Bank Examination Quality

This report summarizes the results of GAO's review of bank and thrift examinations done by the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve Board, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision. GAO focused on how well regulators assess the quality of bank and thrift loan portfolios and related loan loss reserves and the effectiveness of the institutions' internal control systems. In reviewing examinations for 58 randomly selected banks and thrifts, GAO discovered surprising weaknesses. Specifically, examinations were too limited to fully reveal the extent of deficiencies jeopardizing safety and soundness. These limitations impeded early warning of the seriousness of bank and thrift weaknesses and reduced the chance to take timely corrective action and minimize losses to the insurance funds. Similar weaknesses affected the quality of bank holding company inspections. Extensive flexibility granted examiners and a lack of minimum requirements were common problems affecting the quality of examinations and inspections. As measured by the unprecedented failures of banks and thrifts since 1980, the regulatory system has become far less effective in preventing and minimizing the number and the cost of failures. Successful implementation of the FDIC Improvement Act of 1991 and strengthened examinations and accounting rules are vital to regulatory effectiveness and protection of the insurance funds. GAO also identified many inconsistencies among the regulators that may hinder their efficiency and effectiveness. GAO concludes that the regulatory structure that arose from the Great Depression has not kept pace with the banking world, one that has become increasingly competitive and complex in the 1990s. The Comptroller General summarized this series of reports in testimony before Congress; see: Bank and Thrift Regulation: Improvements Needed in Examination Quality and Regulatory Structure, by Charles A. Bowsher, Comptroller General of the United States, before the House Committee on Banking, Finance, and Urban Affairs. GAO/T-AFMD-93-2, Feb. 16, 1993 (47 pages).

GAO found that: (1) although the OCC handbook provides guidance for performing internal control assessments, OCC allows examiners discretion in determining the scope of an examination; (2) OCC did not comprehensively review internal controls in recent examinations of an estimated 72 percent of large banks and 59 percent of small banks supervised by OCC as of September 30, 1990; (3) internal control weaknesses that were evident to examiners were not recognized as early warning signs of financial deterioration and were not specifically considered in assessing bank safety and soundness; (4) OCC insufficiently tested loans for an estimated 50 percent of large and 59 percent of small banks supervised by OCC; (5) examiners assess loan quality based on loan samples that exclude major segments of the banks' loan portfolios; (6) OCC has no minimum loan sampling criteria and believes that the level of loans reviewed during examinations is limited by examiner resource constraints; (7) examiners did not have a sufficient basis to conclude that they had identified the full extent of problem loans and related losses; (8) OCC guidance on risk factors that should be considered in establishing loan loss reserves does not provide a means for quantifying these risk factors; and (9) the OCC handbook included specific guidance regarding working paper documentation and review, but compliance was inconsistent because handbook procedures were not mandatory.

Recommendations

Our recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.

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