Financial Market Regulation: Agencies Engaged in Consolidated
Supervision Can Strengthen Performance Measurement and
Collaboration (15-MAR-07, GAO-07-154).
As financial institutions increasingly operate globally and
diversify their businesses, entities with an interest in
financial stability cite the need for supervisors to oversee the
safety and soundness of these institutions on a consolidated
basis. Under the Comptroller General's Authority, GAO reviewed
the consolidated supervision programs at the Federal Reserve
System (Federal Reserve), Office of Thrift Supervision (OTS), and
Securities and Exchange Commission (SEC) to (1) describe policies
and approaches that U.S. consolidated supervisors use to oversee
large and small holding companies; (2) review the management of
the consolidated supervision programs, including use of program
objectives and performance measures; and (3) evaluate how well
consolidated supervisors are collaborating with other supervisors
and each other in their activities. In conducting this study, GAO
reviewed agency policy documents and supervisory reports and
interviewed agency and financial institution officials.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-07-154
ACCNO: A66866
TITLE: Financial Market Regulation: Agencies Engaged in
Consolidated Supervision Can Strengthen Performance Measurement
and Collaboration
DATE: 03/15/2007
SUBJECT: Bank holding companies
Bank management
Banking regulation
Federal regulations
Federal reserve banks
Financial institutions
Holding companies
Interagency relations
Lending institutions
Performance measures
Policy evaluation
Regulatory agencies
Risk management
Consolidation
Government agency oversight
Policies and procedures
Program goals or objectives
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GAO-07-154
* [1]Results in Brief
* [2]Background
* [3]Modern Financial Services Firms Use Holding Company Structur
* [4]The U.S. Regulatory System Includes Many Agencies
* [5]Primary Bank and Functional Supervisors Oversee Holding
Comp
* [6]Consolidated Supervisors Oversee Holding Companies
* [7]International Bodies Provide Some Guidance for Consolidated
* [8]Agencies Employ Differing Policies and Approaches to Provide
* [9]All Agencies Examine Consolidated Risks, Controls, and Capit
* [10]The Federal Reserve Has a Systematic Risk-Focused
Approach f
* [11]OTS Is Moving to a Broader, More Systematic Approach to
Cons
* [12]SEC's CSE Program Is New and Evolving
* [13]Supervision of Complex Firms Involves Multiple Regulators
* [14]Federal Reserve and OTS Use Abbreviated Approach for Smaller
* [15]Improved Program Objectives and Performance Measures Could E
* [16]Developments in the Financial Services Industry Have Affecte
* [17]Agencies Are Providing Comprehensive Consolidated Supervisio
* [18]Clear Program Objectives and Performance Measures Are Essent
* [19]Goals and Performance Measures Address Supervision Broadly,
* [20]Federal Reserve
* [21]OTS
* [22]SEC
* [23]Agencies Have Opportunities to Better Ensure Effective and C
* [24]Systematic Collaboration Could Enhance Consolidated Supervis
* [25]Systematic Collaboration Is Essential for Multiple Agencies
* [26]In the Oversight of Individual Firms, Supervisors from Diffe
* [27]Moving to Enterprisewide Management and Other
Organizational
* [28]Greater Collaboration among the Three Consolidated Superviso
* [29]Duplicative Effect of Overlapping Jurisdiction between
OTS a
* [30]Agencies Face Broader Risks That Could Be Better Managed
thr
* [31]Conclusions
* [32]Recommendations for Executive Action
* [33]Agency Comments and Our Evaluation
* [34]Principle 24: Consolidated supervision
* [35]GAO Contact
* [36]Staff Acknowledgments
* [37]GAO's Mission
* [38]Obtaining Copies of GAO Reports and Testimony
* [39]Order by Mail or Phone
* [40]To Report Fraud, Waste, and Abuse in Federal Programs
* [41]Congressional Relations
* [42]Public Affairs
Report to Congressional Committees
United States Government Accountability Office
GAO
March 2007
FINANCIAL MARKET REGULATION
Agencies Engaged in Consolidated Supervision Can Strengthen Performance
Measurement and Collaboration
GAO-07-154
Contents
Letter 1
Results in Brief 4
Background 7
Agencies Employ Differing Policies and Approaches to Provide Consolidated
Supervision 16
Improved Program Objectives and Performance Measures Could Enhance
Agencies' Consolidated Supervision Programs 30
Systematic Collaboration Could Enhance Consolidated Supervision Programs
42
Conclusions 54
Recommendations for Executive Action 56
Agency Comments and Our Evaluation 57
Appendix I Objectives, Scope, and Methodology 62
Appendix II Criteria for Consolidated Supervision Included in Basel
Committee on Banking Supervision's Core Principles 65
Appendix III Comments from the Chairman of the Board of Governors of the
Federal Reserve System 68
Appendix IV Comments from the Director of the Office of Thrift Supervision
72
Appendix V Comments from the Chairman of the Securities and Exchange
Commission 75
Appendix VI GAO Contact and Staff Acknowledgments 79
Related GAO Products 80
Tables
Table 1: U.S. Primary Bank, Broker-Dealer, and Insurance Supervisors, 2005
10
Table 2: Number and Type of Institutions That Consolidated Supervisors
Oversee, 2005 12
Table 3: Federal Reserve's Supervisory Cycle for LCBOs 18
Table 4: OTS's Standard Core Framework 22
Table 5: Thrift Holding Company Enterprises by Category, Complexity, Size,
and Primary Business, as of December 31, 2006 28
Table 6: Key Elements of Collaboration 43
Figure
Figure 1: Supervisors for a Hypothetical Financial Holding Company 26
Abbreviations
BaFin German Federal Financial Supervisory Authority (Die Bundesanstalt
fuer Finanzdienstleistungsaufsicht)
BCBS Basel Committee on Banking Supervision
Board Federal Reserve Board of Governors
CAMELS capital adequacy, asset quality, management ability, earnings, liquidity, and
sensitivity to market risk
CIO Complex and International Organizations
CORE capital, organization structure, relationship, and earnings
COSO Committee of Sponsoring Organizations of the Treadway Commission
CSE consolidated supervised entity
District Bank Federal Reserve Bank in each of the 12 Federal Reserve
Districts
EU European Union
FCD Financial Conglomerates Directive
FDIC Federal Deposit Insurance Corporation
Federal Reserve Federal Reserve System
FSA Financials Services Authority of the United Kingdom
GLBA Gramm-Leach-Bliley Act
ILC industrial loan companies
LCBO large complex banking organization
LTCM Long-Term Capital Management
MOU memorandum of understanding
NAIC National Association of Insurance Commissioners
NERO Northeast Regional Office OCC Office of the Comptroller
of the Currency
OCIE Office of Compliance Inspections and Examinations
OTS Office of Thrift Supervision
SEC Securities and Exchange Commission
SIBHC supervised investment bank holding company
SRO self-regulatory organization
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separately.
United States Government Accountability Office
Washington, DC 20548
March 15, 2007
Congressional Committees
Increasingly, financial institutions headquartered in the United States,
and their competitors, operate on a global basis, engage in a variety of
businesses, and manage themselves from a consolidated perspective. Partly
in response to these changes, entities with an interest in financial
institutions have increasingly cited the need for supervisors to oversee
the safety and soundness of these firms on a consolidated basis, mirroring
the risk management practices of the firms. This increased focus is
reflected in U.S. laws that provide holding company supervisors with
authority to examine the financial and operating risks faced by holding
companies and the controls for these risks on a consolidated basis.
Similarly, the European Union's (EU) Financial Conglomerates Directive,
implemented in 2005, requires conglomerates to have a consolidated
supervisor--either an EU supervisor or a home supervisor that has
demonstrated it provides equivalent consolidated supervision--and focuses
on the risks, controls, and capital levels of holding companies.
In the United States, consolidated supervision generally is equated with
holding company supervision at the top tier or ultimate holding company in
a financial enterprise. Three federal agencies--the Federal Reserve System
(Federal Reserve), the Office of Thrift Supervision (OTS), and the
Securities and Exchange Commission (SEC)--engage in oversight of financial
services holding companies on a consolidated basis:^1 the Federal Reserve
oversees bank holding companies (including financial holding companies,
which are bank holding companies qualified to engage in many nonbanking
financial services), OTS oversees thrift holding companies, and SEC
oversees consolidated supervised entities (CSE). Each of these agencies
oversees large, complex financial institutions.
In addition, the Federal Reserve and OTS provide consolidated supervision
for the vast majority of U.S. financial institutions organized as holding
companies that have remained relatively small, and are not complex. Under
U.S. law, consolidated supervisors are to rely on primary bank and
functional supervisors with respect to the supervision of regulated
financial subsidiaries such as banks, broker-dealers, and insurers.^2 The
Federal Deposit Insurance Corporation (FDIC) and the Office of the
Comptroller of the Currency (OCC), for instance, are the primary federal
supervisors for state-chartered banks that are not members of the Federal
Reserve System and for national banks, respectively. SEC is the primary
regulator of broker-dealers and state insurance supervisors of insurers.
^1For enterprises engaged in commercial activities, consolidated
supervision also may refer to supervision of the enterprise consolidated
at the highest level holding company engaged in financial activities. For
foreign banking firms that operate in the United States without a U.S.
holding company, consolidated supervision may refer to the oversight of
all U.S. activities of the foreign firm.
As is generally the case for supervisors dealing with the financial
viability of the entities they oversee, holding company supervisors face
the challenge of striking the appropriate balance between adequately
assessing the risks and controls of financial services firms and placing
undue regulatory burdens on those enterprises. At the consolidated level
the effects of not having the right balance could be unacceptable losses
to the depository insurance fund, systemic failures that could threaten
financial stability, competitive disadvantages for U.S. firms as a whole
or for a firm or group of firms relative to their U.S. competitors, or
higher costs or lower returns for consumers of financial services products
or the owners of those firms.
In previous reports,^3 we have noted the challenges confronting the U.S.
regulatory system:
The present federal financial regulatory structure evolved largely as a
result of periodic ad hoc responses to crises such as financial panics. In
the last few decades, however, the financial services industry, especially
as represented by the largest firms, has evolved, becoming more global,
more concentrated, complex, and consolidated across sectors, and
increasingly converging in terms of product offerings. Multiple
specialized regulators bring critical skills to bear in their areas of
expertise but have difficulty seeing the total risk exposure at large
conglomerate firms or identifying and preemptively responding to risks
that cross industry lines.^4
2For the purposes of this report, functional supervisors also may include
supervisors of foreign subsidiaries, such as the United Kingdom's
Financial Services Authority, the German Federal Financial Supervisory
Authority (Die Bundesanstalt fuer Finanzdienstleistungsaufsicht) called
BaFin, the French Commission Bancaire, and the Japanese Financial Services
Agency.
^3See GAO, 21st Century Challenges: Reexamining the Base of the Federal
Government, [43]GAO-05-325SP (Washington, D.C.: Feb. 1, 2005); Financial
Regulation: Industry Changes Prompt Need to Reconsider U.S. Regulatory
Structure, [44]GAO-05-61 (Washington, D.C.: Oct. 6, 2004); and Industrial
Loan Companies: Recent Asset Growth and Commercial Interest Highlight
Differences in Regulatory Authority, [45]GAO-05-621 (Washington, D.C.:
Sept. 15, 2005).
In particular, we previously concluded that while the strength and
vitality of the U.S. financial services industry demonstrates that the
regulatory structure has not failed, there are questions whether that
structure is appropriate in today's environment, particularly with respect
to large, complex firms managing their risks on a consolidated basis. We
suggested that Congress consider several alternative structures, including
consolidating some or all of the current regulatory agencies or having a
single regulator oversee complex, internationally active firms. However,
this report evaluates consolidated supervision under the existing
regulatory structure and does not address proposals to consolidate federal
financial regulation.
In recognition of the increasing importance of consolidated supervision
for the federal financial regulatory system raised in these earlier
reports, we undertook a review of consolidated supervision in the United
States under the Comptroller General's Authority to initiate reviews. This
report
o describes the policies and approaches U.S. consolidated
supervisors use to oversee large and small holding companies in
the financial services industry;
o reviews the supervisory agencies' management of their
consolidated supervision programs, including program objectives
and performance measures; and
o evaluates how well consolidated supervisors are collaborating
with other supervisors and each other in their activities.
To meet our objectives, we reviewed the structure, policies, and
activities of the Federal Reserve, OTS, and SEC as they relate to
these agencies' consolidated supervision programs. We reviewed
laws and regulations pertinent to each agency's consolidated
supervision, as well as agency planning and performance documents,
and regulatory planning and examination reports and letters for a
group of 14 large, complex firms selected because they had at
least one of these characteristics: (1) major international
operations, so that they were subject to the EU Financial
Conglomerates Directive; (2) operations in several business lines;
or (3) oversight by one or more consolidated supervisors. We also
interviewed agency officials and examiners and officials from some
of the selected group of firms to determine their view of the
regulatory process. In addition, for the Federal Reserve and OTS,
we reviewed examination materials related to the supervision of
smaller, less complex institutions. To determine the adequacy of
management practices at the agencies, we analyzed the goals for
holding company supervision, the strategies agencies employ to
achieve their goals, including collaboration, and how agencies
monitor their performance. We also reviewed officials' and
examiners' statements and other examination materials to determine
the degree to which consolidated supervision programs have
effective internal control, key management practices that provide
agencies with reasonable assurance that the programs are operating
efficiently and effectively. This included an evaluation of how
agencies coordinate their activities relative to the practices for
effective collaboration that we have identified.^5 We conducted
our work between November 2005 and February 2007 in accordance
with generally accepted government auditing standards in
Washington, D.C.; Boston; and locations where financial
institutions we visited are headquartered. See appendix I for
additional details on the objectives, scope, and methodology used
in this report.
Results in Brief
In recent years, financial services firms have grown dramatically
and become more complex in terms of the products and services they
offer; they increasingly operate on a global basis and often
manage risks across the enterprise. The Federal Reserve, OTS, and
SEC have all responded to the dramatic changes in the financial
services industry, and now, for many of the largest, most complex
financial services firms in the United States, these agencies
examine risks, controls, and capital levels on a consolidated
basis. Given the differences in the institutions that the agencies
supervise and other factors, their specific policies and
procedures differ. The agencies divide responsibilities for
developing and implementing policies across a number of agency
components. The Federal Reserve and OTS generally set policy
centrally and implement it through District Banks or regional
offices, respectively. At SEC, the Division of Market Regulation
(Market Regulation) has primary responsibility for policy and for
overseeing how firms manage risks, while SEC's examination offices
scrutinize more control-oriented activities. Almost all firms
overseen by the Federal Reserve are engaged primarily in the
business of banking and those overseen by SEC are engaged
primarily in the securities business. In contrast, a substantial
minority of the firms OTS oversees--especially the large, complex
ones--have primary businesses other than those traditionally
engaged in by thrifts, such as insurance, securities, or
commercial activities. In addition, large firms tend to be
overseen by multiple supervisors and in the case of firms overseen
by the Federal Reserve, on a consolidated basis, OCC or FDIC is
often the primary federal regulator of the lead insured depository
subsidiary. Finally, for their smaller, less complex firms, the
Federal Reserve and OTS use abbreviated examination programs.
Consolidated supervision becomes more important in the face of
changes in the industry, particularly with respect to the
increased importance of enterprise risk management by large,
complex financial services firms. Consolidated supervision
provides a basis for the supervisors to oversee the risks of a
financial services firm on the same level that the firm manages
its risks. Each of the agencies has broad goals for its
consolidated supervision programs. However, each could better
ensure accountability, efficiency, and consistency by more clearly
articulating the objectives of its consolidated supervision
program, distinguishing these objectives from those for primary
supervision, linking its activities to these objectives, and
measuring the extent to which the activities achieve the
objectives by developing and using performance measures that are
specific to the program. In addition, agencies could achieve
greater consistency by improving examiner guidance. We found that
the Federal Reserve, OTS, and SEC were generally meeting criteria
for comprehensive, consolidated supervision. However, particularly
in rapidly changing environments such as the financial services
industry, clearer objectives and performance measures are
essential. The Federal Reserve and OTS identify an objective of
consolidated supervision as protecting the safety and soundness of
depository institutions, but the agencies could take steps to
better measure how consolidated supervision contributes to this
objective in ways that are different from primary bank
supervision. Similarly, SEC identifies protection of regulated
subsidiaries as an objective but does not distinguish the
contribution that consolidated supervision makes in addition to
SEC's oversight of regulated broker-dealers. SEC staff recently
developed a draft document that is intended to provide objectives
specific to its consolidated supervision program. Without such
specific objectives and related performance measures, the agencies
are less able to ensure that their supervisory activities avoid
duplication and treat holding companies in a consistent manner.
We have noted in the past that U.S. financial regulatory agencies
cooperate through a myriad of devices such as the President's
Working Group, the Federal Financial Institutions Examination
Council, and Financial and Banking Information Infrastructure
Committee often at the direction of the President or Congress. In
addition, to varying degrees, examiners and officials at the
supervisory agencies share information on supervisory procedures
and examination findings over the course of exams. However, the
U.S. regulatory system could benefit from more systematic
collaboration, both between consolidated and primary bank and
functional supervisors in the oversight of the largest, most
complex firms and among the consolidated supervisors themselves.
For many of the largest, most complex financial institutions, the
consolidated supervisor is not the primary supervisor of holding
company subsidiaries; other supervisors, such as bank supervisors,
have this responsibility. The supervisory agencies, especially
those involved in commercial bank supervision, do take steps to
avoid duplication by sharing some information and examination
activities. However, we found some evidence of duplication and
lack of accountability when different agencies are responsible for
consolidated and primary supervision, suggesting that
opportunities remain for enhancing collaboration. For example,
while the Federal Reserve and OCC have and generally follow
procedures to resolve differences, one firm we visited had
initially received conflicting information from the Federal
Reserve, its consolidated supervisor, and OCC, its primary bank
supervisor, regarding the firm's business continuity plans. Also,
SEC and OTS both have consolidated supervisory authority for some
of the same firms, but with no effective mechanism to collaborate
in order to prevent duplication, assign accountability, or resolve
potential conflicts in the feedback given to firms. Moreover,
while these agencies all supervise large, complex, internationally
active firms, they could better ensure consistency with more
systematic collaboration to determine common goals, compatible
strategies, and accountability.
In this report, we make seven recommendations primarily related to
improving certain management practices within and across the
agencies engaged in consolidated supervision. We recommend that
each agency better define objectives that are specific to its
consolidated supervision program and develop performance measures
that will help it measure the extent to which it is achieving
these objectives. As noted above, SEC staff have developed draft
objectives and performance measures for SEC's consolidated
supervision program. With regard to the oversight of complex
institutions where primary bank and functional supervisors oversee
certain holding company subsidiaries, we recommend that those
agencies engaged in consolidated supervision of the holding
companies develop mechanisms for more systematic collaboration
with the primary and functional supervisors responsible for the
supervision of the subsidiaries. In a similar vein, we recommend
that the three agencies engaged in consolidated supervision adopt
mechanisms for more systematic collaboration among themselves,
particularly when they share responsibility for the same firms. In
both cases, more systematic collaboration would help to limit
duplication, ensure that all regulatory areas are effectively
covered, and ensure that resources are focused most effectively on
the greatest risks across the regulatory system. In addition, we
also make specific recommendations to each consolidated supervisor
to help ensure that firms are treated consistently. The Chairman
of the Board of Governors of the Federal Reserve System and the
Director of the Office of Thrift Supervision provided written
comments on a draft of this report; their comments are included in
appendixes III and IV, respectively. The Chairman of the
Securities and Exchange Commission provided written comments on a
draft of this report and subsequently provided additional
information detailing some of the actions he was taking in
response to the report; these comments are included in appendix V.
Officials from the three agencies generally agreed with the
recommendations in this report and offered clarifying remarks.
Background
Modern financial services firms use a variety of holding company
structures to manage risk inherent in their businesses. The United
States regulatory system that consists of primary bank
supervisors, functional supervisors, and consolidated supervisors
oversees these firms in part to ensure that they do not take on
excessive risk that could undermine the safety and soundness of
the financial system. Primary bank supervisors oversee banks
according to their charters, and functional
supervisors--primarily, SEC, self-regulatory organizations (SRO),
and state insurance regulators--oversee entities engaged in the
securities and insurance industries as appropriate. Consolidated
supervisors oversee holding companies that contain subsidiaries
that have primary bank or functional supervisors. They are
chartered, registered, or licensed as banks, securities firms,
commodity trading firms, and insurers. International bodies have
provided some guidance for consolidated supervision.
Modern Financial Services Firms Use Holding Company Structures
to Manage Risk
Many modern financial firms are organized as holding companies
that may have a variety of subsidiaries. In recent years, the
financial services industry has become more global, consolidated
within traditional sectors, formed conglomerates across sectors,
and converged in terms of institutional roles and products. The
holding company structure, which allows firms to expand
geographically, move into other permissible product markets, and
obtain greater financial flexibility and tax benefits, has
facilitated these changes. Financial services holding companies
now range in size and complexity from small enterprises that own
only a single bank and are being used for financial flexibility
and tax purposes to large diversified businesses with hundreds of
subsidiaries--including banks, broker-dealers, insurers, and
commercial entities--that have centralized business functions that
may be housed in the holding company. In addition, modern
financial corporate structures often consist of several tiers of
holding companies.
To varying degrees, all financial institutions are exposed to a
variety of risks that create the potential for financial loss
associated with
o failure of a borrower or counterparty to perform on an
obligation--credit risk;
o broad movements in financial prices--interest rates or stock
prices--market risk;
o failure to meet obligations because of inability to liquidate
assets or obtain funding--liquidity risk;
o inadequate information systems, operational problems, and
breaches in internal controls--operational risk;
o negative publicity regarding an institution's business practices
and subsequent decline in customers, costly litigation, or revenue
reductions--reputation risk;
o breaches of law or regulation that may result in heavy penalties
or other costs--legal risk;
o risks that an insurance underwriter takes in exchange for
premiums--insurance risk; and
o events not covered above, such as credit rating downgrades or
factors beyond the control of the firm, such as major shocks in
the firm's markets--business/event risk.
In addition, the industry as a whole is exposed to systemic risk,
the risk that a disruption could cause widespread difficulties in
the financial system as a whole.
As firms have diversified, some holding companies have adopted
enterprisewide risk management practices where they manage and
control risks across the entire holding company rather than within
subsidiaries. These firms have global risk managers who manage
credit, market, liquidity, and other risks across the enterprise
rather than within individual subsidiaries, such as securities,
banking, or insurance businesses or subsidiaries in foreign
countries. In addition, these firms generally provide services
such as information technology on a firmwide basis and have
firmwide compliance and internal audit functions.
The U.S. Regulatory System Includes Many Agencies
We have previously reported that most financial services firms are
subject to federal oversight designed to limit the risks these
firms take on because (1) consumers/investors do not have adequate
information to impose market discipline on the institutions and
(2) systemic linkages may make the financial system as a whole
prone to instability.^6 In the United States, this oversight is
provided by primary bank and functional supervisors as well as by
consolidated supervisors.
Primary Bank and Functional Supervisors Oversee Holding Company
Subsidiaries
As table 1 illustrates, in the United States a variety of federal
bank supervisors oversee banks that are subsidiaries of holding
companies.^7 State bank supervisors also participate in the
oversight of banks with state charters. Similarly, securities
supervisors that include SEC and SROs, such as the New York Stock
Exchange and NASD, oversee broker-dealer subsidiaries and state
insurance supervisors oversee insurance companies and products.
While each of the agencies has multiple goals, all are involved in
assessing the financial solvency of the institutions they
regulate.
^4 [46]GAO-05-325SP , 28.
^5See GAO, Results-Oriented Government: Practices That Can Help Enhance
and Sustain Collaboration among Federal Agencies, [47]GAO-06-15
(Washington, D.C.: Oct. 21, 2005).
^6See [48]GAO-05-61 , pp. 30-31, for a fuller discussion.
^7Banking institutions generally determine their regulator by choosing a
particular kind of charter--commercial bank, thrift, credit union, or
industrial loan company. These charters may be obtained at the state or
national level for all except industrial loan companies, which are
chartered only at the state level.
Table 1: U.S. Primary Bank, Broker-Dealer, and Insurance Supervisors, 2005
Number of
entities
Regulatory body overseen Functions
Federal primary bank
supervisors^a
Federal Deposit 5,245^b Provides oversight of state-chartered
Insurance Corporation banks that are not members of the
Federal Reserve, state savings banks,
and industrial loan corporations with
federally insured deposits. Also serves
as the secondary regulator for all
banks with federally insured deposits.
Federal Reserve 907^c Oversees state-chartered banks that are
members of the Federal Reserve.
Office of the 1,933^d Charters and supervises banks with
Comptroller of the national charters.
Currency
Office of Thrift 866^e Supervises state-chartered savings
Supervision associations that are federally insured
and federally chartered thrifts.
Broker-dealer
supervisors
Securities and Exchange 6,300^f Oversee compliance of securities
Commission and brokers and dealers with federal
self-regulatory securities laws. Self-regulatory
organizations organizations play a major role in
enforcing conduct of business and
capital requirements. The Securities
and Exchange Commission validates
self-regulatory organizations' rules
and inspects and oversees their
regulatory programs.
Insurance supervisors
State insurance 8,794^g Insurance firms are regulated primarily
supervisors at the state level. The National
Association of Insurance Commissioners
aims to achieve some common minimum
standards by encouraging consistency
and cooperation among the various
states as they individually regulate
the insurance industry.^h
Source: GAO analysis of agency data.
aBecause credit unions are not subsidiaries of holding companies, they are
not included here.
bFederal Deposit Insurance Corporation statistics, December 2005.
cFederal Reserve, Annual Report 2005.
dOffice of the Comptroller of the Currency, Annual Report Fiscal Year
2005. This number does not include the 51 federal branches of foreign
banks in the United States that are also overseen by OCC.
eOffice of Thrift Supervision, Budget/Performance Plan Fiscal Year 2006.
fSecurities and Exchange Commission.
gNational Association of Insurance Commissioners, 2005 Insurance
Department Resources Report.
hSEC regulates sales of discrete products, such as certain types of
annuities considered to be securities. Also, banks engage in certain types
of insurance activities, such as underwriting credit insurance and, under
certain circumstances, acting as an insurance agent either directly or
through a subsidiary. Although these activities are subject to OCC
regulation, national banks can be subject to nondiscriminatory state laws
applicable to certain insurance related activities.
All of the primary bank supervisors use the same framework to examine
banks for safety and soundness and compliance with applicable laws and
regulations. Among other things, they examine whether
o the bank has adequate capital on the basis of its size,
composition of its assets and liabilities, and its credit and
market risk profile;
o the bank has an appropriate asset quality based on the credit
risk of loans in its portfolio;
o the bank's earnings trend measures up to that of its peers;
o the competence and integrity of the bank's management and board
of directors to manage the risks of the bank's activities and
their record of complying with banking regulations and other laws;
o the bank has adequate liquidity based on its deposit volatility,
credit conditions, loan commitments and other contingent claims on
the bank's assets and its perceived ability to raise funds on
short notice at acceptable market rates; and
o the bank adequately identifies and manages its exposures to
changes in interest rates and, as applicable, foreign exchange
rates, commodity and equity prices.
Primary bank examiners rate banks in each of the areas; these
ratings are usually referred to as CAMELS ratings (capital
adequacy, asset quality, management ability, earnings, liquidity,
and, where appropriate, sensitivity to market risk).
SROs oversee certain aspects of broker-dealer activity. SEC
concurrently oversees these SROs and independently examines
broker-dealers. SEC considers its enforcement authority crucial
for its protection of investors. Under this authority, it brings
actions against broker-dealers and other securities firms and
professionals for infractions such as insider trading and
providing false or misleading information about securities or the
companies that issue them. However, to protect investors, SEC also
requires broker-dealers to maintain a level of capital that should
allow the broker-dealer to satisfy the claims of its customers,
other broker-dealers, and creditors in the event of potential
losses from proprietary trading or operational events. SEC and the
SROs examine broker-dealers to determine if they are maintaining
required capital and evaluate broker-dealers' internal controls.
The central purpose of insurance regulation is to protect
consumers by monitoring the solvency of insurers and their
business practices. Insurance companies are supervised on a
state-by-state basis, although states often follow general
standards promulgated by the National Association of Insurance
Commissioners (NAIC), a private voluntary association for
insurance regulators. For example, insurance supervisors generally
require insurance firms to prepare their quarterly and annual
financial statements in a format unique to insurance known as
statutory accounting principles that are maintained by NAIC.
Insurance supervisors impose capital requirements on insurance
companies to try to limit insurance company failures and ensure
their long-run viability. In addition, all state insurance
supervisors monitor insurers' business practices and terms of
insurance contracts in their states.
Consolidated Supervisors Oversee Holding Companies
In the United States, three agencies provide consolidated
supervision--the Federal Reserve oversees bank holding companies,
OTS oversees thrift holding companies, and SEC oversees certain
CSEs on a consolidated basis. As table 2 shows, the number and
type of institutions these agencies oversee varies.
Table 2: Number and Type of Institutions That Consolidated Supervisors
Oversee, 2005
Number of
Consolidated entities
supervisor overseen Type of entity overseen
Federal Reserve 5,154 Bank holding companies, including small shell,
medium-sized, and large complex firms--the
majority of which have banking as their primary
business but many, especially larger firms,
have securities or other nonbank subsidiaries.
OTS 476 Savings and loan holding companies, including
small, medium-sized, and large firms that may
include substantial nonbanking subsidiaries
focused on commercial activities, securities,
or insurance.
SEC 5 Large complex firms that focus primarily on
securities and have chosen to be participants
in the CSE program.
Source: GAO analysis of agency data.
As the table shows, SEC, under its CSE program, oversees only large
complex firms. These include Bear Stearns & Co., Goldman Sachs & Co.,
Lehman Brothers Inc., Merrill Lynch & Co. Inc., and Morgan Stanley & Co.,
while the Federal Reserve and OTS oversee firms that vary significantly in
size and complexity. Among larger firms, the Federal Reserve oversees Bank
of America Corporation, Citigroup, and JPMorgan Chase, and OTS oversees
American International Group Inc., General Electric Company, General
Motors Corporation, Merrill Lynch & Co. Inc., and Washington Mutual Inc.
Most of the large bank holding companies that the Federal Reserve oversees
are primarily in the business of banking but to a lesser extent engage in
securities or other nonbank activities as well. Many of the large firms
OTS oversees are engaged in commercial businesses, as well as securities
and insurance. The Federal Reserve and OTS also oversee the vast majority
of U.S. financial institutions that have remained relatively small and are
not complex.
The Federal Reserve and OTS base their consolidated supervision programs
on their long-standing authority to supervise holding companies, while SEC
has only recently become a consolidated supervisor. The Federal Reserve's
authority is set forth primarily in the Bank Holding Company Act of 1956,
which contains the supervisory framework for holding companies that
control commercial banks.^8 OTS's consolidated supervisory authority is
set forth in the Home Owners Loan Act of 1933, as amended, which provides
for the supervision of holding companies that control institutions with
thrift charters (other than bank holding companies).^9 SEC bases its
authority on section 15(c)(3) of the Securities Exchange Act of 1934.^10
Specifically, in 2004, SEC adopted the Alternative Net Capital Rule for
CSEs based on its authority under that provision, which authorizes SEC to
adopt rules and regulations regarding the financial responsibilities of
broker-dealers that it finds necessary or appropriate in the public
interest or for the protection of investors.^11 Under the CSE rules,
qualified broker-dealers can elect to be supervised by SEC on a
consolidated basis. If the holding company of the broker-dealer also is a
bank holding company, SEC defers to the Federal Reserve's supervision of
the holding company. At the same time that it issued the CSE rules, SEC
promulgated final rules for the consolidated supervision of supervised
investment bank holding companies (SIBHC) pursuant to a provision in the
Gramm-Leach-Bliley Act (GLBA).^12 The GLBA provision established a
supervisory framework for SIBHCs--qualified investment bank holding
companies that do not control an insured depository institution--similar
to the approach prescribed in the act for the supervision of bank and
thrift holding companies.^13 As of this date, no firm has elected to be
regulated under the SIBHC scheme.
^812 U.S.C. SS 1841-1850, as amended.
^912 U.S.C. S 1467a, as amended.
^1015 U.S.C. S 78o(3)(c), see 69 Fed. Reg. at 34430.
^1169 Fed. Reg. at 34430 n. 10; Gramm-Leach-Bliley Act, Pub. L. No.
106-102 (1999).
^1269 Fed. Reg. 34472 (June 21, 2004).
The Federal Reserve, SEC, and OTS vary in their missions in that the
Federal Reserve and SEC have responsibilities outside of the supervision
and regulation of financial institutions. The Federal Reserve is the
central bank of the United States, established by Congress in 1913 to
provide the nation with a safer, more flexible, and more stable monetary
and financial system. It is responsible for conducting the nation's
monetary policy; protecting the credit rights of consumers; playing a
major role in operating the nation's payment system; and providing certain
financial services to the U.S. government, the public, financial
institutions, and foreign official institutions. The Federal Reserve
consists of the Board of Governors (Board) and 12 Districts, each with a
Federal Reserve Bank (District Bank). SEC is responsible for, among other
things, overseeing the disclosure activities of publicly traded companies
and the activities of stock markets.
The three agencies engaged in consolidated supervision are financed
differently. The Federal Reserve primarily is funded by income earned from
U.S. government securities that it has acquired through open market
operations; OTS primarily by assessments on the firms it supervises; and
SEC by congressional appropriations. SEC collects fees on registrations,
certain securities transactions, and other filings and reports. However,
unlike the banking regulators, SEC deposits its collections in an
SEC-designated account at the U.S. Treasury that is used by SEC's
congressional appropriators for, among other things, providing
appropriations to SEC.
International Bodies Provide Some Guidance for Consolidated Supervision
International bodies in which U.S. supervisors participate have developed
guidance for consolidated supervision of large, complex, internationally
active financial firms or conglomerates.^14 The Basel Committee on Banking
Supervision (BCBS) does not have formal supervisory authority; rather, it
provides an international forum for regular cooperation on banking
supervisory matters, including the formulation of broad supervisory
standards and guidelines. BCBS has recently revised its "Core Principles
for Effective Banking Supervision," which include countries' requiring
that banking groups be subject to consolidated supervision, although the
definition of a banking group does not always include a top-tier holding
company.^15 These principles include a number of specific criteria that
are presented in appendix II of this report. BCBS also has developed the
Basel Capital Standards, which have been adopted in various forms by
specific countries; a revised set of standards, Basel II, is currently
under consideration for adoption in the United States.^16 These standards
require that holding companies engaged in banking meet specific risk-based
capital requirements.
^13Pub. L. No. 106-102 S 231.
^14The definition of financial conglomerates used by the Joint Forum is
"any group of companies under common control whose exclusive or
predominant activities consist of providing significant services in at
least two different financial sectors (banking, securities, insurance)."
The Joint Forum is described later in this report.
In addition, the Joint Forum, an international group of supervisors
established in 1996 under the aegis of BCBS and equivalent bodies for
securities and insurance regulators^17 to consider issues related to the
supervision of financial conglomerates, has issued supervisory guidance.
The guidance focuses on risks and controls and specifically directs
examiners to review the organizational structure, capital level, risk
management, and control environment of conglomerates.
The EU promulgated rules for consolidated supervision of certain firms
operating in Europe that took effect in 2005. U.S.-headquartered firms
with operations in EU countries are among those affected by these rules,
which, therefore, has had implications for consolidated supervision in the
United States. The Financial Conglomerates Directive (FCD) requires that
all financial conglomerates operating in EU countries have a consolidated
supervisor. Conglomerates not headquartered in the EU must have an
equivalent consolidated supervisor in their home country that has been
approved by a designated supervisor from an EU member state in which the
company operates. That supervision focuses on capital adequacy, intragroup
transactions, risk management, and internal controls.
^15Basel Committee on Banking Supervision, Core Principles for Effective
Banking Supervision (October 2006).
^16GAO has recently completed an assessment of the proposed U.S.
regulation based on these revised capital standards. See GAO, Risk-Based
Capital: Bank Regulators Need to Improve Transparency and Address
Impediments to Finalizing the Proposed Basel II Framework, [49]GAO-07-253
(Washington, D.C.: Feb. 15, 2007).
^17The International Organization of Securities Commissions is composed of
securities regulators from 105 countries, and the International
Association of Insurance Supervisors represents insurance supervisory
authorities of some 180 jurisdictions.
Agencies Employ Differing Policies and Approaches to Provide Consolidated
Supervision
The Federal Reserve, OTS, and SEC have all responded to the dramatic
changes in the financial services industry, and now, for many of the
largest, most complex financial services firms in the United States, these
agencies examine risks, controls, and capital levels on a consolidated
basis. Given the differences in their authorities and in the institutions
that they supervise, as well as other factors, the agencies' specific
policies and procedures differ. Also, the agencies divide responsibilities
for developing and implementing policies across a number of agency
components. The Federal Reserve and OTS generally set policy centrally and
implement it through District Banks or regional offices, respectively. At
SEC, Market Regulation has primary responsibility for policy and for
overseeing how CSEs manage risks, while SEC's examination offices
scrutinize more control-oriented activities. The oversight of complex
firms involves multiple regulators. Finally, for their smaller or less
complex firms, the Federal Reserve and OTS use abbreviated examination
programs.
All Agencies Examine Consolidated Risks, Controls, and Capital Levels of Their
Largest, Most Complex Firms, but Specific Policies and Approaches Differ
All of the agencies have responded to the dramatic changes in the
financial services industry, including dramatic growth, increased
complexity in terms of the products and services firms offer, more global
operations, and greater use of enterprisewide risk management. Now, for
many of the largest, most complex financial services firms in the United
States, the agencies focus on the firms' risks, controls, and capital
levels on a consolidated basis. However, the agencies have developed and
revised their programs over different time frames and used different
frameworks. The Federal Reserve, beginning in the mid-1990s, has developed
a systematic risk-focused approach for large, complex banking
organizations (LCBO); OTS began to move toward a more consistent,
risk-focused approach for some large, complex firms in 2003; and SEC's CSE
program, implemented in 2004, is new and evolving. Both the Federal
Reserve and OTS have approaches to supervision of smaller, less complex
holding companies that reflect the risks of these institutions.
The Federal Reserve Has a Systematic Risk-Focused Approach for Large, Complex
Banking Organizations
In the mid-1990s, the Federal Reserve began to develop a systematic
risk-focused approach for the supervision of LCBOs. The program focuses on
those business activities posing the greatest risk to holding companies
and managements' processes for identifying, measuring, monitoring, and
controlling those risks. According to the Federal Reserve, LCBOs have
significant on- and off-balance sheet risk exposures, offer a broad range
of products and services at the domestic and international levels, are
overseen by multiple supervisors in the United States and abroad, and
participate extensively in large-value payment and settlement systems.^18
As of December 31, 2005, there were 21 LCBOs that together controlled 62
percent of all banking assets in the United States.
In issuing a revised rating system in 2004, the Federal Reserve
acknowledged that the firms it oversees had become even more concentrated
and complex. In addition, it noted that the growing depth and
sophistication of financial markets in the United States and around the
world have led to a wider range of activities being undertaken by banking
institutions.^19 This new rating system has components for the bank
holding company's risk management, financial condition, and potential
impact of the parent (and its nondepository subsidiaries) on the insured
depository institution, as well as a composite rating of the holding
company's managerial and financial condition and potential risk to its
depositories; the system also includes the supervisory ratings for the
subsidiary depository institution.
Generally policy changes for the consolidated supervision program are made
by the Board and implemented by the 12 District Banks which are
responsible for day-to-day examination activities of banks and bank
holding companies. However, the distinction between policy setting and
implementation blurs at the edges. Board staff may participate in exams
and District Bank officials serve on committees that provide input for
policy development and ensure that supervision is provided at some level
of consistency across District Banks.
The Federal Reserve requires that all bank holding companies with
consolidated assets of $500 million or more meet risk-based capital
requirements developed in accordance with the Basel Accord and has
proposed, with the other bank supervisors, revised capital adequacy rules
to implement Basel II for the largest bank holding companies.^20 In
addition, the Federal Reserve requires that all bank holding companies
serve as a source of financial and managerial strength to their subsidiary
banks.^21
18See Federal Reserve, SR 99-15 (June 23, 1999).
^19See 69 Fed. Reg. 43996-44007 (July 23, 2004) (proposed rules); 69 Fed.
Reg. 70444 (Dec. 6, 2004); see also, Federal Reserve, SR 04-18 (Dec. 6,
2004).
^20Bank holding companies with assets of less than $500 million also may
be required to comply with these consolidated capital requirements if they
are engaged in significant nonbank or off-balance sheet activities or if
they have a material amount of SEC-registered debt or securities
outstanding. See 12 CFR Part 225, App. C.
The Federal Reserve's supervisory cycle for LCBOs generally begins with
the development of a systematic risk-focused supervisory plan, follows
with the implementation of that plan, and ends with a rating of the firm.
The rating includes an assessment of holding companies' risk management
and controls; financial condition, including capital adequacy; and impact
on insured depositories. The Federal Reserve noted that in addition to its
other activities, it obtains financial information from LCBOs in a uniform
format through a variety of periodic regulatory reports that other holding
companies also provide. Table 3 provides detailed descriptions for each of
the steps.
Table 3: Federal Reserve's Supervisory Cycle for LCBOs
Supervisory plan The planning process begins with an overview of the
consolidated holding company that may include its
business strategy, organizational structure, and a
summary of supervisory activity performed since the
last review; proceeds through developing a critical
risk assessment; and ends with a supervisory plan
that determines the ongoing and targeted
supervisory activities for the year. The risk
assessment captures a preliminary analysis of
firms' consolidated risks, including credit,
market, liquidity, operational, legal, and
reputational risks that are inherent in firms'
activities and the controls firms use to manage
those risks. Board staff will review key elements
of the supervisory process.
Supervisory activities For LCBOs, a lead examiner called a central point
of contact and dedicated team members assigned as
coordinators for specific risk categories provide
continuous supervision, which consists of regular
ongoing contact with the relevant firm managers.
These teams, which include from 3 to 11 members,
also review internal management reports. For
limited scope examinations and targeted reviews, a
core team risk coordinator leads a team that
includes specialists from the District Bank, and
may have appropriate assistance from other District
Banks or the Board. Targeted reviews can focus on
particular nonbank subsidiaries of the holding
company, such as consumer lending affiliates; one
or more specific activities or business lines of
the consolidated organizations and the risk
management framework used by the holding company to
manage those risks on a consolidated basis, such as
market risk management for structured products; or
compliance with holding company policies and
procedures, and with applicable statutes and
regulations.
Rating Once a year, examiners rate firms on their risk
management and controls, financial condition, the
impact of the holding company and nondepository
subsidiaries on insured depositories, and on a
composite basis. The financial condition component
rating includes an assessment of the quality of the
holding company's consolidated capital, asset
quality, earnings, and liquidity. In evaluating
capital adequacy, examiners are required to
consider the risk inherent in an organization's
activities and the ability of capital to absorb
unanticipated losses. In addition, capital is
expected to provide a basis for growth and support
the level and composition of the parent company and
subsidiaries' debt.
Source: GAO.
For LCBOs, a management group, which consists of District Bank and Board
officials, provides additional review of supervisory plans and examination
findings. Annually, the management group chooses three or four topics for
horizontal exams--coordinated supervisory reviews of a specific activity,
business line, or risk management practice conducted across a group of
peer institutions. Horizontal reviews are designed to (1) identify the
range of practices in use in the industry, (2) evaluate the safety and
soundness of specific activities across business lines or across
systemically important institutions, (3) provide better insight into the
Federal Reserve's understanding of how a firm's operations compare with a
range of industry practices, and (4) consider revisions to the formulation
of supervisory policy. Horizontal examination topics have included
stress-testing practices at the holding company level and the banks
compliance with the privacy provision in GLBA.^22 Staff from more than one
District Bank likely participate in the review. In addition, because many
of the large bank holding companies have national banks, nonmember banks,
or nonbank operations overseen by another governmental agency, Federal
Reserve guidance instructs staff, consistent with the requirements of
GLBA, to leverage information and resources from OCC, FDIC, SEC, and other
agencies, as applicable.^23 After the examinations are completed, the
Federal Reserve informs firms generally on how they compare with their
peers and may provide information on good practices as well.
^2112 CFR 225.4(a).
The Federal Reserve has a range of formal and informal actions it can take
to enforce its regulations for holding companies. The agency's formal
enforcement powers are explicitly set forth in federal law.^24 Federal
Reserve officials noted that the law provides explicit authority for any
formal actions that may be warranted and incentives for firms to address
concerns promptly or through less formal enforcement actions, such as
corrective action resolutions adopted by the firm's board of directors or
memorandums of understanding (MOU) entered into with the relevant District
Bank. According to Federal Reserve officials, in 2006 the Federal Reserve
took six formal enforcement actions against holding companies.
^22See GLBA Title V, Privacy.
^23See Federal Reserve, SR 00-13 (Aug. 15, 2000).
^24The Federal Reserve's formal enforcement powers with respect to bank
holding companies and their nonbank subsidiaries are set forth at 12
U.S.C. S 1818(b)(3).
OTS Is Moving to a Broader, More Systematic Approach to Consolidated Risks for
Some of Its Largest, Most Complex Firms
In 2003, OTS revised its handbook for holding company supervision to
reflect new guidance for its large, complex firms or conglomerates that it
says relies on the international consensus (as evident in Joint Forum
publications) of what constitutes appropriate consolidated oversight of
conglomerates and also responds to the EU's FCD.^25 While the guidance is
presented in OTS's standard CORE--capital, organization, relationship, and
earnings--format, it differs from OTS's standard guidance in that it
focuses on consolidated risks, internal controls, and capital adequacy
rather than on a more narrow view of the holding company's impact on
subsidiary thrifts. As with the Federal Reserve, OTS headquarters
officials generally set nationwide policies and programs and regional
office staff conduct examinations. However, the Complex and International
Organizations group (CIO), which was established in 2004 in OTS
headquarters, both sets policy for holding company supervision of
conglomerates and oversees examiners for three firms that must meet the
FCD. CIO is developing a process that is similar in some respects to the
Federal Reserve's. First, on-site examination teams consisting of lead
examiners and others who focus on specific risk areas provide continuous
supervision. Second, while examiners for firms in the CIO group we spoke
with had not had a formal supervisory plan in past years, these examiners
are now preparing plans that focus on the coming year and, unlike the
Federal Reserve, take a longer 3-year prospective as well. A CIO official
said that this planning framework allows them to examine high-risk areas
on an annual basis while ensuring that lower risk areas are covered at
least every 3 years. The plans we reviewed were less detailed than those
of the Federal Reserve; however, the official in charge of this program
said that the group is looking to develop more systematic risk analyses
and has reviewed those being used by the Federal Reserve and their
counterparts in Europe.
Although OTS's guidance for its large, complex firms provides explicit
directions on determining capital adequacy, OTS does not have specific
capital requirements for holding companies. Generally, OTS requires that
firms hold a "prudential" level of capital on a consolidated basis to
support the risk profile of the holding company. For its most complex
firms, OTS requires a detailed capital calculation that includes an
assessment of capital adequacy on a groupwide basis and identification of
capital that might not be available to the holding company or its other
subsidiaries because it is required to be held by a specific entity for
regulatory purposes. The EU's European Financial Conglomerates Committee's
guidance to EU country supervisors on the U.S. regulatory system noted
OTS's lack of capital standards;^26 however, the United Kingdom's
Financial Services Authority (FSA) has designated OTS as an equivalent
supervisor for the two firms it has reviewed, and in February 2007, the
French supervisory body, Commission Bancaire, approved OTS as an
equivalent supervisor for another complex conglomerate.^27
25This guidance was initially issued in OTS Regulatory Bulletins 35, 32-31
(Nov. 20, 2003).
As noted, only three firms currently are subject to the increasingly
systematic, detailed analysis of risks being implemented through the CIO
program. Regional staff oversee other large, complex conglomerate thrift
holding companies and use OTS's standard CORE framework, which focuses
more directly on the risks to the thrift posed by its inclusion in the
holding company structure rather than an assessment of the risk management
strategy of the holding company (see table 4). We also found that OTS
regional examination staff were expanding their risk analyses of some
large, complex holding companies, but they had not adopted the CIO
program.
^26European Union, General guidance from the European Financial
Conglomerates Committee to EU Supervisors: the extent to which the
supervisory regime in the United States is likely to meet the objectives
of supplementary supervision in Directive 2002/87/EC and General guidance
from the Banking Advisory Committee to EU supervisors: the extent to which
the supervisory regime in the United States is likely to meet the
objectives of consolidated supervision in Chapter 3 of Directive
2000/12/EC (Brussels; July 6, 2004).
^27FSA has approved the Federal Reserve as providing equivalent holding
company supervision for 5 financial holding companies, and BaFin, the
German supervisory body has approved the Federal Reserve as the
consolidated supervisor of a sixth financial holding company. In addition,
FSA has determined that SEC provides equivalent consolidated supervision
for the five investment firms that have been approved as CSEs.
Table 4: OTS's Standard Core Framework
Capital: Examiners focus on the extent to which the holding company
depends on subsidiary thrifts to meet debt commitments and other expenses.
The handbook for holding company supervision defines the risks holding
companies may face but does not provide specifics for analyzing those
risks.
Organizational structure: Examiners review the structure of the thrift
holding company, the ownership/control of the holding company, and its
potential effect on the thrift. They also review the activities of the
holding company and other affiliates to determine whether the company is
doing anything illegal.
Relationship: To determine if the thrift has the ability to "stand alone"
in the event of the parent company's financial collapse, examiners assess
the degree of influence the holding company has over the thrift, whether
the board of directors provides adequate oversight of the thrift, and the
degree of managerial interdependence between the thrift and the holding
company.
Earnings: To determine the potential for the holding company to draw money
or collateral from the thrift, examiners assess the current and
prospective financial condition and the earnings and liquidity of the
holding company. Examiners are also to assess whether the thrift would
suffer operational or reputation risk if the holding company were to fail
due to poor financial condition.
Source: GAO.
Similar to the Federal Reserve, OTS has explicit authority to take
enforcement actions against thrift holding companies that are in violation
of laws and regulations.^28 According to OTS officials, in 2005 OTS took
three formal enforcement actions against holding companies.^29
SEC's CSE Program Is New and Evolving
In 2004, SEC adopted its CSE program partly in response to international
developments, including the need for some large U.S. securities firms to
meet the FCD. However, SEC says that the program is a natural extension of
activities that began as early as 1990 when, under the Market Reform Act,
SEC was given supervisory responsibilities aimed at assessing the safety
and soundness of securities activities at a consolidated or holding
company level.^30 Formally, SEC supervision under the CSE program consists
of four components: a review of firms' applications to be admitted to the
program; a review of monthly, quarterly, and annual filings; monthly
meetings with senior management at the holding company; and an examination
of books and records of the holding company, the broker-dealer, and
material affiliates that are not subject to supervision by a principal
regulator.^31
28See 12 U.S.C. SS 1467a(g), (i).
^29Our reporting of the numbers of formal enforcement actions by the
Federal Reserve and OTS does not imply an evaluation or comparison of the
enforcement activities by these agencies.
^30Pub. L. No. 101-432 S 4(a), 15 U.S.C. S 78q(h) (providing for, among
other things, SEC risk assessment of holding company systems).
Under the net capital rule establishing the CSE program, the Division of
Market Regulation has responsibility for administering the program.^32
Market Regulation recommends policy changes to SEC Commissioners and,
through its Office of Prudential Supervision, performs continuous
supervision of the five firms that have been designated as CSEs. Each firm
is overseen by three analysts, and each of these analysts oversees at
least two firms. This office includes a few additional specialists as
well. Although the rule did not specify a role for the Office of
Compliance Inspections and Examinations (OCIE), this office, with the
assistance of the Northeast Regional Office (NERO), examines firms'
controls and capital calculations.^33 Each of these offices has designated
staff positions for the CSE program but also uses staff from SEC's
broker-dealer examination program.
Market Regulation generally is responsible for overseeing the financial
and operational condition of CSEs, including how they manage their risks,
but does not provide written detailed guidance for examiners. During the
reviews of the firms' applications for admittance to the CSE program,
staff reviewed market, credit, liquidity, operational, and legal and
compliance risk management, as well as the internal audit function, and
continue to do so on an ongoing basis. The firms are to provide SEC with
monthly, quarterly, and annual filings, such as consolidated financial
statements and risk reports, substantially similar to those provided to
the firm's senior managers. Unlike the Federal Reserve and OTS that have
their examiners continuously on site at some of their larger more complex
firms, Market Regulation staff are not on site at the companies. However,
Market Regulation staff meet at least monthly with senior risk managers
and financial controllers at the holding company level to review this
material and share the written results of these meetings among themselves
and with the SEC Commissioners. These reports show that meetings with the
firms cover a variety of subjects, such as fluctuations in firmwide and
asset-specific value-at-risk, changes to risk models, and the impact of
recent trends and events such as Hurricane Katrina. Market Regulation
staff also review activities across firms to ensure that firms are all
held to comparable standards and that staff understand industry trends.
Market Regulation staff has conducted some horizontal reviews of
activities such as hedge fund derivative products and event-driven lending
that are similar in some ways to the Federal Reserve's horizontal
examinations. In addition, one staff member attends all monthly meetings
that Market Regulation staff hold with the firms in a given month. That
staff member identifies common themes and includes these in the monthly
reports.
^31Under the SEC regulation, entities that have a principal regulator
include certain functionally regulated affiliates of a holding company
that are not registered as a broker or dealer, such as insured depository
institutions, firms regulated by the Commodity Futures Trading Commission
or state insurance regulators, and certain foreign banks. See 69 Fed. Reg.
at 34431.
^3269 Fed. Reg. at 34450; see 17 C.F.R. SS 200.19a, 200.30-3.
^33According to senior staff at OCIE, NERO staff report to SEC's Division
of Enforcement and OCIE.
OCIE generally is responsible for testing the control environments of the
CSEs, focusing on compliance issues. OCIE and NERO staff followed detailed
examination guidance when reviewing CSE applications but, unlike the
Federal Reserve and OTS, this guidance is not publicly available. They
reviewed firms' compliance with the CSE rule, including whether
unregulated material affiliates were in compliance with certain rules that
had previously applied only to registered broker-dealers. OCIE and NERO
staff continue to conduct exams of the holding companies, the registered
broker-dealers, and unregulated material affiliates. During our review of
the program, NERO completed the first examination of one of the CSEs,
which included a review of the capital computations for the holding
company and broker-dealer, the firm's internal controls around managing
certain risks, and internal audit.
As a condition of CSE status, CSEs agree to compute a capital adequacy
measure at the holding company in accordance with the new Basel II
standards, and OCIE and NERO validated the firms' calculations as part of
their reviews of firms' CSE applications. The U.S. bank supervisory
agencies have proposed rules to implement Basel II standards for the
largest, most complex banking organizations, and SEC officials said they
will continue to monitor these developments and will adopt rules that are
largely consistent with the banking agencies' final rules implementing the
Basel II standards.^34 According to Market Regulation staff, CSEs' use of
the Basel II capital standards should allow for greater comparability
between CSEs' financial position and that of other securities firms and
banking institutions. As part of their supervisory activities, Market
Regulation staff review the models or other methodologies firms used to
calculate capital allowances for certain types of risks. While the CSEs'
broker-dealers are also required to compute capital according to Basel
standards, these broker-dealers are required to maintain certain capital
measures above minimum levels.^35 SEC staff also noted that CSEs are
required to have sufficient liquidity so that capital would be available
to any entity within the holding company if it were needed.
^34See 71 Fed. Reg. 55830 (Sept. 25, 2006) for the proposed rules.
Unlike the bank regulatory agencies, SEC does not have a range of
enforcement actions that it can take for violations of the CSE regulations
because participation in the CSE program is voluntary. That is, a
violation of the CSE regulations can disqualify a broker-dealer from the
benefits of CSE status without resulting in a violation of SEC regulations
or laws that could lead to an enforcement action. SEC staff noted,
however, that the prospect of not being qualified to operate as a CSE
served as an effective incentive for complying with CSE requirements.
Supervision of Complex Firms Involves Multiple Regulators
Large firms generally contain a number of subsidiaries that are overseen
by primary bank and functional supervisors in the United States as well as
by supervisors in other countries; however, in some cases, the holding
company's supervisor may also be the primary bank or functional supervisor
for subsidiaries in these holding companies. Figure 1 illustrates this
regulatory complexity for a hypothetical financial holding company. A
hypothetical thrift holding company and CSE would differ in that it would
not have national or state member bank subsidiaries and potentially could
have commercial subsidiaries. GLBA instructed the Federal Reserve, SEC,
and OTS, in their roles as consolidated supervisors, to generally rely on
primary bank and functional supervisors for information about regulated
subsidiaries of the holding company.^36
35Broker-dealers subject to CSE rules must maintain tentative net capital
of $1 billion and minimum net capital of $500 million where tentative net
capital is the net capital before deductions for market or credit risk.
These broker-dealers must notify SEC if tentative net capital falls below
$5 billion. 69 Fed. Reg. 34431.
^36See Pub. L. No. 106-102 S 111.
Figure 1: Supervisors for a Hypothetical Financial Holding Company
While the Federal Reserve is the primary federal bank supervisor for the
lead bank in some bank holding companies, OCC and FDIC are more often the
primary bank supervisor for the lead banks in these holding companies.
OCC, because of the growth in the national banking system over the past 10
years, is now most likely to be the supervisor of the lead banks that are
owned by bank holding companies in the Federal Reserves' LCBO program. In
examining these banks, OCC uses a systematic, risk-focused process similar
to that of the Federal Reserve. Specifically, OCC's process begins with a
risk analysis that drives the examination process over the course of the
examination cycle. According to OCC's handbook, in assessing the bank's
condition examiners must consider not only risks in the bank's own
activities but also risks of activities engaged in by nonbanking
subsidiaries and affiliates in the same holding company.^37 FDIC is the
primary federal supervisor of the lead bank in some larger bank holding
companies and of most of the banks in smaller holding companies.^38 In
addition, as part of its deposit insurance role, FDIC officials told us
that they have a continuous on-site presence at six of the largest LCBOs
where OCC is the primary bank supervisor of the lead bank and the Federal
Reserve is the consolidated supervisor. Larger bank holding companies also
include a number of other regulated subsidiaries, including broker-dealers
and thrifts.
Except when a thrift is in a bank holding company, OTS serves as the
supervisor for both the thrift and the thrift holding company.^39 While
most of these firms are in the business of banking, as table 5 shows, OTS
also oversees a number of complex holding companies that are primarily in
businesses other than banking, and some of these are in regulated
industries, especially insurance. In addition, a number of thrift holding
companies contain industrial loan companies (ILC), state-chartered
institutions overseen by FDIC, and some have broker-dealers as well.^40
37Under the National Bank Act, national banks are to provide OCC with
periodic reports to disclose fully the relations between the bank and any
each of its affiliates, other than member banks, necessary for OCC to be
informed of the effect of the relations upon the bank. 12 U.S.C. S 161(c).
Federal banking law also provides national bank examiners with authority
to examine all of the affairs of national bank affiliates, other than
member banks, as is necessary to disclose fully the relations between the
bank and the affiliates and the effect of such relations upon the affairs
of the bank. 12 U.S.C. S 481.
^38FDIC examiners may examine the affairs of any affiliate of a depository
institution as may be necessary to disclose fully the relationship between
the institution and any such affiliate and the effect of the relationship
on the institution. 12 U.S.C. S 1820(b)(4); see also 12 U.S.C. S 1831v(b).
^39Bank holding companies with thrift subsidiaries are not subject to
regulation as a savings and loan holding company. See, e.g., 12 U.S.C. S
1467a(a)(1)(D)(ii), 1467a(t).
^40For a discussion of FDIC's supervision of ILCs, see [50]GAO-05-621 .
Table 5: Thrift Holding Company Enterprises by Category, Complexity, Size,
and Primary Business, as of December 31, 2006
Primary business
Holding companies:
category,
complexity, and Other
size Banking Insurance Securities financial Commercial Total
Category I-low
risk/noncomplex
Assets less that 1 296 6 2 11 4 319
billion
Assets between 1 47 5 2 3 1 58
billion and 5
billion
Assets greater 11 9 0 2 1 23
than 5 billion
Category II-high
risk/complex
Assets less that 1 12 1 0 5 1 19
billion
Assets between 1 9 3 2 5 1 20
billion and 5
billion
Assets greater 7 12 5 5 4 33
than 5 billion
Category
III-conglomerate
Assets less that 1 0 0 0 0 0 0
billion
Assets between 1 0 0 0 0 0 0
billion and 5
billion
Assets greater 0 1 2 0 1 4
than 5 billion
Total 382 37 13 31 13 476
Source: OTS.
Note: These data include 34 holding companies that own state savings banks
where FDIC is the primary federal bank supervisor.
OTS oversees a large number of firms where insurance is the primary
business of the firm and thus shares some responsibilities with state
insurance supervisors that have adopted their own holding company
framework. In addition, OTS and FDIC share responsibilities when thrift
holding companies include ILCs. Generally, OTS guidance refers to
protecting thrifts in thrift holding companies rather than more broadly to
the protection of insured depositories. However, thrifts and ILCs in the
same thrift holding company may face similar threats to their safety and
soundness.
As the consolidated supervisor of CSEs, SEC oversees large, complex
entities that include insured depositories that have FDIC or OTS as their
primary federal supervisor. Those CSEs that have thrifts are also
supervised at the consolidated level by OTS. SEC's consolidated
supervisory activities focus on the financial and operational condition of
the holding company and, in particular, activities conducted in
unregulated material affiliates that may pose risks to the group. SEC
staff noted that they generally rely on the primary bank supervisor with
respect to examination of insured depositories.^41
Federal Reserve and OTS Use Abbreviated Approach for Smaller or Less Complex
Holding Companies
In recent years, the Federal Reserve has limited the resources it uses to
oversee the 4,325 small shell bank holding companies (i.e., companies that
are noncomplex with assets of less than $1 billion) because it perceives
that those entities pose few risks to the insured depositories they
own.^42 The Board has adopted a special supervisory program for these
companies that includes off-site monitoring and relies heavily on primary
federal supervisors' bank examinations. For these companies, the Federal
Reserve assigns only risk and composite ratings, which generally derive
from primary bank supervisors' examinations. Also, in addition to the
primary bank supervisors' examinations, Federal Reserve examiners review a
set of computer surveillance screens that include the small shells'
financial information and performance, primarily to determine if the firms
need more in-depth reviews.
Federal Reserve staff told us that they spend a limited amount of time on
small shell holding company inspections. For example, a Board official
said they spend on average about 2 to 2.5 hours annually on each small
shell bank holding company. According to Federal Reserve guidance, the
only documentation required for small shell ratings where no material
outstanding company or consolidated issues are otherwise indicated are
bank examination reports and a copy of the letter transmitting the ratings
to the company.
Similarly, OTS uses an abbreviated version of its CORE program for its
low-risk and noncomplex or Category I firms, which make up 401 of the 476
holding companies OTS oversees. Once examiners determine that the holding
company is a shell, they are directed to the abbreviated program, which
differs from the full CORE in that it requires less detailed information
in each of the four CORE areas. For example, the abbreviated CORE does not
require that examiners calculate leverage and debt-to-total-asset ratios
in the capital component of the examination, while these are required in
the full CORE program. However, the handbook advises examiners to refer to
the full CORE program for more detailed steps whenever they feel it is
warranted. In addition, the handbook advises examiners to consider the
specific issues that relate to certain holding company populations, such
as those containing insurance firms. At one regional office, managers told
us that examinations of shell holding companies take 5 to 10 days;
however, because the holding company examination is conducted concurrently
with the thrift examination, OTS cannot determine the exact number of
hours spent reviewing the holding company. An OTS official noted that for
shell holding companies, the difference in examiners' activities between
holding company and thrift examinations is largely a matter of perspective
rather than a difference in what examiners review.
^41Under the CSE regulations, banks are among the entities SEC considers
to have a principal regulator. 69 Fed. Reg. at 34431.
^42In determining whether a small holding company is noncomplex and
eligible for this program, the Federal Reserve considers, among other
things, the size and structure of the holding company, the extent of
intercompany transactions between insured depository subsidiaries and the
holding company or nonbank affiliates, the nature and scale of any nonbank
activities, whether risk management processes are consolidated, and
whether the holding company has material debt outstanding. See Federal
Reserve SR 02-01(Jan. 9, 2002).
Improved Program Objectives and Performance Measures Could Enhance Agencies'
Consolidated Supervision Programs
In recent decades, the environment in which the financial services
industry operates, and the industry itself, have undergone dramatic
changes that include globalization, consolidation within traditional
sectors, conglomeration across sectors, and convergence of institutional
roles and products. The industry now is dominated by a relatively small
number of large, complex, and diversified financial services firms, and
these firms generally manage their risks on an enterprisewide or
consolidated basis. Consolidated supervision provides the basis for
supervisory oversight of this risk management, but managing consolidated
supervision programs in an efficient and effective manner presents
challenges to the supervisory agencies. We found that the Federal Reserve,
OTS, and SEC were providing supervision consistent with international
standards for comprehensive, consolidated supervision for many of the
largest, most complex financial services firms in the United States. While
the agencies have articulated anticipated benefits or broad strategic
goals for their supervision programs in testimony and other documents, the
objectives for their consolidated supervision programs are not always
clearly defined or distinguished from the objectives for their primary
supervision programs. Without more specific program objectives, activities
linked to these objectives, and performance measures identified to assess
the extent to which these objectives are achieved, the agencies have a
more difficult task of ensuring efficient and effective oversight. In
particular, with the financial services industry's increased concentration
and convergence in product offerings, paired with a regulatory structure
that includes multiple agencies, it is more difficult to ensure that the
agencies are providing oversight that is not duplicative and is consistent
with that provided by primary, functional, or other consolidated
supervisors. As a result, the agencies could better ensure that
consolidated supervision was being provided efficiently, with the minimal
regulatory burden consistent with maintaining safety and soundness, by
more clearly articulating the objectives of their consolidated supervision
programs, developing and tracking performance measures that are specific
to the programs, and improving supervisory guidance.
Developments in the Financial Services Industry Have Affected the Environment
Facing Financial Supervisors
The environment in which the financial services industry operates, and the
industry itself, have undergone dramatic changes.^43 Financial services
firms have greater capacity and increased regulatory freedom to cross
state and national borders, and technological advances have also lessened
the importance of geography. Increasingly, the industry is dominated by a
relatively small number of large, complex conglomerates that operate in
more than one of the traditional sectors of the industry. These
conglomerates generally manage their risks on an enterprisewide, or
consolidated, basis.
Generally, the greater ability of firms to diversify into new geographic
and product markets would be expected to reduce risk, with new products
and risk management strategies providing new tools to manage risk. Because
of linkages between markets, products, and the way risks interact,
however, the net result of the changes on an individual institution or the
financial system cannot be definitively predicted.
Consolidated supervision provides a basis for the supervisory agencies to
oversee the way in which financial services firms manage risks and to do
so on the same basis that many firms' manage their risk. While primary
bank and functional supervisors retain responsibility for the supervision
of regulated banks, broker-dealers, or other entities, the consolidated
supervisor's approach can encompass a broader, more comprehensive
assessment of risks and risk management at the consolidated level.
^43See [51]GAO-05-61 for a further discussion of these developments.
Agencies Are Providing Comprehensive Consolidated Supervision for Many
Conglomerates with Depository Institutions
The international consensus on standards or "best practices" for
supervising conglomerates that include banks includes the review of risks
and controls at the consolidated level, capital requirements at the
consolidated level, and the authority to take enforcement actions against
the holding company. As described above, we found that the Federal Reserve
generally met these standards for its LCBO firms. OTS meets these
standards for those firms overseen by CIO. For other firms that might be
considered conglomerates, OTS does a more limited review of the risk posed
to insured thrifts by activities outside the thrift and does not require
that holding companies meet specific capital standards. Officials at both
the Federal Reserve and OTS emphasized that the agencies' authority to
examine, obtain reports from, establish capital requirements for, and take
enforcement actions against the holding company was separate from the
authority that primary bank supervisors have.
A full assessment of SEC's CSE program is difficult given the newness of
the program; however, it appears that for the CSE firms dominated by
broker-dealers, SEC is monitoring risks and controls on a consolidated
basis and requires that CSEs meet risk-based capital standards at the
holding company level. However, with regard to SEC's ability to take
enforcement actions at the holding company level. SEC staff acknowledged
that SEC does not have the same ability, under the CSE program, to take
enforcement actions as the Federal Reserve or OTS. Nonetheless, they noted
that the potential removal of a firm's exemption from the net capital rule
and notification of EU regulators that a firm was no longer operating
under the CSE program would serve as effective deterrents. SEC is also
authorized to impose additional supervisory conditions or increase certain
multiplication factors used by the CSE in its capital computation.
Clear Program Objectives and Performance Measures Are Essential for Ensuring
Accountability and Efficiency
Management literature on internal controls, enterprisewide risk
management, and government accountability suggest that to achieve
accountability and efficiency requires that agencies clearly state program
objectives, link their activities to those objectives, and measure
performance relative to those objectives.^44 This literature also
recognizes the increased importance of these management activities in the
face of substantial change in the external environment or in the face of
the adoption of new "products" internally. When applied to the
consolidated supervision programs at the Federal Reserve, OTS, and SEC,
clearly defined objectives of consolidated supervision programs, agency
activities of these programs linked to those objectives, and performance
measures to determine how well the programs are operating are the
management approaches that would contribute to the desired accountability
and efficiency for the programs.
The importance of these management activities is heightened because all
three agencies face substantial changes in the external environment,
including rapid growth in the financial sector, greater consolidation of
firms leading to larger, more complex firms, and greater linkages among
financial sectors and markets. In addition, the Federal Reserve and OTS
have made substantial changes in their consolidated supervisory
programs--particularly with the CIO program at OTS--and SEC has adopted a
program that for the first time has staff providing formal prudential
oversight at the consolidated level. Adopting sound management and control
activities will help ensure that agencies are accountable for exercising
the authority for their consolidated supervision programs and achieving
the objectives of consolidated supervision, in ways that are effective and
efficient. As a result, the regulatory burden would be as low as possible,
consistent with maintaining safety and soundness of financial institutions
and markets.
^44See GAO, Internal Control: Standards for Internal Control in the
Federal Government, [52]GAO/AIMD-00-21 .3.1 (Washington, D.C.: November
1999); and Internal Control Standards: Internal Control Management and
Evaluation Tool, [53]GAO-01-1008G (Washington, D.C.: August 2001). These
standards reflect updates in private sector internal control guidance,
including the issuance of Internal Control--Integrated Framework by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Also see COSO, Enterprise Risk Management--Integrated Framework (September
2004). For the importance of objectives and performance measures in
determining accountability and efficiency, see, for example, GAO,
Results-Oriented Government: GPRA Has Established a Solid Foundation for
Achieving Greater Results, [54]GAO-04-38 (Washington, D.C.: Mar. 10,
2004).
The agencies face challenges in devising performance measures for
consolidated supervision, including rapid changes in the industry. U.S.
financial institutions and their competitors increasingly operate
worldwide and engage in a number of businesses. Consequently, the global
financial system is highly integrated and ensuring financial stability is
even more important than in the past. Developing sound measures in such an
environment can be difficult, and it is a challenge for agencies to
distinguish how much of their work contributes to financial stability, in
contrast to other goals such as protecting insured depositories. Further,
these objectives are concepts that are not easy to measure. Development
and use of appropriate performance measures, however, are critical to
efficiently managing the risks that the agencies have in their
consolidated supervision programs.
Goals and Performance Measures Address Supervision Broadly, Rather Than
Consolidated Supervisory Programs Specifically
Generally we found that the three agencies stated goals for all of their
supervision programs broadly or that specific objectives for consolidated
supervision were the same as those for their primary supervision programs.
As a result, the contributions consolidated supervision programs make to
the safety and soundness of financial institutions and markets could not
be assessed separately from other agency programs. Clearer objectives
specific to the consolidated supervision programs would facilitate linking
program activities to those objectives and the authority that the agencies
have to conduct consolidated supervision. In addition, clear program
objectives would facilitate the development of specific performance
measures to measure the contribution of these programs to those objectives
as well as broader agency goals.
Federal Reserve
Agencies' strategic and performance plans sometimes contain objectives for
important programs. In its strategic plan, the Federal Reserve identifies
objectives for all of its supervision programs: promoting a safe, sound,
competitive, and accessible banking system and stable financial markets.
However, the only discussion specific to consolidated supervision in the
Federal Reserve's strategic plan relates to how the program complements
its central bank functions by providing the Federal Reserve with important
knowledge, expertise, relationships, and authority.
In other statements, Federal Reserve officials have identified a number of
potential benefits of consolidated supervision that reflect the changed
environment. The then-Chairman of the Federal Reserve Board testified
before Congress in 1997 that the knowledge of the financial strength and
risk inherent in a consolidated holding company can be critical to
protecting an insured subsidiary bank and resolving problems once they
arise.^45 In 2006, he noted further that consolidated supervision provides
a number of benefits, including protection for insured banks within
holding companies, protection for the federal safety net^46 that supports
those banks, aiding the detection and prevention of financial crises, and,
thus, mitigating the potential for systemic risk in the financial
system.^47 In congressional testimony delivered in 2006, a Board official
noted that the goals of consolidated supervision are to understand the
financial and managerial strengths and risks within the consolidated
organization as a whole and to give the Federal Reserve the ability to
address significant deficiencies before they pose a danger to the
organization's insured banks and the federal safety net. An official at
the New York District Bank identified the goals of consolidated
supervision as protecting the safety and soundness of depository
institutions in the holding company, promoting the health of the holding
company itself, and mitigating systemic risk.
In its Bank Holding Company Supervision Manual, the Federal Reserve says
that the inspection process is intended to increase the flow of
information to the Federal Reserve System concerning the soundness of
financial and bank holding companies. The manual goes on to explain how
the purpose of bank holding company supervision has evolved since the
passage of the Bank Holding Company Act in 1956, whose primary objective
was to ensure that bank holding companies did not become engaged in
nonfinancial activities. According to the manual, an inspection is to be
conducted to
1. inform the Board of the nature of the operations and financial
condition of each bank holding company and its subsidiaries,
including--
a. the financial and operational risks within the
holding company system that may pose a threat to the
safety and soundness of any depository institution
subsidiary of such bank holding company, and
b. the systems for monitoring and controlling such
financial and operational risks; and
2. monitor compliance by any entity with the provisions of the
Bank Holding Company Act or any other federal law that the Board
has specific jurisdiction to enforce against the entity, and to
monitor compliance with any provisions of federal law governing
transactions and relationships between any depository institution
subsidiary of a bank holding company and its affiliates.
^45Statement of Alan Greenspan, Chairman, Board of Governors of the
Federal Reserve System before the Committee on Banking and Financial
Services, U.S. House of Representatives (May 22, 1997). Statement of Alan
Greenspan, Chairman, Board of Governors of the Federal Reserve System
before the Subcommittee on Finance and Hazardous Materials of the
Committee on Commerce, U.S. House of Representative (July 17, 1997).
^46The federal safety net includes the federal deposit insurance fund, the
payments system, and the Federal Reserve's discount window.
^47Letter from Alan Greenspan, Chairman, Board of Governors of the Federal
Reserve System to the Honorable James A. Leach, U.S. House of
Representatives (Jan. 20, 2006).
The Federal Reserve also noted that the objectives of consolidated
supervision are discussed in its supervisory guidance on the Framework for
Financial Holding Company supervision introduced after GLBA.^48 In the
guidance, the Federal Reserve says that the objective of overseeing
financial holding companies (particularly those engaged in a broad range
of financial activities) is to evaluate, on a consolidated or groupwide
basis, the significant risks that exist in a diversified holding company
in order to assess how these risks might affect the safety and soundness
of depository institution subsidiaries.
The Federal Reserve has also developed a quality management program to
evaluate its supervision programs overall. Board officials told us that
each of the District Banks has established a quality management department
that include quality planning, control, and improvement. As part of its
quality management program, the Board evaluates and reports on District
Banks' supervision function in its operations reviews across the major
supervision and support functions. According to a Board document, each
review assesses how well the Reserve Bank carries out its supervisory
responsibilities, focusing not only on the effectiveness and efficiency of
individual functional areas but also on how well the Officer in Charge of
Supervision organizes and allocates departmental resources, and
facilitates integration among those resources. However, in the three
operations review reports we reviewed, the performance of consolidated
supervisory activities was not assessed independently from the performance
of other supervisory activities.
^48See Federal Reserve, SR 00-13 (Aug. 15, 2000).
Not clearly establishing specific objectives for the consolidated
supervision, however, potentially lessens the Federal Reserve's ability to
ensure that its consolidated supervision program provides comprehensive
and consistent oversight with minimal regulatory burden. The Federal
Reserve has authority for holding company supervision distinct from that
for supervision of the insured depository itself. Specific objectives and
performance measures would enhance the Federal Reserve's ability to ensure
its accountability and the efficiency of its consolidated supervisory
activities.
OTS
OTS consistently identifies the protection of insured depositories as the
objective of consolidated supervision. However, like the Federal Reserve,
OTS generally does not distinguish between the objectives for holding
company supervision and those for primary thrift supervision. In addition,
OTS's activities often vary significantly across firms, depending in part
on the risk and complexity of the firms. While the varying activities
largely reflect the differences among the institutions, a clear link
between these activities and the objectives of its consolidated
supervision program would enhance OTS's ability to provide effective and
consistent oversight with minimal regulatory burden.
OTS identifies several strategic goals in its strategic plan, placing
particular emphasis on achieving a safe and sound thrift industry, and its
Holding Companies Handbook identifies protection of insured thrifts as an
objective of holding company supervision; however, these documents
distinguish the objectives of the holding company supervision program from
those of primary thrift supervision in only one area. The strategic plan
says that one objective of OTS's cross-border discussions is to receive
additional equivalency determinations under EU directives, including the
FCD, and its handbook focuses on international standards in its discussion
of changes in its conglomerate oversight. In its strategic plan, OTS has
five performance measures for supervision, including the percentage of
thrifts that are well-capitalized and the percentage of safety and
soundness examinations started as scheduled, but these largely relate
directly to OTS's authority as a primary bank supervisor rather than as a
holding company supervisor.
Because OTS is almost always both the lead bank supervisor and the holding
company supervisor for the holding companies it supervises, accountability
for its supervision of thrift institutions is clear. However, for those
thrift holding companies whose primary business activities are not
banking, accountability for parts of the institution may still not be
clear. Further, whether an agency is providing consistent and efficient
oversight with minimal regulatory burden for all firms is still at issue.
For firms overseen by CIO, OTS devotes substantial resources to the
oversight of risk and controls consolidated at the highest financial
holding company level, and assesses capital at that level. However, for
some other firms that had some similar characteristics to the
CIO-supervised conglomerates, OTS uses relatively fewer resources in the
oversight of these firms at the holding company level. For these firms,
consistent with its standard CORE program, OTS looks to see that the
holding company is not relying on the thrift to pay off debt or expenses
and then limits its oversight to that part of the firm that might directly
place the thrift at risk.
SEC
Similarly, SEC identifies a number of objectives and performance measures
for the agency in its strategic plan, annual performance reports, and
annual budget documents. However, none of these is specific to the
consolidated supervision program. Instead, these documents provide goals
and performance measures for other areas such as enforcement. Enforcing
compliance with federal securities laws is one of SEC's strategic goals,
and it measures performance in that area by reporting the number of
enforcement cases successfully resolved in its 2005 Performance and
Accountability Report. The only mention of the new CSE program in these
documents is a listing as a "milestone" for Market Regulation in SEC's
2004 Performance and Accountability Report. SEC 2006 and 2007 budget
requests note that OCIE will examine CSEs under the strategic goal of
enforcing compliance with federal securities laws. The 2006 budget request
also includes the need to modify and interpret the rules for CSEs to
maintain consistency with the Basel Standards, in light of amendments to
the Basel Capital Accord, to meet the goal of sustaining an effective and
flexible regulatory environment.
On the Web site created by Market Regulation in June 2006, SEC says that
the aim of the CSE program is to reduce the likelihood that weakness in
the holding company or an unregulated affiliate endangers a regulated
entity or the broader financial system. In addition, SEC officials have
said that the purpose of the program was to provide consolidated oversight
for firms required to meet the EU's FCD. However, CSE oversight activities
are not always linked to these aims and the extent to which these
activities contribute to the aims is not measured.
SEC officials have told us they have developed a draft that would
establish program objectives, link activities to these objectives, and
establish criteria for assessing the performance of the CSE program.
Agencies Have Opportunities to Better Ensure Effective and Consistent
Supervision, with Minimal Regulatory Burden
Because the U.S. regulatory structure assigns responsibility for financial
supervision to multiple agencies, and a single firm may be subject to
consolidated and primary or functional supervision by different agencies,
not having objectives and performance measures for consolidated
supervision programs increases the difficulty of ensuring effective,
efficient, and consistent supervision with minimal regulatory burden and
ensuring that each agency is appropriately accountable for its
activities.^49
The potential for duplication was demonstrated in three financial holding
companies where we discussed Federal Reserve oversight with Federal
Reserve and OCC examiners and with bank officials. Based on our interviews
with OCC examiners, we noted some duplication in Federal Reserve and OCC
activities, despite efforts to coordinate supervision by the two agencies.
In particular, since these institutions manage some risks on an
enterprisewide basis, OCC needed to assess consolidated risk management or
other activities outside the national bank to assess the banks' risks.
Some OCC officials said that the consolidated supervisor structure created
by GLBA was primarily designed for bank holding companies with insurance
subsidiaries, but this structure is not prevalent. The primary value of
consolidated supervision, they said, is to prevent gaps in supervision,
but the benefit for firms that hold primarily bank assets is unclear.
Federal Reserve officials, on the other hand, noted that because OCC is a
bank supervisor, and not a consolidated supervisor, it does not have the
same authority as the Federal Reserve to conduct examinations of, obtain
reports from, establish capital requirements for, or take enforcement
action against a bank holding company or its nonbank subsidiaries. With
more clearly articulated objectives for consolidated supervision that
distinguish this authority from the primary supervisor's authority,
linking consolidated supervisory activities to those goals and measuring
performance would clarify accountability and facilitate greater reliance
by each agency on the other's work, lessening regulatory burden.
^49We have previously identified these features as characteristics of
effective bank supervision. GAO, Bank Oversight: Fundamental Principles
for Modernizing the U.S. Structure, [55]GAO/T-GGD-96-117 (Washington,
D.C.: May 2, 1996); and Bank Oversight Structure: U.S. and Foreign
Experience May Offer Lessons for Modernizing U.S. Structure, GAO/GGD-97-23
(Washington, D.C.: Nov. 20, 1996).
According to officials of the Federal Reserve Board, it takes a number of
actions to ensure that the large banking organizations they oversee are
treated similarly in its consolidated supervision program. These include a
review of LCBO supervisory plans and other elements of the supervisory
process as well as some centralized staffing. However, we found that
because of the autonomy of the District banks and the lack of detailed
guidance, the four District Banks in our study differed in the ways they
identified examination or supervisory findings, prioritized them, and
communicated these findings to firm management.
For example, the Federal Reserve Bank of Atlanta more clearly defines
different types of findings, provides criteria to examiners for
determining and prioritizing findings, and uses this framework to
communicate findings to firm management. At some other District Banks we
visited, examiners did not provide us with explicit criteria for
determining and prioritizing findings. As a result, it is more difficult
to ensure that bank holding companies operating in different Federal
Reserve districts are subject to consistent oversight and receive
consistent supervisory feedback and guidance. To mitigate this potential
for inconsistency, as we noted above, for large, complex institutions,
committees such as the LCBO management group review supervisory findings.
In addition, a Board official said that the Federal Reserve was
considering implementing Atlanta's framework across the system. Without
objectives and performance measures specific to the consolidated
supervision program, however, the Federal Reserve is less able to gauge
the value of the Federal Reserve Bank of Atlanta's more specific guidance
to its examination staff.
In part, because OTS oversees a diverse set of firms and has been changing
some of its consolidated supervisory activities, consistency is a
difficult challenge. An OTS official told us that OTS created the CIO in
its headquarters to promote more systematic and consistent supervision for
certain holding companies. In addition, OTS has issued guidance to help
standardize policies and procedures related to providing continuous
supervision. However, the criteria are not clear for determining whether a
firm is overseen by CIO with continuous comprehensive consolidated
supervision or remains in the regional group where it receives more
limited oversight under the CORE program. In a speech in November 2006,
OTS's Director identified seven internationally active conglomerates OTS
oversees at the holding company level.^50 Of these, three are overseen by
CIO, one receives oversight under the standard CORE program, and two
others are overseen regionally but are receiving greater scrutiny than in
the past. The three firms receiving comprehensive consolidated oversight
by CIO are the firms that have designated OTS as their consolidated
supervisor for meeting the EU equivalency requirements, while three of the
others have opted to become CSEs.
^50OTS, Remarks of John M. Reich, Director, Special Seminar on
International Banking and Finance (Tokyo, Japan; Nov. 15, 2006).
While the small size of SEC's CSE program limits opportunities for
treating firms differently, the lack of more complete written guidance and
the decision to keep guidance confidential limit the ability of industry
participants, analysts, and policymakers to determine whether firms are
being treated consistently. In addition, Market Regulation staff said that
more complete written guidance would reduce the risks of inconsistency
should staff turnover occur. We also found that SEC's lack of program
objectives, performance measures, and written public guidance led to
firms' receiving inconsistent feedback from SEC's divisions and offices.
According to the CSEs and application examinations we reviewed, OCIE
conducted highly detailed audits that resulted in many findings related to
the firms' documentation of compliance with rules and requirements, while
Market Regulation looked broadly at the risk management of the firm. OCIE
shared its findings with the firms, but Market Regulation determined that
many of them did not meet its criteria for materiality and did not include
them in its summary memorandums to the SEC Commissioners recommending
approval of the applications. However, either a full or summary OCIE
examination report was included as an appendix to these memorandums.
Market Regulation staff said they drew on their own knowledge in deciding
which findings were material and explained that a finding is material when
the issue threatens the viability of the holding company. Further, Market
Regulation staff told us that because they rely on managements' openness
in their ongoing reviews of CSE's risk management, they do not always
share supervisory results with OCIE staff. Market Regulation and OCIE
staff stated that they are working on an agreement to facilitate
communication between the offices.
Finally, even if each agency provided consistent treatment and feedback to
firms, there would be no assurance that consistent consolidated
supervision would be provided across the agencies. We have noted before
that, over time, firms in different sectors increasingly face similar
risks and compete to meet similar customer needs.^51 Thus, competitive
imbalances could be created by different regulatory regimes, including
holding company supervision, both here and abroad.
^51 [56]GAO-05-61 .
Systematic Collaboration Could Enhance Consolidated Supervision Programs
Providing consistent efficient, effective oversight of individual
financial institutions has become more difficult as institutions
increasingly manage their more complex operations on an enterprisewide
basis, often under the oversight of multiple federal financial
supervisors. And providing efficient and effective oversight across the
financial sector has become more challenging as institutions in different
sectors and countries increasingly take on similar risks that may pose
issues for a broad swath of the developed world's financial institutions
in a crisis.
The industry's increased concentration and convergence in product
offerings, paired with a regulatory structure with multiple agencies,
means that different large financial services firms, offering similar
products, may be subject to supervision by different agencies. This leads
to risks that the agencies may provide inconsistent supervision and
regulation not warranted by differences in the regulated institutions.
Supervisors in different agencies engaged in the oversight of a single
institution take some steps to share information, avoid duplication, and
jointly conduct some examination activities. However, these agencies did
not consistently and systematically collaborate in these efforts, thus
limiting the efficiency and effectiveness of consolidated supervision. For
the three agencies engaged in consolidated supervision, changes in the
firms they oversee have led to the firms facing similar risks and
competing with each other across industry segments. As a result, it is
essential for consolidated supervisors to systematically collaborate so
that competitive imbalances are not created.
Systematic Collaboration Is Essential for Multiple Agencies Sharing Common
Responsibilities
In a system that is characterized by multiple supervisory agencies
providing supervision for a single holding company and its subsidiaries as
well as several agencies providing consolidated supervision for firms that
provide similar services, collaboration among the supervisory agencies is
essential for ensuring that the supervision is effective, efficient, and
consistent.
Through a review of government programs and the literature on effective
collaboration, we have identified some key collaborative elements, which
are listed in table 6.^52 These elements stress the need to ensure, to the
extent possible, that the agencies are working toward a common goal, that
they minimize resources expended by leveraging resources and establishing
compatible policies and procedures, and that they establish accountability
for various aspects of these programs and for their efforts to
collaborate.
Table 6: Key Elements of Collaboration
Key elements of collaboration Description
Define and articulate a common Agency staff must commit and devote
outcome resources to working across agency lines
to define and articulate the common
outcome they are seeking to achieve.
Establish mutually reinforcing Agencies need to align the partner
or joint strategies agencies' activities, core processes, and
resources to accomplish the common
outcome.
Identify and address needs by Agencies should identify and leverage the
leveraging resources human, information technology, physical,
and financial resources needed to
initiate or sustain their collaborative
effort.
Agree on roles and Agencies should define and agree on their
responsibilities respective roles and responsibilities,
including how to organize their joint and
individual efforts.
Establish compatible policies, Agencies need to address the
procedures, and other means to compatibility of standards, policies,
operate across agency boundaries procedures, and data systems that will be
used, as well as cultural differences.
Develop mechanisms to monitor, Agencies should create the means to
evaluate, and report on results monitor and evaluate their efforts to
enable them to identify areas for
improvement.
Reinforce accountability for Agencies should ensure that goals are
collaborative efforts through consistent and program efforts are
agency plans and reports mutually reinforcing. Accountability for
collaboration is reinforced through
public reporting of agency results.
Reinforce individual As a first step in reinforcing individual
accountability for collaborative accountability for collaborative efforts,
efforts through performance agencies set expectations for
management systems collaboration within and across
organizational boundaries in staff
performance plans.
Source: GAO.
We have noted in our previous work that running throughout these elements
are a number of factors, including leadership, trust, and organizational
culture, that are necessary for a collaborative working relationship. We
have also noted that agencies may encounter a range of barriers when they
attempt to collaborate, including missions that are not mutually
reinforcing, or may conflict, and agencies' concerns about protecting
jurisdiction over missions and control over resources.
^52 [57]GAO-06-15 .
As we have noted in the past, the U.S. financial regulatory agencies meet
in a number of venues to improve coordination.^53 These venues include the
President's Working Group, the Federal Financial Institutions Examination
Council, and the Financial and Banking Information Infrastructure
Committee. In addition, the agencies told us they have frequent informal
contact with each other. These contacts address several of the key
elements of collaboration identified above, but opportunities remain to
enhance collaboration in response to the changes in the financial services
industry. These opportunities exist both for agencies that could
collaborate in oversight of individual firms where agencies share
supervisory responsibility as well as for collaboration among the
consolidated supervisors to ensure consistent approaches to common risks.
In the Oversight of Individual Firms, Supervisors from Different Agencies Take
Steps to Work Together but Could Collaborate More Systematically
Enterprisewide risk management in large financial firms has complicated
the task of regulating them, since agency jurisdiction is defined by legal
entities. When an agency oversees both the ultimate holding company and
its major bank or broker-dealer subsidiary, examination activities tend to
be well-integrated. When consolidated and primary bank or functional
supervisors of a firm's major subsidiaries are from different agencies,
they take some actions to work together and share information. However, we
found instances of duplication and regulatory gaps that could be minimized
through more systematic collaboration.
Moving to Enterprisewide Management and Other Organizational Changes Increases
the Potential for Several Agencies to Share Responsibilities
Large, complex firms are increasingly managing themselves on an
enterprisewide basis, further blurring the distinctions between regulated
subsidiaries and their holding companies. Many of the banking and
securities firms included in our review were managing by business lines
that cut across legal entities, especially those institutions engaged
primarily in banking or securities. At least three of the companies in our
review primarily engaged in banking were simplifying their corporate
structures, either by reducing the number of bank charters or bringing
activities that had been outside an insured depository into the depository
or its subsidiaries. Some of these entities had been unregulated by a
primary federal bank or functional supervisor and thus had been the
primary responsibility of the holding company supervisor or were regulated
by a primary bank supervisor different from the supervisor overseeing the
lead bank. Finally, we found that several firms that are CSEs, thrift
holding companies, or both were conducting extensive banking operations
out of a structure that includes an ILC and a thrift and that these
entities, which are overseen by different primary bank supervisors, might
not be receiving similar oversight from a holding company perspective.
^53 [58]GAO-05-61 .
As a result of changes in corporate structures and management practices,
there are increasing opportunities for collaboration among supervisors
with safety and soundness objectives at the subsidiary level and holding
company supervisors. For example, primary bank and functional supervisors
involved in safety and soundness supervision need to review the
organizational structure of the holding company and have to evaluate
increasingly centralized risk management activities and the controls
around those activities as they may apply to the regulated subsidiary, but
the consolidated supervisor is responsible for understanding the
organizational structure and monitoring risks and controls at the holding
across the entire organization.
When the large enterprises we reviewed had the same agency overseeing
their ultimate holding company and its lead bank (or its broker-dealer, in
the case of CSEs), supervisory activities tended to be well-integrated.
For the financial holding company that was dominated by a state member
bank and the thrift holding company dominated by a federal thrift
institution, we found that the oversight of the dominant financial
subsidiary and the ultimate holding company were conducted jointly with
the same examination team, a single planning document, and the same
timeline. In the case of the CSEs dominated by a broker-dealer, SEC
supervises both the holding company and the broker-dealer; NERO completed
targeted examinations of one firm in 2006 on an integrated basis.
The relationship between the consolidated supervisor and other agencies
that serve as primary or functional supervisors for subsidiaries is
governed by law, which does provide for some information exchange among
the agencies. Under the regulatory structure established by GLBA, the
Federal Reserve and OTS are to rely on the primary supervisors of bank
subsidiaries in holding companies (the appropriate federal and state
supervisory authorities) and the appropriate supervisors of nonbank
subsidiaries that either are functionally regulated or are determined by
the consolidated regulator to be comprehensively supervised by a federal
or state authority.^54 Consistent with this scheme, GLBA limits the
circumstances under which the Federal Reserve Board and OTS may exercise
their examination and monitoring authorities with respect to functionally
regulated subsidiaries and depository institutions that are not subject to
primary supervision by the Board or OTS. GLBA also provides that the
consolidated supervisor is to rely on reports that holding companies and
their subsidiaries are required to submit to other regulators and on
examination reports made by functional regulators, unless circumstances
described in the act exist.^55 Among other things, GLBA specifically
directs the Federal Reserve and OTS, to the fullest extent possible, to
use the reports of examinations of depository institutions made by the
appropriate federal and state depository institution supervisory
authority. Also, consolidated supervisors are directed to rely, to the
extent possible, on the reports of examination made of a broker-dealer,
investment adviser, or insurance company by their functional regulators
and defer to the functional regulators' examinations of these entities.
GLBA also provides for the sharing of information between federal
consolidated supervisors and bank supervisors on the one hand and state
insurance regulators on the other hand. The act authorizes these
regulators to share information pertaining to the entities they supervise
within a holding company. For example, with respect to the holding
company, the act authorizes the Board to share information regarding the
financial condition, risk management policies, and operations of the
holding company and any transaction or relationship between an insurance
company and any affiliated depository institution.^56 The consolidated
supervisor also may provide the insurance regulator any other information
necessary or appropriate to permit the state insurance regulator to
administer and enforce applicable state insurance laws.
Consistent with GLBA, consolidated supervisors have negotiated MOUs or
other formal information sharing agreements with functional supervisors
and were reviewing reports from them. The supervisors had also entered
into MOUs with relevant foreign supervisors. For example, OTS had
negotiated MOUs with 48 state insurance departments, 7 foreign
supervisors, and with the EU. Similarly, the Federal Reserve has a number
of MOUs with regulators. One provides for SEC to share information
concerning broker-dealer examinations for broker-dealers owned by
financial holding companies. Most MOUs include agreements to share
information on an informal basis. For example, the Federal Reserve and SEC
have a "pilot program" that allows the Federal Reserve to share
information on a particular holding company with SEC staff on an ongoing
basis. Examination information from the functional supervisors was being
provided to the consolidated supervisor, and to some extent, the
consolidated supervisor was relying on that information in planning and
reporting.
^54Pub. L. No. 106-102 S 111, 12 U.S.C. 1844(c), as amended.
^55Id.
^56Pub. L. No. 106-102 S 307(b), 15 U.S.C. S 6716(b).
Supervisors do communicate when developing holding company supervisory
programs. For example, staff at SEC, especially in OCIE, noted that they
communicated regularly with the supervisory management at the Federal
Reserve Bank of New York when setting up their CSE program. In addition,
the agencies gave us examples of when they communicated with regard to
specific issues, and the Federal Reserve and SEC have taken opportunities
to learn from the firms under each other's jurisdiction. SEC said the
Federal Reserve had asked to meet with some of CSEs regarding peer
valuation, and SEC had facilitated such meetings.
Following the enactment of GLBA, OCC and the Federal Reserve agreed on how
they would coordinate in the supervision of LCBOs. While some duplication
remains, we found examples of that agreement being implemented. For
example, OCC and the Federal Reserve share supervisory planning documents
for LCBOs when OCC is the primary bank supervisor for the lead bank in the
bank holding company. As a result, the Federal Reserve is able to factor
OCC's planned work into its supervisory plan process.
In addition, we found that OCC and Federal Reserve examiners at some
institutions shared information informally over the course of the
examination cycle, allowing them to conduct joint or shared target
examination activities that might not have been part of the original plan.
OCC examiners told us they are now also receiving information about the
Federal Reserve's horizontal reviews in a timelier manner and can thus
make better decisions about the extent to which they want to participate
in those reviews. Federal Reserve officials said that when OCC has
conducted examination activities related to horizontal reviews, they rely
on OCC's information. OCC and Federal Reserve examiners also told us that
when they disagree on examination findings, they attempt to work out those
disagreements before presenting conflicting information to management.
Finally, OCC and Federal Reserve examiners jointly attend meetings with
management and the Boards of Directors of the financial institutions where
they have primary and consolidated supervisory responsibilities. They
invite other relevant bank examiners to attend some of these meetings as
well. Finally, the Federal Reserve provides OCC and FDIC full online
access to its supervisory database, which contains examination reports and
other supervisory information for bank holding companies.
The supervision of one firm, headquartered abroad but with significant
U.S. operations, including substantial securities activities, is an
example of coordination between the Federal Reserve, the holding company
supervisor for the firm's U.S. operations, two foreign supervisory
agencies involved in the oversight of the ultimate holding company, and
operations in their countries, and the SEC, which is the functional
supervisor of firm's most important U.S. operations. The Federal Reserve
meets with supervisors from the other countries formally twice a year to
coordinate activities. A representative of the firm said the three
agencies meet jointly with representatives of the firm prior to developing
a supervisory plan. The lead examiner at the Federal Reserve said that
including representatives from other governments on examination teams
makes it easier to access information across international borders. While
SEC is not included in these meetings, the Federal Reserve and SEC agreed
to a "pilot program" for the Federal Reserve to regularly share holding
company information with OCIE staff that oversee the firm's U.S.
broker-dealers and investment advisers.
Collectively, these efforts to coordinate do address several of the key
elements of collaboration identified in table 6, above. In particular, the
agreements among the supervisors provide a basis for joint strategies, for
agreements on roles and responsibilities, and for operating across agency
boundaries. Joint examination activities between the Federal Reserve and
OCC, for instance, address these elements and are a way to leverage
resources. Similarly, coordination between SEC offices and the Federal
Reserve promote efforts to learn from each other despite agency
boundaries.
Opportunities remain for the agencies to collaborate more systematically,
however, and thus enhance their ability to provide effective and
consistent oversight when they share responsibility for a holding company
and its subsidiaries. More consistent collaboration between OCC as the
lead bank examiner and the Federal Reserve as the holding company
supervisor, for instance, would allow the agencies to take advantage of
opportunities to supervise some large, complex, banking organizations as
effectively and efficiently as possible. Conducting some examinations and
meetings on a joint basis--the solution adopted by the Federal Reserve and
OCC--is a positive step but does not ensure that the agencies develop
consistent mechanisms to evaluate the results of joint examinations or to
judge the extent to which such examinations or other approaches lessen
duplication, promote consistency, or otherwise enable more efficient
supervision.
In addition, we found that coordination between these agencies did not
always run smoothly. OCC examiners at some of the institutions we reviewed
and officials at headquarters told us that they see some coordination
issues, especially with regard to the horizontal examinations the Federal
Reserve conducts across some systemically important institutions. OCC
examiners at one LCBO said that some cases could lead to the Federal
Reserve and OCC providing inconsistent feedback to the firm. They also
noted that when the Federal Reserve collects information for these
examinations, they do not always rely on OCC for that information when OCC
is the primary bank examiner of the lead bank. Finally, while OCC and the
Federal Reserve follow the procedures they have laid out for resolving
differences, the potential still exists for the two to give conflicting
information to management. We found one firm that had initially received
conflicting information from the Federal Reserve, its consolidated
supervisor, and OCC, its primary bank supervisor, about sufficient
business continuity provisions.
While the holding company supervisor for thrift holding companies (OTS) or
CSEs (SEC) is often the supervisor of the dominant regulated subsidiary,
opportunities to reduce regulatory burden and improve accountability
through better collaboration continue to exist. While an OTS official told
us that one of the main responsibilities of a holding company supervisor
is to improve efficiency by serving as a source of information about the
holding company to the functional supervisors, this opportunity to
leverage information is not fully utilized. FDIC examiners, for instance,
could collect information on the organizational structure of the holding
company from OTS, but obtained this information from bank officials when
examining an ILC that was part of a thrift holding company.
In other instances, OTS and the Federal Reserve have taken some steps to
work collaboratively with other supervisors in supervising a particular
firm, but the results are incomplete. A decision by the United Kingdom's
Financial Services Authority to include the German and French regulators
in a meeting with OTS led OTS to call a November 2005 meeting that
included a broader range of supervisors. OTS officials said they invited
insurance, FDIC, and SEC supervisors in the United States. Officials at
the company told us, however, that FDIC did not attend the 2005 meeting
because the meeting had been arranged hastily. OTS held a similar meeting
in November 2006, and FDIC staff attended this meeting; SEC, however, did
not attend and senior staff at Market Regulation and OCIE told us they
were unaware that SEC had been invited. Similarly, as noted above, the
Federal Reserve has sometimes engaged in integrated examination activities
with foreign supervisors, but these did not consistently include other
relevant U.S. supervisors.
The agencies did not always have consistent approaches to minimizing
regulatory burden and improving accountability through collaboration. For
example, as noted above, the Federal Reserve mitigates challenges posed by
its decentralized structure by creating processes such as reviewing the
plans and findings of LCBOs and centralizing the staffing systems.
However, these processes may make collaboration more difficult. An OCC
official told us that the complex review process at the Federal Reserve
sometimes kept OCC from providing formal results to management on a
timelier basis when the two agencies conducted joint examinations.
Further, the planning cycles are not always consistent across the
agencies. While OCC and the Federal Reserve considered each others'
schedules or examination plans when developing their plans for bank
holding companies where OCC is the lead bank supervisor, not all agencies
do so. For example, at the institutions included in our study, there was
little or no indication that FDIC had coordinated the examinations of ILCs
with relevant holding company supervisors. Finally, bank regulators noted
another barrier to full collaboration--that the board of the bank is
legally liable for the safety and soundness of the bank regardless of the
status of the holding company. FDIC officials specifically noted that the
interests of the bank's management, including its legal responsibilities,
and those of the holding company might diverge when one or the other is in
danger of failing. Similarly, at that time the interests of the holding
company supervisor and the primary and secondary bank supervisor^57 might
diverge as well. Federal Reserve officials noted, however, that risks
would be lessened to the extent that the objectives of the consolidated
supervisor and the primary bank supervisor are the same (e.g., to preserve
the safety and soundness of insured depository institutions) and the
consolidated supervisor takes action to prevent the holding company from
taking actions that are deleterious to its insured depository
institutions.
^57FDIC in its role as the overseer of the deposit insurance fund serves
as the secondary bank supervisor.
Collaboration between the banking agencies and SEC is hindered by cultural
differences and concerns about sharing information. Bank supervisory
officials noted that they were sometimes concerned about sharing
information with SEC because of their compliance, as opposed to prudential
supervision, culture. One official said the Federal Reserve does not want
to be perceived as a fact finder for the SEC when it comes to consolidated
financial information. If they were perceived in that way, he said,
management at financial holding companies may be less willing to share
certain types of confidential information with their holding company
supervisors. SEC and Federal Reserve officials noted that SEC may not have
the same formal legal safeguards as bank supervisors have with regard to
the confidentiality of the information. The impediments to sharing
information at SEC are evident internally as well where, as discussed
above, Market Regulation has not always shared firm risk management
information with OCIE.
Oversight of complex organizations that are primarily insurance companies
pose special collaborative challenges. As noted above, GLBA directed
consolidated supervisors to take certain actions to promote the exchange
of information between consolidated supervisors and relevant state
insurance supervisors, and we found that MOUs had been negotiated and some
communication was taking place. The states have also taken some actions to
oversee insurance companies on a group basis. According to NAIC, most
states have adopted a version of the NAIC model laws concerning holding
company supervision, and NAIC has developed a framework for holding
company supervision. Within that framework, which promotes the assessment
of risks and controls at the holding company level, lead state supervisors
conduct the examination. These examiners are advised to identify and
communicate with the relevant functional supervisors for the holding
company. The framework also recommends that insurance examiners notify the
Federal Reserve if the institution is a financial holding company.
However, only one major insurer is a financial holding company, while a
significant minority of the large, complex thrift holding companies have
significant insurance operations, but the guidance does not recommend that
examiners contact OTS as a holding company supervisor. NAIC officials said
that while they participated in the EU evaluation process of the U.S.
consolidated supervisory framework, they do not believe that insurance
supervisors have been involved in the equivalency determinations for the
specific companies.
As a result of consolidated supervisors and those of the regulated
entities in these complex holding companies not consistently adopting
practices associated with systematic collaboration, U.S. supervisory
agencies may be missing opportunities to better ensure effective,
efficient supervision of individual financial services firms. The agencies
also have not developed methods to evaluate the joint efforts that they do
have under way, thus hindering their efforts to avoid duplication.
Further, since they have not consistently established compatible policies
and supervisory approaches, the agencies have missed opportunities to make
sure they are treating firms consistently.
Greater Collaboration among the Three Consolidated Supervisors Could Improve
Supervisory Efforts
While the three consolidated supervisors have some mechanisms in place to
share information and supervisory approaches, opportunities remain for
them to collaborate more systematically to promote greater consistency,
particularly in oversight of large, complex firms. While these firms'
product offerings generally are similar, ensuring regulatory consistency
remains an ongoing challenge.
In particular, the OTS and SEC have overlapping responsibilities at some
CSEs that own or control thrifts. Further, the agencies do not
consistently work in a collaborative manner to identify the potential for
defining and articulating a common goal, such as identifying regulatory
best practices for consolidated supervision or identifying emerging risks
that would confront all financial services firms.
Duplicative Effect of Overlapping Jurisdiction between OTS and SEC Remains
Unresolved
Three of the five securities firms that have obtained CSE status are also
thrift holding companies. As a result, these firms have two consolidated
supervisors and no mechanism has been developed to limit the potential for
duplicative activities and conflicting findings or to assess
accountability for various supervisory activities. In the preamble to the
final CSE rule, SEC acknowledged the potential for duplication and
conflict for some firms.^58 The rule reduces this potential by, among
other things, providing that SEC will rely on the Federal Reserve's
consolidated supervision of financial holding companies and on
consolidated supervision by other holding company supervisors under
circumstances the SEC determines to be appropriate.^59
5869 Fed. Reg. at 34431.
^5917 C.F.R. S 240.15c3-1(c)(13)(ii).
Currently, SEC has not determined that consolidated supervision of thrift
holding companies by OTS satisfies SEC's supervisory concerns with respect
to CSEs that are thrift holding companies.^60 SEC says that where both it
and OTS are the consolidated supervisors, the firms are primarily
securities firms with small thrift subsidiaries. In addition, SEC
examiners told us that the major risks for these firms are outside the
thrift and other banking subsidiaries and that OTS had not been examining
these activities. When thrifts are included in bank holding companies, the
law dictates that at the holding company level, the Federal Reserve is
solely responsible for holding company supervision. However, no such
mechanism exists for firms that are thrift holding companies who have
opted to become CSEs, and OTS, which notes the growing importance of the
thrift in two of the three institutions, has not chosen to defer to SEC's
consolidated supervision. SEC and OTS officials recognize this issue but
have not yet met to resolve it.
Agencies Face Broader Risks That Could Be Better Managed through Effective
Collaboration
Supervisors in all three agencies have recognized the importance of
allocating scarce resources to the areas of greatest risk and have adopted
some risk-based supervisory policies and procedures. However, the agencies
have not consistently adopted mechanisms to look at risk collaboratively,
recognizing that financial risks are not neatly aligned with agency
jurisdiction. The extent to which these risks cut across regulatory
boundaries was highlighted in our work on Long-Term Capital Management
(LTCM), a large hedge fund.^61 Federal financial regulators did not
identify the extent of weaknesses in banks' and securities and futures
firms' risk management practices until after LTCM's near collapse. Until
LTCM's near collapse, they said they believed that creditors and
counterparties were appropriately constraining hedge funds' leverage and
risk taking. However, examinations done after LTCM's near collapse
revealed weaknesses in credit risk management by banking and securities
firms that allowed LTCM to become too large and leveraged. The existing
regulatory approach, which focuses on the condition of individual
institutions, did not sufficiently consider systemic threats that can
arise from nonregulated entities, such as LTCM. Similarly, information
periodically received from LTCM and its creditors and counterparties did
not reveal the potential threat posed by LTCM. However, the agencies did
not have a strategy to collaboratively identify and resolve problems such
as this, delaying identification of shared issues and work toward their
resolution.
^60In the preamble to the CSE regulation, SEC referred to savings and loan
holding companies as entities whose consolidated supervisory scheme
remains subject to this determination. 69 Fed. Reg. at 34432 n. 25.
^61GAO, Long-Term Capital Management: Regulators Need to Focus Greater
Attention on Systemic Risk, [59]GAO/GGD-00-3 (Washington, D.C.: Oct. 29,
1999).
In addition, there are limited mechanisms to allow agencies to share and
leverage resources when one agency has unique capabilities or lacks
specialized resources. To some extent, agencies share expertise and
resources when they jointly conduct examinations or when they meet
periodically to share information. However, no mechanism exists for
sharing expertise in other situations. This is important for OTS, which is
characterized by a disparity between the size of the agency and the
diverse firms it oversees. While OTS recognizes its need for staff with
specialized skills to oversee some of these firms, the small number of
firms in some categories, combined with the small overall size of the
agency, limits its ability to have any depth in those skill areas. For
example, while OTS oversees a number of holding companies that are
primarily in the insurance business, it has only one specialist in this
area. At the same time, the Federal Reserve has a number of insurance
specialists but oversees only one firm that is primarily in the insurance
business. However, there is no systematic process for sharing insurance
expertise between the two agencies.^62
Conclusions
As financial institutions have grown, become more complex and
internationally active, and adopted enterprisewide risk management
practices, consolidated supervision has become more important. For certain
large complex firms, U.S. supervisors have or are adopting some of the
"best practices" associated with consolidated supervision, as evidenced in
part by the determination of equivalence by EU supervisors. However, U.S.
supervisors could perform consolidated supervision more efficiently and
effectively by adopting management practices in the areas of performance
management and collaboration. These practices are particularly important
in helping to ensure consistent treatment of financial services holding
companies and in clearly defining accountability for providing
consolidated supervision. Consistent rules, consistently applied, and
clear accountability are important because of the decentralized internal
structures the agencies use to develop and implement policies related to
consolidated supervision and the generally fragmented structure of the
U.S. regulatory system.
^62According to the Federal Reserve, as of September 2006, 20 domestic and
13 foreign banking organizations supervised by the Federal Reserve were
conducting insurance underwriting activities under the Financial Holding
Company authority of GLBA. As of the same date, 201 domestic and 12
foreign bank holding companies supervised by the Federal Reserve were
engaged in insurance agency activities under the Financial Holding Company
authority of GLBA.
The first step in any effectively managed organization is to have
well-articulated objectives, strategies, and performance measures. While
these agencies have developed and largely implemented policies or
strategies for consolidated supervision, these strategies could be
improved through the development of more well-articulated, specific
objectives and measurable outcomes. Defining specific, measurable
objectives for the consolidated supervision programs is an inherently
difficult task for financial services supervisors but is a key component
of assessing how consolidated supervision adds to the functional
supervision of banks, thrifts, broker-dealers, and insurers.
Better-articulated objectives will also help to ensure that supervisors
treat firms equitably and that firms receive consistent feedback. SEC has
developed a draft statement of objectives and performance measures for the
CSE program intended to facilitate that assessment. If approved, this
would be particularly important because differences in orientation and
policies and communication weaknesses among different organizational
components of SEC exacerbate the difficulty of taking on the new
responsibilities inherent in the CSE program. Without formal guidance that
delineates the responsibilities and identifies strategies and performance
measures for the divisions and offices, resources will not be used as
effectively as they might be.
Another key facet of effectively managed organizations or systems is the
degree to which the various components collaborate and integrate their
processes. While the agencies do exchange information, they have
opportunities to improve collaboration. We have noted in the past that it
is difficult to collaborate within the fragmented U.S. regulatory system
and have recommended that Congress modernize or consolidate the regulatory
system. However, under the current system, the agencies have opportunities
to collaborate systematically and thus ensure that institutions operating
under the oversight of multiple financial supervisors receive consistent
guidance and face minimal supervisory burden. The agencies have taken some
steps, particularly in the case of some specific holding companies, to
work more collaboratively and thus ensure consistent supervisory
treatment. These steps include joint supervisory meetings, including
foreign supervisors, to develop common examination approaches.
Recommendations for Executive Action
We are recommending that the Federal Reserve, Office of Thrift
Supervision, and Securities and Exchange Commission take the following
seven actions, as appropriate:
To better assess their agencies' achievements as consolidated supervisors,
the Chairman of the Federal Reserve System's Board of Governors, the
Director of the Office of Thrift Supervision, and the Chairman of the
Securities and Exchange Commission should direct their staffs to develop
program objectives and performance measures that are specific to their
consolidated supervision programs.
To ensure they are promoting consistency with primary bank and functional
supervisors and are avoiding duplicating the efforts of these supervisors,
the Chairman of the Federal Reserve System's Board of Governors, the
Director of the Office of Thrift Supervision, and the Chairman of the
Securities and Exchange Commission should also direct their staffs to
identify additional ways to more effectively collaborate with primary bank
and functional supervisors. Some of the ways they might consider
accomplishing this include
o ensuring common understanding of how the respective roles and
responsibilities of primary bank and functional supervisors and of
consolidated supervisors are being applied and defined in
decisions regarding the examination and supervision of
institutions; and
o developing appropriate mechanisms to monitor, evaluate, and
report jointly on results.
To take advantage of the opportunities to promote better
accountability and limit the potential for duplication and
regulatory gaps, the Chairman of the Federal Reserve System's
Board of Governors, the Director of the Office of Thrift
Supervision, and the Chairman of the Securities and Exchange
Commission should foster more systematic collaboration among their
agencies to promote supervisory consistency, particularly for
firms that provide similar services. In particular, the Chairman
of the Securities and Exchange Commission and the Director of the
Office of Thrift Supervision should jointly clarify accountability
for the supervision of the consolidated supervised entities that
are also thrift holding companies and work to reduce the potential
for duplication.
To address certain practices that are specific to an agency, we
recommend the following:
o the Chairman of the Securities and Exchange Commission direct
SEC staff to develop and publicly release explicit written
guidance for supervision of Consolidated Supervised Entities. This
guidance should clarify the responsibilities and activities of the
Office of Compliance Inspections and Examinations and the Division
of Market Regulation's responsibilities for administering the
Consolidated Supervised Entity program.
o the Director of the Office of Thrift Supervision direct OTS
staff to revise the CORE supervisory framework to focus more
explicitly and transparently on risk management and controls so
that it more effectively captures evolving standards for
consolidated supervision and is more consistent with activities of
other supervisory agencies and facilitates consistent treatment of
OTS's diverse population of holding companies.
o The Chairman of the Federal Reserve direct Federal Reserve Board
and District Bank staff to look for ways to further reduce
operational differences in bank supervision among the District
Banks, such as developing additional guidance related to
developing and communicating examination findings.
We requested comments on a draft of this report from the Federal
Reserve, OTS, and SEC. We received written comments from the
Chairman of the Board of Governors of the Federal Reserve System,
the Director of the Office of Thrift Supervision, and the Chairman
of the Securities and Exchange Commission. Their letters are
summarized below and reprinted in appendixes III, IV, and V,
respectively.
The Chairman of the Board of Governors of the Federal Reserve
System noted that the Federal Reserve's program for consolidated
supervision continues to evolve in light of changes in the
structure, activities, risks, and risk management techniques of
the banking industry. He concurred with the importance of clear
and consistent objectives for each supervisory program and
accurate performance measures, as well as noted that the Federal
Reserve has already charged its management committees, comprised
of Board and Reserve Bank officials, to further define and
implement more specific objectives and performance measures for
each of its supervision business lines. He also agreed that it was
appropriate for the Federal Reserve to consider whether additional
opportunities exist to promote effective collaboration among the
Federal financial supervisory agencies and that the Federal
Reserve would continue to work to ensure that the agencies share
information and avoid duplication of supervisory effort.
The Director of the Office of Thrift Supervision agreed with our
characterization of how OTS's consolidated supervision program,
especially for large, complex firms operating on a global basis,
has evolved in recent years. OTS wrote that initiatives for these
firms (that are described in the report) will ensure that it
implements the principles of accountability and supervisory
collaboration recommended in the report. With regard to
consolidated supervision of other firms OTS wrote that it
implements its holding company authority in a broader and deeper
manner than indicated in our draft report. In response to our
recommendation that OTS's CORE framework more explicitly focus on
risk management, the Director reiterated that the CORE approach is
explicitly designed to understand, analyze and evaluate the firm's
risk appetite and its approach to risk management, however, he
said that OTS is considering substantive revisions to the
framework to further sharpen this focus on risk. We agree that
revisions to sharpen the focus on the CORE framework are
appropriate. We also agree that OTS's holding company authority is
broad and deep and that OTS has sought to understand the risk
management approaches of the holding companies it supervises, but
we continue to believe that OTS should focus more explicitly and
transparently on risk management and controls to ensure it
provides consistent treatment of its holding companies.
The Director also wrote that the report correctly points out that
OTS and SEC conduct consolidated supervision activities in some of
the same firms. Further, he wrote that the report cites views of
SEC staff that are incorrect, specifically that the firms in
question have small thrifts and that the major risks for these
firms are outside the thrift and other banking subsidiaries. The
Director wrote that the regulated thrift institutions are sizeable
and significant in at least two of these firms with assets of more
than $14 billion and $19 billion in 2006 and that reviews
thoroughly evaluate holding companies and their risks on a
consolidated basis.
Our report discussed the overlapping responsibilities of OTS and
SEC with regard to several CSEs that, because of their ownership
of thrifts, are also thrift holding companies. We did not offer a
judgment as to which agency should appropriately have the primary
responsibility, but we did recommend that the Director and the
Chairman of the Securities and Exchange Commission clarify
accountability for such supervisory responsibility. The Director
of OTS said that he intends to meet with the Chairman of SEC to
discuss this issue.
In response to our recommendation that the agencies identify
additional ways to collaborate, the Director wrote that the
differences between the holding companies overseen by the Federal
Reserve and OTS would make it difficult to achieve perfect
consistency but that OTS would continue to seek ways to align its
process with best regulatory practice. In response to our
recommendation that the agencies foster more systematic
collaboration, he wrote that OTS remains committed to an open and
inclusive approach and is willing to work with relevant
supervisors to ensure there are not gaps in the review of firms
subject to consolidated supervision. Finally, responding to our
recommendation for program objectives and performance measures
that are specific to consolidated supervision, the Director agreed
that clear objectives and performance measures greatly assist in
evaluating the success of any supervisory program, and that the
agency will continue to assess ways to ensure the program is
focused, disciplined, and equal to the task of holding company
supervision.
The Chairman of the Securities and Exchange Commission wrote that
SEC recognized that the establishment of a prudential consolidated
supervision program for investment bank holding companies
represents a significant expansion of the Commission's activities
and responsibilities. The Chairman further wrote that SEC had
built a prudential regime that is generally consistent with the
oversight that is provided to bank holding companies but that SEC
also takes into account the different risk profiles and business
mixes that distinguish investment bank holding companies from bank
holding companies. In response to our recommendation regarding
coordination within SEC, the Chairman, with the unanimous support
of his fellow Commissioners, subsequently wrote that he is
transferring the responsibilities for on-site testing of CSE
holding company controls to the Division of Market Regulation so
that the expertise related to the prudential supervision of
securities firms will be concentrated there. In addition, the
Chairman wrote that he will allocate additional positions to the
Division of Market Regulation to carry out its increased
responsibilities, and he has directed staff there to provide
greater transparency with regard to the aims and methods of the
program by posting additional information about its components on
SEC's Web site.
We also received separate technical comments on the draft report
from the staffs of the Federal Reserve and SEC, as well as from
FDIC and OCC; we have incorporated their comments into the report,
as appropriate.
We are sending copies of this report to other interested
congressional committees and to the Chairman of the Board of
Governors of the Federal Reserve System, the Director of the
Office of Thrift Supervision, and the Chairman of the Securities
and Exchange Commission. We will also make copies available to
others upon request. In addition, the report will be available at
no charge on the GAO Web site at http://www.gao.gov .
If you or your staffs have any questions about this report, please
contact me at (202) 512-8678 or [email protected] . Contact
points for our Offices of Congressional Relations and Public
Affairs may be found on the last page of this report. Key
contributors are acknowledged in appendix VI.
Richard J. Hillman
Managing Director, Financial Markets and
Community Investment
List of Committees
The Honorable Christopher Dodd
Chairman
The Honorable Richard Shelby
Ranking Member
Committee on Banking, Housing and Urban Affairs
United States Senate
The Honorable Joseph I. Lieberman
Chairman
The Honorable Susan M. Collins
Ranking Member
Committee on Homeland Security and Governmental Affairs
United States Senate
The Honorable Barney Frank
Chairman
The Honorable Spencer Bachus
Ranking Member
Committee on Financial Services
House of Representatives
The Honorable Henry A. Waxman
Chairman
The Honorable Tom Davis
Ranking Member
Committee on Oversight and Government Reform
House of Representatives
Appendix I: Objectives, Scope, and Methodology
Our objectives were to (1) describe the policies and approaches
U.S. consolidated supervisors use to oversee large and small
holding companies in the financial services industry; (2) review
the supervisory agencies' management of its consolidated
supervision program, including program objectives and performance
measures; and (3) evaluate how well consolidated supervisors are
collaborating with other supervisors and each other. We conducted
our work between November 2005 and February 2007 in accordance
with generally accepted government auditing standards in
Washington, D.C.; Boston; and other locations where financial
institutions are headquartered.
To meet our objectives and to better understand how the three
consolidated supervisors--the Federal Reserve System (Federal
Reserve), Office of Thrift Supervision (OTS), and Securities and
Exchange Commission (SEC)--operate their consolidated supervision
programs for large, complex, firms, we selected a number of large
firms that were supervised by each of the three agencies on a
consolidated basis. These firms had at least one of the following
characteristics: (1) major international operations so that they
were subject to the European Union's Financial Conglomerates
Directive or were headquartered abroad, (2) a variety of
businesses (i.e., insurance, banking, and securities) that were
subject to significant supervision by primary bank and functional
supervisors or unregulated subsidiaries, and (3) one or more
consolidated supervisors. Before finalizing our selection of
firms, we held discussions with the three agencies to obtain their
views on the firms we had selected.^1 From this selection process,
we chose a total of 14 firms, 6 U.S. bank holding companies, 1
foreign bank with substantial U.S. operations, 4 thrift holding
companies that did not have another consolidated supervisor, and 3
consolidated supervised entities (CSE) that were also thrift
holding companies. We interviewed officials from some of the
selected firms to obtain their views on the benefits and the costs
of consolidated supervision.
Specifically, to describe the policies and approaches used by U.S.
consolidated supervisors--Federal Reserve, OTS, and SEC--we
reviewed the Bank Holding Company Act of 1956, the
Gramm-Leach-Bliley Act, the Home Owners Loan Act of 1933, and
SEC's Alternative Net Capital Rule for CSEs. We also reviewed the
Federal Reserve Board's Bank Holding Company Supervision Manual
and some of the Board's Division of Banking Supervision and
Regulation Letters on large, complex banking organizations; SEC's
regulations establishing the CSE program and examination modules
specific to that program; and OTS's Holding Companies Handbook and
Examination Handbook for thrifts. In addition, we reviewed recent
Federal Reserve supervisory plans and some reports of targeted
reviews. For the three SEC-supervised firms, we reviewed their
applications to become CSEs and ongoing supervisory materials,
such as monthly risk reports and cross-firm reviews, as well as
the results of one CSE examination completed during our review.
Because these firms were also thrift holding companies, we
reviewed OTS holding company examination reports for them. For the
other OTS-supervised firms, we reviewed holding company and thrift
examination reports and supervisory planning documents when these
were available. In addition to the 14 large firms, we reviewed a
few supervisory documents for smaller holding companies supervised
by the Federal Reserve and OTS.
To review the supervisory agencies' management of its consolidated
supervision program, we reviewed recent strategic and performance
plans from the three agencies. Where relevant, we also reviewed
agency testimonies and budget documents. In addition, we reviewed
agency guidance specific to consolidated supervision to determine
whether program objectives and performance measures were included.
We interviewed officials at the three agencies and examiners who
were responsible for the supervision of the selected firms on what
they considered the goals or benefits of consolidated supervision
to be. In addition, we collected information on the operations
review program that the Federal Reserve developed for its
supervision programs.
To evaluate how well consolidated supervisors are collaborating
with other supervisors and each other, we identified practices for
effective collaboration from our previous work on collaboration.
We also interviewed officials from the three agencies on their
efforts to collaborate with each other and with primary bank and
functional supervisors overseeing subsidiaries in the holding
companies they oversee. In addition, we reviewed examination
reports of some of the subsidiaries owned by the 14 holding
companies we selected. These included examination reports from the
Federal Deposit Insurance Corporation, Office of the Comptroller
of the Currency, and the New York Stock Exchange. We also
interviewed officials and examiners involved in the oversight of
the primary banks or functional entities within some of the 14
firms.
To gain an international perspective on consolidated supervision
and a better understanding of the European Union's Financial
Conglomerates directive, we spoke to supervisors in two other
countries and reviewed documents from a variety of international
sources. Specifically, we spoke with Canada's Office of the
Superintendent of Financial Institutions and the United Kingdom's
Financial Services Authority. We also reviewed documents from
these supervisory bodies as well as other international sources,
including the Basel Committee on Banking Supervision, the Joint
Forum, and the European Union.
^1At the suggestion of one of the supervisory agencies, we included a
foreign-headquartered holding company in our selected firms.
Appendix II: Criteria for Consolidated Supervision Included in
Basel Committee on Banking Supervision�s Core Principles
The following is excerpted from the Basel Committee on Banking
Supervision's "Core Principles Methodology," available at
http://www.bis.org/publ/bcbs130.pdf .
Principle 24: Consolidated supervision
An essential element of banking supervision is that supervisors
supervise the banking group on a consolidated basis, adequately
monitoring and, as appropriate, applying prudential norms to all
aspects of the business conducted by the group worldwide.
Essential criteria
1. The supervisor is familiar with the overall
structure of banking groups and has an understanding
of the activities of all material parts of these
groups, domestic and cross-border.
2. The supervisor has the power to review the overall
activities of a banking group, both domestic and
cross-border. The supervisor has the power to
supervise the foreign activities of banks
incorporated within its jurisdiction.
3. The supervisor has a supervisory framework that
evaluates the risks that non-banking activities
conducted by a bank or banking group may pose to the
bank or banking group.
4. The supervisor has the power to impose prudential
standards on a consolidated basis for the banking
group. The supervisor uses its power to establish
prudential standards on a consolidated basis to cover
such areas as capital adequacy, large exposures,
exposures to related parties and lending limits. The
supervisor collects consolidated financial
information for each banking group.
5. The supervisor has arrangements with other
relevant supervisors, domestic and cross-border, to
receive information on the financial condition and
adequacy of risk management and controls of the
different entities of the banking group.
6. The supervisor has the power to limit the range of
activities the consolidated group may conduct and the
locations in which activities can be conducted; the
supervisor uses this power to determine that the
activities are properly supervised and that the
safety and soundness of the bank are not compromised.
7. The supervisor determines that management is
maintaining proper oversight of the bank's foreign
operations, including branches, joint ventures and
subsidiaries. The supervisor also determines that
banks' policies and processes ensure that the local
management of any cross-border operations has the
necessary expertise to manage those operations in a
safe and sound manner and in compliance with
supervisory and regulatory requirements.
8. The supervisor determines that oversight of a
bank's foreign operations by management (of the
parent bank or head office and, where relevant, the
holding company) includes: (i) information reporting
on its foreign operations that is adequate in scope
and frequency to manage their overall risk profile
and is periodically verified; (ii) assessing in an
appropriate manner compliance with internal controls;
and (iii) ensuring effective local oversight of
foreign operations.
For the purposes of consolidated risk management and
supervision, there should be no hindrance in host
countries for the parent bank to have access to all
the material information from their foreign branches
and subsidiaries. Transmission of such information is
on the understanding that the parent bank itself
undertakes to maintain the confidentiality of the
data submitted and to make them available only to the
parent supervisory authority.
9. The home supervisor has the power to require the
closing of foreign offices, or to impose limitations
on their activities, if:
it determines that oversight by the bank and/or
supervision by the host supervisor is not adequate
relative to the risks the office presents; and/or
it cannot gain access to the information required for
the exercise of supervision on a consolidated basis.
10. The supervisor confirms that oversight of a
bank's foreign operations by management (of the
parent bank or head office and, where relevant, the
holding company) is particularly close when the
foreign activities have a higher risk profile or when
the operations are conducted in jurisdictions or
under supervisory regimes differing fundamentally
from those of the bank's home country.
Additional criteria
1. For those countries that allow corporate ownership
of banking companies:
the supervisor has the power to review the activities
of parent companies and of companies affiliated with
the parent companies, and uses the power in practice
to determine the safety and soundness of the bank;
and
the supervisor has the power to establish and enforce
fit and proper standards for owners and senior
management of parent companies.
2. The home supervisor assesses the quality of
supervision conducted in the countries in which its
banks have material operations.
3. The supervisor arranges to visit the foreign
locations periodically, the frequency being
determined by the size and risk profile of the
foreign operation. The supervisor meets the host
supervisors during these visits. The supervisor has a
policy for assessing whether it needs to conduct
on-site examinations of a bank's foreign operations,
or require additional reporting, and has the power
and resources to take those steps as and when
appropriate.
Appendix III: Comments from the Chairman of the Board of Governors of the
Federal Reserve System
Appendix IV: Comments from the Director of the Office of Thrift Supervision
Appendix V: Comments from the Chairman of the Securities and Exchange Commission
Appendix VI: GAO Contact and Staff Acknowledgments
GAO Contact
Richard J. Hillman, (202) 512-8678 or [email protected]
Staff Acknowledgments
In addition to the contact named above, James McDermott, Assistant
Director; Jason Barnosky; Nancy S. Barry; Lucia DeMaio; Nancy
Eibeck; Marc W. Molino; Paul Thompson; and Barbara Roesmann also
made key contributions to this report.
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Highlights of [83]GAO-07-154 , a report to congressional committees
March 2007
FINANCIAL MARKET REGULATION
Agencies Engaged in Consolidated Supervision Can Strengthen Performance
Measurement and Collaboration
As financial institutions increasingly operate globally and diversify
their businesses, entities with an interest in financial stability cite
the need for supervisors to oversee the safety and soundness of these
institutions on a consolidated basis. Under the Comptroller General's
Authority, GAO reviewed the consolidated supervision programs at the
Federal Reserve System (Federal Reserve), Office of Thrift Supervision
(OTS), and Securities and Exchange Commission (SEC) to (1) describe
policies and approaches that U.S. consolidated supervisors use to oversee
large and small holding companies; (2) review the management of the
consolidated supervision programs, including use of program objectives and
performance measures; and (3) evaluate how well consolidated supervisors
are collaborating with other supervisors and each other in their
activities. In conducting this study, GAO reviewed agency policy documents
and supervisory reports and interviewed agency and financial institution
officials.
[84]What GAO Recommends
GAO recommends that the heads of the three agencies direct their staffs to
develop a set of clear and consistent objectives and related performance
measures specific to consolidated supervision and collaborate more
systematically with each other and with other supervisors. The agencies
generally agreed with these recommendations.
The Federal Reserve, OTS, and SEC have responded to the dramatic changes
in the financial services industry, and for many of the largest financial
services firms, the agencies focus on the firms' consolidated risks,
controls, and capital. Reflecting in part differences in structure,
traditional roles and responsibilities, and the length of time they have
had to develop and refine their programs, the agencies employ somewhat
differing policies and approaches for their consolidated supervision
programs.
Consolidated supervision becomes more important in the face of changes in
the financial services industry, particularly with respect to the
increased importance of enterprise risk management by large, complex
financial services firms. Consolidated supervision provides a basis for
the supervisors to oversee the risks of financial services firms on the
same level that the firms manage those risks. GAO found that while all of
these agencies were meeting international standards for effective
oversight of large, internationally active conglomerates and have broad
goals for supervision, they could more clearly articulate the specific
objectives and performance measures for their evolving consolidated
supervision programs. Both Federal Reserve and OTS, for example, focus on
the safety and soundness of the depository institution but could take
steps to better measure how consolidated supervision contributes to this
in ways that differ from primary supervision of the depository
institution. Such objectives and measures would help the agencies ensure
consistent treatment of the firms that are subject to consolidated
supervision.
More effective collaboration can occur if agencies take a more systematic
approach to agreeing on roles and responsibilities and establishing
compatible goals, policies, and procedures on how to use available
resources as efficiently as possible. While the three agencies coordinate
and exchange information, they could take a more systematic approach to
collaboration with respect to their consolidated supervision programs. For
instance, SEC and OTS have authority for some of the same firms with no
effective mechanism to prevent duplication, assign accountability, or
resolve potential conflicts. Similarly, while the Federal Reserve and
other federal bank supervisory agencies have taken steps to share
information and examination activities when the Federal Reserve is not the
primary supervisor of the lead bank in a bank holding company, some
duplication and lack of accountability remain. As a result, consolidated
supervision of U.S. financial institutions is not as efficient and
effective as it could be if agencies collaborated more systematically. GAO
has noted in the past that it is difficult to collaborate within the
fragmented U.S. regulatory system and has recommended that Congress
modernize or consolidate the regulatory system. However, if the current
system is maintained, it is increasingly important for agencies to
collaborate to ensure effective and efficient consolidated supervision,
consistent treatment of financial services firms, and clear accountability
of the agencies for their supervisory activities.
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64. http://www.gao.gov/cgi-bin/getrpt?GAO-07-253
65. http://www.gao.gov/cgi-bin/getrpt?GAO-06-961T
66. http://www.gao.gov/cgi-bin/getrpt?GAO-06-15
67. http://www.gao.gov/cgi-bin/getrpt?GAO-05-621
68. http://www.gao.gov/cgi-bin/getrpt?GAO-05-325SP
69. http://www.gao.gov/cgi-bin/getrpt?GAO-05-61
70. http://www.gao.gov/cgi-bin/getrpt?GAO-01-1008G
71. http://www.gao.gov/cgi-bin/getrpt?GAO/GGD-00-106
72. http://www.gao.gov/cgi-bin/getrpt?GAO/GGD-00-67R
73. http://www.gao.gov/cgi-bin/getrpt?GAO/GGD-00-48
74. http://www.gao.gov/cgi-bin/getrpt?GAO/AIMD-00-21.3.1
75. http://www.gao.gov/cgi-bin/getrpt?GAO/GGD-00-3
83. http://www.gao.gov/cgi-bin/getrpt?GAO-07-154
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