1

Overview of Foreign Bank Overview of Foreign Bank Supervision in the United StatesSupervision in the United States

World Bank/International Monetary Fund/Federal Reserve SystemWorld Bank/International Monetary Fund/Federal Reserve SystemSeminar for Senior Bank Supervisors from Emerging EconomiesSeminar for Senior Bank Supervisors from Emerging Economies

Monday, October 27, 2008Monday, October 27, 2008

Jack P. Jennings, IIJack P. Jennings, IIAssociate DirectorAssociate Director

Board of Governors of the Board of Governors of the Federal Reserve SystemFederal Reserve System

2

The FBO Community in the The FBO Community in the United States (1)United States (1)

December 31, 2007December 31, 2007175 foreign banking organizations175 foreign banking organizationsTotal 3Total 3rdrd party U.S. assets: $5.4 trillion (Banking, $2.4 trillion; party U.S. assets: $5.4 trillion (Banking, $2.4 trillion; nonbanking, $3.0 trillion) nonbanking, $3.0 trillion) Total U.S. OBS assets = $38 trillionTotal U.S. OBS assets = $38 trillionTop 5 FBO countries by total 3Top 5 FBO countries by total 3rdrd party U.S. assets (in order): party U.S. assets (in order): UK, Germany, Switzerland, France, CanadaUK, Germany, Switzerland, France, Canada

Total 3Total 3rd rd partyparty U.S. assets of their FBOs: $4.4 trillion (81% of U.S. assets of their FBOs: $4.4 trillion (81% of FBO total)FBO total)

Strong, continuous growth in European FBOs’ nonbank assets Strong, continuous growth in European FBOs’ nonbank assets (primarily broker(primarily broker--dealers) and their U.S. bank subsidiaries dealers) and their U.S. bank subsidiaries

2

33

444

555

6

Legal Vehicles Available to FBOs To Legal Vehicles Available to FBOs To Create a Presence in the United StatesCreate a Presence in the United States

Representative OfficeRepresentative Office –– May not book loans or depositsMay not book loans or depositsBranch / AgencyBranch / Agency –– Licensed by States or OCC. Most common Licensed by States or OCC. Most common structure.structure.

Not separately capitalized, but may be subject to asset pledgeNot separately capitalized, but may be subject to asset pledgeGenerally, an agency cannot accept deposits from U.S. residents Generally, an agency cannot accept deposits from U.S. residents or or U.S. citizensU.S. citizensA Branch can accept deposits >$100,000:A Branch can accept deposits >$100,000:

FDICFDIC--insured branch can accept “retail” deposits (i.e., insured branch can accept “retail” deposits (i.e., less than $100,000)less than $100,000)

Business: “Wholesale” Business: “Wholesale” –– Trade finance; Corporate; Cap. Mkts.Trade finance; Corporate; Cap. Mkts.International Banking Facility (“IBF”) International Banking Facility (“IBF”) –– Offshore banking vehicle Offshore banking vehicle within a branch or agency with a separate set of accounting bookwithin a branch or agency with a separate set of accounting bookss

U.S. Bank SubsidiaryU.S. Bank Subsidiary –– Often a major management challenge for FBOOften a major management challenge for FBOU.S. Bank (or Financial) Holding CompanyU.S. Bank (or Financial) Holding CompanyEdge or Agreement CorporationEdge or Agreement CorporationNonbanking companiesNonbanking companies, e.g., broker, e.g., broker--dealer, commercial finance dealer, commercial finance subsidiary, etc. Area of largest growth for FBOs in past decadesubsidiary, etc. Area of largest growth for FBOs in past decade..

7

U.S. Bank Supervisors:U.S. Bank Supervisors:Who Supervises What Who Supervises What –– Domestic and ForeignDomestic and Foreign

Federal Reserve (“FR”)Federal Reserve (“FR”)Financial Holding Companies Financial Holding Companies (“FHC”) and Bank Holding (“FHC”) and Bank Holding Companies (“BHC”)Companies (“BHC”)State licensed branches and State licensed branches and agenciesagenciesRepresentative OfficesRepresentative OfficesEdge Act and Agreement Edge Act and Agreement CorporationsCorporationsState member banksState member banksNonNon--banks, banks, except for brokerexcept for broker--dealers (which dealers (which SEC SEC supervises)supervises)

* * The FR serves as the “umbrella” The FR serves as the “umbrella” supervisor for foreign banking supervisor for foreign banking organizations (“FBO”)organizations (“FBO”)

StatesStatesStateState--licensed branches and licensed branches and agenciesagenciesState member and nonmember State member and nonmember banksbanks

OCCOCCFederally licensed branches Federally licensed branches and agenciesand agenciesNational banksNational banks

FDICFDICState nonmember banksState nonmember banksInsured state licensed branches Insured state licensed branches and agenciesand agencies

8

Legal Framework for FBO Supervision Legal Framework for FBO Supervision (1) (1) -- IBAIBA

International Banking Act, 1978International Banking Act, 1978Substantially equalized treatment (“national treatment”) of Substantially equalized treatment (“national treatment”) of U.S. operations of foreign and U.S. banks:U.S. operations of foreign and U.S. banks:

Federal charter became available: choice of Federal or State Federal charter became available: choice of Federal or State Establish or acquire Edge Act CorporationsEstablish or acquire Edge Act CorporationsObliged to elect “home state” and limit depositObliged to elect “home state” and limit deposit--taking, but:taking, but:

oo Existing depositExisting deposit--taking offices “grandfathered”taking offices “grandfathered”Nonbank powers limited to those of a U.S. BHCNonbank powers limited to those of a U.S. BHCReserve requirements imposed on branches and agenciesReserve requirements imposed on branches and agenciesPrimary responsibility for examination and supervision assigned Primary responsibility for examination and supervision assigned to to the States and OCCthe States and OCC

9

Legal Framework for FBO Supervision Legal Framework for FBO Supervision (2) (2) -- FBSEAFBSEA

Foreign Bank Supervision Enhancement Act, Foreign Bank Supervision Enhancement Act, 1991:1991:

Established and expanded oversight role of the Established and expanded oversight role of the Federal Reserve Federal Reserve –– including power to terminateincluding power to terminate

Approval of FBO presence Approval of FBO presence -- Application process and CCS Application process and CCS (“(“CComprehensive omprehensive CConsolidated onsolidated SSupervisionupervision”) determination”) determinationDirected FR to examine FBO branches and agencies annually Directed FR to examine FBO branches and agencies annually FR coordinates FBO supervision with other U.S. supervisorsFR coordinates FBO supervision with other U.S. supervisorsProhibited FBO branches from applying for deposit insuranceProhibited FBO branches from applying for deposit insuranceTermination: (1) if FBO not subject to CCS; (2) if FBO violates Termination: (1) if FBO not subject to CCS; (2) if FBO violates law law or engages in unsafe/unsound banking practices in the U.S.or engages in unsafe/unsound banking practices in the U.S.

10

Legal Framework for FBO Supervision Legal Framework for FBO Supervision (3) (3) -- RiegleRiegle--NealNeal

RiegleRiegle--Neal Interstate Banking and Branching Neal Interstate Banking and Branching Efficiency Act, 1994Efficiency Act, 1994

National treatment for FBOs in interstate banking and branching:National treatment for FBOs in interstate banking and branching:Foreign banks and their U.S. subsidiaries given the same right Foreign banks and their U.S. subsidiaries given the same right as U.S. banks to establish as U.S. banks to establish de novode novo branches outside their home branches outside their home state and to establish interstate branches through mergers with state and to establish interstate branches through mergers with banks in other statesbanks in other statesOffshore shell branches of FBOs managed or controlled by Offshore shell branches of FBOs managed or controlled by U.S. branches and agencies may only manage the same types of U.S. branches and agencies may only manage the same types of activities permissible for foreign branches and subsidiaries of activities permissible for foreign branches and subsidiaries of U.S. banksU.S. banksStates can give neither U.S. nor foreign banks preferential States can give neither U.S. nor foreign banks preferential treatmenttreatment

11

Legal Framework for FBO Supervision Legal Framework for FBO Supervision (4) (4) -- GLBAGLBA

GrammGramm--LeachLeach--Bliley Act, 1999Bliley Act, 1999GLBA codified and rationalized the erosion of barriers GLBA codified and rationalized the erosion of barriers between the banking, securities, mutual fund, and insurance between the banking, securities, mutual fund, and insurance industries:industries:

The heart of GLBA is the authorization of Financial Holding The heart of GLBA is the authorization of Financial Holding Companies (“FHC”)Companies (“FHC”)

oo Banking Banking –– Securities Securities –– Insurance Insurance –– Mutual Fund Mutual Fund –– Merchant banking Merchant banking oo FBOs can apply for FHC statusFBOs can apply for FHC status

“Well“Well--Capitalized” and “WellCapitalized” and “Well--managed” criteriamanaged” criteriaNational and state banks also permitted to establish “financial National and state banks also permitted to establish “financial subsidiaries” engaged in new powers conferred by GLBAsubsidiaries” engaged in new powers conferred by GLBA“Functional Regulation” “Functional Regulation” –– FR is “umbrella” supervisorFR is “umbrella” supervisor

12

FBO Applications FBO Applications Legal and Regulatory Framework Legal and Regulatory Framework

FR Board authorization is required to establish a FR Board authorization is required to establish a branch, agency, or representative office in the US branch, agency, or representative office in the US

Requirement is contained in the Foreign Bank Supervision Requirement is contained in the Foreign Bank Supervision Enhancement Act of 1991 (FBSEA), which amended the Enhancement Act of 1991 (FBSEA), which amended the International Banking Act of 1978International Banking Act of 1978

Standards for authorization are in FBSEA and the FR Standards for authorization are in FBSEA and the FR Board’s Regulation KBoard’s Regulation K

Applications to establish U.S. banking subsidiaries are Applications to establish U.S. banking subsidiaries are filed under the Bank Holding Company Act (“BHC filed under the Bank Holding Company Act (“BHC Act”) and the FR Board’s Regulation YAct”) and the FR Board’s Regulation Y

13

Comprehensive Consolidated Comprehensive Consolidated Supervision (CCS)Supervision (CCS)

Under FBSEA:Under FBSEA:“Required standards for approval “Required standards for approval –– The Board may The Board may not approve an application…unless it determines not approve an application…unless it determines that ..the foreign bank engages directly in the that ..the foreign bank engages directly in the business of banking outside of the United States and business of banking outside of the United States and is subject to comprehensive supervision or is subject to comprehensive supervision or regulation on a consolidated basis by the appropriate regulation on a consolidated basis by the appropriate authorities in its home country.”authorities in its home country.”

CCS applies to branches, agencies, and subsidiary banks CCS applies to branches, agencies, and subsidiary banks of the FBO in the U.S.of the FBO in the U.S.

14

Comprehensive Consolidated Comprehensive Consolidated Supervision (CCS) Supervision (CCS) -- 22

Under the Board’s Regulation K, the objective of CCS Under the Board’s Regulation K, the objective of CCS analysis is: analysis is:

“…(to) determine whether the foreign bank is supervised or regul“…(to) determine whether the foreign bank is supervised or regulated ated in such a manner that its home country supervisor receives suffiin such a manner that its home country supervisor receives sufficient cient information on the worldwide operations of the foreign bank information on the worldwide operations of the foreign bank (including the relationships of the bank to any affiliate) to as(including the relationships of the bank to any affiliate) to assess the sess the foreign bank's overall financial condition and compliance with lforeign bank's overall financial condition and compliance with law and aw and regulation.” regulation.”

Not a rigid formulaNot a rigid formulaLooks to same objectives as Basel Core PrinciplesLooks to same objectives as Basel Core PrinciplesThe Board may approve an application by the FBO, “…if (1) the The Board may approve an application by the FBO, “…if (1) the home country supervisor is actively working to establish arrangehome country supervisor is actively working to establish arrangements ments for the consolidated supervision of such bank.” (Regulation K)for the consolidated supervision of such bank.” (Regulation K)

The Board also shall consider whether the foreign bank has The Board also shall consider whether the foreign bank has adopted and implemented procedures to combat money adopted and implemented procedures to combat money laundering laundering

15

Comprehensive Consolidated Comprehensive Consolidated Supervision (CCS) Supervision (CCS) -- 33

Regulation K requires the Board to review the extent to which Regulation K requires the Board to review the extent to which the foreign supervisor the foreign supervisor

Ensures that the foreign bank has adequate procedures for monitoEnsures that the foreign bank has adequate procedures for monitoring ring and controlling its activities worldwide;and controlling its activities worldwide;Obtains information on the condition of the foreign bank and itsObtains information on the condition of the foreign bank and itssubsidiaries and offices outside the home country through regulasubsidiaries and offices outside the home country through regular reports r reports of examination, audit reports, or otherwise;of examination, audit reports, or otherwise;Obtains information on the dealings and relationship between theObtains information on the dealings and relationship between the foreign foreign bank and its affiliates, both foreign and domestic;bank and its affiliates, both foreign and domestic;Receives from the foreign bank financial reports that are consolReceives from the foreign bank financial reports that are consolidated on idated on a worldwide basis, or comparable information that permits analysa worldwide basis, or comparable information that permits analysis of the is of the foreign bank's financial condition on a worldwide, consolidated foreign bank's financial condition on a worldwide, consolidated basis;basis;Evaluates prudential standards, such as capital adequacy and risEvaluates prudential standards, such as capital adequacy and risk asset k asset exposure, on a worldwide basis.”exposure, on a worldwide basis.”

16

Financial Holding Company Criteria Financial Holding Company Criteria for FBOs in the U.S.for FBOs in the U.S.

To qualify for FHC status, FBOs must be:To qualify for FHC status, FBOs must be:““WellWell--capitalizedcapitalized”” –– Under whose standard? The Under whose standard? The home countryhome countrysupervisor (must be BIS basis)supervisor (must be BIS basis)

Tier 1 capital of 6% or greater Tier 1 capital of 6% or greater Total Capital of 10% or greaterTotal Capital of 10% or greater

&…&…““WellWell--managedmanaged”” –– TThe composite rating for U.S. branch, agency, and commercial lending company operations (“combined ROCA”) must be at least satisfactory

If the FBO also owns a U.S. subsidiary bank, that bank must be If the FBO also owns a U.S. subsidiary bank, that bank must be "Well capitalized" -- Tier 1 of 6% or greater, Total Capital of 10% or greater, AND a Tier 1 leverage ratio of 5 percent or greater"Well managed" with a composite rating of at least Satisfactory, including a Management component rating of at least Satisfactory

17

Role of Host SupervisorRole of Host Supervisor

Evaluates the overall ability of FBO to support its U.S. Evaluates the overall ability of FBO to support its U.S. operationsoperationsMaintains an understanding of global risk management Maintains an understanding of global risk management and control systems as applied to U.S. operationsand control systems as applied to U.S. operationsNeeds to have full access to information concerning Needs to have full access to information concerning U.S. operations of FBOsU.S. operations of FBOsExchanges information with home supervisor and Exchanges information with home supervisor and coordinates when supervisory followcoordinates when supervisory follow--up is necessaryup is necessary

18

Operating Framework of Operating Framework of RiskRisk--Focused Supervision Focused Supervision

The methodologies and practice of riskThe methodologies and practice of risk--focused supervision have focused supervision have evolved substantially since the midevolved substantially since the mid--1990s when it was first 1990s when it was first phasedphased--in at the largest U.S. bank holding companies (SR93in at the largest U.S. bank holding companies (SR93--69, 69, et alet al.).)The process for supervising the U.S. operations of FBOs and The process for supervising the U.S. operations of FBOs and U.S. banking organizations has many common elementsU.S. banking organizations has many common elementsThe program framework for supervising The program framework for supervising large, complex FBOslarge, complex FBOs in in particular has five core components:particular has five core components:

Designation of a Central Point of Contact (“CPC”)Designation of a Central Point of Contact (“CPC”)Review of functional activities (rather than legal entity Review of functional activities (rather than legal entity approach)approach)Focus on risk management Focus on risk management processesprocessesTailoring of supervisory activitiesTailoring of supervisory activitiesEmphasis on continuous supervisionEmphasis on continuous supervision

19

Operating Framework of Operating Framework of RiskRisk--Focused Supervision (2)Focused Supervision (2)

A “Responsible” Reserve Bank (“RRB”) oversees the entire A “Responsible” Reserve Bank (“RRB”) oversees the entire process and ensures that all examination activities, conducted bprocess and ensures that all examination activities, conducted by y any bank or nonany bank or non--bank regulatory agency, are performed in a bank regulatory agency, are performed in a coordinated and consistent manner. Thus, the RRB: coordinated and consistent manner. Thus, the RRB:

Coordinates development of and execution of supervisory strategyCoordinates development of and execution of supervisory strategyPrepares the annual Summary of Condition of U.S. operations of Prepares the annual Summary of Condition of U.S. operations of the FBOthe FBOManages the supervisory relationship with U.S. regional and headManages the supervisory relationship with U.S. regional and headoffice management of FBOoffice management of FBOEngages in and manages the dialogue with the FBO’s home Engages in and manages the dialogue with the FBO’s home country supervisorscountry supervisors

The CPC and a team of examiners work onsite on a yearThe CPC and a team of examiners work onsite on a year--round round basis at large complex foreign banks, interacting with bank basis at large complex foreign banks, interacting with bank management as often as requiredmanagement as often as required

20

Risk-Focused Supervision Process

IV. Determine and communicate the overall condition of the FBO’s

U.S. Operations

I. Understand the FBOincluding an assessment

of its risks

Risk-FocusedBanking

Supervision

III. Execute the Supervisory Plan and report results

II. Plan and DefineSupervisory ActivitiesSupervisory Activities

21

Understand the FBO Understand the FBO

Principal products for understanding the FBO:Principal products for understanding the FBO:Institutional OverviewInstitutional Overview –– Executive summary of FBO’s Executive summary of FBO’s structure, businesses, funding/liquidity, governancestructure, businesses, funding/liquidity, governanceRisk AssessmentRisk Assessment –– Types of Risk, Magnitude, TrendsTypes of Risk, Magnitude, TrendsSupervisory PlanSupervisory Plan –– Calendar of planned supervisory Calendar of planned supervisory activities and resource requirementsactivities and resource requirementsOverview of Home Country Financial SystemOverview of Home Country Financial System –– Structure, Structure, operating environment, bank supervisory frameworkoperating environment, bank supervisory frameworkSOSASOSA –– Financials, home country banking supervisory Financials, home country banking supervisory system and capabilities, transfer risksystem and capabilities, transfer risk

22

Understand the FBO (2) Understand the FBO (2) Prior to developing a risk assessment and supervisory Prior to developing a risk assessment and supervisory plan, develop an understanding of U.S. operations and plan, develop an understanding of U.S. operations and the interface with head office and the home countrythe interface with head office and the home country

At the U.S. operations level document and understand:At the U.S. operations level document and understand:The FBO’s corporate strategyThe FBO’s corporate strategySignificant activities in the U.S. Significant activities in the U.S. –– revenue and risk drivers, revenue and risk drivers, business lines, products, capital allocations, etc.business lines, products, capital allocations, etc.Structure of U.S. businesses and legal entity structuresStructure of U.S. businesses and legal entity structuresGovernance and primary risk management and internal Governance and primary risk management and internal controls controls –– head office oversight, reporting relationships head office oversight, reporting relationships between U.S. and head officebetween U.S. and head officeFunding and Liquidity for U.S. operationsFunding and Liquidity for U.S. operationsPresence in key financial market activitiesPresence in key financial market activities

23

Understand the FBO (3)Understand the FBO (3)The SOSA process The SOSA process

SOSA SOSA –– SStrength trength oof f SSupport upport AAssessment ssessment Analytical factors considered for H.O. and home country level:Analytical factors considered for H.O. and home country level:

Overview of the consolidated FBOOverview of the consolidated FBOOwnership, organization, businesses, strategies, financialsOwnership, organization, businesses, strategies, financials

Home country supervisory systemHome country supervisory systemSupervisory approach, policies and practicesSupervisory approach, policies and practicesOnOn--site exams and offsite exams and off--site surveillancesite surveillanceIndependenceIndependenceRecord of resolving banking problemsRecord of resolving banking problems

Home country financial systemHome country financial systemOperating environment, accounting practices, financial Operating environment, accounting practices, financial reporting practicesreporting practices

24

Understand the FBOUnderstand the FBOAssessment of RisksAssessment of Risks

A key element of the supervisory planning process is A key element of the supervisory planning process is identifying and assessing risks to be factored into the identifying and assessing risks to be factored into the annual supervisory strategy and exam plansannual supervisory strategy and exam plans

Products are a Products are a Risk AssessmentRisk Assessment and a and a Risk MatrixRisk Matrix, , identifying types of activities and types and levels of identifying types of activities and types and levels of risk including trends risk including trends

All key risks of the FBO’s U.S. operations must be All key risks of the FBO’s U.S. operations must be documented, described and assessed documented, described and assessed

25

Understand the FBO Understand the FBO Assessment of Risks (2)Assessment of Risks (2)

A Risk Matrix identifiesA Risk Matrix identifiessignificant activities significant activities the type and level of inherent risks in these activities, and the type and level of inherent risks in these activities, and the adequacy of risk management over these activities the adequacy of risk management over these activities

A matrix can be developed for the consolidated A matrix can be developed for the consolidated organization, for a separate affiliate, or along functional organization, for a separate affiliate, or along functional business linesbusiness lines

The matrix contains a brief heading of key risks and a The matrix contains a brief heading of key risks and a supervisory assessment thereof, and serves as a tool to supervisory assessment thereof, and serves as a tool to prepare the more detailed risk assessmentprepare the more detailed risk assessment

26

Understand the FBO Understand the FBO Assessment of Risks (3)Assessment of Risks (3)

27

Understand the FBOUnderstand the FBOAssessment of Risks (4)Assessment of Risks (4)

The six Federal Reserve risk dimensions are: The six Federal Reserve risk dimensions are: Market Market CreditCreditLiquidity Liquidity Operational Operational Reputational Reputational LegalLegal

The risk matrix is not formulaThe risk matrix is not formula--driven: it relies primarily on a driven: it relies primarily on a judgmental assessment of the risks in principal business lines ajudgmental assessment of the risks in principal business lines as s noted by the CPC and/or teamnoted by the CPC and/or team

Both the risk matrix and risk assessments are reviewed and Both the risk matrix and risk assessments are reviewed and updated throughout the examination cycleupdated throughout the examination cycle

28

Plan & Define Supervisory Activities Plan & Define Supervisory Activities

RiskRisk--focused approachfocused approach::SOSA+Risk Assessment+Judgment SOSA+Risk Assessment+Judgment …Supervisory Plan+Examination Program…Supervisory Plan+Examination Program

Prioritize supervisory resources based on riskPrioritize supervisory resources based on riskCoordinate reviews and examinationsCoordinate reviews and examinationsStrong focus on (a) riskStrong focus on (a) risk--management, (b) management, (b) compliance, and (c) controls compliance, and (c) controls

29

Plan & Define Supervisory Activities (2)Plan & Define Supervisory Activities (2)

30

Execute the Supervisory Plan Execute the Supervisory Plan Understanding and assessing risk management is at the Understanding and assessing risk management is at the core of all examination activitiescore of all examination activitiesAll of the following are reviewed at every FBO:All of the following are reviewed at every FBO:

Corporate governance functions for U.S. operationsCorporate governance functions for U.S. operationsPrimary risk management and internal control functions for Primary risk management and internal control functions for U.S. operationsU.S. operationsRisk management of material portfolios and business linesRisk management of material portfolios and business linesRisk management of key financial markets activitiesRisk management of key financial markets activitiesFunding and liquidity management of U.S. operationsFunding and liquidity management of U.S. operations

31

Execute the Supervisory Plan (2)Execute the Supervisory Plan (2)In addition, the following are reviewed at certain In addition, the following are reviewed at certain large, complex FBOslarge, complex FBOs

Core clearing and settlement activitiesCore clearing and settlement activitiesFor largeFor large--value payment system operators and market value payment system operators and market utilities utilities –– Focus is on systemic riskFocus is on systemic risk

Significant presence in “critical financial markets”Significant presence in “critical financial markets”Fed funds, F/X, CP, U.S. govt. and agency securities, and Fed funds, F/X, CP, U.S. govt. and agency securities, and corporate debt and equity securitiescorporate debt and equity securities

Issues and developments in areas of emerging Issues and developments in areas of emerging interest with potential financial market consequencesinterest with potential financial market consequences

32

Execute the Supervisory Plan (3) Execute the Supervisory Plan (3) Funding and liquidity are central to FBO supervisionFunding and liquidity are central to FBO supervision

The SOSA analysis is vital to understanding the liquidity and The SOSA analysis is vital to understanding the liquidity and funding profile of the parent FBOfunding profile of the parent FBOOther areas of focus include:Other areas of focus include:

Liquidity and funding structure of U.S. operations, including Liquidity and funding structure of U.S. operations, including subsidiary U.S. banks and any U.S. BHCssubsidiary U.S. banks and any U.S. BHCsLiquidity management policies and practices of all U.S. Liquidity management policies and practices of all U.S. operationsoperationsDegree of reliance on parent FBO for fundingDegree of reliance on parent FBO for fundingAdequacy of funding contingency plans, including strategy for Adequacy of funding contingency plans, including strategy for handling a liquidity crisishandling a liquidity crisis

33

Recent Enhanced Supervisory Recent Enhanced Supervisory Guidance for FBOsGuidance for FBOs

SR08SR08--99: : Consolidated Supervision of Bank Holding Companies and Consolidated Supervision of Bank Holding Companies and the combined U.S. Operations of FBOsthe combined U.S. Operations of FBOs -- October 16, 2008October 16, 2008

Provides enhanced guidance for understanding and assessing bankiProvides enhanced guidance for understanding and assessing banking ng organizations and outlines importance of organizations and outlines importance of testing testing Requires tests of the control processes on at least a 3Requires tests of the control processes on at least a 3--year cycle, and at year cycle, and at least an annual reassessment, of:least an annual reassessment, of:

Internal audit infrastructureInternal audit infrastructureParent company and nonbank funding and liquidity (in the case ofParent company and nonbank funding and liquidity (in the case of FBOs, FBOs, funding and liquidity of U.S. operations)funding and liquidity of U.S. operations)Where applicable, core clearance and settlement activities Where applicable, core clearance and settlement activities Where applicable, activities in critical financial markets in whWhere applicable, activities in critical financial markets in which the ich the organization plays a significant roleorganization plays a significant role

More testing encouraged if concerns exist regarding information More testing encouraged if concerns exist regarding information gaps, gaps, risk management systems and internal controls, problems with a risk management systems and internal controls, problems with a banking subsidiary, corporate governance, etc. banking subsidiary, corporate governance, etc. Testing should be coordinated with domestic primary supervisors Testing should be coordinated with domestic primary supervisors and and functional regulators to extent possiblefunctional regulators to extent possible

34

Determine the Overall Condition of Determine the Overall Condition of the FBO’s U.S. Operations the FBO’s U.S. Operations

ROCAROCA –– RRisk Management, isk Management, OOperations, perations, CCompliance, and ompliance, and AAsset Qualitysset QualityApplies to FBO branches and agencies onlyApplies to FBO branches and agencies only

Capital is not an issue since they have none in the U.S. (other Capital is not an issue since they have none in the U.S. (other than than some form of capital equivalency)some form of capital equivalency)

The ROCA rating operates on similar principles to the CAMELS ratThe ROCA rating operates on similar principles to the CAMELS rating ing systemsystem

Annually, Annually, a combined ROCA ratinga combined ROCA rating is developed for all U.S. branches and is developed for all U.S. branches and agencies of an FBOagencies of an FBO

The Combined ROCA rating is a key factor in determining whether The Combined ROCA rating is a key factor in determining whether an an FBO is “wellFBO is “well--managed” and therefore entitled to retain or apply for FHC managed” and therefore entitled to retain or apply for FHC status status

Also annually, Also annually, a Rating for Combined U.S. Operationsa Rating for Combined U.S. Operations is developedis developedThis rating takes account of This rating takes account of allall U.S. supervisory ratings including any U.S. supervisory ratings including any CAMELS or RFI/C ratings arising from the FBO’s ownership and/or CAMELS or RFI/C ratings arising from the FBO’s ownership and/or control of U.S. banking organizationscontrol of U.S. banking organizations

35

StrengthStrength--ofof--Support Assessment Support Assessment Rankings Rankings

The SOSA is ranked on a scale of 1 to 3 with 1 being The SOSA is ranked on a scale of 1 to 3 with 1 being the highest or best ranking and 3 the lowest or worst the highest or best ranking and 3 the lowest or worst rankingranking

In general, an FBO with a SOSA ranking of “2” is In general, an FBO with a SOSA ranking of “2” is subject to more than normal supervisory surveillance subject to more than normal supervisory surveillance

Those ranked “3” may be subject to specific Those ranked “3” may be subject to specific supervisory procedures to ensure that they can honor supervisory procedures to ensure that they can honor their U.S. obligations at all timestheir U.S. obligations at all times

36

Rating Systems for U.S. banks Rating Systems for U.S. banks and subsidiary U.S. banks of FBOsand subsidiary U.S. banks of FBOs

Different rating systems are used for different types Different rating systems are used for different types of banking organizationsof banking organizations

CAMELSCAMELS for U.S. commercial banksfor U.S. commercial banksRFI/CRFI/C for U.S. BHCs and FBO topfor U.S. BHCs and FBO top--tier U.S. BHCstier U.S. BHCs

CAMELS CAMELS ---- CCapital, apital, AAsset Quality, sset Quality, MManagement, anagement, EEarnings, arnings, LLiquidity, iquidity, SSensitivity to Market Riskensitivity to Market Risk

Note: Note: The composite CAMEL rating as well as theThe composite CAMEL rating as well as theManagement component must always be at least Satisfactory Management component must always be at least Satisfactory (“2”) to apply for or maintain FHC status(“2”) to apply for or maintain FHC status

37

Rating System for Rating System for U.S. Bank Holding CompaniesU.S. Bank Holding Companies

RFI/C (D) RFI/C (D) RRisk Managementisk ManagementFFinancial condition inancial condition (sub(sub--components “CAEL” components “CAEL” –– CCapital, apital, AAsset sset Quality, Quality, EEarnings, arnings, LLiquidity)iquidity)

IImpact mpact –– on U.S. depositoryon U.S. depositoryDDepository Institution(s)epository Institution(s)

Represents a shift to a more forwardRepresents a shift to a more forward--looking looking assessment of Risk Management and financial factorsassessment of Risk Management and financial factors

Applied to the topApplied to the top--tier U.S. BHC subsidiaries of FBOs.tier U.S. BHC subsidiaries of FBOs.

38

Common Features of Rating SystemsCommon Features of Rating Systems

Both CAMELS and RFI/C rating systems range from 1 Both CAMELS and RFI/C rating systems range from 1 (highest quality) to 5 (lowest quality)(highest quality) to 5 (lowest quality)

Composite ratings of “3” (Fair) and worse indicate Composite ratings of “3” (Fair) and worse indicate supervisory concern and carry with them the likelihood supervisory concern and carry with them the likelihood of a formal or informal supervisory action to remedy of a formal or informal supervisory action to remedy problemsproblems

Rating systems remain largely qualitative, demanding Rating systems remain largely qualitative, demanding good judgment by the CPC or Examinergood judgment by the CPC or Examiner--InIn--ChargeCharge

39

Supervisory Tools for Responding Supervisory Tools for Responding to SOSAto SOSA--related Concerns related Concerns

Monitor U.S. operations for areas of concern.Monitor U.S. operations for areas of concern.Assure that adequate contingent funding and Assure that adequate contingent funding and liquidity is in place.liquidity is in place.Restraints on related party transactions Restraints on related party transactions -- require a require a net duenet due--to position.to position.Defined asset maintenance to cover third parties.Defined asset maintenance to cover third parties.Require positive cumulative cash flow.

SOSA 2

Require positive cumulative cash flow.SOSA 3

Some manner of periodic reporting would be required for the above options.

40

Other Supervisory ToolsOther Supervisory ToolsInformal ActionInformal Action

Board ResolutionBoard ResolutionCommitment LetterCommitment LetterMemorandum of Memorandum of UnderstandingUnderstandingNot legally enforceableNot legally enforceableNot public

Formal ActionFormal ActionWritten AgreementWritten AgreementCeaseCease--&&--Desist OrderDesist OrderProhibition OrderProhibition OrderCivil Money Penalty Civil Money Penalty (CMP)(CMP)Legally enforceableLegally enforceablePublicPublic

Enforcement action taken Enforcement action taken against an institution &/or against an institution &/or individual(s)

Not public

individual(s)

41

Communicate the Results of the Communicate the Results of the FBO Supervision Process FBO Supervision Process

Annually, the Federal Reserve communicates in writing Annually, the Federal Reserve communicates in writing the results of the FBO supervision process to the:the results of the FBO supervision process to the:

Head Office Management of the FBOHead Office Management of the FBOResident U.S. management of the FBOResident U.S. management of the FBOHome Country Supervisor of the FBOHome Country Supervisor of the FBO

WhatWhat is communicated?is communicated?1.1. A Summary of Condition of U.S. OperationsA Summary of Condition of U.S. Operations2.2. Rating for Combined U.S. operationsRating for Combined U.S. operations3.3. Combined ROCA ratingCombined ROCA rating4.4. Any corrective actions taken or to be takenAny corrective actions taken or to be taken5.5. The SOSA rankingThe SOSA ranking

42

Information Sharing with Information Sharing with Foreign SupervisorsForeign Supervisors

Information sharing between the FR and bank Information sharing between the FR and bank supervisors in the principal developed economies has supervisors in the principal developed economies has been ongoing for many yearsbeen ongoing for many years

Since the late 1990s, the process has become formalized and Since the late 1990s, the process has become formalized and has been documented in “Memoranda of Understanding”has been documented in “Memoranda of Understanding”The FR has information sharing arrangements in place with The FR has information sharing arrangements in place with bank supervisors in 14 countries (including the European bank supervisors in 14 countries (including the European Commission), Commission), Information sharing arrangements are under negotiation with Information sharing arrangements are under negotiation with supervisors in several additional countriessupervisors in several additional countriesFederal Reserve staff meet with home country supervisors on Federal Reserve staff meet with home country supervisors on trips abroad for widetrips abroad for wide--ranging discussions on banking systems ranging discussions on banking systems and supervisory trends, issues, and initiativesand supervisory trends, issues, and initiatives

43

Information Sharing with Information Sharing with Foreign Supervisors (2)Foreign Supervisors (2)

Today, the Federal Reserve has ongoing dialogue with Today, the Federal Reserve has ongoing dialogue with supervisors globally on a range of issues including FBO supervisors globally on a range of issues including FBO bank examinations, Basel II, and antibank examinations, Basel II, and anti--money launderingmoney laundering

Many bilateral and trilateral discussions are held in the U.S. aMany bilateral and trilateral discussions are held in the U.S. as well s well as overseas at frequent intervals (e.g., quarterly) on large comas overseas at frequent intervals (e.g., quarterly) on large complex plex FBOs, including Basel II plans and implementation, etc.FBOs, including Basel II plans and implementation, etc.Bilateral arrangements can prove helpful in defining the scope oBilateral arrangements can prove helpful in defining the scope of f information to be sharedinformation to be sharedAs a host country supervisor, the Federal Reserve cooperates witAs a host country supervisor, the Federal Reserve cooperates with h the primary home country supervisors of FBOs to facilitate the the primary home country supervisors of FBOs to facilitate the accomplishment of CCS by the home country supervisor.accomplishment of CCS by the home country supervisor.

Additionally, Federal Reserve governors, officers, and staff Additionally, Federal Reserve governors, officers, and staff participate frequently in major multilateral forums on participate frequently in major multilateral forums on supervisory issues supervisory issues