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Banking Supervision and Regulation

The Federal Reerve has supervisory and regulatory authority over a wide range of financial institutions and activities. It works with other federal and state supervisory authorities to ensure the safety and soundness of financial institutions and the stability of the financial markets.

In 2005, U.S. banking organizations reported record earnings and maintained strong asset quality. However, banking organizations also faced some challenges during the year. Throughout the year, a flattening yield curve placed pressure on bank net interest margins, necessitating adjustments to balance-sheet positions and interest-rate risk management strategies at many institutions. In September, banking organizations in several Gulf Coast states faced extraordinary challenges in the aftermath of Hurricanes Katrina and Rita. For the most part, the banking organizations supervised by the Federal Reserve in the affected areas resumed operations expeditiously. The Federal Reserve and the other federal banking agencies encouraged banking organizations to be flexible in responding to the needs of borrowers and other customers in communities and regions affected by the disasters. At year-end, the ramifications of the hurricanes on banking organizations had not been fully quantified. The federal banking agencies continue to work with the banking organizations in the affected regions as they deal with the after-effects of the storms.

During the latter half of the year, personal bankruptcy filings rose sharply as a result of consumers accelerating their filings before the effective date of the 2005 amendments to the Bankruptcy Code. These filings temporarily increased loan losses--particularly within credit card portfolios--but had little effect on the industry's sound loan quality. The number of consumer bankruptcy filings is expected to diminish in 2006.

Rapid growth in home equity lines of credit, nontraditional residential mortgages, and commercial real estate loans raised some supervisory concerns in 2005 and led the federal banking agencies to issue or propose guidance on sound risk-management practices for these lines of business. Nevertheless, delinquencies in these and most other loan segments remained low, and nonperforming asset ratios reached very low levels during the year.

While banks and supervisors have traditionally ranked credit and market risks as top concerns, in recent years these risks often have been overshadowed by compliance and other operational risks. Some of the largest banking organizations have experienced rapid growth and significantly expanded their products and services, heightening supervisory concern about whether these organizations' compliance risk management practices are keeping pace. One significant area of concern for supervisors is compliance with anti-money-laundering laws and regulations. In 2005, the Federal Reserve, in conjunction with the other federal banking agencies and the Department of the Treasury's Financial Crimes Enforcement Network (FinCEN), issued the Bank Secrecy Act/Anti-Money Laundering (BSA/AML) Examination Manual to help strengthen enforcement of these laws and further promote consistent examination approaches among supervisors.

Federal Reserve staff continue to devote considerable effort to revising domestic and international capital standards. In 2006, the U.S. banking agencies expect to issue a notice of proposed rulemaking (NPR) setting forth their views and seeking public comment with respect to the U.S. implementation of the Basel II capital accord, an international agreement among banking supervisors that was issued in June 2004. 1 The Federal Reserve is also working with the other federal banking agencies to develop supervisory guidance for both examiners and the banking industry.

The U.S. banking organizations expect that only a small number of large, internationally active U.S. banking organizations will be subject to the Basel II framework. The vast majority of banking organizations are expected to remain on 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 federal banking agencies in October jointly published an advance notice of proposed rulemaking that contains proposed revisions to Basel I that would enhance its risk sensitivity.

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Scope of Responsibilities for Supervision and Regulation

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 the supervision of all Edge Act and agreement corporations; the international operations of state member banks and U.S. bank holding companies; and the operations of foreign banking companies in the United States.

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.

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Supervision for Safety and Soundness

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 undertakes enforcement and other supervisory actions.

State Member Banks and Holding Companies, 2001-2005
Entity/Item 2005 2004 2003 2002 2001
State member banks  
Total number 907 919 935 949 970
Total assets (billions of dollars) 1,318 1,275 1,912 1,863 1,823
Number of examinations 783 809 822 814 816
By Federal Reserve System 563 581 581 550 561
By state banking agency 220 228 241 264 255
Top-tier bank holding companies  
Large (assets of more than $1 billion)
Total number 394 355 365 329 312
Total assets (billions of dollars) 10,261 8,429 8,295 7,483 6,905
Number of inspections 501 500 454 439 413
By Federal Reserve System 1 496 491 446 431 409
On site 457 440 399 385 372
Off site 39 51 47 46 37
By state banking agency 5 9 8 8 4
Small (assets of $1 billion or less)
Total number 4,760 4,796 4,787 4,806 4,816
Total assets (billions of dollars) 890 852 847 821 768
Number of inspections 3,420 3,703 3,453 3,726 3,486
By Federal Reserve System 3,233 3,526 3,324 3,625 3,396
On site 2 170 186 183 264 730
Off site 3,063 3,340 3,141 3,361 2,666
By state banking agency 187 177 129 101 90
Financial holding companies  
Domestic 591 600 612 602 567
Foreign 38 36 32 30 23

1. For large bank holding companies subject to continuous, risk-focused supervision, includes multiple targeted reviews.   Return to table
2. In 2002, the supervisory program for small bank holding companies was revised, resulting in more inspections being performed off-site versus on-site. See text section "Bank Holding Companies" for more information.   Return to table

Examinations and Inspections

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. Preexamination planning and on-site review of operations are integral parts of the overall effort to ensure the safety and soundness of banking organizations. 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.

To manage the supervisory process, the Federal Reserve follows a risk-focused approach that seeks to focus supervisory resources on (1) those business activities posing the greatest risk to banking organizations and (2) the organizations' management processes for identifing, 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 central point of contact, has responsibility for only one LCBO, and is supported by specialists skilled in evaluating the risks of LCBO business activities and functions), and (4) promoting System-wide and interagency information-sharing through automated systems.

For other banking organizations, the risk-focused supervision program provides that examination procedures should be tailored to each bank's size, complexity, and risk profile. Examinations entail both off-site and on-site work, including planning, preexamination visits, detailed documentation, and examination reports tailored to the scope and findings of the examination.

State Member Banks

At the end of 2005, 907 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 15 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 assets of less than $250 million may be examined once every eighteen months. The Federal Reserve conducted 563 exams of state member banks in 2005.

Bank Holding Companies

At year-end 2005, a total of 5,860 U.S. bank holding companies were in operation, of which 5,154 were top-tier bank holding companies. These organizations controlled 6,160 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 smaller companies that have significant nonbank assets. 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 burden on banking organizations. Small, noncomplex bank holding companies--those that have consolidated assets of $1 billion or less--are subject to a special supervisory program that was implemented in 1997 and modified in 2002. 3 The program permits a more flexible approach to the supervision of these companies. In 2005, the Federal Reserve conducted 496 inspections of large bank holding companies and 3,233 inspections of small, noncomplex bank holding companies.

Financial 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 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 2005, 591 domestic bank holding companies and 38 foreign banking organizations had financial holding company status. Of the domestic financial holding companies, 39 had consolidated assets of $15 billion or more; 115, between $1 billion and $15 billion; 82, between $500 million and $1 billion; and 355, less than $500 million.

Anti-Money-Laundering Examinations

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 (AML) 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 are in place.

Quantitative Risk Management

To better coordinate the System's existing advanced risk-management and risk-measurement efforts, the division created a quantitative risk management group in early 2005. This new group will focus on Basel II quantification and validation, and will play a broader role by helping the System set priorities on the allocation of quantitative resources, identifying important issues at both systemic and institutional levels, collaborating on original research and data analysis with colleagues in the Federal Reserve's economic research divisions, and generally providing input on quantitative matters. In 2005, the group participated in the fourth Basel II Quantitative Impact Study (QIS-4) and other interagency efforts, participated in Basel Committee on Banking Supervision (Basel Committee) working groups and projects, and assisted with quantitative training for examiners and other staff.

Business Continuity

In 2005, 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 Federal Reserve monitored financial institutions' progress toward implementing 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 Office of the Comptroller of the Currency (OCC) and the Securities and Exchange Commission (SEC), which specifies 2005-06 implementation dates. The agencies also provided some guidance to help firms that are implementing the sound practices verify their efforts. In addition, the agencies continue to closely coordinate efforts to ensure a consistent supervisory approach for business-continuity practices.

Specialized Examinations

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.

Information Technology Activities

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 are expected to include a review of information technology risks and activities. During 2005, the Federal Reserve was the lead agency in 2 examinations of large, multiregional data processing servicers examined in cooperation with the other federal banking agencies.

Fiduciary Activities

The Federal Reserve has supervisory responsibility for organizations that together hold more than $26 trillion of assets in various fiduciary or custodial capacities. 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 2005, Federal Reserve examiners conducted 119 on-site fiduciary examinations.

Transfer Agents and Securities Clearing Agencies

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 2005, the Federal Reserve conducted on-site examinations at 24 of the 77 state member banks and bank holding companies that were registered as transfer agents. In 2005, the Federal Reserve also examined 1 state member limited-purpose trust company acting as a national securities depository.

Government and Municipal Securities Dealers and Brokers

The Federal Reserve is responsible for examining state member banks and foreign banks for compliance with the Government Securities Act of 1986 and with Department of the Treasury regulations governing dealing and brokering in government securities. Twenty-eight state member banks and 7 state branches of foreign banks have notified the Board that they are government securities dealers or brokers not exempt from Treasury's regulations. During 2005, the Federal Reserve conducted 9 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 22 entities that dealt in municipal securities during 2005, 7 were examined during the year.

Securities Credit Lenders

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. 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, or the Office of Thrift Supervision (OTS).

At the end of 2005, 628 lenders other than banks, brokers, or dealers were registered with the Federal Reserve. Other federal regulators supervised 216 of these lenders, and the remaining 412 were subject to limited Federal Reserve supervision. On the basis of regulatory requirements and annual reports, the Federal Reserve exempted 181 lenders from its on-site inspection program. The securities credit activities of the remaining 231 lenders were subject to either biennial or triennial inspection. Eighty inspections were conducted during the year, compared with 55 in 2004.

Enforcement Actions and Special Examinations

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 2005, the Federal Reserve completed 64 formal enforcement actions. Civil money penalties totaling $40.2 million were assessed. All civil money penalties, as directed by statute, are remitted either to the Department of the Treasury or to 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 posted on the Board's web site ( ).

In addition to formal enforcement actions, the Reserve Banks completed 95 informal enforcement actions in 2005. Informal enforcement actions include memoranda of understanding and board of directors resolutions. Information about these actions is not available to the public.

Surveillance and Off-Site Monitoring

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. This analysis helps to direct examination resources to institutions that exhibit higher risk profiles. Screening systems also assist in the planning of examinations by identifying companies that are engaging in new or complex activities.

Since 1994, the Federal Reserve's screening systems have included a set of two models that together are known as the System to Estimate Examination Ratings (SEER). These models use econometric techniques to estimate, for each bank, a supervisory rating and probability of failure using the supervisory information and financial data banks report on their Reports of Condition and Income (Call Reports). During 2005, the Federal Reserve completed an initiative to enhance the SEER models; this effort resulted in a new off-site monitoring tool known as the Supervision and Regulation Statistical Assessment of Bank Risk model. The new model is scheduled for implementation in early 2006. To supplement these screens that use financial and supervisory data, 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.

The Federal Reserve also prepares quarterly Bank Holding Company Performance Reports (BHCPRs) for use in monitoring and inspecting supervised banking organizations. The reports contain, for individual bank holding companies, financial statistics and comparisons with peer companies. BHCPRs are compiled from data provided by large bank holding companies in quarterly regulatory reports (FR Y-9C and FR Y-9LP). BHCPRs are made available to the public on the National Information Center web site, which can be accessed at .

During 2005, the surveillance function implemented two major upgrades to its web-based Performance Report Information and Surveillance Monitoring (PRISM) application. 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 System surveillance screens for banks and bank holding companies. The upgrades enhanced the range of regulatory data available for queries, expanded the number of surveillance screens, 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. 4

International Activities

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.

Foreign Operations of U.S. Banking Organizations

To examine 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 their 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; when appropriate, the examinations are coordinated with the OCC.

At the end of 2005, 55 member banks were operating 748 branches in foreign countries and overseas areas of the United States; 34 national banks were operating 693 of these branches, and 21 state member banks were operating the remaining 55. In addition, 16 nonmember banks were operating 20 branches in foreign countries and overseas areas of the United States.

Edge Act and Agreement Corporations

Edge Act corporations are international banking organizations chartered by the Board to provide all segments of the U.S. economy with a means of financing international business, especially exports. Agreement corporations are similar organizations, state 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 2005, 70 banking organizations, operating 9 branches, were chartered as Edge Act or agreement corporations. These corporations are examined annually.

U.S. Activities of Foreign Banks

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, and certain nonbank companies. Foreign banks continue to be significant participants in the U.S. banking system.

As of year-end 2005, 183 foreign banks from 54 countries were operating 220 state-licensed branches and agencies (of which 8 were insured by the Federal Deposit Insurance Corporation) as well as 50 branches licensed by the OCC (of which 4 had FDIC insurance). These foreign banks also directly owned 12 Edge Act and agreement corporations and 2 commercial lending companies; in addition, they held an equity interest of at least 25 percent in 67 U.S. commercial banks.

Altogether, the U.S. offices of these foreign banks at the end of 2005 controlled approximately 18 percent of U.S. commercial banking assets. These foreign banks also operated 73 representative offices; an additional 52 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 addresses the examination process for 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 338 examinations in 2005.

Technical Assistance

In 2005, 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 2005 was concentrated in Latin America, Asia, and former Soviet bloc countries. The Federal Reserve, along with the OCC, FDIC, and Department of the Treasury, was also an active participant in the newly launched Middle East and North Africa (MENA) 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 in 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, 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 Latin America, 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. For the past three years, a Federal Reserve official has served as chairman of the board of directors of ASBA; the Federal Reserve also contributes significantly to ASBA's organizational management and to its training and technical assistance activities.

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Supervisory Policy

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 international supervisory forums, such as the Basel Committee and the International Accounting Standards Board (IASB), and provide support for the work of the FFIEC.

Capital Adequacy Standards

During 2005, the Federal Reserve, OCC, FDIC, and OTS continued to draft proposed revisions to their risk-based capital adequacy regulations to reflect the June 2004 international agreement on capital adequacy for banking organizations, commonly known as Basel II. The agencies also issued an advance notice of proposed rulemaking (ANPR) on potential changes to the Basel I framework; these proposed changes would affect banking organizations not subject to Basel II. Further, the agencies issued joint interagency guidance on capital requirements for asset-backed commercial paper (ABCP) programs, and they are developing a proposal to revise the capital requirements for trading book positions subject to the market risk capital rule. In addition, the Federal Reserve adopted a final rule on the treatment of trust preferred securities in the tier 1 capital of bank holding companies.

Risk-Based Capital Standards for Certain Internationally Active Banking Organizations

During 2005, the agencies continued to prepare for the U.S. implementation of Basel II. In early 2006, the U.S. banking agencies expect to make available a 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.

The agencies expect that only a small number of large, internationally active U.S. banking organizations will be required to use the Basel II framework. In April, the agencies announced preliminary results from the fourth quantitative impact study (QIS-4), which evaluated the potential impact of implementing Basel II at the approximately thirty banking organizations that participated in the study. The preliminary results of QIS-4 showed a larger overall decline and a greater dispersion in regulatory capital requirements than had been originally expected. QIS-4 results also indicated that participating institutions have additional work to do to complete the systems and processes they need to have in place before Basel II is implemented. Partly as a result of concerns identified in the analysis of QIS-4 results, the agencies announced on September 30 additional prudential safeguards and a one-year delay in the timeline for Basel II implementation in the United States.

The NPR will maintain the basic minimum risk-based capital ratio format of regulatory capital divided by risk-weighted assets, with the minimum for tier 1 capital set at 4 percent and the minimum for total qualifying capital set at 8 percent. The components of tier 1 and total qualifying capital have been adjusted to an unexpected-loss basis consistent with the denominator. The primary difference between the current rules and the proposed Basel II rule is the internal-ratings-based methodologies Basel II uses to calculate risk-weighted assets; the proposed rule also contains the Basel II advanced measurement approach for operational risk. 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.

Risk-Based Capital Standards for Banking Organizations Not Subject to Basel II

On October 20, the agencies issued for public comment an ANPR that considers modifications to the existing risk-based capital framework, or Basel I, which would continue to apply to banking organizations not subject to Basel II. The changes seek to enhance the risk sensitivity of Basel I by increasing the number of risk-weight categories, permitting greater use of external ratings as an indicator of credit risk for externally rated exposures, expanding the types of guarantees and collateral that may be recognized, and modifying the risk weights associated with residential mortgages. The ANPR also discusses approaches that would change the credit-conversion factor for certain types of commitments, assign a risk-based capital charge to certain securitizations with early-amortization provisions, and assign a higher risk weight to loans that are 90 days or more past due or in nonaccrual status and to certain commercial real estate exposures. The agencies are also considering modifying the risk weights on certain other retail and commercial exposures. The comment period for the ANPR will end in January 2006.

Asset-Backed Commercial Paper Programs

On August 4, the agencies issued "Interagency Guidance on the Eligibility of Asset-Backed Commercial Paper Program Liquidity Facilities and the Resulting Risk-Based Capital Treatment." The guidance reiterates the agencies' position that the primary function of an eligible ABCP liquidity facility should be to provide liquidity--not to enhance credit. The guidance clarifies (1) the application of the asset-quality test set forth in the agencies' risk-based capital rules for determining the eligibility of an ABCP liquidity facility and (2) the resulting risk-based capital treatment of such a facility for banking organizations. An eligible liquidity facility must have an asset-quality test that precludes funding against assets that are 90 days or more past due, in default, or below investment grade. This test implies that the banking organization providing the ABCP liquidity facility should not be exposed to the credit risk associated with such assets. The guidance clarifies that an ABCP liquidity facility meets the asset-quality test if, at all times throughout the transaction, (1) the liquidity provider has access to certain types of acceptable credit enhancements that support the liquidity facility and (2) the notional amount of such credit enhancements exceeds the amount of underlying assets that are 90 days or more past due, defaulted, or below investment grade that the liquidity provider may be obligated to fund under the facility.

Other Capital Issues

In March, the Board adopted a final rule that allows for the continued inclusion of trust preferred securities in the tier 1 capital of bank holding companies, subject to stricter quantitative limits and clearer qualitative standards. The final rule revised the quantitative limits applied to the aggregate amount of certain core capital elements that may be included in tier 1 capital and revised the qualitative standards for capital instruments included in regulatory capital, consistent with long-standing Board policies.

Board staff members are working with the other agencies to develop a proposal to implement a revised, more risk-sensitive methodology for determining the capital charge for positions subject to the market risk capital rule. The proposal will address the issues identified in the July 2005 paper "The Application of Basel II to Trading Activities and the Treatment of Double Default Effects," which was published by the Basel Committee and the International Organization of Securities Commissioners (IOSCO).

The Board's staff also conduct supervisory analyses of innovative capital instruments and novel transactions in order to determine the appropriate supervisory and regulatory capital treatment and to identify and address supervisory concerns. These reviews frequently require staff to review the various funding strategies proposed in applications for acquisitions and other transactions that institutions submit to the Federal Reserve.

Bank-Owned Life Insurance

In 2005, an interagency working group issued "Interagency Interpretations of the Interagency Statement on the Purchase and Risk Management of Life Insurance." The interpretations clarify financial reporting, credit-exposure limits, concentration limits, and the appropriate methods for calculating the amount of insurance a banking organization may purchase.

New Bank Secrecy Act/Anti-Money Laundering Examination Manual

This interagency manual is a significant step toward consistency in the area of anti-money-laundering examination. The new manual promotes a shared understanding of the Bank Secrecy Act and anti-money-laundering regulations and supervisory expectations.

Susan Schmidt Bies, Member, Board of Governors June 2005

The release of the Bank Secrecy Act/Anti-Money Laundering Examination Manual on June 30, 2005, marked an important milestone for the federal banking agencies in their effort to enhance the consistent application of the Bank Secrecy Act (BSA). The five federal banking agencies 1 developed the new manual, in collaboration with the Department of the Treasury's Financial Crimes Enforcement Network (FinCEN). The state banking agencies and Treasury's Office of Foreign Assets Control (OFAC) also contributed to this initiative.
     In the manual, the agencies emphasize that banking organizations are responsible for establishing and implementing risk-based policies, procedures, and processes to comply with the BSA and to safeguard their operations from money laundering and terrorist financing. The agencies focus on a banking organization's sound risk assessment so that the banking organization can develop an anti-money-laundering program calibrated to its own risk profile. The agencies further emphasize that the primary role of the examiner is to evaluate the adequacy of a banking organization's controls and not to second-guess individual, transaction-level decisions.
     To promote a greater understanding of the BSA and anti-money-laundering (BSA/AML) requirements outlined in the manual, the Federal Reserve, along with the other federal banking agencies, FinCEN, and the OFAC, participated in a series of outreach events following the manual's release. The events, intended for the banking industry and federal and state banking agency examination staff, consisted of nationwide conference calls, regional outreach meetings, and a simultaneous broadcast via the Internet. More than 23,000 bankers and examiners participated in these sessions, where they also had the opportunity to ask questions and receive feedback on specific issues.
     Moving forward, the agencies will ensure that the manual provides the industry and examiners with relevant, up-to-date information. The manual will be revised in response to changes in law or regulation, other guidance, or evolving risks or controls. The agencies will hold periodic discussions with banking industry representatives so that issues related to the manual may be raised. These sessions will be held through the Bank Secrecy Act Advisory Group (BSAAG), which is a public-private partnership sponsored by the Department of the Treasury devoted to evaluating BSA-related matters. Specifically, the meetings will be held through a BSAAG subcommittee on examination issues, co-chaired by the Federal Reserve.
     The Federal Reserve recognizes that banking organizations have invested significant resources to comply with the BSA and related regulations in order to deter and detect money laundering and terrorist financing. Both the banking industry and the regulatory agencies share the goal of combating the threats these crimes pose to the U.S. financial system. The Federal Reserve remains committed to ensuring that supervisory expectations for BSA/AML compliance are clearly understood by banking organizations and examiners.

1. The agencies are the Board of Governors of the Federal Reserve System (Federal Reserve), Federal Deposit Insurance Corporation (FDIC), National Credit Union Administration (NCUA), Office of the Comptroller of the Currency (OCC), and Office of Thrift Supervision (OTS). Return to text

Bank Holding Company Rating System

In January, the Federal Reserve adopted a revised bank holding company rating system known as RFI/C(D). The three main components of the system are Risk management, Financial condition, and potential Impact of the parent company and nondepository subsidiaries (collectively, nondepository entities) on the subsidiary depository institution(s). The fourth component, Depository institution, generally mirrors the primary regulator's assessment of the subsidiary depository institution(s). The revised rating system reflects the shift that has occurred over time in the Federal Reserve's supervisory practices: a shift away from historical analyses of a BHC's financial condition toward more-forward-looking assessments of its risk management and financial factors. One year into the implementation of the new ratings system, Federal Reserve supervisors have found it to be an effective tool for communicating key supervisory points to banking organizations.

Bank Secrecy Act and Anti-Money Laundering

In June 2005, the FFIEC issued a new examination manual that compiles existing regulatory requirements, supervisory expectations, and sound practices for BSA/AML compliance. To foster consistency, the manual includes the examination procedures that each agency's examiners are expected to follow. (For more information, see the box "New Bank Secrecy Act/Anti-Money Laundering Examination Manual. ")

In March and April, the Federal Reserve, FDIC, OCC, OTS, NCUA, and FinCEN issued guidance to clarify the requirements of the BSA/AML regulations for banking organizations that provide banking services to money-services businesses operating in the United States.

International Guidance on Supervisory Policies

As a member of the Basel Committee, the Federal Reserve in 2005 participated in efforts to revise the international capital regime and to develop international supervisory guidance. The Federal Reserve's goals in these activities are to advance sound supervisory policies for internationally active banking organizations and to improve the stability of the international banking system.

Capital Adequacy

To address issues not fully resolved in the Basel II framework, the Federal Reserve in 2005 continued to participate in a number of Basel Committee working groups, including a joint Basel Committee-IOSCO working group reviewing issues related to counterparty credit risk, double-default effects (reflecting the low probability that both a borrower and its guarantor will default at the same time), and the definition of positions that are subject to a market risk capital requirement.

Risk Management

The Federal Reserve contributed to several supervisory policy papers, reports, and recommendations issued by the Basel Committee during 2005 that were generally aimed at improving the supervision of banking organizations' risk-management practices. 5

Core Principles for Effective Banking Supervision

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. During 2005, the Federal Reserve participated in a Basel Committee effort to update the Core Principles in light of the significant changes that have occurred in international banking regulation and the experience that has been gained since the principles were last revised in 1999.

Joint Forum

In 2005, the Federal Reserve also continued its participation in the Joint Forum--a group made up of representatives of the Basel Committee, IOSCO, and the International Association of Insurance Supervisors. The Joint Forum is a forum for supervisors to discuss their experiences with financial conglomerates. The Federal Reserve contributed to several supervisory policy papers, reports, and recommendations issued by the Joint Forum during 2005. 6

International Accounting and Disclosure

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. In particular, officials of the Federal Reserve represent the Basel Committee at meetings that address financial instruments accounting and disclosure issues associated with international accounting standards. In addition, an official of the Federal Reserve is a member of the Standards Advisory Council of the IASB.

The IASB issued an amendment in June that reflects extensive Basel Committee and European Central Bank comments. The amended fair value option (FVO) rule in International Accounting Standard (IAS) 39 allows an organization to irrevocably elect, at inception, a fair value measurement for certain financial instruments, with gains and losses from changes in fair value recorded in current earnings. The FVO rule amendment to IAS 39 will become effective January 1, 2006.

During 2005, the Federal Reserve had a key role in the development of ATF's consultative document "Supervisory Guidance on the Use of the Fair Value Option by Banks under International Financial Reporting Standards," issued for public comment in July. The document provides guidance for the prudential supervision of banks in their implementation of the FVO rule under the amended IAS 39.

The Federal Reserve also provided input on ATF's proposed consultative document "Sound Credit Risk Assessment and Valuation for Loans," which was issued for comment in November. The guidance consists of ten principles addressing supervisory expectations for and supervisory evaluations of a banking organization's establishment and support of its loan-loss allowance accounts.

Response to 2005 Hurricanes

In 2005, the Federal Reserve worked cooperatively with the other federal banking agencies, state banking agencies, and other organizations to determine the operating status of financial institutions located in the areas affected by Hurricanes Katrina, Rita, and Wilma. The agencies encouraged banks to work with consumer and commercial customers experiencing difficulties due to the storms. The agencies promptly released joint guidance on regulatory and reporting issues to assist examiners and banking organizations affected by the hurricanes. In addition, the Federal Reserve, in consultation with the other federal banking agencies, issued responses to questions frequently asked by financial institutions about whether certain BSA provisions applied when providing services to victims of Hurricane Katrina. The agencies also exercised their authority under section 2 of the Depository Institutions Disaster Relief Act of 1992 to waive statutory and regulatory appraisal requirements for transactions that involve real property in major disaster areas, when waiving the appraisal requirements would facilitate disaster recovery and would be consistent with safe and sound banking practice.

In an effort to provide the industry and examiners with further guidance on a growing number of hurricane-related issues, the FFIEC established a formal Katrina working group composed of senior supervision officials from each of the FFIEC agencies. The Katrina working group published frequently asked questions (FAQs) and developed examiner guidance that will be issued in early 2006. Because of the severity and scale of Katrina and the other natural disasters in 2005, the working group's efforts are expected to continue into 2006. The Katrina working group has established a user-friendly, web-based "frequently asked questions" forum on the FFIEC's web site ( ).

Credit Risk Management

The Federal Reserve works with the other federal banking agencies to develop guidance on credit risk management.

Real Estate Appraisals

In September, the Federal Reserve, FDIC, NCUA, OCC, and OTS issued FAQs on the requirements of the agencies' real estate appraisal regulations and on the October 2003 interagency statement "Independence of Appraisal and Evaluation Functions." The agencies also issued FAQs in March to help institutions comply with the agencies' appraisal regulations and real estate lending requirements when financing residential construction in a tract development.

Home Equity Lending

In May, the Federal Reserve and the other federal financial institutions regulatory agencies issued "Interagency Credit Risk Management Guidance on Home Equity Lending" to promote sound risk management in banks' home equity lending. The guidance addressed the agencies' concerns about the easing of underwriting standards as lenders compete to attract home equity lending business--sometimes by offering products with high loan-to-value ratios, requiring only limited documentation of a borrower's assets and income, using automated valuation models to a greater extent, or relying on loans originated by third parties. The guidance advances sound underwriting standards, controls over third-party originations, a robust collateral-valuation process, and account and portfolio management practices.

Nontraditional Mortgage Products

In December, the Federal Reserve and the other federal financial institutions regulatory agencies issued for public comment "Proposed Interagency Guidance on Nontraditional Mortgage Products." Nontraditional mortgage products typically include payment-option adjustable-rate mortgages and interest-only mortgages. These mortgage products allow for principal-payment deferral and negative amortization. Institutions may also combine these products with other risk-layering practices, such as less stringent underwriting standards, reduced loan documentation, or simultaneous second-lien loans. The proposed interagency guidance emphasizes that an institution needs to develop and maintain adequate risk-management practices to monitor and control the risk associated with these products. The proposed guidance also contains recommended practices for providing consumers with information about the terms and risks of nontraditional mortgage products. Comments on the proposal are due March 29, 2006.

Commercial Real Estate Concentrations

During 2005, the Federal Reserve and the federal financial institutions regulatory agencies developed proposed interagency guidance, "Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices." The proposed guidance, to be issued for public comment in January 2006, will respond to the agencies' concerns about rising commercial real estate (CRE) concentrations, particularly at small to medium-sized institutions. This guidance will reinforce the agencies' existing real estate lending guidelines and provide criteria for identifying institutions that have CRE lending concentrations and that should therefore employ heightened risk-management practices. Comments on the proposal are due April 13, 2006.

Overdraft Protection

In February, the Federal Reserve, FDIC, NCUA, and OCC issued interagency guidance to assist insured depository institutions in the responsible disclosure and administration of overdraft-protection services. The guidance (1) seeks to ensure that institutions adopt adequate policies and procedures to address the credit, operational, and other risks associated with overdraft-protection services; (2) alerts institutions offering these services to the need to comply with all applicable federal and state laws; and (3) sets forth examples of best practices that are currently observed in, or recommended by, the industry.

Small Bank Holding Company Threshold

In September, the Board requested comment on a proposal to raise 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 proposal would raise that threshold from $150 million to $500 million in consolidated assets. The proposal would also modify 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 from the capital guidelines. In addition, the proposal would clarify the treatment under the policy statement of subordinated debt associated with trust preferred securities. Final action on this proposal is expected in early 2006.

Economic Growth and Regulatory Paperwork Reduction Act of 1996

The Federal Reserve, OCC, FDIC, and OTS are in the process of reviewing agency regulations as required by the Economic Growth and Regulatory Paperwork Reduction Act of 1996 (EGRPRA). EGRPRA requires that the banking agencies review their regulations every ten years to identify any unnecessary regulatory requirements imposed on insured depository institutions and eliminate these requirements, as appropriate. This review is in addition to the Board's periodic review of each of its regulations.

The agencies met with representatives from the banking industry and from consumer groups around the country to listen to their concerns and to solicit their suggestions for reducing regulatory burden. The agencies have received public comments on several of their regulations and expect to issue a final report in 2006.

Sarbanes-Oxley Act

During 2005, the Federal Reserve continued to evaluate the effects of the Sarbanes-Oxley Act (SOX) on banking organizations. Federal Reserve accounting staff reviewed material internal control weaknesses and deficiencies at certain public banking organizations and are now drafting supervisory guidance for examiners and inspectors. The guidance will instruct examiners and inspectors to consider internal control information, including findings generated by the requirements of section 404 of SOX, in the overall risk-assessment process.

In addition, an official of the Federal Reserve serves on the Standing Advisory Group of the Public Company Accounting Oversight Board (PCAOB); the group is advising the PCAOB as it develops standards for the external audits of publicly traded companies in the United States. The Federal Reserve also continued in 2005 to work with the FDIC and other federal agencies to consider changes that should be made to the regulations implementing the Federal Deposit Insurance Corporation Improvement Act to promote strong internal controls and consistency with the SOX requirements.

Bank Holding Company Regulatory Financial Reports

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 organizations and the formulation of regulations and supervisory policies. The information is also used in responding to requests from Congress and the public for information on bank holding companies and their nonbank subsidiaries. In addition, foreign banking organizations must periodically submit reports to the Federal Reserve.

The FR Y-9 series of reports provides standardized financial statements for bank holding companies on a consolidated and 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-FRY-11, FR 2314, and FR Y-7N--aid the Federal Reserve in determining the condition of bank holding companies that are engaged in nonbanking activities and in monitoring the volume, nature, and condition of their nonbanking subsidiaries.

In March, several revisions to the FR Y-9C and FR Y-9SP reports were implemented in order to identify private equity merchant banking activity, identify firms providing auditing services to the bank holding company, collect information on subordinated notes payable to trusts issuing trust preferred securities (changes affected the FR Y-9C balance sheet), and collect information on nonvoting equity capital (changes affected the FR Y-9SP). In September, the FR Y-9C was modified to collect information on purchased impaired loans in response to Statement of Position 03-3 of the American Institute of Certified Public Accountants, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer," and to collect information related to the Government National Mortgage Association (GNMA) optional repurchase program for mortgage loans (rebooked loans backing GNMA securities).

Effective December 31, revisions to the Annual Report of Foreign Banking Organizations (FR Y-7) reorganized the form and instructions, expanded information collected on foreign companies held under the authority of section 2(h)(2) of the Bank Holding Company Act, added language to the confidentiality section, and clarified the instructions pursuant to Regulation K.

In December, a new report was implemented: the Supplement to the Reports of Changes in Organizational Structure (FR Y-10S). In this report, bank holding companies, financial holding companies, and state member banks not owned by bank holding companies report their SEC registration status and whether they are subject to the requirements of section 404 of SOX. They also report their six-digit CUSIP number to help the Federal Reserve compare regulatory data with market data.

Commercial Bank Regulatory Financial Reports

As the federal supervisor of state member banks, the Federal Reserve, acting in concert with the other federal banking agencies through the FFIEC, requires banks to submit quarterly Call Reports. Call Reports are the primary source of data for the supervision and regulation of banks and for 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.

The Federal Reserve and the other banking agencies under the auspices of the FFIEC have completed the Call Report modernization project. Through the use of new open data exchange standards (known as "eXtensible Business Reporting Language," or XBRL), the new Central Data Repository (CDR) system improves the timeliness and quality of supervisory data and enhances market discipline by ensuring that the public has more timely access to the data. This is the first wide-scale application of XBRL. Enhancements to the data-collection and -disclosure process include requiring banks to submit their Call Report data electronically to the CDR, moving forward the deadline for filing reports, and requiring respondents to validate their data before filing. The effort to set up the CDR was completed and became operational on October 1.

The FFIEC issued for public comment the proposed changes to the 2006 Call Report. The agencies planned to implement some changes effective March 31, 2006, and to defer implementation on other issues until September 30, 2006, and March 31, 2007, pending final interagency approval.

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Supervisory Information Technology

Under the direction of the division's chief technology officer, the supervisory information technology (SIT) function within the division facilitates the management of information technology across the Federal Reserve System's overall supervision function. SIT works through assigned staff at the Board and the Reserve Banks, as well as through a System-wide committee structure, to ensure that key staff members throughout the System participate in identifying requirements and setting priorities for IT initiatives.

In 2005, the SIT function worked on the following strategic projects and initiatives: (1) refine and institutionalize processes governing IT investments to ensure that all technology investments are aligned with business needs and that accountability for business success is clearly defined and accepted; (2) improve the security of information-sharing technologies and provide for seamless collaboration in interagency efforts; (3) develop a measurement-based management and investment culture; (4) identify opportunities to converge and streamline IT applications, including key administrative systems, to provide consistent and seamless information; (5) develop a foundation for evaluating technologies (such as portals, search engines, and content management tools) to improve access to these systems and to integrate supervisory and management information systems that support both office-based and field staff; (6) enhance the information security framework for the supervisory function; and (7) participate in the selection of a learning management system that will enhance the delivery of online examiner training.

National Information Center

The National Information Center (NIC) is the Federal Reserve's comprehensive repository for supervisory, financial, and banking structure data and supervisory documents. NIC includes the structure data system; the National Examination Database (NED), which provides supervisory personnel and state banking authorities with access to 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, which contains documents supporting the supervisory processes.

During 2005, the NED application was modified to incorporate information from consumer affairs and Community Reinvestment Act examinations, thereby eliminating a separate legacy system. In early 2006, NED will be enhanced to begin collecting important BSA information in an automated format to support the Federal Reserve's enforcement activities.

In 2005, the BOND application was enhanced to improve usability, reduce administrative burden, and increase the effectiveness of management reporting. BOND was also updated to accommodate the new FR Y-10S reporting form (see the section "Bank Holding Company Regulatory Financial Reports"). At year-end 2005, BOND had approximately 2,700 registered users across the Federal Reserve System, the OCC, the FDIC, and eleven state banking departments. In 2005, significant resources were also devoted to the FFIEC Call Report modernization initiative (see the section "Commercial Bank Regulatory Financial Reports").

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Staff Development

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.

Training Programs for Banking Supervision and Regulation, 2005
Program Number of sessions conducted
Total Regional
Schools or seminars conducted by the Federal Reserve  
Core schools
Banking and supervision elements 7 5
Operations and analysis 6 5
Bank management 4 2
Report writing 12 12
Management skills 9 7
Conducting meetings with management 10 10
Other schools  
Credit risk analysis 5 4
Examination management 6 4
Real estate lending seminar 3 3
Senior forum for current banking and regulatory issues 3 3
Assessing capital adequacy 1 1
Basel II corporate activities 2 1
Basel II operational risk 1 1
Basel II retail activities 2 0
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 1
CRA risk-focused examination techniques 3 3
Fair lending examination techniques 2 2
Foreign banking organizations seminar 1 1
Information systems continuing education 4 4
Asset liability management (ALM1) 2 2
Asset liability management (ALM2) 1 1
Fundamentals of interest rate risk management 5 5
Trading and operations 1 1
Technology risk integration 3 3
Leadership dynamics 7 6
Fundamentals of fraud 5 5
Information technology seminars 1 13 13
Seminar for senior supervisors of foreign central banks 2 and ten other international courses 35 27
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 70 12
The Options Institute 1 1

1. Held at Chicago IT Lab.   Return to table
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 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, municipal securities dealing, capital markets, payment systems risk, white-collar crime, and real estate lending. In addition, the System co-hosts the World Bank Seminar for supervisors from developing countries.

In 2005, the Federal Reserve trained 3,296 students in System schools, 946 in schools sponsored by the FFIEC, and 11 in other schools, for a total of 4,253, including 266 representatives of foreign central banks and supervisory agencies (see the table on the preceding page). The number of training days in 2005 totaled 18,441.

Results of First Proficiency and Second Proficiency Examinations, 2005
Result First proficiency Second proficiency
Safety and soundness Consumer affairs Information technology
Passed 155 65 18 2

The System gave scholarship assistance to the states for training their examiners in Federal Reserve and FFIEC schools. Through this program, 473 state examiners were trained--267 in Federal Reserve courses, 203 in FFIEC programs, and 3 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 the following three specialty areas: safety and soundness, consumer affairs, or information technology. In 2005, 155 examiners passed the first proficiency examination (see Results of Examinations table). In the second proficiency examination, 65 examiners passed the safety and soundness examination, 18 examiners passed the consumer affairs examination, and 2 examiners passed the information technology examination. The average pass rate for the first proficiency examination was 79 percent. The average pass rate for the second proficiency examinations was 78 percent.

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Regulation of the U.S. Banking Structure

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 include bank holding company formations and acquisitions, bank mergers, and other transactions involving bank or nonbank firms. In 2005, the Federal Reserve acted on 1,283 proposals, which represented 3,442 individual applications filed under the five administered statutes.

Bank Holding Company Act

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 2005, the Federal Reserve acted upon 512 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 bank holding companies that fail to meet certain standards, including the Board's capital adequacy guidelines. In 2005, the Federal Reserve reviewed 6 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 2005, 35 domestic financial holding company declarations and 3 foreign bank declarations were approved.

Bank Merger Act

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 communities to be served, and the competitive effects of the proposed merger. It also considers the views of certain other agencies regarding the competitive factors involved in the transaction. In 2005, the Federal Reserve approved 58 merger applications under the act.

When the FDIC, OCC, or OTS has jurisdiction over a merger, the Federal Reserve is asked to comment on the competitive factors related to the proposal. By using standard terminology in assessing competitive factors in merger proposals, the four agencies have sought to ensure consistency in administering the Bank Merger Act. The Federal Reserve submitted 472 reports on competitive factors to the other agencies in 2005.

Change in Bank Control Act

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. As part of the process, the Federal Reserve may contact other regulatory or law enforcement agencies for information about relevant individuals. In 2005, the Federal Reserve approved 111 changes in control of state member banks and bank holding companies.

Federal Reserve Act

Under the Federal Reserve Act, a member bank may be required to seek prior 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 2005, the Federal Reserve acted on new and merger-related branch proposals for 2,435 domestic branches, and granted prior approval for the establishment of 5 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 2005, 2 applications for financial subsidiaries were approved.

Overseas Investments by U.S. Banking Organizations

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 2005, the Federal Reserve approved 43 proposals for significant overseas investments by U.S. banking organizations. The Federal Reserve also approved 11 applications to make additional investments through an Edge Act or agreement corporation, 3 applications to establish an Edge Act or agreement corporation, and 2 applications to extend the corporate existence of an Edge Act corporation.

International Banking Act

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 2005, the Federal Reserve approved 10 applications by foreign banks to establish branches, agencies, or representative offices in the United States.

Public Notice of Federal Reserve Decisions

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; they are subsequently reported in the Board's weekly H.2 statistical release and in the Federal Reserve Bulletin. 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 ( provides information on orders and announcements as well as a guide for U.S. and foreign banking organizations submitting applications or notices to the Federal Reserve.

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Enforcement of Other Laws and Regulations

Extensions of Credit by State Member Banks to their Executive Officers, 2004 and 2005
Period Number Amount (dollars) Range of
interest rates charged
October 1-December 31 479 53,340,000 0.0--20.8
January 1-March 31 414 54,737,000 0.0--21.2
April 1-June 30 530 117,416,000 0.0--20.6
July 1-September 30 504 56,969,000 0.0--21.6
October 1-December 31 485 57,422,000 0.0--18.0

Source: Call Reports.

The Federal Reserve's enforcement responsibilities also extend to financial disclosures by state member banks, securities credit, and extensions of credit to executive officers.

Financial Disclosures by State Member Banks

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 2005, 18 state member banks were registered with the Board under the Securities Exchange Act of 1934.

Securities Credit

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.

Extensions of Credit to Executive Officers

Under section 22(g) of the Federal Reserve Act, a state member bank must include in its quarterly Call Report information on all extensions of credit by the bank to its executive officers since the date of the preceding report. The accompanying table summarizes this information for 2005.

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Federal Reserve Membership

At the end of 2005, 2,698 banks were members of the Federal Reserve System and were operating 52,639 branches. These banks accounted for 37 percent of all commercial banks in the United States and for 72 percent of all commercial banking offices.

1. The agreement, 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 November 2005 updated version is available on the web site of the Bank for International Settlements ( ).    Return to text
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." Compliance with other banking laws and regulations, which is treated 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. Refer to SR Letter 02-01 for a discussion of the factors considered in determining whether a bank holding company is complex or noncomplex ( ).    Return to text
4. The member agencies of the FFIEC are the Federal Reserve Board, the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision.    Return to text
5. Papers issued by the Basel Committee can be accessed via the Bank for International Settlements web site at .    Return to text
6. Papers issued by the Joint Forum can be accessed via the Bank for International Settlements web site at    Return to text

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