, between $500 million and $1 billion; and 359, less than $500 million.
The Federal Reserve supervises the foreign branches and overseas investments of member banks, Edge Act and agreement corporations, and bank holding companies and also the investments by bank holding companies 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.
In supervising the international operations of state member banks, Edge Act and agreement corporations, and bank holding companies, the Federal Reserve generally conducts its examinations or inspections at the U.S. head offices of these organizations where the ultimate responsibility for the foreign offices lies. Examiners also visit the overseas offices of U.S. banks to obtain financial and operating information and, in some instances, to evaluate the organizations' efforts to implement corrective measures or to test their adherence to safe and sound banking practices. Examinations abroad are conducted with the cooperation of the supervisory authorities of the countries in which they take place; for national banks, the examinations are coordinated with the Office of the Comptroller of the Currency (OCC).
At the end of 2006, 53 member banks were operating 675 branches in foreign countries and overseas areas of the United States; 34 national banks were operating 625 of these branches, and 19 state member banks were operating the remaining 50. In addition, 17 nonmember banks were operating 21 branches in foreign countries and overseas areas of the United States.
Edge Act corporations are international banking organizations chartered by the Board to provide all segments of the U.S. economy with a means of financing international business, especially exports. Agreement corporations are similar organizations, state chartered or federally chartered, that enter into an agreement 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 2006, 71 banking organizations, operating 9 branches, were chartered as Edge Act or agreement corporations. These corporations are examined annually.
The Federal Reserve has broad authority to supervise and regulate the U.S. activities of foreign banks that engage in banking and related activities in the United States through branches, agencies, representative offices, commercial lending companies, Edge Act corporations, commercial banks, bank holding companies, and certain nonbanking companies. Foreign banks continue to be significant participants in the U.S. banking system.
As of year-end 2006, 178 foreign banks from 54 countries were operating 214 state-licensed branches and agencies, of which 8 were insured by the Federal Deposit Insurance Corporation (FDIC), and 45 OCC-licensed branches, of which 4 were insured by the FDIC. These foreign banks also owned 12 Edge Act and agreement corporations and 2 commercial lending companies; in addition, they held a controlling interest in 62 U.S. commercial banks. Altogether, the U.S. offices of these foreign banks at the end of 2006 controlled approximately 19 percent of U.S. commercial banking assets. These 178 foreign banks also operated 85 representative offices; an additional 59 foreign banks operated in the United States solely through a representative office.
State-licensed and federally licensed branches and agencies of foreign banks are examined on-site at least once every eighteen months, either by the Federal Reserve or by a state or other federal regulator. In most cases, on-site examinations are conducted at least once every twelve months, but the period may be extended to eighteen months if the branch or agency meets certain criteria.
In cooperation with the other federal and state banking agencies, the Federal Reserve conducts a joint program for supervising the U.S. operations of foreign banking organizations. The program has two main parts. One part involves examination of those foreign banking organizations that have multiple U.S. operations and is intended to ensure coordination among the various U.S. supervisory agencies. The other part is a review of the financial and operational profile of each organization to assess its general ability to support its U.S. operations and to determine what risks, if any, the organization poses through its U.S. operations. Together, these two processes provide critical information to U.S. supervisors in a logical, uniform, and timely manner. The Federal Reserve conducted or participated with state and federal regulatory authorities in 339 examinations in 2006.
The U.S. Department of the Treasury regulations (31 CFR 103) 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 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, terrorist financing, and other financial crimes. In addition, BSA and Board regulations require that banks develop written programs on BSA/anti-money-laundering compliance and that the programs be formally approved by bank boards of directors. An institution's compliance program must (1) establish a system of internal controls to ensure compliance with the BSA, (2) provide for independent compliance testing, (3) identify individuals responsible for coordinating and monitoring day-to-day compliance, and (4) provide training for personnel as appropriate.
The Federal Reserve is responsible for examining its supervised institutions for compliance with various anti-money-laundering laws and regulations. During examinations of state member banks and U.S. branches and agencies of foreign banks and, when appropriate, inspections of bank holding companies, examiners review the institution's compliance with the BSA and determine whether adequate procedures and controls to guard against money laundering and terrorism financing are in place.
The Federal Reserve conducts specialized examinations of banking organizations in the areas of information technology, fiduciary activities, transfer agent activities, and government and municipal securities dealing and brokering. The Federal Reserve also conducts specialized examinations of certain entities, other than banks, brokers, or dealers, that extend credit subject to the Board's margin regulations.
In recognition of the importance of information technology to safe and sound operations in the financial industry, the Federal Reserve reviews the information technology activities of supervised banking organizations as well as certain independent data centers that provide information technology services to these organizations. All safety and soundness examinations include a risk-focused review of information technology risk management activities. During 2006, the Federal Reserve was the lead agency in 1 cooperative, multiagency examination of a large, multiregional data processing servicer.
The Federal Reserve has supervisory responsibility for state member commercial banks and depository trust companies that together reported, at the end of 2006, $36 trillion of assets in various fiduciary or custodial capacities. Additionally, state member nondepository trust companies supervised by the Federal Reserve reported $33 trillion of assets held in a fiduciary or custodial capacity. During on-site examinations of fiduciary activities, an organization's compliance with laws, regulations, and general fiduciary principles and potential conflicts of interest are reviewed; its management and operations, including its asset- and account-management, risk-management, and audit and control procedures, are also evaluated. In 2006, Federal Reserve examiners conducted 97 on-site fiduciary examinations.
As directed by the Securities Exchange Act of 1934, the Federal Reserve conducts specialized examinations of those state member banks and bank holding companies 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 2006, the Federal Reserve conducted on-site examinations at 15 of the 78 state member banks and bank holding companies that were registered as transfer agents and examined 1 state member limited-purpose trust company acting as a national securities depository.
The Federal Reserve is responsible for examining state member banks and foreign banks for compliance with the Government Securities Act of 1986 and with Department of the Treasury regulations governing dealing and brokering in government securities. Twenty-five state member banks and 8 state branches of foreign banks have notified the Board that they are government securities dealers or brokers not exempt from Treasury's regulations. During 2006, the Federal Reserve conducted 6 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 both state member banks and bank holding companies that act as municipal securities dealers comply with the Securities Act Amendments of 1975. Municipal securities dealers are examined pursuant to the Municipal Securities Rulemaking Board's rule G-16 at least once every two calendar years. Of the 20 entities that dealt in municipal securities during 2006, 9 were examined during the year.
Under the Securities Exchange Act of 1934, the Board is responsible for regulating credit in certain transactions involving the purchase or carrying of securities. As part of its general examination program, the Federal Reserve examines the banks under its jurisdiction for compliance with the Board's Regulation U (Credit by Banks and Persons other than Brokers or Dealers for the Purpose of Purchasing or Carrying Margin Stock). In addition, the Federal Reserve maintains a registry of persons other than banks, brokers, and dealers who extend credit subject to Regulation U. The Federal Reserve may conduct specialized examinations of these lenders if they are not already subject to supervision by the Farm Credit Administration, the National Credit Union Administration (NCUA), or the Office of Thrift Supervision (OTS).
At the end of 2006, 602 lenders other than banks, brokers, or dealers were registered with the Federal Reserve. Other federal regulators supervised 210 of these lenders, and the remaining 392 were subject to limited Federal Reserve supervision. On the basis of regulatory requirements and annual reports, the Federal Reserve exempted 290 lenders from its on-site inspection program. The securities credit activities of the remaining 102 lenders were subject to either biennial or triennial inspection. Sixty inspections were conducted during the year.
In 2006, the Federal Reserve continued its efforts to strengthen the resilience of the U.S. financial system in the event of unexpected disruptions. Throughout the year, the staff continued to work with financial institutions to assess implementation of the sound practices identified in the April 2003 "Interagency Paper on Sound Practices to Strengthen the Resilience of the U.S. Financial System," a joint publication with the OCC and the Securities and Exchange Commission (SEC). During 2006, the agencies provided additional guidance to help institutions implement testing of their business continuity plans. The agencies continue to coordinate their efforts to ensure a consistent supervisory approach for business continuity practices.
The Federal Reserve has enforcement authority over the banking organizations it supervises and their affiliated parties. Enforcement actions may be taken to address unsafe and unsound practices or violations of any law or regulation. Formal enforcement actions include cease-and-desist orders, written agreements, removal and prohibition orders, and civil money penalties. In 2006, the Federal Reserve completed 37 formal enforcement actions. Civil money penalties totaling $212,050 were assessed. All civil money penalties, as directed by statute, are remitted to either the Department of the Treasury or the Federal Emergency Management Agency. Enforcement orders, 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 web site ( www.federalreserve.gov/boarddocs/enforcement ).
In addition to taking these formal enforcement actions, the Reserve Banks completed 70 informal enforcement actions in 2006. Informal enforcement actions include memoranda of understanding and board of directors resolutions. Information about these actions is not available to the public.
The Federal Reserve uses automated screening systems to monitor the financial condition and performance of state member banks and bank holding companies 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.
In January 2006, the Federal Reserve replaced its primary off-site monitoring tool, SEER (System to Estimate Examination Ratings), with the Supervision and Regulation Statistical Assessment of Bank Risk model (SR-SABR). Drawing primarily 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 reports, which are compiled from data provided by large bank holding companies 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 web site, which can be accessed at www.ffiec.gov .
During the year, four major upgrades to the web-based Performance Report Information and Surveillance Monitoring (PRISM) application were completed. PRISM is a querying tool used by Federal Reserve analysts 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 bank holding companies. The upgrades made more regulatory data available for querying, added the results of surveillance screens (including SR-SABR), added new search options, and improved the user interface.
The Federal Reserve works through the Federal Financial Institutions Examination Council (FFIEC) Task Force on Surveillance Systems to coordinate surveillance activities with the other federal banking agencies. 5
In 2006, the Federal Reserve continued to provide technical assistance on bank supervisory matters to foreign central banks and supervisory authorities. Technical assistance involves visits by Federal Reserve staff members to foreign authorities as well as consultations with foreign supervisors who visit the Board or the Reserve Banks. Technical assistance in 2006 was concentrated in Latin America, Asia, and former Soviet bloc countries. The Federal Reserve, along with the OCC, the FDIC, and the Department of the Treasury, was also an active participant in the Middle East and North Africa Financial Regulators' Training Initiative, which is part of the U.S. government's Middle East Partnership Initiative.
During the year the Federal Reserve offered training courses exclusively for foreign supervisory authorities in Washington, D.C., and a number of foreign jurisdictions. System staff also took part in technical assistance and training missions led by the International Monetary Fund, the World Bank, the Inter-American Development Bank, the Asian Development Bank, the Basel Committee on Banking Supervision, and the Financial Stability Institute.
The Federal Reserve is also an associate member of the Association of Supervisors of Banks of the Americas (ASBA), an umbrella group of bank supervisors from countries in the Western Hemisphere. The group, headquartered in Mexico, promotes communication and cooperation among bank supervisors in the region; coordinates training programs throughout the region, with the help of national banking supervisors and international agencies; and aims to help members develop banking laws, regulations, and supervisory practices that conform to international best practices. The Federal Reserve contributes significantly to ASBA's organizational management and to its training and technical assistance activities.
The Federal Reserve's supervisory policy function is responsible for developing guidance for examiners and banking organizations as well as regulations for banking organizations under the Federal Reserve's supervision. Staff members participate in supervisory and regulatory forums, provide support for the work of the FFIEC, and participate in international forums such as the Basel Committee on Banking Supervision, the Joint Forum, and the International Accounting Standards Board.
On September 25, 2006, the Federal Reserve, OCC, FDIC, and OTS published a joint notice of proposed rulemaking (NPR) setting forth their views on Basel II and seeking public comment on the U.S. plan for implementing the agreement. Under the proposal, the basic minimum risk-based capital ratio format--regulatory capital divided by risk-weighted assets--would be maintained, with the minimum for tier 1 capital set at 4 percent and the minimum for total qualifying capital set at 8 percent. The primary differences between the current and proposed rules are the internal-ratings-based methodologies used to calculate risk-weighted assets and the advanced measurement approach for operational risk under Basel II. Banking organizations using the methods set forth in the NPR would also be subject to certain public disclosure requirements, to foster transparency and market discipline. All banking organizations, including those using the internal-ratings-based approach for credit risk and the advanced measurement approach for operational risk, would continue to be subject to the tier 1 leverage ratio requirement and the market risk capital rule, if applicable, as well as the prompt corrective action rules.
On September 25, 2006, the agencies issued for public comment a notice of proposed rulemaking proposing revisions to the market risk capital rule used by the OCC, Board, and FDIC since 1997 for banking organizations having significant exposure to market risk. Under the market risk capital rule, certain banking organizations are required to calculate a capital requirement for the general market risk of their covered positions and the specific risk of their covered debt and equity positions. The proposed revisions would enhance the rule's risk sensitivity, require the market risk capital charge to reflect any incremental default risk of traded positions, and require public disclosure of certain qualitative and quantitative market risk information. The comment period will end on January 23, 2007.
On December 26, 2006, the banking agencies issued for public comment an NPR proposing modifications to Basel I that would be optional for banking organizations not subject to Basel II. The proposals aim to enhance risk sensitivity without unduly increasing regulatory burden. They would expand the number of risk-weight categories, allow the use of external credit ratings to risk-weight certain exposures, expand the range of recognized collateral and eligible guarantors, use loan-to-value (LTV) ratios to risk-weight residential mortgages, increase the credit conversion factor for certain commitments having an original maturity of one year or less, assess a capital charge for early amortizations in securitizations of revolving credit exposures, and remove the 50 percent limit on the risk weight for certain over-the-counter derivatives transactions. The comment period for the NPR will end on March 26, 2007.
Board staff conduct supervisory analyses of innovative capital instruments and novel transactions to determine whether such instruments qualify for inclusion in tier 1 capital. 6 Much of this work in 2006 involved evaluating enhanced forms of trust preferred securities that bank holding companies developed in order to be granted more credit for equity by the rating agencies under the Board's 2005 revisions to the rule on the qualifying components of tier 1 capital.
Staff members also identify and address supervisory concerns related to supervised banking organizations' capital issuances and work with the Reserve Banks to evaluate the overall composition of banking organizations' capital. In this work, the staff often must review the funding strategies proposed in applications for acquisitions and other transactions submitted to the Federal Reserve by banking organizations.
The supervisory policy function is also responsible for monitoring major domestic and international proposals, standards, and other developments affecting the banking industry in the areas of accounting, auditing, internal controls, disclosure, and supervisory financial reporting. Federal Reserve staff members interact with key entities in the accounting and auditing professions, including standards-setters and accounting firms, the other banking agencies, and the banking industry, and issue supervisory guidance as appropriate.
During 2006, the Federal Reserve, together with the other banking agencies, issued a comment letter to the Financial Accounting Standards Board (FASB) on its then-proposed Statement of Financial Accounting Standards titled The Fair Value Option for Financial Assets and Financial Liabilities. 7 The agencies also jointly issued guidance on loan and lease losses and on limitations on the liability of external auditors.
In December the Federal Reserve, FDIC, NCUA, OCC, and OTS issued "Interagency Policy Statement on the Allowance for Loan and Lease Losses," which updates and replaces earlier guidance on the methodology for calculating the allowance for loan and lease losses (ALLL). Revisions were made to ensure that policy is consistent with generally accepted accounting principles and with recent supervisory guidance related to the ALLL. Updated in the guidance are the responsibilities of boards of directors, management, and banking organization examiners; factors to be considered in estimating the ALLL; and the objectives and elements of an effective loan review system, including a sound credit-grading system. The guidance also reiterates the points of agreement between the SEC and the banking agencies since 1999. To assist in application of the revised guidance, the agencies also issued a supplemental document anticipating frequently asked questions.
The Federal Reserve, FDIC, NCUA, OCC, and OTS in May issued "Interagency Advisory on the Unsafe and Unsound Use of Limitation of Liability Provisions in External Audit Engagements." The guidance addresses safety and soundness concerns that may arise when financial institutions enter into external audit contracts that limit the auditor's liability for audit services. Specifically, the guidance informs financial institutions that the inclusion of certain auditor liability limitations in external audit contracts (typically referred to as engagement letters) for audits of financial statements, audits of internal control over financial reporting, or attestations on management's assessment of internal control over financial reporting is generally unsafe and unsound.
In 2006, the FFIEC updated the Bank Secrecy Act/Anti-Money Laundering Examination Manual issued in 2005 by adding sections on risk assessment and automated clearinghouse transactions, updating the section on trade finance, and incorporating regulatory changes. The manual continues to contain an overview of Bank Secrecy Act (BSA) and anti-money-laundering requirements and supervisory expectations, resource materials, and examination procedures and to emphasize a banking organization's responsibility to establish and implement a risk-based approach to complying with the BSA.
In January, the Federal Reserve, the Department of the Treasury's Financial Crimes Enforcement Network, and the other federal banking agencies issued guidance on sharing Suspicious Activity Reports (SARs) with head offices or controlling companies. The guidance confirmed that a U.S. branch or agency of a foreign bank may disclose a SAR to its head office outside the United States. Similarly, a U.S. bank or savings association may disclose a SAR to its controlling company, whether domestic or foreign.
In March, the Federal Reserve issued a final rule amending Regulation K (International Banking Operations) to conform the Board's regulations to BSA requirements and to clarify that Edge and agreement corporations and U.S. branches, agencies, and representative offices of foreign banks supervised by the Federal Reserve must establish and maintain procedures reasonably designed to ensure and monitor compliance with the BSA and its implementing regulations.
In April, the Federal Reserve and the other federal banking agencies entered into a memorandum of understanding with the Office of Foreign Assets Control within the Department of the Treasury to facilitate information-sharing and to further enhance interagency coordination in implementing U.S. sanctions rules.
As a member of the Basel Committee on Banking Supervision (Basel Committee), the Federal Reserve participates in efforts to advance sound supervisory policies for internationally active banking organizations and to improve the stability of the international banking system. In 2006, the Federal Reserve continued to work cooperatively on Basel II, the 2004 accord to revise the international capital regime, and to develop international supervisory guidance. The Federal Reserve also continued to participate in Basel Committee working groups to address issues not fully resolved in the Basel II framework.
The Federal Reserve contributed to supervisory policy papers, reports, and recommendations issued by the Basel Committee during 2006 that were generally aimed at improving the supervision of banking organizations' risk-management practices. 8
The Core Principles, developed by the Basel Committee in 1997, have become the de facto international standard for sound prudential regulation and supervision of banks. In 2006, the Federal Reserve participated in a Basel Committee effort to update the Core Principles in light of the significant changes in international banking regulation and experience gained since the principles were last revised in 1999. The revised guidance, "Core Principles for Effective Banking Supervision," was issued in October.
In 2006, the Federal Reserve also continued to participate in the Joint Forum--a group established under the aegis of the Basel Committee to address issues related to the banking, securities, and insurance sectors, including the regulation of financial conglomerates. It is made up of representatives of the Basel Committee, the International Organization of Securities Commissions, and the International Association of Insurance Supervisors. The Federal Reserve contributed to the following supervisory policy papers, reports, and recommendations issued by the Joint Forum during 2006. 9
The Federal Reserve participates in the Basel Committee's Accounting Task Force (ATF) and represents the Basel Committee at international meetings on accounting, auditing, and disclosure issues affecting global banking organizations. During 2006, Federal Reserve staff were involved in the development of two key Basel Committee documents issued to national supervisors and also of various comment letters related to accounting and auditing that were submitted to the International Accounting Standards Board and the International Auditing and Assurance Standards Board.
The Basel Committee document "Supervisory Guidance on the Use of the Fair Value Option for Financial Instruments by Banks," issued in June, provides guidance on the prudential supervision of banks in their implementation of the fair value option included in the amended International Accounting Standard (IAS) 39, which became effective January 1, 2006. Under IAS 39, the fair value option allows an organization to irrevocably elect, at the date of purchase, a fair value measurement for certain financial instruments and to record in current earnings the gains and losses resulting from changes in fair value.
The Basel Committee document "Sound Credit Risk Assessment and Valuation for Loans," issued in June, provides guidance on assessing credit risk and accounting for loan impairment. Specifically, the document addresses supervisory expectations for, and supervisory evaluations of, a banking organization's establishment and support of its loan-loss-allowance accounts.
Since Hurricane Katrina, the federal banking agencies--the Federal Reserve, FDIC, NCUA, OCC, and OTS--and the state banking agencies in Alabama, Louisiana, and Mississippi have worked together to monitor and support the recovery efforts of financial institutions and their customers in the U.S. Gulf Coast region. In 2006, the interagency efforts included
The Federal Reserve works with the other federal banking agencies to develop guidance on the management of credit risk.
Under the federal banking agencies' regulations on real estate appraisals, regulated institutions must ensure that the appraisals they use in connection with federally related transactions adhere to the Uniform Standards of Professional Appraisal Practice (USPAP). In June 2006, the Federal Reserve, FDIC, NCUA, OCC, and OTS issued an interagency statement informing regulated institutions that the Appraisal Standards Board of the Appraisal Foundation had made significant revisions to USPAP, effective July 1, 2006; providing an overview of the revisions; and discussing the ramifications of the revisions for the institutions' compliance with the regulations.
In September, the Federal Reserve, FDIC, NCUA, OCC, and OTS issued an addendum to guidance issued in 2005--"Interagency Credit Risk Management Guidance for Home Equity Lending"--that provided additional guidance on managing the risks associated with open-end home equity lines of credit (HELOCs) that have interest-only or negative amortization features. While such HELOCs may give consumers some flexibility, the agencies are concerned that consumers may not fully understand the product terms and associated risks. The addendum addressed the timing and content of communications with consumers that are obtaining HELOCs having these features and clarified the agencies' expectations for assessing borrower repayment capacity.
In September, the Federal Reserve, FDIC, NCUA, OCC, and OTS issued guidance, titled "Interagency Guidance on Nontraditional Mortgage Product Risks," that addresses risk-management and consumer disclosure practices that institutions should employ to effectively assess and manage the risks associated with residential mortgage loans that allow borrowers to defer repayment of principal and, sometimes, interest (referred to as nontraditional mortgage loans). Specifically, the guidance states that regulated institutions should
In December, the Federal Reserve, FDIC, and OCC issued guidance titled "Interagency Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices" to remind institutions that strong risk-management practices and appropriate levels of capital are important elements of a sound lending program, particularly if the institution has a concentration in commercial real estate loans. The guidance reinforced and enhanced existing regulations and guidelines for safe and sound real estate lending. (For more information, see the box " Guidance on Concentrations in Commercial Real Estate Lending. ")
As any banker worth his or her salt knows, lending concentrations must be carefully identified, monitored, and managed. It is one of the basics of banking to understand the consequences of placing all your eggs in one basket. Naturally, supervisors from time to time have concerns about growing credit risk concentrations at banks and bankers’ ability to manage them.
Susan Schmidt Bies, Member, Board of Governors
In response to rising concentrations of commercial real estate (CRE) loans at many financial institutions, the Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation on December 12, 2006, issued guidance promoting sound risk-management practices in this sector.1 In the guidance, titled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices,” the agencies recognize that financial institutions play a vital role in funding real estate development in their communities and can do so in a profitable way. However, as an institution’s concentration in CRE lending increases, management should understand its possible exposure to a downturn in the CRE market or to other adverse market and economic events.
Supervisors have observed over the past decade that CRE concentrations have been rising at many institutions, especially at small and medium-size banks. Between 1993 and 2005, CRE loans as a proportion of total equity plus reserves rose from 145 percent to 280 percent for commercial banks with assets between $100 million and $1 billion and from 120 percent to 230 percent for commercial banks with assets of $1 billion to $10 billion. Experience has shown that credit concentrations add a dimension of risk that compounds the simple risk inherent in individual loans.
Further, supervisors are concerned that risk-management practices at some institutions may not have kept pace with the growth of CRE concentrations. The agencies developed the 2006 CRE guidance to remind financial institutions that strong risk-management practices and appropriate capital levels are important elements of a sound CRE lending program, particularly when an institution has a concentration in CRE loans or has experienced rapid portfolio growth. The guidance provides the agencies’ examiners with two supervisory screening criteria designed to identify institutions whose CRE concentrations may require additional scrutiny:
Total loans for construction, land development, and other land represent 100 percent or more of the institution’s total capital; or
Total CRE loans represent 300 percent or more of the institution’s total capital, and the outstanding balance of the institution’s commercial real estate loan portfolio has increased 50 percent or more during the previous thirty-six months.
These screening criteria serve as a starting point for a dialogue between the agencies’ supervisory staff and an institution’s management about the level and nature of CRE concentration risk. The guidance focuses on CRE loans for which the risk of default is sensitive to CRE market demand, capitalization rates, vacancy rates, or rents. The agencies recognize that different types of CRE lending present different levels of risk. For example, a well-structured loan for a multifamily housing project would generally have a lower risk profile than a loan for an office building to be built on speculation. The guidance acknowledges that institutions are in the best position to make such assessments about the level and nature of concentration risk in their CRE portfolios.
Building upon the agencies’ existing regulations and guidelines for real estate lending and loan portfolio management, the guidance describes the key elements that an institution should address in the areas of board and management oversight, portfolio management, management information systems, market analysis, credit-underwriting standards, portfolio stress-testing and sensitivity analysis, and the credit-risk review function.
The Federal Reserve recognizes that commercial real estate lending is a critically important activity that has become the “bread and butter” business of many small and medium-size banks. Supervisors emphasize that they did not intend the guidance to limit commercial real estate lending; rather, they expect that the guidance will encourage institutions to develop and maintain appropriate corporate-governance structures to address the risks posed by their lending strategies.
1. As defined by the guidance, CRE loans include land development and construction loans (including one- to four-family residential and commercial construction loans) and other land loans; loans secured by multifamily property; and loans secured by nonfarm nonresidential property for which 50 percent or more of the source of repayment is third-party, nonaffiliated, rental income or the proceeds of the sale, refinancing, or permanent financing of the property. The guidance also applies to some loans to real estate investment trusts and unsecured loans to developers.Return to text
During the year, the Federal Reserve, FDIC, OCC, OTS, and SEC prepared a final statement on sound practices for complex structured finance transactions (CSFTs). The statement, to be issued in early 2007, describes the types of internal controls and risk-management procedures that financial institutions should use to identify, manage, and address the heightened legal and reputational risks that may arise from certain CSFTs. (Excluded are most structured finance transactions that are familiar to participants in the financial markets and have well-established track records--such as standard public mortgage-backed securities and hedging-type transactions involving "plain vanilla" derivatives or collateralized debt obligations.) Financial institutions that engage in CSFTs should, as part of their process for approving transactions and new products, establish and maintain policies, procedures, and systems that are designed to identify elevated-risk CSFTs and should ensure that transactions and new products so identified are subject to greater review by appropriate levels of management. An institution should decline to participate in an elevated-risk CSFT if it determines that the transaction presents unacceptable risks or would result in a violation of applicable laws, regulations, or accounting principles.
In December, the Board and the SEC requested comments on joint proposed rules that would help define the scope of securities activities that a bank may conduct without registering with the SEC as a securities broker. The Gramm-Leach-Bliley Act eliminated the blanket "broker" exception for banks that had been contained in section 3(a)(4) of the Securities Exchange Act of 1934, but it granted exceptions designed to allow banks to continue to engage in securities transactions for customers in connection with their normal trust, fiduciary, custodial, and other banking operations. The proposed rules would implement the most important "broker" exceptions. Comments on the proposal are due by March 26, 2007.
In February, the Board issued a final rule that raises, from $150 million to $500 million, the asset-size threshold used to determine whether a bank holding company qualifies for (1) the Board's Small Bank Holding Company Policy Statement and (2) an exemption from the Board's risk-based and leverage capital adequacy guidelines for bank holding companies. The final rule also modifies the qualitative criteria used in determining whether a bank holding company that is under the asset-size threshold nevertheless would not qualify for the policy statement or the exemption. In addition, the final rule clarifies the treatment under the policy statement of subordinated debt associated with trust preferred securities.
The Economic Growth and Regulatory Paperwork Reduction Act of 1996 requires that the federal banking agencies review their regulations every ten years to identify and eliminate any unnecessary requirements imposed on insured depository institutions. (In addition, the Board periodically reviews each of its regulations.) During 2006, the Federal Reserve, OCC, FDIC, and OTS conducted the required review. Among other activities, they met with representatives of the banking industry and of consumer groups around the country to hear their concerns and their suggestions for reducing regulatory burden. The agencies expect to issue a final report in 2007.
The Federal Reserve requires that U.S. bank holding companies periodically submit reports providing financial and structure information. This information is essential to the supervision of the companies and the formulation of regulations and supervisory policies. It is also used in responding to requests from Congress and the public for information on bank holding companies and their nonbank subsidiaries. Foreign banking organizations are also required to periodically submit reports to the Federal Reserve.
The FR Y-9 series of reports provides standardized financial statements for bank holding companies on both a consolidated basis and a parent-only basis. The reports are used to detect emerging financial problems, to review performance and conduct pre-inspection analysis, to monitor and evaluate risk profiles and capital adequacy, to evaluate proposals for bank holding company mergers and acquisitions, and to analyze the holding company's overall financial condition. The nonbank subsidiary reports--FR Y-11, FR 2314, and FR Y-7N--help the Federal Reserve determine the condition of bank holding companies that are engaged in nonbank activities and also aid in monitoring the volume, nature, and condition of the companies' nonbank subsidiaries.
In March, several revisions to the FR Y-9C, FR Y-9LP, and FR Y-9SP reports were approved for implementation during 2006. Effective March 31, the asset-size threshold for filing the FR Y-9C and FR Y-9LP reports was raised from $150 million to $500 million, reducing the number of respondents by approximately 60 percent. Other FR Y-9C revisions effective March 31 included the elimination of a number of data items; the addition of data items on loans for purchasing and carrying securities, regulatory capital, and credit derivatives; and the removal of the FR Y-9C filing requirement for lower-tier bank holding companies having total assets of $1 billion or more. Revisions effective September 30 included new officer signature requirements and additional data items on mortgage banking activities and secured borrowings.
Effective June 30, the asset-size cap for the FR Y-9SP was raised from $150 million to $500 million, increasing the number of respondents by approximately 50 percent. Other FR Y-9SP revisions effective June 30 included the addition of two items identifying the total value of off-balance-sheet activities conducted directly or through a nonbank subsidiary and the total value of debt and equity securities registered with the SEC. Revised officer signature requirements for the FR Y-9SP were effective December 31.
In March, the Board also revised the asset-size threshold for the quarterly FR Y-11 and FR 2314 nonbank subsidiary reports, to make it consistent with the revised threshold for the FR Y-9C and to reduce reporting burden. Revising the threshold for the FR Y-11 reduced the number of quarterly respondents by approximately 30 percent; the revision had no immediate effect on the number of FR 2314 filers. Other FR Y-11 and FR 2314 revisions effective March 31 included the addition of a new equity capital component to the balance sheet for reporting partnership interest and, for the FR Y-11 only, the expansion of the scope of several loan items reported on the balance sheet memoranda.
Effective December 31, a new report was implemented: the Annual Report of Merchant Banking Investments Held for an Extended Period (FR Y-12A). The report collects data concerning merchant banking investments that are approaching the end of the holding period permissible under Regulation Y (Bank Holding Companies and Change in Bank Control).
As the federal supervisor of state member banks, the Federal Reserve, along with the other banking agencies through the FFIEC, requires banks to submit quarterly Consolidated Reports of Condition and Income (Call Reports). Call Reports are the primary source of data for the supervision and regulation of banks and the ongoing assessment of the overall soundness of the nation's banking system. Call Report data, which also serve as benchmarks for the financial information required by many other Federal Reserve regulatory financial reports, are widely used by state and local governments, state banking supervisors, the banking industry, securities analysts, and the academic community.
For the 2006 reporting period, the FFIEC implemented various revisions to the Call Report to streamline the reporting requirements and to add new items that focus on areas of increasing supervisory concern. The principal revisions included the collection of data related to the implementation of deposit insurance reform provisions, funding sources (Federal Home Loan Bank advances and other borrowings), and mortgage banking activities. The signature and attestation requirements were revised to add the chief financial officer, or equivalent, to the list of officials required to attest to and sign the Call Report.
In October, the FFIEC proposed revisions for the 2007 reporting period to address new safety and soundness considerations and to facilitate supervision. Among the proposed revisions are changes in data collection related to the deposit insurance assessment collection process; changes in generally accepted accounting principles (including certain financial instruments measured at fair value and principles for accounting for defined benefit pension and other post-retirement plans); and nontraditional mortgage products.
Information technology supporting Federal Reserve supervisory activities is managed within the System supervisory information technology (SSIT) function in the Board's Division of Banking Supervision and Regulation. SSIT works through assigned staff at the Board and the Reserve Banks, as well as through System committees, to ensure that key staff members throughout the System participate in identifying requirements and setting priorities for IT initiatives.
In 2006, the SSIT function worked on the following strategic projects and initiatives: (1) align technology investments with business needs; (2) improve security of information-sharing technologies and provide for seamless collaboration in interagency efforts; (3) identify and implement improvements in the accessibility of technology to staff working in the field; (4) identify opportunities to converge and streamline IT applications, including key administrative systems, to provide consistent and seamless information; (5) evaluate and implement technologies (such as portals, search engines, and content management tools) to integrate supervisory and management information systems that support both office-based and field staff; and (6) enhance the information security framework for the supervisory function, improving both overall security and compliance with best-practices and regulatory requirements.
The National Information Center (NIC) is the Federal Reserve's comprehensive repository for supervisory, financial, and banking structure data and supervisory documents. NIC includes comprehensive data on banking structure throughout the United States; the National Examination Database (NED), which enables supervisory personnel and state banking authorities to access NIC data; the Banking Organization National Desktop (BOND), an application that facilitates secure, real-time electronic information-sharing and collaboration among federal and state banking regulators for the supervision of banking organizations; and the Central Document and Text Repository (CDTR), which contains documents supporting the supervisory processes.
The structure and supervisory data systems are continually being updated to extend their useful lives and improve business workflow efficiency. During 2006, the NED system was modified to begin collecting Bank Secrecy Act information in an automated format, to support Federal Reserve enforcement activities. In 2006, the BOND and CDTR systems were modified to provide further integration with the Federal Reserve's internal surveillance program, to provide additional support for the supervision of large financial institutions, and to allow integration of examinations of technology service providers. In addition, user authentication software was upgraded for external agency users, and use of the BOND and CDTR systems was extended to additional federal and state regulatory agencies.
|Program||Number of sessions conducted|
|Schools or seminars conducted by the Federal Reserve|
|Banking and supervision elements||8||7|
|Financial analysis and risk management||8||7|
|Conducting meetings with management||14||14|
|Credit risk analysis||5||4|
|Real estate lending seminar||3||2|
|Senior forum for current banking and regulatory issues||2||2|
|Basel II corporate activities||3||2|
|Basel II operational risk||2||0|
|Basel II retail activities||3||1|
|Principles of fiduciary supervision||2||2|
|Commercial lending essentials for consumer affairs||1||1|
|Consumer compliance examinations I||2||0|
|Consumer compliance examinations II||2||2|
|CRA examination techniques||2||2|
|CRA risk-focused examination techniques||2||2|
|Fair lending examination techniques||3||3|
|Foreign banking organizations seminar||1||1|
|Information systems continuing education||7||7|
|Asset liability management (ALM1)||2||2|
|Asset liability management (ALM2)||2||1|
|Fundamentals of interest rate risk management||8||8|
|Trading and operations||1||1|
|Technology risk integration||3||3|
|Fundamentals of fraud||16||15|
|Information technology seminars 1||11||11|
|Seminar for senior supervisors of foreign central banks 2 and 13 other international courses||34||26|
|Self-study or online learning 3|
|Orientation (core and specialty)||0||0|
|Self-study modules (26 modules)||0||0|
|Other agencies conducting courses 4|
|Federal Financial Institutions Examination Council||78||2|
|The Options Institute||1||1|
1. Held at the IT Lab at Chicago Reserve Bank.
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2. Conducted jointly with the World Bank. Return to table
3. Self-study programs do not involve group sessions. Return to table
4. Open to Federal Reserve employees. Return to table
The System Staff Development Program trains staff members at the Board, the Reserve Banks, state banking departments, and foreign supervisory authorities. Training is offered at the basic, intermediate, and advanced levels in several disciplines within bank supervision: safety and soundness, information technology, international banking, and consumer affairs. Classes are conducted in Washington, D.C., as well as at Reserve Banks and other locations. The Federal Reserve System also participates in training offered by the FFIEC and by certain other regulatory agencies. The System's involvement includes developing and implementing basic and advanced training in relation to various emerging issues as well as in specialized areas such as international banking, information technology, anti-money laundering, capital markets, payment systems risk, and real estate appraisal. In addition, the System co-hosts the World Bank Seminar for supervisors from developing countries.
In 2006, the Federal Reserve trained 3,619 students in System schools, 952 in schools sponsored by the FFIEC, and 24 in other schools, for a total of 4,595, including 312 representatives of foreign central banks and supervisory agencies (see table). The number of training days in 2006 totaled 23,321.
The System gave scholarship assistance to the states for training their examiners in Federal Reserve and FFIEC schools. Through this program, 605 state examiners were trained--308 in Federal Reserve courses, 293 in FFIEC programs, and 4 in other courses.
A staff member seeking an examiner's commission is required to take a first proficiency examination as well as a second proficiency examination in one of two specialty areas: safety and soundness or consumer affairs. In 2006, 190 examiners passed the first proficiency examination, and 61 passed the second proficiency examination: 53 the safety and soundness exam, and 8 the consumer affairs exam.
The Federal Reserve administers several federal statutes that apply to bank holding companies, financial holding companies, member banks, and foreign banking organizations--the Bank Holding Company Act, the Bank Merger Act, the Change in Bank Control Act, the Federal Reserve Act, and the International Banking Act. In administering these statutes, the Federal Reserve acts on a variety of proposals that directly or indirectly affect the structure of the U.S. banking system at the local, regional, and national levels; the international operations of domestic banking organizations; or the U.S. banking operations of foreign banks. The proposals concern bank holding company formations and acquisitions, bank mergers, and other transactions involving bank or nonbank firms. In 2006, the Federal Reserve acted on 1,378 proposals, which represented 3,171 individual applications filed under the five administered statutes.
Under the Bank Holding Company Act, a corporation or similar legal entity must obtain the Federal Reserve's approval before forming a bank holding company through the acquisition of one or more banks in the United States. Once formed, a bank holding company must receive Federal Reserve approval before acquiring or establishing additional banks. The act also identifies the nonbanking activities permissible for bank holding companies; depending on the circumstances, these activities may or may not require Federal Reserve approval in advance of their commencement.
When reviewing a bank holding company application or notice that requires prior approval, the Federal Reserve may consider the financial and managerial resources of the applicant, the future prospects of both the applicant and the firm to be acquired, the convenience and needs of the community to be served, the potential public benefits, the competitive effects of the proposal, and the applicant's ability to make available to the Federal Reserve information deemed necessary to ensure compliance with applicable law. In the case of a foreign banking organization seeking to acquire control of a U.S. bank, the Federal Reserve also considers whether the foreign bank is subject to comprehensive supervision or regulation on a consolidated basis by its home-country supervisor. In 2006, the Federal Reserve acted on 638 applications filed by bank holding companies to acquire a bank or a nonbank firm, or to otherwise expand their activities.
Bank holding companies generally may engage in only those nonbanking activities that the Board has previously determined to be closely related to banking under section 4(c)(8) of the Bank Holding Company Act. Since 1996, the act has provided an expedited prior-notice procedure for certain permissible nonbank activities and for acquisitions of small banks and nonbank entities. Since that time the act has also permitted well-run bank holding companies that satisfy certain criteria to commence certain other nonbank activities on a de novo basis without first obtaining Federal Reserve approval.
A bank holding company may repurchase its own shares from its shareholders. When the company borrows money to buy the shares, the transaction increases the company's debt and decreases its equity. The Federal Reserve may object to stock repurchases by holding companies that fail to meet certain standards, including the Board's capital adequacy guidelines. In 2006, the Federal Reserve reviewed 7 stock-repurchase proposals by bank holding companies.
The Federal Reserve also reviews elections from bank holding companies seeking financial holding company status under the authority granted by the Gramm-Leach-Bliley Act. Bank holding companies seeking financial holding company status must file a written declaration with the Federal Reserve. In 2006, 48 domestic financial holding company declarations and 7 foreign bank declarations were approved.
The Bank Merger Act requires that all proposals involving the merger of insured depository institutions be acted on by the appropriate federal banking agency. The Federal Reserve has primary jurisdiction if the institution surviving the merger is a state member bank. Before acting on a merger proposal, the Federal Reserve considers the financial and managerial resources of the applicant, the future prospects of the existing and combined organizations, the convenience and needs of the community(ies) to be served, and the competitive effects of the proposed merger. In 2006, the Federal Reserve approved 65 merger applications under the act.
As a result of enactment of the Financial Services Regulatory Relief Act of 2006, the Federal Reserve is no longer required for each proposed bank merger to either request competitive factors reports from the other federal banking and thrift regulatory agencies or provide reports on competitive factors to those other agencies. The Federal Reserve now must consider only the views of the U.S. Department of Justice regarding the competitive aspects of a proposed bank merger. In addition, the views of the Department of Justice need not be solicited for bank mergers involving affiliated insured depository institutions. Before these statutory changes occurred in the third quarter of 2006, the Federal Reserve had submitted 451 reports on competitive factors to the other agencies.
The Change in Bank Control Act requires individuals and certain other parties that seek control of a U.S. bank or bank holding company to obtain approval from the appropriate federal banking agency before completing the transaction. The Federal Reserve is responsible for reviewing changes in the control of state member banks and bank holding companies. In its review, the Federal Reserve considers the financial position, competence, experience, and integrity of the acquiring person; the effect of the proposed change on the financial condition of the bank or bank holding company being acquired; the effect of the proposed change on competition in any relevant market; the completeness of the information submitted by the acquiring person; and whether the proposed change would have an adverse effect on the federal deposit insurance funds. In addition, with enactment of the Financial Services Regulatory Relief Act of 2006, the Federal Reserve must also consider the future prospects of the institution to be acquired: a proposed transaction should not jeopardize the stability of the institution or the interests of depositors. During its review of a proposed transaction, the Federal Reserve may contact other regulatory or law enforcement agencies for information about relevant individuals.
In 2006, the Federal Reserve approved 98 changes in control of state member banks and bank holding companies.
Under the Federal Reserve Act, a member bank may be required to seek Federal Reserve approval before expanding its operations domestically or internationally. State member banks must obtain Federal Reserve approval to establish domestic branches, and all member banks (including national banks) must obtain Federal Reserve approval to establish foreign branches. When reviewing proposals to establish domestic branches, the Federal Reserve considers, among other things, the scope and nature of the banking activities to be conducted. When reviewing proposals for foreign branches, the Federal Reserve considers, among other things, the condition of the bank and the bank's experience in international banking. In 2006, the Federal Reserve acted on new and merger-related branch proposals for 2,033 domestic branches and granted prior approval for the establishment of 7 new foreign branches.
State member banks must also obtain Federal Reserve approval to establish financial subsidiaries. These subsidiaries may engage in activities that are financial in nature or incidental to financial activities, including securities and insurance agency-related activities. In 2006, 1 application for a financial subsidiary was approved.
U.S. banking organizations may engage in a broad range of activities overseas. Many of the activities are conducted indirectly through Edge Act and agreement corporation subsidiaries. Although most foreign investments are made under general consent procedures that involve only after-the-fact notification to the Federal Reserve, large and other significant investments require prior approval. In 2006, the Federal Reserve approved 29 proposals for significant overseas investments by U.S. banking organizations. The Federal Reserve also approved 16 applications to make additional investments through an Edge Act or agreement corporation, 1 application to establish an Edge Act corporation, and 2 applications to extend the corporate existence of an Edge Act corporation.
The International Banking Act, as amended by the Foreign Bank Supervision Enhancement Act of 1991, requires foreign banks to obtain Federal Reserve approval before establishing branches, agencies, commercial lending company subsidiaries, or representative offices in the United States.
In reviewing proposals, the Federal Reserve generally considers whether the foreign bank is subject to comprehensive supervision or regulation on a consolidated basis by its home-country supervisor. It also considers whether the home-country supervisor has consented to the establishment of the U.S. office; the financial condition and resources of the foreign bank and its existing U.S. operations; the managerial resources of the foreign bank; whether the home-country supervisor shares information regarding the operations of the foreign bank with other supervisory authorities; whether the foreign bank has provided adequate assurances that information concerning its operations and activities will be made available to the Federal Reserve, if deemed necessary to determine and enforce compliance with applicable law; whether the foreign bank has adopted and implemented procedures to combat money laundering and whether the home country of the foreign bank is developing a legal regime to address money laundering or is participating in multilateral efforts to combat money laundering; and the record of the foreign bank with respect to compliance with U.S. law. In 2006, the Federal Reserve approved 19 applications by foreign banks to establish branches, agencies, or representative offices in the United States.
Certain decisions by the Federal Reserve that involve an acquisition by a bank holding company, a bank merger, a change in control, or the establishment of a new U.S. banking presence by a foreign bank are made known to the public by an order or an announcement. Orders state the decision, the essential facts of the application or notice, and the basis for the decision; announcements state only the decision. All orders and announcements are made public immediately; they are subsequently reported in the Board's weekly H.2 statistical release. The H.2 release also contains announcements of applications and notices received by the Federal Reserve upon which action has not yet been taken. For each pending application and notice, the related H.2A contains the deadline for comments. The Board's web site ( www.federalreserve.gov ) provides information on orders and announcements as well as a guide for U.S. and foreign banking organizations that wish to submit applications or notices to the Federal Reserve.
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.
State member banks that issue securities registered under the Securities Exchange Act of 1934 must disclose certain information of interest to investors, including annual and quarterly financial reports and proxy statements. By statute, the Board's financial disclosure rules must be substantially similar to those of the SEC. At the end of 2006, 17 state member banks were registered with the Board under the Securities Exchange Act of 1934.
Under the Securities Exchange Act, the Board is responsible for regulating credit in certain transactions involving the purchase 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 trade 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 National Association of Securities Dealers, and the national securities exchanges 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 Farm Credit Administration, the NCUA, and the OTS examine lenders under their respective jurisdictions; and the Federal Reserve examines other Regulation U lenders.
At the end of 2006, 2,593 banks were members of the Federal Reserve System and were operating 53,938 branches. These banks accounted for 35 percent of all commercial banks in the United States and for 71 percent of all commercial banking offices.
1. The Basel II capital accord, an international agreement
formally titled "International Convergence of Capital Measurement and
Capital Standards: A Revised Framework," was developed by the Basel
Committee on Banking Supervision, which is made up of representatives
of the central banks or other supervisory authorities of thirteen
countries. The original document was issued in 2004; the original
version and an updated version issued in November 2005 are available on
the web site of the Bank for International Settlements (
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2. The Board's Division of Consumer and Community Affairs coordinates the Federal Reserve's supervisory activities with regard to compliance with consumer protection and civil rights laws. Those activities are described in the chapter "Consumer and Community Affairs." Supervision for compliance with other banking laws and regulations, which is described in this chapter, is the responsibility of the Board's Division of Banking Supervision and Regulation and the Federal Reserve Banks, whose examiners also check for safety and soundness. Return to text
3. Each of the first two components has four subcomponents: Risk Management--Board and Senior Management Oversight; Policies, Procedures, and Limits; Risk Monitoring and Management Information Systems; and Internal Controls. Financial Condition--Capital; Asset Quality; Earnings; and Liquidity. Return to text
4. The program was implemented in 1997 and modified in 2002. See SR letter 02-01 for a discussion of the factors considered in determining whether a bank holding company is complex or noncomplex ( www.federalreserve.gov/boarddocs/srletters/ ). Return to text
5. The federal banking agencies that are members of the FFIEC are the Federal Reserve Board, the FDIC, the NCUA, the OCC, and the OTS. Return to text
6. Tier 1 capital comprises common stockholders' equity and qualifying forms of preferred stock, less required deductions such as goodwill and certain intangible assets. Return to text
7. The FASB issued the final standard, Statement of Financial Accounting Standard No. 159, in February 2007. Return to text
8. Papers issued by the Basel Committee can be accessed via the Bank for International Settlements web site at www.bis.org . Return to text
9. Papers issued by the Joint Forum can be accessed via the Bank for International Settlements web site at www.bis.org . Return to text