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Federal Reserve Bank of Dallas ROBERT D. McTEER, JR. DALLAS, TEXAS 75265-5906 PRESIDENT AND CHIEF EXECUTIVE OFFICER December 8, 1997 Notice 97-115 TO: The Chief Executive Officer of each financial institution and others concerned in the Eleventh Federal Reserve District SUBJECT Policy Statement on Payments System Risk; Revised Policy for Risk-Focused Supervision of Small Shell Bank Holding Companies DETAILS The Board of Governors of the Federal Reserve System has modified the daylight overdraft measurement rules to accommodate an earlier afternoon presentment deadline for checks drawn on local Federal Reserve Banks. The modification was effective November 14, 1997. The Board has also announced a revised policy for risk-focused supervision of small shell bank holding companies. Small shell bank holding companies are banking organizations with less than $1 billion of consolidated assets that do not have debt outstanding to the public and that do not engage in significant nonbank activities. The new supervisory program supersedes the previous inspection frequency guide lines applicable to small shell organizations and permits a more flexible approach to supervising these entities in a risk-focused environment. Implementation of the new program began Novem ber 30,1997. ATTACHMENTS A copy of the Board’s notice as it appears on pages 61127-28, Vol. 62, No. 220 of the Federal Register dated November 14, 1997, is attached. Also attached is a copy of the Board’s revised policy for risk-focused supervision. For additional copies, bankers and others are encouraged to use one of the following toll-free numbers in contacting the Federal Reserve Bank of Dallas: Dallas Office (800) 333-4460; El Paso Branch Intrastate (800) 592-1631, Interstate (800) 351-1012; Houston Branch Intrastate (800) 392-4162, Interstate (800) 221-0363; San Antonio Branch Intrastate (800) 292-5810. This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) MORE INFORMATION For more information regarding daylight overdrafts, please contact James Smith at (214) 922-5585. For more information regarding risk-focused supervision of small shell bank holding companies, please contact Basil Asaro at (214) 922-6066. For additional copies of this Bank’s notice, contact the Public Affairs Department at (214) 922-5254. Sincerely yours, Federal Register / Vol. 62, No. 220 / Friday, November 14, 1997 / Notices 61127 FEDERAL RESERVE SYSTEM Docket No. R-0989 Policy Statement on Payments System Risk; Modification to the Time Credits are Posted to Federal Reserve Accounts for Checks Drawn on Local Federal Reserve Banks for Purposes of Measuring Daylight Overdrafts AGENCY: B oard of G overnors of the F ed eral Reserve System . ACTION: Policy Statem ent. T he B oard h as m o d ifie d the day light overdraft m e asu rem en t ru les to acco m m odate an earlier aftern oon p re se n tm e n t d ea d lin e for checks d raw n on local F ed eral Reserve Banks. EFFECTIVE DATE: N ovem ber 14, 1997. SUMMARY: FOR FURTHER INFORMATION CONTACT: M yriam P ayne, S enior F in an cial Services A n alyst (202/452-3219), or Stacy Panigay, F in an c ial Services A n aly st (202/452-2934), D ivision of Reserve B ank O perations a n d P ay m ent System s; for th e h earing im p aired only. T eleco m m u n icatio n s D evice for the Deaf, D iane Jenkins (202/452-3544). SUPPLEMENTARY INFORMATION: Background W h en th e B oard m o d ified the P aym ents System Risk R e duction policies in 1992 (57 FR 47093, O ctober 14 ,1 9 9 2 ), it a d o p te d a set of “ p osting ru le s ” w h ic h com p rise a sc h ed u le for th e in tra d ay tim ing of debits a n d credits to in stitu tio n s’ F ederal Reserve acco unts for different types of p ay m en ts. W ith th e im p lem en ta tio n of th e se ru les along w ith th e im p o sitio n of fees for daylight overdrafts, th e B oard w as in tereste d in in d u c in g behavio ral changes to control risk a n d in crease efficiency in th e pay m en ts system . U n d er th e daylight overdraft m e asu rem en t ru les th a t becam e effective on O ctober 14, 1993, d ep o sito ry in stitu tio n s th a t d ep o sit in separately so rted cash letters Checks D raw n on Local F ederal Reserve Banks 61128 Federal Register / Vol. 62, No. 220 / Friday, November 14, 1997 / Notices (i.e., F ederal F u n d s checks), U.S. T reasury Checks, P ostal M oney O rders, an d U.S. Savings Bonds D epo sited u n d e r the EZ-Clear Program by 4 p.m . ET receive cre d it for th e se item s at 5 p.m . ET. Analysis of Federal Funds Checks Presentment Deadline T he B oard believes th a t estab lishin g a c o n siste n t p re se n tm e n t d e a d lin e for F ederal F u n d s checks in all F ederal Reserve d istricts w ill h elp red u c e the ro u tin e use of F ederal F u n d s ch e ck s.1 F ederal F u n d s checks are an in a p p ro p ria te m ean s of p ro viding regular access to an in s titu tio n ’s F ederal Reserve ac co u n t an d th e ir ro u tin e u se is contrary to th e F ederal R eserve’s strategy of p ro m o tin g efficient an d effective m e th o d s of pay m en t. In alm ost all cases w h ere F ederal F u n d s checks are u se d as th e p ay m e n t in stru m en t, the tran sa ctio n c o u ld h av e b ee n m ad e th ro u g h a m ore secure a n d efficient m eth o d , su ch as a fu nds transfer netw ork. To d iscourage th e u se of F ederal F u n d s checks a n d encourage dep o sito ry in stitu tio n s ’ u se of m ore efficient m ean s of p ay m ent, a 3 p.m . local tim e p re se n tm e n t d e a d lin e for F ederal F u n d s checks w ill be im p lem en te d . Policy Statement on Payments System Risk T he F ederal Reserve B oard has ad o p te d th e follow ing changes to the “ F ederal Reserve S ystem Policy S tatem ent on P aym ents S ystem R isk,” u n d e r th e h ea d in g “ I. F ed eral Reserve P o lic y ” : Modified Procedures for Measuring Daylight Overdrafts Post at 5:00 p.m . E astern Time: • T reasu ry checks, postal m o n ey orders, a n d EZ-Clear Savings B ond red e m p tio n s in separately so rted deposits. T hese item s m u st be dep o sited by 4:00 p.m . E astern Time. • Local F ed eral Reserve B ank checks. T hese item s m u st b e p re se n te d before 3:00 p.m . E astern Time. • P ro cessed m a n u a l letters of credit. +/- S am e-day ACH transactio ns. T hese tran sa ctio n s in c lu d e ACH re tu rn item s, ch eck tru n c a tio n item s, a n d flexible settle m e n t item s. 1Federal Funds checks are drafts drawn by a depository institution against its account at a Federal Reserve Bank. These funds represent immediately available funds when presented for payment, and thus, when used, the checks are most often used to settle same-day securities transactions, interbank transfers, international transactions, real estate transactions, payments to state and local governments, Federal Reserve Bank transactions and for other situations where a bank check is required for legal reasons. Post after th e close of F ed w ire fu nds tran sfer system : +/- A ll o th er no n-F edw ire tran saction s. T hese tran sactio n s in c lu d e th e follow ing: local F ederal Reserve B ank checks p re se n te d after 3:00 p.m . E astern T im e b u t before 3:00 p.m . local tim e; n o n c a sh collection; credits for U.S. T reasury an d g ov ern m en t agency definitive security in terest a n d re d e m p tio n p ay m en ts if th e co u p o n s or secu rities are received on or after th e m atu rity date; T reasury T ax a n d Loan (TT&L) calls; su b sc rip tio n s for SLGS; cu rren c y a n d co in sh ip m en ts; sm alldo llar cre d it adju stm ents; all debit adjustm ents; a n d sm all-dollar check collections. D iscount w in d o w loans an d rep ay m en ts are n o rm ally p o ste d after th e close of F edw ire as w ell; how ever, in u n u su a l circum stances a d isc o u n t w in d o w loan m ay be p o ste d earlier in th e day w ith re p a y m e n t 24 h o u rs later, or a loan m ay be re p a id before it w o u ld oth erw ise becom e due. By o rd er of th e B oard of G overnors of th e F ederal Reserve System , N ovem ber 7, 1997. Jennifer J. Johnson, D eputy Secretary of the Board. [FR D oc. 9 7 - 2 9 9 6 2 F ile d 1 1 - 1 3 - 9 7 ; 8:45 am] BILLING CODE 6210-01— P Attachment A RISK-FOCUSED SUPERVISION POLICY FOR SMALL SHELL BANK HOLDING COMPANIES This policy sets forth a framework for applying risk-focused supervision concepts to small shell bank holding companies (SSBHCs).1 It was developed in the interest of increasing the effectiveness of Federal Reserve supervisory activities, while enhancing interagency coordination and reducing regulatory burden on banking organizations. In recent years, changes to statutory frequency requirements for bank examinations, enhancements to off-site monitoring procedures, and the implementation of risk-focused examination practices have made it possible to focus supervisory activities more effectively on SSBHCs exhibiting the greatest degree of risk. Accordingly, the Federal Reserve is adopting a risk-focused supervision program for SSBHCs that tailors supervisory activities for these companies based on an assessment of their reported condition and activities and the condition of their bank subsidiaries. Based on these assessments, Reserve Banks will be required to develop a strategy for addressing the supervisory issues related to each organization. For companies where significant risk factors are present, Reserve Banks must consider a range of supervisory responses, including informational requests and management interviews, visitations or advisory visits, as well as on-site target and full-scope inspection activities. The program is to be implemented as soon as practical, but should be fully operational by November 30, 1997. With the implementation of this program, the Board is rescinding for SSBHCs the bank holding company inspection scope and frequency requirements of SR 85-28, “Examination Frequency and Communicating with Directors.” Risk Assessment Process Under this program, Reserve Banks should perform a risk assessment for 1 Small shell bank holding companies are defined for the purpose of this program as those companies with less than $1 billion in consolidated assets that do not have debt outstanding to the public, and that do not engage in significant nonbank activities. A nonbank activity could be considered significant based on the scope or type of activity. For example, credit extending activities as well as investment and trading activities where the holding company acts as a principal would generally be considered significant. The provision of services on a fee basis such as the provision of data processing services to affiliated and/or unaffiliated banks or the sale of instruments on an agency basis may also, in certain instances, be considered significant, depending on the scale of the activity or other factors that may pose direct or indirect risk to the holding company or any insured depository institution subsidiary. 2 each SSBHC at least once during each “supervisory cycle.” For each company, its supervisory cycle will be determined by the examination frequency mandated for the lead subsidiary bank. The purpose of this risk assessment is to determine whether the risk profile of the SSBHC has weakened, the company is having an adverse effect on the subsidiary bank(s), or there are violations of law or regulation warranting further review. As described more fully below, where the risk assessment does notTaise significant supervisory concerns, the assessment would serve as the basis for assigning a final BOPEC rating for the company. The risk assessment should be completed within 45 days of receipt of the lead bank’s full-scope examination report. While risk assessments will be driven in most cases by the conclusions expressed in the current examination reports for subsidiary banks, they should also incorporate information from other sources available at the Reserve Bank, such as regulatory financial reports, previous inspection reports, and surveillance reports. The preparation of risk assessments should not routinely require requests for additional information from the company. Risk assessments should include reviews of the following areas: • Financial condition of the parent company, including an evaluation of debt levels and cash flow; • Financial condition of bank subsidiaries; • Consolidated analysis (if applicable); • Management, including any changes to senior management or ownership; • Compliance with laws and regulations by the bank holding company and bank subsidiaries, as well as compliance with regulatory orders and other requirements imposed in connection with the granting of any application or other request; • Intercompany and insider transactions as addressed by examinations and financial reports; and • New activities and recent or planned acquisitions. In the process of conducting the risk assessment Reserve Banks should pay special attention to bank examination report findings pertaining to possible violations of law or inappropriate transactions. In addition, changes in the organizational structure, management, or ownership of the company should be assessed to determine whether these may be cause for concern. The use of 3 automated analytical tools and screens to perform the required financial analysis will normally suffice. When this review discloses no material supervisory concerns, the risk assessment should be used to assign a final rating to the company. Development of Supervisory Strategies If no unusual supervisory issues or concerns are identified by the risk assessment, no special follow-up with the company is necessary. However, all companies should continue to be monitored under existing surveillance and monitoring programs aimed at identifying significant changes in a company’s condition, performance, or compliance profile that may prompt further review. Such changes may include 1) a material decline in the earnings performance or capital position of a bank subsidiary; 2) significant changes in management or ownership; 3) a large increase in outstanding debt; 4) new or expanded activities that may pose additional risk; 5) rapid growth; 6) questionable insider or intercompany transactions; 7) less than satisfactory SEER or other performance factors for the subsidiary bank(s); or 8) information suggesting less than satisfactory compliance with regulatory orders and other requirements imposed in connection with the granting of any application or other request. When these or other changes raise supervisory concerns, the risk assessment should be updated using the methods discussed below. When a risk assessment is prepared in conjunction with the review of an examination report for a bank rated satisfactory or better, but supervisory concerns such as those listed above preclude the immediate assignment of a satisfactory BOPEC rating, a strategy for addressing those concerns must be developed and documented as part of the risk assessment. The strategy would typically require gathering additional information from the bank regulator or the company, either written or verbal. Where supervisory concerns are not satisfactorily addressed through off-site measures, a number of remedies should be considered, including visitations, targeted reviews of internal processes and specific transactions, or broader inspections encompassing a review of more significant financial and managerial issues, processes, or reporting systems. The specific timing of these activities is not prescribed by this policy; however, the on-site activity should be conducted as soon as possible following the off-site review, given that it is required only in situations when supervisory concerns have surfaced. Strategies for Problem and Deteriorating Companies and Those with Identified Management Weaknesses A full-scope, on-site inspection should be conducted the first time that the risk assessment preliminarily supports the assignment of a BOPEC rating of 3 or worse, or a management rating of less than satisfactory. Typically, this would occur when a 4 significant subsidiary bank’s CAMELS composite or management component is assigned a rating of 3, 4, or 5. In such a case, an inspection is deemed necessary to ensure that sufficient information is available to develop an effective supervisory strategy. The purpose of the inspection is: 1) to confirm the Reserve Bank’s understanding of the SSBHC’s financial condition, activities, and management oversight of the bank, as well as whether violations of law or regulation or inappropriate intercompany transactions have occurred; 2) to determine the extent to which any of these factors is having an adverse effect on the bank(s); 3) to identify steps the holding company should take to strengthen its subsidiary bank(s); and 4) to assign a BOPEC rating to the company. Based on these inspection results and information available prior to the inspection, and in consultation with the bank’s federal and state supervisory authority(ies), the Reserve Bank should develop a supervisory strategy for dealing with the company. In situations where the company and management are adversely affecting the bank, the strategy should contemplate enforcement activities that are coordinated with those of the bank’s federal or state regulator(s), a clear delineation of the actions and reports expected of holding company management, and plans for additional supervisory activities, either on-site or off-site. The Reserve Bank should designate a primary contact responsible for monitoring the company’s condition and updating the risk assessment and supervisory strategy. In situations where the bank holding company is neither contributing to the bank’s problems nor in a position to serve as a source of strength, a typical supervisory strategy would be to maintain an open dialogue with the bank’s primary regulator(s) and to review relevant regulatory reports. Communicating Supervisory Findings When a risk assessment discloses no supervisory concerns, or when an existing 3, 4, or 5 BOPEC rating is reaffirmed through the risk assessment, a brief letter detailing this overall conclusion and the SSBHC’s BOPEC rating should be forwarded to the company. A prototype of such a letter is attached. When more detailed off-site reviews are performed or on-site targets or visitations are conducted, Reserve Banks may also communicate the scope of these activities, relevant findings, and supervisory recommendations to the company in a letter. Alternatively, the findings can be conveyed to the company in a more structured report similar to the existing bank holding company inspection report. When full-scope inspections are conducted, use of existing bank holding company report pages is mandatory; however, the only pages required to be completed are the Examiner’s Comments, Scope, Analysis of Financial Factors, and the confidential pages. The use 5 of any other page (including financial data pages) should be limited to situations where its presentation is useful for supporting conclusions or recommendations. With regard to correspondence and reports to satisfactorily rated SSBHCs, it is generally appropriate for commissioned, non-officer personnel who are designated as the primary contact or portfolio manager for such companies to have signing authority. Reports and other official communications to problem and deteriorating companies require an officer’s signature. Discontinuation of Risk Management Ratings for SSBHCs Effective January 1, 1997, the Uniform Financial Institutions Rating System (CAMELS) was amended specifically to require the evaluation of risk management systems both in the overall management rating and in the individual financial components. By definition, financial and management activities at SSBHCs are conducted in the subsidiary banks and the risk management process of the company is essentially the same as that of the bank(s). Accordingly, no separate risk management rating will be required of SSBHCs. Newly Formed SSBHCs Consistent with long-standing Federal Reserve policy, an initial full-scope, on-site inspection of a newly formed SSBHC should be conducted within the first 12 to 18 months of operations. Thereafter, risk assessments should be performed in accordance with this policy. 6 Attachment B Prototype Letter to Communicate Findings of a Risk Assessment Board of Directors [name and address of SSBHC] Dear Members of the Board: This Reserve Bank has conducted a review of [SSBHC] based primarily on financial and other information regularly provided by your organization to the Federal Reserve and other supervisory agencies, as well as the recent examination report for [Bank], SSBHC’s subsidiary bank. The review was conducted by Examiner [EIC] and disclosed no supervisory concerns [or, no concerns in addition to those previously communicated to the institution], [SSBHC] is assigned a composite BOPEC rating of [numerical rating], based on a bank component rating of [numerical rating] and a parent company component rating of [numerical rating]. Management is regarded as [rating]. The ratings assigned to the bank holding company are part of the overall findings of this review and are confidential. They should not be disclosed or made public. If you have any questions or comments regarding the risk assessment, or any regulatory matter concerning your organization, please contact [Reserve Bank contact] of this Reserve Bank at [telephone number]. Sincerely yours,