In recent years, banking regulators have changed their examination techniques by placing increased emphasis on an institution’s internal control systems and on the way it manages and controls its risks. The objectives of this report are to (1) describe the general characteristics of the regulators’ risk-focused approach to examinations of large, complex banks, explaining how they differ from past examination practices; (2) compare the implementation of the Federal Reserve’s and OCC’s risk- focused examination approaches; and (3) identify the challenges faced by both agencies as they continue to implement their examination programs for large, complex banks. The Risk-Focused Approach Relies on Ongoing Monitoring and Examination of the Bank

Under the risk-focused approach of both the Federal Reserve and OCC, examiners are to engage in ongoing monitoring and communication to keep abreast of the current financial condition and business strategies of a bank. Our objectives were to (1) describe the general characteristics of the regulators’ risk-focused approach to examinations of large, complex banks, explaining how they differ from past examination practices; (2) compare the implementation of the Federal Reserve’s and OCC’s risk-focused examination approaches; and (3) identify the challenges faced by both agencies as they continue to implement their examination programs for large, complex banks. Transaction testing remains important but is intended to validate examiners’ judgment on the reliability of an institution’s controls. Other Differences Between Risk-Focused and Earlier Approach to Examinations

Other differences between OCC’s and the Federal Reserve’s risk-focused approach to examinations of large, complex banks and earlier procedures include differences in the planning of examinations, allocation of examiner resources, ongoing monitoring of bank operations, and communication of the results of the examination to a bank’s management and board of directors. This results in certain bank operations receiving less scrutiny than others. They are to do this through the review of a variety of management reports and frequent meetings with key bank officials. OCC’s Program is Centrally Managed

OCC’s large bank supervision program, which was formally established in 1995, previously was directed out of its district offices but now is centrally managed by the Bank Supervision Operations group located in its Washington, D.C. headquarters. Examination of Large Banking Organizations Poses Challenges for Federal Reserve and OCC

The Federal Reserve and OCC face a number of challenges as they continue to implement their examination programs for large, complex banks. One key challenge, inherent in the design of the risk-based program, is how to identify the aspects of bank operations where examiner attention should be concentrated. A second challenge is maintaining an awareness of industrywide risk in an institution-specific examination program. Using Bank-Generated Information and Analysis to Make Risk Assessments Creates Heavy Reliance on Bank’s Risk- Management Systems

Examiners are challenged to avoid being overly influenced by banks’ risk- management systems while relying on those systems and other data furnished by the bank to make their assessments. Under risk-focused supervision, examiners assess a bank’s risk-management and internal controls.
Why GAO Did This Study

Pursuant to a congressional request, GAO provided information on the risk-focused approaches used by the Federal Reserve and Office of the Comptroller of the Currency (OCC), focusing on: (1) the general characteristics of the regulators' risk-focused approach to examinations of large, complex banks, explaining how they differ from past examination practices; (2) comparing the implementation of the Federal Reserve's and OCC's risk-focused examination approaches; and (3) the challenges faced by both agencies as they continue to implement their examination programs for large, complex banks.

What GAO Found

GAO noted that: (1) the Federal Reserve and OCC's risk-focused approaches to supervising large, complex banking organizations are evolving with changes intended to strengthen oversight of these entities; (2) their effectiveness will depend on the expertise and independence of examiners, and the regulators' ability to maintain an awareness of industrywide risk in an institution-specific examination program; (3) transaction review and testing under the risk-focused approach is intended to validate the use and effectiveness of internal control and other risk-management systems; (4) examination activities now focus on risk assessments along business lines, which often cross bank charters, and the processes used to manage and control the attendant risks; (5) under a risk-focused approach, activities judged to pose the highest risk to an institution receive the most scrutiny by examiners; (6) this approach relies on examiner judgment and results in certain bank operations receiving less scrutiny than others; (7) examiners monitor and assess a bank's financial condition and risk-management systems through the review of a variety of management reports and meetings with key bank officials, documenting the areas they select for review and including their rationale for selecting those areas; (8) examiners conduct examinations to assess a bank's internal control and risk-management systems; (9) the Federal Reserve and the OCC differ in how they implement their risk-focused examinations programs for large, complex banks; (10) OCC's large bank supervision program is centrally managed from its headquarters and has achieved a degree of uniformity in its use of examiners who are located at the bank throughout the year and conduct ongoing monitoring and examinations, and report to one of three deputy comptrollers located in Washington D.C.; (11) the Federal Reserve's program is implemented through a less centralized system of Reserve Banks and has less uniformity in its ongoing monitoring and examinations, with sometimes differing staffing arrangements in place for each bank; and (12) regulators face a number of challenges in implementing examination programs for large, complex banks, including: (a) identifying the aspects of bank operations where examiner's attention should be concentrated; (b) maintaining an awareness of industrywide risk in an institution-specific examination program; (c) ensuring risk assessments are not overly influenced by the bank's risk-management systems on which they must rely; and (d) maintaining sufficient staffing numbers and expertise.