To All Branches and Agencies of Foreign Banks and Others Concerned in the Second Federal Reserve District:
The attached supervisory guidance letter addresses evaluations of activities conducted or functionally managed by an FBO's U.S. branch, agency or nonbank subsidiary, but booked at a related office in the U.S. or offshore. As such evaluations require reviews of policies, procedures and other documentation that clearly delineate oversight, operational and control responsibilities, such information should be maintained so that it is easily accessible to examiners.
In this regard, we expect all U.S. offices of FBOs to demonstrate adequate risk management processes, operational controls and compliance programs for all activities conducted or managed in the U.S. regardless of where financial transactions are ultimately booked. Of course, this includes robust financial and operational reporting to head office on activities performed in the U.S. on behalf of a related office, and evidence of fully integrated audit processes through which transactions are tested.
The examination treatment under the ROCA rating system for activities conducted by a U.S. office on behalf of another related entity is very similar to that used for activities conducted by a U.S. branch, agency or nonbank subsidiary for its own books. Examiners' assessments of such activities will be reflected in the risk management, operational controls and compliance components of the examined office's ROCA rating and incorporated into the overall composite rating. The assessment of the asset quality component, however, will focus on the quality of the assets on the books of the examined office at the time of the examination.
We encourage you to bring this circular to the attention of your bank's head office staff, internal and external auditors and, of course, any related U.S. offices or nonbank subsidiaries which may be affected.
Questions concerning examination practices may be directed at this Bank to any member of your portfolio management team in our Bank Supervision Group.
Chester B. Feldberg,
Executive Vice President
BOARD OF GOVERNORS
FEDERAL RESERVE SYSTEM
WASHINGTON, D. C. 20551
DIVISION OF BANKING
SUPERVISION AND REGULATION
Introduction and Background
This letter addresses the evaluation of activities of a U.S. branch,agency or nonbank subsidiary [See footnote 1] of a foreign banking organization that arefunctionally managed or operationally performed at the U.S. branch being examinedbut booked at another office of the FBO in the United States or offshore. U.S.branches usually have substantial interaction with other offices of the FBO, and itis not uncommon for a particular branch to generate or to be responsible for loans,trading assets, deposits, or other business that are ultimately booked at, sold, orotherwise transferred to related offices. Similarly, it is not uncommon for a U.S.branch to perform certain operations, such as electronic data processing,accounting, financial reporting, recordkeeping, credit administration, payments andcollections, advisory services, treasury portfolio management, or other activities onbehalf of another office of the FBO.
A U.S. branch may book business outside the United States in orderto take advantage of pricing, funding, or other options not otherwise available atthe U.S. branch. Such business commonly is booked at "shell" branches inoffshore jurisdictions that may or may not be "managed or controlled" [See footnote 2] by the U.S.branch; however, business may also be booked at any other office of the FBO,including the head office.
Policies, Procedures, and Risk Management Processes
In reviewing the duties performed by a U.S. branch on behalf ofanother office of the FBO, examiners should evaluate policies, procedures anddocumentation provided by the U.S. branch to ensure their adequacy. Thesematerials should clearly delineate the oversight, operational, and controlresponsibilities of the U.S. branch for inter-office transactions. The head office ofthe FBO should be aware of and in agreement with the delineation ofresponsibilities. This information should be maintained by the FBO in such amanner that it is accessible to the bank supervisory authorities in all threepotentially affected jurisdictions -- the United States, the home country, and thehost country of any non-U.S. foreign office.
The U.S. branch should have adequate risk management processes,operational controls, and compliance programs covering all activities booked at theU.S. office, as well as all activities for which it is effectively responsible, even ifsuch assets are booked at another office of the FBO. Even when a U.S. branchperforms limited operational functions for a related office, examiners should assesswhether the branch has sufficient records, reports, systems, and controls in placeto execute the delegated responsibilities. In cases where insufficientdocumentation exists at the U.S. branch to discern adequately the nature andextent of the business relationship with another office of the FBO, as well as toassess the performance of the U.S. branch with respect to the relationship,examiners should cite this deficiency in the report of examination as a matter thatrequires immediate attention.
The examination treatment under the ROCA rating system foractivities conducted by a U.S. branch on behalf of another office of the FBO shouldbe the same as for activities conducted by the branch for its own book, except forthe evaluation of asset quality as discussed below.
In evaluating risk management (the "R" component of the ROCArating), the examiner should assess the ability of management at a U.S. branch toidentify, measure, monitor, and control risk in the operations and activities underits responsibility. Special examination focus should be placed on the assessmentof market, credit, and liquidity risk reporting to ensure that all relevant riskexposures are summarized clearly and reported to the appropriate level of localmanagement and to the head office risk management function. In arriving at therisk management assessment, the examiner will need to review all elements of riskgenerated by and under the responsibility of branch management, regardless ofwhere the financial transactions are ultimately booked.
In terms of the operational controls (the "O" component of the ROCArating), the examiner should review the records, reports, systems, and controls thatare in place at the U.S. branch to process, confirm, document, and account fortransactions that are generated or executed by a U.S. branch, whether for the U.S.branch's own book or for the book of another office of the FBO. There should berobust financial and operational reporting to the head office of the FBO on activitiesperformed by the U.S. branch on behalf of a related office.
A fully integrated risk-based audit process should be in evidence totest and confirm the range of transactions initiated by, recorded at, or otherwisemanaged by the U.S. branch, including transactions initiated by related offices. Audit programs should be updated regularly in line with industry best practices. Special attention should be directed to a determination of the adequacy of auditcoverage over business activities that may transcend several jurisdictions. As partof the examination process, examiners should determine if audits are performed forthe multi-jurisdictional businesses and should ensure, to the extent possible, thatthe audit programs are sufficiently rigorous to test adequately the full transactionprocess from initiation through closeout.
In evaluating compliance (the "C" component of the ROCA rating), allthe activities conducted by the management of the U.S. branch should comply withU.S. laws and regulations, to the extent applicable, regardless of the bookinglocation of the business. For example, if the U.S. branch accepts deposits onbehalf of another office, branch management should ensure compliance with BankSecrecy Act regulations and "know your customer" policies, even if the depositsare immediately transferred to a non-U.S. office of the FBO. Additionally, the U.S.branch should ensure compliance with the Regulation K requirement that a foreignbank not use its U.S. office to manage types of activities transacted throughcertain offshore offices that could not be managed by a U.S. bank at its foreignbranches or subsidiaries. The review of regulatory reporting should ensure that therecords of the U.S. branch clearly differentiate between related and non-relatedparty transactions and that the recordkeeping to support such reports is adequate.
In rating asset quality (the "A" component of the ROCA rating), theexaminer only would evaluate assets that are on the books of the U.S. branch. Assets booked elsewhere should not be classified or listed as "special mention" or"other transfer risk problems" within the examination report. Further, examinersshould not require any charge-off adjustments for loss assets not booked at theU.S. branch. However, examiners should be mindful of the general quality ofassets being generated by the U.S. branch and booked elsewhere so as to be alertto any pattern of booking low quality assets outside the United States or any othersituations that might indicate problems in risk management ("R") or operationalcontrols ("O").
Examiners should evaluate all activities for which the U.S. branch hasresponsibility, regardless of where the business is booked. All responsibilities ofU.S. branch management for FBO operations should be clearly documented in the policies and procedures of the U.S. branch. Such policies and procedures shoulddocument risk management methodologies, operational controls and complianceguidelines for all such activities. Examiners' assessments of these activities shouldbe reflected in the risk management, operational controls, and compliancecomponents of the U.S. branch's ROCA rating, and appropriately incorporated intoits composite rating. The branch's asset quality component, however, should bebased only on the quality of assets, including the credit risk element of off-balancesheet exposures, on the branch's books as of the examination date.
Please direct any comments or questions to Joel D. Shapiro, Manager- International Supervision Section (202/452-2056) or Betsy Cross, Manager -International Regulatory and Examination Policy Section (202/452-2574).
Cross Reference: SR 95-22 (SUP.IB) Attachment III
Footnote: 1 Referred to as a "U.S. branch" or collectively as "U.S.branches."
Footnote: 2 For purposes of the FFIEC 002s and Regulation K, a non-U.S.office is considered to be "managed or controlled" by a U.S.branch or agency of a foreign bank if a majority of theresponsibility for business decisions, including but not limitedto decisions with regard to lending or asset management orfunding or liability management, or the responsibility forrecordkeeping with respect to assets or liabilities of that non-U.S. office, resides at the U.S. branch or agency.
FEDERAL RESERVE SYSTEM
DIVISION OF BANKING
SUPERVISION AND REGULATION
Foreign banking organizations ("FBOs") conduct an extensive and diverse business in the United States. Consistent with economic efficiency and national treatment, FBOs are free to conduct their U.S. activities through a variety of legal entities. Banking activities are conducted primarily through branches or agencies licensed by the states or the Comptroller of the Currency and, to a lesser extent, through banks chartered by those entities and through special-purpose banking corporations chartered by the states and the Federal Reserve. Some of these banking entities also are insured and therefore subject to the oversight of the Federal Deposit Insurance Corporation. Non-banking activities are authorized by the Federal Reserve pursuant to the Bank Holding Company Act and the International Banking Act. In addition, the Federal Reserve has supervisory responsibility for FBOs with respect to the business they conduct within the United States. As a result, FBOs are subject to a number of state and federal statutes, and various aspects of their operations are supervised and regulated by both state and federal banking supervisory authorities.
In order to better coordinate and further enhance the supervision of the U.S. activities of FBOs, the banking supervisory authorities that have supervisory and examination powers over the U.S. operations of FBOs have developed a program encompassing the supervisory principles and processes relating to FBOs, which is summarized in the attached documents.
Each Reserve Bank with an FBO presence in its district should begin adoption of the program immediately. Additional detailed guidance regarding implementation of the program will be provided shortly to the System through SR letters. Further, Reserve Banks should ensure that they fully coordinate their FBO supervision activities with the appropriate state banking departments and regional offices of the other federal agencies in their districts.
Should you have any questions regarding this program, please contact Ms. Elizabeth H. Roberts, Manager, International Regulatory and Examination Policy Section, at (202)452-3846 or
Mr. Joel D. Shapiro, Manager, International Supervision Section, at (202)452-2056.
ASSESSMENT OF THE U.S. OPERATIONS OF
FOREIGN BANKING ORGANIZATIONS
This segment of the program is designed to provide a more efficient, rational, and uniform approach to supervising the U.S. operations of foreign banking organizations ("FBOs"), particularly those that operate in the United States through numerous entities and across multiple jurisdictions. In order to ensure coordination of supervisory efforts and avoid duplication, the U.S. banking supervisory agencies will communicate with each other to a greater extent regarding their examination plans, examination results, and, where applicable, their proposed supervisory follow-up actions. In addition, in order to exercise its responsibilities for the overall U.S. operations of individual FBOs, the Federal Reserve will assess annually the combined U.S. operations of each FBO, based largely on input from and discussions with the examining agencies.
The supervisory agencies have agreed that generally each U.S. banking office of an FBO will be subject to one safety and soundness examination per year, unless the condition of that office warrants more frequent examination. To ensure coordination, the licensing and insuring agencies will provide the local Federal Reserve Bank with a copy of their preliminary examination schedule for the coming year for all U.S. offices of an FBO for which the agency anticipates conducting an examination. The Federal Reserve will use these schedules, along with the preliminary examination schedules of the various Reserve Banks, to derive a draft comprehensive examination schedule for all U.S. operations of individual FBOs.
The draft schedule will be provided to each involved agency in order to permit all of the examining agencies to view their own schedules in conjunction with those of the other agencies. In addition, where necessary, an interagency scheduling meeting will take place each year to determine the scope and timing of examinations of FBOs that will be conducted on a more coordinated basis. The Federal Reserve will finalize the comprehensive examination schedule and provide it to all of the supervisory agencies.
For FBOs that conduct all or substantially all of their U.S. operations through entities licensed or chartered by one banking supervisory agency, the timing of the annual examination will be established by the licensing authority. As at present, it is envisioned that, in agreement with the individual states, the Federal Reserve and, for insured branches, the FDIC, will share the burden of conducting the annual examinations of state-licensed branches and agencies. In those years that the Federal Reserve or FDIC will be conducting the examination, the timing will be established by that agency.
FBOs which operate in the United States through multiple offices often will have all offices examined using the same examination date. This will provide the supervisory agencies with increased information on the interrelationship among the various offices and can enhance the examination of individual offices and the FBO's overall U.S. operations. These examinations will be conducted by the various agencies.
Subsequent to the examination scheduling process, detailed examination plans will be developed, exchanged and coordinated among the examining agencies. Each state and federal supervisory agency participating in this program is committed to developing, to the extent possible, examination plans for individual offices of FBOs that they plan to examine based primarily on the following:
A comprehensive examination plan ("Exam Plan") will be developed annually for each FBO with banking offices licensed by more than one supervisory agency and/or with significant U.S. non-banking activities. The Federal Reserve will draft the comprehensive Exam Plan based on the individual examination plans prepared by the different state and federal supervisory agencies for each office to be examined. After conferring with other participating banking supervisory agencies, the scope or timetable of an examination, as set out in the annual comprehensive Exam Plan, may be altered in the event there are impediments to completing an examination as originally planned.
The Federal Reserve will coordinate the sharing of information throughout the examinations of FBOs with multi-state operations. Because of the differing starting dates and lengths of individual examinations, most examinations will be completed by participating banking supervisory agencies at different times. Consequently, an important part of this program is the sharing of critical examination findings throughout the process. The U.S. supervisory agencies have committed to advising those agencies responsible for examining other U.S. offices of the FBO of any critical examination findings prior to the exit meeting for that examination.
The Federal Reserve, in its statutory role as umbrella authority with responsibility for overall U.S. operations, will confer with the examining agencies to determine if its participation in any of the examiner closeout meetings is warranted. Such participation typically will be appropriate in the event there are systemic weaknesses detected in the U.S. operations or problems exist that are so significant as to affect the rating of the overall U.S. operations. In those instances where a Federal Reserve Bank has conducted the examination, that Reserve Bank will confer with the licensing agency to determine if the participation of that agency is warranted. However, the normal presumption is that the banking supervisory agency that conducted the examination also will conduct the closeout meeting without participation by non-examining agencies.
The agency responsible for the examination of any office in a given year is also responsible for completion of the examination and preparation of the examination report for that entity. In the case of joint examinations, the examining agencies will strive to issue only one report of examination for that office of the FBO. The supervisory agency that conducted the examination of an individual office of an FBO also is responsible for the distribution of the transmittal letter and examination report.
Supervisory actions that affect only one office of an FBO also normally will be entered into solely by the licensing authority, unless the action resulted from an examination conducted by the FDIC of the Federal Reserve. In these cases the action would be undertaken by the examining agency or, at the option of the licensing authority, on a joint basis with that authority. Actions that apply to the overall operations of an FBO will be entered into by the Federal Reserve and those licensing or insuring agencies that have offices affected by the supervisory action and wish to enter into such an action with the office they license.
An important component of this program is the integration of individual examination findings into an assessment of an FBO's entire U.S. operations. As envisaged, this assessment will provide the FBO, and the U.S. supervisory agencies, with a view of the overall condition of the U.S. operations, and will help put into context the strengths and weaknesses of individual offices. It will also highlight supervisory concerns regarding any problems that are pervasive in the U.S. operations of the FBO.
The Federal Reserve will conduct an annual assessment of the combined U.S. operations and prepare a "Summary of Condition" for all FBOs with U.S. offices supervised by more than one agency. The summary will include an assessment of all risk factors, including (1) all elements of the ROCA rating system, (2) quality of risk management oversight employed by all levels of management in the FBO's U.S. operations, and (3) the examinations of all vehicles of the FBO conducted during the year. The Summary of Condition will lead to the assignment of a single-component rating between 1 and 5 for the combined U.S. operations.
The Summary of Condition will be drafted by the Federal Reserve which will provide a copy of the draft and proposed rating to each supervisory agency with examination authority over an office of the FBO in order to make certain that information obtained from these agencies was correctly interpreted.
Once the Summary of Condition is finalized, the Federal Reserve will provide a copy, including the rating, to the Chief Executive Officer at the head office of the FBO. The Summary of Condition and the rating will act as a starting point in drafting 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 will be considered; however, this rating will not be based merely on an arithmetic average of the examination ratings of the vehicles examined. The strengths or weaknesses exhibited within individual entities will be evaluated based on the size and importance of the entity relative to the FBO's entire U.S. operations, and the materiality 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. They cause no supervisory concern and require only normal supervisory attention.
Combined Rating of 2 - The combined U.S. operations operate in a basically sound manner, but may have modest weaknesses that can be corrected by management in the normal course of business. They do not require more than normal supervisory attention.
Combined Rating of 3 - Overall U.S. operations are weak in risk management, operational controls, and compliance, or have numerous asset quality problems that in combination with the condition of the FBO cause supervisory concern. U.S. and/or head office management may not be taking the necessary corrective actions to address any weaknesses. This rating may also be assigned when either risk management, operational controls, or compliance is individually viewed as unsatisfactory. Generally, these operations raise supervisory concern and require more than normal supervision to address their weaknesses.
Combined Rating of 4 - The combined U.S. operations have a significant volume of serious weaknesses. Serious problems or unsafe and unsound banking practices or operations exist, which have not been satisfactorily addressed or resolved by U.S. or head office management. These operations require close supervisory attention and surveillance monitoring and a definitive plan for corrective action by head office management.
Combined Rating of 5 - The combined U.S. operations have so many severe weaknesses or unsafe and unsound conditions that they require urgent restructuring by head office management.
This composite assessment will serve to apprise the various U.S. supervisory authorities of the condition of all the U.S. entities of individual FBOs. These agencies can then factor the information that they obtain from the "Summary of Condition" and the composite assessment into their supervision of the U.S. entities under their jurisdiction.
STRENGTH-OF-SUPPORT ASSESSMENT FOR
FOREIGN BANKING ORGANIZATIONS
WITH U.S. OPERATIONS
The strength-of-support assessment provides a general framework for evaluating and assimilating significant financial and managerial information related to individual foreign banking organizations ("FBOs") in order to assign a two-component strength-of-support assessment. The FBO assessment will provide information to the supervisory agencies that will be taken into account in reaching decisions regarding the scope and frequency of examinations and other appropriate supervisory initiatives. The assessment will also provide a basis for the more efficient utilization of supervisory resources.
The first component of the strength-of-support assessment addresses whether any factors relating to the ability of the FBO to meet its U.S. obligations warrant special monitoring of the FBO's U.S. operations. This component is a reflection of the overall financial viability of the FBO as well as several external factors such as the degree of supervision the FBO receives from its home country supervisor. This component is based on a scale of "A" through "E" with "A" representing the lowest level of supervisory concern and "E" representing the highest.
Factors considered in assigning the first component include a review of the FBO's financial condition and prospects, the system of supervision in the FBO's home country, the record of home country government support of the banking system or other sources of support of the FBO, and any transfer risk concerns. In assigning this component, all relevant factors are weighed and evaluated. Standards and criteria for this component, including the five possible strength-of-support indicators, are discussed in greater detail below.
The second component of the strength-of-support assessment, which will be utilized on an as-needed basis, identifies whether there are any factors that raise questions about the ability of the FBO to maintain adequate internal controls and compliance procedures at its U.S. offices, irrespective of the overall financial condition of the FBO. If any such control risks are apparent, an asterisk is placed next to the letter component of the strength-of-support assessment.
Factors considered in assigning the asterisk include the FBO's managerial and operational record and whether current activities such as a recent merger, significant other expansion or changes in operations, or reported control problems at non-U.S. operations pose a potential risk to the U.S. operations. The factors considered for this component also are discussed below. Specific standards or criteria for the second component of the strength-of-support assessment are not discussed because the purpose of this component is to indicate whether any such concerns exist, a determination that is largely judgmental in nature and not readily quantified. For this reason, the asterisk is used rather than an alpha or numeric symbol which would incorrectly imply differing degrees of such concerns.
All strength-of-support assessments are for internal supervisory use only and will not be disclosed to the FBO's management, either in the United States or at the head office or to the home country supervisor(s). If deemed appropriate, any specific concerns raised through the assessment process, rather than the assessment itself, will be communicated directly to the FBO's management and home country supervisor(s), particularly if those concerns lead to supervisory follow-up action with regard to the FBO's U.S. operations.
There are five possible indicators for the first component of the strength-of-support assessment:
Assessment of A - The FBO has a financial profile that is regarded as strong by both home country peer and international standards. It has superior risk-based capital ratios [See footnote 1], more than ample access to U.S. dollar funding, and, if rated by any of the ratings agencies, is accorded one of the two highest market or investment rating categories. Supervision by the home country supervisory agency or agencies is conducted on a comprehensive basis, covering the worldwide operations of the FBO and its affiliates. [See footnote 2] The home country has a good record of supervising financial institutions and dealing with problem institutions, 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 outlook pose a low risk that the FBO will be unable to support its U.S. operations. The FBO is viewed as investment grade or equivalent, capital ratios are above internationally accepted minima, and access to U.S. dollar funding is readily available; however, financial factors are not as strong as those of institutions with an assessment of A. The FBO is subject to a significant degree of supervision of its overall operations by the home country supervisor(s) and the country has a good record for dealing with problems in the local financial system. Transfer risk factors are generally consistent with those of FBOs with an assessment of A. An FBO whose financial profile is consistent with a B assessment could be assigned an assessment of C or lower if its home country has a supervisory system that is lacking in significant respects or significant transfer risk considerations exist.
Assessment of C - The current operating performance of the FBO and its immediate financial outlook, although not posing significant concerns about the ability of the organization to honor its U.S. liabilities, may warrant more than normal review based on such factors as the lack of an investment grade rating, capital ratios below internationally accepted minima, or other factors that are considered less than adequate by international standards. While the FBO currently may not meet all international financial standards, the home country has demonstrated an ability and willingness to support the FBO or similar financial institutions.
Conversely, the financial profile of the FBO may appear to warrant a stronger rating, however, supervision by the home country regulators is lacking in significant respects or significant transfer risk considerations exist.
Assessment of D - Significant financial or supervisory weaknesses are apparent such that imposition of asset maintenance requirements on the U.S. branches and agencies should be considered. The FBO may be expected to continue as a going concern due primarily to government support, ownership, or other significant factors, although resource constraints, transfer risk considerations, operating structure, or other factors may place important limitations on that support. Conversely, the financial profile, based on available information, may imply a higher assessment but home country supervision is deemed to be substantially or wholly deficient, or there are significant transfer risk concerns.
Assessment of E - Due to a seriously deficient financial profile and/or poor operating practices and the absence of any sufficient supervisory oversight and support, there is a strong possibility that the FBO will be unable to honor its U.S. obligations in the near future or is otherwise considered to present a hazard to U.S. financial markets.
Determining whether an individual FBO has the internal or external resources to provide the necessary financial or managerial support to its U.S. operations depends to a great extent upon its financial condition, operating record, and general outlook. A good financial condition combined with capable management is generally sufficient to ensure that support. However, the degree of certainty about the ability of an FBO to provide any necessary financial support may be limited by weaknesses in its home country supervisory system or a significant degree of transfer risk associated with its major operations. These two factors also may influence the home country's record of support for its financial institutions.
Accordingly, the first component of the FBO strength-of-support assessment considers four major factors: (a) the financial profile of the FBO based on its present financial condition and outlook, including capital ratios and access to U.S. dollar liquidity; (b) the FBO's home country banking supervision system; (c) the demonstrated capabilities of the home country in dealing with banking problems; and (d) the degree of transfer risk associated with the FBO's home country and any other countries in which the FBO has major operations.
All assessment factors will be considered as a whole in assigning the first component of the strength-of-support assessment. None of the four principal factors will be assigned a separate "rating" or be considered a discrete component of the final assessment.
The financial profile of the FBO is based on the institution's current condition and future prospects. A review of financial condition is based on the level and trend in financial performance indicators relating to the FBO's capital, profitability and asset quality. These indicators should be evaluated in the context of peer performance and knowledge of the FBO's home country financial system and accounting policies and practices. [See footnote 3] The financial outlook should consider a broad range of external and internal factors, such as the home country banking system, the FBO's political and economic environment, its market position, risk profile, ownership, and management.
Generally, the FBO's short-term and long-term market ratings are good indicators of its financial outlook. An FBO with the highest market ratings should be able to demonstrate a strong financial condition and outlook. The FBO would likely be assigned an A assessment if other factors are consistent with the assessment. Notwithstanding the significance of market ratings, the FBO's financial profile and resultant assessment should not be based on market ratings alone. Rather the ratings should serve as a reference point for the independent assessment of the institution, because market ratings may not always reflect the most current view of the FBO or the supervisory authorities may have information not directly or indirectly available to the market. For example, examination findings of the U.S. operations could raise questions about the FBO's overall operations and management that could lead to a strength-of-support assessment lower than that indicated by the FBO's market ratings. However, any significant difference between the assessment and market ratings will be fully analyzed and justified.
System of Home Country Supervision
A review of the home country supervisory system is essential to ensure that the FBO is subject to an appropriate level of supervision of its global operations. In assigning an FBO assessment, the review of the system of home country supervision should concentrate on its general policies and how the supervisory framework applies in practice to the individual FBO. In this context, the mere presence of a home country supervisor is not considered sufficient.
The FBO's home country supervisory system should be evaluated based on those general principles and practices that ensure regulatory monitoring over the FBO's principal operations and activities, including those outside the home country. These general supervisory principles and practices usually include some level of periodic reporting, on-site and/or off-site review, prudential guidelines (including capital adequacy requirements), and supervisory enforcement powers. Effective regulatory systems may take many forms; however, the system of any country should ensure that the internationally active banks operating under that system are subject to a sufficient level of supervision.
Supervisory systems may also vary with respect to the type of institution. Therefore, the analysis of the supervisory system should evaluate actual regulatory practices for the individual FBO. This assessment will be based largely on the information that has been accumulated over time by the U.S. banking supervisory agencies. It is expected that this assessment will be enhanced as additional information on other supervisory systems is obtained through improved contacts and informational exchange.
Record of Home Country Support
Related to home country supervision is the matter of the home country's record of ensuring the solvency of its financial institutions, particularly those that operate internationally. The record of support will vary by country with respect to structure, coverage of banks, and resources. Such support may be either direct or indirect in nature and may be widespread or only applicable to banking institutions with specific characteristics.
Some countries are able to take whatever steps are necessary to support their banks unequivocally while others will have a more limited degree of support for their banks due to legal restrictions or financial constraints. These factors should be reviewed, giving particular emphasis to past performance and an assessment of the country's resources.
Level of Transfer Risk
Transfer risk, which relates to the FBO's ability to access U.S. dollars, is an essential factor in determining whether the FBO can support its U.S. operations. For some FBOs, transfer risk is increased due to heavy debt servicing or other financial restraints relating to the home country, which often leads to exchange controls and hard currency restrictions. As a result, these FBOs may be limited in providing necessary support to their U.S. operations.
The assessment of transfer risk for individual countries is uniformly handled by U.S. regulators through the Interagency Country Exposure Review Committee ("ICERC"). These ICERC assessments can therefore be used in determining the strength-of-support assessments. For those countries not evaluated by ICERC, the assessments of transfer risk will made in the same manner as conducted by ICERC.
Generally, FBOs from countries rated substandard or worse would be accorded an assessment of no better than C. However, a high level of transfer risk associated with the FBO's home country could be mitigated by other considerations that clearly indicate that the FBO has broad access to U.S. dollars.
Determining whether an FBO poses any managerial or operational control risks to its U.S. operations can be influenced by a broad range of factors that are generally more subjective than those discussed under the first component of the strength-of-support assessment. Any such risks, both actual and potential, which do not directly relate to the ability of an FBO to meet its obligations as discussed earlier, should be denoted by placing an asterisk beside the FBO's letter assessment. The nature of these risks should be discussed separately in the FBO evaluation.
One example of such control risks is an FBO that otherwise has a strength-of-support assessment of A or B but may be experiencing certain operational problems, not necessarily in the United States. The FBO may be undergoing extensive expansion into new markets or products that over time could pose a strain on its financial and managerial resources. The FBO also could be experiencing well-publicized internal control problems at offices outside the United States. Although these control problems would not necessarily affect the ability of the FBO to pay its obligations, they may be symptomatic of larger control problems that also might exist in the U.S. offices. Any such concerns should be explored to the extent possible, particularly as they may influence the examination plan for the FBO's U.S. operations.
As discussed earlier, one of the principal goals of the strength-of-support assessment is to identify those FBOs that may pose 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. The strength-of-support assessment serves to categorize all FBOs conducting banking operations in the United States and to highlight those FBOs warranting higher levels of supervisory attention with respect to their U.S. operations. This assessment may influence the examination plan and potential supervisory follow-up actions for the FBO's U.S. operations.
An FBO's strength-of-support assessment will be taken into consideration in setting the examination plan for the FBO's U.S. operations. The examination plan will consider any issues raised in the assessment process and address them accordingly. For example, the U.S. operations of FBOs whose assessments are marked by an asterisk may have examinations that specially target operational or management areas. The FBO's strength-of-support assessment will also be a factor in determining whether the FBO will be subject to a simultaneous examination.
The FBO's strength-of-support assessment also will be considered in implementing supervisory follow-up action for the U.S. operations. Generally, an assessment of C or worse would imply a level of concern that would subject the FBO's U.S. offices to at least periodic monitoring of their due to/due from positions. Any additional supervisory steps, such as imposing an asset pledge or asset maintenance requirement, would be implemented largely based on the condition and nature of the U.S. operations. An FBO accorded an assessment of D or worse would indicate a higher level of concern with some presumption of asset maintenance regardless of the condition of its U.S. operations.
As with all such supervisory follow-up actions, these steps would be considered and implemented based on the general criteria for applying supervisory follow-up actions in the context of the FBO's strength-of-support assessment. Supervisory follow-up action can be modified based upon a number of criteria. It is stressed that no automatic supervisory program is mandated as part of the FBO strength-of-support assessment. Furthermore, an assessment of A or B generally would imply little if any concern relating to the ability of the FBO to meet its obligations. If an FBO does raise liquidity or solvency concerns, the FBO should not be accorded an assessment of A or B.
Suggested guidelines for supervisory follow-up action for each assessment category are as follows:
A or B Assessment - Normally, any supervisory follow-up action for FBOs with a strength-of-support assessment of A or B would be applied only if warranted by the condition of the U.S. operations. Supervisory measures generally would not relate to liquidation concerns. As such, asset maintenance usually would not be required for branches and agencies of these FBOs; however, supervisory actions would be undertaken, if necessary, to resolve any significant deficiencies in risk management, operations and internal controls, or compliance at any of the U.S. offices.
C Assessment - The FBO's strength-of-support assessment would be reviewed at least annually. The due to/due from position would be closely monitored and any substantial due from position would be fully analyzed for risk implications. If warranted by the condition of the combined U.S. operations or the asset quality at the U.S. offices of such an FBO, asset maintenance would be considered for branches and agencies, and U.S. subsidiary banks could be required to operate at capital levels above the minima.
D Assessment - There is a strong presumption of asset maintenance for branches and agencies of an FBO in this category, and U.S. bank subsidiaries should operate at strong capital levels. The FBO would be more closely monitored and its assessment may be subject to review at least semi-annually.
E Assessment - The FBO will be placed under continuous surveillance and reporting as warranted. Termination proceedings for the U.S. operations of such an FBO will be considered under applicable regulatory guidelines.
The FBO's strength-of-support assessment will be developed annually through a process that will involve all U.S. supervisors that have licensing, chartering, or examining responsibilities over the FBO's U.S. operations. The process will include an analysis of available information on the financial condition of the FBO within the context of the home country financial system, the banking supervisory system, the record of the authorities in preventing or successfully dealing with banking system problems, and transfer risk considerations. The FBO evaluations will be based on information compiled by all of the relevant U.S. banking supervisory agencies.
Information obtained by any of the banking supervisory agencies relating to individual FBOs, their home country financial systems, supervisory systems and accounting policies will be transmitted to the Federal Reserve, which will assume responsibility for organizing and maintaining a database for this information. This database will be made available to all of the relevant U.S. banking supervisory agencies.
All of the relevant state and federal banking supervisory agencies, whenever possible, will obtain information for the database, especially as it relates to the individual FBOs, the financial systems within which they primarily operate and the supervisory systems in the different countries. This information will help to keep the database as current as possible and will be developed primarily through discussions with the U.S. and head office managements of the FBOs as well as the home country supervisor(s).
The information in the database will be used to develop three primary products, each of which will summarize information in the database and provide the supporting data for the strength-of-support assessments. These three products are: (1) an evaluation of the financial condition of the FBO, (2) a review of the home country financial system, and (3) a review of significant home country accounting policies and practices.
Normally, the FBO evaluation will be drafted by the Federal Reserve each year. The initial source of information for the evaluation will be the FR Y7 report as well as any external sources that are readily available (e.g. periodicals and services). Over time, as the database becomes more developed, many additional sources of information will be utilized.
The individual Reserve Banks responsible for drafting FBO evaluations will produce a schedule at the beginning of each year showing the approximate date that the draft evaluation and recommended strength-of-support assessment for each FBO will be circulated for comments. This schedule will be based primarily on the fiscal year-end of the FBO (and consequently the date the FR Y7 report will be received), the extent and overall condition of the FBO's combined U.S. operations, and the prior strength-of-support assessment of the FBO. This schedule will be distributed to all of the state and federal agencies participating in this joint program along with the name of a contact person at each Reserve Bank. The other agencies, as well as the other Reserve Banks, may request, through the assigned contact person, that an FBO evaluation in any given year be given a higher priority than the schedule indicates.
The draft evaluation and the proposed strength-of-support assessment will be circulated for comments within the Federal Reserve System and to all federal and state supervisory agencies involved in supervising the FBO. Each party will review the draft and comment, if necessary. In addition, the analyst who prepared the draft will be available to answer questions regarding the draft. If the initial review of the draft indicates differences in view regarding the proposed assessment that can not be resolved informally, a meeting of the relevant banking supervisory agencies could be called by any supervisory agency to discuss the strength-of-support assessment of the FBO. While it is expected that a consensus assessment will result from this process, individual agencies will retain the right to exercise all statutory authorities available to them to meet their supervisory concerns.
The finalized evaluation will be sent to all of the supervisory agencies involved in the supervision of the U.S. operations of the FBO. The evaluations and assessments normally will be reviewed annually. The evaluations will be revised in the interim only if information is obtained by any of the U.S. supervisory agencies that is significant enough to change the strength-of-support assessment, either positively or negatively.
These evaluations will be kept strictly confidential by each of the agencies, in part to ensure that the sharing of information between the agencies for purposes of analyzing the condition of the FBO and assigning its strength-of-support assessment will not violate state or federal regulations.
As mentioned above, a database containing information on the financial system of each country with bank representation in the United States will be maintained by the Federal Reserve, using its own sources and information submitted by the other supervisory agencies. This information will be made available to all of the agencies. In addition, the Federal Reserve will provide, in a uniform format, reviews summarizing information on the home country financial system, the nature of banking supervision and the country's record in dealing with banking problems. [See footnote 4] These reviews will be updated whenever any of the supervisory agencies obtains significant information regarding the financial system of the particular country. The database will include all such reviews prepared by the Federal Reserve and any provided by the other supervisory agencies.
The database will also contain information on significant accounting policies and practices in other countries and will be utilized to develop reviews of such practices. These reviews will be developed by the Federal Reserve [See footnote 5] utilizing information derived from the same sources as used for the review of the home country financial system as well as from general accounting information provided in the FR Y7 report. These reviews will be updated whenever any significant changes occur in accounting policies or practices.
The rating system for U.S. branches and agencies [See footnote 6] of foreign banking organizations ("FBOs") is a management information and supervisory tool designed to assess the condition of a branch and to identify significant supervisory concerns at a branch in a systematic and consistent fashion. The rating system (ROCA) has been revised from the previous rating system of asset quality, internal controls, and management (AIM), to better assess the condition of a branch within the context of the FBO, of which it is an integral part, and to pinpoint the key areas of concern in a branch office.
For evaluation purposes, the rating system divides a branch's overall activities into three individual components: risk management, operational controls, and compliance. These components represent the major activities or processes of the branch that may raise supervisory concern. The rating system also provides for a specific rating of the quality of the branch's stock of assets as of the examination date.
The overall or composite rating indicates whether, in the aggregate, the operations of the branch may present supervisory concerns and the extent of any concerns. While the individual component ratings will be taken into consideration in arriving at the branch's overall assessment, the composite rating should not be considered merely an arithmetic average of the individual components. The examiner should assign and justify in the report a composite rating using definitions provided below as a guide. [See footnote 7]
The composite rating is based on a scale of one through five in ascending order of supervisory concern. Thus, one represents the lowest level of supervisory concern while five represents the highest level. The five composite ratings are defined as follows.
Composite Rating 1 - Branches in this group are strong in every respect. These branches require only normal supervisory attention.
Composite Rating 2 - Branches in this group are in satisfactory condition, but may have modest weaknesses that can be corrected by branch management in the normal course of business. Generally, they do not require additional or more than normal supervisory attention.
Composite Rating 3 - Branches in this group are viewed as fair due to a combination of weaknesses in risk management, operational controls, and compliance, or asset quality problems that, in combination with the condition of the FBO or other factors, cause supervisory concern. In addition, branch and/or head office management may not be taking the necessary corrective actions to address substantive weaknesses. This rating may also be assigned when risk management, operational controls, or compliance is individually viewed as unsatisfactory. Generally, these branches raise supervisory concern and require more than normal supervisory attention to address their weaknesses.
Composite Rating 4 - Branches in this group are in marginal condition due to serious weaknesses as reflected in the assessments of the individual components. Serious problems or unsafe and unsound banking practices or operations exist, which have not been satisfactorily addressed or resolved by branch and/or head office management. Branches in this category require close supervisory attention and surveillance monitoring and a definitive plan for corrective action by branch and head office management.
Composite Rating 5 - Branches in this group are in unsatisfactory condition due to a high level of severe weaknesses or unsafe and unsound conditions and consequently require urgent restructuring of operations by branch and head office management.
Following approval of the rating by appropriate senior supervisory officials at the examining agency, the composite numeric rating should be disclosed in the open, summary section of the examination report. In disclosing the rating, its meaning should be explained clearly using the appropriate composite rating definition. The report should also make it clear that the rating is part of the overall findings of the examination and is thus confidential. Any composite rating disclosed or discussed at an examination closeout meeting should be held out by the examiner-in-charge to be tentative.
Similar to the composite rating, the individual rating components are evaluated on a scale of one to five, where one represents the lowest level of supervisory concern and five represents the highest. Each component is discussed below followed by a description of the individual performance ratings.
Risk is an inevitable component of any financial institution. Risk management, or the process of identifying, measuring, and controlling risk, is therefore an important responsibility of any financial institution. In a branch, which is typically removed from its head office by location and time zone, an effective risk management system is critical not only to manage the scope of its activities but to achieve comprehensive, ongoing oversight by branch and head office management. In the examination process, examiners will therefore determine the extent to which risk management techniques are adequate (i) to control risk exposures that result from the branch's activities and (ii) to ensure adequate oversight by branch and head office management and thereby promote a safe and sound banking 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 to govern risk taking; and a strong management information system for monitoring and reporting risks.
The process of risk assessment includes the identification of all the risks associated with the branch's balance sheet and off-balance-sheet activities and grouping them into appropriate risk categories. These categories broadly relate to credit, market, liquidity, operational, and legal risks. [See footnote 8] All major risks should be measured explicitly and consistently by branch management; risks should also be reevaluated on an ongoing basis as underlying risk assumptions relating to economic and market conditions vary and as the branch's activities change. The branch's expansion into new products or business lines should not outpace proper risk management or supervision by head office. Where risks cannot be explicitly measured, management should demonstrate knowledge of their potential impact and a sense of how to manage such risks.
Risk identification and measurement are followed by an evaluation of the tradeoff between risks and returns to establish acceptable risk exposure levels, which are stated primarily in the branch's lending and trading policies subject to the approval of head office management. These policies should give standards for evaluating and undertaking risk exposure in individual branch activities as well as procedures for tracking and reporting risk exposure to monitor compliance with established policy limits or guidelines.
Head office management has a role in developing and approving the branch's risk management system as part of its responsibility to provide a comprehensive system of oversight for the branch. Generally, the branch's risk management system, including risk identification, measurement, limits or guidelines, and monitoring should be modeled on that of the FBO as a whole to provide for a fully-integrated risk management system. [See footnote 9]
In assigning the risk management rating, examiners should evaluate the current, ongoing situation and concentrate on developments since the previous examination. The rating should not concentrate on past problems, such as those relating to the current quality of the branch's stock of assets, if risk management techniques have improved significantly since those problems developed. [See footnote 10]
More specifically, in rating the branch's risk management procedures, examiners should consider the following.
For example, in the lending area, a branch would be expected to have (1) experienced lending officers, an effective credit approval and review function, and, where appropriate, credit work-out personnel; (2) a credit risk evaluation system that was viewed as adequate in assessing relative credit risks; (3) branch officer lending limits, lending guidelines, and portfolio policies consistent with the abilities of branch personnel and the financial expertise and resources of the FBO; (4) a system that identified existing and potential problem credits, a method for assessing the likely impact of those credits on existing and future profits, and procedures for accurately informing head office of the credit quality of the portfolio and possible credit losses; and (5) procedures for assessing the impact on the portfolio of specific or general changes in the business climate.
A rating of 1 indicates that management has a fully-integrated risk management system that effectively identifies and controls all major types of risk at the branch, including those from new products and the changing environment. This assessment, in most cases, will be supported by a superior level of financial performance and asset quality at the branch. No supervisory concerns are evident.
A rating of 2 indicates that the risk management system is fully effective with respect to almost all major risk factors. It reflects a responsiveness and ability to cope successfully with existing and foreseeable exposures that may arise in carrying out the branch's business plan. While the branch may have residual risk-related weaknesses, these problems have been recognized and are being addressed by the branch and/or head office. Any such weaknesses will not have a material adverse affect on the branch. Generally, risks are being controlled in a manner that does not require additional or more than normal supervisory attention.
A rating of 3 signifies a risk management system that is lacking in some important measures. Its effectiveness in dealing with the branch's level of risk exposures is cause for more than normal supervisory attention, and deterioration in financial performance indicators is probable. Current risk-related procedures are considered fair, existing problems are not being satisfactorily addressed, or risks are not being adequately identified and controlled. While these deficiencies may not have caused significant problems yet, there are clear indications that the branch is vulnerable to risk-related deterioration.
A rating of 4 represents a marginal risk management system that generally fails to identify and control significant risk exposures in many important respects. Generally, such a situation reflects a lack of adequate guidance and supervision by head office management. As a result, deterioration in overall performance is imminent or is already evident in the branch's overall performance since the previous examination. Failure of management to correct risk management deficiencies that have created significant problems in the past warrants close supervisory attention.
A branch rated 5 has critical performance problems that are due to the absence of an effective risk management system in almost every respect. Not only are there a large volume of problem risk exposures, the problems are also intensifying. Management has not demonstrated the capability to stabilize the branch's situation. If corrective actions are not taken immediately, the operations of the branch are severely endangered.
This component assesses the effectiveness of the branch's operational controls, including accounting and financial controls. The assessment is based on the expectation that branches should have an independent internal audit function and/or an adequate system of head office or external audits as well as a system of internal controls consistent with the size and complexity of their operations. In this regard, internal audit and control procedures should ensure that operations are conducted in accordance with internal guidelines and regulatory policies and that all reports and analyses provided to the head office and branch senior management are timely and accurate.
The rating of operational controls should include the following.
A branch that is rated 1 has a fully comprehensive system of operational controls that protects against losses from transactional and operational risks and ensures accurate financial reporting. Branch operations are fully consistent with sound market practices. The branch also has a well-defined and independent audit function that is appropriate to the size and risk profile of the branch. No supervisory concerns are evident.
A rating of 2 may indicate some minor weaknesses, such as the presence of new business activities where some modest control deficiencies exist, but which management is addressing. Some recommendations may be noted. Overall, the system of controls, including the audit function, is considered satisfactory and effective in maintaining a safe and sound branch operation. Only routine supervisory attention is required.
A rating of 3 indicates that the branch's system of controls, including the quality of the audit function, is lacking in some important respects, particularly as indicated by continued control exceptions and/or substantial deficiencies in or failure to adhere to written policies and procedures. As a result, more than normal supervisory attention is required.
A branch that is rated 4 signifies that the system of operational controls has serious deficiencies that require substantial improvement. In such a case, the branch may lack control functions, including those related to the audit function, that meet minimal expectations; therefore, adherence to bank and regulatory policy is questionable. Head office management has failed to give the branch proper support to maintain operations 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 its operations are in serious jeopardy. The branch either lacks or has a wholly deficient audit function. Immediate substantial improvement is required by branch and head office management, along with strong supervisory attention.
In addition to maintaining an effective system of operational controls, branches should also demonstrate compliance with all applicable state and federal laws and regulations, including reporting and special supervisory requirements. To the extent possible given the size, risk profile and organizational structure of the branch, these responsibilities should be vested in a branch official or compliance officer whose function is separate from line management. Branch management should also ensure that all appropriate personnel are properly trained in meeting regulatory requirements on an ongoing basis. The scope of the branch's audit function also should ensure that the branch is meeting all applicable regulatory requirements.
Accordingly, the branch's level of compliance should be rated based on the following factors.
A branch accorded a rating of 1 demonstrates an outstanding level of compliance with applicable laws, regulations, and reporting requirements. 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 programs are sufficient to prevent significant problems. Minor reporting errors may be present, but they are being adequately addressed by branch management. Only normal supervisory attention is warranted.
A branch that is rated 3 has deficiencies in management and training systems that result in an atmosphere where significant compliance problems could and do occur. Such deficiencies could include a lack of written compliance procedures, no system for identifying possible compliance issues, or a substantial number of minor or repeat violations or deficiencies. More than normal supervisory attention is warranted.
A rating of 4 indicates that compliance matters are not given proper attention by branch and head office management and close supervisory attention is warranted. The lack of an effective compliance program, including an ongoing training program, may be evident along with a failure to meet significant regulatory requirements and/or significant, widespread inaccuracies in regulatory reports.
A rating of 5 would signal that attention to compliance matters is wholly lacking at the branch to the extent that immediate supervisory attention is warranted.
Generally, asset quality is evaluated to determine whether a financial entity has sufficient capital to absorb prospective losses and, ultimately, whether it can maintain its viability as an ongoing entity. The evaluation of asset quality in a branch does not have the same result because a branch is not a separately capitalized entity. Instead, a branch relies on the financial and managerial support of the FBO as a whole.
Nonetheless, the evaluation of asset quality is important both in assessing the effectiveness of credit risk management and in the event of a possible liquidation of a branch. However, as indicated above, a branch is not strictly limited by its own internal and external funding sources in meeting solvency and liquidity needs. The ability of a branch to honor its liabilities ultimately is based upon the condition and level of support from the FBO, a concept that is integral to the FBO supervision program.
This concept states that if the condition of the FBO is satisfactory, the FBO is presumed to be able to support the branch with sufficient resources on a consolidated basis. As a result, the assessment of asset quality in such circumstances would not in and of itself be a predominant factor in the branch's overall assessment, if existing risk management techniques are satisfactory. If, however, support from the FBO is questionable, the evaluation of asset quality should be carefully considered in determining whether supervisory actions are needed to improve the branch's ability to meet its obligations on a stand-alone basis. In cases where a branch is subject to asset maintenance, it is expected that asset quality issues will be addressed by disqualifying classified assets as eligible assets.
The quality of the branch's stock of assets is evaluated based on the following factors. Generally, credit administration concerns should be addressed in rating risk management.
A branch accorded a rating of 1 has strong asset quality.
A branch accorded a rating of 2 has satisfactory asset quality.
A branch accorded a rating of 3 has fair asset quality.
A branch accorded a rating of 4 has marginal asset quality.
A branch accorded a rating of 5 has unsatisfactory asset quality.
Footnote: 1 Risk-based capital ratios based on Basle or EC criteria should be available for most banks. For those banks not providing such ratios, judgments related to the adequacy of capital will be based on the ratio of equity capital to total assets.
Footnote: 2 This would cover instances in which a determination regarding comprehensive, consolidated supervision has already been made by the Federal Reserve Board or where Board staff, based on available information, would be prepared to make a positive recommendation to the Board with regard to comprehensive, consolidated supervision.
Footnote: 3 While recognizing that in many cases knowledge of this nature will take time to develop, it is particularly important because financial disclosure varies among countries. For this reason, meetings with head office management and the home country supervisors of FBOs are useful sources of information.
Footnote: 4 These reviews will be produced based on a schedule provided by the Reserve Banks. The schedules will give priority to those countries that have a major banking presence in the United States or are experiencing significant problems within the home country financial system. It is recognized that not all countries will necessarily be completed in the first year. The draft will be provided to the other agencies for their comments. The analyst who prepared the draft will be available to answer questions regarding the draft.
Footnote: 5 These reviews will be produced based on a schedule provided by the Reserve Banks responsible for drafting the reviews. The schedules will give priority to those countries that have significant bank accounting differences with those generally accepted in the United States. It is recognized that not all countries will necessarily be completed in the first year. The draft will be provided to the other agencies for their comments. The analyst who prepared the draft will be available to answer questions regarding the draft.
Footnote: 6 Branches and agencies are hereafter collectively referred to as branches.
Footnote: 7 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 component greater or lesser weight in arriving at an overall composite rating. In ensuring the protection of branch creditors, an important factor is the strength of the FBO. As the financial strength of the FBO weakens, it becomes increasingly important 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 weighing of the asset quality component in the overall evaluation diminishes.
It also should be recognized that different offices of the FBO 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 given undue credit for having good asset quality. Alternatively, a branch that is designated to hold problem assets generated by other offices of the FBO, in order to better manage the workout 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 tends to be a "trailing" indicator of branch performance. In instances where risk management systems are weak, but problem assets are currently nominal, it is realistic to assume there will be future deterioration in asset quality. By the same measure, management should be given credit in the overall evaluation where the causes of past asset quality problems have been corrected.
Footnote: 8 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 under ROCA.
Footnote: 9 For a more detailed overview of the risk management process in trading operations, refer to the Federal Reserve's Trading Activities Manual.
Footnote: 10 Thus, for example, the change in the level of problem assets since the previous examination would normally be more important than the absolute level of problem assets. At the same time, a loan portfolio that has few borrowers experiencing debt service problems does not necessarily indicate a sound risk management system because weak underwriting standards may make the branch vulnerable to credit problems during a future economic downturn.
Footnote: 11 For specific guidance on evaluating the amount of risk inherent in classified assets and off-balance-sheet or contingent exposures, examiners should refer to the examination manual and any applicable supervisory policies.