United States
Financial Sector Assessment Program-Detailed Assessment of Observance on the Basel Core Principles for Effective Banking Supervision
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This paper discusses key findings of the Detailed Assessment of Observance of the Basel Core Principles for Effective Banking Supervision (BCP) on the United States. The U.S. federal banking agencies have improved considerably in effectiveness. These improvements are reflected in the high degree of compliance with BCP in this current assessment. Shortcomings have been observed, particularly in the treatment of concentration risk and large exposures, but they do not raise concerns overall about the authorities’ ability to undertake effective supervision. These shortcomings should, however, be addressed if the United States is to achieve the standards of supervisory effectiveness expected of one of the most systemically important financial systems in the world.

Abstract

This paper discusses key findings of the Detailed Assessment of Observance of the Basel Core Principles for Effective Banking Supervision (BCP) on the United States. The U.S. federal banking agencies have improved considerably in effectiveness. These improvements are reflected in the high degree of compliance with BCP in this current assessment. Shortcomings have been observed, particularly in the treatment of concentration risk and large exposures, but they do not raise concerns overall about the authorities’ ability to undertake effective supervision. These shortcomings should, however, be addressed if the United States is to achieve the standards of supervisory effectiveness expected of one of the most systemically important financial systems in the world.

Summary and Key Findings

1. The U.S. federal banking agencies (FBAs1) have improved considerably in effectiveness since the previous FSAP. In response to global and domestic reforms, particularly the Dodd-Frank Act (DFA), the FBAs have stepped up their supervisory intensity, especially of large banking organizations, putting emphasis on banks’ capital planning, stress testing and corporate governance. To match, the FBAs have also enhanced their supervisory capacity, adding significantly to their staffing numbers and skills base.

2. These improvements are reflected in the high degree of compliance with the Basel Core Principles for Effective Banking Supervision (BCP) in this current assessment. Shortcomings have been observed, particularly in the treatment of concentration risk and large exposures, but they do not raise concerns overall about the authorities’ ability to undertake effective supervision. These shortcomings should, however, be addressed if the United States is to achieve the standards of supervisory effectiveness expected of one of the most systemically important financial systems in the world.

3. The Dodd-Frank reforms have resulted in some rationalization of supervisory responsibilities but they did not address, fundamentally, the fragmented nature of the U.S. financial regulatory structure. This was an opportunity lost. The problems inherent in multiple regulators with distinct but overlapping mandates remain, with the new challenge of delineating responsibilities with a stand-alone consumer protection agency. The FBAs are committed to making the revised arrangements work and cooperation has clearly improved. Nonetheless, there is substantial duplication of supervisory effort, particularly in respect of entities in major banking groups, and the ongoing risk of inconsistent messages from the agencies. Against this background, the assessors saw scope to sharpen supervisory mandates and opportunities for a more targeted allocation and commitment of resources to the supervision of smaller banking institutions.

4. The U.S. prudential regulatory regime is a complex structure of federal statutes, regulations and reporting requirements, and policy statements and supervisory guidance. Since the crisis, the DFA and other initiatives have introduced various “tiers” of prudential requirements for banks and bank holding companies, which underpin the heightened supervisory focus on large banking organizations but have added to the complexity of the regime. Many requirements of the BCP are in practice, however, determined by the supervisor under a principles-based approach. Such an approach provides flexibility for supervisors to tailor their actions to each individual situation and be more nuanced in their response. Under the Office of the Comptroller of the Currency (OCC)’s new “Heightened Standards”, for example, the supervisor has a range of informal and formal corrective responses that can be pursued before formal enforcement actions—which, in the U.S., are published—are taken. Of course in benign circumstances, when the financial situation of a bank is still satisfactory, a principles-based approach may encourage a delayed supervisory response. However, the assessors observed that banks were responsive to informal guidance and “best practice” recommendations from the FBAs and that supervisory oversight based on that guidance has stepped up in intensity. In the upturn of the cycle, it is important that good supervisory practice established under crisis conditions be maintained.

5. In many cases, this principles-based approach is reflected in a lack of specificity in the regime, for example, the absence of guidelines or supervisory “triggers” for various risks. A greater degree of specificity would be consistent with the principles-based approach and would have three potential benefits: (i) the agencies would have an opportunity to make a preventative statement on risks that signals to banks where greater intensity of supervision can be expected; (ii) greater specificity would be a useful way to articulate the supervisors’ risk appetite and hence shorten the time gap between the build-up of risks and a supervisory response; and (iii) greater specificity would provide a useful (internal) reference point for offsite and continuous monitoring and an indicator of when a bank’s risk profile might need to be escalated up the supervisory management chain. There are a number of ways this greater level of specificity can be achieved within a principles-based approach, starting with agency statements to banks of areas that merit greater supervisory intensity and moving to more formal (internal) triggers for supervisory action.

6. Since the crisis, there has also been a marked improvement in the risk management practices of banking organizations, an area identified to have material shortcomings in the previous FSAP. Consistent with global initiatives to “raise the bar” in risk management, the improvements are apparent in the greater engagement and skill levels of many boards, the strengthening of the risk management function itself, and in the aggregation of risk data. Nonetheless, these efforts are best described as “work-in-progress” from what was, in many cases, a lower starting point than in some major jurisdictions. The full implementation of the OCC’s “Heightened Standards” will add impetus to these efforts, as would a clearer delineation of the contribution of boards and senior management in supervisory assessments.

Mandate, independence and cooperation (CP 1-3)

7. The U.S. system of multiple FBAs with distinct but overlapping responsibilities continues to put an absolute premium on effective cooperation and collaboration. The FBAs will need to ensure that the significant improvements in collaboration in recent years become fully engrained in the modus operandi of each agency. Internationally, the establishment of supervisory colleges and crisis management groups (CMGs) has given greater urgency to information-sharing arrangements and there are no legal or other impediments to the ability and willingness of the FBAs to cooperate and collaborate with foreign supervisors. The dual banking structure does pose a challenge for international cooperation, and state banking agencies with Foreign Banking Organization (FBO) presence do not always inform or coordinate enforcement actions with home supervisors.

8. The FBAs are operationally independent, and have clear mandates for safety and soundness of the banking system. However, the FBAs also have other objectives, and the primacy of the safety and soundness objective needs to be better enshrined in legislation or mission statements to ensure a clear focus on this objective in different phases of the business cycle. In principle, the creation of a stand-alone Consumer Financial Protection Bureau (CFPB) should help establish a greater delineation between individual consumer issues and prudential issues and give the FBAs a clearer sense of purpose, but the delineation is not yet sharp. There is no evidence of direct interference by industry and government in supervisory priorities or decisions. The high level of public and congressional scrutiny and resulting sentiment may have an indirect effect in creating a perception of “cyclical” supervisory responses.

Licensing, permissible activities, transfer ownership and major acquisitions (CP 3-6)

9. The dual banking structure with charter choice adds to the challenge of cooperation and collaboration across multiple agencies. Banks may in principle choose to operate under a federal or state charter that best accommodates their business or strategic needs. Further, state-chartered banks may choose between being supervised primarily by the FDIC or primarily by the Federal Reserve as a member bank, in addition to the supervision of their state supervisory authority. Concerns have been raised that this choice can give rise to “regime shopping” that can undermine the integrity of U.S. regulatory arrangements. The DFA has restricted the ability of weak and troubled banks to change charters, but charter conversions of (well-rated) banks and savings associations continue on a modest scale. The FBAs need to guard against perceptions of differences in supervisory style or treatment in their regional offices that could sway the choices made by banks in charter conversions.

Supervisory approach, processes and reporting and sanctioning powers (CP 8-10)

10. The FBAs have significantly increased their level of resources and intensity of supervision of the largest firms, and have articulated a tiered approach built on asset-based thresholds to achieve the desired proportionality. The traditional focus on on-site examinations has changed a little as there has been a shift towards more stress testing, analysis and horizontal reviews. Overall, the supervisory regime is effective and risk-based. There is an increasing focus on resolution (for the larger firms). There remains scope for better prioritization of matters requiring attention and their communication to banks and for aligning supervisory planning cycles across agencies.

11. The FBAs have a long-established and effective regulatory reporting framework, with the flexibility to expand reporting requirements in response to pressing supervisory needs. There are safeguards built in to guard against redundant data items and information overreach. A lacuna is that supervisory data is not collected from banks at the solo level (i.e. at the level of the bank excluding its subsidiaries), which means supervisors and market participants may not have the information to test whether a bank is adequately capitalized on a stand-alone basis. In practice this omission has little prudential significance under current circumstances as bank subsidiaries tend to be small relative to the parent bank and can only undertake limited activities that the bank itself could undertake in its own name, but supervisors should closely monitor the development of banking groups and consider introducing solo level reporting if the number or size of bank subsidiaries were to expand or banking groups become less transparent.

12. The FBAs have a wide range of supervisory actions available to address safety and soundness concerns and do not hesitate to use them, although follow-up needs to be stricter. The PCA framework is the main plank of the early intervention framework and has clear triggers. The authorities could consider implementing rules for promoting early action for other triggers than bank capital as well as introduce more explicit rules and processes to deal with ageing of MRAs/MRIAs.

Consolidated and cross-border supervision (CP 12-13)

13. Following up on the 2010 FSAP, there have been major improvements in the ability of the FBAs to implement a comprehensive framework for consolidated supervision. Work still remains outstanding, though, on developing regulatory and supervisory rules, guidance, and a formal rating system for SLHCs, as well as on developing a capital rule for corporate and insurance company SLHCs.

14. Reflecting the large cross-border activities of U.S. banks and of foreign banking groups in the U.S., there is a comprehensive framework of policies and processes for co-operation and exchange of information between the FBAs and foreign supervisory authorities. As noted above, this is currently being strengthened by the work in supervisory colleges and in CMGs. The authorities should continue their efforts to establish agreements with their foreign counterparts on a framework of communication strategies, especially for crisis situations. While national treatment is the underlying principle, there remain some instances in which specific rules apply only to foreign institutions, such as the shorter run-off period for foreign branches in liquid asset requirements and requirements on FBOs to set up intermediate U.S. holding companies.

Corporate governance (CP 14)

15. Reflecting the global learnings from the crisis, major changes have taken place in supervisors’ demands on banks’ corporate governance and in the banks’ own approaches. Laws and regulations have gradually raised the requirements and there is clearly heightened focus by boards and management on corporate governance issues. The demands on board involvement and skills have increased substantially and this has, in many instances, led to changes in board composition and calls for wider skill sets of directors. In general, supervisory expectations are tailored to be less strict for smaller, non-systemic banks. This means that there is a shortfall from the criteria, but the assessors judged that this was not sufficiently material to alter their overall conclusions. The assessors welcome that supervisors are encouraging medium and small banks with higher risk activities to adopt better practices in corporate governance and risk management that are appropriate for the risk profile of these firms, moving them closer to the criteria and some of the principles outlined in the requirements for the larger banks.

Risk management, capital adequacy and prudential framework (CP 15-25)

16. There have been substantial improvements in the risk management processes of banks, and risk aggregation has been greatly facilitated by the stress testing requirements. Given the enormity of the task of achieving and sustaining meaningful risk aggregation across the Global Systemically Important Banks (GSIBs), this remains very much work in progress and may take years to complete. Other areas in which progress needs to be made are a better delineation in supervisory guidance of the responsibilities of the board and management and more emphasis on contingency planning, particularly at the smaller end of the banking sector. The level of commitment to stress testing is substantial and there is considerable consensus that the outputs and outcomes of that process were significant in improving risk aggregation. Supervisors and firms were becoming more efficient with each iteration and standards required were also increasing, although there is some way to go before supervisory led stress tests achieve an optimum state of data granularity. There is still room for improvement in firm-led stress testing, where firms seem to be struggling to determine the appropriate severity, whilst maintaining a scenario that remains business relevant.

17. There is a robust and comprehensive approach to setting prudent and adequate capital adequacy requirements, although the U.S. capital regime is in a state of transition. The FBAs have implemented major elements of the Basel II advanced approaches from I January, 2014 and the U.S. standardized approach based on Basel II will begin to come into effect from 1 January, 2015. The broad adoption of the Basel III definition of capital, when applicable to most banks from 1 January 2015, will improve the quality of bank capital by limiting the extent to which certain intangibles, which had previously counted for a high proportion of bank capital, can be included in capital. Stress testing is entrenching a forward-looking approach to capital needs and engaging boards and senior management more fully in the capital planning process. The introduction of risk-based capital rules based on Basel standards for most savings and loan holding companies removes an anomaly created by the previous case-by-case determination of capital requirements for such companies, although a comprehensive capital framework for all savings and loan holding companies is not in place. There are a number of differences between the new U.S. capital regime and the relevant Basel framework, particularly the absence of a capital charge for operational risk and for Credit Value Adjustment (CVA) risk in the U.S. standardized approach, which provides the “floor” for the advanced approach banking organizations and applies to all other banking organizations.

18. The long-established and rigorous process for evaluating banks’ approaches to problem assets and the maintenance of adequate provisions and reserves will be bolstered by accounting changes currently on the anvil. The FBAs have shown a consistent willingness to challenge unrealistic bank estimates of provisions and reserves and to secure increases they judge necessary. This steadfastness in approach will be tested as the U.S. economy continues to improve. Supervisory judgments in this area have been constrained by the “incurred loss” approach of U.S. GAAP, but the introduction of the FASB’s proposed Current Expected Loss Model (CELM) will permit more forward-looking provisioning.

19. The supervisory framework to guard against concentration risk and large exposures needs to be strengthened. The FBAs have an effective supervisory framework for dealing with credit concentration risk. Guidance has been issued on specific areas of concentration of credit risk and this is followed up in supervisory reviews. Supervisors are also giving more attention to the treatment of concentration risk in counterparty credit risk management and stress testing frameworks. However, the new BCP methodology has expanded this Core Principle to also include market and other risk concentrations “where a bank is overly exposed to particular asset classes, products, collateral, or currencies”. While there is some evidence of punctual supervisory action on this front (for instance, funding concentration), at this point a detailed supervisory framework and supervisory guidance for these other risk concentrations is not well developed. Although the widening of the definition of large exposures under the DFA has brought the large exposure thresholds more into line with the requirements of the BCP, some anomalies and omissions remain. The separate and additional limits available to banks for money market investments and security holdings continue to leave open the possibility of excessive risk concentrations. The 50 per cent limit on exposures to a corporate group is also problematic. The authorities are also encouraged to finalize the large exposures framework, with legal limits, for large bank holding companies and foreign banking organizations.

20. In addition, there remain gaps in the related party exposure framework that may heighten concentration risk in the system. There are no formal requirements for prior board approval of transactions with affiliated parties or the write-off of related party exposures exceeding specified amounts, or for board oversight of related party transactions and exceptions to policies, processes and limits on an ongoing basis. However, in practice the FBAs expect banks to apply a high degree of board oversight and monitoring of affiliate and insider transactions and review this as a matter of practice on offsite and onsite examinations. Statutes impose a set of limits on a bank’s exposures to affiliates and insiders that, with one exception, are at least as strict as those for single counterparties or groups of counterparties. The exception is the aggregate limit for lending to insiders of 100 per cent of a bank’s capital and surplus (and 200 per cent for smaller banks). As noted in the 2010 FSAP, this limit is higher than prudent practices and creates the risk that a small group of insiders could deplete the own funds of a bank. There is no formal limit framework for holding company transactions with their affiliates or insiders, which is needed for a comprehensive framework for transactions with related parties. Finally, the “related party” regime in the U.S. regulatory framework does not appear as broad as required by this CP.

21. The approach to interest rate risk in the banking book (IRRBB) is in marked contrast to other key risks and could be usefully updated. The regimes for market and liquidity risks are tiered to support a risk-based approach and are comprehensive and robust, though the former would benefit from the introduction of a de-minimis regime for all banks and the latter from more granular and frequent reporting. The framework for IRRBB stands out with no tiering for example (although supervisory practice seems proportionate to the risk) and the philosophy is firmly principles-based. No specific capital is being set aside against a change in interest rates, nor are any supervisory limits set. Given the stage of the U.S. economic cycle, the inherent interest rate exposure is high and there are particular concentrations in the small bank sector. Updating the 1996 guidance to include more quantitative guidance is merited, as the risk of a principles-based approach is its inconsistency across a sector and across time; as such banks, or a group of banks may be overly exposed.

22. Similarly, the overall regime for operational risk outside the AMA banks has not reached a sufficient level of maturity. There is no overall definition of operational risk, or structured guidance on identification, management and mitigation of operational risks. Guidance for banks under AMA (at the time of this assessment, only 8 banks) is well specified, however for all other bank operational risk management falls within the scope of “general” risk management. Guidance for other banks is disparate, and the weakness is compounded by the absence of a comprehensive reporting regime. There is not a standardized capital charge for operational risk. At the time of the assessment, several initiatives were underway. The FBAs are placing increasing emphasis on operational risk issues and are coordinating on the production of additional inter-agency guidance, as well as identifying and seeking mitigation of a number of issues in their vertical and horizontal reviews. They are also alert to the changing threat landscape, such as the escalation of fines and other penalties from litigation as well as cyber risks. Dealing with cyber risk is a top priority across all agencies and will pose coordination and operational challenges given the nature of the risk and the pressing need to collaborate with other arms of government.

Controls, audit, accounting, disclosure and abuse of financial services (CP 26-29)

23. The bar for audit and control functions has clearly been raised in the wake of the crisis, while further refinements are needed in the framework for abuse of financial services. The internal audit function is the subject of greater supervisory attention and expectations have been significantly raised though, in contrast, there is little mention of the compliance function except with reference to the regime of the Bank Secrecy Act and Anti-Money Laundering. Further, while significant resources are deployed by both the authorities and the firms to meet the BSA/AML standards, the attention to vulnerabilities to other forms of criminal abuse (e.g. theft, burglary) is more disparate. In addition, the regulatory framework at the time of the assessment did not include adequate identification of the ultimate beneficiary owner of legal entity clients, or processes for dealing with domestic Politically Exposed Persons (PEPs). On the external audit front, there is no requirement for an external auditor to report immediately directly to the supervisor, should they identify matters of significant importance, although this gap is mitigated by the frequent contact between supervisors and auditors in the course of planning and examinations.

24. The disclosure regime represents best practice in some respects. The public disclosure of supervisory call reports promotes market discipline and is worthy of global emulation. There remain a few gaps though. Not all banks are required to issue full financial standards that are reviewed by an independent accountant in accordance with independent audit requirements and the U.S. definition of “reporting on a solo basis” differs in that it does not collect or disclose data on a “bank stand-alone basis.”

Introduction

25. This assessment of the current state of the implementation of the Basel Core Principles for Effective Banking Supervision (BCP) in the United States has been completed as part of a FSAP update undertaken by the International Monetary Fund (IMF) from 21 October to 10 November 2014. It reflects the regulatory and supervisory framework in place as of the date of the completion of the assessment. It is not intended to represent an analysis of the state of the banking sector or crisis management framework, which are addressed in the broader FSAP exercise.

26. An assessment of the effectiveness of banking supervision requires a review of the legal framework, and detailed examination of the policies and practices of the institutions responsible for banking regulation and supervision. In line with the BCP methodology, the assessment focused on the three FBAs as the main supervisors of the banking system, and did not cover the specificities of regulation and supervision of other financial intermediaries, which are covered by other assessments conducted in this FSAP. The assessment did not cover supervision conducted by local State regulators,2 the supervision of credit unions, or the activities of the CFPB. As the three federal agencies are the primary regulators of most depository institutions in the country, this assessment should provide a useful picture of current supervisory processes applicable to banks in the United States.

A. Information and Methodology Used for Assessment

27. The U.S. authorities agreed to be assessed according to the Revised BCP Methodology issued by the BCBS (Basel Committee of Banking Supervision) in September 2012. The current assessment was thus performed according to a revised content and methodological basis as compared with the previous BCP assessment carried out in 2009. It is important to note, for completeness’ sake, that the two assessments will not be directly comparable, as the revised BCP have a heightened focus on risk management and its practice by supervised institutions and its assessment by the supervisory authority, raising the bar to measure the effectiveness of a supervisory framework (see box for more information on the Revised BCP).

28. The U.S. authorities also chose to be assessed and rated against not only the Essential Criteria, but also against Additional Criteria. To assess compliance, the BCP Methodology uses a set of essential and additional assessment criteria for each principle. The essential criteria (EC) were usually the only elements on which to gauge full compliance with a CP. The additional criteria (AC) are recommended best practices against which the U.S. authorities have agreed to be assessed and rated. This option was not available to assessed countries before the 2012 Revised BCP. The assessment of compliance with each CP is made on a qualitative basis to allow a judgment on whether the criteria are fulfilled in practice. Effective application of relevant laws and regulations is essential to provide indication that the criteria are met. A four-part grading system is used: compliant; largely compliant; materially noncompliant; and noncompliant. This is explained below in the detailed assessment section.

29. The assessment team3 reviewed the framework of laws, rules, and guidance and held extensive meetings with U.S. officials, and additional meetings with banking sector participants and other stakeholders (auditors, associations, etc). The authorities provided a self-assessment of the CPs rich in quality and comprehensiveness, as well as detailed responses to additional questionnaires, and facilitated access to supervisory documents and files, staff and systems.

30. The team appreciated the very high quality of cooperation received from the authorities. The team extends its thanks to staff of the authorities who provided excellent cooperation, including extensive provision of documentation and access, at a time when staff was burdened by many initiatives related to the implementation of global regulatory changes under Basel III and further national regulatory changes under the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA).

31. The standards were evaluated in the context of the U.S. financial system’s structure and complexity. The CPs must be capable of application to a wide range of jurisdictions whose banking sectors will inevitably include a broad spectrum of banks. To accommodate this breadth of application, a proportionate approach is adopted within the CP, both in terms of the expectations on supervisors for the discharge of their own functions and in terms of the standards that supervisors impose on banks. An assessment of a country against the CPs must, therefore, recognize that its supervisory practices should be commensurate with the complexity, interconnectedness, size, and risk profile and cross-border operation of the banks being supervised. In other words, the assessment must consider the context in which the supervisory practices are applied. The concept of proportionality underpins all assessment criteria. For these reasons, an assessment of one jurisdiction will not be directly comparable to that of another.

32. An assessment of compliance with the BCPs is not, and is not intended to be, an exact science. Reaching conclusions required judgments by the assessment team. Nevertheless, by adhering to a common, agreed methodology, the assessment should provide the U.S. authorities with an internationally consistent measure of the quality of its banking supervision in relation to the CPs, which are internationally acknowledged as minimum standards.

The 2012 Revised BCP

The revised BCPs reflect market and regulatory developments since the last revision, taking account of the lessons learnt from the financial crisis in 2008/2009. These have also been informed by the experiences gained from FSAP assessments as well as recommendations issued by the G-20 and FSB, and take into account the importance now attached to: (i) greater supervisory intensity and allocation of adequate resources to deal effectively with systemically important banks; (ii) application of a system-wide, macro perspective to the microprudential supervision of banks to assist in identifying, analyzing and taking preemptive action to address systemic risk; (iii) the increasing focus on effective crisis preparation and management, recovery and resolution measures for reducing both the probability and impact of a bank failure; and (iv) fostering robust market discipline through sound supervisory practices in the areas of corporate governance, disclosure and transparency.

The revised BCPs strengthen the requirements for supervisors, the approaches to supervision and supervisors’ expectations of banks. The supervisors are now required to assess the risk profile of the banks not only in terms of the risks they run and the efficacy of their risk management, but also the risks they pose to the banking and the financial systems. In addition, supervisors need to consider how the macroeconomic environment, business trends, and the build-up and concentration of risk inside and outside the banking sector may affect the risk to which individual banks are exposed. While the BCP set out the powers that supervisors should have to address safety and soundness concerns, there is a heightened focus on the actual use of the powers, in a forward-looking approach through early intervention.

The number of principles has increased from 25 to 29. The number of essential criteria has expanded from 196 to 231. This includes the amalgamation of previous criteria (which means the contents are the same), and the introduction of 35 new essential criteria. In addition, for countries that may choose to be assessed against the additional criteria, there are 16 additional criteria.

While raising the bar for banking supervision, the BCP must be capable of application to a wide range of jurisdictions. The new methodology reinforces the concept of proportionality, both in terms of the expectations on supervisors and in terms of the standards that supervisors impose on banks. The proportionate approach allows assessments of banking supervision that are commensurate with the risk profile and systemic importance of a wide range of banks and banking systems.

33. To determine the observation of each principle, the assessment has made use of five categories: compliant; largely compliant, materially noncompliant, noncompliant, and non-applicable. An assessment of “compliant” is given when all EC and ACs are met without any significant deficiencies, including instances where the principle has been achieved by other means. A “largely compliant” assessment is given when there are only minor shortcomings, which do not raise serious concerns about the authority’s ability to achieve the objective of the principle and there is clear intent to achieve full compliance with the principle within a prescribed period of time (for instance, the regulatory framework is agreed but has not yet been fully implemented). A principle is considered to be “materially noncompliant” in case of severe shortcomings, despite the existence of formal rules and procedures and there is evidence that supervision has clearly not been effective, the practical implementation is weak or that the shortcomings are sufficient to raise doubts about the authority’s ability to achieve compliance. A principle is assessed “noncompliant” if it is not substantially implemented, several ECs are not complied with, or supervision is manifestly ineffective. Finally, a category of “non-applicable” is reserved for those cases that the criteria would not relate the country’s circumstances.

B. Institutional and Market Structure—Overview4

34. The U.S. has a large, diverse financial sector, with assets stabilizing at about 480 percent of GDP since the crisis. Depository institutions (mostly banks), pension funds, mutual funds and insurance companies account for around 70 percent of the financial sector assets. The structure of the financial system, by sectors, has been relatively stable since the last FSAP. Only mutual funds’ assets have increased whereas Asset Backed Securities (ABS) issuers have continued to reduce their balance sheets and the proportion of credit market debt owed by Government-Sponsored Enterprises (GSEs) has increased. The structure of the financial system, by instruments, has also not changed drastically in the last four years. However, the corporate equities’ market has grown in size and the mortgage market has shrunk. Financial sector’s share of corporate profits has reached a record high in early 2000s, after dipping to a record low in 2008 and returning to its longer-term trend by 2013 while its contribution to gross value added has remained relatively stable. The U.S. financial system contributes about 20 percent to the U.S. GDP and around 25 percent of U.S. corporate profits.

35. Credit intermediation is decentralized. While depository institutions are present in almost every credit market, no single sector dominates the overall credit market. GSEs and banks are the main providers of mortgage credit (the largest credit market). Banks also play an important role in consumer credit market (together with finance companies) and in the market for agency and GSE-backed securities (together with Fed and mutual funds). Broker-dealers are the main players on securities repos market, whereas insurance sector and mutual funds are the main source of financing of corporate debt securities

36. The pension funds sector is the largest financial sector accounting for about 20 percent of total financial sector assets. Private pension funds account for one half of pension funds’ assets and the other half pertains to federal, state and local government retirement funds. The structure of the pension system has been stable since 2010, with defined benefit plans (45 percent of pension funds’ liabilities) representing the largest share of the system.5 The sector’s assets are diversified across debt securities and shares and the remainder across investments in MMF and mutual funds shares and private equity.

37. The banking sector holds 16 percent of all assets held by financial institutions. Banks are the second largest financial sector after pension funds. The overall number of banks has been on a downward trend since early 1990s and has fallen to an all time low level in 2014q1. The number of problem banks has decreased significantly, from around 500 at the peak in 2010 to around 200, but still above the number before the crisis.

38. Banks’ balance sheets and income statements have strengthened. Comparing to a period before the crisis, banks now hold more liquid assets, grant less loans and hold less trading account assets (both in absolute and relative terms). At the same time, banks have attracted more deposits, hold more capital, rely less on credit borrowing and are less leveraged. Profits have reached pre-crisis levels (in nominal terms) mainly due to lower provisions and lower interest expenses. The coverage ratio has stabilized since 2009, and the net charge off rate is slightly above the level before the crisis. However, the results from the CCAR stress tests show that, if hit by a severe global market shock, banks’ capital ratios would fall significantly and banks would face sizable losses from trading activities. For investment banks, a non-trivial dependence on wholesale funding continues to be a source of vulnerability in periods of severe financial market distress.

39. The U.S. banking system is less concentrated than the banking systems of other industrialized countries. The five largest banks account for about 45 percent of the U.S. banking system’s total assets6 (which is twice the share 10 years ago) and around 40 percent of GDP. Eight large banks are designated as G-SIBs. While the proportion of the largest five banks has stabilized over the last four year, the share of banks with asset size larger than $10 bn has continued to increase since 2009.

40. The insurance sector assets correspond to a half of the banking sector assets. Life insurers account for largest part of insurance sector assets. Three U.S. insurers, AIG, Prudential and MetLife have been designated as G-SIIs. The first two have been designated by the Financial Stability Oversight Council (FSOC) as non-bank SIFIs and the latter is in the process of designation. The insurance sector in the U.S. is less concentrated than in other countries—top 10 insurers account for 58 percent (life insurance), 71 percent (health insurance) and 46 percent (in P&C) of the market.

41. Financial intermediation outside the traditional banking system is estimated at 90 percent of GDP, and the debt securities market is dominated by corporate debt securities, treasury securities and GSE backed securities. While the banking sector has continued to grow after the crisis, the size of the shadow banking system7 has contracted substantially since the peak in 2007 mainly due to lower borrowing of ABS issuers. GSEs are the only segment of the shadow banking system that is now larger than before the crisis. The nominal value of outstanding debt securities at end-2013 amounted to about $39 trillion (230 percent of GDP). Corporate bonds, including ABS securities, accounted for a third of this, of which half were issued by non-financial corporations and 10 percent by ABS issuers (down from 30 percent before the crisis). The proportion of treasury securities has almost doubled since 2007 (from 17 percent to 32 percent).

42. The U.S. derivatives market represents 1/3 of the world market. The notional amount of outstanding contracts totaled $237.0 trillion8 (1400 percent of GDP) and has been relatively stable since 2010. The market is dominated by a small group of large financial institutions—four large commercial banks (JPMorgan Chase, Citibank, Bank of America and Goldman Sachs) represent 93 percent of the total banking industry notional amounts.9 Derivative contracts are concentrated in interest rate products, which comprise 82 percent of total derivative notional amounts. Foreign exchange contracts represent 12 percent of the derivatives market and credit derivatives (mostly Credit Default Swaps) 5 percent of total derivatives notionals. Swap contracts represent the bulk of the derivatives market (64 percent of all notionals) followed by futures and forwards (18 percent) and options (14 percent).

Structure for banking supervision

43. The United States operates under a “dual banking system.” A bank charter may be issued by the federal government or by a state. Federal bank charters for “national banks” and “federal savings associations” are issued by the OCC. Each of the 50 states has a banking authority that charters banks under its own laws and regulations. These banks are generally referred to as “state banks” or “state savings associations.” Each U.S. bank, whether chartered under state or federal law, is subject to regulation, supervision, and examination by a primary federal banking supervisor, irrespective of whether the bank is part of a broader organization:

  • for national banks and federal savings associations, the OCC;

  • for state banks that choose to be members of the Federal Reserve System (state member banks), the Federal Reserve;

  • for state banks that choose not to become members of the Federal Reserve System (nonmember banks) and state savings associations, the FDIC.

Table 1.

Summary of Primary Federal Supervisory Responsibilities

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44. The FDIC operates the federal deposit insurance program. In addition to its authority to examine state nonmember banks, the FDIC has the authority to examine for insurance purposes any bank, either directly or in cooperation with state or other federal supervisory authorities. The FDIC has backup enforcement authority over all banks. The FDIC can recommend that another federal banking agency take action against a bank in appropriate circumstances and may take such action directly if the other agency does not take action.

45. The OCC is responsible for chartering, regulating, and supervising all national banks and federal savings associations and for supervising federal branches and agencies of foreign banks.

46. Holding companies are supervised by the Federal Reserve. The Federal Reserve is responsible for regulating and supervising any company that owns or controls a national or state bank. BHCs and their subsidiaries may engage in activities that are closely related to banking. Certain BHCs that, along with their depository institution subsidiaries, meet enhanced capital and managerial standards, may elect to become financial holding companies (FHCs) and engage in a broader array of financial activities, including securities, insurance, and merchant banking. The Federal Reserve is the consolidated supervisor of all BHCs and FHCs on a worldwide consolidated basis. The Federal Reserve also regulates and supervises SLHCs, which, like BHCs, may choose to be treated as FHCs if they and their depository institution subsidiaries meet enhanced capital and managerial standards and, thereby, engage in a broader array of financial activities.

Table 2.

Supervised Institutions

(As of June 30, 2014)

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Source: Federal Reserve Board

47. FBOs may do business in the United States under a policy of “national treatment” which gives FBOs the same powers and applies the same limitations as are given and applied to domestic banks. No FBO may establish a branch or an agency, or acquire ownership or control of a commercial lending company, without the prior approval of the Federal Reserve. All banks and branches or agencies of FBOs have a primary federal regulator. If the FBO chooses a federal license for a branch or agency, then it is supervised and examined solely by the OCC. If an FBO elects to open a branch or agency under a state license, then it is typically examined by the state banking authorities and also by the Federal Reserve on a joint or alternate (i.e., rotating) basis. The Federal Reserve relies on the OCC or state banking agencies to perform examinations and supervision depending on the form of organization and the charter the FBO receives to take in the country.

48. Since the last FSAP, important changes have taken place in the legal and regulatory framework for banks. In response to the crisis, the U.S. Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act or DFA).10 The Act creates an interagency council to monitor and coordinate responses to emerging threats to the financial system (FSOC); requires that large bank holding companies and systemically designated nonbank financial firms be subject to enhanced prudential standards to reduce the risks they may present to the financial system; provides for the consolidated supervision of all systemically important financial institutions; gives the government an important additional tool to safely wind down financial firms whose failure could pose a threat to U.S. financial stability; and provides for the strengthened supervision of systemically important payment, settlement, and clearing utilities.

49. The Dodd Frank Act has made important changes related to banking regulation and supervision., The Act: (i) enhances the limitations on transactions among a BHC, a subsidiary bank, and its affiliates;11 (ii) incorporates a financial stability factor into the statutory analysis of transactions governed by the Bank Holding Company Act (BHC Act) and the Bank Merger Act;12 (iii) incorporates financial stability considerations into the supervision of holding companies; (iv) enhances the requirement for holding companies to be eligible to engage in expanded activities;13 (v) generally eliminates the limitations under the Gramm-Leach-Bliley Act that restricted the Federal Reserve’s ability to examine, obtain reports from, or take enforcement action against a functionally regulated subsidiary of a BHC, such as a broker-dealer or insurance company;14 (vi) authorizes the Federal Reserve to examine the activities of nonbank subsidiaries of holding companies—other than functionally regulated subsidiaries—that are permissible for the organization’s subsidiary banks in the same manner, subject to the same standards, and with the same frequency as if such activities were conducted in the organization’s lead subsidiary depository institution; (vii) prohibits a depository institution that is subject to a formal enforcement order or memorandum of understanding with respect to a significant supervisory matter from converting its charter unless the current and proposed supervisors establish a plan that addresses the problems at the depository institution and that will be implemented and monitored by the new supervisor; and (viii) applies the national bank and savings association loans-to-one borrower limitation to credit exposures arising from derivative transactions and securities financing transactions.15

50. The Dodd-Frank Act also established a new Financial Stability Oversight Council (FSOC) charged with important duties such as monitoring and identifying emerging risks to financial stability across the entire financial system, identifying potential regulatory gaps, and coordinating the agencies’ responses to potential systemic risks. The voting membership of the FSOC is composed of the Treasury Secretary (who is also chairperson of the FSOC); the heads of the three FBAs (FBAs); the heads of the Consumer Financial Protection Bureau (CFPB), Securities and Exchange Commission (SEC), Commodities Futures Trading Commission (CFTC), Federal Housing Finance Agency (FHFA), and National Credit Union Administration (NCUA); and an independent member with insurance expertise appointed by the President and confirmed by the Senate.

51. In addition, the FSOC has the task to designate as systemically important large, interconnected nonbank financial firms. Once designated, these nonbank financial companies are subject to consolidated supervision by the Federal Reserve and enhanced prudential standards. The FSOC has designated three nonbank financial companies: American International Group, Inc., General Electric Capital Corporation, Inc., and Prudential Financial, Inc. In addition, the Act authorizes the FSOC to designate financial market utilities (FMUs) as systemically important if the FSOC determines that that the failure of or a disruption to the functioning of the FMU could pose a threat to U.S. financial stability. Designated FMUs are also subject to heightened prudential and supervisory provisions. In 2012, the FSOC designated eight FMUs as systemically important: The Clearing House Payments Company L.L.C. (on the basis of its role as operator of the Clearing House Interbank Payments System); CLS Bank International; Chicago Mercantile Exchange, Inc.; The Depository Trust Company; Fixed Income Clearing Corporation; ICE Clear Credit LLC; National Securities Clearing Corporation (NSCC); and The Options Clearing Corporation.

52. The DFA also requires the Federal Reserve to conduct and publish summary results of annual stress tests of systemic nonbank financial firms and BHCs with $50 billion or more in assets. Such firms also are required to conduct their own stress tests on a semiannual basis. The DFA requires financial firms with more than $10 billion in assets to conduct annual stress tests in accordance with regulations established by the respective primary federal financial regulatory agency.

53. The new legislation requires that foreign banking organizations with U.S. non-branch assets of $50 billion or more be required to establish a U.S. intermediate holding company over their U.S. subsidiaries. The foreign-owned U.S. intermediate holding company generally will be subject to the same risk-based and leverage capital standards applicable to U.S. bank holding companies. The intermediate holding companies also will be subject to the Federal Reserve’s rules requiring regular capital plans and stress tests. Like U.S. BHCs with assets of $50 billion or more, a foreign banking organization with combined U.S. assets of $50 billion or more will be required to establish a U.S. risk committee and employ a U.S. chief risk officer, and will be required to meet enhanced liquidity risk-management standards. FBOs with total consolidated assets of $50 billion or more, but combined U.S. assets of less than $50 billion, are subject to enhanced prudential standards. However, the capital, liquidity, risk-management, and stress testing requirements applicable to these foreign banking organizations are substantially less than those applicable to foreign banking organizations with a larger U.S. presence.

54. Finally, the DFA dissolved the Office of Thrift Supervision (OTS) and transferred its plenary regulatory and supervisory authority, including the authority to supervise, issue rules, and take enforcement actions, with respect to SLHCs and savings associations to the FBAs: the Federal Reserve regulates SLHCs, the OCC regulates federally chartered savings associations, and the FDIC regulates state-chartered savings associations.

C. Preconditions for Effective Banking Supervision16

Macroprudential framework and cooperation17

55. In addition to the FSOC’s coordinating role, the FFIEC plays an important role in developing uniform approaches among the FBAs and acts as a forum for sharing of technical information. To promote consistency in the examination and supervision of banks and holding companies, in 1978 Congress created the Federal Financial Institutions Examination Council (FFIEC). The FFIEC is composed of the chairpersons of the FDIC and the National Credit Union Administration, the Comptroller of the Currency, the Director of the CFPB, and a governor of the Federal Reserve. As the result of legislation in 2006, the Chair of the FFIEC State Liaison Committee serves as a sixth member of the FFIEC. The State Liaison Committee is composed of five representatives of state agencies that supervise financial institutions. The FFIEC’s objectives are to prescribe uniform federal principles and standards for the examination of depository institutions, to promote coordination of bank supervision among the U.S. FBAs, and to encourage better coordination of federal and state regulatory activities. Through the FFIEC, state and U.S. FBAs may exchange views on important regulatory issues. Among other things, the FFIEC has developed uniform financial reports for federally supervised banks to file with their appropriate federal regulator. In addition to the FFIEC and longstanding information sharing practices, FSOC was created to provide a central body for coordinating the activities of the federal financial regulators, including the FBAs. Among other activities, FSOC has the ability to issue a nonbinding recommendation to any of its member agencies to take a particular action.

Financial Safety Nets and Crisis Management18

56. Numerous liquidity back-stops were provided by the Fed during the crisis but subsequent legislative changes appear to limit its ability to similarly respond in the future. During the crisis additional backstops were provided to mitigate specific risks, for example: (i) run risk in the money market funds sector; (ii) collateral fire sale risk faced by primary dealers in TPR, and (iii) funding risk faced by depository institutions. The DFA (section 214) and changes to the Federal Reserve Act (section 13.3) now seem to limit the provision of such assistance. The Fed’s standing credit facilities (“discount window”) may benefit from reform. The primary credit facility, for higher rated institutions, allows for borrowing on a ‘no questions asked’ basis while access to the secondary credit facility has conditions attached. But in both cases, activity must be disclosed under the Freedom of Information Act with a two year lag. Separating the two more clearly might help reduce stigma that is still associated with ‘normal’ use and with it, reluctance to access the facility (this would focus stigma on the ‘emergency’ use facility).

57. The resolution regime for financial institutions has been enhanced. Title II (“Orderly Liquidation Authority”, OLA) of the DFA, enacted in July 2010, has extended the Federal Deposit Insurance Corporation’s (FDIC) resolution authority to “financial companies”. OLA mandates the appointment of the FDIC as receiver if the Secretary of the Treasury (in consultation with the President) determines that a financial company for which a systemic risk determination has been made is in default or in danger of default, would have a serious adverse effect on the financial stability and no viable private sector alternative is available to prevent the default.

58. Detailed requirements for ‘living wills’ seek to ensure the feasibility of a rapid and orderly resolution, but recent reviews of large banks suggest major shortcomings. The DFA requires covered financial companies to prepare plans for the orderly winding-up of such companies in the event of material financial distress or failure. While financial companies generally have made progress in the preparation of these plans, the Board of Governors of the Federal Reserve System and the FDIC concluded in August 2013 that the plans submitted by the eleven largest banking organizations (still) reflect important shortcomings, including failures to address structural and organizational impediments to orderly resolution. The affected organizations have been instructed to improve their resolvability and update their recovery plans accordingly by July 2015.

Market discipline, business environment, accounting and auditing19

59. Business laws in the United States, including contract, bankruptcy, and property law, are well-developed and reliable. Contract law is established by the combination of common law and state statute. The enforceability of contracts is well-established and enforced by the courts. Laws establishing the enforceability of security interests (i.e., interests in property conveyed to collateralize loans) are governed, primarily, under Article 9 of the Uniform Commercial Code. The enforcement of mortgages of real property is upheld under (non-uniform) state laws. Federal bankruptcy laws incorporate protections for both creditors and debtors. Property rights are protected under the Bill of Rights of the U.S. Constitution and under state laws.

60. Business law disputes are typically resolved in state trial courts of general jurisdiction. Federal courts are available when the claim involves federal law or when a state law claim involves parties from different states. A right of appeal exists in both the federal and state systems. Contracts, both commercial and consumer, are sometimes permitted to also provide for mandatory arbitration rather than dispute resolution through the courts.

61. The United States possesses an independent judiciary and well-regulated accounting, auditing, and legal professions. The judicial system is comprised of both federal and state systems. Judges in both federal and state courts must be members of the bar and generally have significant experience as practicing lawyers before becoming judges. Federal judges are appointed by the President with the advice and consent of the Senate and receive lifetime appointments. States vary in their methods of judicial appointment. Some follow a system similar to the federal system, i.e., the state governor appoints judges with some input from the legislature. Some states, however, appoint judges through a general election.

62. Lawyers must receive a license to practice law from a state or states. All states but one (Wisconsin) require applicants who are not already members of another state’s bar to pass a bar examination prior to receiving a license. In addition to controlling admission into the profession, the states also regulate the profession. Regulation is often delegated to a self regulatory organization, i.e., a state bar association. Lawyers are also subject to ethical standards set by the states.

63. U.S. accounting standards (U.S. GAAP) are established by the Financial Accounting Standards Board (FASB). Both the FASB and International Accounting Standards Board are currently working on a convergence program, designed to bring U.S. and international financial reporting standards (IFRS) into a single framework.

64. Financial statement audit requirements are robust, having been considerably strengthened in 2002 with the passage of the Public Company Accounting Reform and Investor Protection Act (also known as the Sarbanes-Oxley Act). The Sarbanes-Oxley Act enhanced audit scrutiny, toughened auditor independence requirements, required various management attestations about the reliability of financial accounts, and expanded disclosure requirements with the objective of providing the users of financial statements with greater security as to their accuracy and reliability.

Detailed Assessment

65. The assessment of compliance of each principle is made based on the following four-grade scale: compliant, largely compliant, materially noncompliant, and noncompliant. A “not applicable” grading can be used under certain circumstances.

  • Compliant: a country will be considered compliant with a Principle when all essential criteria applicable for this country are met without any significant deficiencies. There may be instances, of course, where a country can demonstrate that the Principle has been achieved by other means. Conversely, due to the specific conditions in individual countries, the essential criteria may not always be sufficient to achieve the objective of the Principle, and therefore other measures may also be needed in order for the aspect of banking supervision addressed by the Principle to be considered effective.

  • Largely compliant: A country will be considered largely compliant with a Principle whenever only minor shortcomings are observed that do not raise any concerns about the authority’s ability and clear intent to achieve full compliance with the Principle within a prescribed period of time. The assessment “largely compliant” can be used when the system does not meet all essential criteria, but the overall effectiveness is sufficiently good, and no material risks are left unaddressed.

  • Materially non-compliant: A country will be considered materially non-compliant with a Principle whenever there are severe shortcomings, despite the existence of formal rules, regulations and procedures, and there is evidence that supervision has clearly not been effective, that practical implementation is weak, or that the shortcomings are sufficient to raise doubts about the authority’s ability to achieve compliance. It is acknowledged that the “gap” between “largely compliant” and “materially non-compliant” is wide, and that the choice may be difficult. On the other hand, the intention has been to force the assessors to make a clear statement.

  • Non-compliant: A country will be considered non-compliant with a Principle whenever there has been no substantive implementation of the Principle, several essential criteria are not complied with, or supervision is manifestly ineffective.

A. Supervisory Powers, Responsibilities and Functions

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B. Prudential Regulations and Requirements

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Summary Compliance with the BCP

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Recommended Actions and Authorities Comments

A. Summary of Recommended Actions

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B. Authorities’ Response to the Assessment

The U.S. authorities strongly support the IMF’s Financial Sector Assessment Program (FSAP), which promotes the soundness of financial systems in member countries and contributes to improving supervisory practices around the world. The authorities appreciate the complexity of assessing the U.S. financial system and the time and resources dedicated by the IMF and its assessment teams to this exercise. The authorities commend the IMF on its diligence and constructive approach in undertaking the assessment. The U.S. authorities welcome the opportunity to provide the following comments.

The IMF rightly holds the United States to the highest and most stringent grading standard, given the complexity, maturity, and systemic importance of our financial sector. Despite this higher grading standard, the assessment found the U.S. regulatory system to be very strong and, in many ways, more rigorous than international standards.

We are pleased to note that the Report acknowledges that the U.S. federal banking agencies have improved considerably in their effectiveness since the previous FSAP was completed in 2010. This is particularly noteworthy since, compared to the 2010 assessment, the federal banking agencies were assessed against four additional Core Principles for Effective Banking Supervision (29 total) and significantly more Essential Criteria and Additional Criteria. This assessment also is more rigorous than the one completed in 2010 since the revised Core Principles have a heightened focus on risk management. The U.S. authorities are pleased that, even under these more stringent principles and when applying a higher standard, the IMF’s assessment of the U.S. system broadly indicates compliance with the Core Principles. Moreover, while the approach of the federal banking agencies is principles-based, the Report reaches its conclusions against the backdrop of an assessment regime that places a premium on specificity in regulations.

The Report recognizes that global and domestic reforms implemented since the 2010 assessment, particularly the Dodd-Frank Act (DFA), have increased the intensity of the supervisory programs of the federal banking agencies. Since the previous review, substantial improvements have been made in risk management and the oversight of large bank organizations by putting enhanced emphasis on banks’ capital planning, stress testing, and corporate governance. The U.S. authorities concede that some reforms are still pending and will take time to fully implement. Notably, the Report acknowledges that additional implementation of the reform programs will further improve the United States’ compliance with the Core Principles.

The Report acknowledges that the federal banking agencies are operationally independent and have clear mandates for safety and soundness of the banking system. However, it concludes there are duplicative efforts by the federal banking agencies and a lack of delineation between safety and soundness and other missions. Although there is not a formal statement that safety and soundness is the sole or primary mission of a federal banking agency, there is no confusion on the part of the agencies, the public, or the industry that the focus of supervision and regulation relates to safety and soundness. The U.S. authorities believe that responsibilities, such as assuring compliance with consumer laws and taking account of financial stability considerations, in no way conflict with the assessment of safety and soundness. Indeed, given the potential high level of operational and reputational risk associated with significant consumer compliance weaknesses, considerations related to such compliance are part of an overall safety and soundness risk assessment.

Furthermore, in practice, there is clarity of mission among the agencies. Clear distinctions exist between prudential safety and soundness responsibilities and consumer protection responsibilities that are shared between the Consumer Financial Protection Bureau (CFPB) and the federal banking agencies. In the view of the U.S. authorities, the federal banking agencies have met the requirement of collaboration required by DFA and have addressed the issue of duplicative efforts by coordinating with each other and the CFPB, as evidenced by interagency Memoranda of Understanding.

The federal banking agencies have taken a number of substantive actions that are not fully reflected in the Report. These include:

  • Establishing forward-looking stress testing requirements for banks with less than $10 billion in assets. Although banks with assets less than $10 billion are not required to complete formal DFA capital stress tests, federal banking agencies require stress testing on certain high-risk and volatile activities, and all banks are expected to have appropriate capital planning processes.

  • Publishing federal banking agencies’ examination manuals and directors’ guides, and conducting outreach and training initiatives, which articulate the responsibilities of boards of directors.

  • Issuing extensive guidance on business resumption planning, which is included in the Federal Financial Institutions Examinations Council’s booklets.

  • Requiring institutions with total assets of less than $500 million in certain instances to have an independent audit of their financial statements.

  • Applying stricter regime standards for affiliate transactions, which include, among other things:

  • tighter U.S. quantitative limits of 10 percent of bank capital for transactions with a single affiliate and 20 percent of capital for the aggregate transactions with all bank affiliates, instead of 25 percent of the bank’s capital,

  • inclusion of asset purchases by a bank from affiliates in the 10/20 limit structure noted above,

  • prohibition on a bank having any unsecured credit exposure to an affiliate,

  • prohibition on a bank purchasing low-quality assets from an affiliate.

Additionally, U.S. authorities not only meet many Basel III international standards, but significantly exceed some of the most important ones, especially those related to capital and liquidity. Examples include:

  • Requiring the largest U.S. bank holding companies to have risk-based capital ratios that exceed Basel minimum capital requirements via the Federal Reserve’s Comprehensive Capital Analysis and Review and annual stress tests programs.

  • Utilizing a Global Systemic Important Bank surcharge to reflect short term wholesale funding, which increases banks’ capital conservation buffer.

  • Exceeding the Basel standard, the largest, most global, systemic U.S. bank holding companies must maintain a supplementary leverage ratio buffer greater than 2 percentage points above the 3 percent minimum, for a total of more than 5 percent, to avoid restrictions on capital distributions and discretionary bonus payments. Insured depository institution subsidiaries of these firms must maintain at least a 6 percent supplementary leverage ratio to be considered “well capitalized.”

The U.S. authorities look forward to continuing a dialogue with the IMF and global counterparts to jointly promote the mission of the FSAP to enhance global financial sector stability and supervisory practices. In terms of this Report’s recommendations, specifically, the U.S. authorities will review them carefully. Action will be taken, where permissible, on items that enhance communication and information sharing among the agencies and ensure more effective oversight of systemic risk.

1

For the purposes of this assessment, the FBAs are the OCC, the Federal Reserve and the FDIC.

2

The assessment team did not assess State supervisors, but met with their representatives to hear their views on issues such as cooperation, regulatory framework, implementation of reforms, and mandates.

3

The assessment team comprised John Laker (former Australian Prudential Regulatory Authority), Göran Lind (Swedish Riksbank), and Lyndon Nelson (Bank of England). Fabiana Melo (IMF) helped coordinate the work of the assessors and the drafting of this report.

4

This part of the document draws from the self assessment presented by the authorities, as well as from Article IV reports and other documents produced for the FSAP, some of which at the time of this assessment were not yet finalized. Unless otherwise stated, figures used in this section refer to December 2013.

5

Only 70 percent of defined benefit schemes are funded at the end of 2013.

6

Herfindahl–Hirschman index (HHI) is equal to 0.045. A HHI index below 0.15 indicates an unconcentrated system.

7

The definition of “shadow banking” is based on Pozsar and others (2010) and includes open market papers, overnight repos, net securities lending, liabilities of GSEs and ABS issuers and total shares outstanding of MMFs.

8

Based on reports of derivatives activities of 1,383 insured U.S. commercial banks and savings associations at the end of the fourth quarter 2013.

9

Most of the contracts are held for trading purposes.

10

For a comprehensive summary of the legislative changes introduced since the last FSAP, see authorities’ self-assessment (http://www.treasury.gov/resource-center/international/Pages/us-fsap.aspx.)

11

Specifically, the DFA clarifies that a “covered transaction” for the purposes of sections 23A and 23B of the Federal Reserve Act includes any credit exposure of a bank to an affiliate arising from derivative transactions or securities borrowing and lending transactions with such affiliate. In addition, the Act eliminates certain exemptions from sections 23A and 23B for subsidiaries of BHCs and requires that any purchase of assets by a bank from an insider must be on market terms.

12

Sections 163 and 604 of the DFA require the appropriate federal banking agency to take into account risks to the stability of the U.S. banking or financial system in approving the relevant applications under the BHC Act and the Bank Merger Act. Similarly, section 173 of the DFA adds financial stability to the list of factors that the Federal Reserve may consider when acting on an application by a foreign banking organization to open an office in the U.S. Specifically, the Federal Reserve may consider whether the foreign banking organization’s home country has adopted or is making demonstrable progress toward adopting a financial regulatory system that mitigates risk to the stability of the U.S. financial system.

13

Section 606(a) of the DFA provides that a BHC must be well capitalized and well managed at the holding company and bank levels in order to become and remain a financial holding company (FHC) eligible to engage in expanded activities. The Federal Reserve has clarified that these requirements also apply to SLHCs. In addition, section 163(b) provides that in order to use authority under section 4(k) of the BHC Act to acquire a nonbank company with $10 billion or more in assets, a designated nonbank financial company that is supervised by the Federal Reserve or a BHC with $50 billion or more in consolidated assets must obtain the Federal Reserve’s prior approval. Further, section 164 applies restrictions on management interlocks to designated nonbank financial companies supervised by the Federal Reserve.

14

See section 604 of the DFA (124. The Federal Reserve, however, must continue to rely on examinations conducted by the subsidiary’s primary bank supervisors or functional regulators to the fullest extent possible and notify such supervisors before conducting an examination of the subsidiary.

15

“Securities financing transactions” mean repurchase agreements, reverse repurchase agreements, securities lending transactions, and securities borrowing transactions.

16

This section draws from other documents produced for the FSAP, some of which at the time of this assessment were not yet finalized. A complete analysis of the macroeconomic framework is contained in Article IV reports.

17

See above, and separate Technical Note on Systemic Risk Oversight, Macroprudential framework, for a more complete description of FSOC’s attributions.

18

See separate Technical Notes on Systemic Risk Oversight, and on Resolution Framework.

19

This is a summary of existing FSAP documents. For detailed information on market discipline, accounting and auditing framework, see separate IOSCO assessment.

20

In this document, “banking group” includes the holding company, the bank and its offices, subsidiaries, affiliates and joint ventures, both domestic and foreign. Risks from other entities in the wider group, for example non-bank (including non-financial) entities, may also be relevant. This group-wide approach to supervision goes beyond accounting consolidation.

21

The activities of authorising banks, ongoing supervision and corrective actions are elaborated in the subsequent Principles.

22

Such authority is called “the supervisor” throughout this paper, except where the longer form “the banking supervisor” has been necessary for clarification.

23

In this document, “risk profile” refers to the nature and scale of the risk exposures undertaken by a bank.

24

In this document, “systemic importance” is determined by the size, interconnectedness, substitutability, global or cross-jurisdictional activity (if any), and complexity of the bank, as set out in the BCBS paper on Global systemically important banks: assessment methodology and the additional loss absorbency requirement, November 2011.

25

Please refer to Principle 1, Essential Criterion 1.

26

Principle 3 is developed further in the Principles dealing with “Consolidated supervision” (12), “Home-host relationships” (13) and “Abuse of financial services” (29).

27

The Committee recognizes the presence in some countries of non-banking financial institutions that take deposits but may be regulated differently from banks. These institutions should be subject to a form of regulation commensurate to the type and size of their business and, collectively, should not hold a significant proportion of deposits in the financial system.

28

This document refers to a governance structure composed of a board and senior management. The Committee recognizes that there are significant differences in the legislative and regulatory frameworks across countries regarding these functions. Some countries use a two-tier board structure, where the supervisory function of the board is performed by a separate entity known as a supervisory board, which has no executive functions. Other countries, in contrast, use a one-tier board structure in which the board has a broader role. Owing to these differences, this document does not advocate a specific board structure. Consequently, in this document, the terms “board” and “senior management” are only used as a way to refer to the oversight function and the management function in general and should be interpreted throughout the document in accordance with the applicable law within each jurisdiction.

29

Therefore, shell banks shall not be licensed. (Reference document: BCBS paper on shell banks, January 2003.)

30

Please refer to Principle 14, Essential Criterion 8.

31

Please refer to Principle 29.

32

While the term “supervisor” is used throughout Principle 6, the Committee recognizes that in a few countries these issues might be addressed by a separate licensing authority.

33

The FBAs noted the major acquisitions framework is too complex to be adequately reflected in a table. This summary table is therefore not exhaustive and only highlights main points required by this EC.

34

In the case of major acquisitions, this determination may take into account whether the acquisition or investment creates obstacles to the orderly resolution of the bank.

35

Please refer to Footnote 33 under Principle 7, Essential Criterion 3

36

On-site work is used as a tool to provide independent verification that adequate policies, procedures and controls exist at banks, determine that information reported by banks is reliable, obtain additional information on the bank and its related companies needed for the assessment of the condition of the bank, monitor the bank’s follow-up on supervisory concerns, etc.

37

Off-site work is used as a tool to regularly review and analyze the financial condition of banks, follow up on matters requiring further attention, identify and evaluate developing risks and help identify the priorities, scope of further off-site and on-site work, etc.

38

Please refer to Principle 10.

39

In the context of this Principle, “prudential reports and statistical returns” are distinct from and in addition to required accounting reports. The former are addressed by this Principle, and the latter are addressed in Principle 27.

40

Please refer to Principle 2.

41

Please refer to Principle 1, Essential Criterion 5.

42

Maybe external auditors or other qualified external parties, commissioned with an appropriate mandate, and subject to appropriate confidentiality restrictions.

43

Maybe external auditors or other qualified external parties, commissioned with an appropriate mandate, and subject to appropriate confidentiality restrictions. External experts may conduct reviews used by the supervisor, yet it is ultimately the supervisor that must be satisfied with the results of the reviews conducted by such external experts.

44

Please refer to Principle 1.

45

Please refer to footnote 19 under Principle 1.

46

Please refer to Principle 16, Additional Criterion 2.

47

See Illustrative example of information exchange in colleges of the October 2010 BCBS Good practice principles on supervisory colleges for further information on the extent of information sharing expected.

48

Please refer to footnote 27 under Principle 5.

49

The OECD (OECD glossary of corporate governance-related terms in “Experiences from the Regional Corporate Governance Roundtables”, 2003,www.oecd.org/dataoecd/19/26/23742340.pdf.) defines “duty of care” as “The duty of a board member to act on an informed and prudent basis in decisions with respect to the company. Often interpreted as requiring the board member to approach the affairs of the company in the same way that a ‘prudent man’ would approach their own affairs. Liability under the duty of care is frequently mitigated by the business judgment rule.” The OECD defines “duty of loyalty” as “The duty of the board member to act in the interest of the company and shareholders. The duty of loyalty should prevent individual board members from acting in their own interest, or the interest of another individual or group, at the expense of the company and all shareholders.”

50

“Risk appetite” reflects the level of aggregate risk that the bank’s Board is willing to assume and manage in the pursuit of the bank’s business objectives. Risk appetite may include both quantitative and qualitative elements, as appropriate, and encompass a range of measures. For the purposes of this document, the terms “risk appetite” and “risk tolerance” are treated synonymously.

51

For the purposes of assessing risk management by banks in the context of Principles 15 to 25, a bank’s risk management framework should take an integrated “bank-wide” perspective of the bank’s risk exposure, encompassing the bank’s individual business lines and business units. Where a bank is a member of a group of companies, the risk management framework should in addition cover the risk exposure across and within the “banking group” (see footnote 19 under Principle 1) and should also take account of risks posed to the bank or members of the banking group through other entities in the wider group.

52

To some extent the precise requirements may vary from risk type to risk type (Principles 15 to 25) as reflected by the underlying reference documents.

53

It should be noted that while, in this and other Principles, the supervisor is required to determine that banks’ risk management policies and processes are being adhered to, the responsibility for ensuring adherence remains with a bank’s Board and senior management.

54

New products include those developed by the bank or by a third party and purchased or distributed by the bank.

55

The Core Principles do not require a jurisdiction to comply with the capital adequacy regimes of Basel I, Basel II and/or Basel III. The Committee does not consider implementation of the Basel-based framework a prerequisite for compliance with the Core Principles, and compliance with one of the regimes is only required of those jurisdictions that have declared that they have voluntarily implemented it.

56

The Basel Capital Accord was designed to apply to internationally active banks, which must calculate and apply capital adequacy ratios on a consolidated basis, including subsidiaries undertaking banking and financial business. Jurisdictions adopting the Basel II and Basel III capital adequacy frameworks would apply such ratios on a fully consolidated basis to all internationally active banks and their holding companies; in addition, supervisors must test that banks are adequately capitalized on a stand-alone basis.

57

At the time of the assessment, the RCAP report had not been published and therefore was not used as a source by assessors. Assessors had access to the preliminary RCAP report based on draft U.S. rules, as published by the Basel Committee on Banking Supervision (BCBS) in October 2012. The final RCAP report for the U.S. was published on 5 December 2014. The report concluded that the U.S. risk-based capital requirements for internationally active banks are “largely compliant” with the applicable Basel framework. The RCAP took into account a number of proposed amendments to the final capital rule announced by the U.S. authorities on 18 November 2014, after the preliminary RCAP assessment was completed. For the benefit of the reader, some references to the RCAP report finalized after this BCP assessment have been included in footnotes.

58

For information, the RCAP report broadly accepted that this “floor” would likely be at least as conservative as the Basel I floor for a typical U.S. bank.

59

For information, taking this difference into account, the RCAP report concluded that the U.S. implementation of the market risk framework was “materially non-compliant”. Unlike the RCAP, the BCP assessment considers materiality but does not attempt to quantify it.

60

Reference documents: Enhancements to the Basel II framework, July 2009 and: International convergence of capital measurement and capital standards: a revised framework, comprehensive version, June 2006.

61

In assessing the adequacy of a bank’s capital levels in light of its risk profile, the supervisor critically focuses, among other things, on (a) the potential loss absorbency of the instruments included in the bank’s capital base, (b) the appropriateness of risk weights as a proxy for the risk profile of its exposures, (c) the adequacy of provisions and reserves to cover loss expected on its exposures and (d) the quality of its risk management and controls. Consequently, capital requirements may vary from bank to bank to ensure that each bank is operating with the appropriate level of capital to support the risks it is running and the risks it poses.

62

“Stress testing” comprises a range of activities from simple sensitivity analysis to more complex scenario analyses and reverse stress testing.

63

Please refer to Principle 12, Essential Criterion 7.

64

The conclusions of this assessment are independent from the RCAP findings. Nevertheless, the RCAP report published after this assessment corroborates the assessors’ understanding. The report considered the risk-based capital requirements for internationally active banks under the advanced approaches “largely compliant” with the applicable Basel framework. The report also concluded that the U.S. implementation of the market risk framework was “materially non-compliant” with the Basel framework.

65

Principle 17 covers the evaluation of assets in greater detail; Principle 18 covers the management of problem assets.

66

Credit risk may result from the following: on-balance sheet and off-balance sheet exposures, including loans and advances, investments, inter-bank lending, derivative transactions, securities financing transactions and trading activities.

67

Counterparty credit risk includes credit risk exposures arising from OTC derivative and other financial instruments.

68

“Assuming” includes the assumption of all types of risk that give rise to credit risk, including credit risk or counterparty risk associated with various financial instruments.

69

Principle 17 covers the evaluation of assets in greater detail; Principle 18 covers the management of problem assets.

70

Reserves for the purposes of this Principle are “below the line” non-distributable appropriations of profit required by a supervisor in addition to provisions (“above the line” charges to profit).

71

It is recognized that there are two different types of off-balance sheet exposures: those that can be unilaterally cancelled by the bank (based on contractual arrangements and therefore may not be subject to provisioning), and those that cannot be unilaterally cancelled.

72

Connected counterparties may include natural persons as well as a group of companies related financially or by common ownership, management or any combination thereof.

73

This includes credit concentrations through exposure to: single counterparties and groups of connected counterparties both direct and indirect (such as through exposure to collateral or to credit protection provided by a single counterparty), counterparties in the same industry, economic sector or geographic region and counterparties whose financial performance is dependent on the same activity or commodity as well as off-balance sheet exposures (including guarantees and other commitments) and also market and other risk concentrations where a bank is overly exposed to particular asset classes, products, collateral, or currencies.

74

The measure of credit exposure, in the context of large exposures to single counterparties and groups of connected counterparties, should reflect the maximum possible loss from their failure (i.e. it should encompass actual claims and potential claims as well as contingent liabilities). The risk weighting concept adopted in the Basel capital standards should not be used in measuring credit exposure for this purpose as the relevant risk weights were devised as a measure of credit risk on a basket basis and their use for measuring credit concentrations could significantly underestimate potential losses (see “Measuring and controlling large credit exposures, January 1991).

75

Such requirements should, at least for internationally active banks, reflect the applicable Basel standards. As of September 2012, a new Basel standard on large exposures is still under consideration.

76

Related parties can include, among other things, the bank’s subsidiaries, affiliates, and any party (including their subsidiaries, affiliates and special purpose entities) that the bank exerts control over or that exerts control over the bank, the bank’s major shareholders, Board members, senior management and key staff, their direct and related interests, and their close family members as well as corresponding persons in affiliated companies.

77

Related party transactions include on-balance sheet and off-balance sheet credit exposures and claims, as well as, dealings such as service contracts, asset purchases and sales, construction contracts, lease agreements, derivative transactions, borrowings, and write-offs. The term transaction should be interpreted broadly to incorporate not only transactions that are entered into with related parties but also situations in which an unrelated party (with whom a bank has an existing exposure) subsequently becomes a related party.

78

An exception may be appropriate for beneficial terms that are part of overall remuneration packages (e.g. staff receiving credit at favorable rates).

79

Country risk is the risk of exposure to loss caused by events in a foreign country. The concept is broader than sovereign risk as all forms of lending or investment activity whether to/with individuals, corporates, banks or governments are covered.

80

Transfer risk is the risk that a borrower will not be able to convert local currency into foreign exchange and so will be unable to make debt service payments in foreign currency. The risk normally arises from exchange restrictions imposed by the government in the borrower’s country. (Reference document: IMF paper on External Debt Statistics – Guide for compilers and users, 2003.)

81

Wherever “interest rate risk” is used in this Principle the term refers to interest rate risk in the banking book. Interest rate risk in the trading book is covered under Principle 22.

82

The Committee has defined operational risk as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. The definition includes legal risk but excludes strategic and reputational risk.

83

In assessing independence, supervisors give due regard to the control systems designed to avoid conflicts of interest in the performance measurement of staff in the compliance, control and internal audit functions. For example, the remuneration of such staff should be determined independently of the business lines that they oversee.

84

The term “compliance function” does not necessarily denote an organisational unit. Compliance staff may reside in operating business units or local subsidiaries and report up to operating business line management or local management, provided such staff also have a reporting line through to the head of compliance who should be independent from business lines.

85

The term “internal audit function” does not necessarily denote an organisational unit. Some countries allow small banks to implement a system of independent reviews, e.g. conducted by external experts, of key internal controls as an alternative.

86

In this Essential Criterion, the supervisor is not necessarily limited to the banking supervisor. The responsibility for ensuring that financial statements are prepared in accordance with accounting policies and practices may also be vested with securities and market supervisors.

87

For the purposes of this Essential Criterion, the disclosure requirement may be found in applicable accounting, stock exchange listing, or other similar rules, instead of or in addition to directives issued by the supervisor.

88

The Committee is aware that, in some jurisdictions, other authorities, such as a financial intelligence unit (FIU), rather than a banking supervisor, may have primary responsibility for assessing compliance with laws and regulations regarding criminal activities in banks, such as fraud, money laundering and the financing of terrorism. Thus, in the context of this Principle, “the supervisor” might refer to such other authorities, in particular in Essential Criteria 7, 8 and 10. In such jurisdictions, the banking supervisor cooperates with such authorities to achieve adherence with the criteria mentioned in this Principle.

89

Consistent with international standards, banks are to report suspicious activities involving cases of potential money laundering and the financing of terrorism to the relevant national centre, established either as an independent governmental authority or within an existing authority or authorities that serves as an FIU.

90

These could be external auditors or other qualified parties, commissioned with an appropriate mandate, and subject to appropriate confidentiality restrictions.

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United States: Financial Sector Assessment Program-Detailed Assessment of Observance on the Basel Core Principles for Effective Banking Supervision
Author:
International Monetary Fund. Monetary and Capital Markets Department