Federal Deposit Insurance Corporation: Results of 2003 and 2002  
Financial Audits (04-MAR-04, GAO-04-522T).			 
                                                                 
GAO is required to annually audit the financial statements of the
three funds administered by the Federal Deposit Insurance	 
Corporation (FDIC): the Bank Insurance Fund (BIF), the Savings	 
Association Insurance Fund (SAIF), and the FSLIC (Federal Savings
and Loan Insurance Corporation) Resolution Fund (FRF). GAO is	 
responsible for obtaining reasonable assurance about whether	 
FDIC's financial statements for BIF, SAIF, and FRF are presented 
fairly in all material respects, in conformity with U.S.	 
generally accepted accounting principles, and whether FDIC	 
maintains effective internal controls and FDIC has complied with 
selected laws and regulations. Created in 1933 to insure bank	 
deposits and promote sound banking practices, FDIC plays an	 
important role in maintaining public confidence in the nation's  
financial system. In 1989, legislation to reform the federal	 
deposit insurance system created three funds to be administered  
by FDIC: BIF and SAIF, which protect bank and savings deposits,  
and FRF, which was created to close out the business of the	 
former Federal Savings and Loan Insurance Corporation. GAO was	 
asked by the Chairwoman of the House Subcommittee on Oversight	 
and Investigations, Committee on Financial Services, to discuss  
the results of its February 13, 2004, report, Financial Audit:	 
Federal Deposit Insurance Corporation Funds' 2003 and 2002	 
Financial Statements (GAO-04-429).				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-522T					        
    ACCNO:   A09431						        
  TITLE:     Federal Deposit Insurance Corporation: Results of 2003   
and 2002 Financial Audits					 
     DATE:   03/04/2004 
  SUBJECT:   Accounting standards				 
	     Bank deposits					 
	     Computer security					 
	     Financial management systems			 
	     Financial statement audits 			 
	     Funds management					 
	     Internal controls					 
	     Reporting requirements				 
	     Risk management					 
	     Bank Insurance Fund				 
	     FSLIC Resolution Fund				 
	     Savings Association Insurance Fund 		 

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GAO-04-522T

United States General Accounting Office

GAO Testimony

Before the Subcommittee on Oversight and Investigations, Committee on
Financial Services, House of Representatives

For Release on Delivery Expected at 10 a.m. EST Thursday, March 4, 2004

FEDERAL DEPOSIT INSURANCE CORPORATION

                   Results of 2003 and 2002 Financial Audits

Statement of Jeanette Franzel, Director Financial Management and Assurance

                                       a

GAO-04-522T

Highlights of GAO-04-522T, testimony before the Subcommittee on Oversight
and Investigations, Committee on Financial Services, House of
Representatives

GAO is required to annually audit the financial statements of the three
funds administered by the Federal Deposit Insurance Corporation (FDIC):
the Bank Insurance Fund (BIF), the Savings Association Insurance Fund
(SAIF), and the FSLIC (Federal Savings and Loan Insurance Corporation)
Resolution Fund (FRF). GAO is responsible for obtaining reasonable
assurance about whether FDIC's financial statements for BIF, SAIF, and FRF
are presented fairly in all material respects, in conformity with U.S.
generally accepted accounting principles, and whether FDIC maintains
effective internal controls and FDIC has complied with selected laws and
regulations.

Created in 1933 to insure bank deposits and promote sound banking
practices, FDIC plays an important role in maintaining public confidence
in the nation's financial system. In 1989, legislation to reform the
federal deposit insurance system created three funds to be administered by
FDIC: BIF and SAIF, which protect bank and savings deposits, and FRF,
which was created to close out the business of the former Federal Savings
and Loan Insurance Corporation.

GAO was asked by the Chairwoman of the House Subcommittee on Oversight and
Investigations, Committee on Financial Services, to discuss the results of
its February 13, 2004, report, Financial Audit: Federal Deposit Insurance
Corporation Funds' 2003 and 2002 Financial Statements (GAO-04-429).

www.gao.gov/cgi-bin/getrpt?GAO-04-522T.

To view the full product, including the scope and methodology, click on
the link above. For more information, contact Jeanette Franzel at (202)
512-9471 or [email protected].

March 4, 2004

FEDERAL DEPOSIT INSURANCE CORPORATION

Results of 2003 and 2002 Financial Audits

In reporting on the results of the 2003 and 2002 audits, GAO issued
unqualified, or "clean," opinions on the three funds administered by the
Federal Deposit Insurance Corporation (FDIC)-the Bank Insurance Fund
(BIF), the Savings Association Insurance Fund (SAIF), and the FSLIC
Resolution Fund (FRF). This means that the funds' financial statements
presented fairly, in all material respects, their financial position as of
December 31, 2003 and 2002. FDIC also maintained, in all material
respects, effective control over financial reporting (including
safeguarding of assets) and compliance with laws and regulations. GAO
identified one reportable internal control weakness in the area of
information system security controls, which although not considered
material, is nevertheless considered a significant deficiency in the
design or operation of controls.

GAO has reported weaknesses in FDIC's information systems security for a
number of years. Although GAO continued to consider information security
weaknesses to be a reportable condition for 2003, we also found that FDIC
has made significant progress in correcting the computer security
weaknesses we previously identified. FDIC took action to address current
and prior-year weaknesses, including completing action on all of the 22
weaknesses that remained open from GAO's 2001 audit and 28 of the 29
weaknesses from our 2002 audit. However, GAO's work in 2003 identified 22
additional security weaknesses in FDIC's information systems. FDIC has
made substantial progress in more fully implementing a computer security
management program. However, it only recently established a program to
test and evaluate its computer control environment and this program does
not yet include all key areas. A mature, comprehensive, ongoing program of
tests and evaluations of control would enable FDIC to better identify and
correct information system security problems such as those found in our
review.

FDIC has reported that banks and savings institutions it insures have
experienced record earnings during 2003. The financial condition of BIF
and SAIF are also showing positive trends. The fund balances, or net
worth, for both BIF and SAIF increased during fiscal year 2003. And, the
current level of estimated losses from probable failures of insured
institutions is low relative to the estimated liabilities that FDIC has
recorded over the last 10 years.

It is important to remember that GAO's opinions on FDIC's financial
statements and its overall positive report on internal controls reflect a
point in time. This also holds true for the positive financial trends that
FDIC and insured financial institutions are currently experiencing. FDIC
must continually monitor its business environment, assess the related
risks, and adapt its internal operations as well as its insurance and
supervision and monitoring functions to manage risk and maximize the value
of its overall mission.

FDIC is taking action to improve its risk monitoring and operations in
several areas, including financial risk management, future financial
management and information needs, and information technology security and
processes.

Madam Chairwoman and Members of the Subcommittee:

I am pleased to be here today to discuss the results of our audits of the
Federal Deposit Insurance Corporation (FDIC) Funds' Financial Statements.
We are required by the Federal Deposit Insurance Act1 to annually audit
the financial statements of the Bank Insurance Fund (BIF), the Savings
Association Insurance Fund (SAIF), and the FSLIC Resolution Fund (FRF),
which are administered by FDIC. Our recent report,2 issued on February 13,
2004, presents the results of our audits of the funds' 2003 and 2002
financial statements.

Today, I will discuss the results of those audits, including the
substantial progress that FDIC has made in the area of information
security controls. In addition, I will provide some information on FDIC's
financial condition and results and considerations for the future.

Audit Results 	In our audits of the 2003 and 2002 financial statements for
BIF, SAIF, and FRF, we found:

o 	the financial statements of each fund are presented fairly in all
material respects in conformity with U.S. generally accepted accounting
principles,

o 	although internal controls in the area of information system security
should be improved, FDIC had effective internal control over financial
reporting (including safeguarding of assets) and compliance with laws and
regulations, and

o  no reportable noncompliance with the laws and regulations we tested.

We issued unqualified or "clean" opinions on the financial statements for
BIF, SAIF, and FRF. This means that the financial statements and
accompanying notes for each fund presented fairly, in all material
respects, the financial position as of December 31, 2003 and 2002, and the
results of operations and cash flows for the years then ended and were in
conformity

112 U.S.C. 1827(d).

2Financial Audit: Federal Deposit Insurance Corporation Funds' 2003 and
2002 Financial Statements, GAO-04-429 (Washington, D.C.: Feb. 13, 2004).

with U.S. generally accepted accounting principles. In order to reach our
conclusions about the financial statements, we (1) tested evidence
supporting the amounts and disclosures in the financial statements, (2)
assessed the accounting principles used and significant estimates made by
management, and (3) evaluated the presentation of the financial
statements. We also considered the results of our work in internal control
when designing the nature and extent of our audit tests.

Regarding FDIC's internal control, we concluded that FDIC management
maintained, in all material respects, effective control over financial
reporting (including safeguarding of assets) and compliance as of December
31, 2003. We identified one reportable internal control weakness related
to information system security controls, which although not considered
material, is nevertheless considered a significant deficiency in the
design or operation of controls. We also noted that FDIC made substantial
progress during 2003 in this area. I will discuss FDIC's progress and the
remaining work that needs to be completed in more detail in a later
section of this testimony.

Our evaluation of internal control covered FDIC's financial reporting
controls, which are the policies, processes, and management in place to
meet the financial reporting objectives of ensuring that transactions are

o 	properly recorded, processed, and summarized to permit the preparation
of financial statements in conformity with U.S. generally accepted
accounting principles and assets are safeguarded against loss from
unauthorized acquisition, use, or disposition and

o 	executed in accordance with laws and regulations that could have a
direct and material effect on the financial statements.

In the course of performing our work on internal control, we obtained an
understanding of FDIC's internal control, evaluated the design and
operating effectiveness of internal control, and tested specific
procedures and controls. We also considered FDIC's "control environment"
and "tone at the top," which refer to management's commitment to setting
and maintaining the organization's ethical tone and a positive and
supportive attitude toward internal control and conscientious management.

During the course of our audit, we also tested compliance with selected
provisions of laws and regulations that have a direct and material impact
on the financial statements. For example, we tested for compliance with

sections of the Federal Deposit Insurance Act that require FDIC to monitor
the designated reserve ratio, set semiannual assessments for each fund,
and keep full and complete accounting records for all costs and expenses.
Our tests for compliance with selected provisions of laws and regulations
disclosed no instances of noncompliance.

This year's audit was notable in that it marked the first year that FDIC's
audited financial statements were issued within 45 days of year end.
FDIC's year end is December 31, and our audit report was issued on
February 13, 2004. In contrast to other agencies that are making heroic
efforts and using large amounts of resources to meet the accelerated
reporting date, FDIC has achieved this milestone through solid financial
processes and controls that help to ensure accurate and reliable financial
reporting throughout the year, so that the preparation of the financial
statements and the related audit can be completed in a short time after
year end. We worked cooperatively with FDIC to begin accelerating the
financial reporting and audit process in 2002. FDIC's accelerated
reporting puts it in sync with the requirements for other federal agencies
to issue their audited agency financial statements for fiscal year 2004
within 45 days of year end.3

  FDIC Has Made Substantial Improvements in Information System Security
  Controls, but Weaknesses Remain

We have reported weaknesses in FDIC's information system security for a
number of years. Although we continued to consider such weaknesses to be a
reportable condition for 2003, we also found that FDIC has made
substantial progress in correcting the security weaknesses we previously
identified. FDIC took action to address current and prior-year weaknesses,
including completing action on all of the 22 weaknesses that remained open
from our 2001 audit,4 and 28 of the 29 weaknesses from our 2002 audit.5 In
addition, FDIC has made substantial progress in more fully implementing an
information system security management program to address the remaining
weaknesses identified in our 2002 audit. Effective information system
controls are essential to safeguarding financial data,

3Office of Management and Budget Bulletin No.01-09, Form and Content of
Agency Financial Statements (as amended by Memorandum for Chief Financial
Officers and Inspectors General dated December 21, 2001.)

4See U.S. General Accounting Office, FDIC Information Security: Progress
Made but Existing Weaknesses Place Data at Risk, GAO-03-630 (Washington,
D.C.: June 18, 2003).

5See U.S. General Accounting Office, FDIC Information Security:
Improvements Made but Weaknesses Remain, GAO-02-689 (Washington, D.C.:
July 15, 2002).

protecting computer application programs, providing for the integrity of
system software, and ensuring continued operations in case of unexpected
interruption.

Our work in 2003 identified 22 additional information security weaknesses
in FDIC's information system. Specifically, FDIC had not adequately
limited the access granted to all authorized users or completely secured
access to its network. The risk created by these access weaknesses was
heightened because FDIC had not completed a program to fully monitor
access activity to identify and investigate unusual or suspicious access
patterns that could indicate unauthorized access. Consequently, critical
FDIC financial and sensitive personnel and bank examination information
were at risk of unauthorized disclosure, disruption of operations, or loss
of assets.

A key reason for FDIC's continuing weaknesses in information system
security controls is that it has not yet fully implemented all of the
elements of a comprehensive security management program. An effective
program includes the following elements:

1.	a central security management structure to provide overall security
policy, guidance, and oversight;

2.	policies and procedures that are based on risk assessments and
reduction of risks to ensure that information security is addressed
throughout the life cycle of each system and applicable requirements are
met;

3.	security awareness training to inform all users of information security
risks and users' responsibilities in complying with information security
policies and procedures;

4.	periodic assessment of risk and magnitude of harm that could result
from unauthorized access, use, or disruption of information systems; and

5.	a program of testing and evaluating the effectiveness of information
security policies, procedures, and practices relating to management,
operational, and technical controls of every major system.

FDIC has made substantial progress in implementing a comprehensive
information system security management program. Specifically, FDIC has (1)
strengthened its central security management structure, (2) updated its

security policies and procedures, (3) enhanced security awareness
training, and (4) developed and begun to implement a risk assessment
program.

The fifth and final key element of an effective information security
program is ongoing review, testing, and evaluation of information security
to ensure that systems are in compliance with policies and procedures and
to identify and correct weaknesses that may occur. FDIC began implementing
this program during 2003. In October 2003, FDIC used a contractor to (1)
develop a self-assessment process that includes annual general and
application control reviews and (2) begin to perform ongoing quarterly
tests of FDIC systems. While FDIC has done much to establish an ongoing
program of tests and evaluations to review its computer control
environment, this program does not yet address all key areas.
Specifically, it does not include adequate provisions to ensure that (1)
all key computer resources supporting FDIC's financial environment are
routinely reviewed and tested, (2) weaknesses detected are analyzed for
systemic solutions, (3) corrective actions are independently tested, and
(4) newly identified weaknesses or emerging security threats are
incorporated into the test and evaluation process. Incorporating these
provisions into its test and evaluation process should allow FDIC to
better identify and correct security problems, such as those identified in
our 2003 audit.

FDIC management has shown a strong commitment to fully establishing a
comprehensive security management program that includes a complete review,
testing, and evaluation program. Fully establishing such a program should
provide FDIC with a solid foundation for resolving computer security
problems and managing its information security risks on an ongoing basis.

  FDIC's Financial Condition and Results

The two deposit insurance funds administered by FDIC-BIF and SAIF- insured
9,182 commercial banks and savings institutions with over $9 trillion in
assets and $3.5 trillion in insured deposits as of December 31, 2003. FDIC
has reported that the banks and savings institutions it insures
experienced record earnings during 2003. FDIC has also identified overall
favorable trends in the loss provisions in the industry. However, within
those trends, FDIC has noted risk and worsening asset quality in
residential mortgage loans and credit cards loans.

During 2003, three BIF-insured institutions with assets of $1.1 billion
failed, at an estimated cost of $103 million to the fund. At December 31,
2003, BIF had a recorded liability of $178 million in estimated losses for
institutions

that are likely to fail within one year of the reporting date unless some
favorable event occurs, such as obtaining additional capital or merging.
As of December 31, 2003, SAIF had a recorded liability of $3.2 million in
estimated losses for institutions that are likely to fail within one year.
As shown in figures 1 and 2, the current level of estimated recorded
liability for failures of insured institutions is relatively low, when
compared to the estimated liabilities that FDIC recorded for probable bank
failures over the past 10 years.

Figure 1: Bank Insurance Fund Estimated Liability for Anticipated
Failures, December 31, 1994 through December 31, 2003

Estimated liability for anticipated failures (dollars in thousands)
2,500,000

2,000,000

1,500,000

1,000,000

500,000

0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Years (as of December
31)

Source: BIF's audited financial statements, December 31, 1994 through
December 31, 2003.

Figure 2: Savings Association Insurance Fund Estimated Liability for
Anticipated Failures, December 31,1994 through December 31, 2003

Estimated liability for anticipated failures (dollars in thousands)
500,000

450,000

400,000

350,000

300,000

250,000

200,000

150,000

100,000

50,000

0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Years (as of December
31)

Source: SAIF's audited financial statements, December 31, 1994 through
December 31, 2003.

The fund balances for both BIF and SAIF increased during fiscal year 2003.
Fund balance represents the difference between assets and liabilities and
is a basic measure of the funds' net worth. Fund balance also represents
the cumulative net income of the funds, and each year fund balance changes
by the amount of comprehensive income earned or losses incurred by the
funds. As of December 31, 2003, BIF's fund balance had increased by $1.7
billion to $33.8 billion, and SAIF's fund balance had increased by $493
million to $12.2 billion. For the year ended 2003, BIF and SAIF had
comprehensive income of $1.7 billion and $493 million, respectively.
During 2003, assessments, interest revenue, and unrealized gains decreased
from what was earned during 2002, but those decreases were more than
offset in BIF and partially offset in SAIF by a reduction in the estimated
losses for future failures.

The Federal Deposit Insurance Corporation Improvement Act of 1991 requires
FDIC to maintain the fund balances for BIF and SAIF at a designated
reserve ratio of at least 1.25 percent of estimated insured deposits. From
lows significantly below 1.25 percent in 1991, the reserve

ratios of both BIF and SAIF had risen above that threshold by 1996. They
have remained at or above 1.25 percent since 1996 and were at 1.33 percent
for BIF and 1.41 percent for SAIF as of December 31, 2003. Figures 3 and 4
show the changes in the reserve ratio for both funds from 1991 through
2003.

Figure 3: Bank Insurance Fund Reserve Ratios from December 31, 1991
through

December 31, 2003

Reserve ratio percentage 1.60

1.40

1.25 1.20

1.00

.80

.60

.40

.20

0

-.20

-.40

-.60 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Years (as of December 31)

Source: GAO calculated the reserve ratio by dividing the fund balance by
the estimated insured deposits. Fund balances are from audited BIF
financial statements as of December 31, 1991 through December 31, 2003.
Estimated insured deposits were provided by FDIC and are unaudited.

Figure 4: Savings Association Insurance Fund Reserve Ratios from December
31, 1991 through December 31, 2003

                            Reserve ratio percentage

It is important to remember that our opinions on FDIC's financial
statements and our overall positive report on internal controls reflect a
point in time. This also holds true for the positive financial trends that
FDIC and insured financial institutions are currently experiencing. The
banking and financial services environment is constantly changing, and in
its role as insurer of financial institutions, FDIC must continually
monitor its business environment, assess the related risks, and adapt its
internal operations as well as its insurance and supervision and
monitoring functions to manage risk and maximize the value of its overall
mission.

                                      1.60

                                      1.40

                                      1.25

                                      1.20

                                      1.00

                                      .80

                                      .60

                                      .40

.20 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Years (as
                                of December 31)

Source: GAO calculated the reserve ratio by dividing the fund balance by
the estimated insured deposits. Fund balances are from audited SAIF
financial statements as of December 31, 1991 through December 31, 2003.
Estimated insured deposits were provided by FDIC and are unaudited.

FDIC also manages FRF, which fulfills the obligations of the former
Federal Savings and Loan Insurance Corporation and the former Resolution
Trust Corporation (RTC). As of December 31, 2003, FRF had $3.5 billion in
assets remaining. Of that total, $3.3 billion was in the form of cash and
cash equivalents, and approximately $200 million represented estimated
recoveries from receiverships for failed institutions. In contrast, FRF
had $11.6 billion in assets at December 31, 1996, after it assumed the
assets and liabilities of RTC. As of December 31, 2003, 52 of the 850 FRF
receiverships remained active primarily due to unresolved litigation.

  Considerations for the Future

To respond to the need to update and improve its risk monitoring and
measurement process, FDIC has ongoing efforts in place to

o 	review and update its method for estimating the contingent liability
for anticipated future failures of financial institutions;

o 	establish new processes to meet future financial management and
financial information needs; and

o 	improve information technology (IT) processes, including its
information system security management program.

During 2003, FDIC hired an outside consulting firm to review its financial
risk management practices. The review focused on FDIC's methods and
procedures for estimating the liability associated with future failures of
financial institutions. FDIC initiated revisions to this methodology in
the third quarter of 2003 and is planning additional revisions during
2004. FDIC last changed this methodology in 1997. The current and planned
changes primarily relate to the methodology used to estimate potential
failure and loss rates of insured financial institutions.

FDIC is also developing new financial systems to enhance its ability to
meet future financial management and financial information needs. A
related benefit of moving to more modernized systems is the ability to
redirect staff resources from processing individual transactions to
carrying out value-added accountability functions, such as financial
analysis, decision making, and risk management functions. FDIC's current
financial system was implemented in 1986, and it currently limits progress
within FDIC because it is comprised of many stand-alone applications that
need work-around and labor-intensive processes to interface with FDIC's
core general ledger system. This current environment necessitates
redundant data entry and requires the use of significant staff resources
to gather and reconcile data and correct errors.

The constant changes to its operational environment require FDIC to
identify opportunities to improve its computerized processes in support of
operations while maintaining effective internal control and computer
security. FDIC's computerized processes are key to its mission. They are
critical to all of FDIC's internal operations and business lines,
including insurance, supervision, consumer protection, and receivership
management. With the constantly changing IT and business environment in
which FDIC operates, it is critical that FDIC maintain sound IT systems,

with adequate internal control and security and applications, to
effectively support and carry out its mission.

In summary, the results of our audits for 2003 were positive-clean
opinions on the financial statements and overall effective internal
control, with significant improvements in the area of information system
security controls, which we have been reporting as a significant
deficiency for several years. We have seen a strong commitment from FDIC
management in promoting excellence in financial reporting and internal
control. FDIC is continuing to take important steps to monitor risk,
modernize its systems, and adapt to change. FDIC's mission of insuring
deposits in our nation's financial institutions is critical to the
citizens of this country and our nation's economy. With the banking and
financial services environment constantly changing, FDIC must continually
monitor its business environment and related risks, and adapt its internal
operations as well as its insurance and supervision and monitoring
functions to manage risk and maximize the value of its overall mission.

This testimony is based on our most recent audit of the FDIC funds' 2003
financial statements as well as our previous years' audits, which were
conducted in accordance with generally accepted government auditing
standards.

Madam Chairwoman, that concludes my prepared statement. I would be pleased
to answer any questions you or the other members of the Subcommittee may
have.

Contacts and	Should you have any questions about this testimony, please
contact me at (202) 512-9471 for financial issues or Robert Dacey at (202)
512-3317 for

Acknowledgments	information technology issues. We can also be reached by
e-mail at [email protected] and [email protected]. Other major contributors to
this testimony were Ronald Bergman, Gary Chupka, Julia Duquette, Maxine
Hattery, Dave Irvin, Meg Mills, Tim Murray, Ed Tanaka, and Charles Vrabel.

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