Foreign Banks: Opportunities Exist to Enhance Supervision Program as
Implementation Proceeds (Letter Report, 05/09/97, GAO/GGD-97-80).
Pursuant to a congressional request, GAO provided information on the
oversight of the U.S. operations of foreign banking organizations (FBO),
focusing on the: (1) the FBO program; and (2) banking supervisors'
progress in implementing this program.
GAO noted that: (1) the FBO Program focuses on integrating into
supervisory procedures a common understanding of a given FBO in its
entirety, including policies and practices in the FBO's home country as
well as the overall condition of the FBO's combined U.S. operations; (2)
the program calls for coordinated development and common use of five new
products; (3) GAO refers to two of these as "the country reports"; (4)
one country report is to provide information about the financial system
and the supervisory and governmental policies in the FBO's home country,
and the other is to provide information about significant accounting
policies and practices in the home country; (5) a third product, the
Strength-of-Support Assessment (SOSA), which is to be based on the
country reports and other financial data, is to provide analysis and a
ranking to reflect the U.S. supervisors' judgment about the FBO's
ability to provide its U.S. operations necessary financial and
managerial support; (6) a fourth product, the Summary of Condition and
Combined Rating, is designed to provide FBO management and U.S.
supervisors with an overall assessment of the FBO's U.S. operations; (7)
the last new supervisory product, an annual comprehensive examination
plan, is intended to better coordinate examinations of U.S. offices of
FBOs with multiple U.S. banking operations and/or significant U.S.
nonbanking operations; (8) in GAO's review of the FBO Program, GAO found
that banking supervisors had made progress in implementing the program
and had begun to realize benefits from it; (9) however, GAO also
identified areas where improvements could be made; (10) supervisors
identified some broad benefits of the program, particularly increased
communication and cooperation among supervisors and improved access to
information about FBOs and their home countries; (11) at the same time,
comments of supervisory officials and staff indicated some skepticism
about how useful the information from the SOSA reports will be in
improving FBO supervision; (12) however, they also said that the various
Federal Reserve Banks are developing different formats and strategies
for integrating the information into the supervisory process; and (13)
in addition, GAO identified a number of weaknesses in SOSA and country
reports that could limit the program's effectiveness, including
inconsistent, incomplete, or outdated information.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: GGD-97-80
TITLE: Foreign Banks: Opportunities Exist to Enhance Supervision
Program as Implementation Proceeds
DATE: 05/09/97
SUBJECT: Bank examination
Interagency relations
Bank management
Financial records
Banking regulation
Accounting procedures
International economic relations
Reporting requirements
Federal reserve banks
Foreign governments
IDENTIFIER: Foreign Banking Organization Supervision Program
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Cover
================================================================ COVER
Report to the Chairwoman and the Ranking Minority Member,
Subcommittee on Financial Institutions and Consumer Credit, House
Committee on Banking and Financial Service
May 1997
FOREIGN BANKS - OPPORTUNITIES
EXIST TO ENHANCE SUPERVISION
PROGRAM AS IMPLEMENTATION PROCEEDS
GAO/GGD-97-80
Foreign Bank Supervision Program
(233499)
Abbreviations
=============================================================== ABBREV
BIS - Bank for International Settlements
DCI - Data Collection Instrument
FRS - Federal Reserve System
FBO - Foreign Banking Organization
FBSEA - Foreign Bank Supervision Enhancement Act of 1991
FDIC - Federal Deposit Insurance Corporation
NPL - Nonperforming loan
OCC - Office of the Comptroller of the Currency
SOSA - Strength-of-Support Assessment
Letter
=============================================================== LETTER
B-272838
May 9, 1997
The Honorable Marge Roukema
Chairwoman
The Honorable Bruce F. Vento
Ranking Minority Member
Subcommittee on Financial Institutions
and Consumer Credit
Committee on Banking and Financial Services
House of Representatives
This report responds to your request for information on the oversight
of the U.S. operations of foreign banking organizations (FBO). The
Foreign Bank Supervision Enhancement Act of 1991 (FBSEA) gave the
Federal Reserve System (FRS) enhanced supervisory and regulatory
authority over foreign banks operating in the United States.\1 Before
FBSEA, each such office was examined by a federal or state supervisor
and treated as a separate entity even if the FBO had multiple offices
in the United States. Although FRS had overall authority for
supervising the foreign banks' U.S. presence, no formal mechanism
existed to enable the various agencies to share information about an
FBO with offices in multiple states and to coordinate supervisory
activities. In keeping with its enhanced authority, FRS has worked
with other supervisory agencies to develop the Foreign Banking
Organization Supervision Program (FBO Program) with the intent of
improving and better coordinating supervision of FBO offices in the
United States.
As agreed with your subcommittee, the objectives of this report are
to (1) describe the FBO Program and (2) evaluate the banking
supervisors' progress in implementing this program.
--------------------
\1 Foreign banks may operate in the United States through bank or
nonbank subsidiaries and other types of offices, including branches,
agencies, and representative offices.
RESULTS IN BRIEF
------------------------------------------------------------ Letter :1
The FBO Program focuses on integrating into supervisory procedures a
common understanding of a given FBO in its entirety, including
policies and practices in the FBO's home country as well as the
overall condition of the FBO's combined U.S. operations. The
program calls for coordinated development and common use of five new
products. We refer to two of these as "the country reports." One
country report is to provide information about the financial system
and the supervisory and governmental policies in the FBO's home
country, and the other is to provide information about significant
accounting policies and practices in the home country.
A third product, the Strength-of-Support Assessment (SOSA), which is
to be based on the country reports and other financial data, is to
provide analysis and a ranking to reflect the U.S. supervisors'
judgment about the FBO's ability to provide its U.S. operations
necessary financial and managerial support. SOSA reports are to be
used along with other information for reaching decisions regarding
the scope and frequency of exams and for other supervisory and
enforcement matters.
A fourth product, the Summary of Condition and Combined Rating, is
designed to provide FBO management and U.S. supervisors with an
overall assessment of the FBO's U.S. operations. The last new
supervisory product, an annual comprehensive examination plan, is
intended to better coordinate examinations of U.S. offices of FBOs
with multiple U.S. banking operations and/or significant U.S.
nonbanking operations. This examination plan is to be developed from
information in the SOSAs, the results of individual prior
examinations, and the overall assessment of the FBO's combined U.S.
operations.
In our review of the FBO Program, we found that banking supervisors
had made progress in implementing the program and had begun to
realize benefits from it. However, we also identified areas where
improvements could be made. As of December 31, 1996, about 43
percent of the required SOSA reports and their related home country
reports had been finalized.\2 Supervisors identified some broad
benefits of the program--particularly increased communication and
cooperation among supervisors and improved access to information
about FBOs and their home countries. At the same time, comments of
supervisory officials and staff indicated some skepticism about how
useful the information from the SOSA reports will be in improving FBO
supervision. However, they also said that the various Federal
Reserve Banks are developing different formats and strategies for
integrating the information into the supervisory process. In
addition, we identified a number of weaknesses in SOSA and country
reports that could limit the program's effectiveness. These included
inconsistent, incomplete, or outdated information, as well as SOSA
rankings that did not appear to be justified by information in the
report.
--------------------
\2 Federal Reserve Board officials told us that, as of April 7, 1997,
approximately 92 percent of the SOSAs and their related home country
reports were in final or draft form.
BACKGROUND
------------------------------------------------------------ Letter :2
As of December 31, 1996, a total of 281 FBOs based in 59 countries
had banking operations in the United States that were subject to the
procedural requirements of the FBO program. FBOs operate in the
United States through a number of types of offices with differing
powers and oversight. The most common of these types of entities are
described in table 1.
Table 1
Types of Offices FBOs Operate in the
United States
Type of office Description Supervision
------------------ ---------------------------------------- ------------------
Branches and Branches are legal and operational FRS and either
agencies extensions of their parent foreign bank Office of the
and have broad banking powers, including Controller of the
accepting limited uninsured deposits, Currency (OCC) if
lending, money market services, trade federal license or
financing, and other activities related states if state
to the service of foreign and U.S. license.\a
clients. Agencies have similar powers
but may not accept deposits from U.S.
citizens or residents.
Subsidiary bank Separately capitalized legal entity OCC, or FDIC and
chartered in the U.S. with shares owned state regulators,
or controlled by the parent foreign or FRS and states.
bank. Banking powers and legal or
regulatory restrictions are the same as
those of any other domestic bank.
Representative A marketing office/liaison between the FRS and states.
office head office of the foreign bank and its
customers and correspondent banks in a
state or region. May engage in
representational and administrative
functions, but may not make any business
decisions on behalf of the foreign bank.
Edge Act Edge Act Corporations are separate Edge Act
Corporation or subsidiaries limited to international corporations:
Agreement banking activities specified in the Edge FRS.
Corporation Act. Domestic activities permitted Agreement
include receipt of deposits from foreign Corporations: FRS,
governments, financing of contracts, states.
projects performed abroad, financing
imports and exports. Agreement
Corporations are limited to essentially
the same powers as Edge Act Corporations
by agreement with FRS.
Commercial lending Specialized nondepository institution FRS and states.
company authorized under state law. May engage
in borrowing and lending activities,
including accepting deposits at off-
shore facilities.
Nonbank subsidiary Nonbank subsidiaries of FBOs may engage FRS, states, and
in activities such as underwriting or other federal
dealing in certain securities to the regulators,
same extent that U.S. bank holding depending on
companies may engage in such activities. activities.
--------------------------------------------------------------------------------
\a There are also a limited number of insured branches that are
supervised in part by the Federal Deposit Insurance Corporation
(FDIC).
As shown in table 2, branches and agencies are the most common types
of FBO banking offices in the United States, and they account for
about 51 percent of the total foreign bank assets in the United
States as of December 31, 1996.
Table 2
U.S. Operations of FBOs as of December
31, 1996
Number of Total assets
Type of office offices (in billions)
---------------------------------------- ------------- =============
Branches and agencies 498 $821
Subsidiary banks 90 226
Edge Act and Agreement Corporations 21 2
Other deposit-taking entities\a 29 25
Total banking offices 638 1,074
U.S. nonbanking subsidiaries 672 537
Representative offices 138 NA
======================================================================
Total 1,448 $1,611
----------------------------------------------------------------------
\a Includes commercial lending companies, savings banks, and trust
companies.
Source: Federal Reserve System.
An individual FBO may have a variety of these types of offices
operating in the United States, and each individual office may be
supervised by a different federal or state regulator, with FRS having
overall authority. Figure 1 shows the organizational structure of
the U.S. operations of a hypothetical FBO. It also shows the U.S.
supervisor for each office.
Figure 1: Organizational
Structure of the U.S.
Operations of a Hypothetical
FBO
(See figure in printed
edition.)
\a FRS has overall authority for all U.S. operations of FBOs.
Source: GAO example developed from FRS documents.
SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :3
To address the objectives of this report, we reviewed examination
manuals, relevant laws, and guidance issued by the Board of Governors
of FRS (Federal Reserve Board). We interviewed officials from the
Federal Reserve Board and the Federal Reserve Banks of Atlanta,
Chicago, New York, and San Francisco. We also interviewed state bank
supervisors from California, Florida, Illinois, and New York, and
officials from FDIC, OCC, and the Institute of International
Bankers--an association of foreign banking organizations with U.S.
operations. The Federal Reserve Banks and state bank supervisors we
interviewed are responsible for overseeing most FBO operations in the
United States.
In addition to our interviews, we developed a data collection
instrument (DCI) to help us systematically collect information from
each of the FBO products: the country reports, SOSAs, examinations,
overall assessments of U.S. offices, and the comprehensive exam
plans. The type of information we collected included basic financial
information on the FBO and its U.S. operations, results of past
examinations of U.S. operations, and information on the supervisory
and financial system of the foreign country, among other things.
This DCI was designed to help us compare the content of these reports
and determine the extent of use of information from SOSAs and country
reports in comprehensive exam plans.
We used the DCI to review the FBO products from 18 different
countries. We chose countries located in Europe, Asia, and North and
South America to obtain variation in geographic location and levels
of financial development. For each country, we chose two FBOs, if
two existed, and reviewed their SOSAs, comprehensive exam plans, and
overall U.S. assessment, if available. We chose the FBOs included
in our judgmental sample to obtain variation in size, SOSA ranking,
and types of offices they had operating in the United States.
We obtained written comments on a draft of this report from the
Federal Reserve Board. These comments are discussed at the end of
this letter and are reprinted in appendix I. We did our work in
Washington, D.C.; New York; California; Illinois; and Florida in
accordance with generally accepted government auditing standards from
September 1996 to January 1997.
THE FBO PROGRAM WAS DESIGNED TO
IMPROVE AND BETTER COORDINATE
SUPERVISION OF FBO OPERATIONS
IN THE UNITED STATES
------------------------------------------------------------ Letter :4
The FBO Program was designed to provide the U.S. banking supervisory
agencies with a collective mechanism for supervising the U.S.
operations of FBOs in a highly coordinated, thorough, and efficient
manner, according to the Federal Reserve Board. FRS began to
implement the FBO Program in March 1995, when it issued its initial
guidance on the program. Federal Reserve Board officials told us
that the program was scheduled to be implemented over a 3- to 5-year
period, but that they hoped to have it fully operational within 3
years.\3 The interagency program--which consists of a number of
supervisory steps and assessments that each have their individual
requirements regarding content, procedures, and timing-- calls for
the development and distribution of six supervisory products.\4
--------------------
\3 For the initial implementation phase of the FBO program, Federal
Reserve Board officials said they decided to apply the FBO program
only to FBOs with a direct banking presence in the United States
through branches or agencies, Edge or Agreement Corporations,
commercial lending companies, or subsidiary banks. Once the program
becomes fully operational, FRS will consider incorporating foreign
banks with a representative office presence only.
\4 These products include the five new products discussed earlier and
the individual exam plan, which the regulators have routinely used in
the past.
THE SIX SUPERVISORY PRODUCTS
ARE TO PROVIDE A WIDE RANGE
OF SUPERVISORY INFORMATION
---------------------------------------------------------- Letter :4.1
The six supervisory products of the FBO Program are to provide
information about the home countries of the FBOs, the FBOs
themselves, and the FBOs' operations in the United States. The six
products are
-- Review of Home Country Financial System,
-- Review of Significant Home Country Accounting Policies and
Practices,
-- Strength-of-Support Assessment,
-- Individual Examination Plan,
-- Comprehensive Examination Plan, and
-- Summary of Condition and Combined Rating.
We refer to the first two products, which focus on a country's
financial system and accounting policies and practices, as "the
country reports." The contents of the six supervisory products are
summarized in table 3.
Table 3
Supervisory Products of FRS' FBO Program
Product Summary of contents
------------------ --------------------------------------------------
Review of Home For each country with bank representation in the
Country Financial United States, the assigned supervisor (usually a
System Federal Reserve Bank) is to describe the financial
system structure, process of supervision and
regulation, treatment of problem or failed
institutions, and, if warranted by existing
issues, current condition and operating
performance of the financial system.
Review of For each country with bank representation in the
Significant Home United States, the assigned supervisor (usually a
Country Accounting Federal Reserve Bank) is to highlight accounting
Policies and policies and practices that differ significantly
Practices from U.S. standards, including asset valuation,
income and expense items, consolidation rules,
off-vs. on-balance sheet items, tax
considerations, and disclosure rules.
Strength-of- For each FBO, the assigned supervisor (usually a
Support Assessment Federal Reserve Bank) is to assess internal and
(SOSA) external resources to give U.S. operations
necessary (1) financial and (2) managerial
support. Financial support assessment--summarized
by A-E rankings--is to be based on available
information on the financial and operational
condition of the FBO in the context of the home
country reports. Managerial support assessment
requires placement of an asterisk (*) beside the
letter assessment if actual or potential
managerial or operational control risks are
apparent.
Individual Exam For each FBO office in the United States, U.S.
Plan federal or state supervisors are to develop
examination plans for individual offices based
primarily on the findings and scope of previous
examinations, the results of any off-site
surveillance, the latest assessment of the
combined U.S. operations of the FBO and the role
of the office in the context of the FBO's overall
U.S. business activities, and the evaluation of
the FBO and the assigned SOSA.
Comprehensive For all U.S. operations of an FBO except for
Examination Plan commercial banks, the assigned Federal Reserve
Bank is to prepare comprehensive examination plans
that describe the overall scope and frequency for
the next series of examinations.
Summary of For all FBOs with multiple U.S. operations, an
Condition and assigned Federal Reserve Bank is to prepare a
Combined Rating summary in the form of a letter to the FBO's head
office management that highlights areas of overall
strength and any systemic weaknesses in the FBO's
U.S. operations. A rating of the FBO's combined
U.S. operations, based on a 1-5 scale, is to be
included.
----------------------------------------------------------------------
The Federal Reserve has assigned responsibility for preparing the FBO
products to the various Reserve Banks that have offices of foreign
banks in their districts.\5 Responsibility for the products is
generally assigned according to the location of the FBO offices in
the United States. Given the preponderance of FBO offices in New
York, the Federal Reserve Bank of New York was preparing the majority
of products. Draft country and SOSA reports are to be circulated to
other relevant U.S. supervisors for comment. Final versions of the
reports are also to be provided to the relevant U.S. supervisors.\6
Based on FRS guidance issued in August 1996, SOSA rankings are to be
considered final only when they have been formally reviewed and
approved by a committee headed by officials of the Federal Reserve
Board's international supervision function.
--------------------
\5 OCC also has responsibility for preparing products for nine FBOs
in six countries that operate in the United States only under a
national charter or license.
\6 For example, copies of draft and final country reports are to be
provided to each state supervisor responsible for a banking office of
an FBO from the country, each Federal Reserve Bank in which an FBO
from that country has a banking presence in the district, OCC if an
FBO from the country has a federally licensed office, FDIC if an FBO
from the country has an insured office, and the Federal Reserve
Board.
THE COUNTRY REPORTS AND THE
SOSA ARE INTENDED TO IMPROVE
U.S. SUPERVISION OF FBO
OPERATIONS IN THE UNITED
STATES
---------------------------------------------------------- Letter :4.2
One of the principal goals of the SOSA is to identify FBOs that may
pose risks to their U.S. operations or to U.S. financial markets
due to financial, operational, or other concerns at the FBO as a
whole. As table 3 shows, the SOSA utilizes a two- component
assessment ranking system for financial and managerial support.
Financial support is summarized by A to E rankings, with A
representing the lowest level of supervisory concern and E the
highest. An asterisk is to be placed beside the letter assessment on
an as-needed basis to identify whether there are any factors that
raise questions about the ability of the FBO to maintain adequate
internal controls and compliance procedures at its U.S. offices,
irrespective of the overall financial condition of the FBO. The
SOSA--which is supported by the two country reports--is to provide
information to the U.S. bank supervisory agencies that they can take
into account in reaching decisions regarding the scope and frequency
of examinations and whether other supervisory initiatives may be
appropriate.\7 The SOSA assessment serves to categorize all FBOs with
U.S. banking operations by levels of supervisory concern,
highlighting those whose U.S. operations are thought to warrant
higher levels of supervisory attention.
An FBO's SOSA, along with other information, is to be taken into
consideration in setting the examination plan for the FBO's U.S.
operations. For example, the U.S. operations of FBOs whose
assessments are marked by an asterisk, denoting potential internal
controls or compliance risks, may receive examinations in which
supervisors investigate those risks.
The FBO's SOSA analysis and ranking are to be considered in
implementing supervisory follow-up action for the U.S. operations,
although specific SOSA rankings are not linked to mandatory
supervisory actions. According to procedural guidance for the
program, an assessment of C or lower is expected to imply a level of
concern that would subject the FBO's U.S. offices to at least
periodic monitoring of their net due to/due from positions.\8 Any
additional supervisory step, such as imposing an asset pledge or
asset maintenance requirement,\9 is to be implemented largely based
on the condition and nature of the U.S. operations. If an FBO is
accorded an assessment of D or lower, this is generally expected to
indicate a higher level of supervisory concern, with some presumption
of asset maintenance regardless of the condition of the FBO's U.S.
operations.\10
As part of the FBO Program, FRS is to maintain a database containing
information on the financial system and on significant accounting
policies and practices of each country with bank representation in
the United States. The information in the database is to be provided
by FRS and other supervisory agencies, and FRS is to make the
information available to all of the supervisory agencies.
--------------------
\7 Any particular changes that need to be made to the supervisory
strategy for the U.S. operations of an FBO that arise from the SOSA
analysis are to be presented in a separate supervisory implications
section of the SOSA. The SOSA is expected to include the specific
implications for any examination plan of a SOSA ranking of C or lower
or when an asterisk is included in the ranking.
\8 Net due to and from positions refer to the flow of funds between
an office of the parent foreign bank and the parent bank or other
offices of the bank. For example, if the U.S. offices are in a net
due from position with the parent foreign bank, then once all the
transactions between the U.S. offices and the parent foreign bank
are netted, the parent bank owes funds to the U.S. offices.
\9 Asset pledges, also called capital equivalency deposits, are
required cash deposits or eligible securities deposits at an approved
depository bank. Asset maintenance requirements are to ensure that a
branch or agency maintains "eligible" assets in excess of third party
liabilities for protecting creditors. Eligible assets usually
include assets for which there is a reasonable expectation of
liquidation on a timely basis.
\10 An assessment of A or B is generally expected to imply little if
any concern relating to the ability of the FBO to meet its
obligations. If an FBO does raise liquidity or solvency concerns,
the FBO should not be accorded an assessment of A or B, according to
the guidance.
THE COMPREHENSIVE
EXAMINATION PLAN AND THE
OVERALL ASSESSMENT ARE TO
HELP COORDINATE AGENCIES'
EFFORTS IN SUPERVISING FBOS
---------------------------------------------------------- Letter :4.3
The comprehensive examination plan and the overall assessment of an
FBO's U.S. operations--that is, the Summary of Condition and the
Combined Rating--are designed to help coordinate agencies' efforts in
supervising FBO offices in the United States. To ensure coordination
of supervisory efforts and avoid duplication, the FBO Program calls
for U.S. banking supervisory agencies to increase interagency
communications regarding their examination plans, examination
results, and any proposed supervisory follow-up actions. Also, to
fulfill its responsibilities for the overall U.S. operations of
individual FBOs, FRS is to prepare annually an overall assessment of
the combined U.S. operations of each FBO, based largely on input
from and discussions with the examining agencies. As noted in figure
2, the comprehensive examination plan is to cover all U.S.
operations of an FBO with the exception of commercial banks, which
are to be treated as domestic institutions for the purpose of
examination planning during the initial implementation of the FBO
Program.
Figure 2: Coverage of FBOs and
Their U.S. Offices by the FBO
Products
(See figure in printed
edition.)
\a FRS has overall authority for all U.S. operations of FBOs.
Source: GAO example developed from FRS documents.
The FBO Program is to provide for the coordination of examination
schedules through the development of an annual comprehensive
examination plan for each FBO with banking offices licensed by more
than one supervisory agency and/or with significant U.S. nonbanking
activities.\11 Other U.S. supervisors of FBO offices in the United
States are to provide responsible Federal Reserve Banks with a copy
of their preliminary examination schedules. FRS is to use these, in
conjunction with the preliminary examination schedules of the Reserve
Banks, to derive a draft comprehensive examination schedule for all
U.S. operations of individual FBOs. This draft schedule, to be
provided to all the supervisory agencies, is designed to permit each
agency to coordinate its own schedule with those of other agencies.
FRS is to provide the final comprehensive examination schedule to all
the supervisory agencies. Likewise, the various supervisors are to
provide individual examination plans to be used by FRS in drafting a
comprehensive examination plan.
According to FRS officials, FBOs that operate in the United States
through multiple offices often will have all offices examined using
the same "as of" financial statement date; this will provide the
supervisory agencies with increased information on the
interrelationship among the various offices and can enhance the
examination of individual offices and the FBO's overall operations.
The U.S. supervisory agencies have committed to advising other
agencies' supervising offices of the same FBO of any critical
examination findings prior to the exit meeting with FBO officials for
that examination.
The overall assessment of an FBO's combined U.S. operations is
intended to provide the FBO and the U.S. supervisory agencies with a
view of the overall condition of the FBO's U.S. operations and help
put into context the strengths and weaknesses of individual offices.
The assessment is to be prepared by FRS for all U.S. offices
supervised by more than one agency. The assessment is to address all
risk factors, including (1) all elements of the ROCA rating
system,\12 (2) the quality of risk management oversight employed by
all levels of management in the FBO's U.S. operations, and (3) the
examinations of all offices of the FBO conducted during the year.
The system for rating the FBO's combined U.S. operations is to
result in the assignment of a single-component rating between 1 and
5, with 1 being the highest. The rating system contains language
describing the level of supervisory concern and required supervisory
attention. See table 4 for a description of the ratings.
Table 4
Definitions of Ratings of the Combined
U.S. Operations of FBOs
Numerical rating Definition
------------------ --------------------------------------------------
1 The overall operations are fundamentally sound in
every respect. They cause no supervisory concern
and require only normal supervisory attention.
2 The combined U.S. operations operate in a
basically sound manner, but may have modest
weaknesses that can be corrected by management in
the normal course of business. They do not require
more than normal supervisory attention.
3 Overall U.S. operations are weak in risk
management, operational controls, and compliance,
or have numerous asset quality problems that, in
combination with the condition of the FBO, cause
supervisory concern. U.S. and/or head office
management may not be taking the necessary
corrective actions to address any weaknesses. This
rating may also be assigned when either risk
management, operational controls, or compliance is
individually viewed as unsatisfactory. Generally,
these operations raise supervisory concern and
require more than normal supervision to address
their weaknesses.
4 The combined U.S. operations have a significant
volume of serious weaknesses. Serious problems or
unsafe and unsound banking practices or operations
exist, which have not been satisfactorily
addressed or resolved by U.S. or head office
management. These operations require close
supervisory attention and surveillance monitoring
and a definitive plan for corrective action by
head office management.
5 The combined U.S. operations have so many
weaknesses or unsafe and unsound conditions that
they require urgent restructuring by head office
management.
----------------------------------------------------------------------
Source: Federal Reserve Board guidance (SR95-22) issued March 31,
1995.
This composite assessment is intended to apprise the various U.S.
supervisory authorities of the overall condition of the U.S. offices
of individual FBOs. These agencies can then factor this information
and that in the Summary of Condition into their supervision of the
U.S. offices under their jurisdiction.
--------------------
\11 For FBOs that conduct all or substantially all of their U.S.
operations through offices licensed or chartered by one banking
supervisory agency, the timing of the annual examination is to be
established by the licensing authority.
\12 The ROCA rating system is the system used to rate U.S. branches
and agencies of FBOs and is an assessment of Risk management,
Operational controls, Compliance, and Asset quality.
THE FBO PROGRAM HAS ACHIEVED
SOME BENEFITS, BUT HAS
WEAKNESSES THAT COULD LIMIT ITS
EFFECTIVENESS
------------------------------------------------------------ Letter :5
Banking supervisors have made progress in implementing the FBO
Program. They have developed and distributed procedural requirements
and guidance. As of December 31, 1996, about 43 percent of the SOSA
reports and their related home country reports had been finalized,
and supervisors were just beginning to use the information in these
reports in developing comprehensive examination plans. Supervisors
identified some broad benefits of the program--particularly increased
communication and cooperation among supervisors and improved access
to information about FBOs and their home countries. At the same
time, supervisors told us that determining how to use this
information to improve their supervision was clearly the biggest
challenge they face as they move forward. In addition, we identified
a number of weaknesses in SOSA and country reports that could limit
the program's effectiveness. These included inconsistent,
incomplete, or outdated information, as well as SOSA rankings that
did not appear to be justified by data in the report.
SUPERVISORS HAVE MADE
PROGRESS IN IMPLEMENTING THE
FBO PROGRAM
---------------------------------------------------------- Letter :5.1
In late March 1995, the Federal Reserve Board distributed to the
Reserve Banks initial guidance for implementing the FBO Supervision
Program. Additional guidance was issued as implementation progressed
from March 1995 to August 1996. As of December 31, 1996, SOSA
reports and accompanying home country reports were completed for 120
(about 43 percent) of the 281 FBOs subject to the requirements of the
program.\13 We found only limited use of country and SOSA report
information in the comprehensive examination plans that we reviewed.
However, at the time of our review, supervisors had just begun to
incorporate SOSA and country report information into the supervisory
process.
--------------------
\13 FRS is responsible for preparing 272 of the 281 SOSA and
accompanying home country reports. FRS officials told us that, as of
April 7, 1997, approximately 92 percent of the SOSAs and their
related home country report were in final or draft form. OCC is
responsible for 9 SOSAs, and an official from OCC told us they had
not completed any of these reports or the accompanying country
reports as of December 31, 1996.
SUPERVISORS IDENTIFIED
BENEFITS OF THE PROGRAM
---------------------------------------------------------- Letter :5.2
Although the FBO Program has not been fully implemented, FRS staff
and other banking supervisors told us of a number of benefits of the
program--most importantly, improved communication and cooperation
among supervisors and bank management, both domestic and foreign, and
improved access to information about FBOs and their home countries.
IMPROVED COMMUNICATION
AND COOPERATION AMONG
SUPERVISORS AND BANK
MANAGEMENT
-------------------------------------------------------- Letter :5.2.1
Regulators reported many instances of increased coordination and
cooperation among federal and state supervisors. Supervisory
officials told us that implementing the FBO Program has, in some
cases, required supervisors from different agencies to coordinate
with each other--whereas before the program, they said coordination
was more ad hoc. For example, because an FBO may have subsidiaries
or offices in several locations across the United States, the
development of a coordinated examination strategy for a given FBO has
required supervisors to work cooperatively, sharing information about
the subsidiaries or offices they individually supervise. This is
important because problems identified at a particular office could
manifest themselves at other offices of an FBO. This improved
coordination and communication is intended to result in improved
supervision of the U.S. operations of FBOs.
FRS officials also said preparing home country reports and SOSAs had
helped them develop valuable relationships with foreign regulators
and foreign central banks. These officials said such preparation has
helped them supervise the U.S. operations of foreign banks. They
also said the relationships they have developed with foreign
regulators have helped them obtain better information on how U.S.
banks are doing abroad.
Finally, officials at a Federal Reserve Bank told us that providing
foreign bank management with a summary of the condition of the FBO's
U.S. operations and a combined rating has helped them communicate
more effectively with foreign bank officials and has resulted in
quicker and better compliance by the foreign banks. These summaries
are to be sent directly to the foreign bank's head office and are to
highlight the issues that need the most attention.
IMPROVED ACCESS TO
INFORMATION ABOUT FBOS
AND THEIR HOME COUNTRIES
-------------------------------------------------------- Letter :5.2.2
Several supervisors stated that the program has been beneficial in
centralizing information about an FBO and its home country. For
example, staff at one Federal Reserve Bank said the FBO Program helps
examiners by providing a single contact for information about an FBO.
The SOSAs and country reports also have provided a benchmark of
information on FBOs and home countries-- so that all supervisors
would have access to the same information about a particular FBO or
country. At another Reserve Bank, staff said the reports have also
provided a ready and complete source of information for U.S.
officials in their meetings with foreign banks and officials from
other countries.
Staff at another Federal Reserve Bank stated that the FBO Program has
given "more form" to their system of supervision. For example, this
Reserve Bank has been monitoring the FBOs' conditions in a particular
country since 1992. However, the staff were not sure whether other
supervisors were doing similar monitoring, and state supervisors told
us they did not have adequate resources for such monitoring. Reserve
Bank officials said the FBO program reduced the likelihood that
problems would fall through the cracks in the supervisory system.
According to supervisory officials, the new program's products and
information have also helped supervisors get information about FBOs
and countries that is not commonly known. FRS has had long-standing
relationships with most of the central banks and bank regulators of
the major industrialized nations. Particularly for the G-10
countries,\14 officials told us that information sharing has occurred
in the past, and that their accounting standards and practices are
generally similar to those in the United States. FRS officials said
such is not the case for other countries, however, particularly many
of the countries with developing financial and supervisory systems
that have banking presences in the United States. For this reason,
some supervisory officials said that the development of SOSAs and
home country reports-- including reports on accounting and auditing
standards and practices--have been particularly useful.
--------------------
\14 The G-10 countries include the United States and the following
foreign countries: Belgium, Canada, France, Germany, Italy, Japan,
the Netherlands, Sweden, Switzerland, and the United Kingdom.
WEAKNESSES EXIST THAT COULD
LIMIT THE EFFECTIVENESS OF
THE FBO PROGRAM
---------------------------------------------------------- Letter :5.3
An important goal of the FBO Program is to enhance supervision by
integrating the information in SOSAs and country reports into the
supervisory and enforcement processes. Officials told us that this
phase of the program was just starting at the time of our review.
However, based on our review of completed SOSA and country reports
and our interviews with supervisory officials and staff, we
identified a number of concerns and weaknesses that could limit the
program's effectiveness in improving supervisory and enforcement
processes in oversight of U.S. operations of FBOs.
SUPERVISORS EXPRESSED
CONCERNS ABOUT USE OF
SOSAS IN EXAM PLANNING
AND ENFORCEMENT
-------------------------------------------------------- Letter :5.3.1
While supervisors and supervisory staff recognized a variety of
benefits of the FBO Program, as discussed earlier, they also
expressed concern about the usefulness of information in the SOSA and
country reports and about how this information could be integrated
into the examination planning process. Further, they expressed
concerns about how to use this information to help them make
enforcement decisions.
Regarding examination planning, some examiners told us that the SOSAs
were useful mainly for general background information, while others
said the information was not particularly useful. Officials from one
Federal Reserve Bank told us they had been experimenting with a new
comprehensive examination plan format that incorporated more
information from the SOSA and country reports, such as key strengths
and weaknesses related to the FBO's lines of business. Officials
from another Reserve Bank said they were in the process of developing
a strategy for integrating the information from SOSA and country
reports into the exam planning process. They said they were also in
the process of considering how the SOSAs could be improved to make
them more useful. They said some possible improvements might include
making the reports shorter and more user friendly for examiners;
updating the reports just before the beginning of an exam cycle; and
focusing the reports more on risk--for example, analyzing the impact
the FBO's overall business strategy might have on its U.S.
operations.
Many supervisors told us that determining how to use information from
the SOSA and country reports to improve their oversight was clearly
the biggest challenge they face as they move forward. In order to
help meet this challenge, Federal Reserve Board officials told us
they commenced development of an FBO training seminar in late 1996
that will emphasize that the FBO Program is a process directed
towards ensuring an appropriate supervisory strategy for the U.S.
operations of each FBO. Among other things, they said the seminar
will place emphasis on creating a greater linkage between the SOSAs
and the comprehensive examination planning process.
With regard to enforcement decisionmaking, some supervisors told us
that they would like to be able to use the SOSAs to some extent to
adjust their supervisory requirements, such as capital equivalency
deposits. In order to do this, SOSAs must be accurate, consistent,
and up-to-date. However, officials told us that they have concerns
about whether this will be possible in the future because of the
difficulties involved in obtaining consistent information from FBOs
and home country regulators.
INFORMATION IN AN FBO'S
SOSA AND COUNTRY REPORTS
WAS SOMETIMES
INCONSISTENT
-------------------------------------------------------- Letter :5.3.2
As we reviewed the 36 SOSAs, we found some examples of inconsistent
information in individual country reports as well as examples of
inconsistency in information between SOSAs and their associated
country reports, as illustrated by the following:
-- A discussion of financial disclosure practices in a certain
country report mentioned that nonperforming loan (NPL) ratios\15
provide a limited indication of the country's problem loan
situation because public disclosure of substandard loans was not
required. In addition, the report said the monetary authority's
manipulation of accounting practices to ease pressure on bank
performance undermines reported financial figures and renders
year-to-year analysis difficult. Yet, the final SOSA report for
an FBO in that country stated that capital was adequate--with
ratios slightly exceeding Bank for International Settlements
(BIS)\16 minimum standards--without providing a clear, explicit
qualification of the statement.
-- One country report pointed out that external auditors had not
yet developed the status or the degree of independence they had
in the United States. The report said that qualified audit
reports were virtually unheard of in this country and warned
that the lack of independence may potentially hinder the
reliability of audited financial statements. However, a SOSA
for one of the FBOs in the country said that the financial
statements were deemed reliable due to an unqualified opinion
rendered by an audit firm.
-- Another report on home country supervision stated that banking
supervision is considered relatively strong. Yet, the same
report noted that reporting of certain key data--such as NPLs,
hidden reserves, off balance sheet items, and risk-based capital
ratios-- was not a supervisory requirement in that country.
--------------------
\15 Nonperforming loans are loans that are not performing according
to the original terms of the borrower's loan agreement. In the
United States, loans 90 days or more past due are generally
considered to be nonperforming.
\16 BIS is an organization of central banks that is based in Basle,
Switzerland. It is the principal forum for consultation,
cooperation, and information exchange among central bankers.
INFORMATION IN THE SOSA
AND COUNTRY REPORTS WAS
SOMETIMES INCOMPLETE
-------------------------------------------------------- Letter :5.3.3
Based on our review of Federal Reserve Board guidance\17 and
discussions with staff at the Federal Reserve Board, Reserve Banks,
OCC, and select state banking departments, we developed a basic list
of information that most supervisors would expect in the SOSAs.\18 We
then reviewed 36 SOSAs and their corresponding country reports to
determine whether this information was provided. In reviewing SOSA
and country reports, we expected some variation in the types of
information provided because of differences in (1) the availability
of information and the financial and supervisory systems in various
countries and (2) the weight that supervisors would place on
different types of information.
Although we expected some variation in the information provided, we
found that nearly all of the SOSAs failed to provide all of the
information on our basic list. Moreover, many seemed incomplete in
ways that would reduce the reliability of the reports for supervisory
use. For example, some of the SOSAs lacked information central to
the purpose of the reports, such as statements of the likelihood of
home country support.
Important details that we found lacking in some SOSA and country
reports were those to clarify
-- the date of the financial data;
-- whether the data were consolidated and, if so, at what level;
-- the date the reports were written and finalized;
-- whether the risk-based capital standards referred to the BIS
standards, and if not, how the capital ratios related to the BIS
standards.
Our findings were consistent with statements of some supervisory
officials we interviewed who expressed concern about the usefulness
of the reports to supervisors. For example, an official from one
banking supervisor told us reports lacked important detail. The same
official also said that the reports lacked candor and did not always
address controversial issues.
A staff member of a federal supervisor also told us that relevant
information for planning examinations of some U.S. operations of
FBOs could be almost wholly lacking in the SOSA report. This staff
member told us that the country reports and SOSAs for the banks he
supervised were useless in preparing examination plans because the
country and SOSA reports focused on credit and asset quality, while
the primary business of the banks in this country is trading in
financial products.
--------------------
\17 Federal Reserve Board guidance describes general categories that
must be addressed, but does not prescribe a list of specific required
information.
\18 Examples of the types of information we looked for in SOSAs
include key activities of the FBO; the operating structure of the
FBO; whether the FBO meets the BIS capital standards; financial
information on the FBO's earnings, asset quality, and liquidity; the
likelihood of home country support; the level of disclosure; and
external audit coverage.
INFORMATION IN THE SOSA
AND COUNTRY REPORTS WAS
SOMETIMES OUTDATED
-------------------------------------------------------- Letter :5.3.4
Some SOSAs and country reports contained outdated information on the
FBO's financial condition or the economic or political condition of
the FBO's home country. In our review, we found that a number of
products completed in 1996 relied on December 1994 or March 1995
data. In addition, some products presented discussions of outdated
political or economic conditions. In discussing these products and
their usefulness, we found that supervisory officials we interviewed
often agreed that outdated information is a problem. Also, staff at
a Federal Reserve Bank identified as a problem the time lag between
when the information was being analyzed and receipt of the finished
product.
To help correct this problem, the Federal Reserve Board is in the
process of pilot testing a program, called FBO Desktop, with the
Federal Reserve Bank of San Francisco. This program is designed to
put all of the FBO Program products on-line. The goal of the program
is to make it more efficient to share information and review FBO
products.\19 An official from the Federal Reserve Board told us the
pilot was nearly completed, as of March 1997, and would be rolled out
soon to the other Federal Reserve Banks and then to the other state
and federal supervisors. However, Federal Reserve Board officials
pointed out that, even though this system is expected to help improve
timeliness, timeliness will continue to be impaired to some degree
due to the fact that FBOs are required to file full financial
statements with FRS only on an annual basis, English translations of
such filings are often not available until mid-year, and disclosure
problems may continue to exist.
--------------------
\19 Federal Reserve Board officials said that data security
procedures will be established so that certain documents can only be
reviewed on a "need to know" basis.
SOME SOSA RANKINGS DID
NOT APPEAR TO BE
SUPPORTED BY INFORMATION
PROVIDED IN THE REPORT
-------------------------------------------------------- Letter :5.3.5
During our review of SOSA reports, we found some cases where the SOSA
rankings did not appear to be justified by the information in the
SOSA reports. For example, the program guidance states that an "A"
SOSA ranking would indicate an FBO with a financial profile that is
regarded as strong, with superior risk-based capital ratios, and that
is comprehensively supervised, among other things. Yet, several FBOs
that received "A" SOSA rankings were based in countries in which (1)
banks were not required to disclose asset quality in reports to
supervisors and (2) the reports said that the efficacy of supervision
was questionable and that the supervisory system lacked an effective
early warning system to identify financially weak institutions.
Many of the supervisors we interviewed told us that they expect that
the assignment of all SOSA rankings will eventually be consistent
with the criteria in program guidance. However, they said achieving
this level of consistency may be difficult because of the differences
in financial and supervisory systems and types of information
available among countries.
CONCLUSIONS
------------------------------------------------------------ Letter :6
Banking supervisors have made progress in implementing the FBO
Program. Supervisors have identified a number of benefits of the
program--most importantly, improved communication and cooperation
among supervisors and improved access to information about FBOs and
their home countries. At the same time, supervisors have just begun
to use the information in SOSA and country reports to improve
supervision and enforcement, and some supervisors indicated some
skepticism about how useful the information from SOSA and country
reports will be in improving FBO oversight. The various Federal
Reserve Banks are developing different formats and strategies for
integrating the information into the supervisory process. In
addition, we identified a number of weaknesses in SOSA and country
reports that could limit the program's effectiveness, including
inconsistent, incomplete, or outdated information, as well as SOSA
rankings that did not appear to be justified by information in the
report.
SOSA rankings that are unsupported or inconsistent with the ranking
system criteria and report information that is inconsistent,
incomplete, and out-of-date are obstacles to achieving a principal
goal of the SOSA--to identify FBOs that may pose risks to their U.S.
operations or to U.S. financial markets. Supervisory use of
unreliable SOSA rankings could lead to inefficient levels and types
of monitoring and to unequal treatment of FBOs' U.S. operations in
enforcement actions, as well as potentially leading to ineffective
oversight. The identified weaknesses could also cause supervisors to
doubt the credibility of SOSA rankings and reports and thus limit
supervisory use of the information resources the FBO supervision
program is designed to provide.
RECOMMENDATIONS
------------------------------------------------------------ Letter :7
As FRS continues its implementation of the FBO Program, we recommend
that the Board of Governors of the Federal Reserve System
-- identify best practices for using the information in the SOSA
and country reports to improve supervision and enforcement, and
disseminate these best practices to all Federal Reserve Banks;
and
-- monitor the report process to help ensure that SOSA and country
reports are consistent, complete, and timely, and that the SOSA
rankings are consistent with the ranking system criteria.
AGENCY COMMENTS AND OUR
EVALUATION
------------------------------------------------------------ Letter :8
The Federal Reserve Board provided written comments on a draft of
this report, and these comments and our responses are reprinted in
appendix I. It also provided technical comments, which we
incorporated where appropriate.
The Federal Reserve Board generally agreed with the conclusions
reached regarding the need for certain improvements in the content
and use of the SOSA reports. In a subsequent conversation, a senior
Federal Reserve Board official stated that the Federal Reserve Board
had no objection to the recommendations. In its written comments,
the Federal Reserve Board also noted that its work going forward will
be largely concentrated on refining certain areas of the FBO Program
to enhance its overall effectiveness, particularly in the areas of
integration of the SOSA into examination planning and ensuring that
appropriate linkages are established between all products in the
program to promote the program's objectives. The Federal Reserve
Board noted four steps that are being taken to help achieve this
program improvement, which we have incorporated into the report.
The Federal Reserve Board also observed that our efforts were
directed principally toward a review of the SOSAs and emphasized that
the SOSA is one of several tools in the FBO Program designed to
assist bank supervisors in meeting the objectives of the program.
While we did review a judgmental sample of finalized SOSAs and
discuss the weaknesses we found, our efforts were not principally
directed toward this review. The report describes each of the
products of the FBO program and their interrelationships, and it
discusses the benefits of all parts of the program realized to date.
---------------------------------------------------------- Letter :8.1
We are sending copies of this report to the Chairmen and Ranking
Minority Members of the Senate Committee on Banking, Housing, and
Urban Affairs and the House Committee on Banking and Financial
Services, the Chairman of the Federal Reserve Board, the Chairman of
the Federal Deposit Insurance Corporation, the Comptroller of the
Currency, and other interested parties. We will also make copies
available to others on request.
Major contributors to this report are listed in appendix II. Please
contact me at (202)512-8678 if you or your staff have any questions.
Thomas J. McCool
Associate Director, Financial Institutions
and Markets Issues
(See figure in printed edition.)Appendix I
COMMENTS FROM THE FEDERAL RESERVE
BOARD
============================================================== Letter
the end of this appendix.
(See figure in printed edition.)
(See figure in printed edition.)
The following are GAO's comments on the Federal Reserve Board's April
28, 1997, letter.
GAO COMMENTS
1. We added a footnote on page 19 that states that there is no
prescribed list of required information for SOSAs.
2. As we stated on page 19, we expect some variation in the
information provided in SOSA reports and as these reports are updated
annually for any material changes, we expect this variation will
continue. However, this variation is not necessarily a problem
provided that important information--such as the likelihood of home
country support or other details necessary for accurate analysis--is
included in the SOSA reports.
3. We added a description of FRS' training seminar on page 18.
4. We added information on the supervisory implications section of
the SOSA report in footnote 7 on page 9.
5. We added information on the procedures to review SOSAs on page 9.
However, for the case of inconsistency between the country report and
final SOSA we described on page 19, the SOSA had been approved
through these new procedures, and this problem had not been
corrected.
6. We added information on the likelihood that some problems with
the timeliness of information will continue on page 21.
MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II
GENERAL GOVERNMENT DIVISION
Susan S. Westin, Assistant Director
Kristi A. Peterson, Evaluator-in-Charge
Charles G. Kilian, Senior Evaluator
Desiree W. Whipple, Communications Analyst
*** End of document. ***