Commercial Bank Examination Manual May 2006 Update

The May 2006 update to the Commercial Bank Examination Manual has been published (supplement no. 25). The manual comprises the Federal Reserve System's regulatory, supervisory, and examination guidance for state member banks. The new supplement includes guidance on the following subjects:

1. Interagency Advisory on the Unsafe and Unsound Use of Limitation of Liability Provisions in External Audit Engagement Letters. The sections titled "Internal Control and Audit Function, Oversight, and Outsourcing" have been revised to incorporate this February 9, 2006, interagency advisory. The advisory informs financial institutions that it is unsafe and unsound to enter into external audit contracts (that is, engagement letters) for the performance of auditing or attestation services when the contracts (1) indemnify the external auditor against all claims made by third parties, (2) hold harmless or release the external auditor from liability for claims or potential claims that might be asserted by the client financial institution (other than claims for punitive damages), or (3) limit the remedies available to the client financial institution (other than punitive damages). See SR Letter 06-4. Such limits on external auditors’ liability weaken the auditor’s independence and performance, thus reducing the supervisory agency’s ability to rely on the auditor’s work. The section’s examination objectives, examination procedures, and internal control questionnaire have been revised to incorporate certain key provisions of the advisory.
2. Supervision and Regulation Statistical Assessment of Bank Risk Model (SR-SABR). The "Federal Reserve System Bank Watch List and Surveillance Programs" section has been substantially revised to replace the former discussion of the SEER (System to Estimate Examination Ratings) surveillance model with a description of the new SR-SABR model, a new econometric framework. The section describes the new model, details the screening thresholds for SR-SABR within the State Member Bank Watch List program, and updates the watch list's follow-up procedures. See SR Letter 06-2.
3. The Definition and Role of the Responsible Reserve Bank. The "Examination Strategy and Risk-Focused Examinations," reaffirms the definition of the responsible Reserve Bank (RRB) and specifies the RRB's responsibilities for conducting inter-District examination and supervision activities for a banking organization. The section highlights and clarifies the role of the RRB with respect to inter-District and local Reserve Bank coordination of banking examination and supervision activities. See SR Letter 05-27 and CA Letter 05-11.
4. Interbank Liabilities. An "Interbank Liabilities" section sets forth supervisory guidance that is based on part 206 of Regulation F (12 CFR 206), authorized by section 23 of the Federal Reserve Act (12 U.S.C. 371b-2). Regulation F established standards to limit the risks posed by the exposure of insured depository institutions to other depository institutions (correspondents) with which they do business. Regulation F applies to FDIC-insured banks, savings associations, and branches of foreign banks, which must have in place internal policies and procedures to evaluate and control the exposure to their correspondents. Regulation F specifies a general "limit," stated in terms of the exposed bank's capital, for overnight credit exposure to an individual correspondent. Examination objectives, examination procedures, and an internal control questionnaire are provided.
5. Conflicts of Interest Rules and Post-Employment Restrictions. This new section, "Conflict-of-Interest Rules for Examiners" informs Federal Reserve System examiners of the Board’s rules and the System’s policies on maintaining an independent appearance by avoiding conflicts of interest. Examiners must comply with statutory prohibitions and adhere to the System's rules on conflicts of interest, which are intended to ensure the examiners' objectivity and integrity. The statutory prohibition (18 U.S.C. 213) on accepting any loan or gratuity from any bank under examination is discussed. The limited easing of examiner borrowing restrictions on obtaining credit cards and certain home mortgage loans also is discussed. See SR Letter 05-2. The special post-employment restrictions of the Intelligence Reform and Terrorism Prevention Act of 2004 are also reviewed. The Board implemented these restrictions in its November 17, 2005, rule (effective December 17, 2005).  See 12 CFR 263 and 264 and SR Letter 05-26.
6. Interagency Guidance on Sharing Suspicious Activity Reports with Head Offices and Controlling Companies. The "Overall Conclusions Regarding Condition of the Bank" section was revised to incorporate this January 20, 2006, interagency guidance. The guidance confirms that (1) a U.S. branch or agency of a foreign bank may disclose a Suspicious Activity Report (SAR) to its head office outside the United States and (2) a U.S. bank or savings association may disclose a SAR to controlling companies, whether domestic or foreign. Banking organizations must maintain appropriate arrangements to protect the confidentiality of SARs. See SR Letter 06-1.

A more detailed summary of changes is included with the update package. The public may obtain the manual and the updates (including pricing information) from Publications Fulfillment, MS-127, Board of Governors of the Federal Reserve System, 20th and C Streets, N.W., Washington, DC 20551; telephone (202) 452-3244; or send a facsimile to (202) 728-5886.

Commercial Bank Examination Manual