BOARD OF GOVERNORS
FEDERAL RESERVE SYSTEM
WASHINGTON, D. C. 20551
DIVISION OF BANKING
SUPERVISION AND REGULATION
SR 97-25 (SUP)
October 1, 1997
TO THE OFFICER IN CHARGE OF SUPERVISION
AT EACH FEDERAL RESERVE BANK
SUBJECT: Risk-Focused Framework for the Supervision of Community Banks
On October 1, 1997, the Federal Reserve will begin implementing a risk- focused framework for the supervision of community banks. This letter outlines this framework and accompanies a handbook that provides more detail.1 Reserve Banks should provide copies of this handbook to appropriate staff and to senior officials of the state banking departments in their districts. Guidance on the risk-focused supervision framework for large complex institutions will be issued in a separate SR-letter.
The risk-focused supervision framework for community banks, as outlined in the handbook, reflects the results of a joint effort by the Federal Reserve and FDIC to develop a common examination process. The process targets activities with the highest levels of risk at each institution, provides a tiered approach to examination procedures, and enhances examiners' abilities to diagnose emerging problems. Implementation of this process will provide greater consistency in examinations conducted by the Federal Reserve and the FDIC and is expected to result in examinations that are more efficient and effective and less burdensome on institutions.
The risk-focused supervision framework relies heavily on the exercise of examiner judgment in determining the scope of the examination during the planning process. This allows examiners to tailor the procedures that are performed on-site to the bank's risk profile. A scope memorandum is to be prepared that contains an assessment of the bank's risks and a description of the examination activities to be performed. In preparing the scope memorandum, examiners are encouraged to contact the bank in order to learn about any changes in management, policies, or strategic direction. New products or markets the bank has entered should also be identified. A sample scope memorandum is included in the attached handbook.
The joint Federal Reserve and FDIC risk-focused supervision framework includes examination procedure modules covering most areas reviewed at community banks. These have been developed to assist examiners in their analyses and their decision-making process. The procedure modules are organized according to the bank's business activities and risk management processes and reflect best practice guidance and a broader process-oriented review of the bank's risks.
Examination procedures are to be tailored to the characteristics of each bank, keeping in mind size, complexity, and risk profile. The procedures examiners select to perform from each module should be focused on developing appropriate documentation to assess adequately management's ability to identify, measure, monitor, and control risks. The examination procedure modules, set forth below, have been designated as primary and supplemental. Normally, the primary modules would be used at each examination, while the supplemental modules would be used when warranted by the bank's activity. Loan references also have been developed for use at banks that engage in specialized lending activities.
Primary Examination Procedure Modules Capital Adequacy Earnings Analysis Loan Portfolio Management2 Liquidity Analysis Securities Analysis Other Assets and Liabilities Management and Internal Control Evaluation
Supplemental Examination Procedure Modules Electronic Funds Transfer International Banking Mortgage Banking Electronic Banking Related Organizations Credit Card Merchant Processing
The examination procedure modules have been automated for use on virtually all laptop computers currently in field use through a standalone software program called "Elvis." Elvis provides a documentation vehicle for work performed on an examination, as well as electronic access to the Federal Reserve's and FDIC's bank examination manuals and an automated Report of Examination. Both the FDIC and Federal Reserve will be using the examination procedure modules in their automated format. These modules replace the Federal Reserve's existing Work Documentation Program.
The Elvis software and the documentation for the automated examination modules have been provided, under separate cover, to staff at each Reserve Bank previously designated as contact for handling the implementation of Elvis.
The implementation of this common examination process by the Federal Reserve and the FDIC represents a significant advancement toward achieving a more consistent, risk-focused approach to examining state-chartered banks. The examination procedure modules were presented to the Conference of State Bank Supervisors at their annual meeting in May of this year. Since that time, examiners from each of the fifty states have been trained in the use of these modules, and a number of state banking departments will begin using them at examinations this year. As you know, extensive training has been provided to Federal Reserve examiners, and the program has been field-tested by a number of Reserve Banks over the last nine months. The Federal Reserve and the FDIC intend to issue joint updates to the examination procedure modules on a quarterly basis.
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Questions or comments concerning the risk-focused supervision framework for community banks should be directed to Norah Barger, Assistant Director, (202/452-2402), Robert Walker, Senior Supervisory Financial Analyst, (202/452-3429), or Thomas Keady, Manager, (202/728-5885). Questions concerning the Elvis program should be directed to David Elkes, Supervisory Financial Analyst, (202/452-5218).
SR letters | 1997