Background and Purpose of Audit

The FDIC is responsible for maintaining stability and public confidence in the nation’s financial system by examining and supervising financial institutions, insuring deposits, and resolving failed financial institutions and managing receiverships. As of March 31, 2007, the FDIC insured 8,650 depository institutions and was the federal banking agency (FBA) for 5,216 of those institutions, which included state-chartered banks that are not members of the Federal Reserve System, generally known as state non-member banks; state-chartered savings institutions; and state-licensed insured branches of foreign banks.

The FDIC’s Division of Supervision and Consumer Protection (DSC) is responsible for the FDIC’s Large Insured Depository Institutions (LIDI) Program, which consists of financial institutions with consolidated banking assets that exceed $10 billion. There are 119 insured institutions covered by the LIDI Program, 25 of which are FDIC supervised. The 119 institutions had total assets exceeding $9 trillion and total deposits of $5.6 trillion, which is comprised of both insured and uninsured deposits. To assist the FDIC in assessing the risks associated with the largest institutions in the LIDI program that are not FDIC-supervised, the FDIC and the other FBAs established the Dedicated Examiner (DE) Program in 2002. Currently, the DE Program includes six LIDIs supervised by either the Office of the Comptroller of the Currency (OCC) or the Office of Thrift Supervision (OTS) as shown in the table.

The objective of the audit was to determine whether the DE Program is contributing to the FDIC’s efforts to assess and quantify the risks posed by the largest institutions to the Deposit Insurance Fund (DIF).

Results of Audit

The FDIC’s DE Program is contributing to the FDIC’s efforts to assess and quantify the risks to the DIF posed by the largest banks. More specifically, the DE Program has been successful in providing the FDIC with supervisory information related to the operations at the six largest insured institutions and risks associated with those institutions. The DE Program has provided the FDIC with information related to those institutions’ organizational and legal structures; international activities; business segments; insured deposits; various types of risks, including credit, market, and interest rate; and supervisory actions and strategies—all of which are important in assessing and mitigating risk to the DIF. FDIC officials indicated that the DE Program has been an effective mechanism through which supervisory, insurance, and resolution-related information is obtained.

Further, the DEs have complied with DSC guidance on reporting information relative to DE Program institutions and have established effective working relationships with the institutions and their respective FBAs—OCC and OTS officials—as well as FDIC officials in the Division of Insurance and Research and Division of Resolutions and Receiverships. These officials generally agreed that the program is useful and working as intended. As of March 31, 2007, the DE Program banks held assets totaling about $4.7 trillion and domestic deposits totaling about $3.0 trillion.

The increasing complexity of the industry and the growing concentration of risk to the DIF in the largest banking organizations are expected to become more pronounced over time and to present greater risk management challenges to the FDIC. The FDIC’s DE Program is a significant resource for the FDIC, and the DEs have provided information that has enhanced the FDIC’s efforts to identify, monitor, and assess risks for large, complex banks that are not supervised by the FDIC.

Recommendations and Management Response

The report does not contain recommendations. However, the FDIC provided a response stating, in part, that the LIDI and DE Programs are effective tools in understanding and assessing risk to the DIF and that the FDIC will continue to assess means for improving the efficiency and overall effectiveness of these programs.

DE Program Contributions to the FDIC’s Efforts to Assess and Quantify Risks

Analytical Reports and Information

Conclusion

Table 1: FDIC-Insured Depository Institutions and Large Bank Programs

Table 2: Financial Institutions Included in the FDIC’s DE Program

Table 3: Analysis of Large Insured Depository Institutions

Table 4: DE Compliance with DSC Guidance

Table 5: Synopsis of Prior Coverage

This report presents the results of the subject FDIC Office of Inspector General (OIG) audit. The FDIC’s Division of Supervision and Consumer Protection (DSC) is responsible for the FDIC’s Large Insured Depository Institutions (LIDI)¹ Program, which has the primary objective to assess and quantify the risks posed by large institutions (those with consolidated banking assets exceeding $10 billion) from a deposit insurer’s perspective. To assist the FDIC in assessing the risks associated with the largest institutions in the LIDI Program, the FDIC and the other federal banking agencies (FBA) established the Dedicated Examiner (DE) Program in 2002. That program currently includes five financial institutions supervised by the Office of the Comptroller of the Currency (OCC) and one supervised by the Office of Thrift Supervision (OTS). The DE Program was established to obtain real-time access to information about the risks and trends in the largest insured institutions that are not supervised by the FDIC.

Table 1 shows the financial institutions insured by the FDIC and how they relate to the FDIC’s insurance and supervisory responsibilities and its large bank programs.

The objective of the audit was to determine whether the DE Program is contributing to the FDIC’s efforts to assess and quantify the risks posed by the largest institutions to the Deposit Insurance Fund (DIF). We conducted this performance audit in accordance with generally accepted government auditing standards. Appendix I of this report discusses our audit objective, scope, and methodology in detail.

BACKGROUND

The FDIC is responsible for maintaining stability and public confidence in the nation’s financial system by examining and supervising financial institutions, insuring deposits, and resolving failed financial institutions and managing receiverships. These responsibilities are shared among the FDIC’s three major business lines—DSC, the Division of Insurance and Research (DIR), and the Division of Resolutions and Receiverships (DRR). Generally, DSC is responsible for the safety and soundness of FDIC-supervised insured depository institutions, protecting consumers’ rights, and promoting community investment initiatives by the institutions. DSC is also responsible for operating a number of supervisory and risk assessment programs to evaluate risks presented by large, complex banks as discussed later in this report. DIR is responsible for providing the public with a sound deposit insurance system by (1) providing comprehensive statistical information on banking; (2) identifying and analyzing emerging risks; (3) conducting research that supports sound deposit insurance, banking policy, improved risk assessment, and consumer protection; and (4) assessing the adequacy of the DIF and implementing an effective and fair risk-based premium system. Finally, the resolutions and receivership management functions of DRR ensure that recovery to creditors of receiverships is achieved in the least costly manner for all failed insured depository institutions.

Monitoring of Large Insured Depository Institutions

Given the growing concentration of the FDIC’s financial risk in a smaller number of institutions, DSC’s supervisory and analysis processes have expanded for large banks, particularly through its Large Bank Supervision Branch. DSC’s large-bank supervision activities can be categorized into three general areas: (1) direct supervision and risk assessment of state nonmember banks; (2) monitoring and risk assessment of national, state member, and thrift institutions; and (3) policy development. DSC’s Large Bank Supervision Branch coordinates the DE Program, LIDI Program, and Large State Nonmember Bank Supervisory Program.² In addition, the Large Bank Supervision Branch reviews and aggregates data on large banks to identify trends and emerging risks and communicates these trends and risks to the FDIC’s Board of Directors and senior management, the other FBAs, and DSC staff. At large institutions where the FDIC is not the primary FBA, DSC case managers (CM)³ and DEs are the primary points of contact with the FBAs to assist the FDIC in monitoring risks.

Large Insured Depository Institutions Program. Assessment of the FDIC’s insurance risk at large institutions, and the large bank sector as a whole, is the cornerstone of the FDIC’s large bank supervision activities. The primary objective of the LIDI Program is to assess and quantify the risks posed by large institutions from a deposit insurer’s perspective. The risk assessment process, which provides a framework for coverage of each large institution, is based on a combination of information obtained from the institution and the associated FBA, supervisory activities, market data, and publicly-available information.

Dedicated Examiner Program. On January 29, 2002, the FDIC implemented an interagency agreement entitled, Coordination of Expanded Supervisory Information Sharing and Special Examinations, with the FBAs. The agreement’s stated objectives are to:

establish fundamental expectations for enhanced coordination and cooperation of supervisory efforts by the federal banking agencies (FBA) to ensure that the FDIC is able to fulfill its responsibilities to protect the DIF in the most efficient and least burdensome manner possible;

confirm the FBAs’ understanding regarding examinations, reports, meetings, examination personnel, and other supervisory information the FDIC will have access to related to FDIC responsibilities; and

confirm the FBAs’ understanding of the general circumstances under which the FDIC will conduct Special Examinations⁴ of insured financial institutions.

The interagency agreement (1) established parameters regarding the FDIC’s participation in examination activities for deposit insurance purposes, (2) permitted the FDIC to establish onsite examiners at the eight largest financial institution holding companies that are not supervised by the FDIC, and (3) allowed the FDIC to establish the DE Program. Due to two mergers that occurred in 2004, there are now six LIDIs in the DE Program (see Table 2).

Under the terms of the interagency agreement, the FDIC will rely on the results of work conducted by the FBAs in assessing the condition of DE Program institutions. The agreement also covers other areas, including:

• FDIC participation in Special Examinations of financial institutions that present heightened risk to the DIF (institutions that are undercapitalized or receive a composite rating⁵ of 3, 4, or 5) and
• information sharing between the FDIC and the three other FBAs, including access to supervisory personnel and information, risk assessments, supervisory plans, reports of examination, and other documents related to selected LIDIs.

Under the program, a DE is assigned to each of the six largest LIDIs to serve as the FDIC’s central point of contact for supervisory, insurance, and resolutions matters and overall risk assessment. The DEs work within the FBAs’ existing supervisory programs to avoid, to the fullest extent possible, any increase in regulatory burden or duplication of effort to assist the FDIC in protecting the DIF. Additionally, the DEs work closely with DSC’s Large Bank Supervision Branch to assess ongoing risk posed by the institutions.

Appendix II of this report provides additional details on the interagency agreement’s provisions that relate to large institutions and the DE Program.

Risks Associated with the Largest Financial Institutions

Analyses of emerging risks and trends in the financial industry or economy identified through the DE Program and other large bank supervisory programs are reviewed by the FDIC’s Risk Analysis Center (RAC)⁶ and the FDIC Board of Directors as part of the semiannual risk case presentation and are incorporated into numerous FDIC publications and written reports. The insurance risk exposure associated with large, complex financial institutions to the FDIC and the DIF is significant, considering that as of March 31, 2007, the total insured and uninsured deposits of the six DE Program financial institutions totaled about $3.0 trillion and the balance of the DIF totaled $50.7 billion. In addition, according to the FDIC’s 2007 Annual Performance Plan, the six DE Program institutions account for about 45 percent of the banking industry’s total assets.

Notably, the FDIC is not the FBA for most of the large, complex institutions it insures and does not supervise any of the DE Program banks. However, the FDIC is responsible for insuring those institutions and would be responsible for resolving the failure of a DE Program bank. As shown in Table 3, as of March 31, 2007, 119 LIDIs held assets totaling about $9 trillion. Of those 119 institutions, only 25 institutions, with assets totaling about $668 billion and deposits totaling about $466 billion, were supervised by the FDIC.

RESULTS OF AUDIT

The FDIC’s DE Program is contributing to the FDIC’s efforts to assess and quantify the risks to the DIF posed by the largest banks. More specifically, the DE program has been successful in providing the FDIC with supervisory information related to the operations at the six largest insured institutions and mitigating risks associated with those institutions. The DE Program has provided the FDIC with information related to those institutions’ organizational and legal structures; international activities; business segments; insured deposits; various types of risks, including credit, market, and interest rate; and supervisory actions and strategies—all of which are important for assessing risk to the DIF. FDIC officials indicated that the DE Program has been an effective mechanism through which supervisory, insurance, and resolution-related information is obtained.

Further, the DEs have complied with DSC guidance on reporting information relative to DE Program institutions and have established effective working relationships with the institutions and their respective FBAs—OCC and OTS officials—as well as bank management and FDIC officials in DSC, DIR, and DRR. These officials generally agreed that the program is useful and working as intended.

DE Program Contributions to the FDIC’s Efforts to Assess and Quantify Risks

The DE Program serves as a means for the FDIC to obtain information on issues that could significantly impact large, complex institutions and increase risks to the DIF. In addition, the DE Program provides (1) information on the supervisory processes at the largest, complex financial institutions that the FDIC does not supervise and (2) the full-time focus of one FDIC examiner for each institution in the program.

The DEs use supervisory information, internal institution information, and external sources to evaluate risks and assign an offsite rating⁷ and overall risk profile indicator⁸ for each of the six banking organizations in the program. The DEs collaborate with each institution’s FBA and other FDIC offices to evaluate the condition of large banks and to identify systemic risks. More specifically, the DEs:

• participate in FBA-targeted reviews⁹ and examination activities;
• access selected financial institution systems for data analysis with FBA and bank management knowledge and approval;
• attend certain financial institution management meetings that include, but are not limited to, audit, asset quality, economic capital, Basel II,¹⁰ operational risks, and credit card operations and bank board of directors and executive management meetings;
• respond to specific requests from FDIC headquarters and regional offices, for example requests for information related to hedge funds, and collateralized debt obligations; and
• report to DSC headquarters and regional offices on significant events, issues, and challenges related to the DE institutions, and submit information on the risk profiles for the institutions.

Potentially heightened insurance risks identified through the DE and other large bank supervision programs are reported to FDIC senior executives, who determine an appropriate course of action.

Additionally, the FDIC has issued the following DE Program guidelines. The related DE responsibilities are listed in Table 4:

• Regional Directors (RD) Memorandum, Dedicated Examiner Program Guidelines, May 2, 2003;
• RD Memorandum, Large Insured Depository Institutions (LIDI) Process Redesign, January 20, 2004; and
• RD Memorandum, Large Insured Depository Institution Risk Monitoring Program, February 2, 2006.

We interviewed the DEs and reviewed reports and information (described later in this report) that the DEs provided to DSC management regarding their respective financial institutions. As shown in Table 4, we determined that the DEs are complying with DSC guidance to provide specific risk-related information to FDIC management.

Dedicated Examiner Responsibilities	Complied
The indicates that the DEs complied with DSC guidance.
Develop and submit various written analytical reports:
Quarterly Executive Summary Report
Annual Business Profile
Annual Risk Assessment Plan
Ad Hoc Reports
Provide periodic presentations for the RAC
Attend quarterly formal meetings at FDIC headquarters
Use FDIC corporate specialists such as credit specialists, capital market specialists, Basel representatives, and statisticians to assist with targeted examinations or special projects
Store documents related to the DE Program banks on DSC’s Large Bank secure Website
Communicate with FBA and financial institution personnel
Develop and submit an FDIC Risk Assessment Plan to the regional office for approval (for companies with total assets exceeding $50 billion, or those that intend to opt-in for Basel II)
Establish regular communication with FBA examination staff
Assess legal entity information to ensure the FDIC's mission critical information needs are met in the areas of insured deposit information and resolutions-related information
Work with the FBAs to:	.
identify FBA reports and institution-generated reports that will be useful in the analysis of key risk areas;
identify selected supervisory activities that are mutually beneficial to participate in and that will increase the DEs’ understanding of issues relevant to FDIC risk assessment needs;
gain an understanding of their assessment of the institution's Basel II qualification and ongoing validation efforts and supervisory procedures designated to evaluate related systems and processes; and
make Basel II data available for the purpose of comparing risk estimates with those of other institutions to measure consistency and identify outliers and other risk trends posed by the institution.

Analytical Reports and Information

As shown in Table 4 earlier, the DEs develop and submit various written analytical reports to FDIC management. The DEs submit standard reports to DSC to assist in identifying, monitoring, and assessing the overall risk associated with the DE Program banks. For example, in addition to providing an overall offsite rating and risk rating, the DEs’ Quarterly Executive Summary Report provides information on a DE Program bank that includes, but is not limited to, the following.

Examples of Information Included in DE Quarterly Executive Summary Reports
Corporate overview	Market agency ratings
Risk profile	Enforcement actions
Supervisory program	Earnings
Economic capital	Credit, market, and interest rate risk
Implementation of Basel II	Derivatives
Source: DE Program Quarterly Executive Summary Report

Annual business profiles prepared by the DEs provide additional information on DE Program banks, such as information on business segments; legal entities and subsidiaries; significant events, such as acquisitions and mergers, strategies, and business plans; and an overview of the bank’s management.

The FDIC’s Annual Risk Assessment Plan for each DE Program financial institution outlines information, including, but not limited to:

• assessment of safety and soundness issues;
• bank management’s view of the institution’s associated risk;
• FBA and, if applicable, Board of Governors of the Federal Reserve System (FRB) supervisory coverage;
• risk to the DIF and risk-related premium analysis;
• insured deposit growth projection;
• resolutions considerations;
• determination of deposit insurance issues;
• marketability of assets;
• assessment of legal entities;
• Basel II implementation;
• international exposures; and
• DE activities.

The DEs also submit various ad hoc reports to assist DSC in assessing risks posed by the DE Program banks. Those reports have included information related, but not limited to, nontraditional mortgages, collaterized debt obligations, and hedge funds.

Further, the DEs present information at Large Bank Supervision Branch meetings, RAC presentations, National and Regional Risk Committee meetings, and briefings to the FDIC Chairman and Vice Chairman. The reports DEs provide assist DSC in evaluating the unique risks that are posed by the six largest insured institutions and provide ongoing information and expanded analyses of emerging risk issues associated with the DE banks as they arise. We reviewed the most recent standardized reports prepared by the six DEs and attended one DE’s presentation to the RAC and determined that the DEs complied with appropriate DSC guidance on DE responsibilities in this area.

In addition to obtaining supervisory information, the DEs obtain information from the FBAs that can assist DIR and DRR in identifying and monitoring insurance and resolution issues. To illustrate, the DEs regularly provide information to DIR to assist with deposit insurance pricing and to DRR on deposit growth forecasts. Further, DRR regional managers meet with DEs to discuss resolution considerations. In addition, DEs have included resolution considerations in their presentations and standard reports. Such considerations relate to insured deposit determination issues, diverse and liquid assets, complex information technology operations, non-bank affiliate businesses, and the number of countries with which the bank has international business. DRR is in the process of providing additional guidance to DSC and the DEs on the type of information it needs for resolution preparedness purposes.

Conclusion

The increasing complexity of