Funds Management and Liquidity Effective date July … Management and Liquidity Effective date July 1997 Section 3200.1 ... liquidity and interest rate risk manage- ... regarding funds

Funds Management and LiquidityEffective date July 1997 Section 3200.1

Funds management is an essential element ofsound planning and financial management forany financial institution. A sound basis forevaluating funds management requires under-standing the branch, its customer mix, the natureof its assets and liabilities, and its economic andcompetitive environment. No single theory canbe applied universally to all branches. Thepurpose of funds management is to ensureadequate liquidity and effectively manage thespread between interest earned and interest paid.Therefore, funds management has two compo-nents: liquidity and interest rate risk manage-ment. This section primarily addresses liquidity.Interest rate risk management is addressed inSection 3210 of this manual, and should be readin conjunction with this section.

LIQUIDITY

Liquidity is defined as the ability to meet assetand liability obligations without delay, includingthe funding of loan commitments. In a soundliquidity management system, it is essential fora branch to provide for fluctuations in its bal-ance sheet and meet immediate or day-to-dayobligations as opposed to providing funds forlong-term growth.

A branch generally has both internal andexternal sources of liquidity. Internal sources ofliquidity include short-term, high-quality assetsthat are readily convertible to cash at a reason-able cost. External sources of liquidity includeborrowings from related offices of the foreignbanking organization (FBO), other financialinstitutions, and overnight or short-termdepositors.

The price of liquidity is a function of generalmarket conditions and the market’s perceptionof the FBO. Generally, the higher the risk profileof the FBO, the higher the FBO’s cost of fundsand the greater its need to meet liquidity demandsthrough the management of its liabilities. Gen-erally, the market perception of the branch canbe no better than the market perception of theFBO.

BRANCH/FBO RELATIONSHIP

Liquidity at a branch is closely integrated with

that of the FBO. While a branch, on a standalone basis, may be able to obtain sufficientfunding at a reasonable cost (by either increas-ing funding sources or converting assets tocash), from a market standpoint, there is nodistinction between the branch and the FBO.Even if all of the branch’s assets consisted ofhigh-quality, liquid securities, liquidity wouldstill be influenced by the market perception ofthe FBO as a whole.

In evaluating funds management and liquid-ity, the examiner should begin with an under-standing of the FBO’s current financial situationand be familiar with any potential liquidityconcerns that could affect the branch.1 Gener-ally, if the FBO is in sound financial conditionand has satisfactory market ratings, the evalua-tion of liquidity at the branch will be a lesserconcern. In such a case, the examiner shouldlimit the analysis of liquidity to (1) reviewinginformation supporting the adequacy of liquidityat the FBO, (2) developing a thorough under-standing of the branch’s funds management andliquidity profile, and (3) reviewing how thebranch’s funding and liquidity are guided andmonitored, either directly or indirectly, by thehead office and/or a U.S. regional office.

In contrast, if the FBO’s current financialcondition or market perception raises concernsregarding funds management and liquidity, theexaminer should conduct a more in-depth evalu-ation of branch liquidity. The evaluation shouldconsider the branch’s funds management profilewith close attention to: (1) funding sources;(2) liquidity and funding gaps; (3) funds man-agement policy guidance from the head office;(4) current economic and market conditions; and(5) the adequacy of the contingency fundingplan. The examiner should be prepared to makerecommendations to address any identified orpotential concerns at the branch and, if appro-priate, at other U.S. or U.S.-managed or con-trolled offshore operations.

FBOs with multiple U.S. operations may cen-tralize funds management and liquidity at aregional U.S. office. The examination of such aregional U.S. office, therefore, should include anevaluation of funds management and liquidity

1. This information is available to examiners as a part ofthe FBO’s annual strength of support assessment. Examinersshould review this assessment as a part of the pre-examinationplanning process, and be prepared to consider this informationin evaluating the branch’s funds management and liquidity.

Branch and Agency Examination Manual September 1997Page 1

for the branch’s entire area of responsibility,including any U.S.-managed or controlled off-shore operations.

FUNDS MANAGEMENT ANDLIQUIDITY PROFILE

The examiner should understand and evaluatethe branch’s funding and liquidity profile.Regardless of the condition of the FBO, thebranch’s funding profile, or whether the branchmanages its own funding needs, this reviewshould begin with an understanding of the FBO’sfunds management guidelines and practices forthe branch. Head office should provide branchmanagement with funds management and liquid-ity guidelines and some method of daily moni-toring compliance with these guidelines. Gener-ally, the greater the complexity of the branch orits responsibilities in funds management andliquidity, the more comprehensive the guide-lines and monitoring practices.

A major point to consider in evaluating branchliquidity is whether the FBO views the branch asa net user or provider of funds. The examinershould determine if the FBO has been a consis-tent supplier of funds, or whether the branch actsas a dollar funding vehicle for the FBO. Thisdetermination, which is particularly important ifthe FBO raises liquidity concerns, will be evi-dent from the trend in the net ‘‘Due From’’position with related parties. The examinershould review a period of branch quarterlyReports of Assets and Liabilities (FFIEC 002) todetermine the direction, volume, and frequencyof the flow of funds between the branch and itshead office or other related parties, includingU.S.-managed or controlled offshore operations.The examiner should take into considerationthat an analysis of quarter-end reports may notprovide a true picture of ongoing activities dueto certain types of balance sheet window dress-ing activities employed by the branch. Averagestatements of condition should be obtained inorder to get a true picture of branch liquidityover time. From a supervisory viewpoint, a netdue to position is regarded more favorably thana net due from position because it provides acushion for nonrelated depositors and creditors.However, any recommendations related to thebranch’s funding role should be considered inrelation to the FBO’s overall financial conditionand other factors discussed in this section. For

additional information on funding transactionswith related parties, refer to Section 3240, DueFrom/Due To Related Parties.

The evaluation of funds management andliquidity should also consider the branch’s costand distribution of funds; economic and markettrends; levels of liquid assets; future earningscapacity; asset quality; concentrations; customermix; the nature and mix of its assets andliabilities, including maturity, currency andrepricing mismatches; and its anticipated fund-ing needs. Generally, these considerations aremore significant if the branch manages its ownfunding and liquidity needs.

The remaining discussion is applicable tobranches that are not simply net users of fundsand have some degree of control over theirfunds management.

POLICY GUIDANCE

Branch management is expected to maintainpolicies and procedures approved by head officethat facilitate the development of funding andliquidity strategies. Policies and proceduresshould provide an outline of goals regarding theFBO’s asset and liability management, liquidity,off-balance-sheet exposure, degree of risk toler-ance, and other relevant factors. The individualor committee responsible for funds managementdecisions, including monitoring anticipated fund-ing needs, funding strategies, guidelines andlimitations, should be specified in the policiesand procedures. The depth of these policies andprocedures will depend upon the degree towhich branch management is responsible forfunds management. In some cases, the headoffice or U.S. regional management is largelyresponsible for funds management at the branch.In other cases, responsibility rests with localbranch management.

Policy statements should address limitationson funding sources to avoid a concentration toany one source or grouping. They also shouldidentify alternative funding sources, the degreeof support dictated by the FBO, and the natureof that support. Interest rate sensitivity match-ing, maturity matching, and the use of financialderivatives may be addressed under these poli-cies or in a separate interest rate risk policy.Written procedures should provide staff with areference document on the day-to-day proce-

3200.1 Funds Management and Liquidity

September 1997 Branch and Agency Examination ManualPage 2

dures in funding and provide for a system ofinternal control in critical areas, such as separa-tion of duties, proper completion of reports, andmonitoring of limits. Refer to Interest Rate RiskManagement, Section 3210 for additional infor-mation on policies and procedures.

MANAGEMENT INFORMATIONSYSTEMS

An effective Management Information System(MIS) is integral to making sound funds man-agement and liquidity decisions and is a factorin evaluating the branch’s financial controls.Reports containing certain basic informationshould be prepared and reviewed regularly bymanagement. Report content and format willvary among branches; however, an effectiveMIS will contain reports detailing liquidity needsand the sources of funds available to meet thoseneeds. Typically MIS may include the follow-ing: the maturity distribution of assets andliabilities, and the related gaps, including maxi-mum and minimum liquidity needs; expectedfunding of commitments; asset yields; liabilitycosts; net interest margins and variances (bothfrom prior months and budget); funding vol-umes by liability, customer, market, andovernight/short-term funds; and exceptions topolicy guidelines and limits. Refer to Section3410, Management Information Systems, foradditional information.

FUNDING AND LIQUIDITYPRACTICES

A branch responsible for its own funding andliquidity needs may meet those needs bymanipulating its asset structure through the saleor planned runoff of short-term or readily mar-ketable assets. As an alternative, the branchcould transfer to the head office or other relatedoffices, a block of assets that would serve toreduce its asset base and increase liquidity. As amatter of general practice, however, a branchcan meet its liquidity needs by manipulating itsliability structure to access discretionary fund-ing sources or derive funds from its intercom-pany funding base. The ability of a branch toaccess discretionary funding sources is ulti-mately a function of the position and reputationof the FBO in the money markets. An FBO with

a good reputation affords its branches easieraccess to funds at market rates.

The ability to obtain additional fundingsources represents liquidity potential. The mar-ginal cost of liquidity or the cost of incrementalfunds acquired is of paramount importance inevaluating liability sources of liquidity. Consid-eration must be given to factors such as howfrequently the branch must regularly refinancematuring liabilities and an evaluation of thebranch’s ongoing ability to obtain funds undernormal market conditions. The obvious diffi-culty in estimating the latter is that until thebranch goes to the market to borrow, it cannotdetermine with complete certainty that fundswill be available at a price that will maintain apositive yield spread. Changes in money marketconditions or the FBO’s reputation and/or finan-cial strength may cause a rapid deterioration in abranch’s capacity to borrow at a favorable rate.In this context, liquidity potential represents theability to attract funds in the market, whenneeded, at reasonable cost compared to assetyield.

Frequently, the base rate for funding costs onmoney market transactions is available only tothe largest and most financially sound institu-tions. Some branches may pay in excess of thebase rate for money market funds, with thedifferential denoting the market’s perception ofthe FBO and home country conditions. The sizeof the premium compared to other FBOs can bea rough indication of the stability of fundingsources in this market. As indicated earlier, ifthe FBO carries a rating of AAA or AA by anindependent rating agency, it is unlikely thatfunding and liquidity will be an examinationissue. If the FBO carries a lower rating or has nomarket presence, the probability that there maybe funding and liquidity concerns grows propor-tionately and funds management and liquidityare more critical.

FUNDING AVAILABILITY

Management at the branch and head office mustbe constantly aware of the composition, charac-teristics, and diversification of its fundingsources. If possible, the branch should securefunding lines from multiple sources. In certaininstances, the branch may be using suballocatedlines from its head office. With multiple sourceadvised discretionary lines of credit, the branch

Funds Management and Liquidity 3200.1


is much better positioned to manage usage androtation in order to ensure availability of fundsat competitive pricing. The role of the FBO inthis circumstance would be to provide backupresources and to be the ultimate lender forcontingency purposes.

Nevertheless, many interbank credit agree-ments contain escape provisions, known as mate-rial adverse change clauses, that enable thelending bank to refuse to allow the borrowingbank to draw on advised credit lines. Bankingorganizations experiencing considerable prob-lems, particularly those relating to asset qualityand/or liquidity, have found that these facilitiesare no longer available. Such escape provisionsshould be considered in the assessment of fundsmanagement and liquidity.

CONTINGENCY FUNDING

Examiners should determine if management atthe branch has an effective contingency plan thatidentifies minimum and maximum liquidityneeds both in normal and adverse market con-ditions, and weighs alternative courses of actionto meet these needs. The branch may rely onback-up funding lines or support from the headoffice or other related offices to meet unforeseenliquidity demands. In this case, examiners shouldcomment on the FBO’s ability to meet theseneeds.

HOME COUNTRY FUNDINGRESTRICTIONS

An FBO’s home country may impose restric-tions on capital outflows. Such impediments

could defeat the attempts of the FBO to aid thebranch in the event of a liquidity crisis. For thisreason, the examiner should investigate homecountry funding restrictions.

TRANSFER RISKCONSIDERATIONS

The stability and availability of funding shouldbe related to the distribution of assets, takinginto consideration certain assets subject to trans-fer risk. Potential liquidity problems may existwhen a branch relies heavily on the U.S. moneymarket for funding, while its assets are concen-trated in a country with serious economic prob-lems. In such a case, the branch is typically in anet due from position with the FBO and prob-lems may arise if the FBO or borrowers do nothave ready access to U.S. dollars to meet theirobligations. Refer to Section 6020, TransferRisk, for additional information.

OFF-BALANCE-SHEETCONSIDERATIONS

The nature, volume and anticipated usage ofoff-balance- sheet activity must be factored intothe assessment of funds management and liquid-ity. The potential for funding contingent liabili-ties varies widely, but the most likely to requirefunding are loan commitments. Economic con-ditions and the business cycle may also influ-ence anticipated usage. The branch should havesufficient existing funding sources to provide foranticipated usage, in view of the nature andvolume of its contingent liabilities.

3200.1 Funds Management and Liquidity


Funds Management and LiquidityExamination ObjectivesEffective date July 1997 Section 3200.2

1. To assess the branch’s ability to obtain stablefunding sources from related and unrelatedparties.

2. To determine if reasonable local policies,procedures, and parameters have been estab-lished and approved by the head office forthe branch’s liquidity position and if thebranch is operating within those establishedguidelines.

3. To evaluate the management of assets, liabili-ties, and off-balance-sheet positions to deter-mine if management is planning adequately

for liquidity and if the branch can effectivelymeet anticipated and potential liquidity needs.

4. To determine if internal management reportsprovide the necessary information forinformed liquidity decisions and monitoringtheir results, and that reports are regularlyprovided and reviewed by head office.

5. To recommend corrective action when poli-cies, practices, procedures, or internal con-trols are deficient or when violations of lawor regulations have been noted.


Funds Management and LiquidityExamination ProceduresEffective date July 1997 Section 3200.3

1. Evaluate the funding relationship betweenthe branch and the FBO. Consider the rea-sons why the branch is in a net due from ordue to position with related offices and affili-ates of the FBO.

2. Review the Funds Management and Liquid-ity policies, practices, and procedures andtest for compliance. Ensure that there are:a. Lines of authority and responsibility for

liquidity management decisions.b. Formal mechanisms to coordinate funds

management and liability decisions.c. Methods to identify liquidity needs and

the means to meet those needs.d. Guidelines for the level of liquid assets

and funding sources in relation to antici-pated and potential needs.

e. Appropriate controls and supervision ofthe volume of loan commitments andother off-balance sheet exposure that mayimpact funding and liquidity.

3. Determine if management has planned prop-erly for liquidity and if the branch hasadequate sources of funds to meet anticipatedor potential needs by:a. Reviewing the internal management reports

detailing liquidity requirements and sourcesof liquidity.

b. Evaluating primary and secondary sourcesof funds.

c. Determining whether funding and liquid-ity requirements are factored into the bud-geting process and are based on growthprojections, changes in the branch’s assetand liability mix, and other anticipatedchanges.

4. Evaluate the effectiveness of the internalmanagement reporting system in providingfor adequate liquidity management.

5. Discuss the following issues with manage-ment and summarize findings in the workpa-pers and, to the degree necessary, for theexamination report:a. The quality of the branch’s planning and

the current ability of the branch to meetanticipated and potential liquidity needs.

b. The quality of administrative control andinternal management reporting systems.

6. Update the workpapers with any informationthat will facilitate future examinations. Dis-cuss with senior branch management thefindings of the examination regarding thebranch’s funding and liquidity policies andpractices, and document the discussion in theworkpapers.


Funds Management and LiquidityInternal Control QuestionnaireEffective date July 1997 Section 3200.4

1. Is the FBO in less than satisfactory condi-tion and subject to liquidity concerns?

2. Is the FBO subject to market disciplinarypricing?

3. Does the FBO’s home country imposerestrictions on capital outflows?

4. Has the branch and head office manage-ment, consistent with its duties and respon-sibilities, adopted funds management poli-cies, practices and procedures which include:a. Lines of authority, and responsibility

for funds management and liquiditydecisions?

b. A formal mechanism to coordinate fundsmanagement and liquidity decisions?

c. A method to identify funding and liquid-ity needs and the means to meet thoseneeds?

d. A contingency funding plan that pro-vides guidelines for the level of liquidassets and other sources of funds inrelationship to anticipated and potentialneeds?

e. An adequate system of internal controlsin critical areas, such as separation ofduties, proper MIS reporting and moni-toring of limits?

f. Transfer risk considerations?5. Does the FBO view the branch as net user

or provider of funds?If the branch is a net user of funds:a. Does the branch have a funding and

liquidity profile that identifies the branchas a non-risk taker?

b. Are funds management and liquiditydecisions centralized at an FBO locationwithin the U.S. that is subject to regula-tory supervision?

If the branch is a net provider of funds,answer the following questions; otherwiseproceed to question 12.

6. Have internal management reports beenprepared that provide an adequate basis for

making ongoing liquidity managementdecisions and for monitoring the results ofthose decisions?

7. Do management reports include the follow-ing:a. Maturity distribution of assets and

liabilities?b. Expected funding commitments?c. Asset yields and liability costs?d. Net interest margin and variance analysis

(e.g., previous month, quarter, year-to-date and budget reporting)?

e. Funding volumes by type of liability(e.g., overnight/short-term funds), cus-tomer and market?

f. Exceptions to policy guidelines andlimits?

8. Does the planning and budgeting functionconsider funding and liquidity requirements?

9. Does the branch’s contingency funding planaddress:a. Minimum and maximum liquidity needs

and alternative courses of action to meetthose needs?

b. Alternative sources of funding?c. Orderly asset liquidation?

10. Have adequate discretionary (back-up) linesof credit been established?

11. Are advised discretionary lines of creditcontaining adverse change clauses consid-ered by branch management in its contin-gency funding plan?

12. Is the information covered by this ICQadequate for evaluating internal controls inthis area? If not, indicate any additionalexamination procedures deemed necessary.

13. Based on the information gathered, evaluatethe internal controls in this area (i.e., strong,satisfactory, fair, marginal, unsatisfactory).


Interest Rate Risk ManagementEffective date July 1997 Section 3210.1

Interest rate risk (IRR) is an aspect of normalbanking operations that became increasinglyimportant in the United States with the deregu-lation of interest rates in the early 1980s. Thephaseout of interest rate controls and increasedcompetitiveness, the latter of which was partlydue to the growing presence of foreign banks inU.S. markets, significantly increased the flexibil-ity of banks in adjusting their IRR profiles. Thisflexibility has been further enhanced by thedevelopment of new financial instruments usedto hedge against or profit from interest ratechanges.

In order to maintain profitability, safety, andsoundness, institutions should fully comprehendthe risks associated with changes in interestrates and should have adequate policies andsystems in place for controlling these risks. Inthis regard, the branch and its head officemanagement both have important responsibilities.

The head office is responsible for providingclear policy guidance to branch management oncontrolling and monitoring IRR. The policiesprovided to branch management by the headoffice should indicate acceptable levels of risk-taking, given the branch’s role in the foreignbanking organization (FBO), and establish pro-cedures and controls to ensure that there is anadequate system for measuring IRR and moni-toring compliance with established limits. Inthis regard, there should also be a reportingprocess that demonstrates adherence with estab-lished limits and an adequate system of internalcontrols.

It is recognized that, as part of a larger entity,IRR management for certain branches may becentralized within the FBO. Whether or not thebranch is responsible for managing its IRR,there should be evidence at the branch, in theform of IRR policy guidelines, managementreports, etc., showing how this risk is beingeffectively identified, measured, and controlledfor the branch.The following discussion pro-vides an overview of IRR considerations, whichthe examiner should use in reviewing, to theextent applicable, this area of risk within thebranch.

INTEREST RATE RISK

IRR is defined as a branch’s vulnerability tochanges in interest rates. IRR arises from differ-

ences in the maturities or repricing dates of assetand liability positions, and cash flows. However,risk may remain in a given branch’s portfolio inwhich long and short positions of differentmaturities are well hedged against a uniformchange in all interest rates, but not against achange in the shape of the yield curve whereinterest rates of different maturities change byvarying amounts. This type of risk is called‘‘yield-curve risk.’’ Similarly, a branch may bewell hedged against yield curve risk but exposedto ‘‘basis risk,’’ in which the prices of particularassets and liabilities, as well as hedging instru-ments, are not perfectly correlated. For example,three-month interbank deposits priced at LIBOR,three-month Eurodollars and three-month Trea-sury bills all pay three-month interest rates.However, these three-month rates are not per-fectly correlated with each other and spreadsbetween their yields may vary over time. As aresult, three-month Treasury bills, for example,funded by three-month interbank deposits arenot a perfectly hedged position. Given a rise ordecline in interest rates, a branch’s interest rateexposure can be viewed as the potential forchange in its reported earnings.

Focusing on the sensitivity of a branch’sreported earnings to changes in interest ratesrepresents an accounting perspective of IRRassessment. In general, this approach involvesassessing the effect that changing rates mighthave on the revenues produced by interest-earning assets, the expense of interest-bearingliabilities, and the resulting net interest incomeof the branch. Risk to current earnings measuresthe timing of income effects, which can help riskmanagers determine what action to take regard-ing exposure.

RISK MEASUREMENTTECHNIQUES

Branches can use a variety of methods to mea-sure their IRR exposure. The three most com-mon generic methods are maturity gap analysis(used to measure the interest rate sensitivity ofearnings), duration analysis, and simulation mod-eling. While these methods highlight differentfacets of IRR, many branches use them incom-bination or use hybrid methods that combinefeatures of each.


Maturity Gap Analysis

Maturity gap analysis begins with constructing amaturity gap report. This report categorizesasset and liability accounts, including off-balance-sheet items, according to the timeremaining to their maturities in specific timeperiods, known as repricing buckets. Thesebuckets vary from branch to branch, but mostbranches include time bands of overnight, over-night to one month, one month to three months,three months to six months, six months to oneyear, and beyond one year. Categorizing assetsand liabilities lacking definitive repricing timeframes into specific time periods (or buckets)varies by institution. As a result, the assump-tions used by each institution should be reviewedby the examiner to ensure that they are reason-able. This approach reflects the accounting orcurrent earnings orientation of gap reports.

For each time period or bucket, rate-sensitiveliabilities (RSL) are subtracted from rate-sensitive assets (RSA) to yield the dollar matu-rity mismatch or gap . The gap measure is eithera positive or negative dollar amount and is theprimary tool used to assess the impact of changesin interest rates on the institution’s net interestincome.

A negative gap (liability sensitive) indicatesthat more liabilities than assets will reprice in agiven time period. During periods of risinginterest rates, net interest income would beadversely affected because the interest expenseon liabilities during that period would show agreater increase relative to the increase in inter-est earnings on assets. If rates decline, a bankwith a negative gap would expect its earnings tobe enhanced because more liabilities than assetswould reprice at lower rates.

Conversely, a positive gap (asset sensitive)indicates that more assets than liabilities willreprice in a given time period. In this case,earnings tend to increase as interest rates increasebecause more assets than liabilities reprice athigher rates.

The maturity gap of an institution is the mostbasic measure of IRR. It is a static measure thatassumes the current balance sheet remains con-stant through time and a given change in interestrates is not reversed over time. For this reason,it may not accurately reflect a branch’s true riskexposure. In addition, its emphasis on the risk toshort-term earnings inadequately addresses therate sensitivity of longer-term fixed rate instru-

ments, the value of which can change dramati-cally without affecting short-term interest income.

Some simple forms of maturity gap analysisidentify only the amount of assets and liabilitiesat risk and ignore basis risk. Basis risk refers tothe likelihood that changes in interest rates abranch pays on liabilities and earns on its assetsare not perfectly correlated. That risk is present,even when the assets and liabilities are matchedin terms of their maturity or repricing periods.Despite these shortcomings, most branches usematurity gap analysis or some variant, as onecomponent of IRR measurement. Many brancheselaborate on the simple gap framework in orderto gain insight into the more complex aspects ofIRR.

While the maturity gap of an institution is awidely used indicator of IRR, it is not a suffi-cient measure for gauging overall exposurewhen taken alone. A branch’s condition andsize, complexity of the balance-sheet and off-balance-sheet activities (if any), degree of com-petition, and sophistication of the markets beingserved also must be considered. For example, asmall, retail-oriented branch may have moder-ately large negative gap positions but may notbe exposed to major risks. Factors that mayminimize such risks are the branch’s strong coredeposit base within its target market.

Duration Analysis

Duration analysis is used to calculate theweighted average maturity of the cash flowsemanating from financial instruments. In con-trast to the simple average nominal cash flows,duration provides more meaningful, analyticalmeasures of a stream of cash flows. The durationmeasure can be used to calculate the percentagechange in the present value of a stream of cashflows that is generated by a one percentage pointchange in interest rates. Duration analysis canmeasure the exposure of a branch’s currentincome to changes in interest rates.

Duration analysis can complement gap analy-sis. Using gap repricing data and selected ratedata, duration provides a more accurate measureof IRR. Duration analysis, unlike gap analysis,accounts for the time value of money by calcu-lating the present value of future cash flows. Inso doing, it properly aggregates the branch’srepricing mismatches or gaps. Thus, durationcan be used to analyze the risk standing of a

3210.1 Interest Rate Risk Management


branch with a complicated series of repricingmismatches. Like gap analysis, duration analy-sis generally assumes that the repricing structureof a branch’s assets and liabilities remainsconstant. In addition, duration analysis requiresinformation on cash flows that may not alwaysbe available.

Used in conjunction with maturity gap analy-sis, duration analysis can add significant insightsinto the IRR exposure of an institution. How-ever, duration also has some limitations, inparticular:

• The duration measure becomes less accurateas the amount of the interest rate changeincreases;

• The duration of different instruments willchange at different rates as time passes, result-ing in a hedged position becoming unhedgedover time; and,

• Duration alone does not address the dispersionof cash flows in a branch’s portfolio.

Simulation Modeling

Simulation techniques attempt to overcome thelimitations of both the static gap and durationmeasures by computer-modeling the branch’sinterest rate sensitivity. Such modeling involvesmaking assumptions about the future course ofinterest rates and changes in a branch’s businessactivity and estimating their effect on thebranch’s net interest income. Branches candevelop their own simulation packages or choosefrom a variety of commercially availablepackages.

A simulation model can provide branch man-agement with an important tool for understand-ing the measurement of, and assisting in themanagement of, IRR, and for evaluating thebranch’s exposure under a variety of interestrate scenarios. Simulation techniques can alsoplay an integral planning role in evaluating theeffect of alternative business strategies on riskexposure. Unlike other methods, simulation cananticipate the effect of changes in customerbehavior induced by interest rate changes (suchas time deposit rollovers, in retail branches).

The usefulness of simulation techniquesdepends on the validity of the underlyingassumptions and the accuracy of the basic struc-ture upon which the model is run. If theseassumptions do not fairly reflect the branch’s

internal and external environment, the resultsobtained will not be meaningful.

ASSESSMENT OF IRRMANAGEMENT

Examiners should focus on the presence of clearand comprehensive policies with correspondingappropriate internal controls when assessing themanagement of IRR. The policies should outlinethe following: the objectives of risk manage-ment, clear lines of authority and communica-tion, and limits on the vulnerability of netinterest income to changes in interest rates. Riskmanagement systems and procedures should beadequate and consistent with the stated policiesof risk management.

Strong internal management controls need tobe maintained given the potential impact ofinterest rate exposure on a branch’s earnings.These controls include policies, risk measure-ment systems, and reporting mechanisms. Eachof these should be reviewed from twoperspectives:

• Does management understand and effectivelyadminister IRR controls?

• Do these controls establish reasonable param-eters considering the specific IRR profile ofthe branch?

In larger branches, IRR may be managed byan Asset/Liability Management Committee(ALCO), which is composed of senior branchmanagers who represent units that undertakeIRR. ALCO is responsible for formulating andadministering branch strategy with regard toIRR, which is based on management’s view ofthe future interest rate environment, the branch’srelative ability to adjust to changing marketconditions, and the head office’s risk-acceptancelevel. The activities of ALCO, including theimplementation of IRR policies, should bereviewed for approval by the head office.

Additionally, in the cases where IRR manage-ment is centralized at a particular branch of theFBO, the following question must be consid-ered: Is the process of transferring a givenbranch’s IRR to the portfolio of the branchhousing the centralized IRR management func-tion adequately governed by appropriate poli-cies and accurate reporting mechanisms?

Interest Rate Risk Management 3210.1


POLICIES

The need for established and properly super-vised IRR policies has increased greatly inrecent years. An adequate policy facilitates thedevelopment of a prospective plan that consid-ers the branch’s goals regarding its asset andliability mix, off-balance-sheet activities, liquid-ity, risk tolerance, and other relevant factors.The policy should establish responsibility forIRR management decisions and provide a mecha-nism for the necessary coordination among dif-ferent departments of the branch, or betweendifferent branches of the FBO, as appropriate.

In addition to establishing responsibility forplanning and day-to-day IRR decisions, thepolicy should set forth certain guidelines:

• Interest rate exposure limits should be estab-lished relative to reasonable forecasts andassumptions;

• Limits should be based on the potential impactof interest rate changes on the branch’s netinterest income;

• Individual limits should be set for units thatincur IRR;

• Clear lines of authority and communicationshould be established for the implementationand execution of strategies; and,

• For those branches that are not authorized toincur or manage IRR, the policy should clearlyoutline procedures for accurately and effec-tively transferring the IRR incurred by itsnormal business activities to a designatedbranch or other office of the FBO responsiblefor the centralized management of IRR.

In most cases branches accomplish the trans-fer of IRR incurred by a given transaction byentering into an offsetting, "mirror" transactionwith the office responsible for managing thebranch’s IRR. As an example, if a branchentered into a five-year, fixed- rate loan, it couldbook a five-year, fixed-rate liability to the relatedoffice to fund the loan; the maturity and princi-pal amount should be matched.

RISK MANAGEMENT SYSTEMS

The effectiveness of assessing IRR through theuse of a risk management system depends to alarge degree on the branch’s ability to measureits exposure. Risk management systems arebased on a quantitative assessment of exposure

(as previously discussed) and management’sadaptation and analysis of that assessment. Thesesystems should be:

• Consistent with established limits;• Comprehensive, covering the rate risk associ-

ated with all asset, liability, and off-balancesheet accounts;

• Capable of identifying excessive exposure;• Capable of measuring the impact of rate

changes on the branch’s chosen targetaccount(s);

• Flexible, so that the introduction of newinstruments and changes in strategy can beabsorbed and accounted for; and,

• Able to suggest strategies for corrective action.

REPORTING MECHANISMS

Strong lines of communication and authority areessential to the timely execution and adjustmentof a branch’s IRR strategy because earnings canbe rapidly eroded by unexpected rate changes.In particular, when risk management responsi-bilities are delegated to those most familiar withparticular products or markets, the need forcommunication becomes stronger, so that posi-tions in one market are not excessively magni-fied by positions elsewhere.

Coordination between the branch and headoffice management and business units that incurIRR is essential to the successful control of IRR.This is especially important when the businessunit incurring IRR is another branch of the FBO.Controls should focus on the following:

• Branch and head office management should beregularly apprised of the nature and results ofrisk management decisions undertaken by thebranch;

• Branch and head office management should beprovided with periodic status reports detailingrisk exposure;

• Treasury management should have periodiccontact with branch line managers responsiblefor undertaking risk;

• Risk-taking units should be aware of limitsestablished by head office and/or branch man-agement, with limit exceptions regularly moni-tored and communicated to senior manage-ment; and,

• Units not allocated risk limits should providethe branch responsible for its IRR manage-

3210.1 Interest Rate Risk Management


ment with reports detailing not only the unit’scurrent positions, but potential or plannedtransactions, as well.

PRICING

Conclusions drawn from the analysis of thebranch’s interest rate sensitivity position restupon the assumption that the branch has anadequate asset-pricing mechanism. A pricingmechanism that is not attuned to the branch’scost of funds, overhead costs, and credit riskwill not allow the branch to maintain an adequatenet interest margin on an ongoing basis. Thus,the examiner should bear in mind the interde-pendence of pricing methods and interest ratesensitivity when assessing the branch’s ability tomaximize and maintain the spread betweeninterest earned and interest paid.

An important component of pricing is the costof funds. Bankers generally price from either theaverage cost of funds or the marginal cost offunds. The average cost of funds is a weightedaverage of all of the rates paid on interest-bearing liabilities. The marginal cost of funds isdefined as the cost of the additional fundsneeded to support asset growth and is consid-ered by many bankers to be the more econom-ically appropriate method. This view is takenbecause funds on the balance sheet alreadysupport assets held and the cost of those fundsshould not enter into the pricing decision fornew assets.

The marginal cost of funds is not, however,always the best method of pricing because thebranch may be replacing assets, instead ofgrowing. If the branch is only changing its assetmix to compensate the organization for its creditrisk, its average cost of funds, plus overhead andrepricing considerations, represent a moreappropriate pricing measure. Additionally, mar-ket forces, which include the demand for andavailability of funds, should be considered ascomplements to cost factors when making pric-ing decisions. The market in which the branchoperates often dictates the pricing mechanismused.

Branches most often obtain funds from thedomestic interbank money market; however,offshore sources, including related branches andthe head office, are frequently used. In many

cases, a FBO may have to pay an additionalspread over interbank rates for perceived coun-try risk, liquidity risk, or credit risk. For branchesrequired to pay such additional spreads, the sizeand volatility of these premiums should beconsidered in the institution’s pricing mechanism.

HEDGING

The examiner should keep in mind that risk maybe reduced by hedging activities when determin-ing the extent of IRR exposure at the branch.These activities may be explicit and easilyquantifiable or they may be implicit and difficultto measure from the branch’s managementinformation system.

Types of explicit hedging activities includeinstruments such as futures, interest rate swaps,forwards, options, and various hybrid products.Types of implicit hedging might include interestrate caps and floors on commercial loans; limitson the amount of rate adjustment allowed forproducts, such as adjustable rate mortgages; oreven investment policies that might set internalstop loss limits on various longer-term portfoliopositions. Explicit hedging strategies can eitherbe matched to a specific asset or liability(‘‘micro’’ hedges) or be designed to reduce theoverall level of risk in a position (‘‘macro’’ or‘‘portfolio’’ hedging).

Institutions engaged in hedging activitiesshould have clearly defined policies that outlinespecific hedge strategies and explain how thosestrategies reduce risk. Individuals responsiblefor hedging activity should be designated andoverall position limits should be established.Internal controls should be established to includea system that measures the degree to which ahedge is meeting its stated objective of reducingrisk (hedge effectiveness). Finally, branch man-agement should regularly provide reports to thehead office that, at a minimum, show gains orlosses on hedge instruments and estimates ofhedge effectiveness.

Finally, some entities now use derivativeinstruments in managing IRR. The individualregulatory agencies have issued policy state-ments regarding derivative instruments. Theexaminer should consult with his/her respectiveagency for guidance.

Interest Rate Risk Management 3210.1


Interest Rate Risk ManagementExamination ObjectivesEffective date July 1997 Section 3210.2

1. To evaluate the policies regarding interestrate risk (IRR) formulated by branch andhead office management, including the limitsestablished for the branch’s IRR profile.

2. To determine if the branch’s IRR profile iswithin those limits.

3. To evaluate the management of the branch’sIRR, including the adequacy of the methodsand assumptions used to measure IRR.

4. To determine if internal management report-ing systems provide the information neces-sary for informed interest rate managementdecisions.

5. To recommend corrective action when inter-est rate management policies, practices, pro-cedures, or internal controls are deficient incontrolling and monitoring IRR.


Interest Rate Risk ManagementExamination ProceduresEffective date July 1997 Section 3210.3

1. Determine if there were concerns in theprevious examination report regarding IRR,and if corrective action was required.

2. Determine if IRR is managed at the branchlevel or at another level within the FBO.a. If IRR is managed at the branch level,

proceed to procedure #3.b. If IRR is managed at a higher level

within the FBO:• Determine if adequate procedures are

in place for any activities at the branchwhich are required by the managinglevel within the FBO (i.e. personnelauthorized and steps necessary for call-ing in funding requirements).

• Provide a description of the activitiesconducted by the managing levelwithin the FBO.

• Proceed to procedure #10.3. Review the branch’s written policies and

procedures for reasonableness. At a mini-mum, policies should cover:a. Definition and measurement of accept-

able risks, including acceptable levels ofinterest rate exposure.

b. Net interest margin goals.c. Sources and uses of funds.d. Off-balance-sheet activities that affect

interest rate exposure.e. Responsibilities within the branch for

IRR management activities.f. Reporting mechanisms.

4. Evaluate the internal controls and/or theinternal audit function. Determine whetherinternal mechanisms are adequate to ensurecompliance with established limits on IRR.Prepare a brief description of the branch’sinternal controls/audit for IRR managementand identify areas in need of improvement.

5. Evaluate management practices. The evalu-ation should include, but not be limited to,the following:a. Determine who is responsible for mak-

ing IRR management decisions (indi-vidual, committee or other), and whetherthis is appropriate, given the level ofexperience and sophistication of theindividuals and the nature of the branch’sactivities.

b. Determine who is responsible for mak-ing principal assumptions and param-

eters used in the measurement system(s),and whether this individual or committeereviews the principal assumptions andparameters on a regular basis and updatesthem as needed.

c. Determine who is responsible for imple-menting strategic decisions. Ensure thatthe scope of that individual’s authority isreasonable. Determine if any one indi-vidual exerts undue influence over theeconomic forecasts and managementdecisions.

d. Assess branch management’s knowledgeof IRR in relation to the size and com-plexity of the branch. In particular, assessmanagement’s understanding of the meth-ods used by the branch to measure therisk.

e. Determine if new products or hedginginstruments are adequately analyzedbefore purchase.

6. Assess senior management (i.e. lead U.S.office for FBO or head office) oversight ofIRR management. The assessment shouldinclude the following:a. Determine how frequently the policy is

reviewed and approved by senior man-agement (at least annually).

b. Determine whether the results of themeasurement system provide clear andreliable information and whether theresults are communicated to senior man-agement at least quarterly. Reports tosenior management should identify thebranch’s current position and relation-ship to policy limits.

c. Determine the extent to which excep-tions to policies and resulting correctivemeasures are reported to senior manage-ment, including the promptness of suchreporting.

7. Evaluate the risk measurement system(s)used by the branch, which should be con-sistent with the size and complexity of itson- and off-balance-sheet activities. Theevaluation should include the following:a. Evaluate whether the risk measurement

system’s structure and capabilities areadequate to accurately assess the riskexposure of the branch, support theinstitution’s risk management process,


and serve as a basis for internal limitsand authorizations.

b. Evaluate whether the risk measurementsystem is operated with sufficient disci-pline to accurately assess the risk expo-sure of the branch, support the institu-tion’s risk management process, andserve as a basis for internal limits andauthorizations.

c. Determine whether the assumptions arereasonable given current business condi-tions and the institution’s strategic plan,and whether assumptions about futurebusiness are sensitive to changes in inter-est rates.

8. Evaluate the branch’s exposure to IRR by:a. Reviewing reports regularly prepared by

management for controlling and moni-toring IRR.

b. Reviewing ‘‘variance reports,’’ i.e., reportsthat compare predicted and actual results.Comment on whether the risk measure-ment system has made reasonably accu-rate predictions in earlier periods.

c. Determining whether the level of risk iswithin the limits management has set.

d. Determining the stability of interest mar-gins under varying economic conditionsor simulations (causes of significant fluc-tuations should be identified).

e. Determining the branch’s ability to adjustits interest rate exposure, or its ability toeffectively transfer its interest rate expo-sure to the designated unit of the FBOfor IRR management.

9. Contact the examiner responsible for ana-lyzing income and expense to determine the

adequacy of the net interest margin, basedon an analysis of the components of themargin (i.e., interest expense and interestincome). If the margin or any component isunusually high or low, determine:a. If goals have been established for net

interest earnings.b. Management’s success in meeting estab-

lished goals.c. The effect of the branch’s IRR position

on meeting established goals.d. The effect of the branch’s pricing poli-

cies on meeting established goals.e. The effect of any premium charged the

branch on borrowed funds resulting fromany perceived liquidity risk, country risk,or credit risk on meeting establishedgoals.

f. The effect of the branch’s credit riskappetite on the margin.

g. The effect of interoffice pricing policiesfor borrowed funds from related offices,and the reliance on these funds, on themargin.

10. Write in appropriate report format and dis-cuss with management:a. The quality of management’s ability to

control and monitor IRR.b. The level of the branch’s IRR exposure

and an assessment of the associateddegree of risk.

c. The quality of the related administrativecontrols and internal management report-ing systems.

d. The effect of IRR management decisionson earnings.

11. Update the workpapers with any informa-tion that will facilitate future examinations.

3210.3 Interest Rate Risk Management: Examination Procedures


Interest Rate Risk ManagementInternal Control QuestionnaireEffective date July 1997 Section 3210.4

Complete the following questions only if IRR ismanaged at the local level. If IRR is managed atanother level within the FBO, determine thatadequate procedures are in place for any activityrequired of the branch by the managing office.

1. Has branch and head office managementadopted an IRR management policy thatincludes:a. Risk management philosophy and objec-

tives regarding IRR?b. Clear lines of responsibility to either

manage IRR or transfer the branch’s IRRpositions to the appropriate unit of theFBO assigned the IRR managementfunction?

c. Defining and setting of limits on IRRexposure?

d. Specific procedures for reporting andapprovals necessary for exceptions topolicies and limits?

e. Plans or procedures management willimplement if IRR falls outside estab-lished limits?

f. Specific IRR measurement system(s)?g. Acceptable activities used to manage or

adjust the institution’s IRR exposure,including, when applicable, proceduresfor the transfer of IRR to the unit assignedthe IRR management function?

h. The individuals or committees who areresponsible for IRR managementdecisions?

i. A process for evaluating major new prod-ucts and their IRR characteristics?

2. Have internal management reports beenprepared that provide an adequate basis formaking interest rate management decisionsand for monitoring the results of thosedecisions? Specifically:a. Are reports prepared on the branch’s

IRR exposure, using an appropriate mea-surement method?

b. Is historical information on asset yields,cost of funds, and net interest marginsreadily available?

c. Are interest margin variations, both fromthe prior reporting period and from thebudget, regularly monitored?

d. Is sufficient information available to per-mit an analysis of the cause of interestmargin variations?

3. Is the bank in compliance with its policies,and is it adhering to its written procedures?If not, are exceptions and deviations:a. Approved by appropriate authorities?b. Made infrequently?c. Nonetheless consistent with safe and

sound banking practices?4. Does senior management review and approve

the policy at least annually?5. Did senior management review positions,

and the relationship of these positions toestablished limits, at least quarterly?

6. Were exceptions to policies promptlyreported to the senior management?

7. Does one individual exert undue influenceover interest risk management activities?

8. Discuss with senior management the branch’sinternal risk measurement model(s) regardto the following:a. Has (Have) internal model(s) been audited

(by internal or external auditors)?b. Does one individual control the model-

ing process, or otherwise exert undueinfluence over the risk measurementprocess?

c. Is the model reconciled to source data toassure data integrity?

d. Are principal assumptions and param-eters used in the model reviewed peri-odically by senior management?

e. Are the workings of, and the assump-tions used in, the internal modeladequately documented and available forexaminer review?

f. Is the model run on the same scenario(s)for which the institution’s limits areestablished?

g. Does management compare the histori-cal results of the model to actual results?

CONCLUSION


10. Based on the information gathered, evaluateinternal controls in this area (i.e. strong,satisfactory, fair, marginal, unsatisfactory).


Borrowed FundsEffective date July 1997 Section 3220.1

Borrowed funds include all nondeposit liabili-ties, exclusive of long-term subordinated debt,such as capital notes and debentures. Commonforms of direct borrowing include Federal fundspurchased (overnight and term), bills payable tothe Federal Reserve, interbank deposits (domes-tic or foreign), due bills, short sales from tradingsecurities, and overdrafts on deposit accountsdue from other depository institutions. Indirectforms of borrowing include rediscounted cus-tomer paper, trade bills and bankers accep-tances, securities borrowed, and assets sold withthe endorsement or guarantee of the FBO orsubject to a repurchase agreement. If an FBOissues commercial paper in the U.S., the issu-ance is generally through a U.S. subsidiary andreflected on the books of the branch as a balancedue to related institutions.

When a branch manages its borrowed fundsposition independently from other FBO offices,a complete analysis of its borrowing activitiessince the previous examination should be done.The principal sources of borrowings, the rangeof amounts, frequency, length of time indebted,concentration of borrowings, and reasonsadvanced by management for such borrowingsshould be explored. Some of the more fre-quently used sources and instruments that pro-vide short-term, nondeposit funds are discussedbelow.

INTRACOMPANY/INTERCOMPANYBORROWING

A principal borrowing relationship frequentlyexists between a branch and its head office. Thebranch may also have borrowing relationshipswith other related branches or affiliated compa-nies. The head office frequently serves as aprimary funding source for the branch, but thelevel and nature of borrowing may be deter-mined by other factors, including the branch’srole in the overall funding strategy of the FBO.For example, an FBO will designate one U.S.branch (generally the branch located in theFBO’s home state) to provide the funding to allother U.S. branches. To develop a completeunderstanding of the borrowing relationship ofthe branch with the head office and other relatedoffices, the examiner must gain an understand-ing of the funding strategy of the FBO in the

U.S., and should determine the purpose of theborrowing and the reason for the level and flowof funds to various offices.

For FBOs with a controlling interest in a U.S.commercial bank, a borrowing relationshipbetween the commercial bank and offices of theFBO must be explored fully to ensure there areno violations of Sections 23A and 23B of theFederal Reserve Act, inasmuch as the FBO isconsidered a foreign bank holding company.Additional information on intercompany borrow-ing and funding relationships is contained inSection 3240, Due From/Due To Related Offices.

FEDERAL FUNDS PURCHASED

The day-to-day use of Federal funds is common-place among U.S. banking organizations, includ-ing branches of FBOs. The most frequent typeof Federal funds transaction is unsecured, forone day, and repayable the following businessday. The rate is usually determined by overallmoney market rates and by the available supplyof and the demand for funds. Most transactionsare in units of $1 million, although the trading ofsmaller amounts is fairly common dependingupon individual situations. In some instances,where the selling and buying relationshipbetween two financial institutions is a more orless continuing one, a line of credit may beestablished on a funds-available basis. Althoughthe most common transaction is on an ‘‘over-night’’ unsecured basis, the selling of funds canalso be on a secured basis and for longer periodsof time such as term Federal funds. While termFederal funds are quite common, the selling offunds on a secured basis is quite rare. Securedborrowing is usually done in instances of severecredit risk and/or perceived default. However,according to the Federal Reserve Act, Section23A(c)(1), if an FBO owns a domestic, FDIC-insured subsidiary bank, any extensions of creditby the domestic bank to the FBO must be doneon a secured basis.

INTERBANK DEPOSITS ANDBORROWINGS

Interbank deposits are not defined as borrowingsfor regulatory purposes, and continue to be


reflected as deposits. Interbank deposit instru-ments include certificates of deposits (CDs),Eurodollar deposits or takings (Euro-CDs) anddeposits taken under separate borrowing agree-ments. These funds are generally obtainedthrough the branch’s money market deposittaking activities. However, narrowly definingthese instruments as deposits instead of borrow-ings is not universally accepted and, in fact, thenegotiable money market CD and Euro-CD arewidely recognized as primary borrowing vehi-cles. Dependence on CDs and Euro-CDs assources of funds is discussed in Section 3230,Deposit Accounts.

Negotiable CDs and Euro-CDs are generallyused by wholesale branches. They consist ofdeposits over $100,000 and are not consideredcore funds. The major distinction between Euro-CDs and negotiable CDs is that Euro-CDs areprimarily funds from offshore sources. Withmore diverse products entering the market, float-ing rate CDs and floating rate Euro-CDs arebecoming more popular.

REPURCHASE AGREEMENTS

Instead of resorting to direct borrowing, a branchmay sell assets to another bank or some otherparty and simultaneously agree to repurchasethe assets at a specified time or after certainconditions have been met. Securities and loansare often sold under repurchase agreements togenerate temporary working funds. Agreementsof this nature are frequently used because thecost of this type of secured borrowing is gener-ally lower than that of unsecured borrowings,such as Federal funds purchased. Repurchaseagreements should not be confused with resaleagreements (also known as reverse repurchaseagreements). The usual terms for sale of secu-rities under a repurchase agreement require that,after a stated period of time, the seller repur-chases the same securities at a predeterminedprice or yield. U.S. government and agencysecurities are the most common type of instru-ments sold under repurchase agreements becausethey are exempt from reserve requirements.

Management should be aware of certain con-siderations and potential settlement risks asso-ciated with repurchase agreements entered intoin large volume with institutional investorsand/or brokers. If the value of the underlyingsecurities exceeds the price at which the repur-

chase agreement was sold, the branch could beexposed to the risk of loss in the event that thebuyer is unable to perform and return thesecurities. This possibility is more likely if thesecurities are physically transferred to the insti-tution or broker with which the branch hasentered into the repurchase agreement. For thisreason, branches should avoid, if possible, pledg-ing excessive collateral. However, most transac-tions today do not involve the physical transferof securities, rather they involve a book entrysystem which can reduce settlement risk. Thebranch should obtain sufficient financial infor-mation on and analyze the financial condition ofthose institutions and brokers with whom theyengage in repurchase transactions.

Branches engaging in repurchase agreementsshould include these transactions when calculat-ing their interest rate sensitivity positions. Inaddition, the degree to which a branch borrowsthrough repurchase agreements should be ana-lyzed with respect to its liquidity needs, andcontingency plans should provide for alternatesources of funds in the event of a run-off ofrepurchase agreement liabilities.

LINES OF CREDIT FROMCORRESPONDENT BANKS

Lines of credit with correspondent banks may beon an advised or unadvised basis. Advised (alsoknow as committed or fee paid) lines of creditprovide a reliable source of back-up funding tothe branch, in that the correspondent bank iscommitted to lend under the specified terms ofthe credit facility. Unadvised lines of credit arenot committed facilities and access to suchfunds can be denied by the correspondent bank.On occasion, branches negotiate loans fromtheir principal correspondent banks. The loansare usually for short periods and may or may notbe secured. Lines of credit to finance tradetransactions evidenced by letters of credit canresult in the correspondent bank financing thebranch for an additional period of time, after asight draft drawn under a letter of credit hasbeen presented at the correspondent bank.

SHORT-TERM DEBT

Short-term borrowings may be found in a branch,both on a direct and indirect basis. Borrowings

3220.1 Borrowed Funds


on a direct basis are usually evidenced bypromissory notes, or through accounts with thehead office or a correspondent bank. Indirectforms of borrowing include notes and trade billsrediscounted; notes, acceptances, import drafts,or trade bills sold with the branch’s endorsementor guarantee; notes and other obligations soldsubject to repurchase agreements; and accep-tance pool participations.

LONG-TERM DEBT

On an infrequent basis, long-term debt borrow-ings may be found in a branch. The most

common form of long-term debt is direct termborrowings from correspondent banks. Branchesare usually more interested in attracting long-term funds through the U.S. capital markets fortheir head office than issuing long-term debt fortheir own utilization.

Borrowed Funds 3220.1


Borrowed FundsExamination ObjectivesEffective date July 1997 Section 3220.2

1. To determine if the policies, practices, pro-cedures, and internal controls regarding bor-rowed funds are adequate.

2. To determine if branch officers are operatingin conformity with the established guidelinesof the head office.

3. To determine the scope and adequacy of theinternal/external audit function as it relates toborrowed funds.

4. To determine compliance with laws and regu-lations as it relates to borrowed funds.

5. To determine if the existing level of bor-rowed funds is consistent with the branch’sactivities.

6. To determine if the existing rates paid are inline with concurrent market rates.



Borrowed FundsExamination ProceduresEffective date July 1997 Section 3220.3

1. If selected for implementation, complete orupdate the Internal Control Questionnaire.

2. Determine if deficiencies noted at the previ-ous examination or by internal/external auditshave been addressed by management.

3. Determine the purpose of each type of bor-rowing and whether the branch’s borrowingposture is justified in light of its role withinthe FBO’s network and other relevantcircumstances.

4. Determine if the branch has adequate contin-gency plans for alternate sources of fundsand if these contingency funding lines areperiodically tested for availability.

5. Prepare, in appropriate report form, and dis-cuss with appropriate management:

a. The adequacy of written policies regard-ing borrowings.

b. The manner in which branch officers areoperating in conformance with establishedpolicy.

c. The existence of any unjustified borrow-ing practices.

d. Any violation of laws or regulations.e. Recommended corrective action when

policies, practices, or procedures are defi-cient; violations of laws or regulationsexist; or when unjustified borrowing prac-tices are being pursued.

6. Update the workpapers with any informationthat will facilitate future examinations.


Borrowed FundsInternal Control QuestionnaireEffective date July 1997 Section 3220.4

POLICY

1. Has the head office approved a written policywhich:a. Outlines the objectives of the branch’s

borrowings?b. Describes the branch’s borrowing philoso-

phy relative to risk considerations, i.e.,leverage/growth, liquidity/income?

c. Provides for risk diversification in termsof staggered maturities, rather than solelyon cost?

d. Limits borrowings by amount outstand-ing, specific type, or total interest expense?

e. Limits or restricts execution of borrow-ings by branch officers?

f. Provides a system of reporting require-ments to monitor borrowing activity?

g. Requires subsequent approval oftransactions?

h. Provides for review and revision of estab-lished policy at least annually?

RECORDS

2. Does the branch maintain subsidiary recordsfor each type of borrowing, including properidentification of the obligee and a writtenconfirmation?

3. Is the preparation, addition, and posting ofthe subsidiary borrowed funds records per-formed or adequately reviewed by personswho do not also:

a. Handle cash?b. Issue official checks and drafts?c. Prepare all supporting documents required

for payment of debt?4. Are subsidiary records for borrowed funds

reconciled with the general ledger accountsat an interval consistent with borrowingactivity, and are the reconciling items inves-tigated by persons who do not also:a. Handle cash?b. Prepare or post to the subsidiary records

for borrowed funds?5. Has it been determined that borrowings from

U.S. bank subsidiaries conform with applica-ble regulatory restrictions?

6. Are corporate resolutions properly preparedas required by creditors and are copies on filefor reviewing personnel?

7. Are monthly reports furnished to the headoffice management reflecting the activity ofborrowed funds, including amounts outstand-ing, interest rates, interest paid to date, andanticipated future activity?

CONCLUSION


9. Based on the information gathered, evaluatethe internal controls in this area (i.e. strong,satisfactory, fair, marginal, unsatisfactory).


Borrowed FundsAudit GuidelinesEffective date July 1997 Section 3220.5

1. Using an appropriate sampling technique,select items for review of supporting docu-mentation, including terms, balances, andother appropriate details, and request a posi-tive confirmation from the lender. Control allanswered confirmations and investigate anyreported differences. Include all confirma-tions in the workpapers and document thedisposition of all exceptions or no-replies.

2. To the extent appropriate, review collateral-ized transactions for the sufficiency of secu-rity to cover the lender’s requirements andensure that the branch’s assets pledged ascollateral are clearly identified.

3. Examine supporting documents for accuracyand trace applicable entries, including pro-ceeds, to detail records and to the generalledger.

4. Test interest computations for accuracy andtrace entries to appropriate accounts.

5. Examine transactions for adherence withterms of borrowing arrangements.

6. Review all borrowings requiring head officeapproval for appropriate documentation andauthorization.


Deposit AccountsEffective date July 1997 Section 3230.1

U.S. branches of foreign banking organizations(FBOs) may hold deposits, which representfunds that branch customers have advanced andthe branch is obligated to repay on demand,after a specific period of time, or after expirationof some required notice period. Definitions ofdeposit types (i.e., demand, savings, and NOWaccounts and their respective availabilities) areoutlined in the Federal Reserve Board’s Regu-lation D and in the instructions to the Reportof Assets and Liabilities of U.S. Branches andAgencies of Foreign Banks (FFIEC 002). Thenature, type, and level of deposits that a branchmay accept is dependent on a variety of fac-tors, including the licensing agency, applicablestate restrictions, Federal Deposit InsuranceCorporation insurance status, and the limitationsimposed based on the type of office, i.e., depo-sitory or nondepository office. Managementshould have policies in place to ensure compli-ance with all applicable deposit-takingrestrictions.

The majority of U.S. branches of FBOs do notmaintain FDIC insurance and are therefore sub-ject to relevant notification requirementsdescribed in the Federal Deposit Insurance-Insured and Uninsured Branches section of thismanual. These wholesale branches generallymay accept deposits over $100,000 or from U.S.nonresidents. Branches, however, can acceptdeposits of less than $100,000 from residentsprovided the branch’s total retail deposits do notexceed 1 of its total deposits. Refer to FDICRules and Regulations Part 346 for additionalinformation. Licensing agencies may apply addi-tional deposit-taking restrictions, which shouldbe incorporated into the review’s scope. Unin-sured branches (non-FDIC-insured) may facelegal limitations on deposits but generally havegreater flexibility in taking borrowed funds.Examiners should review the documentationsupporting deposit and borrowed funds transac-tions to determine that they are properly identi-fied and reported.

Guidelines applicable to offices with FDIC-insured deposits are also available in the sectionon Federal Deposit Insurance- Insured andUninsured Branches.

Some branches use private banking depart-ments to gather and retain large deposit bases.For more information on these depart-ments, see the Private Banking section in thismanual.

REGULATION K SUBPART BSECTION 211.21(B)—CREDITBALANCES

As defined in Regulation K, Subpart B, Section211.21(b), Credit Balances, U.S. agencies, asopposed to branches, of FBOs arenotallowed toaccept deposits from U.S. citizens or residents.Agencies may, however, maintain credit bal-ances for U.S. citizens and residents, in additionto taking deposits from foreign residents. Obli-gations are not considered credit balances unlessthey meetall of the following conditions:

• Arise out of, or are incidental to the exerciseof other lawful banking powers, such as thedisbursement of loan proceeds, receipt of wiretransfer activities, or arise out of letter ofcredit transactions;

• Serve a specific purpose;• Are not solicited from the general public;• Are not used to pay routine operating expenses

in the United States, such as salaries, rent, ortaxes;

• Are withdrawn, within a reasonable period oftime, after the specific purpose for which theywere placed has been accomplished; and

• Are drawn upon in a manner reasonable inrelation to the size and nature of the account.

The agency’s Report of Assets and Liabilitiesshould correctly show such credit balances.

The remaining discussion applies to thosebranches that rely heavily on retail deposits as afunding source.

DEPOSIT DEVELOPMENT ANDRETENTION PROGRAM

Branch management should adopt and imple-ment a development and retention program forall types of deposits because of competition forfunds, the need for most individuals and corpo-rations to minimize idle funds, and the effect ofdisintermediation (the movement of deposits toother higher- yielding markets) on a branch’sdeposit base. The review of a branch’s depositdevelopment and retention program and themethods used to determine the volatility andcomposition of the deposit structure are impor-tant elements of the examination process. The


deposit development and retention program isoften included in the funds management policyand should contain a marketing strategy, projec-tions of deposit structure and associated costs,and a formula for comparing results againstprojections.

Marketing Strategy

In determining its market strategy, managementmust first consider many factors, including:

• The composition of the market area economicbase, especially the countries targeted by theprivate banking, corporate banking, or corre-spondent banking departments;

• The ability to employ deposits profitably;• The adequacy of current operations (staffing

and systems) and the location and size ofbanking quarters relative to its volume ofbusiness;

• The degree of competition from banks andnonbank financial institutions and their pro-grams to attract deposit customers; and

• The effects of the local and foreign economiesand the monetary and fiscal policies of thelocal and foreign government on the branch’smarket area.

After a deposit program is developed, man-agement must continue to monitor those factorsand correlate any findings to determine if adjust-ments are needed. The long term success of anydeposit program relates directly to the ability ofmanagement to detect the need for change at theearliest possible time.

Deposit Structure and AssociatedCosts

Management should not only look at depositgrowth but also at the characteristics of thedeposit structure. Management must be able todetermine what percentage of the overall depositstructure is centered in stable or core deposits, influctuating or seasonal deposits, and in volatiledeposits to properly invest such funds in view ofanticipated or potential withdrawals.

It is important that internal reports with infor-mation concerning the composition of the depositstructure be provided periodically to both branchand head office management. In analyzing thedeposit structure, information gathered by the

various examination procedures should be suf-ficient to allow the examiner to evaluate thecomposition of both volatile and core deposits.Management’s lack of such knowledge couldlead to an asset/liability mismatch, which couldcause problems at a later date. Ultimately, theexaminer should be satisfied that managementhas properly planned for the branch’s future.

Examiners must analyze the present andpotential effect deposit accounts have on thefinancial profile of the branch, particularly withregard to the quality and scope of management’splanning. The examiner’s efforts should bedirected to the various types of deposit accountsthat the branch uses for its funding base. Theexaminers assigned to funds management and toanalytical review of the branch’s income andexpenses should be informed of any significantchange in interest-bearing deposit accountactivity.

For branches with a significant deposit base,interest paid on deposits can represent the larg-est expense to the branch. Additional costsassociated with deposits include general operat-ing costs, promotional and advertising costs, andchanges in required reserves. As a result, interest-bearing deposit accounts employed in a margin-ally profitable manner could have significantand lasting effects on branch earnings. Refer tothe Income and Expense Section of this manualfor additional information.

Comparing Results to Projections

Management should have a formula in place forcomparing results against projections. Projec-tions should be periodically reviewed andupdated throughout the fiscal year. Actual resultsshould be periodically compared to projectionsand material variances should be identified andreviewed by management. Typically, the branch’sannual budget will include projections for depos-its and associated costs. Refer to the Income andExpense section of this manual for additionalinformation on comparing actual results to thoseprojected.

SPECIAL DEPOSIT-RELATEDISSUES

The examiner should keep in mind the followingissues during an examination to ensure that thebranch is in compliance, where applicable.

3230.1 Deposit Accounts


Abandoned Property Law

State abandoned property laws are generallycalled escheat laws. Although escheat laws varyfrom state to state, they normally require abranch to remit the proceeds of any depositaccount to the state treasurer when:

• The deposit account has been dormant for acertain number of years; and

• The owner of the account cannot be located.

Service charges on dormant accounts shouldbear a direct relationship to the cost of servicingthe accounts to ensure that the charges are notexcessive. Management should have policiesand procedures in place to review and documentthe basis on which service charges on dormantaccounts are assessed. There have been occa-sions when, because of excessive charges, therewere no proceeds to remit at the time theaccount became subject to escheat requirementsand courts have required banks to reimburse thestate. (Refer to the discussion on dormantaccounts in the subsequent Potential ProblemAreas section.)

Bank Secrecy Act

Examiners should be aware of the Bank SecrecyAct when examining the deposit area and followup on any unusual activities or arrangementsnoted. The Act was implemented by the Trea-sury Department’s Financial Recordkeeping andReporting of Currency and Foreign TransactionsRegulation. For further information, see theFederal Reserve’s Bank Secrecy Act Manual,Section 208.14 of the Federal Reserve’s Regu-lation H, and other supervisory material. TheFederal Reserve’s Bank Secrecy Act Manualalso includes information on ‘‘Know Your Cus-tomer’’ guidelines.

Banking Hours and Processing ofDemand Deposits

The Uniform Commercial Code (UCC) allows abank or branch to establish a banking day cut-offhour of 2:00 p.m. or later for the handling ofitems received for deposit or presented forpayment (UCC 4-108). A banking day is definedas the part of a day on which the bank or branchis open to the public for substantially all of its

banking functions (UCC 4-104(a)(3)). Forbranches with retail deposit-taking activities, abanking day generally includes, at a minimum,operation of a teller window and the bookkeep-ing and loan departments. Items received on anonbanking day or after the cut-off hour on abanking day may be processed as if received onthe following banking day.

A branch that violates the cut-off hour couldbe subject to civil liability for not performing itsduties under other provisions of the UCC (seeUCC 4-202, 4-213, 4-214, 4-301, and 4-302).

Foreign Currency Deposits

Branches are permitted to accept depositsdenominated in foreign currency. Branchesshould notify customers that such deposits aresubject to foreign exchange risk. The branchconverts such accounts to the U.S. dollar equiva-lents for reporting to the Federal Reserve.Examiners should verify that all reports are inorder and evaluate the branch’s use of suchfunds and management of the accompanyingforeign exchange risk. Foreign currency denomi-nated accounts are not subject to the require-ments of Regulation CC, Availability of Fundsand Collection of Checks. For additional infor-mation, examiners may refer to the FederalReserve’s supervisory guidance letter, SR-90-3(IB), Foreign (Non-U.S.) Currency Denomi-nated Deposits Offered at Domestic DepositoryInstitutions.

International Banking Facilities

An International Banking Facility (IBF) is a setof asset and liability accounts segregated on thebooks of a branch. IBF activities are essentiallylimited to accepting deposits from and extend-ing credit to foreign residents (including banks),other IBFs, and the institutions establishing theIBF. IBFs are not required to maintain reservesagainst their time deposits or loans. Whenexamining an IBF, the examiner should followthe special examination procedures in the Inter-national Banking Facility section of this manual.

Reserve Requirements

Under the Monetary Control Act of 1980 andthe Federal Reserve’s Regulation D, Reserve

Deposit Accounts 3230.1


Requirements of Depository Institutions,branches are subject to reserve requirements inthe following instances:

• It is an insured branch, and its parent foreignbank has total worldwide consolidated bankassets in excess of $1 billion; or

• It is an insured branch, and is controlled by aforeign company or by a group of foreigncompanies that own or control foreign banksthat in the aggregate have total worldwideconsolidated bank assets in excess of $1 bil-lion; or

• It is a branch that is eligible to apply tobecome an insured bank under section 5 of theFederal Deposit Insurance Act.

For reserve requirement purposes, there aretwo categories of deposits: transaction accountsand nontransaction accounts. Refer to the Fed-eral Reserve’s Regulation D and the FFIEC 002instructions for specific definitions of the vari-ous types of deposits. Branches may choose tomaintain reserves for discount window access.

POTENTIAL PROBLEM AREAS

The following paragraphs discuss the types ofdeposit accounts and related activities that haveabove-average risk and, therefore, require theexaminer’s special attention.

Branch-Controlled Deposit Accounts

Branch-controlled deposit accounts, such as sus-pense, official checks, cash collateral, dealerreserves, and undisbursed loan proceeds areused to perform many necessary banking func-tions. However, the absence of sound adminis-trative policies and adequate internal controlsregarding these accounts can cause significantloss to the branch. To ensure that such accountsare properly administered and controlled, branchand head office management must ensure thatoperating policies and procedures are in effectthat establish acceptable purpose and use;appropriate entries; controls over posting entries;and the length of time an item may remainunrecorded, unposted, or outstanding. Internalcontrols that limit employee access to branch-controlled accounts, determine the responsibil-ity for frequency of reconcilement, discourage

improper posting of items, and provide forperiodic internal supervisory review of accountactivity are essential to efficient depositadministration.

The deposit suspense account is used toprocess unidentified, unposted, or rejected items.Characteristically, items posted to such accountsclear in one business day. The length of time anitem remains in control accounts often reflectson the branch’s operational efficiency. Thisdeposit type has a higher risk potential becausethe transactions are incomplete and requiremanual processing to be completed. Due to theneed for human interaction and the exceptionnature of these transactions, the possibility ofmisappropriation exists.

Official checks are a type of demand deposit,and include bank checks, cashier’s checks,expense checks, interest checks, dividend pay-ment checks, certified checks, and money or-ders. Official checks reflect the branch’s prom-ise to pay a specified sum upon presentation ofsuch checks. Because accounts are controlledand reconciled by branch personnel, it is impor-tant that appropriate internal controls are inplace to ensure that account reconcilement issegregated from check origination. Operationalinefficiencies, such as unrecorded checks thathave been issued, can result in a significantunderstatement of the branch’s liabilities. Mis-use of official checks may result in substantiallosses through theft.

Cash collateral, undisbursed loan proceeds,and various loan escrow accounts are alsosources of potential loss. The risk lies in ineffi-ciency or misuse if the accounts become over-drawn or if funds are diverted for other purposes,such as the payment of principal or interest onbranch loans. Funds deposited to these accountsshould be used only for their stated purposes.

Brokered Deposits

Brokered deposits represent funds the branchobtains, directly or indirectly, by or through anydeposit broker for deposit into one or moredeposit accounts. Thus, brokered deposits includeboth those in which the entire beneficial interestin a given branch deposit account or instrumentis held by a single depositor and those in whichthe deposit broker pools funds from more thanone investor for deposit in a given branchdeposit account.



A small or medium-sized branch’s depen-dence on the deposits of customers who resideoutside of or conduct their business outside ofthe branch’s normal service area should beclosely monitored by branch and head officemanagement, and analyzed by the examiner.Such deposits may be the product of personalrelationships or good customer service; how-ever, large out-of-area deposits are sometimesattracted by liberal credit accommodations or byoffering significantly higher interest rates thancompetitors offer. Deposit growth due to liberalcredit accommodations generally proves costlyin terms of the credit risks taken relative to thebenefits received from corresponding deposits,which may be less stable. Deposit developmentand retention policies should recognize the lim-its imposed by prudent competition and thebranch’s service area.

Banking organizations have historically reliedto a limited extent upon funds obtained throughdeposit brokers to supplement their traditionalfunding sources. A concern regarding the activi-ties of deposit brokers is that the ready avail-ability of large amounts of funds through theissuance of such obligations undercuts marketdiscipline, particularly in insured depositoryinstitutions. To compensate for the high ratestypically offered for brokered deposits, institu-tions holding them tend to seek assets that carrycommensurately high yields. These assets canoften involve excessive credit risk or cause thebranch to take on undue interest-rate risk througha mismatch in the maturity of assets andliabilities.

In light of these concerns, certain restrictionson the use of brokered deposits were developedunder section 301 of the Federal Deposit Insur-ance Corporation Improvement Act of 1991(FDICIA), which apply to federally-insuredbranches. Section 301 of FDICIA amendedsection 29 of FDIA to prohibit undercapitalizedinstitutions from accepting funds obtained,directly or indirectly, by or through any depositbroker for deposit into one or more depositaccounts. Adequately capitalized institutions mayaccept such funds only if they first obtain awaiver from the FDIC, while well-capitalizedinstitutions may accept such funds withoutrestriction. Refer to FDIC regulations and guide-lines for information on how these requirementsare applied to federally-insured branches. Eachexamination should include a review for com-pliance with the FDIC’s limitations on the

acceptance of brokered deposits and guidelineson interest payments.

The use of brokered deposits should bereviewed during all on-site examinations, evenfor those institutions not subject to the FDIC’srestrictions. In light of the potential risks accom-panying the use of brokered deposits, the exami-nation should focus on:

• The rate of growth and the credit quality of theloans or investments funded by brokereddeposits;

• Whether brokered funds are in turn sold tobranch customers;

• The corresponding quality of loan files, docu-mentation, and customer credit and depositinformation;

• The ability of branch management to adequatelyevaluate and administer these credits anddeposits and manage the resulting growth;

• The degree of interest-rate risk involved in thefunding activities and the existence of a pos-sible mismatch in the maturity or rate-sensitivity of assets and liabilities;

• The composition and stability of the depositsources and the role of brokered deposits inthe branch’s overall funding position andstrategy; and

• The effect of brokered deposits on the branch’srisk standing and whether or not the use ofbrokered deposits constitutes an unsafe andunsound banking practice.

Check Kiting

Check kiting occurs when a depositor withaccounts at two or more banks draws checksagainst the uncollected balance at one bank totake advantage of the float (i.e., the time requiredfor the bank of deposit to collect from thepaying bank); and the depositor initiates thetransaction with the knowledge that sufficientcollected funds will not be available to supportthe amount of the checks drawn on all of theaccounts.

The key to this deceptive practice, the mostprevalent type of check fraud, is the ability todraw against uncollected funds. However, draw-ing against uncollected funds in and of itselfdoes not necessarily indicate kiting. Kiting onlyoccurs when the aggregate amount of drawingsexceeds the sum of the collected balances in allaccounts. Nevertheless, because drawing against



uncollected funds is the initial step in the kitingprocess, management should closely monitorthis activity. The requirements of RegulationCC, Availability of Funds and Collection ofChecks, increased the risk of check kiting andshould be addressed by management in thebranch’s policies and procedures.

By allowing a borrower to draw againstuncollected funds, the branch is extending creditthat should be subject to an appropriate approvalprocess. Accordingly, management shouldpromptly investigate unusual or unauthorizedactivity because the last bank to recognize checkkiting and pay on the uncollected funds suffersthe loss. Check kiting is illegal, and all sus-pected or known check kiting operations shouldbe reported pursuant to established regulatorypolicy. Branch management should maintaininternal controls to preclude loss from kiting andthe examiner should remember that, in mostcases, kiting is not covered under Blanket BondStandard Form 24.

Delayed Disbursement Practices

Although Regulation CC, Availability of Fundsand Collection of Checks, stipulates time framesfor funds availability and return of items, delayeddisbursement practices (also known as remotedisbursement practices) can present certain risks,especially concerning cashier’s checks, whichhave next-day availability. Delayed disburse-ment is a common cash management practicethat consists of arrangements designed to delaythe collection and final settlement of checks bydrawing checks on institutions located substan-tial distances from the payee or on institutionslocated outside the Federal Reserve cities whenalternate and more efficient payment arrange-ments are available. Such practices deny deposi-tors the availability of funds to the extent thatfunds could otherwise have been available ear-lier. A check drawn on an institution remotefrom the payee often results in increased possi-bilities of check fraud and in higher processingand transportation costs for return items.

Delayed disbursement arrangements couldgive rise to supervisory concerns because abranch may unknowingly incur significant creditrisk through such arrangements. The remotelocation of institutions offering delayed disburse-ment arrangements often increases the collec-tion time for checks by at least a day or more.

The primary risk is payment against uncollectedfunds, which could be a method of extendingunsecured credit to a depositor. Absent properand complete documentation regarding the cred-itworthiness of the depositor, paying itemsagainst uncollected funds could be consideredan unsafe or unsound banking practice. Further-more, such loans, even if properly documented,might exceed the branch’s prudential lendinglimit, if applicable, for loans to one customer.

Examiners should routinely review a branch’spractices in this area to ensure that such prac-tices are conducted prudently. If undue orundocumented credit risk is disclosed or iflending limits are exceeded, appropriate correc-tive action should be taken.

Deposit Sweep Programs/Master NoteArrangements

Deposit sweep programs/master note arrange-ments (sweep programs) can be implemented ona branch level or on a FBO level. On a branchlevel, these sweep programs exist primarily tofacilitate cash management needs of branchcustomers, thereby retaining customers whomight otherwise move their account to an entityoffering higher yields. On a FBO level, thesweep programs are maintained with customersat the branch level and the funds are upstreamedto the FBO as part of its overall funding strategy.Sweep programs use an agreement with thebranch’s deposit customers (typically corporateaccounts) that permits these customers to rein-vest amounts in their deposit accounts above adesignated level in overnight investments. Theseobligations include such instruments as commer-cial paper, program notes, and master noteagreements.

For insured branches, the disclosure agree-ment regarding the sale of these types of non-deposit debt obligations should include a state-ment indicating that these instruments are notfederally insured deposits or obligations of orguaranteed by an insured depository institution.In addition, insured branches and their relatedparties and subsidiaries that have issued or planto issue nondeposit debt obligations should notmarket or sell these instruments in any publicarea of the branch where retail deposits areaccepted, including any lobby area of the branch.This requirement exists to convey the impres-sion or understanding that the purchase of such



obligations by retail depositors of the federally-insured branch can, in the event of default, resultin losses to individuals who believed they hadacquired federally-insured or guaranteedobligations.

Branch Policies and Procedures

Banking organizations with sweep programsshould have adequate policies, procedures, andinternal controls in place to ensure that theactivity is conducted in a manner consistent withsafe and sound banking principles and in accor-dance with all banking laws and regulations.Branch policies and procedures should furtherensure that deposit customers participating in asweep program are given proper disclosures andinformation. When a sweep program is used aspart of a funding strategy for a FBO or anonbank affiliate, examiners should ensure thatliquidity and funding strategies are carried out ina prudent manner.

Application of Deposit Proceeds

In view of the extremely short-term maturity ofmost sweep accounts, branches are expected toexercise great care when investing the proceeds.Branches, from which deposit funds are swept,have a fiduciary responsibility to their customersto ensure that such transactions are conductedproperly. Appropriate uses of the proceeds ofdeposit sweep funds are limited to short-termbank obligations, short-term U.S. governmentsecurities, or other highly liquid, readily market-able, investment-grade assets that can be dis-posed of with minimal loss of principal.1 Use ofsuch proceeds to finance mismatched asset posi-tions, such as those involving leases, loans, orloan participations, can lead to liquidity prob-

lems and are not considered appropriate. Theabsence of a clear ability to redeem overnight orextremely short-term liabilities when they becomedue should generally be viewed as an unsafe andunsound banking activity.

Funding Strategies

A key principle underlying the Federal Reserve’ssupervision of banking organizations is thatFBOs should operate in a way that promotes thesoundness of their U.S. operations. FBOs areexpected to avoid funding strategies or practicesthat could undermine public confidence in theliquidity or stability of their U.S. operations.Any funding strategy should maintain an adequatedegree of U.S. dollar liquidity at the U.S. opera-tion and the FBO, if appropriate. Branch man-agement should avoid, to the extent possible,allowing sweep programs to serve as a source offunds for inappropriate uses at the FBO or at anaffiliate. Concerns exist in this regard, becausefunding mismatches can exacerbate an other-wise manageable period of financial stress and,in the extreme, undermine public confidence inthe FBO’s viability.

Funding Programs

In developing and carrying out funding pro-grams, FBOs should give special attention to theuse of overnight or extremely short-term liabili-ties because a loss of confidence in the issuingorganization could lead to an immediate fundingproblem. Thus, FBOs relying on overnight orextremely short-term U.S. dollar funding sources,should maintain a sufficient level of superior-quality assets that can be immediately liquidatedor converted to cash with minimal loss, at leastequal to the amount of those U.S. dollar fundingsources.

Dormant Accounts

A dormant account is one in which customer-originated activity has not occurred for a prede-termined period of time. Because of this inac-tivity, dormant accounts are frequently the targetof malfeasance and should be carefully con-trolled by a branch. Branch management shouldestablish standards that specifically outline the

1. Some banking organizations have interpreted languagein a 1987 letter signed by the Secretary of the Board ascondoning funding practices that may not be consistent withthe principles set forth in a subsequent supervisory letter datedSeptember 21, 1990, as well as with prior Board rulings. The1987 letter involved a limited set of facts and circumstancesthat pertained to a particular banking organization; it did notestablish or revise Federal Reserve policies on the proper useof the proceeds of short-term funding sources. In any event,banking organizations should no longer rely on the 1987 letterto justify the manner in which they use the proceeds of sweepprograms. Banking organizations employing sweep programsare expected to ensure that these programs conform with thepolicies contained in this manual section.



branch’s policy for the effective control ofdormant accounts, addressing:

• The types of deposit categories that couldcontain dormant accounts, including demand,savings, and official checks;

• The length of time without customer-originatedactivity that qualifies an account to be identi-fied as dormant;

• The controls exercised over the accounts andtheir signature cards, that is, prohibiting releaseof funds by a single branch employee; and

• The follow-up by the branch when ordinarybranch mailings, such as account statementsand advertising flyers, are returned to thebranch because of changed addresses or otherreasons for failure to deliver.

Employee Deposit Accounts

Historically, examiners have discovered variousirregularities and potential wrongdoing throughreviews of employee deposit accounts. As aresult, if employees are permitted to maintainaccounts at the branch, branch policy shouldestablish standards that segregate or speciallyencode employee accounts and encourage peri-odic internal supervisory review. In light ofthese concerns, examiners should review relatedbranch procedures and practices, taking appro-priate measures when warranted.

Overdrafts

The size, frequency, and duration of depositaccount overdrafts are matters that should begoverned by branch policy and controlled byadequate internal controls, practices, and proce-dures. Overdraft charges should be significantenough to discourage abuse. Overdraft authorityshould be approved in the same manner aslending authority and should never exceed theemployee’s lending authority. Systems for moni-toring and reporting overdrafts should empha-size a secondary level of administrative controlthat is distinct from other lending functions soaccount officers, who may be less than objec-tive, do not allow influential customers to exploittheir overdraft privileges. An examiner shouldalso be aware that Regulation O addresses thepayment of overdrafts to executive officers of afederally-insured branch. It is the responsibility

of branch management, with oversight fromhead office, to review overdrafts as they wouldany other extension of credit. In most cases,overdrafts outstanding for more than 30 days,which lack mitigating circumstances, should beconsidered for charge-off.

Payable-Through Accounts

A payable-through account is an accommoda-tion offered to a correspondent bank or othercustomer by a U.S. banking organization,whether they have a domestic or foreign charter,whereby drafts drawn against client subaccountsat the correspondent are paid upon presentationby the U.S. banking institution. The subaccountholders of the payable-through bank are gener-ally non-U.S. residents or owners of businesseslocated outside of the United States. Usually, thecontract between the U.S. banking organizationand the payable-through bank purports to createa contractual relationship, solely between thetwo parties to the contract. Under the contract,the payable-through bank is responsible forscreening subaccount holders and maintainingadequate records with respect to such holders.The examiner should be aware of the potentialfor money laundering through payable-throughaccounts and should refer to the Bank SecrecyAct Manual for examination procedures.

Zero-Balance Accounts

Zero-balance accounts (ZBAs) are demanddeposit accounts, used by a branch’s corporatecustomers, through which checks or drafts arereceived for either deposit or payment. The totalamount received on any particular day is offsetby a corresponding debit or credit to the accountbefore the close of business, to maintain thebalance at or near zero. ZBAs enable a corporatetreasurer to effectively monitor cash receipts anddisbursements. For example, as checks arrivefor payment, they are charged to a ZBA, withthe understanding that funds to cover the checkswill be deposited before the end of the bankingday. Several common methods used to coverchecks include:

• Wire Transfers;• Depository Transfer Checks—a bank-prepared

payment instrument used to transfer money



from a corporate account in one bank toanother bank;

• Concentration Accounts—a separate corporatedemand deposit account at the same bank usedto cover deficits or channel surplus fundsrelative to the ZBA; and

• Extended Settlement—a cash managementarrangement that does not require the corpo-rate customer to provide same-day funds forpayment of its checks.

Because checks are covered before the closeof business on the day they arrive, the branch’sexposure is not reflected in the financial state-ment. The branch, however, assumes risk bypaying against uncollected funds, thereby creat-ing unsecured extensions of credit during the

day (referred to as a daylight overdraft betweenthe account holder and the branch). If thesechecks are not covered, an overdraft occurs,which will be reflected on the branch’s financialstatement.

The absence of prudent safeguards and a lackof full knowledge of the creditworthiness of thedepositor may expose the branch to large,unwarranted, and unnecessary risks. Moreover,the magnitude of unsecured credit risk mayexceed prudent limits. Examiners should rou-tinely review cash management policies andprocedures to ensure that branches do not engagein unsafe and unsound banking practices, mak-ing appropriate comments in the report ofexamination, as necessary.



Deposit AccountsExamination ObjectivesEffective date July 1997 Section 3230.2

1. To determine if the policies, practices, pro-cedures, and internal controls regardingdeposit accounts are adequate.

2. To determine if branch officers and employ-ees are operating in conformance with thebranch’s established guidelines.

3. To evaluate the deposit structure and deter-mine its characteristics and volatility.

4. To determine the scope and adequacy of theaudit function.

5. To determine compliance with applicablelaws and regulations.



Deposit AccountsExamination ProceduresEffective date July 1997 Section 3230.3

1. Determine it deficiencies noted at the pre-vious examination or by internal/externalaudits have been adequately addressed bymanagement.

2. Check applicable restrictions on the nature,type, and level of deposits that can bemaintained by the branch.

3. If selected for implementation, complete theICQ.

4. In conducting an examination, the examinershould use available branch copies of print-outs plus transactions journals, microfiche,or other visual media to minimize expenseto the branch. However, if copies of thesereports are not available, the examinershould determine and request the informa-tion necessary to complete the examinationprocedures and, if required, the internalcontrol questionnaire. Obtain or prepare, asapplicable, the reports indicated below,which are used for a variety of purposes,including the assessment of deposit volatil-ity and liquidity, adequacy of internal con-trols, verification of information containedon required regulatory reports, and assess-ment of loss.a. For demand deposits and other transac-

tion accounts:• Trial balance• Overdrafts• Unposted items• Nonsufficient funds (NSF) report• Dormant accounts• Uncollected funds• Due to banks• Trust department funds• Significant activity• Suspected kiting report• Matured certificates of deposits with-

out an automatic renewal feature• Large balance report

b. For official checks:• Trial balance(s)

c. For time deposits:• Trial balance(s)• Unposted items• Dormant Accounts• Trust department funds• Large balance report• Money market accounts• Negotiable certificates of deposits

• Maturity reportsd. For deposit sweep programs/master note

arrangements:• List individually by deposit type and

amounte. For brokered deposits:

• List individually by deposit type,including amount and rate

f. For foreign currency deposits:• List of accounts and currency type

g. For employee deposit accounts:• List individually by deposit type,

including amount and rate• Overdrafts• Monthly account activity, including

dollar and transaction volume5. If an agency, for credit balances:

a. Review the agency’s policy to ensurecompliance with Subpart B Section211.21(b) of Regulation K dealing withcredit balances.

b. Determine that controls are in place tomonitor compliance with the regulation.

c. Select a sample of credit balances andreview transaction activity to determineif such balances are being used in accor-dance with the regulation.

6. Review the reconcilements of all types ofdeposit accounts and verify the balances todepartment controls and the general ledger,then:a. Determine if reconciliation items are

legitimate and if they clear within areasonable time frame.

b. Retain custody of all trial balances, onlyif necessary and practical.

7. Test documentation on the underlying trans-actions reported as borrowed funds to ensurethat these do not better fit the definition ofdeposits. Refer to the Borrowed Funds sec-tion of this manual and appropriate sectionsof the Board’s Regulation D for additionalguidance. If determined to be deposits,include such transactions in the review ofdeposits.

8. Review the reconciliation process for branchcontrolled accounts, such as official checksand escrow deposits, by:a. Determining if reconciling items are

legitimate and if they clear within areasonable time frame.


b. Scanning activity in such accounts todetermine the potential for improperdiversion of funds for various uses, suchas:• Political contributions• Loan payments (principal or interest)• Personal use

c. Determine if checks are being processedbefore their related credits.

9. Review the branch’s operating proceduresand reconciliation process relative to sus-pense accounts and determine if:a. The disposition of unidentified items is

completed in a timely fashion.b. Reports are generated to periodically

inform management of the type, age, andamounts of items in such accounts.

c. Employees responsible for clearing sus-pense account times are not shifting theitems between accounts.

10. Evaluate the effectiveness of the policies,procedures, and management’s reportingmethods regarding overdrafts and drawingsagainst uncollected funds.a. Concerning overdrafts, determine if:

• Officer-approval limits have beenestablished

• A formal system of review and approvalis in effect

b. Ascertain the existence of formal over-draft protection, and, if it exists:• Obtain a master list of all depositors

with formal overdraft protection• Obtain a trial balance indicating

advances outstanding and compare itwith the master list to ensure compli-ance with approved limits

• Cross-reference the trial balance ormaster list to examiner loan line sheets

• Review credit files on significant for-mal agreements not cross-referencedabove

c. Concerning drawings against uncol-lected funds, determine if:• The uncollected funds report reflects

balances as being uncollected untilthey are actually received

• Management is comparing reports ofsignificant changes in balances andactivity volume to uncollected fundsreports

• Management knows the reasons why adepositor is frequently drawing againstuncollected funds

• A reporting system to inform senior

management of significant activity inthis area has been instituted

• Appropriate employees clearly under-stand the mechanics of drawing againstuncollected funds and the risksinvolved, especially in the area ofpotential check kiting operations

d. Upon completing steps 10.a., 10.b., and10.c., the examiner should:• Cross-reference overdraft and uncol-

lected funds reports to examiner loanline sheets;

• For those depositors not cross refer-enced in the preceding step, review thecredit files of depositors with signifi-cant overdrafts, if available, or thecredit files of depositors who fre-quently draw significant amountsagainst uncollected funds;

• Request management to charge offoverdrafts deemed to be uncollectibleby examiners; and

• Submit a list of the following items tothe appropriate examiner:— Overdrafts considered loss, indicat-

ing borrower and amount.— Aggregate amounts overdrawn 30

days or more, for inclusion in pastdue statistics.

11. Review the branch’s deposit developmentand retention policy, which is often includedin the funds management policy.a. Determine if the policy addresses deposit

structure and related interest costs, includ-ing the percentages of time deposits anddemand deposits of:• Individuals• Corporations

b. Determine if the policy requires periodicreports to management, comparing theaccuracy of projections with results.

c. Assess the reasonableness of the policyand ensure that it is routinely reviewedby management.

12. If a deposit sweep program/master notearrangement exists, review for approval ofrelated policies and procedures by headoffice management.

13. For branches with deposit sweep programs/master note arrangements (sweep programs),compare practices for adherence to approvedpolicies and procedures, including a reviewof:a. The purpose of the sweep program: is it

strictly a customer accommodation trans-

3230.3 Deposit Accounts: Examination Procedures


action or is it intended to fund certainassets at the foreign banking organiza-tion (FBO) level or at an affiliate? Reviewfunding transactions in light of liquidityand funding needs of the FBO by refer-ring to the manual section on FundsManagement and Liquidity.

b. The eligibility requirements used by thebranch to determine the types of custom-ers and accounts that may participate in asweep program, including:• A list of customers participating in

sweep programs, with dollar amountsof deposit funds swept on the date ofexamination.

• The name of the recipient(s) of sweptfunds and:— If an affiliate of the branch (i.e.,

FBO), a schedule of the instru-ments into which the funds wereswept, including the effective ma-turity of these instruments.

— If an unaffiliated third party, deter-mine if the branch adequatelyevaluates the third party’s financialcondition at least annually. Verifyif a fee is received by the branchfor the transaction and, if so, thatit is disclosed in customerdocumentation.

c. Whether the proceeds of sweep pro-grams are invested only in short-termbank obligations, short-term U.S. govern-ment securities, or other highly liquid,readily marketable, investment-gradeassets that can be disposed of with mini-mal loss of principal.

d. Whether the branch has issued or plansto issue nondeposit debt obligations inany public area of the branch whereretail deposits are accepted, includingany lobby area of the branch.

e. Completed sweep program documents todetermine if:• In the case of federally-insured

branches, signed documents boldly dis-close that the instrument into whichdeposit funds will be swept is notinsured by the FDIC and is not anobligation of or guaranteed by thebranch.

• Proper authorization for the instrumentexists between the customer and anauthorized representative of the branch.

• Signed documents properly disclosethe name of the obligor and type ofinstrument into which the depositor’sfunds will be swept. If funds are beingswept into U.S. government securitiesheld by the branch or FBO, verify thatadequate confirmations are provided tocustomers in accordance with the Gov-ernment Securities Act of 1986. (ThisAct requires that all transactions sub-ject to a repurchase agreement be con-firmed in writing at the end of the dayof initiation and that the confirmationcovers specific securities. If any othersecurities are substituted that result ina change of issuer, maturity date, paramount, or coupon rate, another con-firmation must be issued at the end ofthe day during which the substitutionoccurred. Because the confirmation orsafekeeping receipt must list specificsecurities, pooling of securities for anytype of sweep program involving gov-ernment securities is not permitted.Additionally, if funds are swept intoother instruments, similar confirmationprocedures should be applied.)

• Conditions of the sweep program arestated clearly, including the dollaramount (minimum or maximumamounts and incremental amounts),time frame of sweep, time of daysweep transaction occurs, fees pay-able, transaction confirmation notice,pre-payment terms, and terminationnotice.

• The length of any single transactionunder sweep programs in effect has notexceeded 270 days and the amount is$25,000 or more (as stipulated by SECpolicy). Ongoing sweep program dis-closures should occasionally be sent tothe customer to ensure that the termsof the program are updated and thecustomer understands the terms.

f. In the case of federally-insured branches,samples of advertisements (newspaper,radio and television spots, etc.) by thebranch for sweep programs to determineif the advertisements:• Boldly disclose that the instrument

into which deposit funds are swept isnot insured by the FDIC and is not anobligation of, or guaranteed by, thebranch.

Deposit Accounts: Examination Procedures 3230.3


• Are not enclosed with insured depositstatements mailed to customers.

g. Whether the sweep program has had anegative effect on branch liquidity or hasthe potential to undermine public confi-dence in the branch. Additionally:• Review the branch’s Federal funds and

other borrowing activities to ascertainwhether borrowings appear high. If so,compare the branch’s borrowing activ-ity with daily balances of aggregatesweep transactions on selected dates,to see if a correlation exists.

• If sweep activity is significant, com-pare the rates being paid on sweptdeposits with the yields received onthe invested funds and with the rateson other overnight funding instru-ments, such as fed funds, to determineif they are reasonable.

14. Forward the following to the examinerassigned to Funds Management andLiquidity:a. The amount of any deposit decline or

deposit increase anticipated by manage-ment (the time period will be determinedby the examiner performing liquidity andfunds management).

b. A listing by name and amount of anydepositor controlling a significant per-centage of total deposits.

c. A maturity schedule of certificates ofdeposit, detailing maturities within thenext 30, 60, 90, 180, and 360 days.

d. An assessment of the overall character-istics and volatility of the depositstructure.

15. Assess the volatility and the composition ofthe branch’s deposit structure.a. Review the list of time certificates of

deposit of $100,000 or more and relatedmanagement reports to determine:• The aggregate dollar volume of bearer

CDs, if significant.• The aggregate dollar volume of accounts

of depositors by country.• If the branch is paying competitive

rates on CDs.• The aggregate dollar volume of money

market CDs with interest rates higherthan current publicly quoted rateswithin the industry, if significant.

• The dollar amount of brokered CDs, ifany.

b. Select, at a minimum, the 10 largestaccounts to determine if the retention ofthose accounts depends on:• Criticizable loan relationships.• Liberal service accommodations, such

as permissive overdrafts and drawingsagainst uncollected funds.

• Interbank correspondent relationships.• Deposits obtained as a result of special

promotions.• A recognizable trend with respect to:

— Frequent significant balancefluctuations.

— Seasonal fluctuations.— Nonseasonal increases or decreases

in average balances.c. Elicit management’s comments to deter-

mine, to the extent possible:• The potential renewal of large CDs

that mature within the next 12 months.• If a significant dollar volume of

accounts is concentrated in customersengaged in a single business or industry.

16. Test for compliance with the applicablelaws and regulations listed below by per-forming the following procedures:a. For federally-insured branches, Regula-

tion O (12 CFR 215), Loans to ExecutiveOfficers, Directors, and Principal Share-holders of Member Banks:• Review the overdraft listing to ensure

that the branch has not paid an over-draft on any account of an executiveofficer, unless the payment is madeaccording to:— A written, preauthorized, interest-

bearing extension of a credit planproviding for a method of repay-ment or

— A written, preauthorized transferfrom another account of that execu-tive officer.

Payment of inadvertent overdrafts inan aggregate amount of $1,000 or lessis not prohibited, provided the accountis not overdrawn more than five busi-ness days and the executive officer ischarged the same fee charged othercustomers in similar circumstances.Overdrafts are extensions of credit andmust be included when consideringeach insider’s lending limits and otherextensions of credit restrictions and theaggregate lending limit for all outstand-

3230.3 Deposit Accounts: Examination Procedures


ing extensions of credit by the branchto all insiders and their related interests.

b. 12 USC 1972(2), Loans to ExecutiveOfficers, Directors, and Principal Share-holders of Correspondent Banks:• Review the overdraft listing to ensure

that no preferential overdrafts existfrom the branch under examination tothe executive officers, directors, or prin-cipal shareholders of its correspondentbank.

c. Section 301 of the Federal DepositInsurance Corporation Improvement Actof 1991. Refer to the section on FederalDeposit Insurance-Uninsured and InsuredBranches of this manual for proceduralguidance.

d. Regulation D (12 CFR 204), ReserveRequirements of Depository Institutions:• Review the accuracy of the deposit

data used in the branch’s reserverequirement calculation for the exami-

nation date. In cases where a branchissues nondeposit, uninsured obliga-tions that are classified as deposits inthe calculation of reserve require-ments, examiners should determine ifthese items are properly categorized.

e. Local escheat laws:• Determine if the branch is adhering to

the local escheat laws with regard toall forms of dormant deposits, includ-ing official checks.

17. If applicable, determine if the branch isappropriately monitoring and limiting theforeign exchange risk associated with for-eign currency deposits.

18. Discuss overall findings with branch man-agement and prepare report comments on:a. Policy deficiencies.b. Noncompliance with policies.c. Weaknesses in supervision and reporting.d. Violations of laws and regulations.e. Possible conflicts of interest.

Deposit Accounts: Examination Procedures 3230.3


Deposit AccountsInternal Control QuestionnaireEffective date July 1997 Section 3230.4

OPENING DEPOSIT ACCOUNTS

1. Are the opening of new accounts and accessto unused new account records and certifi-cate of deposit (CD) forms handled by anemployee who is not a teller or who cannotmake internal entries to customer accountsor general ledger?

2. Does the branch have a written ‘‘KnowYour Customer’’ policy?a. Do new account applications require suf-

ficient information to clearly identify thecustomer?

b. Are ‘‘starter’’ checks issued only afterverification of data on new transactionaccount applications?

c. Are checkbooks and statements mailedonly to the address of record? If not, is asatisfactory explanation and descriptionobtained for any other mailing address(post office boxes, friend or relative,etc.)?

d. Are employees responsible for openingnew accounts trained to screen deposi-tors for signs of check kiting?

e. Will the branch open new accounts withincomplete documentation?

3. Are accounts referred to the branch byrepresentative offices? If so, are the repre-sentatives employees of the foreign bankingorganization? Are accounts referred to thebranch by other related offices or affiliates?If so, who refers them and why are theybooked at the branch? Do these representa-tives receive ‘‘Know Your Customer’’training?

4. Are new account applications and signaturecards reviewed by an officer prior to open-ing the account?

CLOSING DEPOSIT ACCOUNTS

5. Are signature cards for closed accountspromptly pulled from the active account fileand placed in a closed file? Are closedaccount lists circulated to the appropriatemanagement?

REGULATION K SUBPART BSECTION 211.21(B)—CREDITBALANCES

6. Does the agency have a written policy thataddresses credit balances?

7. Does the agency refuse to accept depositsfrom residents of the United States?

8. Does the agency’s system for monitoringcredit balances include a continuing reviewof checks drawn on the account to ensurethat the checks are not being used to pay forroutine operating expenses in the UnitedStates?

9. Do customer deposit files contain sufficientdocumentation that show the foreign natureof the deposit or foreign citizenship orresidency of the customer?

10. Are private banking officers or other agencypersonnel who solicit or open depositaccounts knowledgeable of the regulation’slimitations on the agency’s deposit-takingpowers?

DEPOSIT ACCOUNT RECORDS

11. Is the preparation of input and posting ofsubsidiary demand deposit records per-formed and/or adequately reviewed by per-sons who do not also:a. Accept or generate transactions?b. Issue official checks and/or handle funds

transfer transactions?c. Prepare or authorize internal entries

(return items, reversals, and directcharges, such as loan payments)?

d. Prepare supporting documents requiredfor disbursements from an account?

e. Perform maintenance on the accounts,such as change of address, stop pay-ments, holds, etc.?

12. Does the branch perform reconciliations foreach deposit account category by individu-als not engaged in accepting or preparingtransactions or in data entry to customers’accounts?

13. Do periodic reports prepared for manage-ment provide an aging of adjustments anddifferences and detail the status of signifi-cant adjustments and differences?


14. Are in-process, suspense, interoffice andother accounts related to deposit accountscontrolled or closely monitored by personswho do not have posting or reconcilementduties?

15. Are periodic reports prepared for manage-ment on open items in suspense, in-process,interoffice and other deposit accounts anddo the reports include aging of items and thestatus of significant items?

16. Does the branch segregate the depositaccount files of:a. Employees and officers?b. The business interests of, or controlled

by, employees and officers?17. Are posting and check filing separated from

statement preparation?18. Are statements mailed or delivered to all

customers, as required by the branch’sdeposit account agreement and in a con-trolled environment that precludes anyindividual from receiving any statement notspecifically authorized by the customer orbranch policy?

DORMANT ACCOUNTS ANDRETURNED MAIL

19. Does the branch have formal policies andprocedures for the handling of dormantaccounts and customers’ transaction andinterest statements that are returned by thepost office as undeliverable? Does thepolicy:a. Require statements to be periodically

mailed on dormant accounts? If so, howoften?

b. Prohibit the handling of such statementsby (1) account officer and (2) otherindividuals with exclusive control ofaccounts?

c. Require positive action to follow up onobtaining new addresses?

d. Require that statements and signaturecards for accounts that cannot be con-tacted (the mail is returned more thanonce or marked ‘‘deceased’’) be placedinto a controlled environment?

e. Require the branch to change the addresson future statements to the department ofthe branch (controlled environment) des-ignated to receive returned mail?

f. Require a written request from the cus-tomer and verification of the customer’ssignature before releasing an accountfrom the controlled environment?

20. Are accounts for which contact cannot bereestablished and do not reflect recentactivity removed from active files andclearly classified as dormant?

21. Before returning a dormant account to activestatus, are transactions reactivating theaccount verified, independent confirmationsobtained directly from the customer, andapproval obtained for an officer who cannotapprove transactions on dormant accounts?

INACTIVE ACCOUNTS

22. Are demand accounts that have been inac-tive for one year and time accounts thathave been inactive for three years classifiedas inactive? If not, state the time period.

23. Does the branch periodically review theinactive accounts to determine if they shouldbe placed in a dormant status and aredecisions to keep such accounts in activefiles documented?

HOLD MAIL

24. Does the branch have a formal policy andprocedure for handling statements and docu-ments that a customer requests not to bemailed but will be picked up at a locationwithin the branch? Does the policy:a. Require that statements will not be held

by an individual (an account officer,branch manager, bookkeeper, etc.) whocould establish exclusive control overentries to and delivery of statements forcustomer accounts?

b. Discourage such arrangements and grantthem only after the customer provides asatisfactory reason for the arrangement?

c. Require the customer to sign a statementdescribing the purpose of the request andthe proposed times for pick-up and des-ignate the individuals authorized to pickup the statement?

d. Require maintenance of signature cardsfor individuals authorized to pick upstatements and compare the authorizedsignatures to those who sign for state-ments held for pick-up?

3230.4 Deposit Accounts: Internal Control Questionnaire


e. Prohibit the delivery of statements toofficers and employees requiring specialattention, unless it is part of the formal‘‘hold mail’’ function?

25. Is a central record maintained in a controlarea that does not originate entries to cus-tomers’ accounts and identify each ‘‘holdmail’’ arrangement, the designated locationfor pick-up, and the scheduled pick-uptimes? Does the control area:a. Maintain current signature cards of indi-

viduals authorized to pick up statements?b. Obtain signed receipts showing the date

of pick-up and compare the receipts tothe signature cards?

c. Follow up on the status of statements notpicked up as scheduled?

26. Does management review activity in ‘‘holdmail’’ accounts that have not been pickedup for extended periods of time (for exam-ple, one year) and, where there is no activ-ity, place the accounts in a dormant status?

OVERDRAFTS

27. Are officer overdraft authorization limitsformally established?

28. Does the branch require an authorized offi-cer to approve overdrafts?

29. Is an overdraft listing prepared daily fordemand deposit and time transactionaccounts?

30. For branches processing overdrafts that arenot automatically approved (‘‘pay none’’system), is the insufficient funds reportcirculated among branch officers?

31. Are overdraft listings circulated among theofficers?

32. Are the statements of accounts with largeoverdrafts reviewed for irregularities?

33. Is a record of large overdrafts included inthe monthly report to head office manage-ment and does it include the overdraftorigination date?

UNCOLLECTED FUNDS

34. Does the branch generate a daily report ofdrawings against uncollected funds fordemand deposits and time transactionaccounts?

a. Is the computation of the uncollectedfunds position based on reasonable checkcollection criteria?

b. Can the reports or a separate accountactivity report reasonably be expected todetect potential kiting conditions?

c. If reports are not generated for timetransaction accounts, is a system in placeto control drawings against uncollectedfunds?

35. Do authorized officers review the uncol-lected funds reports and approve drawingsagainst uncollected funds within establishedlimits?

36. Are accounts that frequently appear on theuncollected funds and/or kite suspect reportsreviewed, regardless of account balances?(For example, accounts with simultaneouslarge debits and credits can reflect lowbalances.)

OTHER MATTERS

37. Are account maintenance activities (changeof address, status changes, rate changes,etc.) separated from data entry and recon-ciling duties?

38. Do all internal entries, other than servicecharges, require the approval of appropriatesupervisory personnel?

39. If not included in the internal/external auditprogram, are employees’ and officers’accounts, accounts of their business inter-ests, and accounts controlled by them peri-odically reviewed for unusual or prohibitedactivity?

40. For unidentified deposits:a. Are deposit slips kept under dual control?b. Is their disposition approved by an

appropriate officer?41. For returned checks, unposted items, and

other rejects:a. Are daily listings of such items prepared?b. Are all items reviewed daily and is

disposition of items required within areasonable time period? If so, indicatethe time period.

c. Are reports prepared for managementshowing items not disposed of within theestablished time frames?

42. Are accounts with a ‘‘hold-balance’’ status—those accounts on which court orders havebeen placed, those pledged as security to

Deposit Accounts: Internal Control Questionnaire 3230.4


customers’ loans, those pending the clear-ing of a large check, and those where theowner is deceased ‘‘blocked-out’’ for trans-actions unless approved by appropriatemanagement?

43. For signature cards on deposit accounts:a. Are procedures in effect to guard against

the substitution of false signatures?Describe the procedures.

b. Are signature cards stored to precludephysical damage?

c. Are signatures compared for withdraw-als and cashed checks? Describe theprocedures.

OFFICIAL CHECKS, MONEYORDERS, AND CERTIFIEDCHECKS

44. Are separate general ledger accounts main-tained for each type of official check?

45. As to the types of checks issued:a. Are multicopy checks and certified check

forms used? If not, are detailed registersof disbursed checks maintained?

b. Are all checks prenumbered and issuedin sequence?

c. Is check preparation and issuance sepa-rate from recordkeeping?

d. Is the signing of checks in advanceprohibited?

e. Do procedures prohibit issuance of acheck before the credit is processed?

46. Is the list authorizing branch personnel tosign official checks kept current? Does thelist include changes in authorization limits,delete employees who no longer work at thebranch, and indicate employees added to thelist?

47. Are appropriate controls in effect over checksigning machines (if used) and certificationstamps?

48. Are voided checks and certified check formspromptly defaced and filed with paidchecks?

49. If reconcilements are not part of the overalldeposit reconciliation function:a. Are outstanding checks listed and recon-

ciled regularly to the general ledger? Ifso, how often?

b. Is permanent evidence of reconcilementsmaintained?

c. Is there clear separation between prepa-ration of checks, data entry, andreconcilement?

d. Are the reconcilements reviewed regu-larly by an authorized officer?

e. Are reconcilement duties rotated on aformal basis in branches where size pre-cludes full separation of duties betweendata entry and reconcilement?

f. Are authorized signatures and endorse-ments checked by the filing clerk?

50. For supplies of official checks:a. Are records of unissued official checks

maintained centrally and at each locationstoring them?

b. Are periodic inventories of unissuedchecks independently performed?

c. Do the inventories include a descriptionof all checks issued out of sequence?

d. If users are assigned a supply, is thatsupply replenished on a consignmentbasis?

51. Are procedures in effect to preclude certifi-cation of checks drawn against uncollectedfunds?

CONCLUSION


53. Based on the information gathered, evaluatethe internal controls in this area (i.e. strong,satisfactory, fair, marginal, unsatisfactory).

3230.4 Deposit Accounts: Internal Control Questionnaire


Deposit AccountsAudit GuidelinesEffective date July 1997 Section 3230.5

It should be noted that some audit guidelinesmay not be easily implemented due to theforeign residence of many branch customers.Therefore, the examiner should exercise judge-ment in implementing these guidelines.1. Test the addition of all trial balances and the

reconciliation to the general ledger.2. Using appropriate techniques, sample depos-

its of all types from their respective trialbalances and:a. Where appropriate, verify that essential

account documentation contains, in aconspicuous manner, disclosure of theaccounts’ noninsured FDIC status.

b. Where necessary, prepare and mail con-firmation forms, followed by secondrequests, to selected depositors.

c. Follow up on any no-replies or excep-tions and resolve differences.

3. For transaction accounts selected in step 2:a. Verify the computation of service charges

for at least one account from each type oftransaction account selected and tracethem to the appropriate income account.

b. Determine, on a test basis, if insufficientfunds and overdraft charges are properlycollected and trace them to the appropri-ate income account.

c. Determine the reasons for statementsnoted for ‘‘no mail’’ or ‘‘hold for pickup’’ and examine appropriate authoriza-tion signed by the customer.

d. Determine if a properly signed authorityto charge is in evidence for accounts thathave an automatic deduction by thebranch.

e. Investigate branch-controlled accounts,such as dealers’ reserves and cash/collateral accounts, to determine thevalidity of entries and of notificationprocedures to the customer of activity.

f. Determine if unidentified funds are prop-erly segregated, that disposition is on atimely basis, and that items are trans-ferred to a dormant account after oneyear.

g. Mail cut-off statements to include debitand credit memos and drafts, and mail anappropriate reconciling form to due tobanks accounts selected. Have the recon-cilement completed and returned. Inves-

tigate significant items used to reconcileand follow through to disposition.

h. Review the reports on drawings againstuncollected funds and significant changesto determine possible kiting. Requeststatements and copies of checks anddeposit media to further investigate thoseselected. If the period for preparinguncollected funds reports is not at least3 days, perform the following steps:• Look at 5 days of reports on uncol-

lected funds, large balances, and sig-nificant changes for unusual depositoractivity. Select account names andnumbers that appear on the reportstwice or more and eliminate largedepositors who are known to depositcash or their own checks to corporateclearing accounts.

• For the remaining accounts, reviewcanceled checks and deposit slips orcash letter items to determine if checkspaid and checks deposited are con-trolled by the same or related parties.

i. Determine that collections deposited inescrow funds are properly credited andthat debits made against the account arefor proper disbursements.

j. Review the debit and credit entries madeon dormant accounts and determinevalidity and conformity to branch policy.

4. For time deposit accounts selected in step 2:a. Determine the reasons for savings account

statements noted for ‘‘hold for pick-up’’or ‘‘no mail’’ and examine appropriateauthorizations signed by the customers.

b. Determine that accounts pledged arenoted on the trial balance to preventwithdrawal of funds without officerapproval.

c. Review the debit and credit entries todormant accounts and determine validityand conformity to branch policy.

d. Verify and detail the written contractsbetween the branch and its trust depart-ment regarding the trust department’stime open account.

e. Determine if unidentified funds are prop-erly segregated and if disposition is on atimely basis. Ensure that items are trans-


ferred to a dormant account after oneyear.

5. For official checks:a. If accounts are on computer, reconcile

the cut-off statements as of the audit dateto bookkeeping totals and run a list ofduplicate outstanding checks.

b. If accounts are manual, run a tape listingof the outstanding checks or the checkregister and balance to the general ledgertotals.

c. Review the copies of the outstandingchecks for unusual items, stale-datedchecks or any checks to persons or orga-nizations that may be in violation of theForeign Corrupt Practices Act or FederalCampaign Acts.

d. Determine that stale checks are segre-gated and review the entries to ascertainvalidity.

e. Determine that all outstanding checkshave been included as liabilities by con-trolling paid checks for a number of daysafter the audit has begun and:• Indicate any checks paid before the

liability was posted.• Inspect the paid checks for authorized

signatures and endorsements.f. Determine if the branch is issuing checks

in numerical sequence and make an

inventory of unissued checks by type.Reconcile the inventory to control ledgerand resolve any differences.

6. Compare the accounts selected from the lastaudit to the current trial balance to deter-mine if any of those accounts were closedor, if none were noted, select accounts fromthe closed account list and send confirma-tions.

7. Review stop-payment orders and compare arepresentative number to the trial balance todetermine if accounts are properly noted.

8. Obtain or prepare a schedule showing theaccrued interest balances and the depositbalances at each quarter-end since the lastaudit and investigate significant fluctuationsor trends.

9. Test interest expense by computing interestexpense based on average deposits andinterest rates on a quarterly basis. Comparethe computed amount to the actual recordedexpenses.

10. If the branch uses prenumbered CD forms,determine that certificates are issued innumerical order. Inventory the unissued cer-tificates and reconcile the inventory to thecontrol list and resolve any differences.

3230.5 Deposit Accounts: Audit Guidelines


Due From/Due To Related OfficesEffective date July 1997 Section 3240.1

Head office and other offices of the foreignbanking organization (FBO) frequently serve asa primary funding source for a branch, in whichcase the branch will be in a net due to positionwith related offices. This situation is commonlyfound in a wholesale branch or a branch that isrestricted by its license from accepting deposits.Funding for these offices is typically providedby related offices and/or interbank borrowings.A retail branch, on the other hand, may be ableto accept deposits and thus be a net provider offunds to related offices or in a net due fromposition. Examiners will find that the overalllevel, nature, and significance of the branch’sfunding relationship with related offices is influ-enced by a number of factors, including com-parative funding costs in the home countryversus the United States and the branch’s role, ifany, in the overall U.S. funding strategy of theFBO. The examiner’s role is to evaluate thesefactors, identify any concerns, and recommendcorrective action, if appropriate.

The evaluation of the branch’s funding rela-tionship with related parties is part of the overallevaluation of the branch’s liquidity position andshould thus be conducted jointly. This sectionprovides specific guidance on the interofficefunding aspect of liquidity, which should besupplemented by referring to the FundsManagement and Liquidity section of thismanual.

To evaluate a funding relationship between abranch and its related offices or affiliates, exam-iners should begin by reviewing the branch’smost recent quarterly call report-Report of Assetsand Liabilities (FFIEC 002), the annual assess-ment of the FBO’s combined U.S. operations,and the FBO’s annual strength-of-supportassessment. A review of recent FFIEC 002reports will give the examiner information onthe branch’s historical level and trend in inter-office funding, which should be used in discus-sions with management on the nature of thebranch’s future interoffice funding position.Schedule M of the call report summarizes thegross due from/due to position with relatedparties and shows whether the branch is in a netdue to or due from related parties position.

For FBOs with multiple U.S. operations, theU.S. operations assessment should provideinformation on the past level and flow of fundsamong its combined U.S. operations, whichshould also provide a basis for reviewing the

branch’s current and future interoffice fundingposition, if any. In conducting this review,special attention should be paid to any fundingrelationship between the branch and a U.S.affiliate bank owned or controlled by the FBO.Such a relationship should be scrutinized toverify compliance with Sections 23A and 23Bof the Federal Reserve Act. If any apparentviolations are noted, they should be referred tothe appropriate regulator.

The FBO’s annual strength-of-support assess-ment also provides a basis for reviewing thebranch’s net due from/due to position. Thestrength-of-support assessment is an importantfactor to consider when the branch is in a netdue from position. In developing these assess-ments, the U.S. banking supervisors make deter-minations about the financial strength of an FBOas well as the adequacy of home country super-vision and the overall condition of the homecountry financial system. The strength-of-supportassessment is considered when reviewingbranches in a net due from position. (See theStrength-of-Support Assessment for ForeignBanking Organizations section of this manualfor more guidance on this subject.) If necessary,the branch may be required to maintain a netdue to related parties position or may be sub-jected to other prudential limitations, includingasset maintenance requirements and growthrestrictions.

From a supervisory viewpoint, a net due toposition is regarded favorably because it pro-vides a cushion for nonrelated depositors andcreditors. A net due from position with relatedparties should be reviewed carefully. The reviewshould consider any information on the under-lying assets represented by a net due fromrelated party account. For example, the due fromhead office account may be used to fund exportfinancing from the home country with paymentof the head office account scheduled to comefrom the receiving party.

In addition to providing funding to relatedentities, branches may also provide U.S. dollarclearing services. Such transactions would flowthrough the due from/due to accounts and wouldconsist of checks and other clearing itemsdenominated in U.S. dollars. The branch would,in turn, clear and process the items typicallythrough its U.S. correspondent bank for payment.

The due from/due to accounts may also con-tain allocations for loan loss reserves and other


contingencies, which would normally flowthrough earnings and be deducted from capitalin a stand-alone operation. Such allocationsmust be identified and fully explored by theexaminers in order to ensure that the branch’sfinancial risks are being covered.

The branch’s current period profit and loss isincluded in the due from/due to subledgeraccounts with a due to a (credit) balance repre-senting profit and a due from (debit) balancerepresenting a loss. Accumulated but unremittedprofit or accumulated but unreimbursed loss alsomay be included in this account. Note that thissituation only applies to the profit and losssegment of the accounts. For example, a veryprofitable branch could have a net due fromrelated parties position for reasons related tofunding but the profit and loss subledger of thisaccount should reveal a due to (profit) balance.

Due from/due to accounts are sometimes usedto effect asset transfers from one office toanother. Such transfers should be scrutinizedand reconciled to ensure propriety. For example,problem loans may be transferred to head office,offshore, or other U.S. and non-U.S. branches.Such transfers should be revealed in the duefrom/due to accounts, and should be communi-cated to the examiner-in-charge.

A branch with an asset maintenance require-ment will need to keep accurate daily records ofthe due from/due to related office positions inorder to accurately track and report its adher-ence to the asset maintenance requirement to theregulators. The gross due from/due to relatedoffice positions are factored into the computa-tion for the asset maintenance requirement. (Seethe Asset Maintenance section of this manualfor more details on this subject.)

3240.1 Due From/Due To Related Offices


Due From/Due To Related OfficesExamination ObjectivesEffective date July 1997 Section 3240.2

1. To determine if the policies, practices, pro-cedures, and internal controls regarding duefrom/due to accounts are adequate.

2. To determine if branch officers are operatingin conformance with the established guide-lines from head office.

3. To evaluate the nature of all related accountsto determine character, volatility, level, flowof funds, and compliance with appropriatelaws.

4. To determine the scope and adequacy of theaudit function with respect to the branch’srelated parties position.

5. To evaluate the branch’s net due from/due toposition with related parties in relation to theFBO’s strength-of-support assessment andthe overall assessment of its combined U.S.operations.

6. To determine that all due from and due toaccounts are reasonably and accuratelyreported.



Due From/Due To Related OfficesExamination ProceduresEffective date July 1997 Section 3240.3

1. Determine the related parties position inaccordance with the instructions to theReport of Assets and Liabilities.

2. Review the FFIEC 002 report and theappropriate due from/due to schedule andreconcile the figures to the general ledger toensure accuracy.

3. Obtain a listing of any deficiencies noted inthe latest review conducted by internal/external auditors with respect to the branch’srelated parties position, and determine ifappropriate corrections have been made.

4. Review the branch prepared reconcilementof related party accounts, match the closingbalances to the general ledger and the cut-off statement, and ensure that departmentalcontrols over entries to the proper accountswithin the general ledger are being fol-lowed, then:a. Determine the reasonableness of any

unusual items noted in the reconciliation.b. Determine if any old open items have

been charged off and, if so, were thecharge-offs appropriate and within headoffice policy.

c. Determine if any large or unusual itemsare outstanding, and review relatedcorrespondence.

d. Determine if any overdrafts exist inrelated party accounts, and determinehow these overdrafts are monitored andapproved by head office. Share thisinformation with the examiner evaluat-ing loans.

e. Retain custody of all trial balances, onlyif necessary and practical.

5. For each account, determine the purpose(e.g., funding, lending, clearing, reserveallocation, etc.) and the level of volatility.Ensure that the purpose of the account isconsistent with the balances and thevolatility.

6. Identify what interest, if any, is paid andreceived on due from/due to accounts todetermine if the rates are above or belowmarket rates. Share this information withthe examiner evaluating earnings.

7. For accounts that represent reserves, deter-mine the precise nature of these reserves,identifying all activity since the previousexamination. Share this information withthe examiner-in-charge and the examinersin charge of loan administration and earn-ings, if applicable.

8. Determine if any transfers of loans haveoccurred between examinations. If so, reviewthe entries and share this information withthe examiner in charge of loan review.

9. Review the workpapers associated with theprofit and loss accounts to ensure thatreported earnings or losses are properlyreflected in the due from/due to accountswith head office. Note whether provisionsfor general reserves are taken throughearnings.

10. If the branch is in a net due from position,determine if it represents a concentration(greater than or equal to 25 percent) of thebranch’s net assets and assess the potentialrisks of such a concentration.

11. Identify any office on which the branchrelies heavily for funding and share thisinformation with the examiner reviewingliquidity.

12. If the branch is operating under a supervi-sory agreement that limits net due frompositions or imposes an asset maintenancerequirement, test check for accuracy ofreporting to the regulators.

13. Update the workpapers with any informa-tion that will facilitate future examinations.


Due From/Due To Related OfficesInternal Control QuestionnaireEffective date July 1997 Section 3240.4

Review the branch’s controls, policies, prac-tices, and procedures for obtaining and servicingloans, placements, deposits, and borrowed fundsfrom related parties. The branch’s system shouldbe documented in a complete and concise man-ner and should include, where appropriate, nar-rative descriptions, flowcharts, copies of formsused, and other pertinent information.

1. Does the branch have in place a writtenpolicy approved by branch and head officemanagement that:a. Outlines the objectives of due from/due

to related accounts?b. Describes the branch’s philosophy rela-

tive to funding and clearing needs,reserve policies, overdraft policies andapproval limits, and proper recognitionof profits and losses?

c. Provides a system of reporting require-ments to monitor interoffice activity?

d. Provides for review and revision ofestablished policy at least annually?

2. Does the branch maintain subsidiary recordsfor each related office?

3. Is the preparation, addition, and posting ofthe subsidiary related accounts records per-formed or adequately reviewed by personswho do not also:a. Handle cash, telex, or wire transfers?b. Issue official checks and drafts?c. Prepare all supporting documents required

for payment of debt?4. Are subsidiary related account records rec-

onciled with the general ledger accounts atan interval consistent with interoffice activ-ity and are the reconciling items investi-gated by persons, who do not also:a. Handle cash, telex, or wire transfers?b. Prepare general ledger entries.c. Prepare or post to the related party’s

borrowed funds records?5. Are interest computations, if any, checked

by persons who do not have access to cash?6. Do monthly reports furnished to the head

office reflect the activity of related accounts,including amounts outstanding, overdrafts,interest rates, interest paid to date, andanticipated future activity?

7. Is the foregoing information an adequatebasis for evaluating internal control in that

there are no significant deficiencies in areasnot covered in this questionnaire that impairany controls? Explain negative answersbriefly and indicate any additional exami-nation procedures deemed necessary.

8. Based on a composite evaluation, as evi-denced by answers to the foregoing ques-tions, internal control is considered(adequate/inadequate).

In the event the branch is in a net due fromposition greater than or equal to 25 percent ofnet assets, conduct the following procedures.

9. Carefully review the FBO’s strength-of-support assessment to determine whetherany concerns exist with respect to its gen-eral ability to support its U.S. operations. Ifso, determine the extent to which the branchdepends on head office or related parties forcontingency funding, and any effect on theability of the branch to meet third partyobligations. Discuss any concerns with theexaminer-in-charge for further guidance.

10. If the branch is in a net due from positiongreater than or equal to 25 percent of netassets with an affiliate located in a countryother than its home country, determine:a. If the affiliate is a financial institution

that has been assigned a strength-of-support assessment or has received arating by an independent agency.

b. If the affiliate is not a financial institu-tion, discuss the nature and future of thisfunding relationship with branch man-agement. Discuss any concerns with theexaminer-in-charge.

11. Is the branch reconciling its accounts withrelated parties at an interval consistent withthe interoffice activity, and is there a systemto identify and monitor old items or largeitems?

12. Are extensions of credit being granted to orare loans being transferred to related par-ties? Are the credit extensions performing?At the time of transfer, were the assetsperforming?

13. Are the due from time deposits with relatedparties performing?a. Are the placements continually renewed

or is there actual payment at maturity?


b. If the branch is providing funding to anoffshore related financial institution,determine the purpose of the funding andits utilization.• Is the entity well capitalized?• Are the funds used to lend to ICERC

classified countries? Are these loans tofinance trade transactions and are theseloans performing?

• Is the entity purchasing problem loansfrom the branch? If so, this relation-ship should be closely scrutinizedbecause the branch may be funding thesale of its problem assets through theplacement of funds with the purchas-ing entity.

14. Does the net due from related parties posi-tion represent a concentration of transferrisk to any one country that could have asignificant impact on the repayment of thebranch’s third party liabilities?

15. If the branch is operating under an assetmaintenance requirement, is it appropriatelymonitoring and accurately reporting duefrom/due to related office positions to theregulators in the asset maintenancecomputation?

3240.4 Due From/Due To Related Offices: Internal Control Questionnaire


Due From/Due To Related OfficesAudit GuidelinesEffective date July 1997 Section 3240.5

1. Using an appropriate sampling technique,select items for review of supporting docu-mentation, including terms, balances, andother appropriate details, and request a posi-tive confirmation from the related office.Control all answered confirmations andinvestigate any reported differences. Includeall confirmations in the workpapers and docu-ment the disposition of all exceptions orno-replies.

2. Examine supporting documents for accuracyand trace applicable entries, including pro-ceeds, to detail records and to the generalledger.

3. Test check interest computations for accu-racy and trace entries to appropriate accounts.

4. Examine transactions for consistency withthe stated purpose of the related accounts.


Documents

Funds Management and Liquidity Effective date July … Management and Liquidity Effective date July 1997 Section 3200.1 ... liquidity and interest rate risk manage- ... regarding funds