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Banking Supervision and Regulation

The Federal Reserve has supervisory and regulatory authority over a variety of financial institutions and activities. It plays an important role as umbrella supervisor of bank holding companies, including financial holding companies. And it is the primary federal supervisor of state banks that are members of the Federal Reserve System.

Two thousand seven was a challenging year for bank holding companies (BHCs) and state member banks. BHC asset quality and earnings deteriorated over the second half of the year, mainly because of the effects of developments in the residential housing market. Nonperforming assets increased notably as the quality of mortgages, home equity lines of credit, and loans to real estate developers weakened. Nevertheless, BHCs reported net income exceeding $90 billion for the full year. A sharp increase in subprime mortgage delinquencies adversely affected the securitization market. Liquidity and capital were strained as some BHCs brought certain off-balance-sheet exposures onto their books. Several institutions also recognized significant valuation writedowns on assets affected by market conditions. Despite these pressures, BHCs continued to maintain regulatory capital ratios in excess of minimum regulatory requirements.

Most state member banks entered 2007 after a sustained period of strong earnings performance, partly mitigating developments in the market. Although net income and return on assets fell late in the year, reflecting asset write-downs and higher loan-loss provisions, these measures of profitability have been at historically high levels since the mid-1990s, helping to provide banks with a substantial base of capital. Risk-based capital ratios declined modestly over the year, but at year-end more than 99 percent of all commercial banks continued to report capital ratios consistent with a "well capitalized" designation under prompt corrective action standards. Although credit quality indicators also worsened during the year, overall loan quality measures remained relatively sound by historical standards.

In 2007 the banking industry saw bank failures for the first time in three years as three insured institutions--two state nonmember banks and one thrift institution with assets totaling approximately $2.6 billion--were closed.

Banking supervisors focused in 2007 on credit risk issues related to subprime lending activities. During the course of the year the federal financial regulatory agencies--the 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)--issued guidance encouraging supervised institutions to work constructively with homeowners unable to continue meeting their mortgage payments. The agencies also released a statement emphasizing the need to maintain prudent underwriting standards and to provide clear and balanced information to consumers so that institutions and consumers can assess the risks arising from certain adjustablerate mortgage (ARM) products that offer discounted or low introductory rates. The Federal Reserve also joined with the FDIC, NCUA, OCC, OTS, and the Conference of State Bank Supervisors to issue a statement encouraging federally regulated financial institutions and state-supervised entities that service securitized residential mortgages to review their authority under pooling and servicing agreements so as to identify borrowers at risk of default and pursue appropriate loss-mitigation strategies designed to preserve sustainable home ownership.

Federal Reserve staff continued to work with the other federal banking agencies in 2007 to prepare for U.S. implementation of the Basel II capital accord.1 In November the Board of Governors approved final rules implementing new risk-based capital requirements for large, internationally active banking organizations (the Basel II advanced approaches framework) and joined the OCC, FDIC, and OTS in publishing those rules in December.

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.

The Federal Reserve also has responsibility for supervising the operations of all Edge Act and agreement corporations, the international operations of state member banks and U.S. bank holding companies, and the U.S. operations of foreign banking organizations.

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 takes enforcement and other supervisory actions as necessary.

State Member Banks and Bank Holding Companies, 2003-2007
Entity/Item 2007 2006 2005 2004 2003
State member banks  
Total number 878 901 907 919 935
Total assets (billions of dollars) 1,519 1,405 1,318 1,275 1,912
Number of examinations 694 761 783 809 822
By Federal Reserve System 479 500 563 581 581
By state banking agency 215 261 220 228 241
Top-tier bank holding companies  
Large (assets of more than $1 billion)
Total number 459 448 394 355 365
Total assets (billions of dollars) 13,281 12,179 10,261 8,429 8,295
Number of inspections 492 566 501 500 454
By Federal Reserve System1 476 557 496 491 446
On site 438 500 457 440 399
Off site 38 57 39 51 47
By state banking agency 16 9 5 9 8
Small (assets of $1 billion or less)
Total number 4,611 4,654 4,760 4,796 4,787
Total assets (billions of dollars) 974 947 890 852 847
Number of inspections 3,186 3,449 3,420 3,703 3,453
By Federal Reserve System 3,007 3,257 3,233 3,526 3,324
On site 120 112 170 186 183
Off site 2,887 3,145 3,063 3,340 3,141
By state banking agency 179 192 187 177 129
Financial holding companies  
Domestic 597 599 591 600 612
Foreign 43 44 38 36 32

1. For large bank holding companies subject to continuous, risk-focused supervision, includes multiple targeted reviews.  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. 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, asset quality, earnings, and liquidity; and (5) a review for compliance with applicable laws and regulations. The table provides information on examinations and inspections conducted by the Federal Reserve during the past five years.

Inspections of bank holding companies, including financial holding companies, are built around a rating system introduced in 2005 that reflects the recent shift in supervisory practices for these organizations away from a historical analysis of financial condition toward a more dynamic, forward looking assessment of risk-management practices and financial factors. Under the system, known as RFI but more fully termed RFI/C(D), holding companies are assigned a composite rating (C) that is based on assessments of three components: Risk Management (R), Financial Condition (F), and the potential Impact (I) of the parent company and its nondepository subsidiaries on the subsidiary depository institution.2 The fourth component, Depository Institution (D), is intended to mirror the primary regulator's rating of the subsidiary depository institution.

In managing the supervisory process, the Federal Reserve takes a risk-focused approach that directs resources to (1) those business activities posing the greatest risk to banking organizations and (2) the organizations' management processes for identifying, measuring, monitoring, and controlling risks. The key features of the supervision program for large complex banking organizations (LCBOs) are (1) identifying those LCBOs that are judged, on the basis of their shared risk characteristics, to present the highest level of supervisory risk to the Federal Reserve; (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 Federal Reserve System's central point of contact for the organization, has responsibility for only one LCBO, and is supported by specialists capable of evaluating the risks of LCBO business activities and functions); and (4) promoting Systemwide and interagency information-sharing through automated systems.

For other banking organizations, the risk-focused supervision program provides that examination procedures are tailored to each banking organization's size, complexity, and risk profile. As with the LCBOs, examinations entail both off-site and on-site work, including planning, pre-examination visits, detailed documentation, and examination reports tailored to the scope and findings of the examination.

State Member Banks

At the end of 2007, 878 state-chartered banks (excluding nondepository trust companies and private banks) were members of the Federal Reserve System. These banks represented approximately 12 percent of all insured U.S. commercial banks and held approximately 14 percent of all insured commercial bank assets in the United States.

The guidelines for Federal Reserve examinations of state member banks are fully consistent with section 10 of the Federal Deposit Insurance Act, as amended by section 111 of the Federal Deposit Insurance Corporation Improvement Act of 1991 and by the Riegle Community Development and Regulatory Improvement Act of 1994. A fullscope, on-site examination of these banks is required at least once a year, although certain well-capitalized, well-managed organizations having total assets of less than $500 million may be examined once every eighteen months.3 The Federal Reserve conducted 479 exams of state member banks in 2007.

Bank Holding Companies

At year-end 2007, a total of 5,793 U.S. bank holding companies were in operation, of which 5,070 were top-tier bank holding companies. These organizations controlled 6,038 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 and complex smaller companies. In judging the financial condition of the subsidiary banks owned by holding companies, Federal Reserve examiners consult examination reports prepared by the federal and state banking authorities that have primary responsibility for the supervision of those banks, thereby minimizing duplication of effort and reducing the supervisory burden on banking organizations. Noncomplex bank holding companies with consolidated assets of $1 billion or less are subject to a special supervisory program that permits a more flexible approach.4 In 2007, the Federal Reserve conducted 476 inspections of large bank holding companies and 3,007 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 supervisory relationship between the Federal Reserve and other regulators. The statute also differentiates between the Federal Reserve's relations with regulators of depository institutions and its relations with functional regulators (that is, regulators for insurance, securities, and commodities firms).

As of year-end 2007, 597 domestic bank holding companies and 43 foreign banking organizations had financial holding company status. Of the domestic financial holding companies, 33 had consolidated assets of $15 billion or more; 136, between $1 billion and $15 billion; 93, between $500 million and $1 billion; and 335, less than $500 million.

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

In supervising the international operations of state member banks, Edge Act and agreement corporations, and bank holding companies, the Federal Reserve generally conducts its examinations or inspections at the U.S. head offices of these organizations where the ultimate responsibility for the foreign offices lies. Examiners also visit the overseas offices of U.S. banks to obtain financial and operating information and, in some instances, to evaluate the organizations' efforts to implement corrective measures or to test their adherence to safe and sound banking practices. Examinations abroad are conducted with the cooperation of the supervisory authorities of the countries in which they take place; for national banks, the examinations are coordinated with the OCC.

At the end of 2007, 55 member banks were operating 619 branches in foreign countries and overseas areas of the United States; 33 national banks were operating 567 of these branches, and 22 state member banks were operating the remaining 52. In addition, 17 nonmember banks were operating 23 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 2007, 67 banking organizations, operating 12 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, bank holding companies, and certain nonbanking companies. Foreign banks continue to be significant participants in the U.S. banking system.

As of year-end 2007, 172 foreign banks from 53 countries were operating 211 state-licensed branches and agencies, of which 8 were insured by the FDIC, and 47 OCC-licensed branches and agencies, of which 4 were insured by the FDIC. These foreign banks also owned 9 Edge Act and agreement corporations and 2 commercial lending companies; in addition, they held a controlling interest in 62 U.S. commercial banks. Altogether, the U.S. offices of these foreign banks at the end of 2007 controlled approximately 18 percent of U.S. commercial banking assets. These 172 foreign banks also operated 91 representative offices; an additional 49 foreign banks operated in the United States through a representative office.

State-licensed and federally licensed branches and agencies of foreign banks are examined on-site at least once every eighteen months, either by the Federal Reserve or by a state or other federal regulator. In most cases, on-site examinations are conducted at least once every twelve months, but the period may be extended to eighteen months if the branch or agency meets certain criteria.

In cooperation with the other federal and state banking agencies, the Federal Reserve conducts a joint program for supervising the U.S. operations of foreign banking organizations. The program has two main parts. One part involves examination of those foreign banking organizations that have multiple U.S. operations and is intended to ensure coordination among the various U.S. supervisory agencies. The other part is a review of the financial and operational profile of each organization to assess its general ability to support its U.S. operations and to determine what risks, if any, the organization poses through its U.S. operations. Together, these two processes provide critical information to U.S. supervisors in a logical, uniform, and timely manner. The Federal Reserve conducted or participated with state and federal regulatory authorities in 357 examinations in 2007.

Compliance with Regulatory Requirements

The Federal Reserve examines supervised institutions for compliance with a broad range of legal requirements, including anti-money-laundering and consumer protection laws and regulations, and other laws pertaining to certain banking and financial activities. Most compliance supervision is conducted under the oversight of the Division of Banking Supervision and Regulation, but consumer compliance supervision is conducted under the oversight of the Division of Community and Consumer Affairs. The two divisions coordinate their efforts with each other and also with the Board's Legal Division to ensure consistent and comprehensive Federal Reserve supervision for compliance with legal requirements.

Anti-Money-Laundering Examinations

With regard to anti-money-laundering requirements, 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, terrorism financing, and other financial crimes. In addition, BSA and Board regulations require that banks develop written programs on BSA/anti-money-laundering compliance and that the programs be formally approved by bank boards of directors. An institution's compliance program must (1) establish a system of internal controls to ensure compliance with the BSA, (2) provide for independent compliance testing, (3) identify individuals responsible for coordinating and monitoring day-to-day compliance, and (4) provide training for personnel as appropriate.

The Federal Reserve is responsible for examining its supervised institutions for compliance with various antimoney-laundering laws and regulations. During examinations of state member banks and U.S. branches and agencies of foreign banks and, when appropriate, inspections of bank holding companies, examiners review the institution's compliance with the BSA and determine whether adequate procedures and controls to guard against money laundering and terrorism financing are in place.

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 include a risk-focused review of information technology risk management activities. During 2007, the Federal Reserve was the lead agency in 2 cooperative, interagency examinations of large, multiregional data processing servicers.

Fiduciary Activities

The Federal Reserve has supervisory responsibility for state member commercial banks and depository trust companies that together reported, at the end of 2007, $39 trillion of assets in various fiduciary or custodial capacities. Additionally, state member nondepository trust companies supervised by the Federal Reserve reported $40 trillion of assets held in a fiduciary or custodial capacity. During on-site examinations of fiduciary activities, an organization's compliance with laws, regulations, and general fiduciary principles and its 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 2007, Federal Reserve examiners conducted 98 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 2007, the Federal Reserve conducted on-site examinations at 18 of the 68 state member banks and bank holding companies that were registered as transfer agents and examined 1 state member limited-purpose trust company acting as a national securities depository.

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 Treasury regulations governing dealing and brokering in government securities. Thirty state member banks and 6 state branches of foreign banks have notified the Board that they are government securities dealers or brokers not exempt from Treasury's regulations. During 2007, the Federal Reserve conducted 7 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 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 2007, 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 (Credit by Banks and Persons other than Brokers or Dealers for the Purpose of Purchasing or Carrying Margin Stock). In addition, the Federal Reserve maintains a registry of persons other than banks, brokers, and dealers who extend credit subject to Regulation U. The Federal Reserve may conduct specialized examinations of these lenders if they are not already subject to supervision by the Farm Credit Administration (FCA), the NCUA, or the OTS.

At the end of 2007, 621 lenders other than banks, brokers, or dealers were registered with the Federal Reserve. Other federal regulators supervised 200 of these lenders, and the remaining 421 were subject to limited Federal Reserve supervision. On the basis of regulatory requirements and annual reports, the Federal Reserve exempted 246 lenders from its on-site inspection program. Nonexempt lenders are subject to either biennial or triennial inspection. Sixty-eight inspections were conducted during the year.

Business Continuity

In 2007, the Federal Reserve continued its efforts to strengthen the resilience of the U.S. financial system in the event of unexpected disruptions. The Federal Reserve, the OCC, and the Securities and Exchange Commission (SEC) continued joint supervisory assessments of the activities of core clearing and settlement firms and significant market participants in implementing and maintaining sound business resiliency and continuity practices as outlined in "Interagency Paper on Sound Practices to Strengthen the Resilience of the U.S. Financial System." The Federal Reserve and the other Federal Financial Institutions Examination Council (FFIEC) agencies continued to coordinate their efforts to ensure a consistent supervisory approach for business continuity practices.5

Enforcement Actions

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 2007, the Federal Reserve completed 34 formal enforcement actions. Civil money penalties totaling $20,255,290 were assessed. As directed by statute, all civil money penalties are remitted to either the Treasury or the Federal Emergency Management Agency. Enforcement orders, which are issued by the Board, and written agreements, which are executed by the Reserve Banks, are made public and are posted on the Board's website.

In addition to taking these formal enforcement actions, the Reserve Banks completed 67 informal enforcement actions in 2007. 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. Such monitoring and analysis helps direct examination resources to institutions that have higher risk profiles. Screening systems also assist in the planning of examinations by identifying companies that are engaging in new or complex activities.

The primary off-site monitoring tool used by the Federal Reserve is the Supervision and Regulation Statistical Assessment of Bank Risk model (SRSABR). Drawing primarily on the financial data that banks report on their Reports of Condition and Income (Call Reports), SR-SABR uses econometric techniques to identify banks that report financial characteristics weaker than those of other banks assigned similar supervisory ratings. To supplement the SR-SABR screening, the Federal Reserve also monitors various market data, including equity prices, debt spreads, agency ratings, and measures of expected default frequency, to gauge market perceptions of the risk in banking organizations. In addition, the Federal Reserve prepares quarterly Bank Holding Company Performance Reports (BHCPRs) for use in monitoring and inspecting supervised banking organizations. The BHCPRs, which are compiled from data provided by large bank holding companies in quarterly regulatory reports (FR Y-9C and FR Y-9LP), contain, for individual companies, financial statistics and comparisons with peer companies. BHCPRs are made available to the public on the National Information Center (NIC) website.

During 2007, three major upgrades to the web-based Performance Report Information and Surveillance Monitoring (PRISM) application were completed. PRISM is a querying tool used by Federal Reserve analysts to access and display financial, surveillance, and examination data. In the analytical module, users can customize the presentation of institutional financial information drawn from Call Reports, Uniform Bank Performance Reports, FR Y-9 statements, BHCPRs, and other regulatory reports. In the surveillance module, users can generate reports summarizing the results of surveillance screening for banks and bank holding companies. The upgrades made more regulatory data available for querying, gave users the ability to display commercial real estate guidance data, and provided a way to access structure information for all institutions in NIC.

The Federal Reserve works through the FFIEC Task Force on Surveillance Systems to coordinate surveillance activities with the other federal banking agencies.

International Training and Technical Assistance

In 2007, 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 2007 was concentrated in Latin America, Asia, and former Soviet bloc countries. The Federal Reserve, along with the OCC, the FDIC, and the Treasury, was also an active participant in the Middle East and North Africa Financial Regulators' Training Initiative, which is part of the U.S. government's Middle East Partnership Initiative.

During the year the Federal Reserve offered training courses exclusively for foreign supervisory authorities, both in the United States 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 on Banking Supervision (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 the region, with the help of national banking supervisors and international agencies; and aims to help members develop banking laws, regulations, and supervisory practices that conform to international best practices. The Federal Reserve contributes significantly to ASBA's organizational management and to its training and technical assistance activities.

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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 supervisory and regulatory forums, provide support for the work of the FFIEC, and participate in international forums such as the Basel Committee, the Joint Forum, and the International Accounting Standards Board.

Capital Adequacy Standards

Risk-Based Capital Standards for Certain Internationally Active Banking Organizations

On December 7, 2007, the Federal Reserve, OCC, FDIC, and OTS published final rules implementing new risk-based capital requirements for large, internationally active banking organizations (the Basel II advanced approaches framework). The advanced approaches framework is broadly consistent with international approaches to implementation of Basel II and includes a number of prudential safeguards, such as the requirement that banking organizations satisfactorily complete a four-quarter parallel run period before operating under the Basel II framework, and the use of transitional capital floors. It retains the long-standing minimum risk-based capital requirement of 4 percent tier 1 capital and 8 percent total qualifying capital and the tier 1 leverage ratio. Banking organizations subject to the framework are expected to meet certain public disclosure requirements designed to foster transparency and market discipline. In addition, the prompt corrective action rules for banks that are not adequately capitalized remain in effect. (For more information, see the box "New Capital Adequacy Framework for U.S. Banking Organizations.")

New Capital Adequacy Framework for U.S. Banking Organizations

Aligning regulatory capital requirements with risk and fostering good risk measurement and management practices for our largest and most complex banking organizations will, I believe, contribute to safer and sounder banks and a more resilient financial system.

Randall S. Kroszner, Member, Board of Governors
November 2007

On December 7, 2007, the U.S. banking agencies published a new risk-based capital adequacy framework.1 The new framework--known as the advanced approaches framework--is designed to align more closely the amount of capital U.S. banking organizations are required to hold as a cushion against potential losses with the risks to which they are exposed. Effective April 2008, large, internationally active U.S. banking organizations will be required to transition to the advanced approaches framework to calculate the amount of capital they must hold relative to their risk profile; other banking organizations may choose to use the new framework.2 The advanced approaches framework for U.S. banking organizations is based on the revised international capital accord known as Basel II, which was adopted in 2006 by international banking authorities working through the Basel Committee on Banking Supervision.

The need for a new capital adequacy framework arose from continuing rapid and extensive evolution and innovation in the financial marketplace, which has substantially reduced the effectiveness of the existing risk-based capital rules (the Basel I-based rules) for large, internationally active banking organizations. The Basel II-based rules are more sensitive to risk and are tailored to the different kinds of risk to which banking organizations are exposed. Basel II regulatory capital requirements will vary from organization to organization in line with the organization's actual risk profile, so that a banking organization exposed to greater risk will have higher requirements than one exposed to less risk.

Both the international and the U.S. frameworks encompass three elements, or pillars: minimum risk-based capital requirements (pillar 1); supervisory review of capital adequacy (pillar 2); and market discipline through enhanced public disclosure (pillar 3).

Pillar 1 addresses calculation of regulatory capital requirements in relation to certain risk exposures. To calculate their minimum requirements in relation to the credit risk arising from wholesale and retail exposures, U.S. banking organizations will use an internal ratings-based approach, inserting their own internal estimates of key credit risk parameters into formulas provided by supervisors. They will calculate their minimum requirements in relation to operational risk using advanced measurement approaches, which rely on the institutions' internal risk-measurement and capital calculation processes. The advanced approaches framework also specifies separate methodologies for calculating capital requirements in relation to securitization and equity exposures.

Compared with the Basel I-based rules, banking organizations under Basel II-based rules will be required to take greater account of their off-balance-sheet activities in calculating their capital requirements. The new framework also provides a more-risk-sensitive regulatory capital approach to capital markets activities and transactions, such as repurchase agreements, securities borrowing and lending, margin loans, and over-the-counter derivatives. The enhanced risk sensitivity of the advanced approaches framework should provide incentives for lending to creditworthy counterparties and using effective credit-risk mitigation techniques, such as requiring collateral.

The advanced approaches build on the risk-measurement and risk-management approaches already being used by sophisticated banking organizations and are designed to evolve over time as these organizations refine and enhance their internal practices. As a result, these approaches are better able than the Basel I-based rules to be adapted to innovations in banking and financial markets and to capture the risks arising from new products and activities. This increased adaptability and flexibility suggests that the relationship between the risk-based regulatory measure of capital adequacy and a banking organization's actual risk exposures and its day-to-day risk management will be stronger and more consistent.

Pillars 2 and 3 are also essential elements of the advanced approaches framework. Under pillar 2, banking organizations are required to have an internal process for ensuring that they are holding enough capital to support their overall risk profile (including those risks not captured or not fully addressed under pillar 1), particularly during economic downturns and periods of financial stress. These internal processes will be subject to rigorous supervisory review.

Pillar 3 addresses banking organizations' communication with market participants about their risks, the associated levels of capital, and the manner in which they are meeting the requirements of the advanced approaches framework. The public disclosures called for under pillar 3 are expected to increase the transparency of banking organizations' activities and exposures, giving market participants useful information about banking organizations' risk profiles and their ability to manage risk.

Adoption of the advanced approaches framework is an important milestone for the U.S. banking agencies, but effective implementation in the coming years will be just as important. Implementation of the Basel II-based rules, and the associated improvements in risk management, will not be a one-time event, but rather an ongoing process. The agencies will observe carefully how the advanced approaches work in practice, assessing their advantages and limitations, to ensure that they are operating as intended.

1. The U.S. banking agencies are the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision.Return to text
2. Banking organizations with at least $250 billion of consolidated total assets or at least $10 billion of foreign exposure are required to use the advanced approaches and to meet the rule's rigorous qualification requirements; other banking organizations may opt into the advanced approaches framework, provided they also meet its requirements.Return to text

Revisions to the Market Risk Capital Rule

During 2007, the Federal Reserve, OCC, FDIC, and OTS considered public comments on a September 2006 notice of proposed rulemaking that presented revisions to the market risk capital rule used by the Federal Reserve, OCC, and FDIC since 1997 for banking organizations having significant exposure to market risk. Under the existing market risk capital rule, certain banking organizations are required to calculate a capital requirement for the general market risk of their covered positions and the specific risk of their covered debt and equity positions. The proposed revisions would enhance the rule's risk sensitivity, require banking organizations that model specific risk to reflect any incremental default risk of traded positions, and require public disclosure of certain qualitative and quantitative market risk information. The agencies expect to finalize this rule in the first half of 2008.

In July 2007, the Federal Reserve issued a letter reminding supervised banking organizations that the application of the fair value option to securities may subject the organization to the market risk capital rule. The letter directed those organizations to contact their Reserve Bank to discuss their plans to address the rule's requirements.

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

During 2007, the Federal Reserve, OCC, FDIC, and OTS considered public comments on a notice of proposed rulemaking (NPR) issued in December 2006 proposing modifications to the current Basel I-based capital rules. The proposed rules would provide an option to those banking organizations that are not required to adopt Basel II and do not wish to voluntarily follow the advanced approaches. This option is known as the Basel I-A proposal.

In response to comments calling for an option to adopt the standardized approach under Basel II, the agencies revised the Basel I-A proposal and intend to issue a new NPR setting forth a proposed standardized Basel II capital rule in the first half of 2008.

Other Capital Issues

Board staff conduct supervisory analyses of innovative capital instruments and novel transactions to determine whether such instruments qualify for inclusion in tier 1 capital.6 Much of this work in 2007 involved evaluating enhanced forms of trust preferred securities and mandatory convertible securities.

Staff members also identify and address supervisory concerns related to supervised banking organizations' capital issuances and work with the Reserve Banks to evaluate the overall composition of banking organizations' capital. In this work, the staff often must review the funding strategies proposed in applications for acquisitions and other transactions submitted to the Federal Reserve by banking organizations.

Accounting Policy

The supervisory policy function is also responsible for monitoring major domestic and international proposals, standards, and other developments affecting the banking industry in the areas of accounting, auditing, internal controls over financial reporting, financial disclosure, and supervisory financial reporting. Federal Reserve staff members interact with key constituents in the accounting and auditing professions, including regulators, standard-setters, accounting firms, accounting and banking industry trade groups, and the banking industry, and issue supervisory guidance as appropriate.

Domestic Accounting

The Federal Reserve continues to closely monitor domestic and international accounting standard-setting related to the use of fair value accounting. In previous comment letters to the Financial Accounting Standards Board (FASB), the Federal Reserve has raised concerns about the reliability of reported financial results based on fair value measurements, especially when financial instruments are illiquid. In May 2007, Federal Reserve staff issued a comment letter to the FASB regarding its "Invitation to Comment on Valuation Guidance for Financial Reporting" that strongly supported efforts to consider the need for additional valuation guidance.

The FASB's Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, issued in February 2007, allows most financial assets and financial liabilities to be reported at fair value. As part of its continued focus on the use of fair value accounting at banking organizations, and in light of the potential increased use of fair value accounting for loans, the Federal Reserve staff conducted a study of fair value measurements of commercial loan values. The study was intended to provide additional insight into valuation methodologies used and related control frameworks for loans at a number of large, internationally active banking organizations. The study report, issued in June 2007, summarizes commercial loan fair value measurement practices at these organizations.

Federal Reserve staff participated in a number of SEC and FASB efforts to address current accounting issues. A senior Federal Reserve representative is an official observer on the SEC Advisory Committee on Improvements to Financial Reporting, which was established to examine the U.S. financial reporting system with the goals of reducing unnecessary complexity and making information more useful and understandable for investors. Federal Reserve staff also participated in FASB efforts to improve financial reporting, including roundtable discussions on modifications of securitized subprime mortgage loans and the joint FASB-International Accounting Standards Board (IASB) project on Financial Statement Presentation.

Bank Secrecy Act and Anti-Money Laundering

In 2007, the FFIEC again updated the Bank Secrecy Act/Anti-Money Laundering Examination Manual (originally issued in 2005) to further clarify supervisory expectations, incorporate new regulatory issuances, and respond to industry requests for additional guidance. Significant revisions included updates to the chapters on customer due diligence, suspicious activity reporting, foreign correspondent accounts, electronic banking, and trade finance. The manual provides current and consistent riskbased guidance to help banking organizations comply with the BSA and safeguard operations from money laundering and terrorism financing.

Also during the year, the FFIEC agencies issued "Interagency Statement on Enforcement of Bank Secrecy Act/Anti-Money Laundering Requirements" setting forth their interpretation of the requirement in the Federal Deposit Insurance Act relating to supervisory actions to address certain BSA compliance issues. The statement provides greater consistency among the agencies on certain BSA enforcement decisions and describes considerations that affect those decisions.

The Federal Reserve and other federal banking agencies continued during 2007 to share information with the Financial Crimes Enforcement Network (FinCEN) under the interagency memorandum of understanding (MOU) that was finalized in 2004, and with the Treasury's Office of Foreign Assets Control (OFAC) under the interagency MOU that was finalized in 2006.

The Federal Reserve continues to participate in efforts to promote transparency and address risks faced by financial institutions that act as intermediaries in international funds transfers. The Federal Reserve, other U.S. banking agencies, and the Treasury have supported private-sector efforts to address the anti-money-laundering and sanctions concerns of banks that have international operations. In addition, the Federal Reserve participates in the Anti-Money Laundering and Countering the Financing of Terrorism Expert Group, a subcommittee of the Basel Committee's International Liaison Group.

International Guidance on Supervisory Policies

As a member of the Basel Committee, the Federal Reserve participates in efforts to advance sound supervisory policies for internationally active banking organizations and to improve the stability of the international banking system. In 2007, the Federal Reserve participated in ongoing cooperative work on implementation of Basel II and on development of international supervisory guidance, particularly in the area of funding liquidity risk management.

The Federal Reserve also continued to participate in Basel Committee working groups addressing issues not fully resolved in the Basel II framework. One effort is a look at eligible capital instruments across jurisdictions with the goal of developing a definition of capital. The Federal Reserve also participated in a workshop addressing supervisory and industry expectations with regard to implementation of pillar 2 of Basel II (supervisory review).

Risk Management

The Federal Reserve contributed to supervisory policy papers, reports, and recommendations issued by the Basel Committee during 2007 that were generally aimed at improving the supervision of banking organizations' risk-management practices.7 Two of these were

The Federal Reserve contributed to efforts begun in January 2007 to look at liquidity regulation across jurisdictions and to review the 2000 Basel Committee paper "Sound Practices for Managing Liquidity in Banking Organisations" with a view toward updating the paper.

Joint Forum

In 2007, the Federal Reserve continued to participate in the Joint Forum--a group established under the aegis of the Basel Committee to address issues related to the banking, securities, and insurance sectors, including the regulation of financial conglomerates. The Joint Forum is made up of representatives of the Basel Committee, the International Organization of Securities Commissions, and the International Association of Insurance Supervisors. The Federal Reserve contributed to the development of supervisory policy papers, reports, and recommendations issued by the Joint Forum during 2007, including work on risk concentrations, credit risk transfer, customer suitability, and implementation of principles for the supervision of financial conglomerates.8 The Federal Reserve also participated in Joint Forum-sponsored information-sharing on pandemic planning and other business continuity initiatives.

International Accounting

The Federal Reserve participates in the Basel Committee's Accounting Task Force (ATF), which represents the Basel Committee at international meetings on accounting, auditing, and disclosure issues affecting global banking organizations. During 2007, Federal Reserve staff contributed to the development of numerous Basel Committee comment letters related to accounting and auditing matters that were submitted to the IASB and the International Auditing and Assurance Standards Board (IAASB).

The Basel Committee in May 2007 issued a comment letter to the IASB on its discussion paper "Fair Value Measurements." The paper was prepared by the IASB as part of its efforts to develop a standard for fair value measurements similar to the FASB Statement of Financial Accounting Standards No. 157, Fair Value Measurements, issued in September 2006. In its letter, the Basel Committee emphasized the importance of sound guidance on fair value measurement, particularly as part of the joint FASB-IASB program on convergence between International Financial Reporting Standards and U.S. generally accepted accounting principles (GAAP).

In 2007 the Basel Committee also issued a series of comment letters to the IAASB related to the international standards on auditing (ISAs) that are being revised as part of the IAASB's Clarity Project. The Clarity Project is part of an effort by the IAASB to increase consistency in the application of auditing standards around the world and to improve the clarity of the ISAs. The revised ISAs cover such audit areas as planning the audit, auditing different types of financial statements, audit evidence, related parties, going concern, fair value measurements, internal audit, and the auditor's report.

Credit Risk Management

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

Working with Mortgage Borrowers

In April 2007 the Federal Reserve, FDIC, NCUA, OCC, and OTS issued staff guidance to encourage supervised institutions to work constructively with homeowners who are financially unable to continue meeting their mortgage payments. The agencies reminded institutions that prudent workout arrangements that are consistent with safe and sound lending practices are generally in the long-term best interest of both the financial institution and the borrower.

Subprime Mortgage Lending

In June the Federal Reserve, FDIC, NCUA, OCC, and OTS issued "Statement on Subprime Mortgage Lending" to address issues and questions related to certain adjustable-rate mortgage (ARM) products marketed to subprime borrowers. The statement emphasizes the need for prudent underwriting standards and clear and balanced consumer information, so that institutions and consumers can assess the risks arising from certain ARM products that have discounted or low introductory rates. It describes the prudent safety and soundness and consumer protection standards that institutions should follow to ensure that borrowers obtain loans they can afford to repay. These standards include qualifying borrowers on a fully indexed, fully amortized basis and guidelines on the use of risk-layering features, including an expectation that stated income and reduced documentation would be accepted only if there are documented factors that clearly minimize the need for verification of the borrower's repayment capacity. Consumer protection standards include clear and balanced product disclosures for customers and limits on prepayment penalties so that customers have a reasonable period to refinance without penalty, typically at least sixty days before expiration of the initial fixed interest rate period.

Statement on Loss-Mitigation Strategies

In September the Federal Reserve, FDIC, NCUA, OCC, OTS, and Conference of State Bank Supervisors issued a statement encouraging federally regulated financial institutions and state-supervised entities that service securitized residential mortgages to review their authority under pooling and servicing agreements to identify borrowers at risk of default and to pursue appropriate loss-mitigation strategies designed to preserve sustainable home ownership. The statement outlines the steps a servicer may take when there is an increased risk of default, including identifying borrowers at heightened risk of delinquency or default, contacting borrowers to assess their ability to repay, and determining whether default is reasonably foreseeable. The statement goes on to explain possible loss-mitigation techniques that a servicer may pursue with a borrower, recognizing that the servicer must consider the documents governing the securitization trust to determine its authority to restructure loans that are delinquent or are at risk of imminent default.

Pandemic Planning

In December, the FFIEC agencies published guidance on planning for the purpose of minimizing the potential adverse effects of an influenza pandemic. The guidance emphasizes the importance of (1) a preventive program to reduce the likelihood that the institution's operations will be significantly affected by a pandemic, (2) a documented strategy that scales the response to the particular stages of an outbreak, (3) a comprehensive framework of facilities, systems, or procedures needed to continue critical operations, (4) a testing program, and (5) an oversight program. In September and October, the Federal Reserve participated with the other FFIEC agencies in a Treasury-sponsored, industrywide business continuity exercise to test the financial sector's ability to respond to a pandemic crisis. The Federal Reserve helped develop the after-exercise report, which was published in January 2008.

Banks' Securities Activities

In September, the Federal Reserve and the SEC adopted joint final rules defining the scope of securities activities a bank may conduct without registering with the SEC as a securities broker. The Gramm-Leach-Bliley Act eliminated the blanket "broker" exception for banks that had been contained in section 3(a)(4) of the Securities Exchange Act of 1934, but it granted exceptions designed to allow banks to continue to engage in securities transactions for customers in connection with their normal trust, fiduciary, custodial, and other banking operations. The rules implement the most important "broker" exceptions for trust and fiduciary activities, custodial and deposit "sweep" functions, and third-party networking arrangements.

Economic Growth and Regulatory Paperwork Reduction Act of 1996

The Economic Growth and Regulatory Paperwork Reduction Act of 1996 (EGRPRA) requires that the federal banking agencies review their regulations every ten years to identify and eliminate any unnecessary requirements imposed on insured depository institutions. (In addition, the Board periodically reviews each of its regulations.) During 2007, the Federal Reserve, OCC, FDIC, and OTS completed the required review and issued a joint report to Congress, which is available on the EGRPRA website.

Regulatory Reports

The supervisory policy function is responsible for developing, coordinating, and implementing regulatory reporting requirements for various financial reporting forms filed by domestic and foreign financial institutions subject to Federal Reserve supervision. Federal Reserve staff members interact with appropriate federal and state supervisors, including foreign bank supervisors as needed, to recommend and implement appropriate and timely revisions to the reporting forms and the attendant instructions.

Bank Holding Company Regulatory Reports

The Federal Reserve requires that U.S. bank holding companies periodically submit reports providing financial and structure information. The information is essential in supervising the companies and in formulating regulations and supervisory policies. It is also used in responding to requests from Congress and the public for information about bank holding companies and their nonbank subsidiaries. Foreign banking organizations also are required to periodically submit reports to the Federal Reserve.

Reports in the FR Y-9 series--FR Y-9C, FR Y-9LP, and FR Y-9SP--provide standardized financial statements for bank holding companies on both a consolidated and a parent-only basis. The reports are used to detect emerging financial problems, to review performance and conduct pre-inspection analysis, to monitor and evaluate risk profiles and capital adequacy, to evaluate proposals for bank holding company mergers and acquisitions, and to analyze the holding company's overall financial condition. Nonbank subsidiary reports--FR Y-11, FR 2314, and FR Y-7N--help the Federal Reserve determine the condition of bank holding companies that are engaged in nonbank activities and also aid in monitoring the number, nature, and condition of the companies' nonbank subsidiaries.

In March, several revisions to the FR Y-9C report were approved for implementation during 2007: (1) collection of certain data on the sources of fair value measurements from all institutions that choose, under GAAP, to apply a fair value option to one or more financial instruments and one or more classes of servicing assets and liabilities, and from certain institutions that report trading assets and liabilities; (2) collection of information on the cumulative change in the fair value of liabilities accounted for under the fair value option that is attributable to changes in the bank holding company's own creditworthiness, for purposes of determining regulatory capital; (3) collection of certain data on one-to four-family residential mortgage loans that have terms allowing for negative amortization; and (4) revision of instructions for reporting time deposits and brokered deposits.

Effective March 2007, four new items were added to the quarterly FR Y-11 and FR 2314 reporting forms to facilitate monitoring of the extension of negatively amortizing residential mortgage loans. Also, a new section concerning notes to the financial statements was added to the FR 2314.

Effective June 2007, reporting forms used to collect information on changes in organizational structure and the status of a foreign branch (FR Y-10, FR Y-10F, FR Y-10S, and FR 2058) were combined into one event-generated form called the FR Y-10. Also, a supplemental form was created (FR Y-10E) to collect additional structure information that the Federal Reserve deems to be critical and is needed in an expedited manner in order to meet new legislative requirements, answer congressional inquiries, or respond to market events. Effective December 2007, a requirement that an institution verify its list of domestic branches was added to the FR Y-6.

In November, the Federal Reserve proposed a number of revisions to the FR Y-9 for the 2008 reporting period comparable to those proposed for the bank Consolidated Reports of Condition and Income (Call Report) as described in the next section. In addition, the Federal Reserve proposed to collect certain data on the FR Y-9LP, FR Y-9SP, FR Y-11, FR 2314, FR Y-7, and FR 2886b forms from all institutions that choose to apply a fair value option to financial instruments and servicing assets and liabilities, and also proposed to collect other information on sources of income for supervisory purposes.

Commercial Bank Regulatory Financial Reports

As the federal supervisor of state member banks, the Federal Reserve, along with the other banking agencies through the FFIEC, requires banks to submit quarterly Call Reports. Call Reports are the primary source of data for the supervision and regulation of banks and the ongoing assessment of the overall soundness of the nation's banking system. Call Report data, which also serve as benchmarks for the financial information required by many other Federal Reserve regulatory financial reports, are widely used by state and local governments, state banking supervisors, the banking industry, securities analysts, and the academic community.

For the 2007 reporting period, the FFIEC implemented various revisions to the Call Report to address new safety and soundness considerations and to facilitate supervision. Among these revisions were changes related to the reporting of data for deposit insurance assessments; changes to provide for the reporting of data on nontraditional mortgage products; and changes to provide for the reporting of data related to certain financial instruments measured at fair value.

In September, the FFIEC proposed a number of revisions to the Call Report for the 2008 reporting period. The proposed revisions include collecting additional information related to one- to four-family residential mortgage loans; modifying the definition of trading account in response to the creation of a fair value option in generally accepted accounting principles; revising certain schedules to enhance the reporting of information available under the fair value option; revising the instructions for reporting daily average deposit data by newly insured institutions to conform with the FDIC's assessment regulations; and clarifying the instructions for reporting credit derivatives data in the risk-based capital schedule.

In 2007, Federal Reserve staff led a review of the Call Report by the federal banking agencies to determine which data requirements are no longer necessary or appropriate. The review, required by the Financial Regulatory Relief Act of 2006 to be conducted every five years, documented the safety and soundness and other public policy uses of each Call Report item and will serve as a reference for future changes to the Call Report.

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Supervisory Information Technology

Information technology supporting Federal Reserve supervisory activities is managed within the System supervisory information technology (SSIT) function in the Board's Division of Banking Supervision and Regulation. SSIT works through assigned staff at the Board and the Reserve Banks, as well as through System committees, to ensure that key staff members throughout the System participate in identifying requirements and setting priorities for information technology initiatives.

In 2007, the SSIT function worked on several strategic projects and initiatives: (1) alignment of technology investments with business needs; (2) identification and implementation of improvements to make technology more accessible to staff working in the field; (3) strengthening of compliance with data-privacy regulations; (4) identification of opportunities to converge and streamline IT applications, including key administrative systems, to provide consistent and seamless information; (5) evaluation and implementation of collaboration and analysis technologies (such as communities of practice and business intelligence tools) to integrate supervisory and management information systems that support both office-based and field staff; (6) with the other federal regulatory agencies, modernization of the Shared National Credit system; and (7) enhancement of the information security framework for the supervisory function, improving both overall security and compliance with best-practices and regulatory requirements (security enhancements included the encryption of data on all laptop computers and distribution of encrypted portable drives). In addition, new, advanced security measures were pilot-tested prior to expected implementation in 2008.

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 data on banking structure throughout the United States; the National Examination Database (NED), which enables supervisory personnel as well as federal and state banking authorities to access NIC data; the Banking Organization National Desktop (BOND), an application that facilitates secure, real-time electronic information-sharing and collaboration among federal and state banking regulators for the supervision of banking organizations; and the Central Document and Text Repository (CDTR), which contains documents supporting the supervisory processes.

Within the NIC, the supporting systems have been modified over time to extend their useful lives and improve business workflow efficiency. During 2007 work continued on upgrading the entire NIC infrastructure in order to provide easier access to information, a consistent Federal Reserve enterprise information layer, a comprehensive metadata repository, and uniform security across the Federal Reserve. Implementation is expected to be phased in beginning midyear 2008, with a completion target of 2010. Also in 2007, the NED system was modified to enhance the collection and reporting of Bank Secrecy Act information. In addition, the BOND and CDTR systems were enhanced to provide the document storage facility for the new national Federal Reserve Consumer Help call center. Key summary documentation regarding consumer complaints and inquiries is posted into the CDTR and made available to System staff and staff at the other federal banking agencies via the BOND system. The BOND and CDTR systems were also enhanced to provide an automated, electronic means for passing examination and inspection reports to the records management system of the Board's Office of the Secretary. This new electronic process has allowed the Reserve Banks to discontinue the long-standing practice of sending hard-copy reports to the Board for records management purposes.

Finally, during 2007 the Federal Reserve continued to work closely with other federal and state banking agencies--including federal agency chief information officers, FFIEC task forces and subgroups, and the Conference of State Bank Supervisors--on a variety of technology-related initiatives and projects supporting the supervision business function.

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Staff Development

Training Programs for Banking Supervision and Regulation, 2007
Program Number of sessions conducted
Total Regional
Schools or seminars conducted by the Federal Reserve  
Core schools
Banking and supervision elements 9 8
Financial analysis and risk management 9 8
Bank management 3 1
Report writing 17 17
Team dynamics and negotiation 9 9
Conducting meetings with management 15 15
Other schools  
Credit risk analysis 7 7
Examination management 6 5
Real estate lending seminar 2 1
Senior forum for current banking and regulatory issues 1 1
Basel II corporate activities 1 1
Basel II operational risk 2 1
Basel II retail activities 2 2
Principles of fiduciary supervision 1 1
Commercial lending essentials for consumer affairs 1 1
Consumer compliance examinations I 2 0
Consumer compliance examinations II 2 2
CRA examination techniques 2 2
CA risk-focused examination techniques 2 2
Fair lending examination techniques 2 2
Foreign banking organizations seminar 1 1
Information systems continuing education 8 8
Asset liability management (ALM1) 2 2
Fundamentals of interest rate risk management 6 6
Technology risk integration 4 4
Trading risk management 2 2
Leadership and influence 4 4
Fundamentals of fraud 7 7
Information technology seminars1 21 21
Self-study or online learning2  
Orientation (core and specialty) 0 0
Self-study programs 1, 2, and 3 3 0
Self-study modules . 0 0
Other agencies conducting courses3  
Federal Financial Institutions Examination Council 71 1
The Options Institute 1 1

1. Held at the IT Lab at the Chicago Federal Reserve Bank.  Return to table
2. Self-study programs do not involve group sessions.  Return to table
3. Open to Federal Reserve employees.  Return to table

The System Staff Development Program trains staff members at the Board, the Reserve Banks, and state banking departments. Training is offered at the basic, intermediate, and advanced levels in several disciplines within bank supervision: safety and soundness, information technology, foreign banking organizations, and consumer affairs. Classes are conducted in Washington, D.C., as well as at Reserve Banks and other locations. The Federal Reserve also participates in training offered by the FFIEC and by certain other regulatory agencies. The System's involvement includes developing and implementing basic and advanced training in relation to various emerging issues as well as in specialized areas such as international banking, information technology, anti-money laundering, capital markets, payment systems risk, and real estate appraisal (see table).

In 2007, the Federal Reserve trained 2,588 students in Federal Reserve System schools, 894 in schools sponsored by the FFIEC, and 26 in other schools, for a total of 3,508. The number of training days in 2007 totaled 16,791.

The System provides scholarship assistance to the states for training their examiners in Federal Reserve and FFIEC schools. Through this program, 659 state examiners were trained--347 in Federal Reserve courses, 309 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 two specialty areas, safety and soundness or consumer affairs. In 2007, 161 examiners passed the first proficiency examination and 73 passed the second proficiency examination, 53 examiners in safety and soundness and 20 in consumer affairs. An information technology specialty is also offered; it requires passing a proficiency examination and an examination administered by an information technology industry association.

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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 concern bank holding company formations and acquisitions, bank mergers, and other transactions involving bank or nonbank firms. In 2007, the Federal Reserve acted on 1,365 proposals, which represented 2,661 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 2007, the Federal Reserve acted on 603 applications and notices filed by bank holding companies to acquire a bank or a nonbank firm, or to otherwise expand their activities.

Bank holding companies generally may engage in only those nonbanking activities that the Board has previously determined to be closely related to banking under section 4(c)(8) of the Bank Holding Company Act. Since 1996, the act has provided an expedited prior notice procedure for certain permissible nonbank activities and for acquisitions of small banks and nonbank entities. Since that time the act has also permitted well-run bank holding companies that satisfy certain criteria to commence certain other nonbank activities on a de novo basis without first obtaining Federal Reserve approval.

A bank holding company may repurchase its own shares from its shareholders. When the company borrows money to buy the shares, the transaction increases the company's debt and decreases its equity. The Federal Reserve may object to stock repurchases by holding companies that fail to meet certain standards, including the Board's capital adequacy guidelines. In 2007, the Federal Reserve reviewed 11 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 2007, 37 domestic financial holding company declarations and 2 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 community(ies) to be served, and the competitive effects of the proposed merger. The Federal Reserve also must consider the views of the U.S. Department of Justice regarding the competitive aspects of any proposed bank merger involving unaffiliated insured depository institutions. In 2007, the Federal Reserve approved 68 merger applications under the act.

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 future prospects of the institution to be 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 fund. A proposed transaction should not jeopardize the stability of the institution or the interests of depositors. During its review of a proposed transaction, the Federal Reserve may contact other regulatory or law enforcement agencies for information about relevant individuals.

In 2007, the Federal Reserve approved 106 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 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 2007, the Federal Reserve acted on new and merger-related branch proposals for 1,520 domestic branches and granted prior approval for the establishment of 20 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 2007, no financial subsidiary applications were filed.

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 2007, the Federal Reserve approved 69 proposals for overseas investments by U.S. banking organizations, many of which represented investments through an Edge Act or agreement 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 homecountry 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 2007, the Federal Reserve approved 18 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 immediately; they are subsequently reported in the Board's weekly H.2 statistical release. The H.2 release also contains announcements of applications and notices received by the Federal Reserve upon which action has not yet been taken. For each pending application and notice, the related H.2 contains the deadline for comments. The Board's website provides information on orders and announcements as well as a guide for U.S. and foreign banking organizations that wish to submit applications or notices to the Federal Reserve.

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Enforcement of Other Laws and Regulations

The Federal Reserve's enforcement responsibilities also extend to the disclosure of financial information by state member banks and the use of credit to purchase and carry securities.

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 2007, 12 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 purchase 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 Financial Industry Regulatory Authority (formed through the combination of the National Association of Securities Dealers and the regulation, enforcement, and arbitration functions of the New York Stock Exchange), and the Chicago Board Options Exchange 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 FCA, the NCUA, and the OTS examine lenders under their respective jurisdictions; and the Federal Reserve examines other Regulation U lenders.

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Federal Reserve Membership

At the end of 2007, 2,489 banks were members of the Federal Reserve System and were operating 55,603 branches. These banks accounted for 36 percent of all commercial banks in the United States and for 71 percent of all commercial banking offices.

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1. The Basel II capital accord, an international agreement formally titled "International Convergence of Capital Measurement and Capital Standards: A Revised Framework," was developed by the Basel Committee on Banking Supervision, which is made up of representatives of the central banks or other supervisory authorities of thirteen countries. The original document was issued in 2004; the original version and an updated version issued in November 2005 are available on the website of the Bank for International Settlements.Return to text
2. Each of the first two components has four subcomponents: Risk Management--Board and Senior Management Oversight; Policies, Procedures, and Limits; Risk Monitoring and Management Information Systems; and Internal Controls. Financial Condition--Capital; Asset Quality; Earnings; and Liquidity.Return to text
3. The total assets threshold for this group of well-capitalized, well-managed organizations was increased during the year. The Financial Services Regulatory Relief Act of 2006, which became effective in October 2006, authorized the federal banking agencies to raise the threshold from $250 million to $500 million, and final rules incorporating the change into existing regulations were issued on September 21, 2007.Return to text
4. The special supervisory program was implemented in 1997 and modified in 2002. See SR letter 02-01 for a discussion of the factors considered in determining whether a bank holding company is complex or noncomplex.Return to text
5. The FFIEC member agencies are the Federal Reserve Board, the FDIC, the NCUA, the OCC, and the OTS.Return to text
6. Tier 1 capital comprises common stockholders' equity and qualifying forms of preferred stock, less required deductions such as goodwill and certain intangible assets.Return to text
7. Papers issued by the Basel Committee can be accessed via the Bank for International Settlements website. Return to text
8. Papers issued by the Joint Forum can be accessed via the Bank for International Settlements website. Return to text

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