Financial Market Regulation
Agencies Engaged in Consolidated Supervision Can Strengthen Performance Measurement and Collaboration Gao ID: GAO-07-154 March 15, 2007As financial institutions increasingly operate globally and diversify their businesses, entities with an interest in financial stability cite the need for supervisors to oversee the safety and soundness of these institutions on a consolidated basis. Under the Comptroller General's Authority, GAO reviewed the consolidated supervision programs at the Federal Reserve System (Federal Reserve), Office of Thrift Supervision (OTS), and Securities and Exchange Commission (SEC) to (1) describe policies and approaches that U.S. consolidated supervisors use to oversee large and small holding companies; (2) review the management of the consolidated supervision programs, including use of program objectives and performance measures; and (3) evaluate how well consolidated supervisors are collaborating with other supervisors and each other in their activities. In conducting this study, GAO reviewed agency policy documents and supervisory reports and interviewed agency and financial institution officials.
The Federal Reserve, OTS, and SEC have responded to the dramatic changes in the financial services industry and for many of the largest financial services firms the agencies focus on the firms' consolidated risks, controls, and capital. Reflecting in part differences in structure, traditional roles and responsibilities, and the length of time they have had to develop and refine their programs, the agencies employ somewhat differing policies and approaches for their consolidated supervision programs. Consolidated supervision becomes more important in the face of changes in the financial services industry, particularly with respect to the increased importance of enterprise risk management by large, complex financial services firms. Consolidated supervision provides a basis for the supervisors to oversee the risks of financial services firms on the same level that the firms manage those risks. GAO found that while all of these agencies were meeting international standards for effective oversight of large, internationally active conglomerates and have broad goals for supervision, they could more clearly articulate the specific objectives and performance measures for their evolving consolidated supervision programs. Both Federal Reserve and OTS, for example, focus on the safety and soundness of the depository institution but could take steps to better measure how consolidated supervision contributes to this in ways that differ from primary supervision of the depository institution. Such objectives and measures would help the agencies ensure consistent treatment of the firms that are subject to consolidated supervision. More effective collaboration can occur if agencies take a more systematic approach to agreeing on roles and responsibilities and establishing compatible goals, policies, and procedures on how to use available resources as efficiently as possible. While the three agencies coordinate and exchange information, they could take a more systematic approach to collaboration with respect to their consolidated supervision programs. For instance, SEC and OTS have authority for some of the same firms with no effective mechanism to prevent duplication, assign accountability, or resolve potential conflicts. Similarly, while the Federal Reserve and other federal bank supervisory agencies have taken steps to share information and examination activities when the Federal Reserve is not the primary supervisor of the lead bank in a bank holding company, some duplication and lack of accountability remain. As a result, consolidated supervision of U.S. financial institutions is not as efficient and effective as it could be if agencies collaborated more systematically. GAO has noted in the past that it is difficult to collaborate within the fragmented U.S. regulatory system and has recommended that Congress modernize or consolidate the regulatory system. However, if the current system is maintained, it is increasingly important for agencies to collaborate to ensure effective and efficient consolidated supervision, consistent treatment of financial services firms, and clear accountability of the agencies for their supervisory activities.
RecommendationsOur 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.
Director: Team: Phone:GAO-07-154, Financial Market Regulation: Agencies Engaged in Consolidated Supervision Can Strengthen Performance Measurement and Collaboration
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Report to Congressional Committees:
United States Government Accountability Office:
GAO:
March 2007:
Financial Market Regulation:
Agencies Engaged in Consolidated Supervision Can Strengthen Performance
Measurement and Collaboration:
GAO-07-154:
GAO Highlights:
Highlights of GAO-07-154, a report to congressional committees
Why GAO Did This Study:
As financial institutions increasingly operate globally and diversify
their businesses, entities with an interest in financial stability cite
the need for supervisors to oversee the safety and soundness of these
institutions on a consolidated basis. Under the Comptroller General‘s
Authority, GAO reviewed the consolidated supervision programs at the
Federal Reserve System (Federal Reserve), Office of Thrift Supervision
(OTS), and Securities and Exchange Commission (SEC) to (1) describe
policies and approaches that U.S. consolidated supervisors use to
oversee large and small holding companies; (2) review the management of
the consolidated supervision programs, including use of program
objectives and performance measures; and (3) evaluate how well
consolidated supervisors are collaborating with other supervisors and
each other in their activities. In conducting this study, GAO reviewed
agency policy documents and supervisory reports and interviewed agency
and financial institution officials.
What GAO Found:
The Federal Reserve, OTS, and SEC have responded to the dramatic
changes in the financial services industry, and for many of the largest
financial services firms, the agencies focus on the firms‘ consolidated
risks, controls, and capital. Reflecting in part differences in
structure, traditional roles and responsibilities, and the length of
time they have had to develop and refine their programs, the agencies
employ somewhat differing policies and approaches for their
consolidated supervision programs.
Consolidated supervision becomes more important in the face of changes
in the financial services industry, particularly with respect to the
increased importance of enterprise risk management by large, complex
financial services firms. Consolidated supervision provides a basis for
the supervisors to oversee the risks of financial services firms on the
same level that the firms manage those risks. GAO found that while all
of these agencies were meeting international standards for effective
oversight of large, internationally active conglomerates and have broad
goals for supervision, they could more clearly articulate the specific
objectives and performance measures for their evolving consolidated
supervision programs. Both Federal Reserve and OTS, for example, focus
on the safety and soundness of the depository institution but could
take steps to better measure how consolidated supervision contributes
to this in ways that differ from primary supervision of the depository
institution. Such objectives and measures would help the agencies
ensure consistent treatment of the firms that are subject to
consolidated supervision.
More effective collaboration can occur if agencies take a more
systematic approach to agreeing on roles and responsibilities and
establishing compatible goals, policies, and procedures on how to use
available resources as efficiently as possible. While the three
agencies coordinate and exchange information, they could take a more
systematic approach to collaboration with respect to their consolidated
supervision programs. For instance, SEC and OTS have authority for some
of the same firms with no effective mechanism to prevent duplication,
assign accountability, or resolve potential conflicts. Similarly, while
the Federal Reserve and other federal bank supervisory agencies have
taken steps to share information and examination activities when the
Federal Reserve is not the primary supervisor of the lead bank in a
bank holding company, some duplication and lack of accountability
remain. As a result, consolidated supervision of U.S. financial
institutions is not as efficient and effective as it could be if
agencies collaborated more systematically. GAO has noted in the past
that it is difficult to collaborate within the fragmented U.S.
regulatory system and has recommended that Congress modernize or
consolidate the regulatory system. However, if the current system is
maintained, it is increasingly important for agencies to collaborate to
ensure effective and efficient consolidated supervision, consistent
treatment of financial services firms, and clear accountability of the
agencies for their supervisory activities.
What GAO Recommends:
GAO recommends that the heads of the three agencies direct their staffs
to develop a set of clear and consistent objectives and related
performance measures specific to consolidated supervision and
collaborate more systematically with each other and with other
supervisors. The agencies generally agreed with these recommendations.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-154].
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Richard J. Hillman at
(202) 512-8678 or hillmanr@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Agencies Employ Differing Policies and Approaches to Provide
Consolidated Supervision:
Improved Program Objectives and Performance Measures Could Enhance
Agencies' Consolidated Supervision Programs:
Systematic Collaboration Could Enhance Consolidated Supervision
Programs:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: Criteria for Consolidated Supervision Included in Basel
Committee on Banking Supervision's Core Principles:
Appendix III: Comments from the Chairman of the Board of Governors of
the Federal Reserve System:
Appendix IV: Comments from the Director of the Office of Thrift
Supervision:
Appendix V: Comments from the Chairman of the Securities and Exchange
Commission:
Appendix VI: GAO Contact and Staff Acknowledgments:
Related GAO Products:
Tables:
Table 1: U.S. Primary Bank, Broker-Dealer, and Insurance Supervisors,
2005:
Table 2: Number and Type of Institutions That Consolidated Supervisors
Oversee, 2005:
Table 3: Federal Reserve's Supervisory Cycle for LCBOs:
Table 4: OTS's Standard Core Framework:
Table 5: Thrift Holding Company Enterprises by Category, Complexity,
Size, and Primary Business, as of December 31, 2006:
Table 6: Key Elements of Collaboration:
Figure:
Figure 1: Supervisors for a Hypothetical Financial Holding Company:
Abbreviations:
BaFin: German Federal Financial Supervisory Authority (Die
Bundesanstalt für Finanzdienstleistungsaufsicht):
BCBS: Basel Committee on Banking Supervision:
Board: Federal Reserve Board of Governors:
CAMELS: capital adequacy, asset quality, management ability, earnings,
liquidity, and sensitivity to market risk:
CIO: Complex and International Organizations:
CORE: capital, organization structure, relationship, and earnings:
COSO: Committee of Sponsoring Organizations of the Treadway Commission:
CSE: consolidated supervised entity:
District Bank: Federal Reserve Bank in each of the 12 Federal Reserve
Districts:
EU: European Union:
FCD: Financial Conglomerates Directive:
FDIC: Federal Deposit Insurance Corporation:
Federal Reserve: Federal Reserve System:
FSA: Financials Services Authority of the United Kingdom:
GLBA: Gramm-Leach-Bliley Act:
ILC: industrial loan companies:
LCBO: large complex banking organization:
LTCM: Long-Term Capital Management:
MOU: memorandum of understanding:
NAIC: National Association of Insurance Commissioners:
NERO: Northeast Regional Office:
OCC: Office of the Comptroller of the Currency:
OCIE: Office of Compliance Inspections and Examinations:
OTS: Office of Thrift Supervision:
SEC: Securities and Exchange Commission:
SIBHC: supervised investment bank holding company:
SRO: self- regulatory organization:
[End of section]
March 15, 2007:
Congressional Committees:
Increasingly, financial institutions headquartered in the United
States, and their competitors, operate on a global basis, engage in a
variety of businesses, and manage themselves from a consolidated
perspective. Partly in response to these changes, entities with an
interest in financial institutions have increasingly cited the need for
supervisors to oversee the safety and soundness of these firms on a
consolidated basis, mirroring the risk management practices of the
firms. This increased focus is reflected in U.S. laws that provide
holding company supervisors with authority to examine the financial and
operating risks faced by holding companies and the controls for these
risks on a consolidated basis. Similarly, the European Union's (EU)
Financial Conglomerates Directive, implemented in 2005, requires
conglomerates to have a consolidated supervisor--either an EU
supervisor or a home supervisor that has demonstrated it provides
equivalent consolidated supervision--and focuses on the risks,
controls, and capital levels of holding companies.
In the United States, consolidated supervision generally is equated
with holding company supervision at the top tier or ultimate holding
company in a financial enterprise. Three federal agencies--the Federal
Reserve System (Federal Reserve), the Office of Thrift Supervision
(OTS), and the Securities and Exchange Commission (SEC)--engage in
oversight of financial services holding companies on a consolidated
basis:[Footnote 1] the Federal Reserve oversees bank holding companies
(including financial holding companies, which are bank holding
companies qualified to engage in many nonbanking financial services),
OTS oversees thrift holding companies, and SEC oversees consolidated
supervised entities (CSE). Each of these agencies oversees large,
complex financial institutions.
In addition, the Federal Reserve and OTS provide consolidated
supervision for the vast majority of U.S. financial institutions
organized as holding companies that have remained relatively small, and
are not complex. Under U.S. law, consolidated supervisors are to rely
on primary bank and functional supervisors with respect to the
supervision of regulated financial subsidiaries such as banks, broker-
dealers, and insurers.[Footnote 2] The Federal Deposit Insurance
Corporation (FDIC) and the Office of the Comptroller of the Currency
(OCC), for instance, are the primary federal supervisors for state-
chartered banks that are not members of the Federal Reserve System and
for national banks, respectively. SEC is the primary regulator of
broker-dealers and state insurance supervisors of insurers.
As is generally the case for supervisors dealing with the financial
viability of the entities they oversee, holding company supervisors
face the challenge of striking the appropriate balance between
adequately assessing the risks and controls of financial services firms
and placing undue regulatory burdens on those enterprises. At the
consolidated level the effects of not having the right balance could be
unacceptable losses to the depository insurance fund, systemic failures
that could threaten financial stability, competitive disadvantages for
U.S. firms as a whole or for a firm or group of firms relative to their
U.S. competitors, or higher costs or lower returns for consumers of
financial services products or the owners of those firms. =
In previous reports,[Footnote 3] we have noted the challenges
confronting the U.S. regulatory system:
The present federal financial regulatory structure evolved largely as a
result of periodic ad hoc responses to crises such as financial panics.
In the last few decades, however, the financial services industry,
especially as represented by the largest firms, has evolved, becoming
more global, more concentrated, complex, and consolidated across
sectors, and increasingly converging in terms of product offerings.
Multiple specialized regulators bring critical skills to bear in their
areas of expertise but have difficulty seeing the total risk exposure
at large conglomerate firms or identifying and preemptively responding
to risks that cross industry lines.[Footnote 4]
In particular, we previously concluded that while the strength and
vitality of the U.S. financial services industry demonstrates that the
regulatory structure has not failed, there are questions whether that
structure is appropriate in today's environment, particularly with
respect to large, complex firms managing their risks on a consolidated
basis. We suggested that Congress consider several alternative
structures, including consolidating some or all of the current
regulatory agencies or having a single regulator oversee complex,
internationally active firms. However, this report evaluates
consolidated supervision under the existing regulatory structure and
does not address proposals to consolidate federal financial regulation.
In recognition of the increasing importance of consolidated supervision
for the federal financial regulatory system raised in these earlier
reports, we undertook a review of consolidated supervision in the
United States under the Comptroller General's Authority to initiate
reviews. This report:
* describes the policies and approaches U.S. consolidated supervisors
use to oversee large and small holding companies in the financial
services industry;
* reviews the supervisory agencies' management of their consolidated
supervision programs, including program objectives and performance
measures; and:
* evaluates how well consolidated supervisors are collaborating with
other supervisors and each other in their activities.
To meet our objectives, we reviewed the structure, policies, and
activities of the Federal Reserve, OTS, and SEC as they relate to these
agencies' consolidated supervision programs. We reviewed laws and
regulations pertinent to each agency's consolidated supervision, as
well as agency planning and performance documents, and regulatory
planning and examination reports and letters for a group of 14 large,
complex firms selected because they had at least one of these
characteristics: (1) major international operations, so that they were
subject to the EU Financial Conglomerates Directive; (2) operations in
several business lines; or (3) oversight by one or more consolidated
supervisors. We also interviewed agency officials and examiners and
officials from some of the selected group of firms to determine their
view of the regulatory process. In addition, for the Federal Reserve
and OTS, we reviewed examination materials related to the supervision
of smaller, less complex institutions. To determine the adequacy of
management practices at the agencies, we analyzed the goals for holding
company supervision, the strategies agencies employ to achieve their
goals, including collaboration, and how agencies monitor their
performance. We also reviewed officials' and examiners' statements and
other examination materials to determine the degree to which
consolidated supervision programs have effective internal control, key
management practices that provide agencies with reasonable assurance
that the programs are operating efficiently and effectively. This
included an evaluation of how agencies coordinate their activities
relative to the practices for effective collaboration that we have
identified.[Footnote 5] We conducted our work between November 2005 and
February 2007 in accordance with generally accepted government auditing
standards in Washington, D.C; Boston; and locations where financial
institutions we visited are headquartered. See appendix I for
additional details on the objectives, scope, and methodology used in
this report.
Results in Brief:
In recent years, financial services firms have grown dramatically and
become more complex in terms of the products and services they offer;
they increasingly operate on a global basis and often manage risks
across the enterprise. The Federal Reserve, OTS, and SEC have all
responded to the dramatic changes in the financial services industry,
and now, for many of the largest, most complex financial services firms
in the United States, these agencies examine risks, controls, and
capital levels on a consolidated basis. Given the differences in the
institutions that the agencies supervise and other factors, their
specific policies and procedures differ. The agencies divide
responsibilities for developing and implementing policies across a
number of agency components. The Federal Reserve and OTS generally set
policy centrally and implement it through District Banks or regional
offices, respectively. At SEC, the Division of Market Regulation
(Market Regulation) has primary responsibility for policy and for
overseeing how firms manage risks, while SEC's examination offices
scrutinize more control-oriented activities. Almost all firms overseen
by the Federal Reserve are engaged primarily in the business of banking
and those overseen by SEC are engaged primarily in the securities
business. In contrast, a substantial minority of the firms OTS
oversees--especially the large, complex ones--have primary businesses
other than those traditionally engaged in by thrifts, such as
insurance, securities, or commercial activities. In addition, large
firms tend to be overseen by multiple supervisors and in the case of
firms overseen by the Federal Reserve, on a consolidated basis, OCC or
FDIC is often the primary federal regulator of the lead insured
depository subsidiary. Finally, for their smaller, less complex firms,
the Federal Reserve and OTS use abbreviated examination programs.
Consolidated supervision becomes more important in the face of changes
in the industry, particularly with respect to the increased importance
of enterprise risk management by large, complex financial services
firms. Consolidated supervision provides a basis for the supervisors to
oversee the risks of a financial services firm on the same level that
the firm manages its risks. Each of the agencies has broad goals for
its consolidated supervision programs. However, each could better
ensure accountability, efficiency, and consistency by more clearly
articulating the objectives of its consolidated supervision program,
distinguishing these objectives from those for primary supervision,
linking its activities to these objectives, and measuring the extent to
which the activities achieve the objectives by developing and using
performance measures that are specific to the program. In addition,
agencies could achieve greater consistency by improving examiner
guidance. We found that the Federal Reserve, OTS, and SEC were
generally meeting criteria for comprehensive, consolidated supervision.
However, particularly in rapidly changing environments such as the
financial services industry, clearer objectives and performance
measures are essential. The Federal Reserve and OTS identify an
objective of consolidated supervision as protecting the safety and
soundness of depository institutions, but the agencies could take steps
to better measure how consolidated supervision contributes to this
objective in ways that are different from primary bank supervision.
Similarly, SEC identifies protection of regulated subsidiaries as an
objective but does not distinguish the contribution that consolidated
supervision makes in addition to SEC's oversight of regulated broker-
dealers. SEC staff recently developed a draft document that is intended
to provide objectives specific to its consolidated supervision program.
Without such specific objectives and related performance measures, the
agencies are less able to ensure that their supervisory activities
avoid duplication and treat holding companies in a consistent manner.
We have noted in the past that U.S. financial regulatory agencies
cooperate through a myriad of devices such as the President's Working
Group, the Federal Financial Institutions Examination Council, and
Financial and Banking Information Infrastructure Committee often at the
direction of the President or Congress. In addition, to varying
degrees, examiners and officials at the supervisory agencies share
information on supervisory procedures and examination findings over the
course of exams. However, the U.S. regulatory system could benefit from
more systematic collaboration, both between consolidated and primary
bank and functional supervisors in the oversight of the largest, most
complex firms and among the consolidated supervisors themselves. For
many of the largest, most complex financial institutions, the
consolidated supervisor is not the primary supervisor of holding
company subsidiaries; other supervisors, such as bank supervisors, have
this responsibility. The supervisory agencies, especially those
involved in commercial bank supervision, do take steps to avoid
duplication by sharing some information and examination activities.
However, we found some evidence of duplication and lack of
accountability when different agencies are responsible for consolidated
and primary supervision, suggesting that opportunities remain for
enhancing collaboration. For example, while the Federal Reserve and OCC
have and generally follow procedures to resolve differences, one firm
we visited had initially received conflicting information from the
Federal Reserve, its consolidated supervisor, and OCC, its primary bank
supervisor, regarding the firm's business continuity plans. Also, SEC
and OTS both have consolidated supervisory authority for some of the
same firms, but with no effective mechanism to collaborate in order to
prevent duplication, assign accountability, or resolve potential
conflicts in the feedback given to firms. Moreover, while these
agencies all supervise large, complex, internationally active firms,
they could better ensure consistency with more systematic collaboration
to determine common goals, compatible strategies, and accountability.
In this report, we make seven recommendations primarily related to
improving certain management practices within and across the agencies
engaged in consolidated supervision. We recommend that each agency
better define objectives that are specific to its consolidated
supervision program and develop performance measures that will help it
measure the extent to which it is achieving these objectives. As noted
above, SEC staff have developed draft objectives and performance
measures for SEC's consolidated supervision program. With regard to the
oversight of complex institutions where primary bank and functional
supervisors oversee certain holding company subsidiaries, we recommend
that those agencies engaged in consolidated supervision of the holding
companies develop mechanisms for more systematic collaboration with the
primary and functional supervisors responsible for the supervision of
the subsidiaries. In a similar vein, we recommend that the three
agencies engaged in consolidated supervision adopt mechanisms for more
systematic collaboration among themselves, particularly when they share
responsibility for the same firms. In both cases, more systematic
collaboration would help to limit duplication, ensure that all
regulatory areas are effectively covered, and ensure that resources are
focused most effectively on the greatest risks across the regulatory
system. In addition, we also make specific recommendations to each
consolidated supervisor to help ensure that firms are treated
consistently. The Chairman of the Board of Governors of the Federal
Reserve System and the Director of the Office of Thrift Supervision
provided written comments on a draft of this report; their comments are
included in appendixes III and IV, respectively. The Chairman of the
Securities and Exchange Commission provided written comments on a draft
of this report and subsequently provided additional information
detailing some of the actions he was taking in response to the report;
these comments are included in appendix V. Officials from the three
agencies generally agreed with the recommendations in this report and
offered clarifying remarks.
Background:
Modern financial services firms use a variety of holding company
structures to manage risk inherent in their businesses. The United
States regulatory system that consists of primary bank supervisors,
functional supervisors, and consolidated supervisors oversees these
firms in part to ensure that they do not take on excessive risk that
could undermine the safety and soundness of the financial system.
Primary bank supervisors oversee banks according to their charters, and
functional supervisors--primarily, SEC, self-regulatory organizations
(SRO), and state insurance regulators--oversee entities engaged in the
securities and insurance industries as appropriate. Consolidated
supervisors oversee holding companies that contain subsidiaries that
have primary bank or functional supervisors. They are chartered,
registered, or licensed as banks, securities firms, commodity trading
firms, and insurers. International bodies have provided some guidance
for consolidated supervision.
Modern Financial Services Firms Use Holding Company Structures to
Manage Risk:
Many modern financial firms are organized as holding companies that may
have a variety of subsidiaries. In recent years, the financial services
industry has become more global, consolidated within traditional
sectors, formed conglomerates across sectors, and converged in terms of
institutional roles and products. The holding company structure, which
allows firms to expand geographically, move into other permissible
product markets, and obtain greater financial flexibility and tax
benefits, has facilitated these changes. Financial services holding
companies now range in size and complexity from small enterprises that
own only a single bank and are being used for financial flexibility and
tax purposes to large diversified businesses with hundreds of
subsidiaries--including banks, broker-dealers, insurers, and commercial
entities--that have centralized business functions that may be housed
in the holding company. In addition, modern financial corporate
structures often consist of several tiers of holding companies.
To varying degrees, all financial institutions are exposed to a variety
of risks that create the potential for financial loss associated with:
² failure of a borrower or counterparty to perform on an obligation--
credit risk;
² broad movements in financial prices--interest rates or stock prices-
-market risk;
² failure to meet obligations because of inability to liquidate assets
or obtain funding--liquidity risk;
² inadequate information systems, operational problems, and breaches in
internal controls--operational risk;
² negative publicity regarding an institution's business practices and
subsequent decline in customers, costly litigation, or revenue
reductions--reputation risk;
² breaches of law or regulation that may result in heavy penalties or
other costs--legal risk;
² risks that an insurance underwriter takes in exchange for premiums--
insurance risk; and:
² events not covered above, such as credit rating downgrades or factors
beyond the control of the firm, such as major shocks in the firm's
markets--business/event risk.
In addition, the industry as a whole is exposed to systemic risk, the
risk that a disruption could cause widespread difficulties in the
financial system as a whole.
As firms have diversified, some holding companies have adopted
enterprisewide risk management practices where they manage and control
risks across the entire holding company rather than within
subsidiaries. These firms have global risk managers who manage credit,
market, liquidity, and other risks across the enterprise rather than
within individual subsidiaries, such as securities, banking, or
insurance businesses or subsidiaries in foreign countries. In addition,
these firms generally provide services such as information technology
on a firmwide basis and have firmwide compliance and internal audit
functions.
The U.S. Regulatory System Includes Many Agencies:
We have previously reported that most financial services firms are
subject to federal oversight designed to limit the risks these firms
take on because (1) consumers/investors do not have adequate
information to impose market discipline on the institutions and (2)
systemic linkages may make the financial system as a whole prone to
instability.[Footnote 6] In the United States, this oversight is
provided by primary bank and functional supervisors as well as by
consolidated supervisors.
Primary Bank and Functional Supervisors Oversee Holding Company
Subsidiaries:
As table 1 illustrates, in the United States a variety of federal bank
supervisors oversee banks that are subsidiaries of holding
companies.[Footnote 7] State bank supervisors also participate in the
oversight of banks with state charters. Similarly, securities
supervisors that include SEC and SROs, such as the New York Stock
Exchange and NASD, oversee broker-dealer subsidiaries and state
insurance supervisors oversee insurance companies and products. While
each of the agencies has multiple goals, all are involved in assessing
the financial solvency of the institutions they regulate.
Table 1: U.S. Primary Bank, Broker-Dealer, and Insurance Supervisors,
2005:
Federal primary bank supervisors[A].
Regulatory body: Federal Deposit Insurance Corporation;
Number of entities overseen: 5,245[B]; [Empty];
Functions: Provides oversight of state-chartered banks that are not
members of the Federal Reserve, state savings banks, and industrial
loan corporations with federally insured deposits. Also serves as the
secondary regulator for all banks with federally insured deposits.
Regulatory body: Federal Reserve;
Number of entities overseen: 907[C];
Functions: Oversees state-chartered banks that are members of the
Federal Reserve.
Regulatory body: Office of the Comptroller of the Currency;
Number of entities overseen: 1,933[D];
Functions: Charters and supervises banks with national charters.
Regulatory body: Office of Thrift Supervision;
Number of entities overseen: 866[E];
Functions: Supervises state-chartered savings associations that are
federally insured and federally chartered thrifts.
Broker-dealer supervisors.
Regulatory body: Securities and Exchange Commission and self-regulatory
organizations;
Number of entities overseen: 6,300[F];
Functions: Oversee compliance of securities brokers and dealers with
federal securities laws. Self-regulatory organizations play a major
role in enforcing conduct of business and capital requirements. The
Securities and Exchange Commission validates self-regulatory
organizations' rules and inspects and oversees their regulatory
programs.
Insurance supervisors.
Regulatory body: State insurance supervisors;
Number of entities overseen: 8,794[G];
Functions: Insurance firms are regulated primarily at the state level.
The National Association of Insurance Commissioners aims to achieve
some common minimum standards by encouraging consistency and
cooperation among the various states as they individually regulate the
insurance industry.[H].
Source: GAO analysis of agency data.
[A] Because credit unions are not subsidiaries of holding companies,
they are not included here.
[B] Federal Deposit Insurance Corporation statistics, December 2005.
[C] Federal Reserve, Annual Report 2005.
[D] Office of the Comptroller of the Currency, Annual Report Fiscal
Year 2005. This number does not include the 51 federal branches of
foreign banks in the United States that are also overseen by OCC.
[E] Office of Thrift Supervision, Budget/Performance Plan Fiscal Year
2006.
[F] Securities and Exchange Commission.
[G] National Association of Insurance Commissioners, 2005 Insurance
Department Resources Report.
[H] SEC regulates sales of discrete products, such as certain types of
annuities considered to be securities. Also, banks engage in certain
types of insurance activities, such as underwriting credit insurance
and, under certain circumstances, acting as an insurance agent either
directly or through a subsidiary. Although these activities are subject
to OCC regulation, national banks can be subject to nondiscriminatory
state laws applicable to certain insurance related activities.
[End of table]
All of the primary bank supervisors use the same framework to examine
banks for safety and soundness and compliance with applicable laws and
regulations. Among other things, they examine whether:
² the bank has adequate capital on the basis of its size, composition
of its assets and liabilities, and its credit and market risk profile;
² the bank has an appropriate asset quality based on the credit risk of
loans in its portfolio;
² the bank's earnings trend measures up to that of its peers;
² the competence and integrity of the bank's management and board of
directors to manage the risks of the bank's activities and their record
of complying with banking regulations and other laws;
² the bank has adequate liquidity based on its deposit volatility,
credit conditions, loan commitments and other contingent claims on the
bank's assets and its perceived ability to raise funds on short notice
at acceptable market rates; and:
² the bank adequately identifies and manages its exposures to changes
in interest rates and, as applicable, foreign exchange rates, commodity
and equity prices.
Primary bank examiners rate banks in each of the areas; these ratings
are usually referred to as CAMELS ratings (capital adequacy, asset
quality, management ability, earnings, liquidity, and, where
appropriate, sensitivity to market risk).
SROs oversee certain aspects of broker-dealer activity. SEC
concurrently oversees these SROs and independently examines broker-
dealers. SEC considers its enforcement authority crucial for its
protection of investors. Under this authority, it brings actions
against broker-dealers and other securities firms and professionals for
infractions such as insider trading and providing false or misleading
information about securities or the companies that issue them. However,
to protect investors, SEC also requires broker-dealers to maintain a
level of capital that should allow the broker-dealer to satisfy the
claims of its customers, other broker-dealers, and creditors in the
event of potential losses from proprietary trading or operational
events. SEC and the SROs examine broker-dealers to determine if they
are maintaining required capital and evaluate broker-dealers' internal
controls.
The central purpose of insurance regulation is to protect consumers by
monitoring the solvency of insurers and their business practices.
Insurance companies are supervised on a state-by-state basis, although
states often follow general standards promulgated by the National
Association of Insurance Commissioners (NAIC), a private voluntary
association for insurance regulators. For example, insurance
supervisors generally require insurance firms to prepare their
quarterly and annual financial statements in a format unique to
insurance known as statutory accounting principles that are maintained
by NAIC. Insurance supervisors impose capital requirements on insurance
companies to try to limit insurance company failures and ensure their
long-run viability. In addition, all state insurance supervisors
monitor insurers' business practices and terms of insurance contracts
in their states.
Consolidated Supervisors Oversee Holding Companies:
In the United States, three agencies provide consolidated supervision-
-the Federal Reserve oversees bank holding companies, OTS oversees
thrift holding companies, and SEC oversees certain CSEs on a
consolidated basis. As table 2 shows, the number and type of
institutions these agencies oversee varies.
Table 2: Number and Type of Institutions That Consolidated Supervisors
Oversee, 2005:
Consolidated supervisor: Federal Reserve;
Number of entities overseen: 5,154;
Type of entity overseen: Bank holding companies, including small shell,
medium-sized, and large complex firms--the majority of which have
banking as their primary business but many, especially larger firms,
have securities or other nonbank subsidiaries.
Consolidated supervisor: OTS;
Number of entities overseen: 476;
Type of entity overseen: Savings and loan holding companies, including
small, medium-sized, and large firms that may include substantial
nonbanking subsidiaries focused on commercial activities, securities,
or insurance.
Consolidated supervisor: SEC;
Number of entities overseen: 5;
Type of entity overseen: Large complex firms that focus primarily on
securities and have chosen to be participants in the CSE program.
Source: GAO analysis of agency data.
[End of table]
As the table shows, SEC, under its CSE program, oversees only large
complex firms. These include Bear Stearns & Co., Goldman Sachs & Co.,
Lehman Brothers Inc., Merrill Lynch & Co. Inc., and Morgan Stanley &
Co., while the Federal Reserve and OTS oversee firms that vary
significantly in size and complexity. Among larger firms, the Federal
Reserve oversees Bank of America Corporation, Citigroup, and JPMorgan
Chase, and OTS oversees American International Group Inc., General
Electric Company, General Motors Corporation, Merrill Lynch & Co. Inc.,
and Washington Mutual Inc. Most of the large bank holding companies
that the Federal Reserve oversees are primarily in the business of
banking but to a lesser extent engage in securities or other nonbank
activities as well. Many of the large firms OTS oversees are engaged in
commercial businesses, as well as securities and insurance. The Federal
Reserve and OTS also oversee the vast majority of U.S. financial
institutions that have remained relatively small and are not complex.
The Federal Reserve and OTS base their consolidated supervision
programs on their long-standing authority to supervise holding
companies, while SEC has only recently become a consolidated
supervisor. The Federal Reserve's authority is set forth primarily in
the Bank Holding Company Act of 1956, which contains the supervisory
framework for holding companies that control commercial banks.[Footnote
8] OTS's consolidated supervisory authority is set forth in the Home
Owners Loan Act of 1933, as amended, which provides for the supervision
of holding companies that control institutions with thrift charters
(other than bank holding companies).[Footnote 9] SEC bases its
authority on section 15(c)(3) of the Securities Exchange Act of
1934.[Footnote 10] Specifically, in 2004, SEC adopted the Alternative
Net Capital Rule for CSEs based on its authority under that provision,
which authorizes SEC to adopt rules and regulations regarding the
financial responsibilities of broker-dealers that it finds necessary or
appropriate in the public interest or for the protection of
investors.[Footnote 11] Under the CSE rules, qualified broker-dealers
can elect to be supervised by SEC on a consolidated basis. If the
holding company of the broker-dealer also is a bank holding company,
SEC defers to the Federal Reserve's supervision of the holding company.
At the same time that it issued the CSE rules, SEC promulgated final
rules for the consolidated supervision of supervised investment bank
holding companies (SIBHC) pursuant to a provision in the Gramm-Leach-
Bliley Act (GLBA).[Footnote 12] The GLBA provision established a
supervisory framework for SIBHCs--qualified investment bank holding
companies that do not control an insured depository institution--
similar to the approach prescribed in the act for the supervision of
bank and thrift holding companies.[Footnote 13] As of this date, no
firm has elected to be regulated under the SIBHC scheme.
The Federal Reserve, SEC, and OTS vary in their missions in that the
Federal Reserve and SEC have responsibilities outside of the
supervision and regulation of financial institutions. The Federal
Reserve is the central bank of the United States, established by
Congress in 1913 to provide the nation with a safer, more flexible, and
more stable monetary and financial system. It is responsible for
conducting the nation's monetary policy; protecting the credit rights
of consumers; playing a major role in operating the nation's payment
system; and providing certain financial services to the U.S.
government, the public, financial institutions, and foreign official
institutions. The Federal Reserve consists of the Board of Governors
(Board) and 12 Districts, each with a Federal Reserve Bank (District
Bank). SEC is responsible for, among other things, overseeing the
disclosure activities of publicly traded companies and the activities
of stock markets.
The three agencies engaged in consolidated supervision are financed
differently. The Federal Reserve primarily is funded by income earned
from U.S. government securities that it has acquired through open
market operations; OTS primarily by assessments on the firms it
supervises; and SEC by congressional appropriations. SEC collects fees
on registrations, certain securities transactions, and other filings
and reports. However, unlike the banking regulators, SEC deposits its
collections in an SEC-designated account at the U.S. Treasury that is
used by SEC's congressional appropriators for, among other things,
providing appropriations to SEC.
International Bodies Provide Some Guidance for Consolidated
Supervision:
International bodies in which U.S. supervisors participate have
developed guidance for consolidated supervision of large, complex,
internationally active financial firms or conglomerates.[Footnote 14]
The Basel Committee on Banking Supervision (BCBS) does not have formal
supervisory authority; rather, it provides an international forum for
regular cooperation on banking supervisory matters, including the
formulation of broad supervisory standards and guidelines. BCBS has
recently revised its "Core Principles for Effective Banking
Supervision," which include countries' requiring that banking groups be
subject to consolidated supervision, although the definition of a
banking group does not always include a top-tier holding
company.[Footnote 15] These principles include a number of specific
criteria that are presented in appendix II of this report. BCBS also
has developed the Basel Capital Standards, which have been adopted in
various forms by specific countries; a revised set of standards, Basel
II, is currently under consideration for adoption in the United
States.[Footnote 16] These standards require that holding companies
engaged in banking meet specific risk-based capital requirements.
In addition, the Joint Forum, an international group of supervisors
established in 1996 under the aegis of BCBS and equivalent bodies for
securities and insurance regulators[Footnote 17] to consider issues
related to the supervision of financial conglomerates, has issued
supervisory guidance. The guidance focuses on risks and controls and
specifically directs examiners to review the organizational structure,
capital level, risk management, and control environment of
conglomerates.
The EU promulgated rules for consolidated supervision of certain firms
operating in Europe that took effect in 2005. U.S.-headquartered firms
with operations in EU countries are among those affected by these
rules, which, therefore, has had implications for consolidated
supervision in the United States. The Financial Conglomerates Directive
(FCD) requires that all financial conglomerates operating in EU
countries have a consolidated supervisor. Conglomerates not
headquartered in the EU must have an equivalent consolidated supervisor
in their home country that has been approved by a designated supervisor
from an EU member state in which the company operates. That supervision
focuses on capital adequacy, intragroup transactions, risk management,
and internal controls.
Agencies Employ Differing Policies and Approaches to Provide
Consolidated Supervision:
The Federal Reserve, OTS, and SEC have all responded to the dramatic
changes in the financial services industry, and now, for many of the
largest, most complex financial services firms in the United States,
these agencies examine risks, controls, and capital levels on a
consolidated basis. Given the differences in their authorities and in
the institutions that they supervise, as well as other factors, the
agencies' specific policies and procedures differ. Also, the agencies
divide responsibilities for developing and implementing policies across
a number of agency components. The Federal Reserve and OTS generally
set policy centrally and implement it through District Banks or
regional offices, respectively. At SEC, Market Regulation has primary
responsibility for policy and for overseeing how CSEs manage risks,
while SEC's examination offices scrutinize more control-oriented
activities. The oversight of complex firms involves multiple
regulators. Finally, for their smaller or less complex firms, the
Federal Reserve and OTS use abbreviated examination programs.
All Agencies Examine Consolidated Risks, Controls, and Capital Levels
of Their Largest, Most Complex Firms, but Specific Policies and
Approaches Differ:
All of the agencies have responded to the dramatic changes in the
financial services industry, including dramatic growth, increased
complexity in terms of the products and services firms offer, more
global operations, and greater use of enterprisewide risk management.
Now, for many of the largest, most complex financial services firms in
the United States, the agencies focus on the firms' risks, controls,
and capital levels on a consolidated basis. However, the agencies have
developed and revised their programs over different time frames and
used different frameworks. The Federal Reserve, beginning in the mid-
1990s, has developed a systematic risk-focused approach for large,
complex banking organizations (LCBO); OTS began to move toward a more
consistent, risk-focused approach for some large, complex firms in
2003; and SEC's CSE program, implemented in 2004, is new and evolving.
Both the Federal Reserve and OTS have approaches to supervision of
smaller, less complex holding companies that reflect the risks of these
institutions.
The Federal Reserve Has a Systematic Risk-Focused Approach for Large,
Complex Banking Organizations:
In the mid-1990s, the Federal Reserve began to develop a systematic
risk-focused approach for the supervision of LCBOs. The program focuses
on those business activities posing the greatest risk to holding
companies and managements' processes for identifying, measuring,
monitoring, and controlling those risks. According to the Federal
Reserve, LCBOs have significant on-and off-balance sheet risk
exposures, offer a broad range of products and services at the domestic
and international levels, are overseen by multiple supervisors in the
United States and abroad, and participate extensively in large-value
payment and settlement systems.[Footnote 18] As of December 31, 2005,
there were 21 LCBOs that together controlled 62 percent of all banking
assets in the United States.
In issuing a revised rating system in 2004, the Federal Reserve
acknowledged that the firms it oversees had become even more
concentrated and complex. In addition, it noted that the growing depth
and sophistication of financial markets in the United States and around
the world have led to a wider range of activities being undertaken by
banking institutions.[Footnote 19] This new rating system has
components for the bank holding company's risk management, financial
condition, and potential impact of the parent (and its nondepository
subsidiaries) on the insured depository institution, as well as a
composite rating of the holding company's managerial and financial
condition and potential risk to its depositories; the system also
includes the supervisory ratings for the subsidiary depository
institution.
Generally policy changes for the consolidated supervision program are
made by the Board and implemented by the 12 District Banks which are
responsible for day-to-day examination activities of banks and bank
holding companies. However, the distinction between policy setting and
implementation blurs at the edges. Board staff may participate in exams
and District Bank officials serve on committees that provide input for
policy development and ensure that supervision is provided at some
level of consistency across District Banks.
The Federal Reserve requires that all bank holding companies with
consolidated assets of $500 million or more meet risk-based capital
requirements developed in accordance with the Basel Accord and has
proposed, with the other bank supervisors, revised capital adequacy
rules to implement Basel II for the largest bank holding
companies.[Footnote 20] In addition, the Federal Reserve requires that
all bank holding companies serve as a source of financial and
managerial strength to their subsidiary banks.[Footnote 21]
The Federal Reserve's supervisory cycle for LCBOs generally begins with
the development of a systematic risk-focused supervisory plan, follows
with the implementation of that plan, and ends with a rating of the
firm. The rating includes an assessment of holding companies' risk
management and controls; financial condition, including capital
adequacy; and impact on insured depositories. The Federal Reserve noted
that in addition to its other activities, it obtains financial
information from LCBOs in a uniform format through a variety of
periodic regulatory reports that other holding companies also provide.
Table 3 provides detailed descriptions for each of the steps.
Table 3: Federal Reserve's Supervisory Cycle for LCBOs:
Supervisory plan;
The planning process begins with an overview of the consolidated
holding company that may include its business strategy, organizational
structure, and a summary of supervisory activity performed since the
last review; proceeds through developing a critical risk assessment;
and ends with a supervisory plan that determines the ongoing and
targeted supervisory activities for the year. The risk assessment
captures a preliminary analysis of firms' consolidated risks, including
credit, market, liquidity, operational, legal, and reputational risks
that are inherent in firms' activities and the controls firms use to
manage those risks. Board staff will review key elements of the
supervisory process.
Supervisory activities;
For LCBOs, a lead examiner called a central point of contact and
dedicated team members assigned as coordinators for specific risk
categories provide continuous supervision, which consists of regular
ongoing contact with the relevant firm managers. These teams, which
include from 3 to 11 members, also review internal management reports.
For limited scope examinations and targeted reviews, a core team risk
coordinator leads a team that includes specialists from the District
Bank, and may have appropriate assistance from other District Banks or
the Board. Targeted reviews can focus on particular nonbank
subsidiaries of the holding company, such as consumer lending
affiliates; one or more specific activities or business lines of the
consolidated organizations and the risk management framework used by
the holding company to manage those risks on a consolidated basis, such
as market risk management for structured products; or compliance with
holding company policies and procedures, and with applicable statutes
and regulations.
Rating;
Once a year, examiners rate firms on their risk management and
controls, financial condition, the impact of the holding company and
nondepository subsidiaries on insured depositories, and on a composite
basis. The financial condition component rating includes an assessment
of the quality of the holding company's consolidated capital, asset
quality, earnings, and liquidity. In evaluating capital adequacy,
examiners are required to consider the risk inherent in an
organization's activities and the ability of capital to absorb
unanticipated losses. In addition, capital is expected to provide a
basis for growth and support the level and composition of the parent
company and subsidiaries' debt.
Source: GAO.
[End of table]
For LCBOs, a management group, which consists of District Bank and
Board officials, provides additional review of supervisory plans and
examination findings. Annually, the management group chooses three or
four topics for horizontal exams--coordinated supervisory reviews of a
specific activity, business line, or risk management practice conducted
across a group of peer institutions. Horizontal reviews are designed to
(1) identify the range of practices in use in the industry, (2)
evaluate the safety and soundness of specific activities across
business lines or across systemically important institutions, (3)
provide better insight into the Federal Reserve's understanding of how
a firm's operations compare with a range of industry practices, and (4)
consider revisions to the formulation of supervisory policy. Horizontal
examination topics have included stress-testing practices at the
holding company level and the banks compliance with the privacy
provision in GLBA.[Footnote 22] Staff from more than one District Bank
likely participate in the review. In addition, because many of the
large bank holding companies have national banks, nonmember banks, or
nonbank operations overseen by another governmental agency, Federal
Reserve guidance instructs staff, consistent with the requirements of
GLBA, to leverage information and resources from OCC, FDIC, SEC, and
other agencies, as applicable.[Footnote 23] After the examinations are
completed, the Federal Reserve informs firms generally on how they
compare with their peers and may provide information on good practices
as well.
The Federal Reserve has a range of formal and informal actions it can
take to enforce its regulations for holding companies. The agency's
formal enforcement powers are explicitly set forth in federal
law.[Footnote 24] Federal Reserve officials noted that the law provides
explicit authority for any formal actions that may be warranted and
incentives for firms to address concerns promptly or through less
formal enforcement actions, such as corrective action resolutions
adopted by the firm's board of directors or memorandums of
understanding (MOU) entered into with the relevant District Bank.
According to Federal Reserve officials, in 2006 the Federal Reserve
took six formal enforcement actions against holding companies.
OTS Is Moving to a Broader, More Systematic Approach to Consolidated
Risks for Some of Its Largest, Most Complex Firms:
In 2003, OTS revised its handbook for holding company supervision to
reflect new guidance for its large, complex firms or conglomerates that
it says relies on the international consensus (as evident in Joint
Forum publications) of what constitutes appropriate consolidated
oversight of conglomerates and also responds to the EU's FCD.[Footnote
25] While the guidance is presented in OTS's standard CORE--capital,
organization, relationship, and earnings--format, it differs from OTS's
standard guidance in that it focuses on consolidated risks, internal
controls, and capital adequacy rather than on a more narrow view of the
holding company's impact on subsidiary thrifts. As with the Federal
Reserve, OTS headquarters officials generally set nationwide policies
and programs and regional office staff conduct examinations. However,
the Complex and International Organizations group (CIO), which was
established in 2004 in OTS headquarters, both sets policy for holding
company supervision of conglomerates and oversees examiners for three
firms that must meet the FCD. CIO is developing a process that is
similar in some respects to the Federal Reserve's. First, on-site
examination teams consisting of lead examiners and others who focus on
specific risk areas provide continuous supervision. Second, while
examiners for firms in the CIO group we spoke with had not had a formal
supervisory plan in past years, these examiners are now preparing plans
that focus on the coming year and, unlike the Federal Reserve, take a
longer 3-year prospective as well. A CIO official said that this
planning framework allows them to examine high-risk areas on an annual
basis while ensuring that lower risk areas are covered at least every 3
years. The plans we reviewed were less detailed than those of the
Federal Reserve; however, the official in charge of this program said
that the group is looking to develop more systematic risk analyses and
has reviewed those being used by the Federal Reserve and their
counterparts in Europe.
Although OTS's guidance for its large, complex firms provides explicit
directions on determining capital adequacy, OTS does not have specific
capital requirements for holding companies. Generally, OTS requires
that firms hold a "prudential" level of capital on a consolidated basis
to support the risk profile of the holding company. For its most
complex firms, OTS requires a detailed capital calculation that
includes an assessment of capital adequacy on a groupwide basis and
identification of capital that might not be available to the holding
company or its other subsidiaries because it is required to be held by
a specific entity for regulatory purposes. The EU's European Financial
Conglomerates Committee's guidance to EU country supervisors on the
U.S. regulatory system noted OTS's lack of capital standards;[Footnote
26] however, the United Kingdom's Financial Services Authority (FSA)
has designated OTS as an equivalent supervisor for the two firms it has
reviewed, and in February 2007, the French supervisory body, Commission
Bancaire, approved OTS as an equivalent supervisor for another complex
conglomerate.[Footnote 27]
As noted, only three firms currently are subject to the increasingly
systematic, detailed analysis of risks being implemented through the
CIO program. Regional staff oversee other large, complex conglomerate
thrift holding companies and use OTS's standard CORE framework, which
focuses more directly on the risks to the thrift posed by its inclusion
in the holding company structure rather than an assessment of the risk
management strategy of the holding company (see table 4). We also found
that OTS regional examination staff were expanding their risk analyses
of some large, complex holding companies, but they had not adopted the
CIO program.
Table 4: OTS's Standard Core Framework:
Capital: Examiners focus on the extent to which the holding company
depends on subsidiary thrifts to meet debt commitments and other
expenses. The handbook for holding company supervision defines the
risks holding companies may face but does not provide specifics for
analyzing those risks.
Organizational structure: Examiners review the structure of the thrift
holding company, the ownership/control of the holding company, and its
potential effect on the thrift. They also review the activities of the
holding company and other affiliates to determine whether the company
is doing anything illegal.
Relationship: To determine if the thrift has the ability to "stand
alone" in the event of the parent company's financial collapse,
examiners assess the degree of influence the holding company has over
the thrift, whether the board of directors provides adequate oversight
of the thrift, and the degree of managerial interdependence between the
thrift and the holding company.
Earnings: To determine the potential for the holding company to draw
money or collateral from the thrift, examiners assess the current and
prospective financial condition and the earnings and liquidity of the
holding company. Examiners are also to assess whether the thrift would
suffer operational or reputation risk if the holding company were to
fail due to poor financial condition.
Source: GAO.
[End of table]
Similar to the Federal Reserve, OTS has explicit authority to take
enforcement actions against thrift holding companies that are in
violation of laws and regulations.[Footnote 28] According to OTS
officials, in 2005 OTS took three formal enforcement actions against
holding companies.[Footnote 29]
SEC's CSE Program Is New and Evolving:
In 2004, SEC adopted its CSE program partly in response to
international developments, including the need for some large U.S.
securities firms to meet the FCD. However, SEC says that the program is
a natural extension of activities that began as early as 1990 when,
under the Market Reform Act, SEC was given supervisory responsibilities
aimed at assessing the safety and soundness of securities activities at
a consolidated or holding company level.[Footnote 30] Formally, SEC
supervision under the CSE program consists of four components: a review
of firms' applications to be admitted to the program; a review of
monthly, quarterly, and annual filings; monthly meetings with senior
management at the holding company; and an examination of books and
records of the holding company, the broker-dealer, and material
affiliates that are not subject to supervision by a principal
regulator.[Footnote 31]
Under the net capital rule establishing the CSE program, the Division
of Market Regulation has responsibility for administering the
program.[Footnote 32] Market Regulation recommends policy changes to
SEC Commissioners and, through its Office of Prudential Supervision,
performs continuous supervision of the five firms that have been
designated as CSEs. Each firm is overseen by three analysts, and each
of these analysts oversees at least two firms. This office includes a
few additional specialists as well. Although the rule did not specify a
role for the Office of Compliance Inspections and Examinations (OCIE),
this office, with the assistance of the Northeast Regional Office
(NERO), examines firms' controls and capital calculations.[Footnote 33]
Each of these offices has designated staff positions for the CSE
program but also uses staff from SEC's broker-dealer examination
program.
Market Regulation generally is responsible for overseeing the financial
and operational condition of CSEs, including how they manage their
risks, but does not provide written detailed guidance for examiners.
During the reviews of the firms' applications for admittance to the CSE
program, staff reviewed market, credit, liquidity, operational, and
legal and compliance risk management, as well as the internal audit
function, and continue to do so on an ongoing basis. The firms are to
provide SEC with monthly, quarterly, and annual filings, such as
consolidated financial statements and risk reports, substantially
similar to those provided to the firm's senior managers. Unlike the
Federal Reserve and OTS that have their examiners continuously on site
at some of their larger more complex firms, Market Regulation staff are
not on site at the companies. However, Market Regulation staff meet at
least monthly with senior risk managers and financial controllers at
the holding company level to review this material and share the written
results of these meetings among themselves and with the SEC
Commissioners. These reports show that meetings with the firms cover a
variety of subjects, such as fluctuations in firmwide and asset-
specific value-at-risk, changes to risk models, and the impact of
recent trends and events such as Hurricane Katrina. Market Regulation
staff also review activities across firms to ensure that firms are all
held to comparable standards and that staff understand industry trends.
Market Regulation staff has conducted some horizontal reviews of
activities such as hedge fund derivative products and event-driven
lending that are similar in some ways to the Federal Reserve's
horizontal examinations. In addition, one staff member attends all
monthly meetings that Market Regulation staff hold with the firms in a
given month. That staff member identifies common themes and includes
these in the monthly reports.
OCIE generally is responsible for testing the control environments of
the CSEs, focusing on compliance issues. OCIE and NERO staff followed
detailed examination guidance when reviewing CSE applications but,
unlike the Federal Reserve and OTS, this guidance is not publicly
available. They reviewed firms' compliance with the CSE rule, including
whether unregulated material affiliates were in compliance with certain
rules that had previously applied only to registered broker-dealers.
OCIE and NERO staff continue to conduct exams of the holding companies,
the registered broker-dealers, and unregulated material affiliates.
During our review of the program, NERO completed the first examination
of one of the CSEs, which included a review of the capital computations
for the holding company and broker-dealer, the firm's internal controls
around managing certain risks, and internal audit.
As a condition of CSE status, CSEs agree to compute a capital adequacy
measure at the holding company in accordance with the new Basel II
standards, and OCIE and NERO validated the firms' calculations as part
of their reviews of firms' CSE applications. The U.S. bank supervisory
agencies have proposed rules to implement Basel II standards for the
largest, most complex banking organizations, and SEC officials said
they will continue to monitor these developments and will adopt rules
that are largely consistent with the banking agencies' final rules
implementing the Basel II standards.[Footnote 34] According to Market
Regulation staff, CSEs' use of the Basel II capital standards should
allow for greater comparability between CSEs' financial position and
that of other securities firms and banking institutions. As part of
their supervisory activities, Market Regulation staff review the models
or other methodologies firms used to calculate capital allowances for
certain types of risks. While the CSEs' broker-dealers are also
required to compute capital according to Basel standards, these broker-
dealers are required to maintain certain capital measures above minimum
levels.[Footnote 35] SEC staff also noted that CSEs are required to
have sufficient liquidity so that capital would be available to any
entity within the holding company if it were needed.
Unlike the bank regulatory agencies, SEC does not have a range of
enforcement actions that it can take for violations of the CSE
regulations because participation in the CSE program is voluntary. That
is, a violation of the CSE regulations can disqualify a broker-dealer
from the benefits of CSE status without resulting in a violation of SEC
regulations or laws that could lead to an enforcement action. SEC staff
noted, however, that the prospect of not being qualified to operate as
a CSE served as an effective incentive for complying with CSE
requirements.
Supervision of Complex Firms Involves Multiple Regulators:
Large firms generally contain a number of subsidiaries that are
overseen by primary bank and functional supervisors in the United
States as well as by supervisors in other countries; however, in some
cases, the holding company's supervisor may also be the primary bank or
functional supervisor for subsidiaries in these holding companies.
Figure 1 illustrates this regulatory complexity for a hypothetical
financial holding company. A hypothetical thrift holding company and
CSE would differ in that it would not have national or state member
bank subsidiaries and potentially could have commercial subsidiaries.
GLBA instructed the Federal Reserve, SEC, and OTS, in their roles as
consolidated supervisors, to generally rely on primary bank and
functional supervisors for information about regulated subsidiaries of
the holding company.[Footnote 36]
Figure 1: Supervisors for a Hypothetical Financial Holding Company:
[See PDF for image]
Source: GAO.
[End of figure]
While the Federal Reserve is the primary federal bank supervisor for
the lead bank in some bank holding companies, OCC and FDIC are more
often the primary bank supervisor for the lead banks in these holding
companies. OCC, because of the growth in the national banking system
over the past 10 years, is now most likely to be the supervisor of the
lead banks that are owned by bank holding companies in the Federal
Reserves' LCBO program. In examining these banks, OCC uses a
systematic, risk-focused process similar to that of the Federal
Reserve. Specifically, OCC's process begins with a risk analysis that
drives the examination process over the course of the examination
cycle. According to OCC's handbook, in assessing the bank's condition
examiners must consider not only risks in the bank's own activities but
also risks of activities engaged in by nonbanking subsidiaries and
affiliates in the same holding company.[Footnote 37] FDIC is the
primary federal supervisor of the lead bank in some larger bank holding
companies and of most of the banks in smaller holding
companies.[Footnote 38] In addition, as part of its deposit insurance
role, FDIC officials told us that they have a continuous on-site
presence at six of the largest LCBOs where OCC is the primary bank
supervisor of the lead bank and the Federal Reserve is the consolidated
supervisor. Larger bank holding companies also include a number of
other regulated subsidiaries, including broker-dealers and thrifts.
Except when a thrift is in a bank holding company, OTS serves as the
supervisor for both the thrift and the thrift holding company.[Footnote
39] While most of these firms are in the business of banking, as table
5 shows, OTS also oversees a number of complex holding companies that
are primarily in businesses other than banking, and some of these are
in regulated industries, especially insurance. In addition, a number of
thrift holding companies contain industrial loan companies (ILC), state-
chartered institutions overseen by FDIC, and some have broker- dealers
as well.[Footnote 40]
Table 5: Thrift Holding Company Enterprises by Category, Complexity,
Size, and Primary Business, as of December 31, 2006:
Category I-low risk/ noncomplex.
Holding companies: category, complexity, and size: Assets less that 1
billion;
Primary business: Banking: 296;
Primary business: Insurance: 6;
Primary business: Securities: 2;
Primary business: Other financial: 11;
Primary business: Commercial: 4;
Primary business: Total: 319.
Holding companies: category, complexity, and size: Assets between 1
billion and 5 billion;
Primary business: Banking: 47;
Primary business: Insurance: 5;
Primary business: Securities: 2;
Primary business: Other financial: 3;
Primary business: Commercial: 1;
Primary business: Total: 58.
Holding companies: category, complexity, and size: Assets greater than
5 billion;
Primary business: Banking: 11;
Primary business: Insurance: 9;
Primary business: Securities: 0;
Primary business: Other financial: 2;
Primary business: Commercial: 1;
Primary business: Total: 23.
Category II-high risk/complex.
Holding companies: category, complexity, and size: Assets less that 1
billion;
Primary business: Banking: 12;
Primary business: Insurance: 1;
Primary business: Securities: 0;
Primary business: Other financial: 5;
Primary business: Commercial: 1;
Primary business: Total: 19.
Holding companies: category, complexity, and size: Assets between 1
billion and 5 billion;
Primary business: Banking: 9;
Primary business: Insurance: 3;
Primary business: Securities: 2;
Primary business: Other financial: 5;
Primary business: Commercial: 1;
Primary business: Total: 20.
Holding companies: category, complexity, and size: Assets greater than
5 billion;
Primary business: Banking: 7;
Primary business: Insurance: 12;
Primary business: Securities: 5;
Primary business: Other financial: 5;
Primary business: Commercial: 4;
Primary business: Total: 33.
Category III- conglomerate.
Holding companies: category, complexity, and size: Assets less that 1
billion;
Primary business: Banking: 0;
Primary business: Insurance: 0;
Primary business: Securities: 0;
Primary business: Other financial: 0;
Primary business: Commercial: 0;
Primary business: Total: 0.
Holding companies: category, complexity, and size: Assets between 1
billion and 5 billion;
Primary business: Banking: 0;
Primary business: Insurance: 0;
Primary business: Securities: 0;
Primary business: Other financial: 0;
Primary business: Commercial: 0;
Primary business: Total: 0.
Holding companies: category, complexity, and size: Assets greater than
5 billion;
Primary business: Banking: 0;
Primary business: Insurance: 1;
Primary business: Securities: 2;
Primary business: Other financial: 0;
Primary business: Commercial: 1;
Primary business: Total: 4.
Total;
Primary business: Banking: 382;
Primary business: Insurance: 37;
Primary business: Securities: 13;
Primary business: Other financial: 31;
Primary business: Commercial: 13;
Primary business: Total: 476.
Source: OTS.
Note: These data include 34 holding companies that own state savings
banks where FDIC is the primary federal bank supervisor.
[End of table]
OTS oversees a large number of firms where insurance is the primary
business of the firm and thus shares some responsibilities with state
insurance supervisors that have adopted their own holding company
framework. In addition, OTS and FDIC share responsibilities when thrift
holding companies include ILCs. Generally, OTS guidance refers to
protecting thrifts in thrift holding companies rather than more broadly
to the protection of insured depositories. However, thrifts and ILCs in
the same thrift holding company may face similar threats to their
safety and soundness.
As the consolidated supervisor of CSEs, SEC oversees large, complex
entities that include insured depositories that have FDIC or OTS as
their primary federal supervisor. Those CSEs that have thrifts are also
supervised at the consolidated level by OTS. SEC's consolidated
supervisory activities focus on the financial and operational condition
of the holding company and, in particular, activities conducted in
unregulated material affiliates that may pose risks to the group. SEC
staff noted that they generally rely on the primary bank supervisor
with respect to examination of insured depositories.[Footnote 41]
Federal Reserve and OTS Use Abbreviated Approach for Smaller or Less
Complex Holding Companies:
In recent years, the Federal Reserve has limited the resources it uses
to oversee the 4,325 small shell bank holding companies (i.e.,
companies that are noncomplex with assets of less than $1 billion)
because it perceives that those entities pose few risks to the insured
depositories they own.[Footnote 42] The Board has adopted a special
supervisory program for these companies that includes off-site
monitoring and relies heavily on primary federal supervisors' bank
examinations. For these companies, the Federal Reserve assigns only
risk and composite ratings, which generally derive from primary bank
supervisors' examinations. Also, in addition to the primary bank
supervisors' examinations, Federal Reserve examiners review a set of
computer surveillance screens that include the small shells' financial
information and performance, primarily to determine if the firms need
more in-depth reviews.
Federal Reserve staff told us that they spend a limited amount of time
on small shell holding company inspections. For example, a Board
official said they spend on average about 2 to 2.5 hours annually on
each small shell bank holding company. According to Federal Reserve
guidance, the only documentation required for small shell ratings where
no material outstanding company or consolidated issues are otherwise
indicated are bank examination reports and a copy of the letter
transmitting the ratings to the company.
Similarly, OTS uses an abbreviated version of its CORE program for its
low-risk and noncomplex or Category I firms, which make up 401 of the
476 holding companies OTS oversees. Once examiners determine that the
holding company is a shell, they are directed to the abbreviated
program, which differs from the full CORE in that it requires less
detailed information in each of the four CORE areas. For example, the
abbreviated CORE does not require that examiners calculate leverage and
debt-to-total-asset ratios in the capital component of the examination,
while these are required in the full CORE program. However, the
handbook advises examiners to refer to the full CORE program for more
detailed steps whenever they feel it is warranted. In addition, the
handbook advises examiners to consider the specific issues that relate
to certain holding company populations, such as those containing
insurance firms. At one regional office, managers told us that
examinations of shell holding companies take 5 to 10 days; however,
because the holding company examination is conducted concurrently with
the thrift examination, OTS cannot determine the exact number of hours
spent reviewing the holding company. An OTS official noted that for
shell holding companies, the difference in examiners' activities
between holding company and thrift examinations is largely a matter of
perspective rather than a difference in what examiners review.
Improved Program Objectives and Performance Measures Could Enhance
Agencies' Consolidated Supervision Programs:
In recent decades, the environment in which the financial services
industry operates, and the industry itself, have undergone dramatic
changes that include globalization, consolidation within traditional
sectors, conglomeration across sectors, and convergence of
institutional roles and products. The industry now is dominated by a
relatively small number of large, complex, and diversified financial
services firms, and these firms generally manage their risks on an
enterprisewide or consolidated basis. Consolidated supervision provides
the basis for supervisory oversight of this risk management, but
managing consolidated supervision programs in an efficient and
effective manner presents challenges to the supervisory agencies. We
found that the Federal Reserve, OTS, and SEC were providing supervision
consistent with international standards for comprehensive, consolidated
supervision for many of the largest, most complex financial services
firms in the United States. While the agencies have articulated
anticipated benefits or broad strategic goals for their supervision
programs in testimony and other documents, the objectives for their
consolidated supervision programs are not always clearly defined or
distinguished from the objectives for their primary supervision
programs. Without more specific program objectives, activities linked
to these objectives, and performance measures identified to assess the
extent to which these objectives are achieved, the agencies have a more
difficult task of ensuring efficient and effective oversight. In
particular, with the financial services industry's increased
concentration and convergence in product offerings, paired with a
regulatory structure that includes multiple agencies, it is more
difficult to ensure that the agencies are providing oversight that is
not duplicative and is consistent with that provided by primary,
functional, or other consolidated supervisors. As a result, the
agencies could better ensure that consolidated supervision was being
provided efficiently, with the minimal regulatory burden consistent
with maintaining safety and soundness, by more clearly articulating the
objectives of their consolidated supervision programs, developing and
tracking performance measures that are specific to the programs, and
improving supervisory guidance.
Developments in the Financial Services Industry Have Affected the
Environment Facing Financial Supervisors:
The environment in which the financial services industry operates, and
the industry itself, have undergone dramatic changes.[Footnote 43]
Financial services firms have greater capacity and increased regulatory
freedom to cross state and national borders, and technological advances
have also lessened the importance of geography. Increasingly, the
industry is dominated by a relatively small number of large, complex
conglomerates that operate in more than one of the traditional sectors
of the industry. These conglomerates generally manage their risks on an
enterprisewide, or consolidated, basis.
Generally, the greater ability of firms to diversify into new
geographic and product markets would be expected to reduce risk, with
new products and risk management strategies providing new tools to
manage risk. Because of linkages between markets, products, and the way
risks interact, however, the net result of the changes on an individual
institution or the financial system cannot be definitively predicted.
Consolidated supervision provides a basis for the supervisory agencies
to oversee the way in which financial services firms manage risks and
to do so on the same basis that many firms' manage their risk. While
primary bank and functional supervisors retain responsibility for the
supervision of regulated banks, broker-dealers, or other entities, the
consolidated supervisor's approach can encompass a broader, more
comprehensive assessment of risks and risk management at the
consolidated level.
Agencies Are Providing Comprehensive Consolidated Supervision for Many
Conglomerates with Depository Institutions:
The international consensus on standards or "best practices" for
supervising conglomerates that include banks includes the review of
risks and controls at the consolidated level, capital requirements at
the consolidated level, and the authority to take enforcement actions
against the holding company. As described above, we found that the
Federal Reserve generally met these standards for its LCBO firms. OTS
meets these standards for those firms overseen by CIO. For other firms
that might be considered conglomerates, OTS does a more limited review
of the risk posed to insured thrifts by activities outside the thrift
and does not require that holding companies meet specific capital
standards. Officials at both the Federal Reserve and OTS emphasized
that the agencies' authority to examine, obtain reports from, establish
capital requirements for, and take enforcement actions against the
holding company was separate from the authority that primary bank
supervisors have.
A full assessment of SEC's CSE program is difficult given the newness
of the program; however, it appears that for the CSE firms dominated by
broker-dealers, SEC is monitoring risks and controls on a consolidated
basis and requires that CSEs meet risk-based capital standards at the
holding company level. However, with regard to SEC's ability to take
enforcement actions at the holding company level. SEC staff
acknowledged that SEC does not have the same ability, under the CSE
program, to take enforcement actions as the Federal Reserve or OTS.
Nonetheless, they noted that the potential removal of a firm's
exemption from the net capital rule and notification of EU regulators
that a firm was no longer operating under the CSE program would serve
as effective deterrents. SEC is also authorized to impose additional
supervisory conditions or increase certain multiplication factors used
by the CSE in its capital computation.
Clear Program Objectives and Performance Measures Are Essential for
Ensuring Accountability and Efficiency:
Management literature on internal controls, enterprisewide risk
management, and government accountability suggest that to achieve
accountability and efficiency requires that agencies clearly state
program objectives, link their activities to those objectives, and
measure performance relative to those objectives.[Footnote 44] This
literature also recognizes the increased importance of these management
activities in the face of substantial change in the external
environment or in the face of the adoption of new "products"
internally. When applied to the consolidated supervision programs at
the Federal Reserve, OTS, and SEC, clearly defined objectives of
consolidated supervision programs, agency activities of these programs
linked to those objectives, and performance measures to determine how
well the programs are operating are the management approaches that
would contribute to the desired accountability and efficiency for the
programs.
The importance of these management activities is heightened because all
three agencies face substantial changes in the external environment,
including rapid growth in the financial sector, greater consolidation
of firms leading to larger, more complex firms, and greater linkages
among financial sectors and markets. In addition, the Federal Reserve
and OTS have made substantial changes in their consolidated supervisory
programs--particularly with the CIO program at OTS--and SEC has adopted
a program that for the first time has staff providing formal prudential
oversight at the consolidated level. Adopting sound management and
control activities will help ensure that agencies are accountable for
exercising the authority for their consolidated supervision programs
and achieving the objectives of consolidated supervision, in ways that
are effective and efficient. As a result, the regulatory burden would
be as low as possible, consistent with maintaining safety and soundness
of financial institutions and markets.
The agencies face challenges in devising performance measures for
consolidated supervision, including rapid changes in the industry. U.S.
financial institutions and their competitors increasingly operate
worldwide and engage in a number of businesses. Consequently, the
global financial system is highly integrated and ensuring financial
stability is even more important than in the past. Developing sound
measures in such an environment can be difficult, and it is a challenge
for agencies to distinguish how much of their work contributes to
financial stability, in contrast to other goals such as protecting
insured depositories. Further, these objectives are concepts that are
not easy to measure. Development and use of appropriate performance
measures, however, are critical to efficiently managing the risks that
the agencies have in their consolidated supervision programs.
Goals and Performance Measures Address Supervision Broadly, Rather Than
Consolidated Supervisory Programs Specifically:
Generally we found that the three agencies stated goals for all of
their supervision programs broadly or that specific objectives for
consolidated supervision were the same as those for their primary
supervision programs. As a result, the contributions consolidated
supervision programs make to the safety and soundness of financial
institutions and markets could not be assessed separately from other
agency programs. Clearer objectives specific to the consolidated
supervision programs would facilitate linking program activities to
those objectives and the authority that the agencies have to conduct
consolidated supervision. In addition, clear program objectives would
facilitate the development of specific performance measures to measure
the contribution of these programs to those objectives as well as
broader agency goals.
Federal Reserve:
Agencies' strategic and performance plans sometimes contain objectives
for important programs. In its strategic plan, the Federal Reserve
identifies objectives for all of its supervision programs: promoting a
safe, sound, competitive, and accessible banking system and stable
financial markets. However, the only discussion specific to
consolidated supervision in the Federal Reserve's strategic plan
relates to how the program complements its central bank functions by
providing the Federal Reserve with important knowledge, expertise,
relationships, and authority.
In other statements, Federal Reserve officials have identified a number
of potential benefits of consolidated supervision that reflect the
changed environment. The then-Chairman of the Federal Reserve Board
testified before Congress in 1997 that the knowledge of the financial
strength and risk inherent in a consolidated holding company can be
critical to protecting an insured subsidiary bank and resolving
problems once they arise.[Footnote 45] In 2006, he noted further that
consolidated supervision provides a number of benefits, including
protection for insured banks within holding companies, protection for
the federal safety net[Footnote 46] that supports those banks, aiding
the detection and prevention of financial crises, and, thus, mitigating
the potential for systemic risk in the financial system.[Footnote 47]
In congressional testimony delivered in 2006, a Board official noted
that the goals of consolidated supervision are to understand the
financial and managerial strengths and risks within the consolidated
organization as a whole and to give the Federal Reserve the ability to
address significant deficiencies before they pose a danger to the
organization's insured banks and the federal safety net. An official at
the New York District Bank identified the goals of consolidated
supervision as protecting the safety and soundness of depository
institutions in the holding company, promoting the health of the
holding company itself, and mitigating systemic risk.
In its Bank Holding Company Supervision Manual, the Federal Reserve
says that the inspection process is intended to increase the flow of
information to the Federal Reserve System concerning the soundness of
financial and bank holding companies. The manual goes on to explain how
the purpose of bank holding company supervision has evolved since the
passage of the Bank Holding Company Act in 1956, whose primary
objective was to ensure that bank holding companies did not become
engaged in nonfinancial activities. According to the manual, an
inspection is to be conducted to:
1. inform the Board of the nature of the operations and financial
condition of each bank holding company and its subsidiaries, including-
-:
a. the financial and operational risks within the holding company
system that may pose a threat to the safety and soundness of any
depository institution subsidiary of such bank holding company, and:
b. the systems for monitoring and controlling such financial and
operational risks; and:
2. monitor compliance by any entity with the provisions of the Bank
Holding Company Act or any other federal law that the Board has
specific jurisdiction to enforce against the entity, and to monitor
compliance with any provisions of federal law governing transactions
and relationships between any depository institution subsidiary of a
bank holding company and its affiliates.
The Federal Reserve also noted that the objectives of consolidated
supervision are discussed in its supervisory guidance on the Framework
for Financial Holding Company supervision introduced after
GLBA.[Footnote 48] In the guidance, the Federal Reserve says that the
objective of overseeing financial holding companies (particularly those
engaged in a broad range of financial activities) is to evaluate, on a
consolidated or groupwide basis, the significant risks that exist in a
diversified holding company in order to assess how these risks might
affect the safety and soundness of depository institution subsidiaries.
The Federal Reserve has also developed a quality management program to
evaluate its supervision programs overall. Board officials told us that
each of the District Banks has established a quality management
department that include quality planning, control, and improvement. As
part of its quality management program, the Board evaluates and reports
on District Banks' supervision function in its operations reviews
across the major supervision and support functions. According to a
Board document, each review assesses how well the Reserve Bank carries
out its supervisory responsibilities, focusing not only on the
effectiveness and efficiency of individual functional areas but also on
how well the Officer in Charge of Supervision organizes and allocates
departmental resources, and facilitates integration among those
resources. However, in the three operations review reports we reviewed,
the performance of consolidated supervisory activities was not assessed
independently from the performance of other supervisory activities.
Not clearly establishing specific objectives for the consolidated
supervision, however, potentially lessens the Federal Reserve's ability
to ensure that its consolidated supervision program provides
comprehensive and consistent oversight with minimal regulatory burden.
The Federal Reserve has authority for holding company supervision
distinct from that for supervision of the insured depository itself.
Specific objectives and performance measures would enhance the Federal
Reserve's ability to ensure its accountability and the efficiency of
its consolidated supervisory activities.
OTS:
OTS consistently identifies the protection of insured depositories as
the objective of consolidated supervision. However, like the Federal
Reserve, OTS generally does not distinguish between the objectives for
holding company supervision and those for primary thrift supervision.
In addition, OTS's activities often vary significantly across firms,
depending in part on the risk and complexity of the firms. While the
varying activities largely reflect the differences among the
institutions, a clear link between these activities and the objectives
of its consolidated supervision program would enhance OTS's ability to
provide effective and consistent oversight with minimal regulatory
burden.
OTS identifies several strategic goals in its strategic plan, placing
particular emphasis on achieving a safe and sound thrift industry, and
its Holding Companies Handbook identifies protection of insured thrifts
as an objective of holding company supervision; however, these
documents distinguish the objectives of the holding company supervision
program from those of primary thrift supervision in only one area. The
strategic plan says that one objective of OTS's cross-border
discussions is to receive additional equivalency determinations under
EU directives, including the FCD, and its handbook focuses on
international standards in its discussion of changes in its
conglomerate oversight. In its strategic plan, OTS has five performance
measures for supervision, including the percentage of thrifts that are
well-capitalized and the percentage of safety and soundness
examinations started as scheduled, but these largely relate directly to
OTS's authority as a primary bank supervisor rather than as a holding
company supervisor.
Because OTS is almost always both the lead bank supervisor and the
holding company supervisor for the holding companies it supervises,
accountability for its supervision of thrift institutions is clear.
However, for those thrift holding companies whose primary business
activities are not banking, accountability for parts of the institution
may still not be clear. Further, whether an agency is providing
consistent and efficient oversight with minimal regulatory burden for
all firms is still at issue. For firms overseen by CIO, OTS devotes
substantial resources to the oversight of risk and controls
consolidated at the highest financial holding company level, and
assesses capital at that level. However, for some other firms that had
some similar characteristics to the CIO-supervised conglomerates, OTS
uses relatively fewer resources in the oversight of these firms at the
holding company level. For these firms, consistent with its standard
CORE program, OTS looks to see that the holding company is not relying
on the thrift to pay off debt or expenses and then limits its oversight
to that part of the firm that might directly place the thrift at risk.
SEC:
Similarly, SEC identifies a number of objectives and performance
measures for the agency in its strategic plan, annual performance
reports, and annual budget documents. However, none of these is
specific to the consolidated supervision program. Instead, these
documents provide goals and performance measures for other areas such
as enforcement. Enforcing compliance with federal securities laws is
one of SEC's strategic goals, and it measures performance in that area
by reporting the number of enforcement cases successfully resolved in
its 2005 Performance and Accountability Report. The only mention of the
new CSE program in these documents is a listing as a "milestone" for
Market Regulation in SEC's 2004 Performance and Accountability Report.
SEC 2006 and 2007 budget requests note that OCIE will examine CSEs
under the strategic goal of enforcing compliance with federal
securities laws. The 2006 budget request also includes the need to
modify and interpret the rules for CSEs to maintain consistency with
the Basel Standards, in light of amendments to the Basel Capital
Accord, to meet the goal of sustaining an effective and flexible
regulatory environment.
On the Web site created by Market Regulation in June 2006, SEC says
that the aim of the CSE program is to reduce the likelihood that
weakness in the holding company or an unregulated affiliate endangers a
regulated entity or the broader financial system. In addition, SEC
officials have said that the purpose of the program was to provide
consolidated oversight for firms required to meet the EU's FCD.
However, CSE oversight activities are not always linked to these aims
and the extent to which these activities contribute to the aims is not
measured.
SEC officials have told us they have developed a draft that would
establish program objectives, link activities to these objectives, and
establish criteria for assessing the performance of the CSE program.
Agencies Have Opportunities to Better Ensure Effective and Consistent
Supervision, with Minimal Regulatory Burden:
Because the U.S. regulatory structure assigns responsibility for
financial supervision to multiple agencies, and a single firm may be
subject to consolidated and primary or functional supervision by
different agencies, not having objectives and performance measures for
consolidated supervision programs increases the difficulty of ensuring
effective, efficient, and consistent supervision with minimal
regulatory burden and ensuring that each agency is appropriately
accountable for its activities.[Footnote 49]
The potential for duplication was demonstrated in three financial
holding companies where we discussed Federal Reserve oversight with
Federal Reserve and OCC examiners and with bank officials. Based on our
interviews with OCC examiners, we noted some duplication in Federal
Reserve and OCC activities, despite efforts to coordinate supervision
by the two agencies. In particular, since these institutions manage
some risks on an enterprisewide basis, OCC needed to assess
consolidated risk management or other activities outside the national
bank to assess the banks' risks. Some OCC officials said that the
consolidated supervisor structure created by GLBA was primarily
designed for bank holding companies with insurance subsidiaries, but
this structure is not prevalent. The primary value of consolidated
supervision, they said, is to prevent gaps in supervision, but the
benefit for firms that hold primarily bank assets is unclear. Federal
Reserve officials, on the other hand, noted that because OCC is a bank
supervisor, and not a consolidated supervisor, it does not have the
same authority as the Federal Reserve to conduct examinations of,
obtain reports from, establish capital requirements for, or take
enforcement action against a bank holding company or its nonbank
subsidiaries. With more clearly articulated objectives for consolidated
supervision that distinguish this authority from the primary
supervisor's authority, linking consolidated supervisory activities to
those goals and measuring performance would clarify accountability and
facilitate greater reliance by each agency on the other's work,
lessening regulatory burden.
According to officials of the Federal Reserve Board, it takes a number
of actions to ensure that the large banking organizations they oversee
are treated similarly in its consolidated supervision program. These
include a review of LCBO supervisory plans and other elements of the
supervisory process as well as some centralized staffing. However, we
found that because of the autonomy of the District banks and the lack
of detailed guidance, the four District Banks in our study differed in
the ways they identified examination or supervisory findings,
prioritized them, and communicated these findings to firm management.
For example, the Federal Reserve Bank of Atlanta more clearly defines
different types of findings, provides criteria to examiners for
determining and prioritizing findings, and uses this framework to
communicate findings to firm management. At some other District Banks
we visited, examiners did not provide us with explicit criteria for
determining and prioritizing findings. As a result, it is more
difficult to ensure that bank holding companies operating in different
Federal Reserve districts are subject to consistent oversight and
receive consistent supervisory feedback and guidance. To mitigate this
potential for inconsistency, as we noted above, for large, complex
institutions, committees such as the LCBO management group review
supervisory findings. In addition, a Board official said that the
Federal Reserve was considering implementing Atlanta's framework across
the system. Without objectives and performance measures specific to the
consolidated supervision program, however, the Federal Reserve is less
able to gauge the value of the Federal Reserve Bank of Atlanta's more
specific guidance to its examination staff.
In part, because OTS oversees a diverse set of firms and has been
changing some of its consolidated supervisory activities, consistency
is a difficult challenge. An OTS official told us that OTS created the
CIO in its headquarters to promote more systematic and consistent
supervision for certain holding companies. In addition, OTS has issued
guidance to help standardize policies and procedures related to
providing continuous supervision. However, the criteria are not clear
for determining whether a firm is overseen by CIO with continuous
comprehensive consolidated supervision or remains in the regional group
where it receives more limited oversight under the CORE program. In a
speech in November 2006, OTS's Director identified seven
internationally active conglomerates OTS oversees at the holding
company level.[Footnote 50] Of these, three are overseen by CIO, one
receives oversight under the standard CORE program, and two others are
overseen regionally but are receiving greater scrutiny than in the
past. The three firms receiving comprehensive consolidated oversight by
CIO are the firms that have designated OTS as their consolidated
supervisor for meeting the EU equivalency requirements, while three of
the others have opted to become CSEs.
While the small size of SEC's CSE program limits opportunities for
treating firms differently, the lack of more complete written guidance
and the decision to keep guidance confidential limit the ability of
industry participants, analysts, and policymakers to determine whether
firms are being treated consistently. In addition, Market Regulation
staff said that more complete written guidance would reduce the risks
of inconsistency should staff turnover occur. We also found that SEC's
lack of program objectives, performance measures, and written public
guidance led to firms' receiving inconsistent feedback from SEC's
divisions and offices. According to the CSEs and application
examinations we reviewed, OCIE conducted highly detailed audits that
resulted in many findings related to the firms' documentation of
compliance with rules and requirements, while Market Regulation looked
broadly at the risk management of the firm. OCIE shared its findings
with the firms, but Market Regulation determined that many of them did
not meet its criteria for materiality and did not include them in its
summary memorandums to the SEC Commissioners recommending approval of
the applications. However, either a full or summary OCIE examination
report was included as an appendix to these memorandums. Market
Regulation staff said they drew on their own knowledge in deciding
which findings were material and explained that a finding is material
when the issue threatens the viability of the holding company. Further,
Market Regulation staff told us that because they rely on managements'
openness in their ongoing reviews of CSE's risk management, they do not
always share supervisory results with OCIE staff. Market Regulation and
OCIE staff stated that they are working on an agreement to facilitate
communication between the offices.
Finally, even if each agency provided consistent treatment and feedback
to firms, there would be no assurance that consistent consolidated
supervision would be provided across the agencies. We have noted before
that, over time, firms in different sectors increasingly face similar
risks and compete to meet similar customer needs.[Footnote 51] Thus,
competitive imbalances could be created by different regulatory
regimes, including holding company supervision, both here and abroad.
Systematic Collaboration Could Enhance Consolidated Supervision
Programs:
Providing consistent efficient, effective oversight of individual
financial institutions has become more difficult as institutions
increasingly manage their more complex operations on an enterprisewide
basis, often under the oversight of multiple federal financial
supervisors. And providing efficient and effective oversight across the
financial sector has become more challenging as institutions in
different sectors and countries increasingly take on similar risks that
may pose issues for a broad swath of the developed world's financial
institutions in a crisis.
The industry's increased concentration and convergence in product
offerings, paired with a regulatory structure with multiple agencies,
means that different large financial services firms, offering similar
products, may be subject to supervision by different agencies. This
leads to risks that the agencies may provide inconsistent supervision
and regulation not warranted by differences in the regulated
institutions. Supervisors in different agencies engaged in the
oversight of a single institution take some steps to share information,
avoid duplication, and jointly conduct some examination activities.
However, these agencies did not consistently and systematically
collaborate in these efforts, thus limiting the efficiency and
effectiveness of consolidated supervision. For the three agencies
engaged in consolidated supervision, changes in the firms they oversee
have led to the firms facing similar risks and competing with each
other across industry segments. As a result, it is essential for
consolidated supervisors to systematically collaborate so that
competitive imbalances are not created.
Systematic Collaboration Is Essential for Multiple Agencies Sharing
Common Responsibilities:
In a system that is characterized by multiple supervisory agencies
providing supervision for a single holding company and its subsidiaries
as well as several agencies providing consolidated supervision for
firms that provide similar services, collaboration among the
supervisory agencies is essential for ensuring that the supervision is
effective, efficient, and consistent.
Through a review of government programs and the literature on effective
collaboration, we have identified some key collaborative elements,
which are listed in table 6.[Footnote 52] These elements stress the
need to ensure, to the extent possible, that the agencies are working
toward a common goal, that they minimize resources expended by
leveraging resources and establishing compatible policies and
procedures, and that they establish accountability for various aspects
of these programs and for their efforts to collaborate.
Table 6: Key Elements of Collaboration:
Key elements of collaboration: Define and articulate a common outcome;
Description: Agency staff must commit and devote resources to working
across agency lines to define and articulate the common outcome they
are seeking to achieve.
Key elements of collaboration: Establish mutually reinforcing or joint
strategies;
Description: Agencies need to align the partner agencies' activities,
core processes, and resources to accomplish the common outcome.
Key elements of collaboration: Identify and address needs by leveraging
resources;
Description: Agencies should identify and leverage the human,
information technology, physical, and financial resources needed to
initiate or sustain their collaborative effort.
Key elements of collaboration: Agree on roles and responsibilities;
Description: Agencies should define and agree on their respective roles
and responsibilities, including how to organize their joint and
individual efforts.
Key elements of collaboration: Establish compatible policies,
procedures, and other means to operate across agency boundaries;
Description: Agencies need to address the compatibility of standards,
policies, procedures, and data systems that will be used, as well as
cultural differences.
Key elements of collaboration: Develop mechanisms to monitor, evaluate,
and report on results;
Description: Agencies should create the means to monitor and evaluate
their efforts to enable them to identify areas for improvement.
Key elements of collaboration: Reinforce accountability for
collaborative efforts through agency plans and reports;
Description: Agencies should ensure that goals are consistent and
program efforts are mutually reinforcing. Accountability for
collaboration is reinforced through public reporting of agency results.
Key elements of collaboration: Reinforce individual accountability for
collaborative efforts through performance management systems;
Description: As a first step in reinforcing individual accountability
for collaborative efforts, agencies set expectations for collaboration
within and across organizational boundaries in staff performance plans.
Source: GAO.
[End of table]
We have noted in our previous work that running throughout these
elements are a number of factors, including leadership, trust, and
organizational culture, that are necessary for a collaborative working
relationship. We have also noted that agencies may encounter a range of
barriers when they attempt to collaborate, including missions that are
not mutually reinforcing, or may conflict, and agencies' concerns about
protecting jurisdiction over missions and control over resources.
As we have noted in the past, the U.S. financial regulatory agencies
meet in a number of venues to improve coordination.[Footnote 53] These
venues include the President's Working Group, the Federal Financial
Institutions Examination Council, and the Financial and Banking
Information Infrastructure Committee. In addition, the agencies told us
they have frequent informal contact with each other. These contacts
address several of the key elements of collaboration identified above,
but opportunities remain to enhance collaboration in response to the
changes in the financial services industry. These opportunities exist
both for agencies that could collaborate in oversight of individual
firms where agencies share supervisory responsibility as well as for
collaboration among the consolidated supervisors to ensure consistent
approaches to common risks.
In the Oversight of Individual Firms, Supervisors from Different
Agencies Take Steps to Work Together but Could Collaborate More
Systematically:
Enterprisewide risk management in large financial firms has complicated
the task of regulating them, since agency jurisdiction is defined by
legal entities. When an agency oversees both the ultimate holding
company and its major bank or broker-dealer subsidiary, examination
activities tend to be well-integrated. When consolidated and primary
bank or functional supervisors of a firm's major subsidiaries are from
different agencies, they take some actions to work together and share
information. However, we found instances of duplication and regulatory
gaps that could be minimized through more systematic collaboration.
Moving to Enterprisewide Management and Other Organizational Changes
Increases the Potential for Several Agencies to Share Responsibilities:
Large, complex firms are increasingly managing themselves on an
enterprisewide basis, further blurring the distinctions between
regulated subsidiaries and their holding companies. Many of the banking
and securities firms included in our review were managing by business
lines that cut across legal entities, especially those institutions
engaged primarily in banking or securities. At least three of the
companies in our review primarily engaged in banking were simplifying
their corporate structures, either by reducing the number of bank
charters or bringing activities that had been outside an insured
depository into the depository or its subsidiaries. Some of these
entities had been unregulated by a primary federal bank or functional
supervisor and thus had been the primary responsibility of the holding
company supervisor or were regulated by a primary bank supervisor
different from the supervisor overseeing the lead bank. Finally, we
found that several firms that are CSEs, thrift holding companies, or
both were conducting extensive banking operations out of a structure
that includes an ILC and a thrift and that these entities, which are
overseen by different primary bank supervisors, might not be receiving
similar oversight from a holding company perspective.
As a result of changes in corporate structures and management
practices, there are increasing opportunities for collaboration among
supervisors with safety and soundness objectives at the subsidiary
level and holding company supervisors. For example, primary bank and
functional supervisors involved in safety and soundness supervision
need to review the organizational structure of the holding company and
have to evaluate increasingly centralized risk management activities
and the controls around those activities as they may apply to the
regulated subsidiary, but the consolidated supervisor is responsible
for understanding the organizational structure and monitoring risks and
controls at the holding across the entire organization.
When the large enterprises we reviewed had the same agency overseeing
their ultimate holding company and its lead bank (or its broker-dealer,
in the case of CSEs), supervisory activities tended to be well-
integrated. For the financial holding company that was dominated by a
state member bank and the thrift holding company dominated by a federal
thrift institution, we found that the oversight of the dominant
financial subsidiary and the ultimate holding company were conducted
jointly with the same examination team, a single planning document, and
the same timeline. In the case of the CSEs dominated by a broker-
dealer, SEC supervises both the holding company and the broker-dealer;
NERO completed targeted examinations of one firm in 2006 on an
integrated basis.
The relationship between the consolidated supervisor and other agencies
that serve as primary or functional supervisors for subsidiaries is
governed by law, which does provide for some information exchange among
the agencies. Under the regulatory structure established by GLBA, the
Federal Reserve and OTS are to rely on the primary supervisors of bank
subsidiaries in holding companies (the appropriate federal and state
supervisory authorities) and the appropriate supervisors of nonbank
subsidiaries that either are functionally regulated or are determined
by the consolidated regulator to be comprehensively supervised by a
federal or state authority.[Footnote 54] Consistent with this scheme,
GLBA limits the circumstances under which the Federal Reserve Board and
OTS may exercise their examination and monitoring authorities with
respect to functionally regulated subsidiaries and depository
institutions that are not subject to primary supervision by the Board
or OTS. GLBA also provides that the consolidated supervisor is to rely
on reports that holding companies and their subsidiaries are required
to submit to other regulators and on examination reports made by
functional regulators, unless circumstances described in the act
exist.[Footnote 55] Among other things, GLBA specifically directs the
Federal Reserve and OTS, to the fullest extent possible, to use the
reports of examinations of depository institutions made by the
appropriate federal and state depository institution supervisory
authority. Also, consolidated supervisors are directed to rely, to the
extent possible, on the reports of examination made of a broker-dealer,
investment adviser, or insurance company by their functional regulators
and defer to the functional regulators' examinations of these entities.
GLBA also provides for the sharing of information between federal
consolidated supervisors and bank supervisors on the one hand and state
insurance regulators on the other hand. The act authorizes these
regulators to share information pertaining to the entities they
supervise within a holding company. For example, with respect to the
holding company, the act authorizes the Board to share information
regarding the financial condition, risk management policies, and
operations of the holding company and any transaction or relationship
between an insurance company and any affiliated depository
institution.[Footnote 56] The consolidated supervisor also may provide
the insurance regulator any other information necessary or appropriate
to permit the state insurance regulator to administer and enforce
applicable state insurance laws.
Consistent with GLBA, consolidated supervisors have negotiated MOUs or
other formal information sharing agreements with functional supervisors
and were reviewing reports from them. The supervisors had also entered
into MOUs with relevant foreign supervisors. For example, OTS had
negotiated MOUs with 48 state insurance departments, 7 foreign
supervisors, and with the EU. Similarly, the Federal Reserve has a
number of MOUs with regulators. One provides for SEC to share
information concerning broker-dealer examinations for broker-dealers
owned by financial holding companies. Most MOUs include agreements to
share information on an informal basis. For example, the Federal
Reserve and SEC have a "pilot program" that allows the Federal Reserve
to share information on a particular holding company with SEC staff on
an ongoing basis. Examination information from the functional
supervisors was being provided to the consolidated supervisor, and to
some extent, the consolidated supervisor was relying on that
information in planning and reporting.
Supervisors do communicate when developing holding company supervisory
programs. For example, staff at SEC, especially in OCIE, noted that
they communicated regularly with the supervisory management at the
Federal Reserve Bank of New York when setting up their CSE program. In
addition, the agencies gave us examples of when they communicated with
regard to specific issues, and the Federal Reserve and SEC have taken
opportunities to learn from the firms under each other's jurisdiction.
SEC said the Federal Reserve had asked to meet with some of CSEs
regarding peer valuation, and SEC had facilitated such meetings.
Following the enactment of GLBA, OCC and the Federal Reserve agreed on
how they would coordinate in the supervision of LCBOs. While some
duplication remains, we found examples of that agreement being
implemented. For example, OCC and the Federal Reserve share supervisory
planning documents for LCBOs when OCC is the primary bank supervisor
for the lead bank in the bank holding company. As a result, the Federal
Reserve is able to factor OCC's planned work into its supervisory plan
process.
In addition, we found that OCC and Federal Reserve examiners at some
institutions shared information informally over the course of the
examination cycle, allowing them to conduct joint or shared target
examination activities that might not have been part of the original
plan. OCC examiners told us they are now also receiving information
about the Federal Reserve's horizontal reviews in a timelier manner and
can thus make better decisions about the extent to which they want to
participate in those reviews. Federal Reserve officials said that when
OCC has conducted examination activities related to horizontal reviews,
they rely on OCC's information. OCC and Federal Reserve examiners also
told us that when they disagree on examination findings, they attempt
to work out those disagreements before presenting conflicting
information to management. Finally, OCC and Federal Reserve examiners
jointly attend meetings with management and the Boards of Directors of
the financial institutions where they have primary and consolidated
supervisory responsibilities. They invite other relevant bank examiners
to attend some of these meetings as well. Finally, the Federal Reserve
provides OCC and FDIC full online access to its supervisory database,
which contains examination reports and other supervisory information
for bank holding companies.
The supervision of one firm, headquartered abroad but with significant
U.S. operations, including substantial securities activities, is an
example of coordination between the Federal Reserve, the holding
company supervisor for the firm's U.S. operations, two foreign
supervisory agencies involved in the oversight of the ultimate holding
company, and operations in their countries, and the SEC, which is the
functional supervisor of firm's most important U.S. operations. The
Federal Reserve meets with supervisors from the other countries
formally twice a year to coordinate activities. A representative of the
firm said the three agencies meet jointly with representatives of the
firm prior to developing a supervisory plan. The lead examiner at the
Federal Reserve said that including representatives from other
governments on examination teams makes it easier to access information
across international borders. While SEC is not included in these
meetings, the Federal Reserve and SEC agreed to a "pilot program" for
the Federal Reserve to regularly share holding company information with
OCIE staff that oversee the firm's U.S. broker-dealers and investment
advisers.
Collectively, these efforts to coordinate do address several of the key
elements of collaboration identified in table 6, above. In particular,
the agreements among the supervisors provide a basis for joint
strategies, for agreements on roles and responsibilities, and for
operating across agency boundaries. Joint examination activities
between the Federal Reserve and OCC, for instance, address these
elements and are a way to leverage resources. Similarly, coordination
between SEC offices and the Federal Reserve promote efforts to learn
from each other despite agency boundaries.
Opportunities remain for the agencies to collaborate more
systematically, however, and thus enhance their ability to provide
effective and consistent oversight when they share responsibility for a
holding company and its subsidiaries. More consistent collaboration
between OCC as the lead bank examiner and the Federal Reserve as the
holding company supervisor, for instance, would allow the agencies to
take advantage of opportunities to supervise some large, complex,
banking organizations as effectively and efficiently as possible.
Conducting some examinations and meetings on a joint basis--the
solution adopted by the Federal Reserve and OCC--is a positive step but
does not ensure that the agencies develop consistent mechanisms to
evaluate the results of joint examinations or to judge the extent to
which such examinations or other approaches lessen duplication, promote
consistency, or otherwise enable more efficient supervision.
In addition, we found that coordination between these agencies did not
always run smoothly. OCC examiners at some of the institutions we
reviewed and officials at headquarters told us that they see some
coordination issues, especially with regard to the horizontal
examinations the Federal Reserve conducts across some systemically
important institutions. OCC examiners at one LCBO said that some cases
could lead to the Federal Reserve and OCC providing inconsistent
feedback to the firm. They also noted that when the Federal Reserve
collects information for these examinations, they do not always rely on
OCC for that information when OCC is the primary bank examiner of the
lead bank. Finally, while OCC and the Federal Reserve follow the
procedures they have laid out for resolving differences, the potential
still exists for the two to give conflicting information to management.
We found one firm that had initially received conflicting information
from the Federal Reserve, its consolidated supervisor, and OCC, its
primary bank supervisor, about sufficient business continuity
provisions.
While the holding company supervisor for thrift holding companies (OTS)
or CSEs (SEC) is often the supervisor of the dominant regulated
subsidiary, opportunities to reduce regulatory burden and improve
accountability through better collaboration continue to exist. While an
OTS official told us that one of the main responsibilities of a holding
company supervisor is to improve efficiency by serving as a source of
information about the holding company to the functional supervisors,
this opportunity to leverage information is not fully utilized. FDIC
examiners, for instance, could collect information on the
organizational structure of the holding company from OTS, but obtained
this information from bank officials when examining an ILC that was
part of a thrift holding company.
In other instances, OTS and the Federal Reserve have taken some steps
to work collaboratively with other supervisors in supervising a
particular firm, but the results are incomplete. A decision by the
United Kingdom's Financial Services Authority to include the German and
French regulators in a meeting with OTS led OTS to call a November 2005
meeting that included a broader range of supervisors. OTS officials
said they invited insurance, FDIC, and SEC supervisors in the United
States. Officials at the company told us, however, that FDIC did not
attend the 2005 meeting because the meeting had been arranged hastily.
OTS held a similar meeting in November 2006, and FDIC staff attended
this meeting; SEC, however, did not attend and senior staff at Market
Regulation and OCIE told us they were unaware that SEC had been
invited. Similarly, as noted above, the Federal Reserve has sometimes
engaged in integrated examination activities with foreign supervisors,
but these did not consistently include other relevant U.S. supervisors.
The agencies did not always have consistent approaches to minimizing
regulatory burden and improving accountability through collaboration.
For example, as noted above, the Federal Reserve mitigates challenges
posed by its decentralized structure by creating processes such as
reviewing the plans and findings of LCBOs and centralizing the staffing
systems. However, these processes may make collaboration more
difficult. An OCC official told us that the complex review process at
the Federal Reserve sometimes kept OCC from providing formal results to
management on a timelier basis when the two agencies conducted joint
examinations. Further, the planning cycles are not always consistent
across the agencies. While OCC and the Federal Reserve considered each
others' schedules or examination plans when developing their plans for
bank holding companies where OCC is the lead bank supervisor, not all
agencies do so. For example, at the institutions included in our study,
there was little or no indication that FDIC had coordinated the
examinations of ILCs with relevant holding company supervisors.
Finally, bank regulators noted another barrier to full collaboration--
that the board of the bank is legally liable for the safety and
soundness of the bank regardless of the status of the holding company.
FDIC officials specifically noted that the interests of the bank's
management, including its legal responsibilities, and those of the
holding company might diverge when one or the other is in danger of
failing. Similarly, at that time the interests of the holding company
supervisor and the primary and secondary bank supervisor[Footnote 57]
might diverge as well. Federal Reserve officials noted, however, that
risks would be lessened to the extent that the objectives of the
consolidated supervisor and the primary bank supervisor are the same
(e.g., to preserve the safety and soundness of insured depository
institutions) and the consolidated supervisor takes action to prevent
the holding company from taking actions that are deleterious to its
insured depository institutions.
Collaboration between the banking agencies and SEC is hindered by
cultural differences and concerns about sharing information. Bank
supervisory officials noted that they were sometimes concerned about
sharing information with SEC because of their compliance, as opposed to
prudential supervision, culture. One official said the Federal Reserve
does not want to be perceived as a fact finder for the SEC when it
comes to consolidated financial information. If they were perceived in
that way, he said, management at financial holding companies may be
less willing to share certain types of confidential information with
their holding company supervisors. SEC and Federal Reserve officials
noted that SEC may not have the same formal legal safeguards as bank
supervisors have with regard to the confidentiality of the information.
The impediments to sharing information at SEC are evident internally as
well where, as discussed above, Market Regulation has not always shared
firm risk management information with OCIE.
Oversight of complex organizations that are primarily insurance
companies pose special collaborative challenges. As noted above, GLBA
directed consolidated supervisors to take certain actions to promote
the exchange of information between consolidated supervisors and
relevant state insurance supervisors, and we found that MOUs had been
negotiated and some communication was taking place. The states have
also taken some actions to oversee insurance companies on a group
basis. According to NAIC, most states have adopted a version of the
NAIC model laws concerning holding company supervision, and NAIC has
developed a framework for holding company supervision. Within that
framework, which promotes the assessment of risks and controls at the
holding company level, lead state supervisors conduct the examination.
These examiners are advised to identify and communicate with the
relevant functional supervisors for the holding company. The framework
also recommends that insurance examiners notify the Federal Reserve if
the institution is a financial holding company. However, only one major
insurer is a financial holding company, while a significant minority of
the large, complex thrift holding companies have significant insurance
operations, but the guidance does not recommend that examiners contact
OTS as a holding company supervisor. NAIC officials said that while
they participated in the EU evaluation process of the U.S. consolidated
supervisory framework, they do not believe that insurance supervisors
have been involved in the equivalency determinations for the specific
companies.
As a result of consolidated supervisors and those of the regulated
entities in these complex holding companies not consistently adopting
practices associated with systematic collaboration, U.S. supervisory
agencies may be missing opportunities to better ensure effective,
efficient supervision of individual financial services firms. The
agencies also have not developed methods to evaluate the joint efforts
that they do have under way, thus hindering their efforts to avoid
duplication. Further, since they have not consistently established
compatible policies and supervisory approaches, the agencies have
missed opportunities to make sure they are treating firms consistently.
Greater Collaboration among the Three Consolidated Supervisors Could
Improve Supervisory Efforts:
While the three consolidated supervisors have some mechanisms in place
to share information and supervisory approaches, opportunities remain
for them to collaborate more systematically to promote greater
consistency, particularly in oversight of large, complex firms. While
these firms' product offerings generally are similar, ensuring
regulatory consistency remains an ongoing challenge.
In particular, the OTS and SEC have overlapping responsibilities at
some CSEs that own or control thrifts. Further, the agencies do not
consistently work in a collaborative manner to identify the potential
for defining and articulating a common goal, such as identifying
regulatory best practices for consolidated supervision or identifying
emerging risks that would confront all financial services firms.
Duplicative Effect of Overlapping Jurisdiction between OTS and SEC
Remains Unresolved:
Three of the five securities firms that have obtained CSE status are
also thrift holding companies. As a result, these firms have two
consolidated supervisors and no mechanism has been developed to limit
the potential for duplicative activities and conflicting findings or to
assess accountability for various supervisory activities. In the
preamble to the final CSE rule, SEC acknowledged the potential for
duplication and conflict for some firms.[Footnote 58] The rule reduces
this potential by, among other things, providing that SEC will rely on
the Federal Reserve's consolidated supervision of financial holding
companies and on consolidated supervision by other holding company
supervisors under circumstances the SEC determines to be
appropriate.[Footnote 59]
Currently, SEC has not determined that consolidated supervision of
thrift holding companies by OTS satisfies SEC's supervisory concerns
with respect to CSEs that are thrift holding companies.[Footnote 60]
SEC says that where both it and OTS are the consolidated supervisors,
the firms are primarily securities firms with small thrift
subsidiaries. In addition, SEC examiners told us that the major risks
for these firms are outside the thrift and other banking subsidiaries
and that OTS had not been examining these activities. When thrifts are
included in bank holding companies, the law dictates that at the
holding company level, the Federal Reserve is solely responsible for
holding company supervision. However, no such mechanism exists for
firms that are thrift holding companies who have opted to become CSEs,
and OTS, which notes the growing importance of the thrift in two of the
three institutions, has not chosen to defer to SEC's consolidated
supervision. SEC and OTS officials recognize this issue but have not
yet met to resolve it.
Agencies Face Broader Risks That Could Be Better Managed through
Effective Collaboration:
Supervisors in all three agencies have recognized the importance of
allocating scarce resources to the areas of greatest risk and have
adopted some risk-based supervisory policies and procedures. However,
the agencies have not consistently adopted mechanisms to look at risk
collaboratively, recognizing that financial risks are not neatly
aligned with agency jurisdiction. The extent to which these risks cut
across regulatory boundaries was highlighted in our work on Long-Term
Capital Management (LTCM), a large hedge fund.[Footnote 61] Federal
financial regulators did not identify the extent of weaknesses in
banks' and securities and futures firms' risk management practices
until after LTCM's near collapse. Until LTCM's near collapse, they said
they believed that creditors and counterparties were appropriately
constraining hedge funds' leverage and risk taking. However,
examinations done after LTCM's near collapse revealed weaknesses in
credit risk management by banking and securities firms that allowed
LTCM to become too large and leveraged. The existing regulatory
approach, which focuses on the condition of individual institutions,
did not sufficiently consider systemic threats that can arise from
nonregulated entities, such as LTCM. Similarly, information
periodically received from LTCM and its creditors and counterparties
did not reveal the potential threat posed by LTCM. However, the
agencies did not have a strategy to collaboratively identify and
resolve problems such as this, delaying identification of shared issues
and work toward their resolution.
In addition, there are limited mechanisms to allow agencies to share
and leverage resources when one agency has unique capabilities or lacks
specialized resources. To some extent, agencies share expertise and
resources when they jointly conduct examinations or when they meet
periodically to share information. However, no mechanism exists for
sharing expertise in other situations. This is important for OTS, which
is characterized by a disparity between the size of the agency and the
diverse firms it oversees. While OTS recognizes its need for staff with
specialized skills to oversee some of these firms, the small number of
firms in some categories, combined with the small overall size of the
agency, limits its ability to have any depth in those skill areas. For
example, while OTS oversees a number of holding companies that are
primarily in the insurance business, it has only one specialist in this
area. At the same time, the Federal Reserve has a number of insurance
specialists but oversees only one firm that is primarily in the
insurance business. However, there is no systematic process for sharing
insurance expertise between the two agencies.[Footnote 62]
Conclusions:
As financial institutions have grown, become more complex and
internationally active, and adopted enterprisewide risk management
practices, consolidated supervision has become more important. For
certain large complex firms, U.S. supervisors have or are adopting some
of the "best practices" associated with consolidated supervision, as
evidenced in part by the determination of equivalence by EU
supervisors. However, U.S. supervisors could perform consolidated
supervision more efficiently and effectively by adopting management
practices in the areas of performance management and collaboration.
These practices are particularly important in helping to ensure
consistent treatment of financial services holding companies and in
clearly defining accountability for providing consolidated supervision.
Consistent rules, consistently applied, and clear accountability are
important because of the decentralized internal structures the agencies
use to develop and implement policies related to consolidated
supervision and the generally fragmented structure of the U.S.
regulatory system.
The first step in any effectively managed organization is to have well-
articulated objectives, strategies, and performance measures. While
these agencies have developed and largely implemented policies or
strategies for consolidated supervision, these strategies could be
improved through the development of more well-articulated, specific
objectives and measurable outcomes. Defining specific, measurable
objectives for the consolidated supervision programs is an inherently
difficult task for financial services supervisors but is a key
component of assessing how consolidated supervision adds to the
functional supervision of banks, thrifts, broker-dealers, and insurers.
Better-articulated objectives will also help to ensure that supervisors
treat firms equitably and that firms receive consistent feedback. SEC
has developed a draft statement of objectives and performance measures
for the CSE program intended to facilitate that assessment. If
approved, this would be particularly important because differences in
orientation and policies and communication weaknesses among different
organizational components of SEC exacerbate the difficulty of taking on
the new responsibilities inherent in the CSE program. Without formal
guidance that delineates the responsibilities and identifies strategies
and performance measures for the divisions and offices, resources will
not be used as effectively as they might be.
Another key facet of effectively managed organizations or systems is
the degree to which the various components collaborate and integrate
their processes. While the agencies do exchange information, they have
opportunities to improve collaboration. We have noted in the past that
it is difficult to collaborate within the fragmented U.S. regulatory
system and have recommended that Congress modernize or consolidate the
regulatory system. However, under the current system, the agencies have
opportunities to collaborate systematically and thus ensure that
institutions operating under the oversight of multiple financial
supervisors receive consistent guidance and face minimal supervisory
burden. The agencies have taken some steps, particularly in the case of
some specific holding companies, to work more collaboratively and thus
ensure consistent supervisory treatment. These steps include joint
supervisory meetings, including foreign supervisors, to develop common
examination approaches.
Recommendations for Executive Action:
We are recommending that the Federal Reserve, Office of Thrift
Supervision, and Securities and Exchange Commission take the following
seven actions, as appropriate:
To better assess their agencies' achievements as consolidated
supervisors, the Chairman of the Federal Reserve System's Board of
Governors, the Director of the Office of Thrift Supervision, and the
Chairman of the Securities and Exchange Commission should direct their
staffs to develop program objectives and performance measures that are
specific to their consolidated supervision programs.
To ensure they are promoting consistency with primary bank and
functional supervisors and are avoiding duplicating the efforts of
these supervisors, the Chairman of the Federal Reserve System's Board
of Governors, the Director of the Office of Thrift Supervision, and the
Chairman of the Securities and Exchange Commission should also direct
their staffs to identify additional ways to more effectively
collaborate with primary bank and functional supervisors. Some of the
ways they might consider accomplishing this include:
* ensuring common understanding of how the respective roles and
responsibilities of primary bank and functional supervisors and of
consolidated supervisors are being applied and defined in decisions
regarding the examination and supervision of institutions; and:
* developing appropriate mechanisms to monitor, evaluate, and report
jointly on results.
To take advantage of the opportunities to promote better accountability
and limit the potential for duplication and regulatory gaps, the
Chairman of the Federal Reserve System's Board of Governors, the
Director of the Office of Thrift Supervision, and the Chairman of the
Securities and Exchange Commission should foster more systematic
collaboration among their agencies to promote supervisory consistency,
particularly for firms that provide similar services. In particular,
the Chairman of the Securities and Exchange Commission and the Director
of the Office of Thrift Supervision should jointly clarify
accountability for the supervision of the consolidated supervised
entities that are also thrift holding companies and work to reduce the
potential for duplication.
To address certain practices that are specific to an agency, we
recommend the following:
* the Chairman of the Securities and Exchange Commission direct SEC
staff to develop and publicly release explicit written guidance for
supervision of Consolidated Supervised Entities. This guidance should
clarify the responsibilities and activities of the Office of Compliance
Inspections and Examinations and the Division of Market Regulation's
responsibilities for administering the Consolidated Supervised Entity
program.
* the Director of the Office of Thrift Supervision direct OTS staff to
revise the CORE supervisory framework to focus more explicitly and
transparently on risk management and controls so that it more
effectively captures evolving standards for consolidated supervision
and is more consistent with activities of other supervisory agencies
and facilitates consistent treatment of OTS's diverse population of
holding companies.
* The Chairman of the Federal Reserve direct Federal Reserve Board and
District Bank staff to look for ways to further reduce operational
differences in bank supervision among the District Banks, such as
developing additional guidance related to developing and communicating
examination findings.
Agency Comments and Our Evaluation:
We requested comments on a draft of this report from the Federal
Reserve, OTS, and SEC. We received written comments from the Chairman
of the Board of Governors of the Federal Reserve System, the Director
of the Office of Thrift Supervision, and the Chairman of the Securities
and Exchange Commission. Their letters are summarized below and
reprinted in appendixes III, IV, and V, respectively.
The Chairman of the Board of Governors of the Federal Reserve System
noted that the Federal Reserve's program for consolidated supervision
continues to evolve in light of changes in the structure, activities,
risks, and risk management techniques of the banking industry. He
concurred with the importance of clear and consistent objectives for
each supervisory program and accurate performance measures, as well as
noted that the Federal Reserve has already charged its management
committees, comprised of Board and Reserve Bank officials, to further
define and implement more specific objectives and performance measures
for each of its supervision business lines. He also agreed that it was
appropriate for the Federal Reserve to consider whether additional
opportunities exist to promote effective collaboration among the
Federal financial supervisory agencies and that the Federal Reserve
would continue to work to ensure that the agencies share information
and avoid duplication of supervisory effort.
The Director of the Office of Thrift Supervision agreed with our
characterization of how OTS's consolidated supervision program,
especially for large, complex firms operating on a global basis, has
evolved in recent years. OTS wrote that initiatives for these firms
(that are described in the report) will ensure that it implements the
principles of accountability and supervisory collaboration recommended
in the report. With regard to consolidated supervision of other firms
OTS wrote that it implements its holding company authority in a broader
and deeper manner than indicated in our draft report. In response to
our recommendation that OTS's CORE framework more explicitly focus on
risk management, the Director reiterated that the CORE approach is
explicitly designed to understand, analyze and evaluate the firm's risk
appetite and its approach to risk management, however, he said that OTS
is considering substantive revisions to the framework to further
sharpen this focus on risk. We agree that revisions to sharpen the
focus on the CORE framework are appropriate. We also agree that OTS's
holding company authority is broad and deep and that OTS has sought to
understand the risk management approaches of the holding companies it
supervises, but we continue to believe that OTS should focus more
explicitly and transparently on risk management and controls to ensure
it provides consistent treatment of its holding companies.
The Director also wrote that the report correctly points out that OTS
and SEC conduct consolidated supervision activities in some of the same
firms. Further, he wrote that the report cites views of SEC staff that
are incorrect, specifically that the firms in question have small
thrifts and that the major risks for these firms are outside the thrift
and other banking subsidiaries. The Director wrote that the regulated
thrift institutions are sizeable and significant in at least two of
these firms with assets of more than $14 billion and $19 billion in
2006 and that reviews thoroughly evaluate holding companies and their
risks on a consolidated basis.
Our report discussed the overlapping responsibilities of OTS and SEC
with regard to several CSEs that, because of their ownership of
thrifts, are also thrift holding companies. We did not offer a judgment
as to which agency should appropriately have the primary
responsibility, but we did recommend that the Director and the Chairman
of the Securities and Exchange Commission clarify accountability for
such supervisory responsibility. The Director of OTS said that he
intends to meet with the Chairman of SEC to discuss this issue.
In response to our recommendation that the agencies identify additional
ways to collaborate, the Director wrote that the differences between
the holding companies overseen by the Federal Reserve and OTS would
make it difficult to achieve perfect consistency but that OTS would
continue to seek ways to align its process with best regulatory
practice. In response to our recommendation that the agencies foster
more systematic collaboration, he wrote that OTS remains committed to
an open and inclusive approach and is willing to work with relevant
supervisors to ensure there are not gaps in the review of firms subject
to consolidated supervision. Finally, responding to our recommendation
for program objectives and performance measures that are specific to
consolidated supervision, the Director agreed that clear objectives and
performance measures greatly assist in evaluating the success of any
supervisory program, and that the agency will continue to assess ways
to ensure the program is focused, disciplined, and equal to the task of
holding company supervision.
The Chairman of the Securities and Exchange Commission wrote that SEC
recognized that the establishment of a prudential consolidated
supervision program for investment bank holding companies represents a
significant expansion of the Commission's activities and
responsibilities. The Chairman further wrote that SEC had built a
prudential regime that is generally consistent with the oversight that
is provided to bank holding companies but that SEC also takes into
account the different risk profiles and business mixes that distinguish
investment bank holding companies from bank holding companies. In
response to our recommendation regarding coordination within SEC, the
Chairman, with the unanimous support of his fellow Commissioners,
subsequently wrote that he is transferring the responsibilities for on-
site testing of CSE holding company controls to the Division of Market
Regulation so that the expertise related to the prudential supervision
of securities firms will be concentrated there. In addition, the
Chairman wrote that he will allocate additional positions to the
Division of Market Regulation to carry out its increased
responsibilities, and he has directed staff there to provide greater
transparency with regard to the aims and methods of the program by
posting additional information about its components on SEC's Web site.
We also received separate technical comments on the draft report from
the staffs of the Federal Reserve and SEC, as well as from FDIC and
OCC; we have incorporated their comments into the report, as
appropriate.
We are sending copies of this report to other interested congressional
committees and to the Chairman of the Board of Governors of the Federal
Reserve System, the Director of the Office of Thrift Supervision, and
the Chairman of the Securities and Exchange Commission. We will also
make copies available to others upon request. In addition, the report
will be available at no charge on the GAO Web site at [Hyperlink,
http://www.gao.gov].
If you or your staffs have any questions about this report, please
contact me at (202) 512-8678 or hillmanr@gao.gov. Contact points for
our Offices of Congressional Relations and Public Affairs may be found
on the last page of this report. Key contributors are acknowledged in
appendix VI.
Signed by:
Richard J. Hillman:
Managing Director, Financial Markets and Community Investment:
List of Committees:
The Honorable Christopher Dodd:
Chairman:
The Honorable Richard Shelby:
Ranking Member:
Committee on Banking, Housing and Urban Affairs:
United States Senate:
The Honorable Joseph I. Lieberman:
Chairman:
The Honorable Susan M. Collins:
Ranking Member:
Committee on Homeland Security and Governmental Affairs:
United States Senate:
The Honorable Barney Frank:
Chairman:
The Honorable Spencer Bachus:
Ranking Member:
Committee on Financial Services:
House of Representatives:
The Honorable Henry A. Waxman:
Chairman:
The Honorable Tom Davis:
Ranking Member:
Committee on Oversight and Government Reform:
House of Representatives:
[End of section]
Appendix I: Objectives, Scope, and Methodology:
Our objectives were to (1) describe the policies and approaches U.S.
consolidated supervisors use to oversee large and small holding
companies in the financial services industry; (2) review the
supervisory agencies' management of its consolidated supervision
program, including program objectives and performance measures; and (3)
evaluate how well consolidated supervisors are collaborating with other
supervisors and each other. We conducted our work between November 2005
and February 2007 in accordance with generally accepted government
auditing standards in Washington, D.C; Boston; and other locations
where financial institutions are headquartered.
To meet our objectives and to better understand how the three
consolidated supervisors--the Federal Reserve System (Federal Reserve),
Office of Thrift Supervision (OTS), and Securities and Exchange
Commission (SEC)--operate their consolidated supervision programs for
large, complex, firms, we selected a number of large firms that were
supervised by each of the three agencies on a consolidated basis. These
firms had at least one of the following characteristics: (1) major
international operations so that they were subject to the European
Union's Financial Conglomerates Directive or were headquartered abroad,
(2) a variety of businesses (i.e., insurance, banking, and securities)
that were subject to significant supervision by primary bank and
functional supervisors or unregulated subsidiaries, and (3) one or more
consolidated supervisors. Before finalizing our selection of firms, we
held discussions with the three agencies to obtain their views on the
firms we had selected.[Footnote 63] From this selection process, we
chose a total of 14 firms, 6 U.S. bank holding companies, 1 foreign
bank with substantial U.S. operations, 4 thrift holding companies that
did not have another consolidated supervisor, and 3 consolidated
supervised entities (CSE) that were also thrift holding companies. We
interviewed officials from some of the selected firms to obtain their
views on the benefits and the costs of consolidated supervision.
Specifically, to describe the policies and approaches used by U.S.
consolidated supervisors--Federal Reserve, OTS, and SEC--we reviewed
the Bank Holding Company Act of 1956, the Gramm-Leach-Bliley Act, the
Home Owners Loan Act of 1933, and SEC's Alternative Net Capital Rule
for CSEs. We also reviewed the Federal Reserve Board's Bank Holding
Company Supervision Manual and some of the Board's Division of Banking
Supervision and Regulation Letters on large, complex banking
organizations; SEC's regulations establishing the CSE program and
examination modules specific to that program; and OTS's Holding
Companies Handbook and Examination Handbook for thrifts. In addition,
we reviewed recent Federal Reserve supervisory plans and some reports
of targeted reviews. For the three SEC-supervised firms, we reviewed
their applications to become CSEs and ongoing supervisory materials,
such as monthly risk reports and cross-firm reviews, as well as the
results of one CSE examination completed during our review. Because
these firms were also thrift holding companies, we reviewed OTS holding
company examination reports for them. For the other OTS-supervised
firms, we reviewed holding company and thrift examination reports and
supervisory planning documents when these were available. In addition
to the 14 large firms, we reviewed a few supervisory documents for
smaller holding companies supervised by the Federal Reserve and OTS.
To review the supervisory agencies' management of its consolidated
supervision program, we reviewed recent strategic and performance plans
from the three agencies. Where relevant, we also reviewed agency
testimonies and budget documents. In addition, we reviewed agency
guidance specific to consolidated supervision to determine whether
program objectives and performance measures were included. We
interviewed officials at the three agencies and examiners who were
responsible for the supervision of the selected firms on what they
considered the goals or benefits of consolidated supervision to be. In
addition, we collected information on the operations review program
that the Federal Reserve developed for its supervision programs.
To evaluate how well consolidated supervisors are collaborating with
other supervisors and each other, we identified practices for effective
collaboration from our previous work on collaboration. We also
interviewed officials from the three agencies on their efforts to
collaborate with each other and with primary bank and functional
supervisors overseeing subsidiaries in the holding companies they
oversee. In addition, we reviewed examination reports of some of the
subsidiaries owned by the 14 holding companies we selected. These
included examination reports from the Federal Deposit Insurance
Corporation, Office of the Comptroller of the Currency, and the New
York Stock Exchange. We also interviewed officials and examiners
involved in the oversight of the primary banks or functional entities
within some of the 14 firms.
To gain an international perspective on consolidated supervision and a
better understanding of the European Union's Financial Conglomerates
directive, we spoke to supervisors in two other countries and reviewed
documents from a variety of international sources. Specifically, we
spoke with Canada's Office of the Superintendent of Financial
Institutions and the United Kingdom's Financial Services Authority. We
also reviewed documents from these supervisory bodies as well as other
international sources, including the Basel Committee on Banking
Supervision, the Joint Forum, and the European Union.
[End of section]
Appendix II: Criteria for Consolidated Supervision Included in Basel
Committee on Banking Supervision's Core Principles:
The following is excerpted from the Basel Committee on Banking
Supervision's "Core Principles Methodology," available at [Hyperlink,
http://www.bis.org/publ/bcbs130.pdf].
Principle 24: Consolidated supervision:
An essential element of banking supervision is that supervisors
supervise the banking group on a consolidated basis, adequately
monitoring and, as appropriate, applying prudential norms to all
aspects of the business conducted by the group worldwide.
Essential criteria:
1. The supervisor is familiar with the overall structure of banking
groups and has an understanding of the activities of all material parts
of these groups, domestic and cross-border.
2. The supervisor has the power to review the overall activities of a
banking group, both domestic and cross-border. The supervisor has the
power to supervise the foreign activities of banks incorporated within
its jurisdiction.
3. The supervisor has a supervisory framework that evaluates the risks
that non-banking activities conducted by a bank or banking group may
pose to the bank or banking group.
4. The supervisor has the power to impose prudential standards on a
consolidated basis for the banking group. The supervisor uses its power
to establish prudential standards on a consolidated basis to cover such
areas as capital adequacy, large exposures, exposures to related
parties and lending limits. The supervisor collects consolidated
financial information for each banking group.
5. The supervisor has arrangements with other relevant supervisors,
domestic and cross-border, to receive information on the financial
condition and adequacy of risk management and controls of the different
entities of the banking group.
6. The supervisor has the power to limit the range of activities the
consolidated group may conduct and the locations in which activities
can be conducted; the supervisor uses this power to determine that the
activities are properly supervised and that the safety and soundness of
the bank are not compromised.
7. The supervisor determines that management is maintaining proper
oversight of the bank's foreign operations, including branches, joint
ventures and subsidiaries. The supervisor also determines that banks'
policies and processes ensure that the local management of any cross-
border operations has the necessary expertise to manage those
operations in a safe and sound manner and in compliance with
supervisory and regulatory requirements.
8. The supervisor determines that oversight of a bank's foreign
operations by management (of the parent bank or head office and, where
relevant, the holding company) includes: (i) information reporting on
its foreign operations that is adequate in scope and frequency to
manage their overall risk profile and is periodically verified; (ii)
assessing in an appropriate manner compliance with internal controls;
and (iii) ensuring effective local oversight of foreign operations.
For the purposes of consolidated risk management and supervision, there
should be no hindrance in host countries for the parent bank to have
access to all the material information from their foreign branches and
subsidiaries. Transmission of such information is on the understanding
that the parent bank itself undertakes to maintain the confidentiality
of the data submitted and to make them available only to the parent
supervisory authority.
9. The home supervisor has the power to require the closing of foreign
offices, or to impose limitations on their activities, if:
it determines that oversight by the bank and/or supervision by the host
supervisor is not adequate relative to the risks the office presents;
and/or:
it cannot gain access to the information required for the exercise of
supervision on a consolidated basis.
10. The supervisor confirms that oversight of a bank's foreign
operations by management (of the parent bank or head office and, where
relevant, the holding company) is particularly close when the foreign
activities have a higher risk profile or when the operations are
conducted in jurisdictions or under supervisory regimes differing
fundamentally from those of the bank's home country.
Additional criteria:
1. For those countries that allow corporate ownership of banking
companies:
the supervisor has the power to review the activities of parent
companies and of companies affiliated with the parent companies, and
uses the power in practice to determine the safety and soundness of the
bank; and:
the supervisor has the power to establish and enforce fit and proper
standards for owners and senior management of parent companies.
2. The home supervisor assesses the quality of supervision conducted in
the countries in which its banks have material operations.
3. The supervisor arranges to visit the foreign locations periodically,
the frequency being determined by the size and risk profile of the
foreign operation. The supervisor meets the host supervisors during
these visits. The supervisor has a policy for assessing whether it
needs to conduct on-site examinations of a bank's foreign operations,
or require additional reporting, and has the power and resources to
take those steps as and when appropriate.
[End of section]
Appendix III: Comments from the Chairman of the Board of Governors of
the Federal Reserve System:
Board Of Governors Of The Federal Reserve System:
Washington, D. C. 20551:
Ben S. Bernanke:
Chairman:
February 26, 2007:
Mr. Richard J. Hillman:
Managing Director:
Financial Markets and Community Investment:
Government Accountability Office:
Washington, DC 20548:
Dear Mr. Hillman:
The Federal Reserve appreciates the opportunity to comment on a draft
of the GAO's report on the consolidated supervision programs of the
Federal Reserve and certain other federal agencies, particularly as
they apply to large or complex firms (GAO-07-154). The Federal Reserve
has served as the consolidated supervisor of all bank holding companies
since 1956 when the federal Bank Holding Company Act (BHC Act) was
enacted. Congress has reaffirmed this role and the need for federal
supervision of bank holding companies on a consolidated or group-wide
basis on numerous occasions, including most recently in the Gramm-
Leach-Bliley Act of 1999 (GLB Act). Moreover, as your report notes, the
continuing trend toward enterprise-wide risk management by the large
and complex firms that control banks has only increased the need for a
federal supervisor with the ability and authority to identify, assess
and, where appropriate, address the risks that arise from such an
organization's group-wide activities.
The Federal Reserve has long been a proponent for consolidated
supervision of banking organizations both in the United States and
abroad. Indeed, the Federal Reserve's consolidated supervision program
has served as the benchmark for many of the current and evolving
international standards for the consolidated supervision of financial
groups. Key concepts that have been part of the Federal Reserve's
approach to consolidated supervision for many years are reflected in
the Basel Committee on Banking Supervision's Minimum Standards for
Internationally Active Banks (1992), Capital Accords (1988 and 2006)
and Core Principles of Effective Banking Supervision (first promulgated
in 1997), and are now used by the International Monetary Fund and World
Bank in connection with their assessment of countries' bank supervisory
regimes.
As your report notes, the Federal Reserve has a well-developed,
systematic and risk-focused program for supervising all large, complex
bank holding companies (referred to as LCBOs) on a consolidated basis.
While not the focus of your report, we also have developed and
implemented tailored, risk-focused supervisory programs for the
numerous smaller and less complex bank holding companies, as well as
the U.S. operations of foreign banks, that the Federal Reserve has
statutory responsibility to oversee and supervise. In fact, today the
Federal Reserve acts as the consolidated supervisor for more than five
thousand bank holding companies, which together have assets of more
than $11 trillion. Bank holding companies and foreign banks treated as
bank holding companies also controlled five of the largest ten U.S.
broker-dealers in terms of capital, as of January 1, 2006.
The Federal Reserve's program for consolidated supervision continues to
evolve in light of changes in the structure, activities, risks and risk-
management techniques of the banking industry. For example, shortly
after enactment of the GLB Act, the Federal Reserve issued policy
guidance, SR Letter 00-13, to help explain the key objectives of
consolidated supervision of large, diversified banking organizations
and how the Federal Reserve would seek to fulfill these objectives.
This document provides that, consistent with Congressional guidance,
the Federal Reserve supervises financial holding companies to identify
and evaluate, on a consolidated or group-wide basis, the significant
risks that exist in a diversified holding company in order to assess
how these risks might affect the safety and soundness of depository
institution subsidiaries. SR Letter 00-13 also describes how the
Federal Reserve will seek to achieve these objectives through three
broad categories of activities: information gathering, assessments and
supervisory cooperation; ongoing supervision; and promotion of sound
practices and improved disclosure. Importantly, the objectives and
strategies outlined in SR Letter 00-13 are exposited and implemented
through a wide variety of supervisory manuals, procedures, and
guidance, including the comprehensive Bank Holding Company Supervision
Manual and the RFI rating system for all bank holding companies.
In practice, the Federal Reserve's consolidated supervisory program for
LCBOs is composed of several key and inter-related components, each of
which is supported by specific statutory authority. The Federal Reserve
conducts risk-focused examinations of all large, complex bank holding
companies on a routine basis, many of which are performed by exam teams
dedicated to the individual institution. In conducting these
examinations, supervisory staff draw on internal management reports and
assessments, the reports and findings of other supervisors, as well as
information derived from detailed financial reports filed with the
Federal Reserve. Consolidated capital adequacy is a key pillar of this
supervisory framework. The Federal Reserve has established risk-based
and leverage capital standards by rule for bank holding companies as
part of its overall assessment of capital adequacy. Importantly, if
these supervisory activities and resources reveal unsafe or unsound
practices at a bank holding company or nonbank affiliate, the Board has
the ability and authority to take appropriate enforcement action,
including issuing cease and desist orders and imposing civil money
penalties. Through all these components, the Federal Reserve's program
of consolidated supervision seeks to identify and address serious
problems before they pose a risk to the company's subsidiary depository
institutions.
Your report recommends that the Federal Reserve look for ways to more
clearly articulate the specific objectives and performance measures for
our consolidated supervision program and reduce operational differences
in bank supervision among the System's twelve Reserve Banks. We concur
that it is important for supervisors to have clear and consistent
objectives for each of their supervisory functions and that accurate
performance measures can help supervisors assess how well specific
programs are achieving their goals. As your report acknowledges,
developing good performance measures for consolidated supervisory
programs is a difficult task.
As discussed above, the Federal Reserve has developed extensive
supervisory materials that describe the objectives, components and
specific activities of our consolidated supervisory program. In
addition, the Federal Reserve uses a variety of mechanisms, including
the Operations Review program and inter-District management committees,
to help assess the performance of our supervisory programs, identify
areas for possible improvement and enhance consistency. The Federal
Reserve is committed to reviewing and enhancing our supervision
programs on an ongoing basis. As part of this process, we will look for
ways to more clearly articulate the specific objectives and performance
measures relevant to our consolidated supervision program and reduce
operational differences in bank supervision among the Reserve Banks. I
am pleased to note that the Federal Reserve already has charged our
management committees, comprised of Board and Reserve Bank officials,
to further define and implement more specific objectives and
performance measures for each of our supervision business lines.
The report also recommends that the Federal Reserve seek to identify
additional ways to collaborate effectively with the other bank or
functional supervisors that may be involved in the supervision of the
individual subsidiaries of a bank holding company and to collaborate
more systematically with the other Federal agencies that supervise
large or complex financial firms. We agree that, as stated in SR Letter
00-13, effective supervision of financial holding companies requires
strong, cooperative relationships between the Federal Reserve, as
umbrella supervisor, and bank, thrift, functional and foreign
supervisors. Indeed, the Federal Reserve relies, to the fullest extent
possible, on the examination and other supervisory work conducted by
the primary bank and functional supervisors of a bank holding company's
subsidiaries in assessing the risks of the organization as a whole. We
have worked hard to establish the requisite information sharing
agreements and protocols that make systematic collaboration possible
and, as noted in the report, we provide the OCC and FDIC full on-line
access to our supervisory databases concerning bank holding companies.
The Federal Reserve participates in a variety of forums for the
discussion of broad industry issues and supervisory strategies. These
include the Federal Financial Institutions Examination Council and the
President's Working Group on Financial Markets.
Nevertheless, we recognize that it is appropriate to consider whether
additional opportunities exist to promote effective collaboration among
the Federal financial supervisory agencies. All relevant agencies must
work together to achieve the full benefits that come from well-
orchestrated collaboration that is consistent with the individual
statutory missions and responsibilities of the respective agencies. As
such, the Federal Reserve will continue its efforts to bridge
information gaps where they exist among the agencies and eliminate
unnecessary redundancy in the execution of our supervisory programs.
Federal Reserve staff has separately provided GAO staff with technical
and correcting comments on the draft report. We hope that these
comments were helpful.
We appreciate the recommendations made in the report and will give them
our consideration as we continue to refine our supervision programs. We
also appreciate the efforts and the professionalism of the GAO's review
team in conducting the review on this important and complex matter.
Sincerely,
Signed by:
Ben Bernanke:
[End of section]
Appendix IV: Comments from the Director of the Office of Thrift
Supervision:
Office of Thrift Supervision:
Department of the Treasury:
1700 G Street, N.W.,
Washington, DC:
20552:
(202) 906-6590:
John M. Reich, Director:
March 1, 2007:
Mr. Richard J. Hillman:
Managing Director, Financial Markets and Community Investment:
Government Accountability Office:
441 G Street, NW:
Washington, DC 20548:
Dear Mr. Hillman:
Thank you for the opportunity to comment on your report "Agencies
Engaged in Consolidated Supervision can Strengthen Performance
Measurement and Collaboration."
The subject of consolidated supervision is critically important to OTS
given its role as the top-tier supervisor of a diverse population of
holding companies that are major participants in the global financial
services market. I appreciate the opportunity OTS had to work with GAO
in the formulation of this report.
The report correctly states that OTS's consolidated supervision program
has evolved with the financial services industry in recent years. This
is particularly the case for the supervision of financial conglomerates
- or the large, complex companies that operate across several business
lines on a global basis. In recent years OTS has:
* Adopted specific examination procedures for supervising financial
conglomerates;
* Designed and implemented a `continuous supervision' program that
includes a rigorous risk assessment, comprehensive supervisory
planning, and continuous, on-site supervision by conglomerate examiners
and specialists;
* Developed a broad network of supervisory relationships both
domestically and internationally to learn from the perspective of the
regulators who supervise entities within the conglomerates' corporate
structures, and;
* Created a specific headquarters division responsible for implementing
and overseeing the supervision of financial conglomerates.
These initiatives have strengthened OTS's consolidated supervision
program and will ensure it implements the principles of accountability
and supervisory collaboration outlined in your report.
Briefly, I would like to offer two points of clarification on the
report:
* First, the report, on several occasions, indicates OTS's CORE
(Capital, Organization, Relationship, and Earnings) program for holding
company supervision is focused exclusively on the holding company's
impact on, and relationship with, the insured depository institution.
While these are important considerations, examiners are also tasked
with looking at the key risks within the consolidated corporate
entities and how the companies manage and mitigate these risks. This is
particularly true for the more complex and diversified companies
subject to OTS supervision. OTS implements its holding company
authority in a broader and deeper manner than you suggest.
* Second, in several places the report correctly points out that both
OTS and SEC conduct examination activities in some of the same firms.
Further, the report cites the SEC staff's view that the firms in
question have small thrift subsidiaries and that "the major risks for
these firms are outside the thrift and other banking subsidiaries and
that OTS had not been examining these activities." These assumptions
are incorrect. The regulated thrift institutions are sizeable and
significant in at least two of these firms, with assets of more than
$14 billion and more than $19 billion as of year-end 2006. Further, the
reviews thoroughly evaluate the holding companies and their risks on a
consolidated basis. Given OTS's strong statutory supervision of these
firms, the SEC's CSE program seems inconsistent with the functional
regulation principle at the heart of the Gramm Leach Bliley law.
Finally, I would like to share my thoughts on the specific
recommendations contained in the report:
* "To ensure that they are promoting consistency .[the agencies should]
identify additional ways to more effectively collaborate."
Consistency is a laudable goal and, as your report indicates, the
agencies tasked with consolidated supervision have coalesced around a
risk-focused supervisory approach. However, differences in the
statutory authorities and responsibilities, and the diversity between
OTS and Federal Reserve holding company populations, make perfect
consistency difficult to achieve. OTS has and will continue to seek
ways to align our process with best regulatory practice.
* "To take advantage of the opportunities to promote better
accountability and limit the potential for duplication and regulatory
gaps, the [agencies] should foster a more systematic collaboration."
Strong collaboration between the supervisors can reduce the potential
for regulatory gaps and can improve the overall approach to supervising
complex financial services firms. As indicated in your report, OTS
works hard to include all relevant functional regulators in its holding
company supervision program - in both formal and informal venues. It is
important to have the benefit of their views, and the exchange of
information is useful. In particular, I agree with your suggestion that
OTS and SEC should improve collaboration and I intend to meet with
Chairman Cox to discuss that issue. OTS remains committed to an open
and inclusive approach and is willing to work with relevant supervisors
to ensure there are no gaps in the review of firms subject to
consolidated supervision.
* OTS should "revise the CORE supervisory framework to focus more
explicitly and transparently on risk management and controls."
It is critical to focus supervisory efforts at the holding company
level on risk management and controls. As indicated above, the CORE
approach is explicitly designed to understand, analyze, and evaluate
the firm's risk appetite and its approach to risk management. The more
complex the firm, the more comprehensive the assessment of its risk
profile and the effectiveness of its risk control functions. Further,
as indicated in the report, OTS is considering substantive revisions to
its CORE examination format that will further sharpen this focus on
risk.
* "To better assess their agencies achievements as consolidated
supervisors, the [agencies] should . develop program objectives and
performance measures that are specific to their consolidated
supervision programs"
Clear objectives and performance measures greatly assist in evaluating
the success of any supervision program. As pointed out in the report,
OTS has a specific division in headquarters accountable for the
supervision of its most complex firms. As further mentioned, OTS
recently outlined a clear internal process for implementing the
`continuous supervision' program, and the relevant OTS executives are
held accountable for its execution. The agency will continue to assess
ways to ensure the program is focused, disciplined, and equal to the
task of holding company supervision.
Again, I appreciate GAO's efforts in developing this report and for the
opportunity to comment on the recommendations. The agency found its
interactions with your review team useful and informative. OTS will
continue working to improve its consolidated supervision program.
Sincerely,
Signed by:
John M. Reich:
Director:
[End of section]
Appendix V: Comments from the Chairman of the Securities and Exchange
Commission:
United States Securities And Exchange Commission:
Washington, D.C. 20549:
The Chairman:
March 5, 2007:
Mr. Richard J. Hillman:
Director:
Financial Markets and Community Investment:
U.S. Government Accountability Office:
441 G Street, N.W.
Washington, D.C. 20548:
Re: GAO Report 07-154: "Agencies Engaged in Consolidated Supervision
Can Strengthen Performance Measurement and Collaboration"
Dear Mr. Hillman:
Thank you for the opportunity to respond to your draft report entitled
"Agencies Engaged in Consolidated Supervision Can Strengthen
Performance Measurement and Collaboration" (GAO-07-154).
As noted in the text of the draft report, the Securities and Exchange
Commission's Consolidated Supervised Entity ("CSE") program is a
relatively new program, having been created through Commission action
in 2004. We are keenly aware that the establishment of a prudential
consolidated supervision program for investment bank holding companies
represents a significant expansion of the Commission's activities and
responsibilities. Whereas we had traditionally focused primarily on the
U.S. broker-dealer, we must in our new role consider the broader
potential implications of the financial and operational condition of
the holding company and its unregulated affiliates, for all regulated
entities, both U.S. and foreign, as well as the broader financial
system.
Over the past two years the SEC has built a prudential regime that is
generally consistent with the oversight that is provided to bank
holding companies. For example, it requires for the first time that
investment bank holding companies supervised as CSEs report a capital
adequacy measure consistent with the Basel Standard. We have also
strived in constructing our program to take into account the different
risk profiles and business mixes that distinguish investment bank
holding companies from bank holding companies. In particular, we
believe that our regime is appropriately focused on maintaining the
liquidity of the consolidated entity, through such means as requiring
that a pool of highly liquid assets be held by each firm in a manner
that assures their availability to address financial or operational
weaknesses in an affiliate that might otherwise place regulated
entities at risk.
In implementing this regime for the five investment bank holding
companies whose applications have been approved by the Commission under
the CSE program, we have strived for consistency where appropriate with
other U.S. consolidated supervisors, particularly with respect to
implementation of the Basel Standard. We have worked closely with the
U.S. banking regulators, both bilaterally and in the context of
international regulatory efforts, toward this and other important
common regulatory aims. We will continue to do so as U.S.
implementation of Basel II proceeds in the coming years.
Given its relative newness, there will be continued evolution in the
mechanisms, although not in the goals, of the program. Consistent with
a broad theme in the draft report, we are committed to communicating
these developments as clearly as possible to firms supervised under the
program and other stakeholders, thereby facilitating greater
cooperation and coordination with other regulatory agencies. As noted
in the draft report, we consider the web pages that were created over
the past year an important step in this direction. But we recognize
that there is more work to be done.
With respect to the particular recommendation in the report concerning
the current bifurcation of responsibility for the CSE program between
the Office of Compliance Inspections and Examinations and the Division
of Market Regulation, we are currently completing the process of
evaluating both your analysis and our internal operations, with a view
to effecting organizational changes that will clarify responsibilities
both internally and externally. We expect that this process will be
complete, and described in a detailed internal document, by March 17,
2007.
Thank you again for this opportunity to review and comment on your
draft report.
Sincerely,
Signed by:
Christopher Cox:
Chairman:
Christopher Cox:
Chairman:
Headquarters:
100 F Street, NE:
Washington, DC 20549:
Regional Offices:
New York, Chicago, Los Angeles, Denver, Miami:
District Offices:
Boston, Philadelphia, Atlanta, Fort Worth, Salt Lake City, San
Francisco:
United States:
Securities And Exchange Commission March 9, 2007:
Mr. Richard J. Hillman Director:
Financial Markets and Community Investment:
U.S. Government Accountability Office:
441 G Street, NW Washington, D.C. 20548:
Re: GAO Report 07-154:
Dear Mr. Hillman:
I write to provide an update on the steps that the Commission has taken
to address issues raised in GAO Report 07-154 ("Agencies Engaged in
Consolidated Supervision Can Strengthen Performance Measurement and
Collaboration") relating to the Commission's Consolidated Supervised
Entity ("CSE") program.
I am gratified that the GAO's report highlights many broad similarities
between the Commission's CSE program and the Federal Reserve's
oversight of bank holding companies, which is the obvious model for a
program of this type. I am also pleased that the report recognizes
certain differences between investment banks and commercial banks, and
that these should be reflected in the holding company supervision
provided to each type of institution.
The goal of the CSE program is to provide prudential supervision to
investment bank holding companies that is broadly consistent with the
Federal Reserve's oversight of bank holding companies. Its aim is not
to extend the Commission's broker-dealer compliance regime across the
holding company, but rather to monitor the holding company and its
unregulated affiliates for financial and operational weaknesses that
might place regulated entities or the broader financial system at risk.
The GAO's report has been extremely helpful to the Commission in
identifying improvements to the CSE program. In particular, your report
raises serious concerns about the lack of coordination between the
inspection and supervisory components of the CSE program. The report's
primary recommendation asks that the Commission clarify the division of
responsibilities within the Commission between the Division of Market
Regulation, which sets overall policy for the CSE program and provides
ongoing supervision of CSE holding companies, and the Office of
Compliance Inspections and Examinations, which conducts detailed on-
site testing of each CSE firm's documented controls.
To implement this recommendation, I have carefully considered the
question of which organizational structure will best achieve the goal
of the CSE program. I have concluded that the success of the CSE
program will be best ensured if the supervision of CSE firms is fully
integrated with, rather than merely coordinated with, the detailed on-
site testing that is done of the documented controls at CSE firms. As a
result, I have decided to transfer responsibility for on-site testing
of CSE holding company controls to the Division of Market Regulation.
This will better align the testing and supervision components of the
CSE program, will strengthen its prudential character, and will most
efficiently utilize the Commission's resources. With the new structure,
ongoing supervision activities will be more directly informed by the
results of focused testing of controls, and field inspections will be
more precisely targeted using information from ongoing supervisory
work. In addition, the Commission's expertise related to the prudential
supervision of securities firms will be concentrated in the Division of
Market Regulation, which will foster improved communication and
coordination among the staff responsible for administering various
components the CSE program.
I reached this decision after careful consideration of the views of the
professional staff of the Commission, including the Director of the
Division of Market Regulation and the Director of the Office of
Compliance Inspections and Examinations.
I have also solicited the views of my fellow Commissioners, who are
unanimous in supporting the decision to consolidate within the Division
of Market Regulation the responsibility for oversight of the CSE
program.
Along with this transfer of responsibilities, which is currently being
implemented, I will also be allocating additional staff positions to
the Division of Market Regulation in order that we may increase the
number of Commission staff members who spend their:
time exclusively on the oversight of CSE holding companies. Further, I
have directed the Division of Market Regulation to prepare a
description of the review component as well as of the other components
of the CSE program. Upon completion, this will be made available on the
Commission's web site. As I noted in my earlier letter, I believe that
transparency with regard to the aims and methods of the CSE program is
essential to its overall success and to better coordination with other
regulators. I consider the public posting of these documents as an
important step towards this transparency.
Again, I would like to thank you and your colleagues for your efforts
on this project.
Sincerely,
Signed by:
Christopher Cox:
Chairman:
[End of section]
Appendix VI: GAO Contact and Staff Acknowledgments:
GAO Contact:
Richard J. Hillman, (202) 512-8678 or hillmanr@gao.gov:
Staff Acknowledgments:
In addition to the contact named above, James McDermott, Assistant
Director; Jason Barnosky; Nancy S. Barry; Lucia DeMaio; Nancy Eibeck;
Marc W. Molino; Paul Thompson; and Barbara Roesmann also made key
contributions to this report.
[End of section]
Related GAO Products:
Risk-Based Capital: Bank Regulators Need to Improve Transparency and
Address Impediments to Finalizing the Proposed Basel II Framework. GAO-
07-253. Washington, D.C.: Feb. 15, 2007.
Industrial Loan Corporations: Recent Asset Growth and Commercial
Interest Highlight Differences in Regulatory Authority. GAO-06-961T.
Washington, D.C.: July 12, 2006.
Results-Oriented Government: Practices That Can Help Enhance and
Sustain Collaboration among Federal Agencies. GAO-06-15. Washington,
D.C.: October 21, 2005.
Industrial Loan Corporations: Recent Asset Growth and Commercial
Interest Highlight Differences in Regulatory Authority. GAO-05-621.
Washington, D.C.: September 15, 2005.
21st Century Challenges: Reexamining the Base of the Federal
Government. GAO-05-325SP. Washington, D.C.: February 1, 2005.
Financial Regulation: Industry Changes Prompt Need to Reconsider U.S.
Regulatory Structure. GAO-05-61. Washington, D.C.: October 6, 2004.
Internal Control Management and Evaluation Tool. GAO-01-1008G.
Washington, D.C.: August 1, 2001.
Managing for Results: Barriers to Interagency Coordination. GAO/GGD- 00-
106. Washington, D.C.: March 29, 2000.
Responses to Questions Concerning Long-Term Capital Management and
Related Events. GAO/GGD-00-67R. Washington, D.C.: February 23, 2000.
Risk-Focused Bank Examinations: Regulators of Large Banking
Organizations Face Challenges. GAO/GGD-00-48. Washington, D.C.: January
24, 2000.
Standards for Internal Control in the Federal Government. GAO/AIMD-00-
21.3.1. Washington, D.C.: November 1, 1999.
Long-Term Capital Management: Regulators Need to Focus Greater
Attention on Systemic Risk. GAO/GGD-00-3. Washington, D.C.: October 29,
1999.
(250258):
[End of section]
(250258):
FOOTNOTES
[1] For enterprises engaged in commercial activities, consolidated
supervision also may refer to supervision of the enterprise
consolidated at the highest level holding company engaged in financial
activities. For foreign banking firms that operate in the United States
without a U.S. holding company, consolidated supervision may refer to
the oversight of all U.S. activities of the foreign firm.
[2] For the purposes of this report, functional supervisors also may
include supervisors of foreign subsidiaries, such as the United
Kingdom's Financial Services Authority, the German Federal Financial
Supervisory Authority (Die Bundesanstalt für
Finanzdienstleistungsaufsicht) called BaFin, the French Commission
Bancaire, and the Japanese Financial Services Agency.
[3] See GAO, 21st Century Challenges: Reexamining the Base of the
Federal Government, GAO-05-325SP (Washington, D.C.: Feb. 1, 2005);
Financial Regulation: Industry Changes Prompt Need to Reconsider U.S.
Regulatory Structure, GAO-05-61 (Washington, D.C.: Oct. 6, 2004); and
Industrial Loan Companies: Recent Asset Growth and Commercial Interest
Highlight Differences in Regulatory Authority, GAO-05-621 (Washington,
D.C.: Sept. 15, 2005).
[4] GAO-05-325SP, 28.
[5] See GAO, Results-Oriented Government: Practices That Can Help
Enhance and Sustain Collaboration among Federal Agencies, GAO-06-15
(Washington, D.C.: Oct. 21, 2005).
[6] See GAO-05-61, pp. 30-31, for a fuller discussion.
[7] Banking institutions generally determine their regulator by
choosing a particular kind of charter--commercial bank, thrift, credit
union, or industrial loan company. These charters may be obtained at
the state or national level for all except industrial loan companies,
which are chartered only at the state level.
[8] 12 U.S.C. §§ 1841-1850, as amended.
[9] 12 U.S.C. § 1467a, as amended.
[10] 15 U.S.C. § 78o(3)(c), see 69 Fed. Reg. at 34430.
[11] 69 Fed. Reg. at 34430 n. 10; Gramm-Leach-Bliley Act, Pub. L. No.
106-102 (1999).
[12] 69 Fed. Reg. 34472 (June 21, 2004).
[13] Pub. L. No. 106-102 § 231.
[14] The definition of financial conglomerates used by the Joint Forum
is "any group of companies under common control whose exclusive or
predominant activities consist of providing significant services in at
least two different financial sectors (banking, securities,
insurance)." The Joint Forum is described later in this report.
[15] Basel Committee on Banking Supervision, Core Principles for
Effective Banking Supervision (October 2006).
[16] GAO has recently completed an assessment of the proposed U.S.
regulation based on these revised capital standards. See GAO, Risk-
Based Capital: Bank Regulators Need to Improve Transparency and Address
Impediments to Finalizing the Proposed Basel II Framework, GAO-07-253
(Washington, D.C.: Feb. 15, 2007).
[17] The International Organization of Securities Commissions is
composed of securities regulators from 105 countries, and the
International Association of Insurance Supervisors represents insurance
supervisory authorities of some 180 jurisdictions.
[18] See Federal Reserve, SR 99-15 (June 23, 1999).
[19] See 69 Fed. Reg. 43996-44007 (July 23, 2004) (proposed rules); 69
Fed. Reg. 70444 (Dec. 6, 2004); see also, Federal Reserve, SR 04-18
(Dec. 6, 2004).
[20] Bank holding companies with assets of less than $500 million also
may be required to comply with these consolidated capital requirements
if they are engaged in significant nonbank or off-balance sheet
activities or if they have a material amount of SEC-registered debt or
securities outstanding. See 12 CFR Part 225, App. C.
[21] 12 CFR 225.4(a).
[22] See GLBA Title V, Privacy.
[23] See Federal Reserve, SR 00-13 (Aug. 15, 2000).
[24] The Federal Reserve's formal enforcement powers with respect to
bank holding companies and their nonbank subsidiaries are set forth at
12 U.S.C. § 1818(b)(3).
[25] This guidance was initially issued in OTS Regulatory Bulletins 35,
32-31 (Nov. 20, 2003).
[26] European Union, General guidance from the European Financial
Conglomerates Committee to EU Supervisors: the extent to which the
supervisory regime in the United States is likely to meet the
objectives of supplementary supervision in Directive 2002/87/EC and
General guidance from the Banking Advisory Committee to EU supervisors:
the extent to which the supervisory regime in the United States is
likely to meet the objectives of consolidated supervision in Chapter 3
of Directive 2000/12/EC (Brussels; July 6, 2004).
[27] FSA has approved the Federal Reserve as providing equivalent
holding company supervision for 5 financial holding companies, and
BaFin, the German supervisory body has approved the Federal Reserve as
the consolidated supervisor of a sixth financial holding company. In
addition, FSA has determined that SEC provides equivalent consolidated
supervision for the five investment firms that have been approved as
CSEs.
[28] See 12 U.S.C. §§ 1467a(g), (i).
[29] Our reporting of the numbers of formal enforcement actions by the
Federal Reserve and OTS does not imply an evaluation or comparison of
the enforcement activities by these agencies.
[30] Pub. L. No. 101-432 § 4(a), 15 U.S.C. § 78q(h) (providing for,
among other things, SEC risk assessment of holding company systems).
[31] Under the SEC regulation, entities that have a principal regulator
include certain functionally regulated affiliates of a holding company
that are not registered as a broker or dealer, such as insured
depository institutions, firms regulated by the Commodity Futures
Trading Commission or state insurance regulators, and certain foreign
banks. See 69 Fed. Reg. at 34431.
[32] 69 Fed. Reg. at 34450; see 17 C.F.R. §§ 200.19a, 200.30-3.
[33] According to senior staff at OCIE, NERO staff report to SEC's
Division of Enforcement and OCIE.
[34] See 71 Fed. Reg. 55830 (Sept. 25, 2006) for the proposed rules.
[35] Broker-dealers subject to CSE rules must maintain tentative net
capital of $1 billion and minimum net capital of $500 million where
tentative net capital is the net capital before deductions for market
or credit risk. These broker-dealers must notify SEC if tentative net
capital falls below $5 billion. 69 Fed. Reg. 34431.
[36] See Pub. L. No. 106-102 § 111.
[37] Under the National Bank Act, national banks are to provide OCC
with periodic reports to disclose fully the relations between the bank
and any each of its affiliates, other than member banks, necessary for
OCC to be informed of the effect of the relations upon the bank. 12
U.S.C. § 161(c). Federal banking law also provides national bank
examiners with authority to examine all of the affairs of national bank
affiliates, other than member banks, as is necessary to disclose fully
the relations between the bank and the affiliates and the effect of
such relations upon the affairs of the bank. 12 U.S.C. § 481.
[38] FDIC examiners may examine the affairs of any affiliate of a
depository institution as may be necessary to disclose fully the
relationship between the institution and any such affiliate and the
effect of the relationship on the institution. 12 U.S.C. § 1820(b)(4);
see also 12 U.S.C. § 1831v(b).
[39] Bank holding companies with thrift subsidiaries are not subject to
regulation as a savings and loan holding company. See, e.g., 12 U.S.C.
§ 1467a(a)(1)(D)(ii), 1467a(t).
[40] For a discussion of FDIC's supervision of ILCs, see GAO-05-621.
[41] Under the CSE regulations, banks are among the entities SEC
considers to have a principal regulator. 69 Fed. Reg. at 34431.
[42] In determining whether a small holding company is noncomplex and
eligible for this program, the Federal Reserve considers, among other
things, the size and structure of the holding company, the extent of
intercompany transactions between insured depository subsidiaries and
the holding company or nonbank affiliates, the nature and scale of any
nonbank activities, whether risk management processes are consolidated,
and whether the holding company has material debt outstanding. See
Federal Reserve SR 02-01(Jan. 9, 2002).
[43] See GAO-05-61 for a further discussion of these developments.
[44] See GAO, Internal Control: Standards for Internal Control in the
Federal Government, GAO/AIMD-00-21.3.1 (Washington, D.C.: November
1999); and Internal Control Standards: Internal Control Management and
Evaluation Tool, GAO-01-1008G (Washington, D.C.: August 2001). These
standards reflect updates in private sector internal control guidance,
including the issuance of Internal Control--Integrated Framework by the
Committee of Sponsoring Organizations of the Treadway Commission
(COSO). Also see COSO, Enterprise Risk Management--Integrated Framework
(September 2004). For the importance of objectives and performance
measures in determining accountability and efficiency, see, for
example, GAO, Results-Oriented Government: GPRA Has Established a Solid
Foundation for Achieving Greater Results, GAO-04-38 (Washington, D.C.:
Mar. 10, 2004).
[45] Statement of Alan Greenspan, Chairman, Board of Governors of the
Federal Reserve System before the Committee on Banking and Financial
Services, U.S. House of Representatives (May 22, 1997). Statement of
Alan Greenspan, Chairman, Board of Governors of the Federal Reserve
System before the Subcommittee on Finance and Hazardous Materials of
the Committee on Commerce, U.S. House of Representative (July 17,
1997).
[46] The federal safety net includes the federal deposit insurance
fund, the payments system, and the Federal Reserve's discount window.
[47] Letter from Alan Greenspan, Chairman, Board of Governors of the
Federal Reserve System to the Honorable James A. Leach, U.S. House of
Representatives (Jan. 20, 2006).
[48] See Federal Reserve, SR 00-13 (Aug. 15, 2000).
[49] We have previously identified these features as characteristics of
effective bank supervision. GAO, Bank Oversight: Fundamental Principles
for Modernizing the U.S. Structure, GAO/T-GGD-96-117 (Washington, D.C.:
May 2, 1996); and Bank Oversight Structure: U.S. and Foreign Experience
May Offer Lessons for Modernizing U.S. Structure, GAO-GGD-97-23
(Washington, D.C.: Nov. 20, 1996).
[50] OTS, Remarks of John M. Reich, Director, Special Seminar on
International Banking and Finance (Tokyo, Japan; Nov. 15, 2006).
[51] GAO-05-61.
[52] GAO-06-15.
[53] GAO-05-61.
[54] Pub. L. No. 106-102 § 111, 12 U.S.C. 1844(c), as amended.
[55] Id.
[56] Pub. L. No. 106-102 § 307(b), 15 U.S.C. § 6716(b).
[57] FDIC in its role as the overseer of the deposit insurance fund
serves as the secondary bank supervisor.
[58] 69 Fed. Reg. at 34431.
[59] 17 C.F.R. § 240.15c3-1(c)(13)(ii).
[60] In the preamble to the CSE regulation, SEC referred to savings and
loan holding companies as entities whose consolidated supervisory
scheme remains subject to this determination. 69 Fed. Reg. at 34432 n.
25.
[61] GAO, Long-Term Capital Management: Regulators Need to Focus
Greater Attention on Systemic Risk, GAO/GGD-00-3 (Washington, D.C.:
Oct. 29, 1999).
[62] According to the Federal Reserve, as of September 2006, 20
domestic and 13 foreign banking organizations supervised by the Federal
Reserve were conducting insurance underwriting activities under the
Financial Holding Company authority of GLBA. As of the same date, 201
domestic and 12 foreign bank holding companies supervised by the
Federal Reserve were engaged in insurance agency activities under the
Financial Holding Company authority of GLBA.
[63] At the suggestion of one of the supervisory agencies, we included
a foreign-headquartered holding company in our selected firms.
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