## _cr10121 — Summary Compliance with the Basel Core Principles—Detailed

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### Introduction, scope, and methodology
- Assessment undertaken as part of an IMF Financial Sector Assessment Program during October–November 2009, reflecting regulatory and supervisory framework in place as of completion date; legislative reforms not credited.
- Focus: major banks and holding companies.
- Methodology: review of legal framework, extensive discussions with Federal Reserve, OCC, FDIC, OTS, U.S. Treasury, GAO, IGs, FFIEC, state supervisors, industry, and private sector; used revised BCPs (2006) and four-part grading: compliant (C); largely compliant (LC); materially non-compliant (MNC); non-compliant (NC).

### Key weaknesses identified
- Three overarching weaknesses:
  - (i) a complicated regulatory structure requiring heavy inter-agency cooperation and coordination;
  - (ii) legislative provisions that hinder and discourage strong consolidated supervision (notably GLB Act limitations);
  - (iii) material weaknesses in oversight of banks’ risk monitoring and risk management.

### Institutional and market context — selected statistics
- At end-2007:
  - total U.S. financial assets amounted to almost four and a half times the size of GDP.
  - less than a quarter of total financial assets were accounted for by traditional depository institutions.
  - pension and other investment funds each represented about 18 percent of total financial assets.
  - insurance companies represented 11 percent of total assets.
  - GSEs accounted for 20 percent of total financial assets, mostly concentrated in mortgage markets.
  - corporate sector reliance on bank credit was around 10 percent.
- Households’ net worth fell by some US$11 trillion during 2008.

### Crisis impact and capital/supervisory actions — exact figures
- Reconfiguration and market dynamics:
  - top investment banks reconfigured as bank holding companies; nonbanks severely weakened; housing GSEs in government conservatorship; private securitization dormant but showing signs of pickup.
- Capital and supervisory actions:
  - After early-May 2009 stress test publication, the 19 top BHCs were able to raise nearly US$200 billion (of which 63 percent was in the form of common equity).
  - They repaid US$74.4 billion of CPP preferred shares.
  - The 10 BHCs needing an additional SCAP buffer increased their Tier 1 common equity by more than US$77 billion by their deadline of November 2009.
  - As of early February 2010:
    - 13 of the participating BHCs have fully redeemed their US$156.7 billion of preferred shares under the Treasury’s CPP.
    - Another five have either announced or taken steps to do so in the near future.
- Asset quality (third quarter of 2009):
  - Banks’ nonperforming loans rose to 4.9 percent of total loans.
  - Net charge-offs rose to 2.7 percent (highest levels in the 26-year history of such recorded data).
- Authorities expect further write-downs and charge-offs; indicators likely to deteriorate if jobless rates continue to rise.

### Macroeconomic outlook — exact forecasts and indicators
- IMF staff forecasts:
  - annual contraction of 2.5 percent in 2009;
  - growth of 2.7 percent in 2010.
- Recovery characteristics and headwinds:
  - GDP declined by 6.4 percent in 2009 Q1 and 0.1 percent in Q2 at an annual rate.
  - recovery expected to continue gradually, slower than typical recoveries, with growth returning to a lower trend only in mid-2010.
  - unemployment expected to continue rising, cresting slightly below 10 percent in 2010.
  - rebuilding household and financial intermediaries’ balance sheets will pose headwinds; financial conditions improved but remain reliant on policy support.

### Preconditions for effective banking supervision — summary
- Public infrastructure well-developed but complex and sometimes fragmented; federal-state division produces complexity and occasional fragmentation.
- Holding company supervision interpreted as integral to bank supervision given widespread use of holding structures.

---

### Findings on supervisory framework, powers, and cooperation (CP 1 and related)
- System features a multiplicity of agencies (Federal Reserve, OCC, FDIC, OTS) producing benefits (constructive challenge, checks and balances) but requiring strong cooperation to avoid overlap/gaps.
- GLB Act limitations impede consolidated supervision and access to information; U.S. Treasury proposals aim to remove some limitations.
- Assessors recommend clarifying mandates and expectations of each FBA, preserving core safety-and-soundness mandates while addressing expanding systemic/consumer roles.
- Supervisory governance and integration recommendations:
  - improvement plans should be inter-agency (not agency-specific);
  - better integration of field and headquarters risk views and stronger timeliness/appropriateness of supervisory responses needed.

### Crisis causes, credit culture, and corporate governance — key observations
- Drivers of crisis included erosion of credit culture, originate-to-distribute practices, low interest rates, public policy incentives for mortgage lending, competition from non-bank sector, opaque off-balance-sheet exposures.
- Corporate governance weaknesses: board composition and role separation issues, complex proxy procedures, compensation schemes incentivizing short-term results.
- Market discipline shortcomings: rating agencies’ deficiencies and opacity of complex structured products; inadequate information on shadow banking exposures.

---

### Supervisory assessments by core principles — selected gradings and key comments
- CP 1 Objectives, independence, powers, transparency, and cooperation — Grading: C
  - Need for greater clarity on mandates, forward-looking risk measures, and cross-FBA collaboration.
- CP 2 Permissible activities — Grading: C
- CP 3 Licensing criteria — Grading: C
  - Note: absolute minimum capital for new banks stated as US$2 million (practically often higher).
- CP 6 Capital adequacy — Grading: LC
  - Shortcomings: Tier 1 definition for holding companies, absence of capital rules for SLHCs, allowing intangibles to count heavily in Tier 1.
- CP 7 Risk management process — Grading: MNC
  - “Severe shortcomings in enterprise-wide risk monitoring and management”; supervisory oversight ineffective in identifying/remediating weaknesses; remediation will take several years.
- CP 8 Credit risk — Grading: LC
  - Well-developed rules but processes not fully effective for some markets (residential mortgages, CRE at smaller/mid-size banks).
- CP 9 Problem assets, provisions, and reserves — Grading: C
  - Effectiveness would increase if accounting rules allowed more forward-looking provisioning.
- CP 10 Large exposure limits — Grading: C
  - Aggregate regulatory limits high compared with international practices; reporting lacks detail.
- CP 11 Exposure to related parties — Grading: C
  - Aggregate lending limit to a single related party set at 15 percent of the bank's own fund plus surplus funds; overall limit to all related parties set at 100 percent of own funds plus surplus funds.
- CP 13 Market risks — Grading: LC
  - Material weaknesses in market risk measurement, models, valuation; substantial improvements in progress.
- CP 14 Liquidity risk — Grading: LC
  - Guidance consistent with international standards; implementation enhancements required.
- CP 15 Operational risk — Grading: C
- CP 16 Interest rate risk in the banking book — Grading: C
- CP 19 Supervisory approach — Grading: LC
  - Need improved group-wide oversight, domestic supervisory colleges, and overhaul of risk rating systems.
- CP 20 Supervisory techniques — Grading: C
- CP 21 Supervisory reporting — Grading: C
  - Recommend review of solo reporting and implications of U.S. GAAP for supervision and PCA.
- CP 22 Accounting and disclosure — Grading: C
  - Suggest consideration of statutory auditor whistleblower obligations with protections.
- CP 23 Corrective and remedial powers of supervisors — Grading: C
- CP 24 Consolidated supervision — Grading: LC
  - Present legislation and practices hinder effective consolidated supervision; SLHC capital supervised case-by-case.
- CP 25 Home-host relationships — Grading: C (authorities comply with this CP)

---

### Capital framework and prudential specifics — precise requirements and issues
- U.S. capital framework:
  - Essentially consistent with Basel I for banks/BHCs; Basel II advanced approaches enacted and implementation in progress for "core banking organizations".
  - Core banking organizations defined to include entities with US$250 billion or more of total consolidated assets or US$10 billion or more of on-balance-sheet foreign exposure.
  - At assessment time, implementation plans had been received from 14 core banking organizations.
- Minimum capital requirements (explicit):
  - 4 percent Tier 1 risk-based capital;
  - 8 percent total risk-based capital;
  - 4 percent Tier 1 leverage capital;
  - 3 percent Tier 1 leverage capital minimum for banks and BHCs rated composite 1 and for BHCs that have implemented the market risk rule.
- PCA “well capitalized” thresholds (explicit):
  - Total risk-based capital ratio of “10 percent or greater”;
  - Tier 1 risk-based capital ratio of “6 percent or greater”;
  - Leverage ratio of “5 percent or greater”.
- Tier 1 innovative instruments and intangibles:
  - For largest BHCs (mandatory Basel II): 15 percent limit on innovative instruments in Tier 1; for other BHCs: 25 percent.
  - Cumulative preferred shares and cumulative trust preferred securities included in 15/25 percent limit in the U.S., contrary to BCBS rules.
  - Qualifying intangibles (including MSRs, NMSRs, PCCRs) may be included in capital up to 100 percent of Tier 1 capital (no more than 25 percent can be NMSRs and PCCRs).
  - MSRs typically amounted to “10–20 percent of Tier 1 capital for a number of the largest banks,” were “in the range of 40 percent of Tier 1 capital for some banks,” and were “75 percent to over 100 percent of Tier 1 at a small number of institutions (including some that failed).”
- SLHCs:
  - No formal capital rules; adequacy assessed case-by-case; SLHCs account for approximately 10 per cent of total bank and thrift assets.

---

### Risk management, supervisory tools, and operational findings
- Principle 7 (Risk management) — Materially Non-Compliant:
  - Identified weaknesses: inadequate enterprise-wide aggregation of credit/market/liquidity risk, valuation difficulties for complex products, insufficient stress-testing, over-reliance on external ratings, IT/MIS deficiencies.
  - Supervisory recommendations: regular inter-agency horizontal detailed assessments, robust testing of improvements, inclusion of all large complex banking organizations, publication of regular reports/guidance, and ensuring sufficient ongoing resources.
- Supervisory methods and reporting:
  - On-site full-scope examinations at least annually (or every 18 months for qualifying smaller banks); continuous supervision for largest organizations with dedicated teams.
  - CAMELS/UFIRS rating system described as outdated, slow to adjust, sticky, and insufficiently risk-differentiated; recommendation to overhaul or supplement with a consistent, granular, forward-looking common language.
  - Off-site surveillance tools cited: Fed – SABR; OCC – Canary; FDIC – SCOR; OTS – RMS.
- Liquidity and market risk supervision:
  - Liquidity guidance being formalized; agencies collecting enhanced liquidity metrics and monitoring daily/intra-day during crisis.
  - Market risk: material breakdowns in market risk controls and valuation at several large firms; horizontal reviews and validation efforts underway.

---

### Large exposures, related-party limits, and concentration issues — numeric limits
- Single borrower limit:
  - a bank’s total outstanding loans and extensions of credit to one borrower or group of connected borrowers are limited to 15 percent of a bank’s capital (Tier 1) and surplus funds; a further 10 percent may be extended if fully secured by readily marketable collateral (12 U.S.C. §84).
- Related parties and insiders:
  - aggregate limit for lending to all related parties in aggregate set at 100 percent of own funds plus surplus funds (assessors note this is high by international standards).
- Assessors recommend:
  - include all exposures (issued securities, asset holdings) within large exposure limits and strengthen reporting frequency and detail (e.g., quarterly reporting of largest exposures).

---

### AML/CFT, CP 18, payment systems, and crisis management
- AML/CFT findings:
  - FATF 2006 identified several deficiencies (beneficial ownership, trusts, ongoing due diligence, customer identification timing, senior management approval for correspondent accounts) that the assessors support remedying.
  - Supervisory approach to suspicious activity reporting and AML is in place; agencies have specialist personnel and enforcement tools.
- Payment and settlement systems:
  - Systemically important wholesale systems: Fedwire (RTGS) and CHIPS; retail systems not considered systemically important.
  - Systems performed well during crisis; vulnerabilities include late-in-the-day RTGS payments and concentration of clearing activities.
- Crisis management and safety nets:
  - FDIC deposit insurance insures deposits up to US$250,000 per depositor (temporarily increased from US$100,000 to US$250,000 until year-end 2013).
  - FDIC Receiver powers include purchase-and-assumption transactions, insured deposit transfers, loss-sharing, puts for troubled assets, and bridge banks.
  - PCA regime requires receivership within 90 days when tangible equity falls below 2 percent; PCA “well-capitalized” thresholds noted above.
  - Federal Reserve emergency lending authority used during crisis for liquidity support to solvent but illiquid banks, undercapitalized banks certified viable, and, in “unusual and exigent circumstances,” other entities; Fed supported commercial paper market.

---

### Recommended Action Plan — selected actions (condensed)
- Governance and mandates:
  - Consider legislating clear mandates/objectives for FBAs; clarify primary regulator vs holding company regulator responsibilities.
  - Improve inter-agency coordination, integrated supervision planning, and a common forward-looking risk rating approach.
- Licensing and entry:
  - Strengthen interagency agreement to prevent inappropriate charter conversions; increase effective minimum capital for new banks.
- Capital and SLHCs:
  - Work with BCBS and domestically to clarify Tier 1/core capital definition, cap intangibles in Tier 1 capital, and establish formal capital rules for SLHCs.
- Risk management and market/liquidity risk:
  - Conduct regular inter-agency horizontal assessments of risk monitoring/management improvements at major complex banking groups; transition crisis-driven liquidity improvements into sustainable supervisory programs; complete horizontal assessment of Market Risk Amendment implementation.
- Consolidated supervision and large exposures:
  - Make legislative/practice changes to ensure effective consolidated supervision; introduce consolidated regulatory limits and reporting for large exposures and related lending.
- Supervisory techniques and reporting:
  - Review supervisory manuals under FFIEC, harmonize processes, and review solo reporting requirements; consider statutory reporting obligations for external auditors to supervisors.

---

### Authorities’ response — key points and numerical assertions
- Authorities appreciate the assessment and dispute the CP 7 MNC rating, arguing supervisory crisis actions are important.
- On CP 6 (Capital Adequacy) the authorities state:
  - “The United States is the first highly complex economy evaluated under the Core Principles as updated in 2006.”
  - “Currently, approximately 96 percent of U.S. banks, representing approximately 99 percent of total bank assets, hold 50 percent or more capital than international minimums.”
  - Prior to the crisis most U.S. banks had Tier 1 capital composed mostly of common equity (80–90 percent or higher).
  - SCAP and other supervisory actions led to major capital increases at the largest banks.
- Agencies’ remedial actions cited:
  - SCAP stress assessment on 19 largest BHCs (together holding two-thirds of assets and more than one-half of the loans in the U.S. banking system) leading to substantial common equity raises;
  - joining international supervisory colleges; directing improved risk aggregation and contingency funding plans; targeted leveraged lending reviews; high quality Basel II implementation; interagency guidance on subprime/non-traditional mortgages; new data gathering projects covering over 60 percent of residential mortgages serviced in the United States.
- Authorities commit to reviewing recommendations and taking actions within their authority, including enhanced inter-agency communication, improved oversight of systemic risks, and requiring increased liquidity buffers at systemically important institutions.

*Source: IMF FSAP assessment—_cr10121: Summary Compliance with the Basel Core Principles—Detailed Assessments (October–November 2009)_*

### 1. Summary Compliance with the Basel Core Principles—Detailed

### 1. Summary Compliance with the Basel Core Principles—Detailed Assessments

### Introduction
- Assessment undertaken in the immediate aftermath of a period of extreme market stress and continued general economic downturn.
- Purpose: assess U.S. implementation of the Basel Core Principles for Effective Banking Supervision (BCPs) as part of an IMF Financial Sector Assessment Program during October–November 2009.
- Assessment reflects regulatory and supervisory framework in place as of the date of completion of the assessment.
- Not intended to assess the merits or effectiveness of wide-ranging program of reforms proposed and adopted within the U.S.; legislative reforms were continuing to be evaluated and therefore not credited in this assessment.
- Assessment focused on major banks and holding companies given their importance to the system.

### Methodology and Information Used for Assessment
- The assessment team reviewed the legal framework and held extensive discussions with:
  - Federal Reserve System, Office of the Comptroller of Currency (OCC), Federal Deposit Insurance Corporation (FDIC), Office of Thrift Supervision (OTS)
  - U.S. Treasury, Government Accountability Office, Offices of Inspector General
  - Federal Financial Institutions Examination Council, New York Department of State Banks, Conference of State Bank Supervisors
  - Industry associations, think-tanks, private sector participants
- Team examined current practice of on-site and off-site supervision of the Federal supervisory agencies and worked with a comprehensive self-assessment completed by U.S. agencies.
- Assessment used the revised BCPs (2006) and the four-part assessment system: compliant; largely compliant; materially non-compliant; non-compliant.
  - To achieve “compliant” all essential criteria generally must be met without any significant deficiencies.
  - “Largely compliant” if only minor shortcomings observed.
  - “Materially non-compliant” when severe shortcomings exist despite formal rules, and practical implementation is weak; assessors rated one CP materially non-compliant.
  - “Non-compliant” when no substantive progress toward compliance has been achieved.
- Assessment examined whether the four Federal banking agencies (FBAs)—the Federal Reserve, the OCC, the OTS, and the FDIC—by themselves provide sufficiently effective supervision to meet the BCPs.
- Where gaps or shortcomings in FBAs were identified, assessors considered whether state banking agencies would be sufficient to compensate.

### Scope and Interpretive Context
- The revised BCPs have a heightened focus on risk management and supervisory practice; expectations applied to the U.S. were high given system sophistication and complexity.
- The assessment did not cover the entire U.S. regulatory system:
  - Did not extend to supervisory arrangements for government-sponsored enterprises (GSEs), other government-sponsored credit providers, non-bank mortgage originators and brokers, or oversight of smaller community-based bank-like organizations such as credit unions.
- Use of holding company structures is fundamental; assessors adopted an interpretation incorporating supervision of bank and thrift holding companies as integral to bank supervision.

### Key Weaknesses Identified
- Three key weaknesses identified:
  - (i) a complicated regulatory structure that necessitates a heavy burden of cooperation and coordination between agencies;
  - (ii) legislative provisions that have hindered and discouraged strong consolidated supervision;
  - (iii) certain material weaknesses in the oversight of banks’ risk monitoring and risk management practices.

### Institutional and Macroeconomic Setting and Market Structure—Overview
- U.S. financial system is large and highly diversified.
  - At end-2007, total U.S. financial assets amounted to almost four and a half times the size of GDP.
  - Less than a quarter of total financial assets were accounted for by traditional depository institutions.
  - Pension and other investment funds each represented about 18 percent of total financial assets.
  - Insurance companies represented 11 percent of total assets.
  - Corporate sector reliance on bank credit was around 10 percent.
  - At end-2007, GSEs accounted for 20 percent of total financial assets, mostly concentrated in mortgage markets.

### Crisis Impact and Recent Measures
- Crisis-induced structural changes:
  - Top investment banks reconfigured as bank holding companies.
  - Nonbanks severely weakened.
  - Housing GSEs in government conservatorship.
  - Private securitization remained dormant but showing signs of picking up due to supervisory policy responses and government support programs.
  - Securitization markets may become more bank-centered and initially more concentrated.
- Capital and supervisory actions:
  - Capital adequacy of large BHCs bolstered by the U.S. Capital Purchase Program (CPP).
  - After publication of authorities’ stress test results in early-May 2009:
    - The 19 top BHCs were able to raise nearly US$200 billion capital (of which 63 percent was in the form of common equity).
    - They repaid US$74.4 billion of CPP preferred shares.
  - The 10 BHCs needing an additional Supervisory Capital Assessment Program (SCAP) buffer increased their Tier 1 common equity by more than US$77 billion by their deadline of November 2009.
  - As of early February 2010:
    - 13 of the participating BHCs have fully redeemed their US$156.7 billion of preferred shares under the Treasury’s CPP.
    - Another five have either announced or taken steps to do so in the near future.
- Asset quality and provisioning:
  - After the crisis, asset quality continued to deteriorate despite aggressive loan loss provisioning.
  - In the third quarter of 2009:
    - Banks’ nonperforming loans rose to 4.9 percent of total loans.
    - Net charge-offs rose to 2.7 percent (highest levels in the 26-year history of such recorded data).
  - Authorities expect further write-downs and charge-offs to emerge for some time; indicators likely to further deteriorate if jobless rates continue to rise.

### Macroeconomic Developments and Policy Response
- U.S. economy trajectory:
  - After a sharp contraction, the U.S. economy appears to have hit bottom in the second quarter of 2009 and is showing signs of recovery, although underlying economic activity remains weak.
  - GDP declined by 6.4 percent in 2009 Q1 and 0.1 percent in Q2 at an annual rate.
- Policy response:
  - Federal Reserve lowered policy rate to the 0–25 basis points range in December 2008 and expanded credit easing measures.
  - In January 2009 the Federal Reserve indicated conditions likely to warrant an exceptionally low rate for an extended period.
  - Fiscal stimulus of some 5 percent of GDP over fiscal years 2009–11 is supporting demand.
  - U.S. financial supervisors’ efforts have contributed to a substantial improvement in financial conditions and eased the post-Lehman credit crunch.
- Outstanding issue: sustainability of present buoyancy in some financial markets.

*Source: IMF FSAP assessment—1. Summary Compliance with the Basel Core Principles—Detailed Assessments (October–November 2009).*

### 15.      Looking ahead, the near-term outlook is for the gradual recovery to continue,

### _cr10121 - 15.      Looking ahead, the near-term outlook is for the gradual recovery to continue,

### Near-term macroeconomic outlook
- IMF staff forecasts:
  - annual contraction of 2.5 percent in 2009
  - growth of 2.7 percent in 2010
- Recovery characteristics and headwinds:
  - recovery expected to continue gradually, albeit slower than the typical recovery in previous cycles, with growth returning to a lower trend only in mid-2010
  - process of rebuilding household and financial intermediaries’ balance sheets will pose headwinds to demand for some time
  - relatively feeble labor market conditions expected to persist; unemployment is expected to continue rising, cresting slightly below 10 percent in 2010
  - households’ net worth fell by some US$11 trillion during 2008
  - banks face continued pressure from a challenging credit cycle
  - financial conditions, while significantly improved from severely stressed levels, remain strained as key markets continue to depend heavily on policy support
  - recent rapid pace of destocking may provide upside to production, but the strength of both domestic and foreign demand remains in question

### Medium-term outlook
- Post-crisis trend expectations:
  - the post-crisis trend rate of U.S. growth is expected to be lower than the pre-crisis trend
  - protracted recession and tighter financial conditions will crimp capital accumulation
  - high and persistent unemployment will boost equilibrium unemployment
  - both factors will lower potential growth

### Preconditions for effective banking supervision — overall assessment
- Public infrastructure supporting effective banking supervision is well-developed but complex and, at times, fragmented, with scope for enhancements to improve resilience
- Federal system note: Federal Government has considerable authority while individual states retain significant authority and responsibility, producing complexity and occasional fragmentation

### Business laws, courts, and professions
- Business law framework:
  - contract law established by common law and state statute; enforceability upheld by courts
  - enforceability of security interests primarily governed under Article 9 of the Uniform Commercial Code
  - enforcement of mortgages of real property upheld under (non-uniform) state laws
  - federal bankruptcy laws incorporate protections for both creditors and debtors
  - property rights protected under the Bill of Rights and state laws
- Dispute resolution:
  - business law disputes typically resolved in state trial courts of general jurisdiction; federal courts available for federal law claims or interstate parties
  - right of appeal exists in both federal and state systems
  - contracts may provide for mandatory arbitration rather than court resolution
- Judiciary and legal profession:
  - independent judiciary; federal and state judicial systems
  - federal judges appointed by the President with Senate advice and consent and receive lifetime appointments; states vary in appointment methods, some using general elections
  - lawyers require state licenses; all states but one (Wisconsin) require applicants not already members of another state’s bar to pass a bar examination
  - states regulate the profession and set ethical standards, often delegating regulation to state bar associations

### Accounting, auditing, and disclosures
- Accounting standards:
  - U.S. accounting standards (U.S. GAAP) established by the Financial Accounting Standards Board (FASB)
  - FASB and IASB pursuing a convergence program, but recent statements have raised issues of possible divergence in accounting for financial investments
  - standard setters examining lessons from the financial crisis, including debate over fair value accounting and loan loss provisioning
- Audit and disclosure framework:
  - financial statement audit requirements strengthened by the Sarbanes-Oxley Act (2002), which enhanced audit scrutiny, auditor independence, management attestations, and disclosure requirements
  - major banks disclose considerable quantitative and qualitative information quarterly and annually; adoption of Basel II for advanced banks will enhance disclosures
- Accounting policy issues highlighted by the crisis:
  - concerns about reliability of fair value for financial instruments not widely traded
  - debate over loan loss provisioning models and desire for more forward-looking provisioning versus accounting concerns about income smoothing
  - some observers see U.S. application as allowing less forward-looking provisioning than the equivalent IASB standard
  - proposals range from altering current standards to replacing them with comprehensive fair value accounting; experience with fair values during the crisis has led some banks and regulators to express doubts about full fair value requirements

### Regulatory reform proposals and gaps
- U.S. Treasury White Paper proposals under consideration by Congress include measures to:
  - establish systemic risk oversight
  - create a resolution regime for complex financial firms
  - strengthen regulation and supervision of securitization markets
  - comprehensively regulate all over-the-counter (OTC) derivatives (including credit default swaps)
  - harmonize futures and securities regulation
  - strengthen oversight, settlement capabilities, and liquidity of systemically important payment, clearing, and settlement systems
  - improve consumer and investor protection
- Identified regulatory weaknesses:
  - gaps within broader regulation of financial markets highlighted by the White Paper

### Causes of the crisis — credit culture and business models
- Erosion of credit culture manifested as lenders requiring less equity and/or collateral from borrowers for mortgage and corporate/leveraged lending
- Contributing factors:
  - stable macroeconomic environment with low interest rates
  - public policy incentives for lending to homeowners by banks and non-banks
  - competition from the non-bank/unregulated sector
  - reliance on originate-to-distribute model reduced underwriter incentives to maintain lending standards
  - lack of scrutiny by capital markets and end investors that financed poor quality credits
  - many off-balance sheet exposures were opaque and insufficiently distant; under stress they were brought back onto bank balance sheets

### Market discipline and corporate governance
- Market discipline infrastructure:
  - well-developed continuous disclosure obligations by public companies, extensive disclosure for certain investments, active rating agencies and analyst community
  - FBAs publish bank performance reports via inter-agency coordinating group; formal enforcement actions by FBAs are routinely made public
  - U.S. Banking Laws require banks and holding companies to provide detailed financial information to shareholders, depositors, and the public
- Weaknesses revealed by the crisis:
  - credit rating agencies criticized for inappropriate ratings approaches and opaque methodologies related to structured products and certain mortgage backed securities
  - opaqueness of complex structured products contributed to market disruption when sub-prime asset quality was questioned
  - inadequate information on exposures of the “shadow banking system” (structured investment vehicles and hedge funds) has led to proposals for registration and reporting to securities regulators and markets
- Corporate governance concerns:
  - criticisms include flawed board member selection, failure to separate CEO and board Chair roles, complex proxy/proposal procedures impeding director replacement, and compensation schemes incentivizing short-term results
  - SEC and U.S. administration have proposed strengthening shareholder rights to nominate board members and have a voice in executive compensation
- Interactions with regulatory objectives:
  - developments in corporate governance, accounting standards, and non-bank regulation could materially impact the environment for banking regulation and supervision
  - extending fair value accounting to banks’ entire loan portfolios could weaken safety and soundness infrastructure
  - failure to introduce more forward-looking loan provisioning could make bank regulation more difficult
  - bank regulators are actively involved in deliberations and must be prepared to take compensating action if policy developments make safety-and-soundness regulation materially more difficult

### Payment and settlement systems
- Wholesale payment infrastructure:
  - two systemically important systems settle in central bank money: Fedwire Funds Services (Fedwire) (RTGS operated by central bank) and CHIPS (private sector system combining net and gross real time settlement)
- Retail payment infrastructure:
  - employs public and private Automated Clearing Houses, regional and interregional check exchanges, and card payment schemes; none considered systemically important
- Performance during crisis:
  - payment and settlement systems performed well during market stress despite unprecedented challenges (higher-than-normal and variable volumes/values, financial difficulties of participants)
  - IMF FSAP attributes stability to robustness of settlement and operational risk management frameworks and massive liquidity support by authorities
- Identified vulnerabilities:
  - late-in-the-day payments in the RTGS system and concentration of payment and clearing activities on a few players identified as potential vulnerabilities in wholesale payment systems

### Crisis management and safety nets
- Remedial powers of Federal Banking Agencies (FBAs):
  - FBAs can require institutions to adopt board resolutions committing to corrective actions, issue enforceable cease and desist orders, and levy civil money penalties against banks, holding companies, officers, directors, controlling shareholders, and independent contractors
  - Prompt Corrective Action (PCA) regime requires FBAs to institute receivership proceedings within 90 days when tangible equity falls below 2 percent of a bank’s assets or to take other appropriate action with FDIC concurrence
  - PCA triggers action earlier when capital falls below “well-capitalized” threshold of 6/10 percent (Tier 1/Total capital)
  - authority to institute conservatorship allows the FDIC to control a troubled institution without closing it while seeking a permanent resolution
- Deposit insurance:
  - FDIC-sponsored deposit insurance insures all deposits at insured banks up to US$250,000 per depositor
  - deposit insurance assessments are risk-based; banks with higher assessed risk or less capital pay higher premiums
  - FDIC uses ex-ante funding and can replenish the Deposit Insurance Fund (DIF) through emergency assessments and borrowings from Treasury
  - due to current and expected demands on the DIF, insured institutions paid, in 2009, an advance premium for the coming three-year period
  - the DIF may be used, on a least-cost basis, either to compensate depositors or to facilitate resolution of a failed bank, typically through a purchase-and-assumption transaction
  - footnote: The amount of insurance was temporarily increased from US$100,000 to US$250,000 until year-end 2013.
- Systemic risk exception:
  - FDI Act includes a systemic risk exception requiring the Federal Reserve Board of Governors and the FDIC Board of Directors to recommend (by a 2/3 vote of the respective Boards) to the Secretary of the Treasury that a systemic risk determination be made
  - the Secretary of the Treasury (in consultation with the President) makes the systemic risk determination and finds that invoking the exception is necessary because compliance with the least-cost requirements of the FDI Act would have a serious adverse effect on economic conditions or financial stability
  - subject to these conditions, the exception permits the FDIC to take a wide range of actions
- Coordination and emergency lending:
  - President’s Working Group on Financial Markets (PWG) (Secretary of the Treasury, Chairman of the Fed, Chairs of the SEC and CFTC) has been a coordination mechanism in responding to the financial crisis
  - Federal Reserve emergency lending authority includes providing liquidity assistance to (i) solvent but illiquid banks, (ii) undercapitalized banks certified by their primary supervisor to be viable, and (iii) any individual, partnership, or corporation “in unusual and exigent circumstances” when the borrower is unable to obtain financing from banks
  - the Fed used this authority during the crisis to support financial institutions and non-financial entities (e.g., support of the commercial paper market)

*Source: _cr10121 - 15. Looking ahead, the near-term outlook is for the gradual recovery to continue,*

### 38.      The FDI Act provides a comprehensive scheme for the resolution of an insolvent

### _cr10121 - 38.      The FDI Act provides a comprehensive scheme for the resolution of an insolvent

### FDI Act and FDIC resolution tools
- The FDI Act provides a comprehensive definition of insolvency that includes a balance sheet test, a liquidity test, and various tests of viability.
- The FDI Act authority, together with the “prompt corrective action” provisions, authorizes a bank to be placed in receivership or otherwise resolved before its capital has been exhausted.
- As Receiver, the FDIC has authority to use:
  - purchase and assumption transactions,
  - insured deposit transfers,
  - loss-sharing arrangements,
  - puts for troubled assets,
  - bridge banks.
- FDIC practices:
  - prepares for closing the bank well in advance whenever feasible,
  - seeks to sell viable portions of the bank’s business with minimal publicity and disruption,
  - can provide depositors with virtually uninterrupted access to the insured portion of their funds in most cases.
- Judicial review of a Federal Supervisor’s decision to place a bank in receivership is available; litigants seeking to halt such a decision in advance of the Court’s final decision bear a heavy burden.
- An exemption from limits and delays ordinarily imposed by anti-trust laws permits transactions involving failed banks to proceed immediately.

### Main Findings: Objectives, independence, powers, transparency, and cooperation (CP 1)
- The U.S. supervisory system features a multiplicity of agencies; benefits include constructive challenge and checks and balances, but the system requires strong cooperation and coordination to avoid overlap and gaps.
- Sharing and confidentiality arrangements exist to facilitate inter-agency information sharing, but these arrangements form a “patchwork” with remaining gaps in consolidated oversight.
- The assessors observed:
  - redundancies in supervisory efforts,
  - lack of clarity in agency roles, partly due to the general absence of detailed, clearly stated objectives and mandates in original governing statutes.
- The assessment team recommends authorities (defined to include the FBAs, departments responsible for policy, and legislators) ensure clarity in the roles and expectations of each FBA.
- As mandates related to systemic stability expand and consumer protection mandates potentially alter, preserving the core safety and soundness mandates and missions of individual agencies is important to maintain accountability.
- Interaction between supervisory focus on bank/thrift versus holding company/group needs resolution; the crisis showed the two cannot be separated.
- The Gramm-Leach-Bliley Act of 1999 (GLB Act) limits information-gathering powers for individual agencies, impacting the FBAs’ capacity for full and effective consolidated supervision; U.S. Treasury proposes to remove some limitations as part of financial regulation reform proposals.
- FBAs have a tradition of authority and accountability vested in those in charge of supervision of individual banks and holding companies; improvements are needed to better integrate institution-specific information with system-wide perspectives.
- Improvement plans should be inter-agency, not only within each agency, requiring strong governance; some FBAs should ensure major institutions receive ongoing attention at the highest levels.
- Internal governance and accountability structures/processes could be modified to better integrate field and headquarters risk views and strengthen timeliness and appropriateness of supervisory responses.

### Licensing and structure (CPs 2–5)
- Banks have some degree of choice over their regulator due to the dual banking structure (state and Federal charters) and multiple federal regulators.
- The U.S. Treasury White Paper on Financial Regulatory Reform notes that “fragmentation of supervisory responsibilities...allowed owners of banks...to shop for the regulator of their choice.”
- Authorities have taken partial steps to reduce improper charter conversion; implementation of new rules (and supplementary rules if needed) should be closely monitored.
- Assessors note the actual number of conversions each year is small, but an “implicit threat” of conversion from banks to their supervisors remains.
- The stated minimum capital for new banks is US$2 million; this is relatively low compared to many other countries, though in practice much higher capital can be required for de-novo banks.

### Prudential regulation and requirements (CPs 6–18)
- The U.S. system remains on the Basel I risk-based capital framework; the advanced approaches of Basel II have been enacted and will apply to major banks over the next 2–3 years.
- U.S. Basel I framework includes additional features (e.g., an approach to securitization) not present in Basel I.
- U.S. capital regulations include minimum leverage ratio requirements.
- Shortcomings relative to CP 6 include:
  - definition of Tier 1 capital for holding companies with regard to innovative instruments,
  - absence of capital rules for SLHCs,
  - allowing intangibles to count for a very high portion of a bank or thrift’s Tier 1 capital.
- International discussions on definition of capital and harmonization of deductions are ongoing at the Basel Committee on Banking Supervision (BCBS).
- Crisis revealed severe shortcomings in bank risk management and supervisory oversight failing to identify and remedy weaknesses; these weaknesses were sufficiently large to create serious problems for individual banks and the financial system.
- Weakness drivers included confluence of credit (including counterparty credit), market, and liquidity risk under extreme conditions; multiple mergers contributed to inconsistencies in enterprise-wide risk architecture.
- Improvements needed and strategy to achieve them are broadly understood; processes to monitor progress are in place. However:
  - major risk monitoring improvements involving complex IT systems take time,
  - better relating compensation to risk is at an early stage of implementation,
  - supervisors need to consider compensating measures firms should maintain until risk management improvements are fully embedded.
- Credit risk supervision:
  - FBAs have well-developed policies for traditional credit risk, but processes were not fully effective for certain markets and products during the turmoil.
  - Supervisors were ineffective in preventing a widespread and material decline in underwriting standards of residential mortgage loans.
  - Material credit concentrations emerged (including CRE concentrations at smaller and mid-size banks) and were monitored, but action was insufficient.
  - Weaknesses existed in analysis of complex credit products and in stress testing at large and smaller banks.
  - Surveillance and monitoring of credit risk needs enhancement across banks and their affiliates.
- Supervisory strategy should link monitoring to effective action through a more comprehensive, shared, coordinated, and strategic approach addressing:
  - forcefulness of interventions,
  - timeliness of guidance,
  - whether guidance occasionally needs specific limits,
  - consistency of follow-up on new guidance,
  - FBAs’ ability to intervene on systemic weaknesses that may require broader authority.
- Market risk monitoring:
  - Material weaknesses in market risk measurement and monitoring by financial institutions were revealed.
  - Major issues: suitability of market risk measurement and models at certain major firms, lack of reliable valuation of mark-to-market positions, completeness and use of market stress testing.
  - Supervisory implementation of rules was not sufficiently effective; substantive improvements are required and in progress, some requiring considerable time.
  - Confirming new processes operate effectively as planned will be important as market conditions improve.
- Liquidity risk:
  - FBA guidance on liquidity risk management and supervision is consistent with international standards and likely to evolve due to pending interagency guidance and Basel liquidity standards.
  - Liquidity monitoring was greatly expanded during the crisis and contingency plans tested; improvements are required to make crisis-driven measures sustainable and structured.
  - Further progress is needed at certain major complex banks for high-quality ongoing liquidity risk management, including timely stress testing linked to management decisions on P&L and balance sheet.
  - Improvements depend on better enterprise-wide aggregation of on- and off-balance sheet data linked to P&L, financial, and balance sheet systems.
- Operational risk supervision appears effective overall; greater focus and specialization could be beneficial, and achieving a truly group-wide perspective requires considerable inter-agency coordination.
  - Examples of inter-agency work: FFIEC’s IT Subcommittee (ITS) common examination/guidance material, MDPS, Regional Technology Service Provider (TSP), and Basel II operational risk supervisory processes.
- Interest rate risk supervision is broadly consistent across FBAs; benefits could be achieved from improved consistency in examination approaches and measurement techniques.
  - A common framework for Interest Rate Risk (IRR) measurement across all FBAs is desirable (with variations for complexity differences) to better assess and compare banks and improve CAMELS consistency.
- Banks maintain comprehensive programs to prevent abuse of operations and services; supervisors monitor compliance via full-scope or targeted examinations.
  - Internal audit and internal controls contribute to oversight.
  - Reporting requirements on suspicious transactions (within banks, to supervisors, and to judicial authorities) appear adequate.
  - The FATF assessment in 2006 identified deficiencies relevant to banks that need remedy.

### Methods of ongoing banking supervision (CPs 19–21)
- FBAs collectively have broad, but not unlimited, legal authority to regulate and supervise banks and holding companies within their jurisdiction.
- Primary supervisory tools:
  - on-site examinations (full-scope on-site examinations of banks at least once every year or 18 months),
  - off-site analyses and surveillance between full-scope examinations.
- For the largest banking organizations, supervisory activities are continuous and supported by on-site examination teams.
- Bank holding company inspection cycles are mandated depending on size, complexity, and rating; SLHC examinations are conducted concurrently with OTS examinations of subsidiary savings associations.
- Continuous supervision program exists at major banks.
- Each FBA employs standard supervisory techniques broadly consistently and provides supervisors with manuals, guidance, and assessment mechanisms embedded in practice.
- Areas for improvement:
  - consistency between agency operating processes,
  - development of a “best of breed” model for supervision,
  - unnecessary differences in examination manuals and supplementary assessments,
  - varying off-site surveillance models.
- The CAMELS-based rating system:
  - is somewhat outdated compared to overseas peers and relies on high-level, broad descriptions,
  - does not distinguish well between inherent risk and risk controls,
  - guidance on assigning component ratings tends to overlap,
  - ratings are slow to adjust (reflecting annual review cycle) and are “sticky” over time.
  - Lack of risk differentiation in ratings may reflect adverse incentives due to multiple uses of ratings (e.g., influence on deposit insurance premiums, deposit-gathering capacity, and branching/acquisition approval requirements).

*Source: _cr10121 - 38.      The FDI Act provides a comprehensive scheme for the resolution of an insolvent*

### 57.      The FBAs consider that the uniform CAMELS framework and their own

### _cr10121 - 57.      The FBAs consider that the uniform CAMELS framework and their own

### Risk rating frameworks and recommendations
- FBAs use the uniform CAMELS framework and agency-specific supplementary risk rating systems that serve distinct purposes and, when combined, provide more complete information than either alone.
- Assessors note it is unclear why a single measure cannot capture this information and that supplementary systems differ by agency and are not readily comparable.
- Recommendations:
  - Either (i) overhaul the Uniform Financial Institutions Ratings System (UFIRS), building on agency-developed, more granular and risk-based rating systems; or
  - (ii) if the CAMELS system is too embedded to change, direct greater effort to develop a consistent, more granular, forward-looking risk rating system that at least provides a “common language” across the FBAs.

### Market turmoil, supervisory coordination, and consolidated oversight
- Recent market turmoil highlighted areas where regulatory oversight and coordination need strengthening.
- The general approach and structure of supervision did not assist in developing and maintaining a thorough understanding of the operations of individual banking groups or the banking system as a whole.
- The U.S. Treasury Department’s financial reform package proposes strengthening consolidated oversight capacity; supervisory intensity of non-banking parts of banking groups will also need to increase.

### Accounting and disclosure (CP 22)
- U.S. agencies require extensive disclosure of financial information by regulated banks and holding companies, founded on U.S. GAAP.
- FASB and IASB are reviewing accounting standards to (i) converge to a single set of standards, and (ii) consider lessons from the recent financial crisis; key decisions relate to revised international standards for fair value accounting and loan loss provisions.
- Supervisory staff criticized aligning regulatory reporting with U.S. GAAP for allowance for loan losses because U.S. GAAP applies an incurred loss model that does not permit consideration of future events when estimating loan losses.
  - Supervisors are frustrated at limitations on requiring banks to report what they consider appropriate loan loss reserves from a safety-and-soundness perspective.
  - Assessors noted larger buffers against loan losses could be achieved by imposing higher minimum capital requirements, but supervisory staff viewed an 'above the line' charge to explicitly recognize potential future loan losses as more appropriate.
- The current framework undermines the efficacy of the PCA regime because thresholds for regulatory intervention are aligned to U.S. GAAP reporting; assessors noted numerous instances of 'well capitalized' banks being subject to regulatory sanctions for being insufficiently capitalized.

### Corrective and remedial powers of supervisors (CP 23)
- FBAs identify problems during on-site and off-site examinations; most issues are resolved informally during examination or ongoing discussions with the EIC/Central Point of Contact (CPC).
- Serious, pervasive or repeated problems may require formal supervisory action, always expressed in a written document; formal actions are published monthly (with limited exceptions).
- Supervisors may request detailed policies and action plans with specific target dates and review board plans and written progress reports against milestone dates; progress is also assessed through ad hoc or normal on-site examinations.
- Supervisory tools and penalties:
  - Agencies may impose remedial penalties and sanctions on banks, holding companies, management, board members, employees, controlling shareholders, other persons participating in affairs, and independent contractors.
  - Agencies may take prompt remedial action, including formal enforcement action if deficiencies are serious or repeated.
  - In cases of immediate threat to a bank or depositors' interests, an agency may issue a temporary order to cease and desist.

### Prompt Corrective Action (PCA) regime
- PCA applies when a bank’s capital falls below prescribed minimum ratios/levels and provides a backstop against regulatory forbearance.
- Agencies have powers to intervene before minimum capital ratios are breached.
- Rapid resolution of some major banks (and non-banks) during the crisis is noted as an indicator of timely action.
- Dichotomy: supervisors often assess banks as capital deficient and require capital infusion while banks may be defined as “well capitalized” under PCA definitions, due to inconsistency between U.S. GAAP-based PCA regime and supervisory risk assessment systems; this could weaken credibility of enforcement actions.

### Consolidated and cross-border banking supervision (CPs 24–25)
- Existing legislation for consolidated supervision needs strengthening.
  - Federal Reserve is responsible for consolidated supervision for U.S. BHCs, including FHCs.
  - OTS is responsible for consolidated supervision of SLHCs.
  - All BHCs and SLHCs are subject to consolidated supervision.
- Federal Reserve and OTS are expected to rely on primary supervisors and functional regulators for information on financial institutions within holding companies.
- The GLB Act impedes the Federal Reserve’s ability, as consolidated supervisor, to obtain information from or impose prudential restrictions on subsidiaries of a BHC that already have a primary supervisor; the same holds for OTS and SLHCs.
- Restrictions, statutory and practical, on access to information hinder group-wide risk assessment.
- Some steps taken post-crisis: FBAs ramped up consolidated supervision efforts including for former investment banks now BHCs.
- Desirable changes:
  - Clear, ready, direct, legally supported access for consolidated supervisors.
  - Repeal legislative restrictions that allow workarounds only when there is “a material risk to the bank.”
  - Explicitly mandate risk-based application and monitoring of large exposure and related party limits for holding companies.
  - OTS does not apply formal consolidated capital requirements for SLHCs; SLHC capital supervision is case-by-case.

### International cooperation and information sharing
- FBAs have clear authority to share confidential supervisory information with foreign banking and other sector supervisors to facilitate global consolidated supervision and home-host relationships, subject to limitation of not impinging on “U.S. interests.”
- Information must be used for lawful supervisory purposes and recipients must keep it confidential.
- FBAs provide adequate data and information to host country supervisors about U.S. banks and holding companies and maintain ongoing contact with supervisors in other countries with material U.S. operations, including periodic visits.

### Table 1 — Summary compliance with the Basel Core Principles — selected core principles, gradings and key comments
- CP 1 Objectives, independence, powers, transparency, and cooperation — Grading: C
  - Subcomponents 1.1–1.6: all graded C with comments on need for greater clarity on mandates, linking strategic resource planning to forward-looking risk measures, and need for improved collaboration across FBAs.
- CP 2 Permissible activities — Grading: C
- CP 3 Licensing criteria — Grading: C
  - Note: scope of interagency agreement to prevent inappropriate charter conversions should be strengthened; (absolute) minimum capital requirement for new banks is relatively low, although practice has required higher levels of capital.
- CP 4 Transfer of significant ownership — Grading: C
- CP 5 Major acquisitions — Grading: C
- CP 6 Capital adequacy — Grading: LC
  - Shortcomings: definition of Tier 1 capital for holding companies with regard to innovative instruments; absence of capital rules for SLHCs; allowing intangibles (especially mortgage servicing rights) to count for a very high portion of Tier 1 capital.
- CP 7 Risk management process — Grading: MNC
  - Severe shortcomings in enterprise-wide risk monitoring and management at banks revealed by the crisis; supervisory oversight ineffective in identifying and remediating weaknesses; needed improvements will take time to implement and test.
- CP 8 Credit risk — Grading: LC
  - Well-developed rules and guidance, but processes not fully effective for some markets, particularly residential mortgages and CRE exposures at smaller and mid-size banks; weaknesses in understanding risks of complex credit products.
- CP 9 Problem assets, provisions, and reserves — Grading: C
  - FBAs process is well developed and effective; effectiveness would increase if accounting rules allowed more-forward-looking provisioning.
- CP 10 Large exposure limits — Grading: C
  - Aggregate regulatory limits for total large exposures are high compared with international practices; reporting lacks detail (e.g., not showing total indebtedness).
- CP 11 Exposure to related parties — Grading: C
  - Supervisory regulations lack specificity on board oversight and reporting requirements; aggregate lending limit to a single related party or connected group set at 15 percent of the bank's own fund plus surplus funds; overall limit for lending to all related parties in aggregate set at 100 percent of own funds plus surplus funds.
- CP 12 Country and transfer risks — Grading: C
- CP 13 Market risks — Grading: LC
  - Material weaknesses in market risk monitoring, use of models, valuation and risk management; substantial improvements in progress but will take time.
- CP 14 Liquidity risk — Grading: LC
  - Guidance consistent with international standards; needed effectiveness improvements in progress; crisis-induced focus on liquidity being formalized into enhanced supervisory program.
- CP 15 Operational risk — Grading: C
  - Agencies should continue to build more holistic and structured approaches, utilizing enhanced cross-agency mechanisms.
- CP 16 Interest rate risk in the banking book — Grading: C
  - Consider introducing a consistent measurement approach across FBAs.
- CP 17 Internal control and audit — Grading: C
- CP 18 Abuse of financial services — Grading: C
  - Noted that a number of CP 18-relevant issues as identified by the FATF remain to be addressed.
- CP 19 Supervisory approach — Grading: LC
  - Need to improve group-wide oversight of financial groups, including unregulated entities; introducing domestic “supervisory colleges” may assist; review of risk rating systems needed to better distinguish between banks.
- CP 20 Supervisory techniques — Grading: C
  - Suggested review of supervisory manuals and processes to remove unnecessary differences and develop a “best of breed” approach.
- CP 21 Supervisory reporting — Grading: C
  - Suggested review of solo reporting requirements and consideration of implications of U.S. GAAP for supervision and the PCA regime.
- CP 22 Accounting and disclosure — Grading: C
  - Could consider statutory reporting (“whistleblower”) obligations for external auditors reporting to bank supervisors, with associated protections.
- CP 23 Corrective and remedial powers of supervisors — Grading: C
- CP 24 Consolidated supervision — Grading: LC
  - Present legislation and practices hinder effective consolidated supervision; gaps in regulatory limits and reporting of large exposures, related lending, and capital on a consolidated basis at the holding company level; de facto practices of applying and monitoring large exposure and related lending limits should be expressly mandated; SLHC capital supervised on a case-by-case basis.

*Source: _cr10121 - 57.      The FBAs consider that the uniform CAMELS framework and their own*

### 25. Home-host relationships C The authorities comply with this CP.

### _cr10121 - 25. Home-host relationships C The authorities comply with this CP.

### Principle 1 — Objectives, autonomy, powers, and resources: summary assessment
- Assessment: Compliant
- System: “dual banking system” (federal or state charter choice).
- Primary federal banking authorities (FBAs) responsible for each bank type:
  - OCC: national banks
  - Federal Reserve: state member banks
  - FDIC: state nonmember banks
  - OTS: federal or state savings associations
- Federal Reserve and OTS: responsibility for regulating/supervising bank and thrift holding companies (BHCs, SLHCs).
- Coordination mechanisms: FFIEC, interagency arrangements; GLB Act imposes limits on information access between functional supervisors and umbrella supervisors.

### Principle 1(1) — Responsibilities and objectives: findings and analysis
- Findings:
  - Agencies operate pursuant to express statutory grants; substantive statutory requirements establish objectives (promote safety and soundness, maintain financial stability, effective competition, fair access/treatment).
  - FDIC additional objective: minimize disruptive effects of bank failures.
  - OTS additional objective: encourage savings associations to provide housing credit safely and soundly.
  - Agencies use delegated rulemaking, guidance, manuals; supervisory framework addresses capital adequacy, loan underwriting, single borrower and related party exposure limits, asset quality, provisioning, risk management, internal controls, accounting, liquidity, AML/CFT/anti-fraud.
  - FFIEC mandate: provide uniform principles, standards and report forms for federal examination.
  - GLB Act: umbrella supervisors rely on primary functional supervisor examinations; practice altered during crisis to work around restrictions.
  - Some entities (ILCs, special purpose credit card banks, grandfathered institutions) may access safety net without consolidated supervision; Administration proposes to require consolidated regulation/supervision as BHC within five years for these entities.
- Assessment: Compliant
- Comments (selected):
  - Multiplicity of mandates across agencies; best practice would have all mandates set out in legislation.
  - Risk of blurred accountability as agencies enhance group-level supervision.
  - Need to better link strategic resource planning to forward-looking risk assessment; CAMELS ratings used but are imprecise and not very forward-looking.

### Principle 1(2) — Independence, accountability and transparency: findings and analysis
- Findings:
  - Governance: OCC and OTS report to Secretary of the Treasury (statutory protections); FDIC independent agency with three internal directors plus OCC and OTS heads; Federal Reserve is independent with Board of Governors and Reserve Banks.
  - Agency heads: appointed by President with Senate advice/consent; fixed terms; removal only for cause with Senate notified.
  - Funding: agencies funded outside congressional appropriation process (OCC/OTS by fees; FDIC supervision/regulation program from interest earnings on deposit insurance fund; FRB supervision from income on FRB operations).
  - Performance reporting: compliance with Government Performance and Results Act of 1993; variation across agencies in goals/measures; performance reports focus often on activity measures (examination completion).
  - Quality control: internal review, lessons learned, independent Inspectors General (IGs); material loss reviews mandated when bank failure costs FDIC insurance fund more than US$25 million.
  - Staffing and resources: large dedicated on-site teams for major banks (10–20 at holding company to 50–70 at a major bank; total up to 80–90 including multiple agencies); portfolio approach for smaller banks; resource plans typically current year and one year forward; modest FTE increases starting 2007/2008 and accelerating, largest FTE increases at FDIC.
  - Human resources risk: around one-third of supervisory staff eligible for retirement already or in the next five years.
  - Training and compensation: commissioning tests, internal/external/shared training (FFIEC), variable-pay and retention programs; FBAs have more generous compensation than general Federal Government scales.
- Assessment: Compliant
- Comments (selected):
  - Need to better integrate field and headquarters risk views.
  - Consider formalizing Federal Reserve governance for supervisory matters (e.g., Fed governor as vice chair with oversight).
  - Raise threshold for material loss reviews to give IGs more discretion; use IGs to draw themes from individual reviews.

### Principle 1(3) — Legal framework (authorization and supervision): findings
- Findings:
  - OCC and OTS: licensing/revocation authority for national banks and federal savings associations; states license state banks/savings associations.
  - FDIC: sole authority to grant/deny/revoke Federal deposit insurance.
  - FBAs generally can set/implement/modify prudential measures without statutory changes; limited statutory prescriptive limits exist (e.g., single borrower limits, affiliate/related party transaction limits).
  - Agencies publish supervisory guidance and examination manuals (not legally binding) and may seek public comment.
  - FBAs have broad authority to obtain information from banks and affiliates; GLB Act limits some agency access where other functional supervisors exist.
- Assessment: Compliant
- Comments:
  - Fragmented system allows banks some choice of regulator; GLB Act limitations affect consolidated supervision; Treasury proposals aim to remove some limitations.

### Principle 1(4) & 1(5) — Legal powers and remedial measures: findings
- Findings:
  - Statutory Prompt Corrective Action regime (12 U.S.C. 1831o) implemented.
  - Broad statutory authority to obtain information (12 U.S.C. §§ 324–26, 481, 483, 602, 625, 1467, 1817, 1820, 1844, 1867) and full access to books, records, employees, external auditors’ work papers.
  - Agencies can impose remedial measures, sanctions, require prompt remedial action, cease-and-desist orders, and revoke licenses; compliance powers used routinely.
- Assessment: Compliant
- Comments:
  - GLB Act limits require reliance on other functional supervisors for some information; ad-hoc information-sharing arrangements established.

### Principle 1(5) — Legal protections for supervisors
- Findings:
  - FBAs and staff protected against lawsuits for good-faith actions; sovereign immunity and qualified immunity apply; limited civil suits permitted with United States substituted as defendant upon certification.
  - Agencies protect executives/staff against defense costs in practice (few cases).
- Assessment: Compliant

### Principle 1(6) — Cooperation and information-sharing
- Findings:
  - Statutory powers to share confidential business information (12 U.S.C.§§1817(a)(2)(A) and (C); 3412(e)).
  - FFIEC coordination mandated for certain matters, shared electronic databases and examination procedures.
  - Agencies have formal cooperation agreements with foreign supervisors and exchange letters for best-effort sharing; routine informal sharing occurs.
  - Prior to sharing, assurances required that information used only for lawful supervisory purposes and kept confidential; International Banking Act requires determination that disclosure is appropriate and recipient agreement to keep confidentiality to “the extent possible under applicable law” (12 U.S.C. § 3109 (b)).
  - Agencies may resist compelled disclosure and must notify U.S. law enforcement if criminal law violations indicated.
- Assessment: Compliant
- Comments:
  - Ad-hoc structure of arrangements works but deficiencies in consolidated oversight remain (see CP 24). Examples where opportunities for cooperation and constructive challenge were missed; need to redouble coordination efforts.

### Principle 2 — Permissible activities: findings
- Assessment: Compliant
- Findings:
  - Federal and state laws define “bank” by charter, permitted activities (including accepting demand deposits and lending), and supervision.
  - Specialized institutions (savings associations) provide similar services; some institutions (ILCs, trust companies, credit card banks, “non-bank banks”) may not be subject to full banking regulation and may remain in deposit insurance via grandfathering.
  - Criminal prohibitions on unauthorized use of the word “bank” and terms implying federal charter, membership, or deposit insurance (12 U.S.C. §378).
  - FFIEC / National Information Center publish updated information on banks and holding companies, including structural and financial data.

### Principle 3 — Licensing criteria: findings and recommendations
- Assessment: Compliant
- Findings:
  - Licensing authorities and criteria set in statutes/regulations (OCC 12 U.S.C. §21 et seq.; OTS 12 U.S.C. §1464(a); FDIC authority on deposit insurance).
  - Licensing evaluations consider organizers’ familiarity with laws, competent management, capitalization/liquidity, profitability prospects, safety and soundness (12 CFR 5.20(f)(2)); FDIC considers seven statutory factors under Section 6 of the FDI Act.
  - Initial capital practical minimum: de facto US$2 million (FDIC deposit insurance requirement); federal savings association initial required capital also US$2 million; practice often requires more (example: US$10 million typical for a bank planning to grow to US$100 million assets).
  - Applicants must identify prospective shareholders and key policymakers; principal shareholders generally those owning 10 percent or more must provide detailed background; beneficial ownership investigated.
  - For foreign banks, licensing/approval involves Federal Reserve and confirmation of home-country consolidated supervision.
  - Applicants must show strategic/operational plans viable; expectation that new banks achieve stable profitability typically within three years.
  - Agencies monitor de novo banks for two to three years after licensing; prior notice of business plan changes required in first three years.
- Comments:
  - Dual banking structure and multiplicity of regulators allow charter choice; interagency agreement restricts conversions while supervisory measures pending only for banks with CAMELS rating 3, 4 or 5, leaving three quarters of banks outside this agreement.
  - Assessors noted licensing application summaries (SOIs) provided to decision-makers were sometimes insufficiently deep; decision-makers need more comprehensive assessed information.

### Principle 4 — Transfer of significant ownership: findings
- Assessment: Compliant
- Findings:
  - Change in Bank Control Act (CIBC Act, 12 U.S.C. §1817(j)) requires prior authorization for acquisitions of control; control defined as power to direct management or vote 25 percent or more; refutable presumption of control at 10 percent.
  - BHC Act (12 U.S.C. §1842(a)) and HOLA (12 U.S.C. §1467a(e)) contain similar provisions.
  - Agencies require notices and can deny or condition acquisitions; after-the-fact notices possible with penalties and unwinding authority.
  - Agencies obtain shareholder identities annually (Federal Reserve requires submission for 5 percent or more; OTS reports for more than 5 percent) and trace beneficial ownership up company ownership chains (25 percent threshold at each higher level).
- Assessment: Compliant

### Principle 5 — Major acquisitions: findings
- Assessment: Compliant
- Findings:
  - Federal/state laws limit and define permissible acquisitions/investments; agencies review major acquisitions/business combinations; FHCs and certain Edge corporation investments have specific exemptions (e.g., Edge investments in FBOs not exceeding US$25 million).
  - Criteria for approval include competitive concerns, financial/managerial resources, convenience and needs, future prospects, and impact on Deposit Insurance Fund.
  - Agencies assess cross-border operations for host-country supervisory capacity and ability to obtain information; authority to deny requests lacking adequate supervisory information.
  - Some acquisitions/investments may proceed without prior approval tied to capital/management criteria or size (e.g., opening a second foreign branch in same country often does not need approval).
- Assessment: Compliant

### Principle 6 — Capital adequacy: findings and key numeric requirements
- Assessment: Compliant
- Findings:
  - Laws/regulations require banks and BHCs to maintain minimum capital ratios; FBAs have adopted risk-based capital and leverage capital requirements based on Basel I framework.
  - SLHCs: no risk-based capital rules apply; OTS assesses capital adequacy on case-by-case basis; SLHCs account for approximately 10 per cent of total bank and thrift assets.
  - Market risk rule (market risk amendment to Basel I) adopted for banks/BHCs with material market risks; OTS to implement BCBS market risk charges by year-end 2010.
  - Market risk rule applicability: trading activity equal to 10 percent or more of total assets, or US$1 billion or more (worldwide consolidated basis); approximately 30 banking groups were subject to the market risk rule at the time of assessment.
  - Foreign banks seeking FHC status: well-capitalized standard consistent with domestic PCA regime: 6 percent Tier 1, 10 percent Total capital (usually home country calculations) with no explicit leverage requirement.
  - Minimum capital requirements for individual banks and BHCs:
    - 4 percent Tier 1 risk-based capital
    - 8 percent total risk-based capital
    - 4 percent Tier 1 leverage capital
    - 3 percent Tier 1 leverage capital minimum for banks and BHCs rated composite 1 under respective rating systems and for BHCs that have implemented the market risk rule
  - Most banks and BHCs operate with capital levels well above these minimum requirements.
  - Capital instrument qualification: must be unsecured and not contain covenants, terms, or restrictions inconsistent with safe and sound banking practices.
- Assessment: Compliant

*Source: _cr10121 - 25. Home-host relationships C The authorities comply with this CP.*

### Section 0100 of the OTS Examination Handbook for a full definition and description of Tier 1 and

### _cr10121 - Section 0100 of the OTS Examination Handbook for a full definition and description of Tier 1 and

### Tier capital definitions and roles
- Tier 1 and Tier 2 capital: see Section 0100 of the OTS Examination Handbook for a full definition and description of Tier 1 and Tier 2 capital.
- Tier 3 capital:
  - Permitted to protect against market risks.
  - Characterized as unsecured subordinated debt with several other characteristics described in the market risk rule.
  - Use of Tier 3 capital is rare.

### Bifurcated capital requirements
- The FBAs have implemented what they describe as "bifurcated" capital requirements for banks and BHCs.

### New risk-based capital framework (Basel II advanced approaches)
- A new risk-based capital framework (based on the advanced approaches in the Basel II framework):
  - Is mandatory for "core banking organizations" and available on a voluntary basis to other banks and BHCs.
  - Is enacted and implementation is in progress.
  - Banks and BHCs are only eligible to calculate their regulatory capital based on this rule starting no earlier than 2011, once they have met a range of qualifying criteria including successfully completing a parallel run over a minimum of four quarters.
  - FBAs must approve a banking organisation moving out of the parallel run.
  - Core banking organizations include banks and BHCs that have US$250 billion or more of total consolidated assets or US$10 billion or more of on-balance-sheet foreign exposure.
  - At the time of assessment, implementation plans have been received from 14 core banking organizations.
  - As this rule is not yet the basis for banks’ capital calculations, it was not assessed in detail in this FSAP; however, given the imminent implementation the assessors performed a high level review of the state of implementation and provided separate comments to the FBAs.

### Proposed Basel II standardized approach (standardized approach rule)
- The FBAs have issued a proposed rule that would implement the Basel II standardized approach with certain modifications to address U.S. markets, most notably residential mortgages.
- The proposal would permit banks and BHCs (other than core banking organizations subject to the advanced approaches final rule) to choose to remain under the current risk-based capital rule or opt into the standardized approach rule as described in the proposal.
- Regulatory notice: See 73 Fed. Reg. 43982 (July 29, 2008).
- Status: Comments were received on this proposal but the implementing rule has not been finalized, and there is no publicly-announced date for its [finalization].

*Source: _cr10121 - Section 0100 of the OTS Examination Handbook for a full definition and description of Tier 1 and*

### introduction. Accordingly, it was not included in this assessment.

### _cr10121 - introduction. Accordingly, it was not included in this assessment.

### Capital definition, scope, and Basel alignment (EC 2–5)
- U.S. risk-weighting and capital calculation for banks and BHCs are “essentially consistent with Basel I,” though the Basel I Accord does not formally apply to holding companies.
- Basel II rules, including the definition of capital, apply formally to holding companies.
- Market risk capital requirement:
  - Applies only to “certain large, complex, commercial banks and BHCs” considered internationally active.
  - FBAs report the market risk component in smaller banks “is not large.”
  - Leverage ratio is computed as Tier 1 capital divided by average total consolidated assets and must exceed a specified level; it does not include off-balance sheet risks.
- Advanced approaches final rule (Basel II) for core banks (once implemented, potentially starting in 2011) will produce more risk-sensitive capital requirements for on- and off-balance-sheet items.

### Tier 1 capital and innovative instruments (EC 2, comments)
- Limits on innovative instruments included in Tier 1 capital:
  - For the largest BHCs (the mandatory, “core” Basel II banks): 15 percent (the limit in BCBS rules on innovative instruments).
  - For other BHCs, including those that opt in to the advanced approaches rule: 25 percent.
- Cumulative preferred shares and cumulative trust preferred securities:
  - Are included in the 15/25 percent limit in the U.S., contrary to BCBS rules and the published 1998 BCBS standards where such instruments would have to be non-cumulative to qualify in Tier 1.
  - Returns paid on certain of them (i.e., trust preferred securities) are tax deductible.
- Quantitative prevalence:
  - These instruments make up “10–15 percent on average of consolidated Tier 1 capital of the 14 ‘core’ BHC’s (those under the advanced approaches rule).”
  - More recently, cumulative preferred shares beyond the 15/25 percent limit issued as part of TARP are included in Tier 1 capital through specific changes to risk-based and advanced approaches capital rules.

### Intangibles and mortgage servicing rights (MSRs) (EC 2)
- U.S. authorities do not require automatic deduction of MSRs from capital for banks and BHCs.
- “Qualifying intangibles” category (which do not need to be deducted) includes:
  - Mortgage servicing rights (MSRs)
  - Non-mortgage servicing rights (NMSRs)
  - Purchased credit card receivables (PCCRs)
- Limits and composition:
  - Qualifying intangibles may be included in capital “up to 100 percent of Tier 1 capital,” of which “no more than 25 percent can consist of NMSRs and PCCRs.”
- Materiality of MSRs in Tier 1 capital:
  - MSRs typically amounted to “10–20 percent of Tier 1 capital for a number of the largest banks.”
  - Were “in the range of 40 percent of Tier 1 capital for some banks.”
  - Were “75 percent to over 100 percent of Tier 1 at a small number of institutions (including some that failed).”
- Risk-based capital rules at the bank level in a corporate group do not permit these intangibles; the holdco-level rules permitting them are carried into the advanced approaches capital rule and “are not compliant with the Basel II requirements in this regard.”

### Supervision of capital adequacy and corrective powers (EC 3, EC 6)
- Statutory authority:
  - Agencies have broad statutory authority to establish minimum capital levels (reference 12 USC § 3907(a)(2)).
  - PCA statute: 12 USC § 1831o.
  - Capital directives authority: 12 USC § 3907(b)(2).
- Use of authority:
  - Supervisors can impose specific capital charges and have used this authority in practice.
  - Under UFIRS, supervisors assess capital adequacy every full-scope examination; reflected in the Capital component of CAMELS.
  - RFI/C rating system “F” component assesses BHC financial condition, including capital adequacy; OTS CORE rating includes SLHC capital.
- Prompt Corrective Action (PCA) trigger thresholds and effects:
  - To be “well capitalized” a bank must have:
    - Total risk-based capital ratio of “10 percent or greater”;
    - Tier 1 risk-based capital ratio of “6 percent or greater”;
    - Leverage ratio of “5 percent or greater”.
  - Consequences of undercapitalization include mandatory submission of a capital restoration plan, possible guarantees by the holding company up to “5 percent of the bank’s total assets at the time the institution became undercapitalized,” restrictions on asset growth and new lines of business, and potential removal of officers/directors and appointment of receiver or conservator if critically undercapitalized.

### Internal models, model approval, and scope (EC 7)
- Certain banks can use internal risk assessments as inputs to regulatory capital calculation for market risk and for certain positions in ABCP programs (resulting in a “100–200 percent risk weight”), subject to rigorous qualifying standards and supervisory approval of models.
- Use of internal assessments will become more prevalent with Basel II advanced approaches implementation.
- Supervisors may revoke authorizations but “are more likely to use alternatives if models do not continue to meet the standards.”

### Consolidation, SLHCs, and assessment differences (AC 4, AC 1–3)
- Capital adequacy of holding companies is assessed on a top-tier, fully consolidated basis; subsidiary bank-level ratios also assessed on a consolidated basis at that level.
- No calculation of the solo bank capital position excluding subsidiaries.
- SLHCs:
  - No specific capital rules; adequacy determined case-by-case.
  - For financial SLHC groups similar to BHCs, a proxy capital calculation according to BHC risk-based capital (Basel I) rules may be used; other factors such as experience in comparable non-financial peers may be considered.
  - Lack of formal capital rules for SLHCs is a significant departure from international core principles and can allow SLHCs to be less well capitalized in practice.
- Application across banks:
  - All non-internationally active banks are subject to Basel I risk-based capital requirements; non-internationally active banks may not be subject to the market risk rule depending on trading book size.

### Risk management process, deficiencies, and supervisory effectiveness (Principle 7; ECs and Assessment)
- Requirements and guidance:
  - Banks and holding companies must have comprehensive risk management policies and processes; interagency safety and soundness guidelines require internal controls and information systems appropriate to size and activities.
  - Supervisory Guidance on the Supervisory Review Process (Pillar 2) sets further requirements for core banks under Basel II.
- Identified weaknesses (2007–2009 period):
  - Weaknesses in firm-wide aggregation of credit, market, and liquidity risks; inadequate enterprise-wide risk monitoring and IT/risk infrastructure.
  - Difficulty valuing complex products consistently, estimating counterparty credit risk, aggregating exposures, and performing forward-looking stress testing.
  - Reliance on external ratings (e.g., AAA) without independent assessment in some cases.
  - Off-balance-sheet structures not fully considered due to legal separateness but supported by banks.
- Supervisory approach and challenges:
  - Supervisors assess risk management in CAMELS, RFI/C, and OTS CORE ratings; use continuous supervision, on-site reviews, and horizontal reviews.
  - Supervisors reported cases where inherent risk was rated high while risk management was only satisfactory or weak; the bar for “strong” is intentionally high.
  - Integration of market, credit, and liquidity risk assessments and a holistic forward-looking view of major banks remain challenging; concrete inter-agency plans were not fully in place at time of assessment.
  - Basel II implementation and SCAP process helped promote enhanced supervisory analysis and inter-agency coordination.
- Model validation and information systems:
  - Banks generally expected to have independent validation and testing of risk models; guidance exists (OCC Bulletin 2000–16; FRB SR letter 95–51).
  - Federal Reserve planned to issue enhanced guidance on supervisory expectations for model validation and testing.
  - IT and management information system deficiencies in some major firms prevented timely enterprise-wide aggregation of risk.
- Assessment outcome:
  - Overall assessment for Principle 7: Materially Non-Compliant.
  - Key assessment comments:
    - “Severe shortcomings in bank risk management have been revealed” and supervisory oversight “was not effective” in identifying and remediating weaknesses.
    - Weaknesses were sufficiently large to create serious problems for individual banks and the financial system.
    - Improvements underway but “these weaknesses have not yet been fully remedied,” and full remediation will take several years.
    - Supervisors should repeat horizontal reviews at major banks at regular intervals, including detailed testing of robustness of risk monitoring and risk management improvements.
    - Supervisors need to ensure sufficient resources, inter-agency cooperation, and capacity to assess board effectiveness and governance.

### Capital planning, stress testing, and supervisory expectations (EC 5, EC 6)
- FBAs expect forward-looking capital plans and consider capital composition; the SCAP exercise assessed capital needs using multiple indicators including Tier 1 and pro-forma equity capital.
- Agencies expect common equity to be the predominant form of capital.
- Agencies have high-level guidance for smaller and mid-sized banks on capital adequacy in relation to risk profiles.
- Banks and holding companies are expected to conduct stress testing and maintain internal capital processes independent of regulatory minima; deficiencies in stress testing were observed.

### Assessment of compliance with CP 6 and summary comments
- Overall assessment for the capital-related CPs: Largely Compliant.
- Main shortcomings identified:
  - Definition of Tier 1 capital for holding companies with regard to innovative instruments.
  - Absence of formal capital rules for SLHCs, notably those primarily financial and similar to BHCs.
  - Allowing certain intangibles to count for a very high portion of bank or thrift Tier 1 capital.
  - Market risk rule size threshold appears high relative to other countries; FBAs have authority to require application below threshold; recommendation that authorities proceed with plans to apply the rule for thrifts by the end of 2010 and periodically review thresholds.

*Source: Extracted text from the IMF assessment document titled “_cr10121 - introduction. Accordingly, it was not included in this assessment.”*

### appendix D-1, part II(C) & (D) (addressing loan documentation and credit underwriting); 12 CFR

### _cr10121 - appendix D-1, part II(C) & (D) (addressing loan documentation and credit underwriting); 12 CFR

### Credit-risk management framework, supervisory expectations, and board oversight
- Sources (statutes, regulations, supervisory guidance, manuals) require banks and holding companies to establish, review, update (as appropriate), and implement credit-risk management strategies, policies, and procedures for identifying, measuring, controlling and reporting on credit risk (including counterparty risk).
- The board of directors is responsible for:
  - understanding the level and nature of credit risk to the bank and holding company;
  - setting the firm’s risk appetite;
  - ensuring management implements appropriate risk-management practices to identify, measure, monitor and control these risks.
- FBAs review compliance with supervisory guidance and internal credit-risk management through interviews, policy/procedure review, transaction testing, review of board materials and minutes, and interviews with board members.
- FBAs evaluate banks against UFIRS (CAMELS) guidelines; Asset Quality (A) component combines quantitative measures (levels of delinquent, troubled, and classified assets) and qualitative evaluations (board/senior management oversight, credit policies, procedures and limits, MIS, internal controls). Peer practice comparisons and off-site monitoring/data analyses are integral to the evaluation process.

### Findings on underwriting deterioration and concentrations
- Broad agreement that there was a material and widespread erosion in underwriting standards for residential mortgages across banks, non-bank affiliates and non-bank lenders during the recent period.
- Decline in underwriting also affected commercial real estate and other asset categories such as C&I credits and leveraged loans (shared national credit data for loans written in 2006 and 2007 identifies these weaknesses).
- Contributing influences for residential mortgages included:
  - belief in ability to package and distribute loans;
  - practices of unregulated mortgage brokers and other entities;
  - belief in the unlikelihood of sustained house price declines after years of growth and abundant liquidity;
  - behavior of GSEs and federal policies (e.g., affordable housing goals).
- CRE concentration increases: data reviewed showed the proportion of banks with concentrations of CRE at 300 percent, 400 percent or 500 percent or more of capital had roughly doubled from their lows in 1996 to 2002/03; concentrations then increased more moderately in subsequent years.
- Interagency guidance did not set hard limits on CRE concentrations but indicated 300 percent as a high-level indication of potential CRE concentration risk. A statute limits aggregate commercial loans by federal savings associations to 20 percent of total assets, with amounts in excess of 10 percent usable only for small business loans (12 U.S.C. § 1464(c)(2)(A)).

### Supervisory timing, coordination, and scope issues
- Agencies issued guidance in the period 2005–2007 on home equity lending (May 2005), sub-prime and non-traditional mortgage lending (Oct. 2006), and commercial real estate concentrations (Jan 2007); in some cases guidance was issued well after increased risk was identified.
- Delays in finalizing guidance occurred due to interagency differences and industry resistance during comment periods.
- Supervisors acknowledged difficulty in dealing with weak credit-risk management in banks in advance of serious problems, influenced by:
  - a period with observed actual losses very low;
  - the incurred loss accounting model, creating difficulties getting banks to increase allowances;
  - auditor requirements and accounting-rule features such as “exit price” valuation.
- Assessors found a need for a more comprehensive, strategic, and coordinated supervisory approach addressing:
  - forcefulness and timeliness of interventions;
  - whether some guidance should include specific limits;
  - consistency of follow-up on new guidance;
  - ability of FBAs to intervene regarding systemic weaknesses outside their direct control.
- Supervisors are developing/enhancing off-site and on-site tools for monitoring, supervisory credit-portfolio stress testing, and outlier identification; multi-agency coordination difficulties sometimes limit coordination.

### Supervision of non-bank affiliates and off-balance-sheet entities
- Many weaknesses originated in unregulated entities and non-bank affiliates of major banks; supervisors agreed non-bank affiliates sometimes accepted risks banks would not have taken.
- Under U.S. system, non-bank affiliates often fall under holding company supervision, with statutory limitations (see CP 24) on what holding company supervisors may review at non-bank affiliates.
- Greater attention required on credit risk in off-balance-sheet entities and non-bank affiliates; supervisors and bankers noted institutions often lacked risk-management practices commensurate with assumed risks.

### Stress testing, model reliance, and valuation issues
- Stress testing guidance exists but practices need improvement in severity and in capturing portfolio-level impacts of credit-risk events.
- Many smaller and mid-size banks perform simple “what if” analysis; FBAs indicate more-formalized stress analysis would be helpful.
- Large-bank example: SCAP exercise is a notable example of increased agency use of stress testing.
- Excessive reliance on external ratings was identified as an issue where ratings proved inappropriate for actual credit risk measurement.
- Valuation and MTM issues:
  - valuation procedures often not robust to changes in market liquidity;
  - need for a “waterfall” of valuation procedures for varying market conditions;
  - material weaknesses in aggregating MTM positions across books/geographies and linking valuation to P&L;
  - improvement efforts underway, but significant IT and risk infrastructure work remains.

### Allowance for loan and lease losses (ALLL) and problem assets
- Safety-and-soundness provision (12 U.S.C. § 1831p-1(b)) requires systems to identify problem assets and prevent deterioration; interagency guidance elaborates asset-quality obligations and supervisory expectations on ALLL (FAS 5, FAS 114).
- Banks expected to:
  - conduct periodic asset-quality reviews;
  - estimate inherent losses and establish allowances/reserves sufficient to absorb estimated losses;
  - compare problem asset totals to capital; and
  - take corrective action to resolve problem assets.
- FBAs review adequacy of loan classification, loss provisioning, and capital adequacy each supervisory cycle; transaction testing compares supervisory classifications (pass, special mention, sub-standard, doubtful, loss) to bank classifications.
- Shared National Credit Program (SNC) example:
  - 2009 review covered 8,900 credit facilities with commitments totaling US$2.9 trillion;
  - review found credit quality deteriorating to record levels; leverage finance credits represented more than 40 percent of the value of criticized credits.
- FBAs can require adjustments to ALLL, require additional provisioning or restatement, and require capital adjustments (see 12 U.S.C. § 1818(b)).

### Specific operational expectations and transaction-level controls
- Supervisors expect:
  - limits and approval authorities clearly defined for credit exposures;
  - credit policies to describe approvals and reporting to the board;
  - major credits beyond a certain size to be decided by senior management; new or non-mainstream products to receive senior/formal attention;
  - policies/processes to identify, measure, monitor, and control counterparty credit-risk exposure, including potential future exposure;
  - targeted transaction testing where activities show significant growth, above-normal profitability or large potential future exposures.
- No specific regulatory requirement to monitor total indebtedness of borrowers, but bank practice and supervisory review include monitoring total indebtedness.

### Large exposures and concentration limits
- Legal limits:
  - a bank’s total outstanding loans and extensions of credit to one borrower or group of connected borrowers are limited to 15 percent of a bank’s capital (Tier 1) and surplus funds; a further 10 percent may be extended if the loan is fully secured by readily marketable collateral (12 U.S.C. §84);
  - a bank may not loan more than 50 percent of its Tier I capital and surplus funds to a corporate group (rarely applied).
- Comments and assessors’ recommendations:
  - thresholds in AC1 are higher than international best practices (international best practice example cited: 25 percent of capital funds for aggregated exposures to a single counterparty);
  - recommend including additional exposures (issued securities, asset holdings) in the 15 plus 10 percent limits to avoid excessive concentrations.
- Reporting and supervisory monitoring exist (SNC, largest banks), and assessors recommend harmonized, periodic reporting (e.g., quarterly) of largest exposures and exposures exceeding thresholds such as 10 percent of own funds.

### Exposures to related parties and insiders
- Statutory framework includes sections 23A and 23B and sections 22(g) and 22(h) of the Federal Reserve Act, restricting affiliate and insider transactions and requiring arm’s length terms.
- Aggregate limits:
  - affiliate exposures typically limited to 10 percent to a single affiliate and 20 percent to all affiliates of institution’s capital funds;
  - limit on extensions of credit to an individual insider aggregated with related interests generally may not exceed 15 percent of institution’s capital funds; aggregate insider exposure may not exceed institution’s capital funds.
- Specifics and gaps:
  - extensions of credit to an insider must be reviewed and approved by the board if aggregate exposure, including proposed amount, would exceed US$500,000 (lower threshold applies for smaller banks); the insider must not participate in preparation/discussion/vote.
  - no regulation requiring board pre-approval for most transactions with affiliates, nor for write-offs of related party transactions.
  - assessors note aggregate limit for lending to insiders at 100 percent of a bank’s capital (aggregate insider exposure limit) is higher than international best practices and could, in practice, deplete own funds.
  - lack of formal limits at holding company level and potential narrow statutory definitions are weaknesses; nonetheless, FBAs expect high board involvement and can criticize high insider exposures as unsafe and unsound.

### Country and transfer risk
- FBAs evaluate foreign country exposure and transfer risk; statutory basis includes 12 U.S.C. § 3903(a) and (b).
- Reporting requirements:
  - banks/BHCs meeting certain cross-border exposure criteria submit quarterly reports detailing significant claims by country.
- Interagency Country Exposure Review Committee (ICERC):
  - ICERC assigns transfer risk ratings and may determine Allocated Transfer Risk Reserves (ATRR) for exposures where ultimate obligor resides in defaulting country (12 CFR 211.43; Guide to ICERC Process (November 2008)).
  - ICERC minimum threshold for review: aggregate exposure of US$1 billion or more for at least two consecutive quarters; exposures between US$200 million and US$1 billion also reviewed if exposure at five or more U.S. banks/BHCs exceeds 25 percent of Tier 1 capital plus the allowance for loan and lease losses.
- Assessment: Compliant.

### Market risk supervision
- Expectations:
  - comprehensive risk management policies/processes for identifying, evaluating, monitoring, and controlling market risk;
  - large banks with aggregate trading assets and liabilities of US$1billion or more or 10 percent of total assets are subject to market risk capital rules implementing 1996 Basel I Market Risk Amendment (12 CFR 3, appendix B).
- Key concerns identified:
  - material breakdowns in risk management related to MTM portfolios at a number of larger firms;
  - weaknesses in understanding price risks, warehousing/opacity of products, imbalance between risk control and trading units, over-reliance on single measures (VaR) and lack of adequate stress testing.
- Supervisory actions:
  - horizontal reviews of Market Risk Amendment implementation underway;
  - supervisors require independent valuation units, frequent revaluation of MTM positions, scenario analysis, stress testing and model validation.
- Stress/scenario guidance: scenario analysis and stress testing expected; at minimum, the Joint Policy Statement on Interest Rate Risk suggests instantaneous +/-200 basis point parallel shift for a one year horizon (see IRR section); market-risk validations include annual independent reviews.

### Liquidity risk supervision and contingency planning
- Interagency policy statement on liquidity-risk management released for comment June 30, 2009; agencies collecting and enhancing liquidity metrics and monitoring.
- Expectations include:
  - ongoing assessment of current and expected future funding needs and ensuring sufficient funds/access to funds;
  - maintaining an adequate cushion of liquidity for a continuum of contingent events (from high-probability/low-severity to low-probability/high-severity).
- Supervisory tools and data:
  - Call Reports and Thrift Financial Reports capture liability/deposit mix, maturities, repricing, large uninsured deposits, non-maturity deposits, wholesale funding and off-balance-sheet commitments.
  - heightened monitoring during 2007–2009: daily/intra-day monitoring, more granular liquidity assessment, tested contingency plans.
- FBAs’ enhancements:
  - interagency statement, consolidated supervision guidance on group-wide liquidity, new SLHC rating definitions, increased monitoring of systemically important institutions, improved coordination (SCAP example).
- Assessment: Largely Compliant — guidance compliant with international standards but implementation requires sustained enhancements, IT/risk architecture upgrades, and enterprise-wide aggregation capabilities.

### Operational risk, internal controls, and audit
- Legal basis: safety-and-soundness statutes (12 U.S.C. § 1831p-1) and interagency guidance require internal controls, information systems and internal audit appropriate to size and scope.
- FBAs review operational risk through on-site examinations, off-site surveillance, and an interagency operational risk group.
- Business continuity, IT risk, outsourcing:
  - FFIEC materials (Business Continuity Planning Booklet, IT Examination Handbook, Information Security Standards) guide supervision;
  - MDPS and Regional TSP programs assess third-party data processors.
- Internal audit expectations:
  - independence, qualified personnel, adequate testing, documentation, review by audit committee/board.
- Assessment: Compliant — supervision effective overall, but assessors note need for stronger group-wide perspective given fragmented supervisory oversight of large banking groups; recommend continued inter-agency coordination.

### Interest rate risk in the banking book (IRR)
- Statutory requirement for FBAs to prescribe standards on IRR (12 U.S.C. § 1831p-1(a)(1)(D)); 1996 Joint Policy Statement on Interest Rate Risk provides guidance; OTS Thrift Bulletin 13a addresses IRR for thrifts.
- Supervisory expectations:
  - board-approved IRR strategy and policies; comprehensive IRR measurement systems; regular model validation.
  - supervisors expect scenario testing that includes at minimum an instantaneous +/-200 basis point parallel shift over a one year horizon.
- Agency practices:
  - OTS uses Net Portfolio Value (NPV) Model for savings associations; other agencies utilize internal measures and surveillance screens.
- Assessment: Compliant — effective supervision, but potential benefit from more consistent measurement frameworks across FBAs.

### Internal controls, corporate governance, and Sarbanes-Oxley consequences
- Interagency guidelines and statutes define expectations for internal control systems, clear lines of authority, segregation of duties, timely and accurate reporting, internal audit independence, and board/audit committee oversight.
- For insured institutions with US$500 million or more in total assets, requirement for outside non-executive directors on boards (12 U.S.C. §1831m(g); 12 CFR §363.5(a)); stricter requirements for larger asset thresholds (US$1 billion, US$3 billion) on audit committee composition and expertise.
- Supervisors evaluate internal control adequacy and can require corrective plans or take enforcement action (12 U.S.C. §1818(b), §1818(e)).

### Anti-money laundering (AML), know-your-customer (KYC), and supervisory enforcement
- Agencies and Treasury require banks to:
  - establish BSA/AML internal controls;
  - conduct independent testing;
  - appoint compliance officers;
  - implement training;
  - establish customer identification programs (CIPs).
- Suspicious Activity Report (SAR) requirements:
  - file with FinCEN within 30 days of initial detection (60 days if attempting to identify a subject);
  - filing thresholds: SAR required where an insider was involved or over US$5,000 involved with an identifiable suspect, or over US$25,000 involved, or if amount exceeds US$5,000 and may violate BSA/AML rules;
  - board or relevant committee must be promptly informed when a SAR is filed.
- Correspondent banking:
  - 31 U.S.C. 5318(i) requires due diligence on correspondent accounts for foreign financial institutions; enhanced due diligence for certain high-risk correspondents; prohibition on correspondent accounts for shell banks (31 U.S.C. §5318(j)).
- Supervisory actions and coordination:
  - agencies regularly examine BSA Compliance Programs (12 U.S.C. §1818(s)); off-site review of FinCEN SAR/CTR data; formal/informal enforcement actions, cease-and-desist orders for BSA violations; FinCEN and DOJ criminal enforcement authorities.
- Assessment: Compliant — agencies employ specialist personnel and supervisory practices to enforce AML/KYC standards.

*Source: IMF mission assessment text from appendix D-1, part II(C) & (D) (addressing loan documentation and credit underwriting); 12 CFR*

### 1.   Banks, in particular large banks, maintain comprehensive programs, policies and procedures to

### _cr10121 - 1.   Banks, in particular large banks, maintain comprehensive programs, policies and procedures to

### Bank risk-reduction programs, policies and procedures
- Banks, in particular large banks, maintain comprehensive programs, policies and procedures to reduce the risk of endangering the safety and soundness of the bank through abuse of its operations and services, including physical safety.

### Supervisory monitoring, internal controls, and reporting requirements
- Supervisors monitor effectively, in their full-scope or targeted examinations, that banks comply with their undertakings.
- Internal audit and internal controls will also contribute to overall oversight.
- There exist adequate reporting requirements on, e.g., suspicious transactions, both within the bank, to the supervisors, and to relevant judicial authorities.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10121.pdf*

### 3.   The assessors perused supervisory examination reports and can confirm that these were

### 3.   The assessors perused supervisory examination reports and can confirm that these were sufficiently comprehensive and deep.

### AML/CFT and CP 18 — relationship and identified deficiencies
- A. AML/CFT issues constitute only a part of CP 18, which encompasses all issues of abuse, including fraud, embezzlement, robbery, phishing and more.
- B. Only those AML/CFT issues which are clearly relevant to the safety and soundness of the bank are relevant to CP 18.
- C. A separate FATF assessment was conducted in 2006 and an IMF update is part of the current FSAP. The BCP assessors were informed that the authorities have addressed several of the earlier identified weaknesses.
- The assessors quote a number of 2006 FATF-identified deficiencies relevant to banks; they were not deemed materially sufficient to warrant a downgrade under the BCP/CP 18 methodology, but the assessors support FATF’s recommendation that these deficiencies be remedied. Quoted deficiencies:
  - Obligations to identify beneficial owners are limited to specific circumstances, such as correspondent banking and private banking for non-U.S. clients.
  - No measures in place to ensure that there is adequate, timely and accurate information on the beneficial ownership and control of legal persons that can be obtained or accessed in a timely fashion by the competent authorities.
  - Minimal information concerning the beneficial owners of trusts that can be obtained or accessed by the competent authorities in a timely fashion.
  - No explicit obligation to conduct ongoing due diligence, except in certain defined circumstances.
  - Customer identification for occasional transactions limited to cash deals only.
  - Verification of identity until after the establishment of the business relationship is not limited to circumstance where it is essential not to interrupt the normal course of business.
  - No explicit obligation to terminate relationship if verification process cannot be accomplished.
  - No obligation to require senior management approval when opening individual correspondent accounts.

### Principle 19 — Supervisory approach: description, practices, and assessment
- Key descriptive elements and practices:
  - Banking laws vest the FBAs collectively with broad, but not unlimited, authority to regulate and supervise banks and holding companies.
  - Primary supervisory tool: full-scope on-site examinations at least once every year (banks with assets of less than US$500 million and considered well-managed and well-capitalized: may extend to 18 months).
  - For very largest banks, full-time on-site examination staff could aggregate across the FBAs to as many as 80 people full-time, supplemented by rotating examiners.
  - Off-site surveillance complements on-site work; agency analytical tools named: Fed – SABR; OCC – Canary; FDIC – SCOR; OTS – RMS.
  - GLB Act imposes responsibility to defer to functional regulators where they exist; ad-hoc information sharing mechanisms established.
  - Aggregations of quarterly data collections used to assess portfolio conditions; UFIRS/CAMELS and other rating systems employed (URSIT, MOECA, RFI, CORE, ROCA).
- Findings and concerns:
  - Many rating systems not sufficiently responsive or differentiated: more than half of all banks in the United .States. are rated within a single CAMELS grading category, and more than three-quarters sit within two rating grades.
  - Internal agency tools sometimes more influential than UFIRS.
- Assessment: Largely Compliant
- Comments / recommendations:
  - Recent market turmoil highlights areas for strengthened oversight and coordination.
  - Fragmented supervisory mandates impede thorough understanding of banking groups and system-wide risks; domestic supervisory colleges including functional supervisors would have considerable merit.
  - UFIRS/CAMELS is relatively outdated, subjective, does not distinguish inherent risk from risk controls, slow to adjust, and ‘sticky’ over time; assessors recommend either (i) overhaul the UFIRS, building on agency granular systems, or (ii) develop a consistent, more granular, forward-looking risk rating system providing a ‘common language’ across the FBAs.

### Principle 20 — Supervisory techniques: description, practices, and assessment
- Key descriptive elements and practices:
  - Supervision via combination of on-site examinations and off-site reviews; primary FBA conducts annual on-site examinations (smaller qualifying banks may be examined on an 18-month cycle).
  - Overlapping examination authority exists (e.g., 12 U.S.C. § 1820(b)(3) gives FDIC and Federal Reserve authority to examine any bank).
  - Off-site surveillance includes regulatory reports, internal/external audit reports, public filings, and discussions with management and supervisors.
  - Resident on-site supervisors provide continuous supervision and at least quarterly updates for larger banks.
  - Agencies have authority to take enforcement action (12 U.S.C. §§ 1813 and 1818).
  - Quality assurance programs and public scrutiny (Material Loss Review reports) exist.
- Assessment: Compliant
- Comments / recommendations:
  - Agencies employ standard supervisory techniques consistently; guidance is extensive and well embedded.
  - Opportunities exist to improve consistency across agency manuals, supplementary rating systems, and off-site surveillance models.
  - FFIEC could consider stocktaking of supervisory manuals to eliminate unnecessary differences and promote good practice.

### Principle 21 — Supervisory reporting: description, practices, and assessment
- Key reporting framework elements:
  - Extensive periodic regulatory reporting on balance sheet items, off-balance-sheet exposures, profit and loss, capital adequacy, liquidity, asset quality, loan loss provisioning, interest rate risk sensitivity and market risk.
  - Quarterly consolidated reporting requirement for banks; BHCs with consolidated assets of US$500 million or more and SLHCs of all sizes must submit quarterly consolidated information. Parent BHCs submit solo reports (large BHCs quarterly; small BHCs semi-annually). No bank reporting on a solo basis.
  - Central Data Repository (CDR) and Call Report used for quarterly data; agencies can require more frequent reporting (e.g., daily liquidity reporting during crisis).
  - Accounting: agencies generally adopt U.S. GAAP for regulatory reporting.
  - Audited financial statements required annually for banks with assets of US$500 million or more; additional internal control assessments required for banks with assets of US$1 billion or more (12 CFR 363.2).
  - FBAs use automated edit and validity checks on regulatory reports; edit exceptions must be corrected or explained.
  - External experts used rarely; when used they are supervised by agency personnel.
- Assessment: Compliant
- Comments / recommendations:
  - FBAs do not collect information at the solo bank level; this limits tracking of regulatory requirements relative to the bank excluding its subsidiaries.
  - Exemption from quarterly reporting for smaller BHCs should be reviewed given no similar exemption for SLHCs.
  - Exemption granted to smaller banks from providing an annual assessment of internal controls could be reviewed.
  - Supervisory staff criticized alignment with U.S. GAAP (incurred loss model) for allowance for loan losses; this constrains supervisory ability to require loan loss reserves reflecting future events and undermines PCA regime effectiveness. Assessors suggest authorities consider interaction between accounting standards and regulatory requirements and possible use of higher minimum capital or ‘above the line’ charges to address insufficiencies in loan loss allowances.

### Principle 22 — Accounting and disclosure: description, practices, and assessment
- Key elements:
  - Banks and SLHCs exceeding US$500 million required to prepare annual financial statements in accordance with U.S. GAAP, audited by independent public accountant.
  - Annual CEO/CFO reporting obligations and management assessments required; for banks with assets of US$1 billion or more, management and independent public accountant assessments of internal control effectiveness required [see, e.g., 12 U.S.C. § 1831m(b)(2) and 12 CFR 363.2(b)].
  - Approximately 97 percent of consolidated assets of U.S. bank holding companies were audited as of year-end 2007.
  - External auditors may be barred for “good cause” (12 U.S.C. § 1831m(g)(4) and 12 CFR 19.243); supervisors may review audit work papers and bar accountants if necessary.
  - Publication of UBPR/UTPR and BHCPR for performance and peer comparisons.
- Assessment: Compliant
- Comments / recommendations:
  - Consider merits of introducing a statutory obligation on external auditors to report matters directly to bank supervisors with attendant protections (‘whistleblower’ protection), as practiced in many other countries.

### Principle 23 — Corrective and remedial powers of supervisors: description, practices, and assessment
- Key elements:
  - FBAs identify problems and typically resolve many issues informally; serious or repeated problems addressed through formal supervisory action documented in writing and publicized monthly (with narrow exceptions).
  - FBAs have authority to appoint conservator or receiver; FDIC appointed receiver for closed insured banks.
  - Range of enforcement actions includes Formal agreements; Cease and Desist Orders; Safety and Soundness Orders; Capital Directives; PCA directives; Civil Money Penalty Assessments; and temporary cease-and-desist orders where immediate action required (12 U.S.C. § 1818 (u)).
  - PCA regime: undercapitalized banks must not pay dividends and must submit a capital restoration plan; undercapitalized banks must submit plan within 45 days and agency must review within 60 days; critically undercapitalized banks must be closed within 90 days.
- Assessment: Compliant
- Comments / recommendations:
  - Dichotomy exists where supervisors may deem banks capital deficient while PCA definitions label them “well capitalized”; this weakens enforcement credibility and should be rectified.

### Principle 24 — Consolidated supervision: description, practices, and assessment
- Key elements:
  - Federal Reserve responsible for consolidated supervision for U.S. BHCs (including FHCs); OTS responsible for consolidated supervision of SLHCs. All BHCs and SLHCs subject to consolidated supervision.
  - Federal Reserve and OTS rely on primary supervisors and functional regulators for information; authority to inspect and obtain reports from holding companies and their subsidiaries (BHC Act, HOLA).
  - No consolidated quantitative limits required by regulation (e.g., large exposures, insider lending, general lending limits); supervisors monitor aggregated exposures on case-by-case basis.
  - Assessments include cross-border operations, and agencies may impose remedial measures where material impediments exist (including imposing limits on foreign operations).
- Assessment: Largely Compliant
- Comments / recommendations:
  - GLB Act impedes consolidated supervisors’ ability to obtain information or impose prudential restrictions on subsidiaries with primary supervisors; the ‘material risk to the bank’ escape valve is not workable in practice.
  - Assessors saw major supervisory efforts to enhance group-wide supervision, but worry these may not persist without legislative changes.
  - Consider removing GLB restrictions to improve access to non-bank entities in banking groups; clarify division of responsibilities between consolidated and primary supervisors.
  - Implement domestic supervisory colleges including functional supervisors to reduce “silo treatment.”
  - Lack of regulations to apply quantitative consolidated limits (large exposures, related-party lending) and absence of consolidated capital requirements for SLHCs noted; current case-by-case approach may lack robustness.

### Principle 25 — Home-host relationships: description, practices, and assessment
- Key elements:
  - FBAs have authority to share confidential supervisory information with foreign supervisors (subject to limitation of not impinging on the “U.S. interest”).
  - Agencies establish formal or informal arrangements (MOUs/SOCs) for information sharing; arrangements disclosed to involved bank but not otherwise publicly known.
  - FBAs provide information to host supervisors in response to requests and cooperate in licensing, supervision, and problem handling; U.S. agencies may not act against “the U.S. interest.”
  - International coordination examples: FBO Supervision Program provides essential supervisory products to home country supervisors; supervisors participate in supervisory colleges and Basel II/FSB activities.
  - EF: establishment of “shell banks” not permitted in the US; legal measures prevent foreign shell banks from accessing U.S. system.
- Assessment: Compliant
- Comments / recommendations:
  - “In the U.S. interest” concept should be interpreted broadly—often solving problems for the whole international financial group, in cooperation with foreign authorities, will better serve U.S. interests than ring-fencing U.S. operations.

### Recommended Action Plan (introductory note)
- The document transitions to a Recommended Action Plan and Authorities’ Response, with Table 3 titled "Recommended Action Plan to Improve Compliance with the Basel Core Principles." The detailed table of recommended actions follows in the source material.

*Source: IMF FSAP assessment text as provided in the content unit.*

### 1. Objectives, independence, powers, transparency, and

### 1. Objectives, independence, powers, transparency, and

### Responsibilities and objectives
- Consider formally setting out the mandate and objectives of the FBAs in legislation.
- Ensure core safety and soundness mandates and individual accountability for each FBA are clear.
- Clarify expectations and accountability for the primary federal bank regulator and the holding company regulator, noting they are inextricably linked in the case of large complex banking groups.
- Strengthen inter-agency coordination of supervisory processes, pursuing opportunities for:
  - more integrated supervision planning;
  - more commonality of forward-looking risk rating systems;
  - more sharing of off-site surveillance methodology and results; and
  - more joint reviews.

### Independence, accountability and transparency
- Develop a more forward-looking detailed resource plan that takes account of risk assessments, lessons learned, and new and existing priorities.
- Focus senior governance within and between agencies on improvements in supervisory process.
- Improve public performance reporting.
- Alter the governance rules at Reserve Banks to remove appearance of industry influence.
- Raise threshold for triggering material loss reviews and consider the themes from those reviews (e.g., timeliness and forcefulness of intervention) to improve performance.

### Cooperation
- Strengthen channels for cooperation, coordination, and learning from best practices—within and between FBAs and functional supervisors.

### Reference Principles — Selected Recommended Actions
- 3. Licensing criteria
  - Strengthen interagency agreement to prevent inappropriate charter conversions. Monitor developments to see if said agreement needs further strengthening.
  - Deepen assessment and presentation to chartering decision-makers on the operational plan for the applicant bank.
  - Increase the (absolute) minimum capital requirement for new banks.
- 6. Capital adequacy
  - Work with the BCBS and domestically to strengthen the definition of what counts as Tier 1/core capital especially for holding companies.
  - Revisit ability for banks and thrifts to have a large part of their Tier 1 capital composed of intangibles by capping the percentage allowed at a lower level.
  - Put in place formal capital rules for SLHCs.
- 7. Risk management process
  - Conduct regular inter-agency horizontal detailed assessment of all risk monitoring, management and risk governance improvements at major complex banking groups.
  - Include detailed testing of the robustness of improvements.
  - Include all large complex banking organizations in these regular assessments.
  - Publish regular reports and guidance to reinforce supervisory expectations.
  - Ensure adequate ongoing resources for these reviews.
- 8. Credit risk
  - Develop a clear comprehensive strategy to reduce the extent and severity of credit risk problems resulting from a future credit cycle and building on (and extending across agencies) improvements in credit risk monitoring and surveillance already started.
  - Address: timeliness and forcefulness of supervisory interventions; timeliness of guidance; revisiting whether guidance needs to occasionally contain specific limits to be effective; consistency of follow-up on new guidance.
  - Strengthen FBAs’ ability to intervene to make their views known about systemic weaknesses in credit risk management practices or contributing policies not controlled by them.
  - Strengthen inter-agency processes to enhance collective assessment of emerging problems.
  - Ensure sufficient specialist resources are available to assess complex credit risk matters in smaller and mid-size, as well as larger banks.
- 10. Large exposure limits
  - Include all exposures within the limits and reporting of large exposures.
  - Strengthen reporting requirements on large exposures.
  - Advance supervisory guidance further on sectoral and geographical concentration risk identification and management.
- 11. Exposure to related parties
  - Strengthen regulations on board oversight and involvement.
  - Enhance reporting requirements to board and to the supervisors.
  - Lower the current limit on the aggregate amount of loans to all insiders (it now equals a bank’s own funds plus “surplus” funds).
  - Incorporate all exposures to insiders (and affiliates) in the definition of insider transactions and in the limits.
- 13. Market risks
  - Complete the current horizontal assessment of the Market Risk Amendment and determine how much further in-depth horizontal review of market risk and valuation improvements at major banks is required.
  - Conduct regular, horizontal, in-depth assessments of banks’ progress in market risk enhancements.
- 14. Liquidity risk
  - Transition crisis-driven improvements in banks and supervisors liquidity risk processes into organized, sustainable, improved liquidity risk management and supervisory monitoring and assessment.
  - Update the supervisory program, and conduct regular supervisory assessments of risk management and crisis and contingency plans at banks.
- 15. Operational risk
  - Consider a more holistic and structured approach to operational risk assessment, utilizing enhanced cross-agency mechanisms.
- 16. Interest rate risk in the banking book
  - Consider the capacity to improve the assessment of interest rate risk by introducing a more consistent measurement approach.
- 18. Abuse of financial services
  - Rectify certain CP 18-relevant deficiencies as identified by the FATF.
- 19. Supervisory approach
  - Improve the capacity for group-wide oversight of financial groups, including unregulated entities.
  - Introducing domestic “supervisory colleges” involving all main regulators (not just the FBAs) of major banking groups may assist, although broader reform is necessary.
  - An overhaul of risk rating systems, with a view to improve their capacity to distinguish between banks, is recommended.
- 20. Supervisory techniques
  - Review, perhaps under the auspices of the FFIEC, existing supervisory manuals and processes to remove unnecessary differences and develop a “best of breed” approach.
- 21. Supervisory reporting
  - Review the solo reporting requirements to ensure prudential requirements can be monitored relative to an individual bank’s balance sheet.
  - Consider the implications of U.S. GAAP for the effectiveness of supervision and the PCA regime.
- 22. Accounting and disclosure
  - Consider the introduction of statutory reporting (“whistleblower”) obligations for external auditors, along with associated protections.
- 24. Consolidated supervision
  - Make changes in legislation and practices to ensure effective conduct of consolidated supervision of financial groups.
  - Introduce regulatory limits and reporting of adherence to those on the consolidated group level, including at the holding company level, for large exposures, and related lending.

### Authorities’ response to the assessment — Key points and actions
- The U.S. authorities express appreciation for the IMF assessment and strongly support the Financial Sector Assessment Program.
- Context emphasized:
  - The assessment follows a severe financial crisis and economic downturn that tested the resilience of the U.S. financial sector and its supervisory framework.
  - The United States is the first highly complex economy evaluated under the Core Principles as updated in 2006; the revised Core Principles place greater emphasis on risk management and require assessors to consider practices of banks as well as policies and practices of banking agencies.
  - The IMF’s assessment is that the U.S. system is broadly in compliance with the Core Principles despite the more stringent standards.
- The authorities note many identified weaknesses are being addressed by federal banking agencies and by legislative reforms, but the Report could not incorporate or give credit for actions underway.
- The authorities dispute the “Materially Non-Compliant” rating for CP 7, Risk Management Process, arguing supervisors’ actions during the crisis are as important as pre-crisis oversight.
- The authorities state each FBA has statutory and organizational mandates and authority to compel improvements in risk management and other processes, and they are actively working with institutions.
- On CP 6, Capital Adequacy:
  - The IMF’s Largely Compliant assessment does not fully reflect aspects of U.S. bank supervision.
  - U.S. banks are held to a higher capital standard than international standards because of U.S. Prompt Corrective Action law and regulation.
  - Currently, approximately 96 percent of U.S. banks, representing approximately 99 percent of total bank assets, hold 50 percent or more capital than international minimums.
  - Prior to the crisis most U.S. banks, including the largest, had Tier 1 capital composed mostly of common equity (80–90 percent or higher).
  - As a result of the Supervisory Capital Assessment Program (SCAP), the largest U.S. banks now have risk-based ratios of Tier 1 capital and Tier 1 common equity that far exceed Basel minimum capital requirements.
- Federal banking agencies have taken substantive actions not fully reflected in the Report, including:
  - The SCAP stress assessment on the 19 largest bank holding companies, which together hold two-thirds of the assets and more than one-half of the loans in the U.S. banking system; the SCAP resulted in large banks raising a substantial amount of common equity capital.
  - Joining international efforts to initiate supervisory colleges for large, globally active U.S. banks.
  - Directing large banks to improve aggregation of risks across legal entities and product lines and requiring improved contingency funding plans.
  - Conducting targeted, leveraged lending reviews at the largest syndication banks focusing on syndicated pipeline management, stress testing, and limit setting.
  - Conducting high quality implementation of Basel II.
  - Issuing and implementing interagency guidance on subprime and non-traditional mortgages.
  - Initiating new data gathering, e.g., a project that provides data on over 60 percent of residential mortgages serviced in the United States.
- The U.S. authorities will review the Report’s recommendations and take action where they have authority, including enhancing communication and information-sharing among the agencies, ensuring more effective oversight of systemic risks, and requiring increased liquidity buffers at systemically important institutions. They look forward to continuing dialogue to improve stability and effective supervision.

*Source: IMF Financial Sector Assessment Program — 1. Objectives, independence, powers, transparency, and (excerpts).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10121.pdf_