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Enhanced Framework for Supervising the U.S. Operationsof Foreign Banking OrganizationsEffective date July 1997 Section 2000.1

Foreign banking organizations (‘‘FBOs’’) con-duct an extensive and diverse business in the

United States. Consistent with economic effi-ciency and national treatment, FBOs are free toconduct their U.S. activities through a variety of legal entities. Banking activities are conductedprimarily through branches or agencies licensedby the individual states or by the Comptroller of the Currency and, to a lesser extent, throughbanks chartered by those banking supervisoryauthorities and through special-purpose bankingcorporations chartered by the states and theFederal Reserve. Some of these banking entities

also are insured and therefore subject to theoversight of the Federal Deposit Insurance Cor-poration. Non-banking activities are authorizedby the Federal Reserve pursuant to the Bank Holding Company Act and the International

Banking Act. In addition, the Federal Reserveshares supervisory responsibility with other

regulatory agencies for FBOs with respect to thebusiness they conduct within the United States,including representative offices. As a result,FBOs are subject to a number of state andfederal statutes, and various aspects of theiroperations are supervised and regulated byboth state and federal banking supervisoryauthorities.

In order to better coordinate and furtherenhance the supervision of the U.S. activities of FBOs, the banking supervisory authorities that

have supervisory and examination powers overthe U.S. operations of FBOs have developed aprogram encompassing the supervisory prin-ciples and processes relating to FBOs, which issummarized in the following sections.

Branch and Agency Examination Manual September 1997Page 1



Strength-of-Support Assessment for Foreign BankingOrganizations with U.S. OperationsEffective date July 1997 Section 2001.1

OVERVIEW

The strength-of-support assessment (SOSA) pro-vides a general framework for evaluating andassimilating significant financial and managerialinformation related to individual foreign bank-ing organizations (FBOs) in order to assign atwo-component SOSA. The FBO assessmentprovides information to the supervisory agen-cies that is taken into account in reachingdecisions regarding the scope and frequency of examinations and other appropriate supervisoryinitiatives. The assessment also provides a basis

for the more efficient utilization of supervisoryresources.

The first component of the SOSA addresseswhether any factors relating to the ability of theFBO to meet its U.S. obligations warrant specialmonitoring of the FBO’s U.S. operations. Thiscomponent is a reflection of the overall financialviability of the FBO as well as several externalfactors such as the degree of supervision theFBO receives from its home country supervisor.

This component is based on a scale of ‘‘A’’through ‘‘E’’ with ‘‘A’’ representing the lowestlevel of supervisory concern and ‘‘E’’ represent-ing the highest.

Factors considered in assigning the first com-ponent include a review of the FBO’s financialcondition and prospects, the system of supervi-sion in the FBO’s home country, the record of home country government support of the bank-ing system or other sources of support of theFBO, and any transfer risk concerns. In assign-

ing this component, all relevant factors areweighed and evaluated. Standards and criteriafor this component, including the five possiblestrength-of-support indicators, are discussed ingreater detail below.

The second component of the SOSA, which isutilized on an as-needed basis, identifies whetherthere are any factors that raise questions aboutthe ability of the FBO to maintain adequateinternal controls and compliance procedures atits U.S. offices, irrespective of the overall finan-

cial condition of the FBO. If any such controlrisks are apparent, an asterisk is placed next tothe letter component of the SOSA.

Factors considered in assigning the asterisk include the FBO’s managerial and operationalrecord and whether current activities such as a

recent merger, significant other expansion orchanges in operations, or reported control prob-

lems at non-U.S. operations pose a potential risk to the U.S. operations. The factors consideredfor this component also are discussed below.Specific standards or criteria for the secondcomponent of the SOSA are not discussedbecause the purpose of this component is toindicate whether any such concerns exist, adetermination that is largely judgmental in natureand not readily quantified. For this reason, theasterisk is used rather than an alpha or numericsymbol which would incorrectly imply differing

degrees of such concerns.All SOSAs are for internal supervisory use

only and are not disclosed to the general publicor to FBO’s management, either in the UnitedStates or at the head office or to the homecountry supervisor(s). If deemed appropriate,any specific concerns raised through the assess-ment process, rather than the assessment itself,will be communicated directly to the FBO’smanagement and home country supervisor(s),

particularly if those concerns lead to supervisoryfollow-up action with regard to the FBO’s U.S.operations.

SOSA INDICATORS

There are five possible indicators for the firstcomponent of the SOSA:

Assessment of A—The FBO has a financialprofile that is regarded as strong by both homecountry peer and international standards. It hassuperior risk-based capital ratios,1 more thanample access to U.S. dollar funding, and, if ratedby any of the ratings agencies, is accorded oneof the two highest market or investment ratingcategories. Supervision by the home countrysupervisory agency or agencies is conducted ona comprehensive basis, covering the worldwide

1. Risk-based capital ratios based on Basle or EC criteria

are available for most banks. For those banks not providingsuch ratios, judgments related to the adequacy of capital arebased on the ratio of equity capital to total assets.




operations of the FBO and its affiliates.2 Thehome country has a good record of supervisingfinancial institutions and dealing with probleminstitutions, and transfer risk is not an issue of concern. The FBO is an unquestioned source of

strength to its U.S. operations.

Assessment of B—The financial profile and out-look pose a low risk that the FBO will be unableto support its U.S. operations. The FBO isviewed as investment grade or equivalent, capi-tal ratios are above internationally acceptedminima, and access to U.S. dollar funding isreadily available; however, financial factors arenot as strong as those of institutions with anassessment of A. The FBO is subject to a

significant degree of supervision of its overalloperations by the home country supervisor(s)and the country has a good record for dealingwith problems in the local financial system.Transfer risk factors are generally consistentwith those of FBOs with an assessment of A. AnFBO whose financial profile is consistent with aB assessment could be assigned an assessmentof C or lower if its home country has a super-visory system that is lacking in significantrespects or significant transfer risk consider-

ations exist.

Assessment of C —The current operating perfor-mance of the FBO and its immediate financialoutlook, although not posing significant con-cerns about the ability of the organization tohonor its U.S. liabilities, may warrant more thannormal review based on such factors as the lack of an investment grade rating, capital ratiosbelow internationally accepted minima, or otherfactors that are considered less than adequate by

international standards. While the FBO cur-rently may not meet all international financialstandards, the home country has demonstratedan ability and willingness to support the FBO orsimilar financial institutions.

Conversely, the financial profile of the FBOmay appear to warrant a stronger rating; how-ever, supervision by the home country regula-tors is lacking in significant respects or signifi-cant transfer risk considerations exist.

Assessment of D—Significant financial or super-visory weaknesses are apparent such that impo-sition of asset maintenance requirements on theU.S. branches and agencies should be consid-ered. The FBO may be expected to continue as

a going concern due primarily to governmentsupport, ownership, or other significant factors,although resource constraints, transfer risk con-siderations, operating structure, or other factorsmay place important limitations on that support.Conversely, the financial profile, based on avail-able information, may imply a higher assess-ment, but home country supervision is deemedto be substantially or wholly deficient, or thereare significant transfer risk concerns.

Assessment of E —Due to a seriously deficientfinancial profile and/or poor operating practicesand the absence of any sufficient supervisoryoversight and support, there is a strong possibil-ity that the FBO will be unable to honor its U.S.obligations in the near future or is otherwiseconsidered to present a hazard to U.S. financialmarkets.

SOSA FACTORS

Determining whether an individual FBO has theinternal or external resources to provide thenecessary financial or managerial support to itsU.S. operations depends to a great extent uponits financial condition, operating record, andgeneral outlook. A good financial conditioncombined with capable management is gener-ally sufficient to ensure that support. However,the degree of certainty about the ability of anFBO to provide any necessary financial support

may be limited by weaknesses in its homecountry supervisory system or a significantdegree of transfer risk associated with its majoroperations. These two factors also may influ-ence the home country’s record of support for itsfinancial institutions.

Accordingly, the first component of the SOSAconsiders four major factors: (a) the financialprofile of the FBO based on its present financialcondition and outlook, including capital ratiosand access to U.S. dollar liquidity; (b) the FBO’shome country banking supervision system;(c) the demonstrated capabilities of the homecountry in dealing with banking problems; and(d) the degree of transfer risk associated with theFBO’s home country and any other countries inwhich the FBO has major operations.

2. This covers instances in which a determination regard-ing comprehensive, consolidated supervision has already beenmade by the Federal Reserve Board or where Board staff,

based on available information, are prepared to make apositive recommendation to the Board with regard to com-prehensive, consolidated supervision.

2001.1 Strength-of-Support Assessment for Foreign Banking Organizations with U.S. Operations

September 1997 Branch and Agency Examination Manual

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All assessment factors are considered as awhole in assigning the first component of theSOSA. None of the four principal factors areassigned a separate ‘‘rating’’ or are considered adiscrete component of the final assessment.

Financial Profile

The financial profile of the FBO is based on theinstitution’s current condition and future pros-pects. A review of financial condition is basedon the level and trend in financial performanceindicators relating to the FBO’s capital, profit-ability and asset quality. These indicators should

be evaluated in the context of peer performanceand knowledge of the FBO’s home countryfinancial system and accounting policies andpractices.3 The financial outlook should con-sider a broad range of external and internalfactors, such as the home country bankingsystem, the FBO’s political and economic envi-ronment, its market position, risk profile, own-ership, and management.

Generally, the FBO’s short-term and long-term market ratings are good indicators of its

financial outlook. An FBO with the highestmarket ratings should be able to demonstrate astrong financial condition and outlook. The FBOwould likely be assigned an A assessment if other factors are consistent with the assessment.Notwithstanding the significance of market rat-ings, the FBO’s financial profile and resultantassessment should not be based on marketratings alone. Rather the ratings should serve asa reference point for the independent assessmentof the institution, because market ratings may

not always reflect the most current view of theFBO or the supervisory authorities may haveinformation not directly or indirectly availableto the market. For example, examination find-ings of the U.S. operations could raise questionsabout the FBO’s overall operations and manage-ment that could lead to a SOSA lower than thatindicated by the FBO’s market ratings. How-ever, any significant difference between theassessment and market ratings should be fullyanalyzed and justified.

System of Home Country Supervision

A review of the home country supervisorysystem is essential to ensure that the FBO issubject to an appropriate level of supervision of

its global operations. In assigning an FBO’SSOSA, the review of the system of home coun-try supervision should concentrate on its generalpolicies and how the supervisory framework applies in practice to the individual FBO. In thiscontext, the mere presence of a home countrysupervisor is not considered sufficient.

The FBO’s home country supervisory systemshould be evaluated based on those generalprinciples and practices that ensure regulatorymonitoring over the FBO’s principal operations

and activities, including those outside the homecountry. These general supervisory principlesand practices usually include some level of periodic reporting, on-site and/or off-site review,prudential guidelines (including capital adequacyrequirements), and supervisory enforcementpowers. Effective regulatory systems may takemany forms; however, the system of any coun-try should ensure that the internationally activebanks operating under that system are subject toa sufficient level of supervision.

Supervisory systems may also vary withrespect to the type of institution. Therefore, theanalysis of the supervisory system should evalu-ate actual regulatory practices for the individualFBO. This assessment will be based largely onthe information that has been accumulated overtime by the U.S. banking supervisory agencies.It is expected that this assessment will beenhanced as additional information on othersupervisory systems is obtained through improved

contacts and informational exchange.

Record of Home Country Support

Related to home country supervision is thematter of the home country’s record of ensuringthe solvency of its financial institutions, particu-larly those that operate internationally. Therecord of support varies by country with respectto structure, coverage of banks, and resources.Such support may be either direct or indirect innature and may be widespread or only applica-ble to banking institutions with specificcharacteristics.

Some countries are able to take whateversteps are necessary to support their banks

3. While recognizing that in many cases knowledge of thisnature will take time to develop, it is particularly important

because financial disclosure varies among countries. For thisreason, meetings with head office management and the homecountry supervisors of FBOs are useful sources of information.

Strength-of-Support Assessment for Foreign Banking Organizations with U.S. Operations 2001.1




unequivocally while others will have a morelimited degree of support for their banks due tolegal restrictions or financial constraints. Thesefactors should be reviewed, giving particularemphasis to past performance and an assessment

of the country’s resources.

Level of Transfer Risk

Transfer risk, which relates to the FBO’s abilityto access U.S. dollars, is an essential factor indetermining whether the FBO can support itsU.S. operations. For some FBOs, transfer risk isincreased due to heavy debt servicing or otherfinancial restraints relating to the home country,

which often leads to exchange controls and hardcurrency restrictions. As a result, these FBOsmay be limited in providing necessary supportto their U.S. operations.

The assessment of transfer risk for individualcountries is uniformly handled by U.S. regula-tors through the Interagency Country ExposureReview Committee (ICERC). These ICERCassessments can therefore be used in determin-ing the SOSAs. For those countries not evalu-ated by ICERC, the assessments of transfer risk will made in the same manner as conducted byICERC.

Generally, FBOs from countries rated substan-dard or worse would be accorded an assessmentof no better than C. However, a high level of transfer risk associated with the FBO’s homecountry could be mitigated by other consider-ations that clearly indicate that the FBO hasbroad access to U.S. dollars.

Other Factors

Determining whether an FBO poses any mana-gerial or operational control risks to its U.S.operations can be influenced by a broad range of factors that are generally more subjective thanthose discussed under the first component of theSOSA. Any such risks, both actual and poten-tial, which do not directly relate to the ability of an FBO to meet its obligations as discussedearlier, should be denoted by placing an asterisk beside the FBO’s letter assessment. The natureof these risks should be discussed separately inthe FBO evaluation.

One example of such control risks is an FBOthat otherwise has a SOSA of A or B but may be

experiencing certain operational problems, notnecessarily in the United States. The FBO maybe undergoing extensive expansion into newmarkets or products that over time could pose astrain on its financial and managerial resources.

The FBO also could be experiencing well-publicized internal control problems at officesoutside the United States. Although these con-trol problems would not necessarily affect theability of the FBO to pay its obligations, theymay be symptomatic of larger control problemsthat also might exist in the U.S. offices. Anysuch concerns should be explored to the extentpossible, particularly as they may influence theexamination plan for the FBO’s U.S. operations.

GENERAL SUPERVISORYIMPLICATIONS

As discussed earlier, one of the principal goalsof the SOSA is to identify those FBOs that maypose risks to their U.S. operations or to U.S.financial markets due to financial, operational,or other concerns at the FBO as a whole. TheSOSA serves to categorize all FBOs conducting

banking operations in the United States and tohighlight those FBOs warranting higher levelsof supervisory attention with respect to theirU.S. operations. This assessment may influencethe examination plan and potential supervisoryfollow-up actions for the FBO’s U.S. operations.

An FBO’s SOSA is taken into considerationin setting the examination plan for the FBO’sU.S. operations. The examination plan considersany issues raised in the assessment process andaddresses them accordingly. For example, the

U.S. operations of FBOs whose assessments aremarked by an asterisk may have examinationsthat specially target operational or managementareas. The FBO’s SOSA is also a factor indetermining whether the FBO will be subject toa simultaneous examination.

The FBO’s SOSA also is considered in imple-menting supervisory follow-up action for theU.S. operations. Generally, an assessment of Cor worse would imply a level of concern thatwould subject the FBO’s U.S. offices to at leastperiodic monitoring of their due to/due frompositions. Any additional supervisory steps, suchas imposing an asset pledge or asset main-tenance requirement, would be implementedlargely based on the condition and nature of theU.S. operations. An FBO accorded an assess-



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ment of D or worse indicates a higher level of concern with some presumption of asset main-tenance regardless of the condition of its U.S.operations.

As with all such supervisory follow-up actions,

these steps are considered and implementedbased on the general criteria for applying super-visory follow-up actions in the context of theFBO’s SOSA. Supervisory follow-up action canbe modified based upon a number of criteria. Itis stressed that no automatic supervisory pro-gram is mandated as part of the FBO SOSA.Furthermore, an assessment of A or B generallywould imply little if any concern relating to theability of the FBO to meet its obligations. If anFBO does raise liquidity or solvency concerns,

the FBO should not be accorded an assessmentof A or B.

Suggested guidelines for supervisory follow-upaction for each assessment category are asfollows:

A or B Assessment —Normally, any supervisoryfollow-up action for FBOs with a SOSA of A orB is applied only if warranted by the conditionof the U.S. operations. Supervisory measures

generally would not relate to liquidation con-cerns. As such, asset maintenance usually wouldnot be required for branches and agencies of these FBOs; however, supervisory actions wouldbe undertaken, if necessary, to resolve anysignificant deficiencies in risk management,operations and internal controls, or complianceat any of the U.S. offices.

C Assessment —The FBO’s SOSA is reviewed

at least annually. The due to/due from position isclosely monitored and any substantial due fromposition is fully analyzed for risk implications.If warranted by the condition of the combinedU.S. operations or the asset quality at the U.S.offices of such an FBO, asset maintenancewould be considered for branches and agencies,and U.S. subsidiary banks could be required tooperate at capital levels above the minima.

D Assessment —There is a strong presumptionof asset maintenance for branches and agenciesof an FBO in this category, and U.S. bank subsidiaries should operate at strong capitallevels. The FBO is more closely monitored andits assessment may be subject to review at leastsemi-annually.

E Assessment — The FBO will be placed undercontinuous surveillance and reporting as war-ranted. Termination proceedings for the U.S.operations of such an FBO will be consideredunder applicable regulatory guidelines.

DEVELOPING THE SOSA

The FBO’s SOSA is developed annually througha process that involves all U.S. supervisors thathave licensing, chartering, or examining respon-sibilities over the FBO’s U.S. operations. Theprocess includes an analysis of available infor-mation on the financial condition of the FBOwithin the context of the home country financialsystem, the banking supervisory system, therecord of the authorities in preventing or suc-cessfully dealing with banking system prob-lems, and transfer risk considerations. The FBOevaluations are based on information compiledby all of the relevant U.S. banking supervisoryagencies.

Information obtained by any of the bankingsupervisory agencies relating to individual FBOs,their home country financial systems, supervi-

sory systems and accounting policies should betransmitted to the Federal Reserve, which willassume responsibility for organizing and main-taining a database for this information. Thisdatabase is available to all of the relevant U.S.banking supervisory agencies.

All of the relevant state and federal bankingsupervisory agencies, whenever possible, willobtain information for the database, especiallyas it relates to the individual FBOs, the financialsystems within which they primarily operate and

the supervisory systems in the different coun-tries. This information will help to keep thedatabase as current as possible and is developedprimarily through discussions with the U.S. andhead office managements of the FBOs as well asthe home country supervisor(s).

PRIMARY PRODUCTS

The information in the database is used todevelop three primary products, each of whichsummarizes information in the database andprovides the supporting data for the SOSA.These three products are: (1) an evaluation of the financial condition of the FBO, (2) a reviewof the home country financial system, and (3) a





review of significant home country accountingpolicies and practices.

Evaluation of the Financial Conditionof the FBO

Normally, the FBO evaluation is drafted by theFederal Reserve each year. The initial source of information for the evaluation is the FR Y7report as well as any external sources that arereadily available (e.g. periodicals and services).Over time, as the database becomes more devel-oped, many additional sources of informationwill be utilized.

The individual Reserve Banks responsible fordrafting FBO evaluations produce a schedule atthe beginning of each year showing the approxi-mate date that the draft evaluation and recom-mended SOSA for each FBO will be circulatedfor comments. This schedule is based primarilyon the fiscal year-end of the FBO (and conse-quently the date the FR Y7 report is received),the extent and overall condition of the FBO’scombined U.S. operations, and the prior SOSAof the FBO. This schedule is distributed to all of

the state and federal agencies participating inthis joint program along with the name of acontact person at each Reserve Bank. The otheragencies, as well as the other Reserve Banks,may request, through the assigned contact per-son, that an FBO evaluation in any given year begiven a higher priority than the scheduleindicates.

The draft evaluation and the proposed SOSAis circulated for comments within the FederalReserve System and to all federal and state

supervisory agencies involved in supervising theFBO. Each party reviews the draft and com-ments, if necessary. In addition, the analyst whoprepared the draft will be available to answerquestions regarding the draft. If the initial reviewof the draft indicates differences in view regard-ing the proposed assessment that can not beresolved informally, a meeting of the relevantbanking supervisory agencies could be called byany supervisory agency to discuss the SOSA of the FBO. While it is expected that a consensusassessment will result from this process, indi-vidual agencies retain the right to exercise allstatutory authorities available to them to meettheir supervisory concerns.

The finalized evaluation is sent to all of thesupervisory agencies involved in the supervision

of the U.S. operations of the FBO. The evalua-tions and assessments normally are reviewedannually. The evaluations will be revised in theinterim only if information is obtained by any of the U.S. supervisory agencies that is significant

enough to change the SOSA, either positively ornegatively.These evaluations are kept strictly confiden-

tial by each of the agencies, in part to ensure thatthe sharing of information between the agenciesfor purposes of analyzing the condition of theFBO and assigning its SOSA does not violatestate or federal regulations.

Review of Home Country FinancialSystem

As mentioned above, a database containinginformation on the financial system of eachcountry with bank representation in the UnitedStates is maintained by the Federal Reserve,using its own sources and information submittedby the other supervisory agencies. This informa-tion is made available to all of the agencies. Inaddition, the Federal Reserve provides, in a

uniform format, reviews summarizing informa-tion on the home country financial system, thenature of banking supervision and the country’srecord in dealing with banking problems.4 Thesereviews are updated whenever any of the super-visory agencies obtain significant informationregarding the financial system of the particularcountry. The database includes all such reviewsprepared by the Federal Reserve and any pro-vided by the other supervisory agencies.

Review of Home Country AccountingPractices

The database also contains information on sig-nificant accounting policies and practices inother countries and is utilized to develop reviewsof such practices. These reviews are developedby the Federal Reserve utilizing information

4. These reviews are produced based on a schedule pro-

vided by the Reserve Banks. The schedules give priority tothose countries that have a major banking presence in theUnited States or are experiencing significant problems within

the home country financial system. The draft is provided to theother agencies for their comments. The analyst who preparedthe draft is available to answer questions regarding the draft.



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derived from the same sources as used for thereview of the home country financial system aswell as from general accounting information

provided in the FR Y7 report. These reviews areupdated whenever any significant changes occurin accounting policies or practices.





Examination Planning and the Assessment of theU.S. Operations of Foreign Banking OrganizationsEffective date July 1997 Section 2002.1

OVERVIEW

This segment of the program is designed toprovide a more efficient, rational, and uniformapproach to supervising the U.S. operations of foreign banking organizations (FBOs), particu-larly those that operate in the United Statesthrough numerous entities and across multiple

jurisdictions. In order to ensure coordination of supervisory efforts and avoid duplication, theU.S. banking supervisory agencies communicatewith each other to a greater extent regardingtheir examination plans, examination results,

and, where applicable, their proposed supervi-sory follow-up actions. In addition, the FederalReserve assesses annually the combined U.S.operations of each FBO, based largely on inputfrom and discussions with the examiningagencies.

EXAMINATION SCHEDULINGAND DEVELOPMENT OF

EXAMINATION PLANS

FBSEA requires that each U.S. branch andagency of an FBO be subject to one safety andsoundness examination in each twelve monthperiod. More frequent examination may be war-ranted in certain situations.1

To ensure coordination, the licensing andinsuring agencies provide the local FederalReserve Bank with a copy of their preliminaryexamination schedule for the coming year for all

U.S. offices of an FBO for which the agencyanticipates conducting an examination. The Fed-eral Reserve uses these schedules, along withthe preliminary examination schedules of thevarious Reserve Banks, to derive a draft com-prehensive examination schedule for all U.S.operations of individual FBOs.

The draft schedule is provided to eachinvolved agency in order to permit all of theexamining agencies to review their own sched-ules in conjunction with those of the otheragencies. In addition, where necessary, an inter-agency

scheduling meeting takes place each year todetermine the scope and timing of examinations

of FBOs that are to be conducted on a morecoordinated basis. The Federal Reserve finalizesthe comprehensive examination schedule andprovides it to all of the supervisory agencies.

For FBOs that conduct all or substantially allof their U.S. operations through entities licensedor chartered by one banking supervisory agency,the timing of the annual examination is estab-lished by the licensing authority. In agreementwith the individual states, the Federal Reserveand, for insured branches, the FDIC, share theburden of conducting the annual examinationsof state-licensed branches and agencies. In thoseyears that the Federal Reserve or FDIC conductthe examination, the timing will be establishedby that agency.

FBOs which operate in the United Statesthrough multiple offices often will have alloffices examined using the same ‘‘as of’’ finan-cial statement date. This provides the supervi-sory agencies with increased information on the

interrelationships among the various offices andcan enhance the examination of individual officesand the FBO’s overall U.S. operations. Theseexaminations are conducted by the variousagencies.

Sometimes, certain activities of a branch arefunctionally managed or operationally per-formed at the branch being examined, but arebooked at another office of the FBO, either inthe U.S. or offshore. It is not uncommon for onebranch to generate, or be responsible for loans,

trading assets, or deposits that are ultimatelybooked at another office. Similarly, it also is notuncommon for a branch to perform certainoperations such as electronic data processing,accounting, financial reporting, or credit admin-istration on behalf of another office of the FBO.Even when a U.S. branch performs limitedoperational functions for a related office, exam-iners should evaluate whether the branch hassufficient records and controls in place to executethe delegated responsibilities. If there is insuffi-cient information to evaluate the nature of andthe performance of the U.S. branch with respectto the business relationship with another officeof the FBO, examiners should cite this defi-ciency in the report of examination as a matterthat requires immediate attention.

1. Under legislation passed in 1996, branches and agencies

that meet certain size and other criteria may be examined oncein every 18 month period. Those criteria currently are underdevelopment and further guidance will be issued.




SR 96-36 provides detailed guidance on howto review duties performed by one branch on thebehalf of another. Essentially, a branch perform-ing duties on behalf of another office of the FBOshould have adequate policies, procedures, and

documentation to clearly delineate the over-sight, operational, and control responsibilities of the branch. There should be adequate risk man-agement processes, operational controls, andcompliance programs covering all activities forwhich the branch has responsibility. The exami-nation treatment under the ROCA rating systemfor activities conducted by a U.S. branch onbehalf of another office of the FBO should bethe same as for activities conducted by thebranch for its own book, except for the evalua-

tion of asset quality. In rating asset quality, theexaminer should only evaluate assets that are onthe books of the U.S. branch. However, exam-iners should be mindful of the general quality of assets being generated by the U.S. branch andbooked elsewhere so as to be alert to any patternof booking low quality assets outside the U.S. orany other situations that might indicate prob-lems in risk management or operational controls.

EXAMINATION PLAN

Subsequent to the examination scheduling pro-cess, detailed examination plans are developed,exchanged and coordinated among the examin-ing agencies. Each state and federal supervisoryagency participating in this program is commit-ted to developing, to the extent possible, exami-nation plans for individual offices of FBOs thatthey plan to examine based primarily on the

following:

• findings and scope of previous examinations;• the results of any off-site surveillance;• the latest assessment of the combined U.S.

operations of the FBO and the role of theoffice in the context of the FBO’s overall U.S.business activities;

• results of meetings with both U.S. and headoffice management of the FBO, and the homecountry supervisor(s); and,

• the evaluation of the FBO and the SOSAassigned.

A comprehensive examination plan (‘‘ExamPlan’’) is developed annually for each FBO withbanking offices licensed by more than one

supervisory agency and/or with significant U.S.non-banking activities. The Federal Reservedrafts the comprehensive Exam Plan based onthe individual examination plans prepared bythe different state and federal supervisory agen-

cies for each office to be examined. Theseexamination plans should be developed after theregulatory agency has completed its most recentexamination of the FBO entity subject to itssupervision. The plan should be incorporatedinto the confidential section of the examinationreport. After conferring with other participatingbanking supervisory agencies, the scope or time-table of an examination, as set out in the annualcomprehensive Exam Plan, may be altered in theevent there are impediments to completing an

examination as originally planned.

IMPLEMENTING THE ANNUALEXAMINATION PLAN

The Federal Reserve coordinates the sharing of information throughout the examinations of FBOs with multi-state operations. Because of the differing starting dates and lengths of indi-

vidual examinations, most examinations are com-pleted by participating banking supervisory agen-cies at different times. Consequently, an importantpart of this program is the sharing of criticalexamination findings throughout the process.The U.S. supervisory agencies have committedto advising those agencies responsible for exam-ining other U.S. offices of the FBO of anycritical examination findings prior to the exitmeeting for that examination.

The Federal Reserve, in its statutory role asumbrella authority with responsibility for over-all U.S. operations, confers with the examiningagencies to determine if its participation in anyof the examiner closeout meetings is warranted.Such participation typically is appropriate in theevent there are systemic weaknesses detected inthe U.S. operations or problems exist that are sosignificant as to affect the rating of the overallU.S. operations. In those instances where aFederal Reserve Bank has conducted the exami-nation, that Reserve Bank confers with thelicensing agency to determine if the participa-tion of that agency is warranted. However, thenormal presumption is that the banking super-visory agency that conducted the examinationalso will conduct the closeout meeting withoutparticipation by non-examining agencies.

2002.1 Examination Planning and the Assessment of the U.S. Operations of Foreign Banking Organizations


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The agency responsible for the examinationof any office in a given year is also responsiblefor completion of the examination and prepara-tion of the examination report for that entity. Inthe case of joint examinations, the examining

agencies strive to issue only one report of examination for that office of the FBO. Thesupervisory agency that conducted the examina-tion of an individual office of an FBO also isresponsible for the distribution of the transmittalletter and examination report.

Supervisory actions that affect only one officeof an FBO also normally are entered into solelyby the licensing authority, unless the actionresulted from an examination conducted by theFDIC or the Federal Reserve. In these cases the

action is undertaken by the examining agencyor, at the option of the licensing authority, on a

joint basis with that authority. Actions that applyto the overall operations of an FBO are enteredinto by the Federal Reserve and those licensingor insuring agencies that have offices affected bythe supervisory action and wish to enter intosuch an action with the office they license.

ASSESSMENT OF COMBINED U.S.OPERATIONS AND ASSIGNMENTOF A RATING

An important component of this program is theintegration of individual examination findingsinto an assessment of an FBO’s entire U.S.operations. This assessment provides the FBOand the U.S. supervisory agencies with a view of the overall condition of the U.S. operations, andhelps put into context the strengths and weak-

nesses of individual offices. It also highlightssupervisory concerns regarding any problemsthat are pervasive in the U.S. operations of theFBO.

The Federal Reserve conducts an annualassessment of the combined U.S. operations andprepares a "Summary of Condition" for allFBOs with U.S. offices supervised by more thanone agency. The summary includes an assess-ment of all risk factors, including (1) all ele-ments of the ROCA rating system, (2) quality of risk management oversight employed by alllevels of management in the FBO’s U.S. opera-tions, and (3) the examinations of all vehicles of the FBO conducted during the year. The Sum-mary of Condition leads to the assignment of asingle-component rating between 1 and 5 for the

combined U.S. operations.The Summary of Condition is drafted by the

Federal Reserve which provides a copy of thedraft and proposed rating to each supervisoryagency with examination authority over an office

of the FBO in order to make certain thatinformation obtained from these agencies wascorrectly interpreted.

Once the Summary of Condition is finalized,the Federal Reserve provides a copy, includingthe rating, to the Chief Executive Officer at thehead office of the FBO. The Summary of Con-dition and the rating serve as a starting point indrafting the Exam Plan for the next year.

In arriving at the rating for the combined U.S.operations of the FBO, all of the FBO’s U.S.

vehicles are considered; however, this rating isnot based merely on an arithmetic average of theexamination ratings of the vehicles examined.The strengths or weaknesses exhibited withinindividual entities are evaluated based on thesize and importance of the entity relative to theFBO’s entire U.S. operations, and the material-ity and extent of the weaknesses.

The five ratings are defined as follows:

Combined Rating of 1—The overall operations

are fundamentally sound in every respect. Theycause no supervisory concern and require onlynormal supervisory attention.

Combined Rating of 2—The combined U.S.operations operate in a basically sound manner,but may have modest weaknesses that can becorrected by management in the normal courseof business. They do not require more thannormal supervisory attention.

Combined Rating of 3—Overall U.S. operationsare weak in risk management, operational con-trols, and compliance, or have numerous assetquality problems that in combination with thecondition of the FBO cause supervisory con-cern. U.S. and/or head office management maynot be taking the necessary corrective actions toaddress weaknesses. This rating may also beassigned when either risk management, opera-tional controls, or compliance is individuallyviewed as unsatisfactory. Generally, these opera-tions raise supervisory concern and require morethan normal supervision to address theirweaknesses.

Combined Rating of 4—The combined U.S.operations have a significant volume of serious

Examination Planning and the Assessment of the U.S. Operations of Foreign Banking Organizations 2002.1




weaknesses. Serious problems or unsafe andunsound banking practices or operations exist,which have not been satisfactorily addressed orresolved by U.S. or head office management.These operations require close supervisory

attention and surveillance monitoring and adefinitive plan for corrective action by headoffice management.

Combined Rating of 5—The combined U.S.operations have so many severe weaknesses or

unsafe and unsound conditions that they requireurgent restructuring by head office management.

This composite assessment serves to apprisethe various U.S. supervisory authorities of the

condition of all the U.S. entities of individualFBOs. These agencies can then factor the infor-mation that they obtain from the Summary of Condition and the composite assessment intotheir supervision of the U.S. entities under their

jurisdiction.

2002.1 Examination Planning and the Assessment of the U.S. Operations of Foreign Banking Organizations


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Rating System for U.S. Branches and Agencies of ForeignBanking OrganizationsEffective date July 1997 Section 2003.1

The rating system for U.S. branches of FBOs isa management information and supervisory tool

designed to assess the condition of a branch andto identify significant supervisory concerns at abranch in a systematic and consistent fashion.The rating system (ROCA) has been revisedfrom the previous rating system of asset quality,internal controls, and management (AIM), tobetter assess the condition of a branch within thecontext of the FBO, of which it is an integralpart, and to pinpoint the key areas of concern ina branch office.

For evaluation purposes, the rating system

divides a branch’s overall activities into threeindividual components: risk management, opera-tional controls, and compliance. These compo-nents represent the major activities or processesof the branch that may raise supervisory con-cern. The rating system also provides for aspecific rating of the quality of the branch’sstock of assets as of the examination date.

COMPOSITE RATINGThe overall or composite rating indicates whether,in the aggregate, the operations of the branchmay present supervisory concerns and the extentof any concerns. While the individual compo-nent ratings are taken into consideration inarriving at the branch’s overall assessment, thecomposite rating should not be merely an arith-metic average of the individual components.The examiner should assign and justify in the

report a composite rating using definitions pro-vided below as a guide.1

The composite rating is based on a scale of one through five in ascending order of supervi-

sory concern. Thus, one represents the lowestlevel of supervisory concern while five repre-sents the highest level. The five compositeratings are defined as follows.

Composite Rating 1

Branches in this group are strong in everyrespect. These branches require only normalsupervisory attention.

Composite Rating 2

Branches in this group are in satisfactory con-dition, but may have modest weaknesses thatcan be corrected by branch management in thenormal course of business. Generally, they donot require additional or more than normalsupervisory attention.

Composite Rating 3

Branches in this group are viewed as fair due toa combination of weaknesses in risk manage-ment, operational controls, and compliance, orasset quality problems that, in combination withthe condition of the FBO or other factors, causesupervisory concern. In addition, branch and/orhead office management may not be taking thenecessary corrective actions to address substan-tive weaknesses. This rating may also beassigned when risk management, operationalcontrols, or compliance is individually viewed1. Assessment of asset quality is an integral part of any

examination; however, under certain circumstances, it may be

appropriate to give the individual asset quality rating compo-nent greater or lesser weight in arriving at an overall compos-ite rating. In ensuring the protection of branch creditors, an

important factor is the strength of the FBO. As the financialstrength of the FBO weakens, it becomes increasingly impor-tant to look to the quality of the assets booked in the United

States as the source of protection for local creditors, and, at a

certain point, asset maintenance should be imposed. Similarly,where the FBO is strong, and the need to look to local assets

for protection of creditors seems remote, the relative weighingof the asset quality component in the overall evaluationdiminishes.

It also should be recognized that different offices of theFBO can be assigned widely different roles in the FBO’s

overall strategy. Thus, an individual office that books very few

loans, but is otherwise poorly managed should not be givenundue credit for having good asset quality. Alternatively, a

branch that is designated to hold problem assets generated byother offices of the FBO, in order to better manage theworkout process, should not be penalized, so long as the FBO

has the ability to support the level of problem assets.

Finally, it should be recognized that asset quality tendsto be a ‘‘trailing’’ indicator of branch performance. In instances

where risk management systems are weak, but problem assetsare currently nominal, it is realistic to assume there will befuture deterioration in asset quality. By the same measure,

management should be given credit in the overall evaluationwhere the causes of past asset quality problems have beencorrected.




as unsatisfactory. Generally, these branches raisesupervisory concern and require more thannormal supervisory attention to address theirweaknesses.

Composite Rating 4

Branches in this group are in marginal conditiondue to serious weaknesses as reflected in theassessments of the individual components.Serious problems or unsafe and unsound bank-ing practices or operations exist, which have notbeen satisfactorily addressed or resolved bybranch and/or head office management. Branchesin this category require close supervisory atten-

tion and surveillance monitoring and a definitiveplan for corrective action by branch and headoffice management.

Composite Rating 5

Branches in this group are in unsatisfactorycondition due to a high level of severe weak-nesses or unsafe and unsound conditions andconsequently require urgent restructuring

of operations by branch and head officemanagement.

DISCLOSURE

Following approval of the rating by appropriatesenior supervisory officials at the examiningagency, the numeric ratings for all componentsas well as the overall composite rating should be

disclosed in the open, summary section of theexamination report. This also applies when con-ducting meetings with senior management. Indisclosing the rating, its meaning should beexplained clearly using the appropriate compos-ite rating definition. The report should alsomake it clear that the rating is part of the overallfindings of the examination and is thus confi-dential. Any rating disclosed or discussed at anexamination closeout meeting should be heldout by the examiner-in-charge to be tentative.

COMPONENT EVALUATIONS

Similar to the composite rating, the individualrating components are evaluated on a scale of

one to five, where one represents the lowestlevel of supervisory concern and five representsthe highest. Each component is discussed belowfollowed by a description of the individualperformance ratings.

Risk Management

Risk is an inevitable component of any financialinstitution. Risk management, or the process of identifying, measuring, and controlling risk, istherefore an important responsibility of anyfinancial institution. In a branch, which is typi-cally removed from its head office by locationand time zone, an effective risk management

system is critical not only to manage the scopeof its activities but to achieve comprehensive,ongoing oversight by branch and head officemanagement. In the examination process, exam-iners will therefore determine the extent towhich risk management techniques are adequate(i) to control risk exposures that result from thebranch’s activities and (ii) to ensure adequateoversight by branch and head office manage-ment and thereby promote a safe and soundbanking environment.

The primary components of a sound risk management system are a comprehensive risk assessment approach; a detailed structure of limits, guidelines, and other parameters used togovern risk taking; and a strong managementinformation system for monitoring and reportingrisks.

The process of risk assessment includes theidentification of all the risks associated with thebranch’s balance sheet and off-balance-sheet

activities and grouping them into appropriaterisk categories. These categories broadly relateto credit, market, liquidity, operational, andlegal risks.2 All major risks should be measuredexplicitly and consistently by branch manage-ment; risks should also be reevaluated on anongoing basis as underlying risk assumptionsrelating to economic and market conditions varyand as the branch’s activities change. Thebranch’s expansion into new products or busi-ness lines should not outpace proper risk man-

agement or supervision by head office. Whererisks cannot be explicitly measured, manage-

2. While operational risks are identified as part of the

branch’s overall risk assessment process, the effectiveness of the branch’s operational controls is separately evaluated underROCA.

2003.1 Rating System for U.S. Branches and Agencies of Foreign Banking Organizations


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ment should demonstrate knowledge of theirpotential impact and a sense of how to managesuch risks.

Risk identification and measurement are fol-lowed by an evaluation of the tradeoff between

risks and returns to establish acceptable risk exposure levels, which are stated primarily inthe branch’s lending and trading policies subjectto the approval of head office management.These policies should give standards for evalu-ating and undertaking risk exposure in indi-vidual branch activities as well as procedures fortracking and reporting risk exposure to monitorcompliance with established policy limits orguidelines.

Head office management has a role in devel-

oping and approving the branch’s risk manage-ment system as part of its responsibility toprovide a comprehensive system of oversightfor the branch. Generally, the branch’s risk management system, including risk identifica-tion, measurement, limits or guidelines, andmonitoring should be modeled on that of theFBO as a whole to provide for a fully-integratedrisk management system.3

In assigning the risk management rating,examiners should evaluate the current, ongoing

situation and concentrate on developments sincethe previous examination. The rating should notconcentrate on past problems, such as thoserelating to the current quality of the branch’sstock of assets, if risk management techniqueshave improved significantly since those prob-lems developed.4

More specifically, in rating the branch’s risk management procedures, examiners should con-sider the following.

• The extent to which the branch is able tomanage the risks inherent in its lending, trad-ing, and other activities, specifically its abilityto identify, measure, and control these risks.

• The soundness of the qualitative and quanti-tative assumptions implicit in the risk man-agement system.

• Whether risk policies, guidelines, and limits atthe branch are consistent with its lending,trading, and other activities; management’sexperience level; and the overall financialstrength of the branch and/or the FBO.

• Whether the management information systemand other forms of communication are consis-tent with the level of business activity at thebranch and sufficient to accurately monitorrisk exposure, compliance with establishedlimits, and sufficient to enable the head officeto monitor the real performance and risks of the branch.

• Management’s ability to recognize and accom-modate new risks that may arise from the

changing environment, and to identify andaddress risks not readily quantified in a risk management system.

For example, in the lending area, a branch isexpected to have (1) experienced lending offi-cers, an effective credit approval and reviewfunction, and, where appropriate, credit work-out personnel; (2) a credit risk evaluation systemthat is adequate in assessing relative credit risks;(3) branch officer lending limits, lending guide-

lines, and portfolio policies consistent with theabilities of branch personnel and the financialexpertise and resources of the FBO; (4) a systemthat identifies existing and potential problemcredits, a method for assessing the likely impactof those credits on existing and future profits,and procedures for accurately informing headoffice of the credit quality of the portfolio andpossible credit losses; and (5) procedures forassessing the impact on the portfolio of specificor general changes in the business climate.

A rating of 1 indicates that management has afully-integrated risk management system thateffectively identifies and controls all major typesof risk at the branch, including those from newproducts and the changing environment. Thisassessment, in most cases, will be supported bya superior level of financial performance andasset quality at the branch. No supervisoryconcerns are evident.

A rating of 2 indicates that the risk manage-ment system is fully effective with respect toalmost all major risk factors. It reflects a respon-siveness and ability to cope successfully withexisting and foreseeable exposures that mayarise in carrying out the branch’s business plan.

3. For a more detailed overview of the risk managementprocess in trading operations, refer to the Federal Reserve’sTrading Activities Manual.

4. Thus, for example, the change in the level of problemassets since the previous examination is normally more

important than the absolute level of problem assets. At thesame time, a loan portfolio that has few borrowers experienc-ing debt service problems does not necessarily indicate a

sound risk management system because weak underwritingstandards may make the branch vulnerable to credit problemsduring a future economic downturn.

Rating System for U.S. Branches and Agencies of Foreign Banking Organizations 2003.1




While the branch may have residual risk-relatedweaknesses, these problems have been recog-nized and are being addressed by the branchand/or head office. Any such weaknesses willnot have a material adverse affect on the branch.

Generally, risks are being controlled in a mannerthat does not require additional or more thannormal supervisory attention.

A rating of 3 signifies a risk managementsystem that is lacking in some important mea-sures. Its effectiveness in dealing with thebranch’s level of risk exposures is cause formore than normal supervisory attention, anddeterioration in financial performance indicatorsis probable. Current risk-related procedures are

considered fair, existing problems are not beingsatisfactorily addressed, or risks are not beingadequately identified and controlled. While thesedeficiencies may not have caused significantproblems yet, there are clear indications that thebranch is vulnerable to risk-related deterioration.

A rating of 4 represents a marginal risk management system that generally fails to iden-tify and control significant risk exposures inmany important respects. Generally, such a situ-

ation reflects a lack of adequate guidance andsupervision by head office management. As aresult, deterioration in overall performance isimminent or is already evident in the branch’soverall performance since the previous exami-nation. Failure of management to correct risk management deficiencies that have created sig-nificant problems in the past warrants closesupervisory attention.

A branch rated 5 has critical performance

problems that are due to the absence of aneffective risk management system in almostevery respect. Not only are there a large volumeof problem risk exposures, the problems are alsointensifying. Management has not demonstratedthe capability to stabilize the branch’s situation.If corrective actions are not taken immediately,the operations of the branch are severelyendangered.

Operational Controls

This component assesses the effectiveness of thebranch’s operational controls, including account-ing and financial controls. The assessment is

based on the expectation that branches shouldhave an independent internal audit functionand/or an adequate system of head office orexternal audits as well as a system of internalcontrols consistent with the size and complexity

of their operations. In this regard, internal auditand control procedures should ensure thatoperations are conducted in accordance withinternal guidelines and regulatory policies andthat all reports and analyses provided to the headoffice and branch senior management are timelyand accurate.

The rating of operational controls shouldinclude the following.

• The adequacy of controls and the level of

adherence to existing procedures and systems.(These are separate but related factors.)

• The frequency, scope, and adequacy of thebranch’s internal and external audit function,relative to the size and risk profile of thebranch, and the independence of the internalaudit function from line management.

• The number and severity of internal controland audit exceptions.

• Whether internal control and audit exceptionsare effectively tracked and resolved in a timely

manner.• The adequacy and accuracy of management

information reports. This assessment shouldbe based primarily on whether reports andanalyses are sufficient to properly inform headoffice management of the branch’s conditionon a timely basis, and whether there aresufficient procedures to ensure the accuracy of those reports.

• Whether the system of controls is regularlyreviewed to keep pace with changes in

the branch’s business plan and laws andregulations.

A branch that is rated 1 has a fully compre-hensive system of operational controls that pro-tects against losses from transactional andoperational risks and ensures accurate financialreporting. Branch operations are fully consistentwith sound market practices. The branch alsohas a well-defined and independent audit func-tion that is appropriate to the size and risk profile of the branch. No supervisory concernsare evident.

A rating of 2 may indicate some minorweaknesses, such as the presence of new busi-ness activities where some modest control defi-



Page 4



ciencies exist, but which management is address-ing. Some recommendations may be noted.Overall, the system of controls, including theaudit function, is considered satisfactory andeffective in maintaining a safe and sound branch

operation. Only routine supervisory attention isrequired.

A rating of 3 indicates that the branch’ssystem of controls, including the quality of theaudit function, is lacking in some importantrespects, particularly as indicated by continuedcontrol exceptions and/or substantial deficien-cies in or failure to adhere to written policiesand procedures. As a result, more than normalsupervisory attention is required.

A branch that is rated 4 signifies that thesystem of operational controls has serious defi-ciencies that require substantial improvement.In such a case, the branch may lack controlfunctions, including those related to the auditfunction, that meet minimal expectations; there-fore, adherence to bank and regulatory policy isquestionable. Head office management has failedto give the branch proper support to maintainoperations in accordance with U.S. norms. Close

supervisory attention is required.

A branch that is rated 5 lacks a system of operational controls to such a degree that itsoperations are in serious jeopardy. The brancheither lacks or has a wholly deficient auditfunction. Immediate substantial improvement isrequired by branch and head office management,along with strong supervisory attention.

Special audit procedures are required when

both the O component and the composite ratingare 3 or worse. If both the O component and thecomposite rating are 3, the special audit proce-dures may be performed by the internal auditfunction if, and only if, the audit function isconsidered satisfactory. If the internal auditfunction is less than satisfactory, or if both the Ocomponent and composite rating are 4 or worse,then an external audit is required. An externalaudit also is required if the internal auditors hadperformed the special audit procedures follow-ing the previous examination, and the O andcomposite ratings are again assigned a 3 rating.As significant internal control weaknesses in theoperations of one office may be an indication of systemic weaknesses in other branches as well,the special audit procedures may be applied

to other U.S. offices of the FBO. SR 96-27provides additional guidance regarding thesespecial audits.

Compliance

In addition to maintaining an effective system of operational controls, branches should also dem-onstrate compliance with all applicable state andfederal laws and regulations, including reportingand special supervisory requirements. To theextent possible given the size, risk profile andorganizational structure of the branch, theseresponsibilities should be vested in a branchofficial or compliance officer whose function is

separate from line management. Branch man-agement should also ensure that all appropriatepersonnel are properly trained in meeting regu-latory requirements on an ongoing basis. Thescope of the branch’s audit function also shouldensure that the branch is meeting all applicableregulatory requirements.

Accordingly, the branch’s level of compli-ance should be rated based on the followingfactors.

• The level of adherence to applicable state andfederal laws and regulations and any supervi-sory follow-up actions.

• The effectiveness of (i) written complianceprocedures and (ii) training of line personnelcharged with maintaining compliance withregulatory requirements.

• Management’s ability to submit required regu-latory reports in a timely and accurate manner.

• Management’s ability to identify and correct

compliance issues.• Whether the internal audit function checks forcompliance with applicable state and federallaws and regulations.

A branch accorded a rating of 1 demonstratesan outstanding level of compliance with appli-cable laws, regulations, and reporting require-ments. No supervisory concerns are evident.

A rating of 2 indicates that compliance is

generally effective with respect to most factors.Compliance monitoring and related training pro-grams are sufficient to prevent significant prob-lems. Minor reporting errors may be present, butthey are being adequately addressed by branchmanagement. Only normal supervisory attentionis warranted.

Rating System for U.S. Branches and Agencies of Foreign Banking Organizations 2003.1




A branch that is rated 3 has deficiencies inmanagement and training systems that result inan atmosphere where significant complianceproblems could and do occur. Such deficienciescould include a lack of written compliance

procedures, no system for identifying possiblecompliance issues, or a substantial number of minor or repeat violations or deficiencies. Morethan normal supervisory attention is warranted.

A rating of 4 indicates that compliance mat-ters are not given proper attention by branch andhead office management and close supervisoryattention is warranted. The lack of an effectivecompliance program, including an ongoing train-ing program, may be evident along with a failure

to meet significant regulatory requirementsand/or significant, widespread inaccuracies inregulatory reports.

A rating of 5 would signal that attention tocompliance matters is wholly lacking at thebranch to the extent that immediate supervisoryattention is warranted.

Asset Quality

Generally, asset quality is evaluated to deter-mine whether a financial entity has sufficientcapital to absorb prospective losses and, ulti-mately, whether it can maintain its viability asan ongoing entity. The evaluation of asset qual-ity in a branch does not have the same resultbecause a branch is not a separately capitalizedentity. Instead, a branch relies on the financialand managerial support of the FBO as a whole.

Nonetheless, the evaluation of asset quality isimportant both in assessing the effectiveness of credit risk management and in the event of apossible liquidation of a branch. However, asindicated above, a branch is not strictly limitedby its own internal and external funding sourcesin meeting solvency and liquidity needs. The

ability of a branch to honor its liabilities ulti-mately is based upon the condition and level of support from the FBO, a concept that is integralto the FBO supervision program.

This concept states that if the condition of the

FBO is satisfactory, the FBO is presumed to beable to support the branch with sufficientresources on a consolidated basis. As a result,the assessment of asset quality in such circum-stances would not in and of itself be a predomi-nant factor in the branch’s overall assessment, if existing risk management techniques are satis-factory. If, however, support from the FBO isquestionable, the evaluation of asset qualityshould be carefully considered in determiningwhether supervisory actions are needed to

improve the branch’s ability to meet its obliga-tions on a stand-alone basis. In cases where abranch is subject to asset maintenance, it isexpected that asset quality issues will beaddressed by disqualifying classified assets aseligible assets.

The quality of the branch’s stock of assets isevaluated based on the following factors. Gen-erally, credit administration concerns should be

addressed in rating risk management.

• The level, distribution, and severity of assetand off-balance-sheet exposures classified forcredit and transfer risk.5

• The level and composition of nonaccrual andreduced rate assets.

A branch rated 1 has strong asset quality.

A branch rated 2 has satisfactory asset quality.

A branch rated 3 has fair asset quality.

A branch rated 4 has marginal asset quality.

A branch rated 5 has unsatisfactory asset quality.

5. The various state and federal agencies may differ interms of specific practices and methodologies used to imple-

ment the above guidelines. For further guidance in this area,examiners should consult with their respective agencies.



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Risk-Focused Approach to Pre-Examination PlanningEffective date July 1997 Section 2010.1

Risk-focused examinations emphasize effectiveplanning and scoping in order to customizeexaminations to the size and activities of the

institution and to concentrate examiner resourceson areas that expose the institution to the great-est degree of risk. In addition, under a risk-focused approach, the resources directed toassessing an organization’s management aregenerally increased, while the degree of trans-action testing may be reduced in order to mini-mize the regulatory burden.

Transaction testing includes the reconciliationof internal accounting records to financial reports(in order to evaluate the accuracy of account

balances), the comparison of day-to-day prac-tices to the office’s policies and procedures (inorder to assess compliance with internal sys-tems), and all other supervisory testing proce-dures, such as the review of the quality of individual loans and investments. Risk-focusedexaminations still require an appropriate level of transaction testing to verify (1) the adequacy of,and adherence to, internal policies, procedures,and limits; (2) the accuracy and completeness of management reports and financial records; and

(3) the adequacy and reliability of internalcontrol systems. However, under a risk-focusedexamination approach, the degree of transactiontesting should be reduced when internal risk management processes are determined to beadequate or risks considered minimal.

Generally, advance notification of an exami-nation is given to enable branch management tohave the necessary information available forexaminers when they arrive on-site. This prac-tice results in significant savings in time and

personnel resources. However, surprise or non-routine examinations may be conducted at anytime at the examining agency’s discretion.

PURPOSE OF PRE-EXAMINATIONPREPARATION

Pre-examination planning results in more effec-tive examinations that are focused on risksparticular to the specific institution and thusminimizes regulatory burden. Further, such plan-ning facilitates close coordination with otherstate and Federal banking agencies and allowsinformation requests to be better tailored to thespecific institutions.

RISK ASSESSMENT

In order to focus procedures on the areas of

greatest risk to the branch, a risk assessmentshould be performed in advance of the on-sitework. The risk assessment process highlightsboth the strengths and the vulnerabilities of theinstitution and provides a foundation from whichto determine the procedures to be conductedduring an examination. Risk assessments entailthe identification of the financial activities inwhich a banking organization has chosen toengage, the determination of the types andquantities of risk, and the consideration of the

quality of the management and control of theserisks. At the conclusion of the risk assessmentprocess, a preliminary supervisory strategy forthe institution and each of its major activitiescan be formulated. Those activities that are mostsignificant to the organization’s risk profile orthat have inadequate risk management processesor rudimentary internal controls represent thehighest risks to the institution and should undergothe most rigorous scrutiny and testing.

Identifying the significant activities of aninstitution is the first step in the risk assessmentprocess. These activities may be identifiedthrough the review of prior examination andinspection reports and workpapers, surveillanceand monitoring reports generated by the Boardand Reserve Bank staff, regulatory reports, andother relevant supervisory material. Once sig-nificant activities have been identified, the typesand quantities of risks to which these activitiesexpose the institution should be determined.

This allows identification of the high risk areasthat should be emphasized during the examina-tion. The types of risk which may be encoun-tered individually or in various combinations arecredit, market, liquidity, operational, legal, orreputational. These risk types are discussedfurther in Section 3000.1 of this manual.

The quantity of risk can be determined by anumber of factors. For example, in order toassess the quantity of credit risk in loans andcommitments, the level of past due loans, inter-nally classified or watch list loans, nonperform-ing loans, and concentrations of credit to par-ticular industries or regions should be considered.In addition, the examiner should consider thetrends in special mention and classified loansand historic chargeoff levels.




Once the types and quantities of risk in eachactivity have been identified, a preliminaryassessment of the process in place to identify,measure, monitor, and control these risks shouldbe completed. Sound risk management will vary

from branch to branch, but generally includefour basic elements. These are: (1) active seniormanagement oversight, (2) adequate policies,procedures, and limits, (3) adequate risk mea-surement, monitoring, and management infor-mation systems, and (4) comprehensive internalaudits and controls.

Ordinarily the pre-examination preparation isperformed by the examiner-in-charge or desig-nee and one or more assistants. Time require-ments for this preparation may vary consider-

ably depending upon the size, complexity, andcondition of the branch being examined. Thetiming should allow overall scheduling effi-ciency and should consider such factors as thenumber and experience of participating person-nel, geographic location of the branch, and theresults of previous examinations. Schedulingfactors may result in the pre-examination prepa-ration being performed from many weeks beforethe start of the examination to the week imme-diately preceding the examination.

ASSIGNMENT AND SUPERVISIONOF PERSONNEL

Early review allows the examiner-in-charge thegreatest flexibility in determining the number of examining personnel needed and any specialexpertise required.

The examiner-in-charge must be able to pri-

oritize critical categories of the examination anddetermine the optimum timing of simultaneousactivities. Budgeting and allocating humanresources should include the followingconsiderations:

• Assignment of examiners based on their skills/ expertise and examination objectives.

• Assignment of priorities to avoid duplicationof effort and ensure timely completion of theexamination.

• Coordination with other regulatory agenciesthat may be conducting a joint, concurrent, orrelated office examination.

• Assignment of examining personnel in a man-ner to maintain an even workload throughoutthe examination.

GENERAL GUIDELINES FORPRE-EXAMINATIONPREPARATION

Because the primary purpose of the pre-

examination preparation is to determine exami-nation objectives and scope, only general guide-lines for the procedures to be performed can begiven. Accordingly, the procedures that followmay be modified to fit the specific circumstancesencountered. General guidelines for pre-examination preparation include:

• Reviewing the examination strategy/annualexamination plan developed by the appropri-ate supervisory authorities.

• Reviewing examination manuals, programs,and regulatory letters applicable to the exami-nation.

• Reviewing all other available analyses pre-pared by the coordinating Reserve Bank andother supervisory agencies.

• Reviewing all available regulatory reports,including the Report of Assets and Liabilitiesof U.S. Branches and Agencies of ForeignBanks (FFIEC 002) and the Country ExposureReport (FFIEC 019).

• Reviewing the branch’s strategic or businessplan, if available. This plan, provided by thebranch, can be useful in examination plan-ning, as it may indicate new or discontinuedservices that could affect the scope and direc-tion of the examination. The plan can alsoserve as a reference between examinations.The plan usually contains goals and prospectsfor the branch over the next business period,indicating target markets and the expected

level of profitability and other performancestandards to be achieved.

• Reviewing the following list of branch ser-vices and products to determine their impor-tance to the examination:

— Deposit services: checking, automaticfunds transfer, telephone transfer;

— Credit services: commercial loans, over-draft banking, installment loans, mortgagelending, letters of credit, bills discounted;

— EDP services;

— Securities trading and off-balance sheetactivities, including foreign exchange;

— Fiduciary activities; and

— Private banking.

• Reviewing all related examination and visita-tion reports, correspondence, enforcement

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actions, minutes, and memoranda of significance.

• Coordinating with other pertinent regulatoryagencies or units, particularly in the case of special examinations resulting from novel or

unusual situations. Determining which relatedorganizations are to be examined and theextent of the procedures to be performed.

• Completing personnel assignments and coor-dinating with assisting personnel regardingany preliminary procedures that are to beperformed.

• Determining the cut-off line or the appropriatestatistical sampling technique to be used forperforming risk asset review. Note any unusualconsiderations that may affect the establish-

ment of the factors.• Reviewing and customizing the First Day

Letter before presentation to branch manage-ment; early presentation permits timely comple-tion of bank-prepared information.

Upon completion of the pre-examinationpreparation, the scope of the examination shouldbe established and a planning memorandumshould be developed. Accomplishing the fore-going tasks before starting the examination willprovide for an efficient examination, consistentwith established objectives.

DETERMINING THE SCOPE OFTHE EXAMINATION

Full-scope examinations under a risk-focusedapproach are not comprised of a fixed set of

routine procedures. Rather, the procedures thatmust be performed to fulfill the objectives of afull-scope examination must be adjusted depend-ing on the circumstances of the institution beingevaluated. At a minimum, however, full-scopeexaminations should include sufficient proce-dures to reach an informed judgement on therisk management, operational, and compliancefactors rated under ROCA.

If necessary, the examiner-in-charge shouldmeet with the principal branch officers beforethe start of the examination to determine thebreadth of their individual responsibilities. Theexaminer-in-charge should determine at thismeeting whether any important developmentshave occurred since the previous examination orif any planned or probable events are expected

in the near-term. Arrangements should be madewith branch personnel as to the level of theirassistance required during the examination.

Discussions should be held with any examin-ers offering specialized assistance during the

examination, for example, consumer affairs,EDP, or audit, to determine the scope of theirreview and the inclusion of those results withinthe context of the overall examination report, if so planned.

At this point in time, the scope of the exami-nation should be developed so as to facilitate thedevelopment of a First Day Letter applicable tothe branch being examined.

PREPARATION OF A SCOPEMEMORANDUM

Once the examination planning and risk assess-ment processes are completed, a scope memo-randum should be prepared. A scope memoran-dum provides a detailed summary of thesupervisory strategy for an institution and assigns

specific responsibilities to examination teammembers. A scope memorandum should betailored to the size and complexity of the insti-tution, should define the objectives of eachexamination, and generally should include:

• Name and location of entity to be examined.

• Results of previous examination.

• Objectives of the examination.

• Identification of the risks to be assessed.

• Scope of the examination/nature and depth of coverage.

• An overview of the branch’s managementstructure.

• Summary of the branch’s activities.

• Summary of earnings and other performanceinformation to date.

• Summary of the structure and businessstrategy/plan of the branch.

• Balance sheet and contingency/memoranda

items.• Administrative issues.

• Allocation of assigned personnel resources.

• Business components and support functions.

• Workpaper and report of examinationrequirements.

Risk-Focused Approach to Pre-Examination Planning 2010.1




DEVELOPING THE FIRST DAYLETTER

Once the scope memorandum is completed, theexaminer-in-charge can develop the First Day

Letter, which should be delivered to branchmanagement in a timely manner, before the startof the examination. Upon presentation of theFirst Day Letter, the examiner should ensurethat management understands what is being

requested and how to avoid duplication of effortthrough the use of information that may alreadybe generated by the branch’s own managementinformation systems.

The examiner-in-charge must ensure that

branch personnel are fully aware of how theinformation is to be prepared, when the infor-mation is required, and the need for accuracyand completeness.

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Loan SamplingEffective date July 1997 Section 2020.1

A risk-focused review of a loan portfolio is oneof the most important elements of an examina-tion. Credit reviews are an examiner’s primary

means for evaluating the effectiveness of inter-nal loan review and credit-grading systems,determining that credit is being extended incompliance with internal policies and creditstandards, ascertaining a branch’s compliancewith applicable laws and regulations, and judg-ing the safety and soundness of the branch’slending and credit administration functions.Examiners must select for review a sample of loans1 that is sufficient in size and scope toenable them to reach reliable conclusions about

the branch’s overall lending function. The spe-cific details of selecting the sample is subject tothe examiners’s discretion, based on the level of risk perceived at the institution.

Sampling enables the examiner to draw con-clusions regarding the condition of the entireloan portfolio and selected off-balance-sheetitems by reviewing only a selected portion of outstanding credit facilities. Thus, such tech-niques economize on the use of examinationresources and allow examiners to devote more

of their time and efforts to other areas of examination interest.

Generally, a judgmental sampling techniqueis used for reviewing credit facilities. Thistechnique enables examiners to evaluate theportfolio by reviewing a desired percentage of all loans and appropriate off-balance-sheet itemsover preselected cut-off amounts. In addition tothe judgmental sampling approach, statisticalsampling techniques can also be valid methodsfor evaluating credit portfolios. Two statistical

sampling techniques that may be selectivelyimplemented during on-site examinations areattribute sampling and proportional sampling.Attribute sampling is used in certain branchesthat have formal loan review programs; propor-tional sampling is used in branches without suchinternal credit review programs.

In statistical sampling, the examiner appliessampling techniques to the design, selection,

and evaluation of samples by employing theconcepts of probability. Use of these conceptseliminates (or at least minimizes) biases by

satisfying a condition that each item in thepopulation must have an equal or otherwisedeterminable probability of being included inthe examined portion. By satisfying that condi-tion, statistical sampling provides the examinerwith a quantitative measure of risk that can becontrolled at a level that is tolerable to theexaminer. Statistical sampling techniques maybe implemented only in those branches thatwere found to be in financially sound conditionat the latest examination and only in those

branches where it is determined that the systemsand controls are appropriate for implementingsuch techniques. Moreover, if during the exami-nation where statistical sampling is being used,the examiner determines that the sample resultsare unsatisfactory or the condition of the branchhas deteriorated since the previous examination,the traditional judgmental sampling techniquemust be implemented.

The following is a description of the tworecommended statistical sampling techniques:

ATTRIBUTE SAMPLING

The objective of attribute sampling is to use asample, within specified reliability limits, todetermine the validity of the branch’s internalcredit review program. The reliability limits aredetermined by the examiner who formulates ahypothesis about the branch’s credit review

program when evaluating its policies, practices,and procedures with regard to extensions of credit. The sample population consists of allloans and appropriate off-balance-sheet itemsbetween certain dollar parameters, except forcredit facilities reviewed under the SharedNational Credit Program and facilities to iden-tified problem industries, which are reviewedseparately during the examination. The lowerdollar parameter is an amount that the examinerdeems sufficient to achieve the desired coverageof the portfolio and is selected in much the samemanner as a cut-off line is chosen in judgmentalsampling. The upper dollar parameter is anamount over which all credit facilities must bereviewed because of the significant effect eachcould have on the branch’s condition. Credit

1. For the purposes of this section, the term "loans"includes all sources of credit exposure arising from loans and

leases including interbank placements, investment securities,and banker’s acceptances. This exposure also includes credit-related off-balance-sheet items such as standby letters of

credit, loan commitments, and risk participations in accep-tances. Credit exposures arising from trading and derivativesactivities are not generally included.




facilities are selected from the sample popula-tion by using a random digit table.

When the selected credit facilities are reviewed,the examiner compares the findings with thoseof the branch’s credit review program. An error

exists if the examiner’s criticism of a particularcredit is significantly more severe than thebranch’s findings. If the error rate in the sampleis beyond the reliability limits that the examineris willing to accept, all credit facilities over theappropriate cut-off line will be reviewed. If theexaminer is satisfied with the sample results, thebranch’s internal classifications may be acceptedfor all criticized loans within the sample popu-lation. Even when the branch’s classificationsare deemed acceptable by the examiner, any

loans reviewed and found to be in error will beappropriately classified in the report.

PROPORTIONAL SAMPLING

Generally speaking, the procedures for propor-tional sampling are similar to those followed forattribute sampling. The examiner formulates ahypothesis about the quality of the examinedbranch’s credit administration based upon ananalysis of its loan policies, practices, and pro-cedures with regard to extensions of credit.Additionally, the branch is asked to provide aproblem credit list, without grading the creditfacilities. The examiner’s findings are comparedto that list. The objective of this sampling

technique is to determine whether managementcan identify all the criticizable credit facilities inits portfolio. In proportional sampling, everycredit in the sample population is given an equalchance of selection proportionate to its size;

therefore, the larger the credit, the more likely itwill be selected for review.

As in attribute sampling, the examiner speci-fies the desired precision of the sample, i.e., thatthe true error rate in the branch’s problem creditlist should be contained within a certain range of values. As a control measure, sample precisionis set to represent a specified percentage of thebranch’s net assets. A statistical error occurswhenever the examiner criticizes a credit notpreviously identified by the branch. If the error

rate is higher than expected, the examiner mayreview all credit facilities over selected cut-off lines, which are determined by using the samecriteria used for line selection in judgmentalsampling. If the sample results indicate an errorrate within expectations, then the examiner mayaccept the branch’s problem credit list as beingrepresentative of the quality of the population of credits from which the sample was taken. Theexaminer will then review each credit on theproblem list over the selected cut-off lines to

determine the amounts that should be classified.

For detailed procedures on how to implementboth attribute and proportional sampling tech-niques, examiners should contact appropriateregulatory agency staff.

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WorkpapersEffective date July 1997 Section 2030.1

The primary goal of workpapers is to strengthenthe examination process by providing a clearrecounting of the many tasks performed during

an examination. Workpapers, their purpose, theirquality, and organization are important to thesupervisory process because the workpaperssupport the information and conclusions con-tained in the related report of examination.Accordingly, they could include, but are notnecessarily limited to: risk-focused scope memo-randum (as discussed in section 2010), exami-nation procedures and verifications, memo-randa, schedules, questionnaires, checklists,abstracts of branch documents, analyses pre-

pared or obtained by examiners, and a summarymemorandum for each component. To this end,the workpapers should achieve the followingobjectives:

• Organize the material assembled during anexamination to facilitate review and futurereference;

• Aid the examiner in efficiently conducting theexamination;

• Document the policies, practices, procedures,and internal controls of the branch;

• Provide written support of the examinationprocedures performed during the examination;

• Indicate why certain steps or procedures wereeliminated or deemed unnecessary;

• Document the results of testing and formalizethe examiner’s conclusions; and,

• Substantiate the assertions of fact or opinioncontained in the report of examination.

They also are useful as:

• A tool for the examiner-in-charge to use inplanning, directing, and coordinating the work of the other examiners;

• A means of evaluating the quality of the work performed;

• A confirmation that the work recommendedby the annual examination plan was per-

formed as specified;• A guide in estimating future personnel and

time requirements; and

• A record of the procedures used by the branchto assemble data for reports to supervisoryauthorities.

WORKPAPER DOCUMENTATION

Each individual workpaper should include a

workpaper coversheet, scope, and conclusion.

Workpaper Coversheet —A workpaper cover-sheet should provide the following information:

• Office name and location;

• Workpaper title;

• Examination date and work performance date;

• Initials of preparer and initials of the assignedreviewer;

• Name and title of person or description of records that provided the information for theworkpaper; and

• An index number identifying the workpaperand facilitating organization of the workpaperfiles.

Scope—This should address the activities per-

formed in order to examine the particular area,including the nature, timing, and extent of test-ing in the application of examination and auditprocedures as well as the examiner’s evaluationof and reliance on internal and external auditprocedures and compliance testing of internalcontrols. To the extent that this information iscontained in other workpapers, such as therisk-focused scope memorandum, a reference tothe appropriate workpaper will be sufficient.Because of the risk-focused nature of examina-tions, an explanation should be provided in thescope section of the workpapers explaining whythe particular scope was chosen for a specificarea or function. The workpapers also shouldcontain an explanation as to why certain steps orexamination procedures were eliminated ordeemed unnecessary. This information is neces-sary in order to ensure that an effective audittrail is documented in the workpapers detailingthe reasons for the scope chosen.

Conclusion—This summarizes the findings bothpositive and negative, and lists any recommen-dations made by examiners. Each workpapersummary is consolidated into the applicablecomponent(s) rating conclusion memorandum.




ORGANIZATION OFWORKPAPERS

To promote efficiency and help ensure that allapplicable areas of an examination have been

considered and documented, examiners shoulduse an indexing system to organize workpaperfiles. A general outline or index of all examina-tion areas provides a basis for organization towhich a numbering or other sequential systemcan be assigned and applied to each workpaperfile.

When all workpapers pertinent to a specificarea of the examination have been completed,the workpapers should be indexed and filed byeach rating component. A component rating

conclusion memorandum is then prepared foreach of the ROCA components. This memoran-dum should include a list of workpapers com-pleted, a summary of findings and conclusions, arecommended rating for the component, and anyrequired corrective action to be recommended inthe report.

CONTROL AND REVIEW

All examiners assigned to an examination shouldensure that workpapers are controlled at alltimes while the examination is in progress. Forexample, when in the branch’s offices, the work-papers should be secured at night and safe-guarded during the lunch hour or at other timeswhen no examining personnel are present in theimmediate vicinity. It is essential to completelycontrol confidential information provided by thebranch. In addition, information relating to the

extent of tests and similar details of examinationprocedures should not be made available tobranch employees.

In cases where customary workpaper proce-dures are not practical, alternative proceduresand the extent to which they are applied shouldbe documented. The need for completenessrequires that there be no open items, unfinishedoperations, or unanswered questions in the work-papers at the conclusion of the examination.

The clarity of workpapers should be such thatan examiner or examining official unfamiliarwith the work could readily understand them.Commentaries should be legible, concise, andsupport the examiner’s conclusions. Descrip-tions of work completed, notations of confer-ences with branch management, conclusions

reached, and explanations of symbols usedshould be free from ambiguity or obscurity. Inaddition, examining personnel should beinstructed on workpaper standards and contentto ensure that they will meet the quality stan-

dards of the regulatory agencies. When workpa-pers have the necessary qualities of complete-ness, clarity, conciseness, and neatness, aqualified reviewer may easily determine theirrelative value in support of conclusions andobjectives reached. Incomplete, unclear, or vagueworkpapers may lead a reviewer to the conclu-sion that the examination has not been adequatelyperformed.

REVIEW PROCEDURES

Experienced personnel must review all workpa-pers prepared during an examination. Usually,that review is performed by the examiner-in-charge, although in some cases, the examiner-in-charge may designate other experienced per-sonnel to perform the review. The primarypurposes of a review of workpapers by seniorpersonnel are to determine that the work is

adequate, given the circumstances, and to ensurethat the record is sufficient to support the con-clusions reached in the report of examination.The timely review and discussion of workpaperswith the individual who prepared them is oneof the more effective on-the-job trainingprocedures.

Normally, the review should be performed assoon as practicable after the completion of eachassignment. This review ideally occurs at thebranch’s office, so that, if additional information

or work is required, the matter can be promptlyattended to with a minimum loss of efficiency.

When the review of workpapers is completed,the reviewer should sign or initial the applicabledocuments. Although all workpapers should bereviewed, the depth and degree of reviewdepends on factors such as:

• The nature of the work and its relative impor-tance to the overall examination objectives.

• The extent to which the reviewer has beenassociated with the area during the examination.

• The experience of the examiners who havecarried out the various operations.

Examiner judgment must be exercised through-out the review process.

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WORKPAPER RETENTION

Examiners should consult with their respectiveagency for further guidance on workpaper reten-tion guidelines.

Workpapers 2030.1




Supervisory Follow-up ActionsEffective date July 1997 Section 2040.1

Supervisory follow-up actions are implementedto ensure that appropriate corrective actions aretaken in a timely manner to resolve any super-

visory concerns that exist with respect to abranch. Generally, supervisory action is initiatedbased upon the results of an on-site examina-tion. Action may be initiated, however, inresponse to concerns developed through varioussupervisory monitoring programs or through thereview of other available information.

Because branches are subject to supervisionby their federal or state licensing authority,branches may be subject to supervisory follow-upactions by all of these supervisory authorities. In

most cases, however, if concerns are limited toone branch of the foreign banking organization,supervisory follow-up action will be the respon-sibility of the examining agency or agencies. If problems are apparent in other branches of theforeign banking organization, the various super-visory authorities will coordinate the develop-ment of the supervisory action plan for theinstitution.

INFORMAL AND FORMALSUPERVISORY ACTIONS

As a general rule, informal and formal supervi-sory action should be considered when normalfollow-up procedures and other more routinemeasures, such as formal discussions with abranch’s local or head office management, havefailed to resolve supervisory concerns. Thispractice is consistent with the treatment of

domestic banking organizations and is based onthe expectation that all banking institutionsoperating in the United States are expected tooperate in a safe and sound manner and incompliance with applicable U.S. laws and regu-lations. Accordingly, when supervisory con-cerns are identified, corrective action should beinitiated by branch or head office managementas soon as possible. In this regard, examinersshould communicate to the management of thebranch throughout the course of the examinationand at its close, both the problems identified andthe actions recommended to correct thoseproblems.

Generally, an informal supervisory action isappropriate when supervisory concerns havebeen identified that, while not overly serious in

nature, do warrant some type of remedial actionundertaking with the foreign banking organiza-tion. Such concerns may be isolated in one

branch or may be evident in other branches of the foreign banking organization. In either case,the action is entered into with the foreignbanking organization and the affected U.S.branch or branches; it involves a mutually agreedupon understanding between the foreign bank-ing organization and the supervisory agency oragencies. The action generally lists and describeshow specific objectives are to be achieved,including timeframes for achieving thoseobjectives.

Informal enforcement actions that may beutilized for branches include the CommitmentLetter and the Memorandum of Understanding.

A Commitment Letter is a document thatcontains specific written commitments to takecorrective action in response to problems orconcerns identified by the supervisory agency oragencies. A Commitment Letter is not a bindinglegal document; however, failure to meet thecommitments in the letter will provide strongevidence of the need for more formal supervi-

sory action.A Memorandum of Understanding is a more

formally designed action, though still not abinding legal document, that incorporates evengreater specificity concerning the measures beingtaken to resolve problems than found in aCommitment Letter. A Memorandum of Under-standing suggests a higher level of supervisoryconcern over that of a Commitment Letter. Itgenerally must be signed by senior officials fromthe head office.

Formal supervisory actions are appropriate ininstances where supervisory concerns have risento a level where stronger or more immediateaction is necessary to ensure that correctiveactions are taken and fully implemented. Theseactions are authorized by statute and noncom-pliance has a legal liability, i.e. violators can besubject to additional enforcement actions, suchas the assessment of civil money penalties.

Formal enforcement actions include the Ceaseand Desist Order, including a Temporary (Emer-gency) Cease and Desist Order, and the WrittenAgreement. Cease and desist action may beinitiated when there is a finding that an offenderis engaging, has engaged, or may engage in anunsafe or unsound practice in conducting thebusiness of the institution. An action may also




be deemed necessary due to a finding that theoffender is violating, has violated, or may vio-late a law, rule, or regulation, or any conditionimposed in writing, for example, by the Boardof Governors in connection with the granting of

any application or written agreement.In the event that a violation of law, rule, or

regulation, or the undertaking of an unsafe orunsound practice meets certain criteria, a tem-porary (emergency) cease and desist order maybe issued. This order may also be issued if it isdetermined that the institution’s books andrecords are incomplete or that the institution’sfinancial condition or the details or purpose of any transaction cannot be determined throughthe normal supervisory process. The temporary

order may require the same corrections as anorder issued either on consent or after the fulladministrative process. Its advantage is that it iseffective immediately upon service on the entityor individual. A hearing must be held within30–60 days, during which time the temporaryorder stays in effect. Within 5–10 days of theservice of the temporary order, the subject mayappeal to a U.S. District Court for relief from theorder.

When circumstances warrant a less severeform of formal supervisory action, a formalwritten agreement may be used. Other enforce-ment tools that are applicable to branches includethe imposition of civil money penalties, prohi-bition orders, and possibly termination.

CIVIL MONEY PENALTIES

Under provisions of the Financial InstitutionsRegulatory and Interest Rate Control Act of 1978 (FICA) (Pub. L. 95-630), the appropriatefederal banking agency is authorized to assesscivil money penalties for violations of any lawor regulation or for violation of the terms of anywritten agreement, any final or temporary ceaseand desist order or any condition imposed inwriting by a federal banking agency in connec-tion with the granting of any application by theforeign banking organization. Civil money pen-alties may also be imposed, in certain cases, forengaging in unsafe and unsound practices (12USC Section 1818). In addition, civil moneypenalties may be assessed against officers,directors, and other institution-affiliated partiesfor violations of any of the above situations.

In determining the appropriateness of initiat-ing a civil money penalty assessment proceed-ing, the federal banking agencies may use avariety of relevant factors. For example, inassessing a civil money penalty, the Board of

Governors is required to consider the size of thefinancial resources and good faith of the respon-dent, the gravity of the violation, the history of previous violations and such other matters as

justice may require. (See FRRS, Section 3-1605.)Other regulatory agencies have their own guide-lines. (See, for example, OCC Policy and Pro-cedures Manual.)

Depending upon the regulatory agency in-volved, examiners may be responsible for theinitial analyses of potential civil money penal-

ties. Civil money penalties may be proposed forserious violations and for violations that, becauseof their frequency or recurring nature, show ageneral disregard for the law. After the examinerhas reviewed the facts and decided to recom-mend a civil money penalty, he or she shouldcontact the appropriate federal regulatory agencyfor advice on proper documentation and anyother assistance.

ASSET MAINTENANCE

In cases where there is doubt concerning theability of a foreign banking organization tocontinue to serve as a source of strength to itsU.S. branch(es), supervisory action may have tobe taken to safeguard the U.S. branch(es) andensure that it can honor its liabilities to thirdparties. Under these circumstances, an assetmaintenance requirement1 of at least 105 per-

cent material may be imposed on the individualbranch.Other actions that may be taken to address

concerns of this nature regarding the foreignbanking organization include: asset pledgerequirements, increased capital equivalencydeposits, restrictions on transactions with related

1. Asset maintenance means the maintenance of eligibleassets in the United States covering a specified percentage of

third party liabilities of a branch. In general, eligible assets are

those for which there is a reasonable expectation of liquida-tion on a timely basis. When under an asset maintenance

requirement, a branch must maintain a net due to relatedparties position at all times. Thus, the branch is preventedfrom providing net funding to other branches or the head

office. For more specific information on the examinationobjectives and procedures relating to asset maintenance, referto that section of the manual.

2040.1 Supervisory Follow-up Actions


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parties, funding limitations, growth limitations,and voluntary or involuntary termination of thebranch.

In some cases, because of concerns about thefinancial condition of the foreign banking orga-

nization or circumstances in the home countrythat may adversely affect the foreign bankingorganization’s U.S. operations, asset mainte-nance may be necessary even when the U.S.operations are in satisfactory condition. Whenthe U.S. operations, of a foreign banking orga-nization are in less than satisfactory condition,the severity of the problems in those operations,combined with the degree of concern over thesolvency of the foreign banking organization,will be used to determine the appropriate com-

bination of informal or formal supervisory actionand asset maintenance requirement.

When an asset maintenance requirement isdeemed necessary, the preferred way to imple-ment such a requirement is by action of the

appropriate licensing agency and the insurerthrough any means available, including mutualagreement, authorization under state law, orformal supervisory action. Asset maintenancemay therefore be imposed regardless of whetherit is a specific regulatory tool of the licensingauthority. When multiple branches are involved,as a general principle, asset maintenance require-ments will be defined to be applied in a consis-tent manner to all of the operations of theforeign banking organization.

Supervisory Follow-up Actions 2040.1

Documents

US Federal Reserve: usb p2