About this Manual Section 1000.0

PURPOSE AND THE ROLE OF should not be considered a legal reference docu- GUIDANCE ment. Questions concerning the applicability of and compliance with federal laws and regula- The Bank Holding Company Supervision tions should be referred to appropriate legal Manual is prepared by Federal Reserve supervi- counsel. sion personnel to provide guidance to examiners as they conduct inspections of bank holding companies (BHCs) and their nonbank subsidi- aries as well as savings and loan holding compa- USE OF THE MANUAL nies (SLHCs). The manual is a compilation of formalized procedures and Board supervisory The Bank Holding Company Supervision policies that examiners and supervision person- Manual is presented in “sections” which have nel should follow for the supervision of these been grouped together into “parts” that have in organizations. It also discusses the relevant stat- common a central theme pertaining to holding utes, regulations, interpretations, and orders that company supervision. For example, Part I pro- pertain to holding company supervision. The vides an overview of the supervisory process of manual enhances the staff’s ability to implement holding companies. Part II is composed of sec- the Board’s inspection, supervisory, and moni- tions that discuss topics of special interest for toring activities, which is integral to the Federal supervisory review. Part III is composed of sec- Reserve’s supervision program for organiza- tions that discuss the various exemptive provi- tions operating under a holding company struc- sions to the nonbank prohibitions of the BHC ture. This manual is periodically updated on the Act. Part IV presents sections on the preparation Board’s public website to reflect the latest super- of a financial analysis. visory policy and procedures and to address The content of the sections within parts II–IV changes in industry risk-management practices.1 are grouped into four broad categories: (1) Main The Federal Reserve and the other banking Section Content (2) Inspection Objectives, (3) In- and regulatory agencies issue various types of spection Procedures, and (4) Laws, Regulations, supervisory guidance, including interagency Interpretations, and Orders. Not all of the cate- statements, advisories, bulletins, policy state- gories are presented in each section. This manual ments, questions and answers, and frequently uses a numbering system for organizing and asked questions, to their respective supervised referencing content. Content in subsections with institutions. A statute or regulation has the force headings having “tenths” or one decimal point and effect of law.2 Unlike a law or regulation, generally provide higher-level or foundational supervisory guidance does not have the force information. Content under subheadings with and effect of law, and the agencies do not take several decimal points convey more detailed enforcement actions based on supervisory guid- information. ance. Rather, supervisory guidance outlines the Where a particular topic is exclusively finan- agencies’ supervisory expectations or priorities cially related and does not involve legal consid- and articulates the agencies’ general views re- erations, the subsection on “Laws, Regulations,” garding appropriate practices for a given subject may be omitted. These procedures were de- area. Supervisory guidance often provides ex- signed for a full-scope, comprehensive inspec- amples of practices that the agencies generally tion. It is recognized that in some instances the consider consistent with safety-and-soundness procedures may not apply in their entirety to all standards or other applicable laws and regula- holding companies. Examiners should exercise tions, including those designed to protect con- supervisory judgment in completing procedures sumers. See SR letter 18-5/CA letter 18-7, “In- depending upon the characteristics of the orga- teragency Statement Clarifying Role of nization under inspection. Supervisory Guidance.” This manual is designed to provide guidance to examination and supervision personnel. It

1. https://www.federalreserve.gov/boarddocs/supmanual/ 2. Government agencies issue regulations that generally have the force and effect of law. Such regulations generally take effect only after the agency proposes the regulation to the public and responds to comments on the proposal in a final BHC Supervision Manual February 2019 rulemaking document. Page 1 About this Manual 1000.0

TYPES OF HOLDING COMPANIES Savings and Loan Holding Companies

Savings and loan holding companies (SLHCs) Bank Holding Companies (Including directly or indirectly control a savings associa- Financial Holding Companies) tion. Federal savings associations (those with federal charters) are supervised by the Office of Banks are often owned or controlled by another the Comptroller of the Currency, while state- company, called a bank holding company (BHC). chartered savings associations are generally su- The Federal Reserve has supervisory and regu- pervised by the Federal Deposit Insurance Cor- latory authority for all BHCs, regardless of porationandtheircharteringstate.Besidesowning whether subsidiary banks of the holding com- federal and/or state savings associations, an pany are national banks, state member banks, or SLHC that meets capital and management re- state nonmember banks. It also has supervisory quirements and elects to be treated as a financial authority over any nonbank subsidiary of a BHC holding company may also engage in activities that is not functionally regulated by another as if it were a financial holding company that federal or state supervisor, such as a leasing controls a bank. subsidiary. Historically, SLHCs were regulated by other The Gramm-Leach-Bliley Act of 1999 per- agencies: at first, the Federal Home Loan Bank mits BHCs that meet certain criteria to become Board, and more recently, by the Office of Thrift financial holding companies (FHCs), which are Supervision (OTS). In 2010, the Dodd-Frank also under Federal Reserve’s supervisory and Wall Street Reform and Consumer Protection regulatoryauthority.FHCsengageinanexpanded Act eliminated the OTS and transferred supervi- list of activities including securities underwrit- sory and regulatory responsibilities for SLHCs ing and dealing, merchant banking, insurance to the Federal Reserve. As a result, the Federal underwriting, and the sale of insurance. When Reserve now supervises and regulates all SLHCs an FHC engages in these activities, the Federal regardless of the charters of the subsidiary sav- Reserve coordinates its supervisory efforts with ings associations. The Federal Reserve coordi- those of the subsidiary’s functional regulator— nates its supervisory efforts with the appropriate for example, the U.S. Securities and Exchange functional regulator(s) for a SLHC. Commission in the case of a broker-dealer, and state insurance regulators in the case of an insur- ance company.

BHC Supervision Manual February 2019 Page 2 General Table of Contents Bank Holding Company Supervision Manual 1010.0

This general table of contents lists the major section heads for each part of the manual: 1000 About this Manual, Supervisory Process 2000 Supervisory Policy and Issues 3000 Nonbanking Activities 4000 Financial Analysis 5000 BHC Inspection Program

Sections Title

1000 ABOUT THIS MANUAL, SUPERVISORY PROCESS

1000.0 About this Manual

1010.0 Table of Contents

1020.0– Reserved 1030.0 1040.0 Bank Holding Company Examination and Inspection Authority

1045.0 Supervision of Holding Companies with Total Consolidated Assets of $10 Billion or Less

1050.0 Consolidated Supervision of Bank Holding Companies and the Combined U.S. Operations of Foreign Banking Organizations

1050.1 Guidance for the Consolidated Supervision of Domestic Bank Holding Companies that are Large Complex Banking Organizations

1050.2 Guidance for the Consolidated Supervision of Regional Bank Holding Companies

1060.0 Large Financial Institution Rating System

1062.0 RFI Rating System

1063.0 Holding Company Ratings Applicability and Inspection Frequency

1065.0 Nondisclosure of Supervisory Ratings and Confidential Supervisory Information

1070.1 Communication of Supervisory Findings

2000 SUPERVISORY POLICY AND ISSUES

2000.0 Introduction to Topics for Supervisory Review

2010.0 Supervision of Subsidiaries

2010.1 Funding Policies

2010.2 Loan Administration

BHC Supervision Manual February 2020 Page 1 General Table of Contents Section 1010.0

Sections Title

2010.3 Investments

2010.4 Consolidated Planning Process

2010.5 Environmental Liability

2010.6 Financial Institution Subsidiary Retail Sales of Nondeposit Investment Products

2010.7 Reserved

2010.8 Sharing of Facilities and Staff by Banking Organizations

2010.9 Required Absences from Sensitive Positions

2010.10 Internal Loan Review

2010.11 Private-Banking Functions and Activities

2010.12 Fees Involving Investments of Fiduciary Assets in Mutual Funds and Potential Conflicts Interest

2010.13 Establishing Accounts for Foreign Governments Embassies, and Political Figures

2020.0 Intercompany Transactions—Introduction

2020.1 Intercompany Transactions Between Affiliates—Sections 23A and 23B of the Federal Reserve Act

2020.2 Loan Participations—Intercompany Transactions

2020.3 Sale and Transfer of Assets

2020.4 Compensating Balances

2020.5 Dividends

2020.6 Management and Service Fees

2020.7 Transfer of Low-Quality Assets

2020.8 Reserved

2020.9 Split-Dollar Life Insurance

2030.0 Grandfather Rights—Retention and Expansion of Activities

2040.0 Commitments to the Federal Reserve

2050.0 Extensions of Credit to BHC Officials

2060.0 Management Information Systems

BHC Supervision Manual February 2020 Page 2 General Table of Contents Section 1010.0

Sections Title

2060.05 Policy Statement on the Internal Audit Function and Its Outsourcing

2060.07 Supplemental Policy Statement on the Internal Audit Function and Its Outsourcing

2060.1 Audit

2060.2 Budget

2060.3 Records and Statements

2060.4 Structure and Reporting

2060.5 Insurance

2065.1 Accounting, Reporting, and Disclosure Issues— Nonaccrual Loans and Restructured Debt

2065.2 Determining an Adequate Level for the Allowance for Loan and Lease Losses

2065.3 Maintenance of an Adequate Allowance for Loan and Lease Losses

2065.4 ALLL Methodologies and Documentation

2065.5 ALLL Estimation Practices for Loans Secured by Junior Liens

2068.0 Sound Incentive Compensation Policies

2070.0 Taxes—Consolidated Tax Filing

2080.0 Funding—Introduction

2080.05 Bank Holding Company Funding and Liquidity

2080.1 Commercial Paper and Other Short-Term Uninsured Debt Obligations and Securities

2080.2 Long-Term Debt

2080.3 Equity

2080.4 Retention of Earnings

2080.5 Pension Funding and Employee Stock Option Plans

2080.6 Bank Holding Company Funding from Sweep Accounts

2090.0 Control and Ownership—General

2090.05 Qualified Family Partnerships

2090.1 Change in Control

BHC Supervision Manual February 2020 Page 3 General Table of Contents Section 1010.0

Sections Title

2090.2 BHC Formations

2090.3 Treasury Stock Redemptions

2090.4 Policy Statements on Equity Investments in Banks and BHCs

2090.5 Acquisitions of Bank Shares Through Fiduciary Accounts

2090.6 Divestiture Control Determinants

2090.7 Nonbank Banks

2090.8 Liability for Commonly Controlled Depository Institutions

2091.0− Reserved 2092.0 2093.0 Control and Ownership—Shareholder Protection Arrangements

2100.0 International Banking Activities

2110.0 Formal Corrective Actions

2120.0 Foreign Corrupt Practices Act and Federal Election Campaign Act

2122.0 Internal Credit-Risk Ratings at Large Banking Organizations

2124.0 Risk-Focused Safety-and-Soundness Inspections

2124.01 Risk-Focused Supervisory Framework for Large Complex Banking Organizations

2124.02– Reserved 2124.04 2124.05 Consolidated Supervision Framework for Large Financial Institutions

2124.07 Compliance Risk-Management Programs and Oversight at Large Banking Organizations with Complex Compliance Profiles

2124.1 Assessment of Information Technology in Risk-Focused Supervision

2124.2 Reserved

2124.3 Managing Outsourcing Risk

2124.4 Information Security Standards

2124.5 Identity Theft Red Flags and Address Discrepancies

2125.0 Trading Activities of Banking Organizations—Risk Management and Internal Controls

BHC Supervision Manual February 2020 Page 4 General Table of Contents Section 1010.0

Sections Title

2126.0 Model Risk Management

2126.1 Investment Securities and End-User Derivatives Activities

2126.2 Investing in Securities without Reliance on Ratings of Nationally Recognized Statistical Rating Organizations 2126.3 Counterparty Credit Risk Management Systems

2126.5 Procedures for a Banking Entity to Request an Extended Transition Period for Illiquid Funds 2127.0 Interest-Rate Risk—Risk Management and Internal Controls

2128.0 Structured Notes—Risk Management and Internal Controls

2128.01 Reserved

2128.02 Asset Securitization

2128.03 Credit-Supported and Asset-Backed Commercial Paper

2128.04 Implicit Recourse Provided to Asset Securitizations

2128.05 Securitization Covenants Linked to Supervisory Actions or Thresholds

2128.06 Valuation of Retained Interests and Risk Management of Securitization Activities 2128.07 Reserved

2128.08 Subprime Lending

2128.09 Elevated-Risk Complex Structured Finance Activities

2129.0 Credit Derivatives—Risk Management and Internal Controls

2129.05 Risk and Capital Management—Secondary-Market Credit Activities

2130.0 Futures, Forward, and Option Contracts

2140.0 Securities Lending

2150.0 Repurchase Transactions

2160.0 Recognition and Control of Exposure to Risk

2175.0 Sale of Uninsured Annuities

2178.0 Support of Bank-Affiliated Investment Funds

2180.0 Securities Activities in Overseas Markets

BHC Supervision Manual February 2020 Page 5 General Table of Contents Section 1010.0

Sections Title

2187.0 Violations of Federal Reserve Margin Regulations Resulting from “Free-Riding” Schemes

2220.3 Note Issuance and Revolving Underwriting Credit Facilities

2231.0 Real Estate Appraisals and Evaluations

2240.0 Guidelines for the Review and Classification of Troubled Real Estate Loans

2241.0 Retail-Credit Classification

2250.0 Domestic and Other Reports to Be Submitted to the Federal Reserve

2260.0 Venture Capital

2500.0 Supervision of Savings and Loan Holding Companies

3000 NONBANKING ACTIVITIES

3000.0 Introduction to BHC Nonbanking and FHC Activities

3001.0 Section 2(c) of the BHC Act—Savings Bank Subsidiaries of BHCs Engaging in Nonbanking Activities

3005.0 Section 2(c)(2)(F) of the BHC Act—Credit Card Bank Exemption from the Definition of a Bank

3010.0 Section 4(c)(i) and (ii) of the BHC Act—Exemptions from Prohibitions on Acquiring Nonbank Interests

3020.0 Section 4(c)(1) of the BHC Act—Investment in Companies Whose Activities Are Incidental to Banking

3030.0 Section 4(c)(2) and (3) of the BHC Act—Acquisition of DPC Shares, Assets, or Real Estate

3032.0 Rental of Other Real Estate Owned Residential Property 3040.0 Section 4(c)(4) of the BHC Act—Interests in Nonbanking Organizations

3050.0 Section 4(c)(5) of the BHC Act—Investments Under Section 5136 of the Revised Statutes

3060.0 Section 4(c)(6) and (7) of the BHC Act—Ownership of Shares in Any Nonbank Company of 5 Percent or Less

3070.0 Section 4(c)(8) of the BHC Act—Mortgage Banking

3070.3 Non-Traditional Mortgages—Associated Risks

3071.0 Section 4(c)(8) of the BHC Act—Mortgage Banking— Derivative Commitments to Originate and Sell Mortgage Loans

BHC Supervision Manual February 2020 Page 6 General Table of Contents Section 1010.0

Sections Title

3072.0 Section 4(c)(8) of the BHC Act—Activities Related to Extending Credit

3072.8 Real Estate Settlement Services

3073.0 Section 4(c)(8) of the BHC Act—Education-Financing Activities

3080.0 Section 4(c)(8) of the BHC Act—Servicing Loans

3084.0 Section 4(c)(8) of the BHC Act—Asset-Management, Asset-Servicing, and Collection Activities

3090.0 Section 4(c)(8) of the BHC Act—Receivables

3090.1 Factoring

3090.2 Accounts Receivable Financing

3100.0 Section 4(c)(8) of the BHC Act—Consumer Finance

3104.0 Section 4(c)(8) of the BHC Act—Acquiring Debt in Default

3105.0 Section 4(c)(8) of the BHC Act—Credit Card Authorization and Lost/Stolen Credit Card Reporting Services 3107.0 Section 4(c)(8) of the BHC Act—Stand-Alone Inventory Inspection Services

3110.0 Section 4(c)(8) of the BHC Act—Industrial Banking

3111.0 Section 4(c)(8) of the BHC Act—Acquisition of Savings Associations

3120.0 Section 4(c)(8) of the BHC Act—Trust Services

3130.0 Section 4(c)(8) of the BHC Act—General Financial and Investment Advisory Activities 3130.1 Investment or Financial Advisers

3130.2 Reserved

3130.3 Advice on Mergers and Similar Corporate Structurings, Capital Structurings, and Financing Transactions

3130.4 Informational, Statistical Forecasting, and Advisory Services for Transactions in Foreign Exchange and Swaps, Commodities, and Derivative Instruments 3130.5 Providing Educational Courses and Instructional Materials for Consumers on Individual Financial Management Matters

3130.6 Tax-Planning and Tax-Preparation Services

3140.0 Section 4(c)(8) of the BHC Act—Leasing Personal or Real Property

3150.0 Section 4(c)(8) of the BHC Act—Community Welfare Projects

BHC Supervision Manual February 2020 Page 7 General Table of Contents Section 1010.0

Sections Title

3160.0 Section 4(c)(8) of the BHC Act—EDP Servicing Company

3160.1 EDP Servicing—Network for the Processing and Transmission of Medical Payment Data

3160.2 Electronic Benefit Transfer, Stored-Value-Card, and Electronic Data Interchange Services

3160.3 Data Processing Activities: Obtaining Traveler’s Checks and Postage Stamps Using an ATM Card and Terminal

3160.4 Providing Data Processing for ATM Distribution of Tickets, Gift Certificates, Telephone Cards, and Other Documents

3160.5 Engage in Transmitting Money

3165.1 Support Services—Printing and Selling MICR-Encoded Items

3170.0 Section 4(c)(8) of the BHC Act—Insurance Agency Activities of Bank Holding Companies

3180.0 Section 4(c)(8) of the BHC Act—Insurance Underwriters

3190.0 Section 4(c)(8) of the BHC Act—Courier Services

3200.0 Section 4(c)(8) of the BHC Act—Management Consulting and Counseling

3202.0 Section 4(c)(8) of the BHC Act—Employee Benefits Consulting Services

3204.0 Section 4(c)(8) of the BHC Act—Career Counseling

3210.0 Section 4(c)(8) of the BHC Act—Money Orders, Savings Bonds, and Traveler’s Checks

3210.1 Payment Instruments

3220.0 Section 4(c)(8) of the BHC Act—Arranging Commercial Real Estate Equity Financing

3230.0 Section 4(c)(8) of the BHC Act—Agency Transaction Services for Customer Investments (Securities Brokerage)

3230.05 Securities Brokerage (Board Decisions)

3230.1 Securities Brokerage in Combination with Investment Advisory Services

3230.2 Securities Brokerage with Discretionary Investment Management and Investment Advisory Services

3230.3 Offering Full Brokerage Services for Bank-Ineligible Securities

3230.4 Private-Placement and Riskless-Principal Activities

BHC Supervision Manual February 2020 Page 8 General Table of Contents Section 1010.0

Sections Title

3230.5 Acting as a Municipal Securities Brokers’ Broker

3230.6 Acting as a Conduit in Securities Borrowing and Lending

3240.0 Section 4(c)(8) of the BHC Act—Underwriting and Dealing in U.S. Obligations, Municipal Securities, and Money Market Instruments

3250.0 Section 4(c)(8) of the BHC Act—Agency Transactional Services (Futures Commission Merchants and Futures Brokerage)

3251.0 4(c)(8) Agency Transactional Services—FCM Board Orders

3255.0 Section 4(c)(8) of the BHC Act—Agency Transactional Services for Customer Investments

3260.0 Section 4(c)(8) of the BHC Act—Investment Transactions as Principal

3270.0 Section 4(c)(8) of the BHC Act—Real Estate and Personal Property Appraising

3320.0 Section 4(c)(8) of the BHC Act—Check-Guaranty and Check-Verification Services

3330.0 Section 4(c)(8) of the BHC Act—Operating a Collection Agency

3340.0 Section 4(c)(8) of the BHC Act—Operating a Credit Bureau

3500.0 Tie-In Considerations of the BHC Act

3510.0 Sections 4(c)(9) and 2(h) of the BHC Act—Nonbanking Activities of Foreign Banking Organizations

3520.0 Section 4(c)(10) of the BHC Act—Grandfather Exemption from Section 4 for BHCs Which Are Banks

3530.0 Section 4(c)(11) of the BHC Act—Authorization for BHCs to Reorganize Share Ownership Held on the Basis of Any Section 4 Exemption

3540.0 Section 4(c)(12) of the BHC Act—Ten-Year Exemption from Section 4 of the BHC Act

3550.0 Section 4(c)(13) of the BHC Act—International Activities of Bank Holding Companies

3560.0 Section 4(c)(14) of the BHC Act—Export Trading Companies

3600.0 Permissible Activities by Board Order

3600.1 Operating a “Pool Reserve Plan”

3600.2– Reserved 3600.4 3600.5 Engaging in Banking Activities via Foreign Branches

BHC Supervision Manual February 2020 Page 9 General Table of Contents Section 1010.0

Sections Title

3600.6 Operating a Securities Exchange

3600.7 Acting as a Certification Authority for Digital Signatures

3600.8 Private Limited Investment Partnerships

3600.9– Reserved 3600.12 3600.13 FCM Activities

3600.14– Reserved 3600.16 3600.17 Insurance Activities

3600.18– Reserved 3600.20

3600.21 Underwriting and Dealing

3600.22 Reserved

3600.23 Issuance and Sale of Mortgage-Backed Securities Guaranteed by GNMA

3600.24 Sales-Tax Refund Agent and Cashing U.S. Dollar Payroll Checks

3600.25 Providing Government Services

3600.26 Real Estate Settlement through a Permissible Title Insurance Agency

3600.27 Providing Administrative and Certain Other Services to Mutual Funds

3600.28 Developing Broader Marketing Plans and Advertising and Sales Literature for Mutual Funds 3600.29 Providing Employment Histories to Third Parties

3600.30 Real Estate Title Abstracting

3610.1 Section 4(c)(8) of the BHC Act—Board Staff Legal Interpretation—Financing Customers’ Commodity Purchase and Forward Sales 3610.2 Section 4(c)(8) of the BHC Act—Board Legal Staff Interpretation—Certain Volumetric-Production-Payment Transactions Involving Physical Commodities 3700.0 Impermissible Activities

3700.1 Land Investment and Development

3700.2 Insurance Activities

3700.3 Real Estate Brokerage and Syndication

BHC Supervision Manual February 2020 Page 10 General Table of Contents Section 1010.0

Sections Title

3700.4 General Management Consulting

3700.5 Property Management

3700.6 Travel Agencies

3700.7 Providing Credit Ratings on Bonds, Preferred Stock, and Commercial Paper

3700.8 Acting as a Specialist in Foreign-Currency Options on a Securities Exchange

3700.9 Design and Assembly of Hardware for Processing or Transmission of Banking and Economic Data

3700.10 Armored Car Services

3700.11 Computer Output Microfilm Service

3700.12 Clearing Securities Options and Other Financial Instruments for the Accounts of Professional Floor Traders

3900.0 Section 4(k) of the BHC Act—Financial Holding Companies

3901.0 U.S. Bank Holding Companies Operating as Financial Holding Companies

3903.0 Foreign Banks Operating as Financial Holding Companies

3905.0 Permissible Activities for FHCs

3906.0 Disease Management and Mail-Order Pharmacy Activities

3907.0 Merchant Banking

3909.0 Supervisory Guidance on Equity Investment and Merchant Banking Activities

3910.0 Acting as a Finder

3912.0 To Acquire, Manage, and Operate Defined Benefit Pension Plans in the United Kingdom (Section 4(k) of the BHC Act)

3920.0 Limited Physical-Commodity-Trading Activities

3950.0 Insurance Sales Activities and Consumer Protection in Sales of Insurance

3980.0 Establishment of an Intermediate Holding Company

4000 FINANCIAL ANALYSIS

4000.0 Financial Factors—Introduction

4010.0 Parent Only: Debt-Servicing Capacity—Cash Flow

4010.1 Leverage

BHC Supervision Manual February 2020 Page 11 General Table of Contents Section 1010.0

Sections Title

4010.2 Liquidity

4020.0 Banks

4020.1 Banks: Capital

4020.2 Banks: Asset Quality 4020.3 Banks: Earnings

4020.4 Banks: Liquidity

4020.5 Banks: Summary Analysis

4020.6– Reserved 4020.8 4020.9 Supervision Standards for De Novo State Member Banks of Bank Holding Companies

4030.0 Nonbanks

4030.1 Nonbanks: Credit Extending—Classifications

4030.2 Nonbanks: Credit Extending—Earnings

4030.3 Nonbanks: Credit Extending—Leverage

4030.4 Nonbanks: Credit Extending—Reserves

4040.0 Nonbanks: Noncredit Extending

4050.0 Nonbanks: Noncredit Extending—Service Charters

4060.0 Consolidated—Earnings

4060.1 Consolidated: Asset Quality

4060.2 Reserved

4060.3 Consolidated Capital—Examiners’ Guidelines for Assessing the Capital Adequacy of BHCs

4060.4 Reserved

4060.5 Capital Adequacy—Advanced Approaches

4060.6 Reserved

4060.7 Assessing Capital Adequacy and Risk at Large Banking Organizations and Others with Complex Risk Profiles

BHC Supervision Manual February 2020 Page 12 General Table of Contents Section 1010.0

Sections Title

4060.8 Overview of Asset-Backed Commercial Paper Programs

4060.9 Consolidated Capital Planning Processes—Payment of Dividends, Stock Redemptions, and Stock Repurchases at Bank Holding Companies

4061.0 Consolidated Capital—Capital Planning

4062.0 Reserved

4063.0 Federal Reserve Supervisory Assessment of Capital Planning and Positions for LISCC Firms and Large and Complex Firms 4064.0 Reserved

4065.0 Federal Reserve Supervisory Assessment of Capital Planning and Positions for Large and Noncomplex Firms 4066.0 Consolidated—Funding and Liquidity Risk Management

4070.1 Rating Risk-Management Processes and Internal Controls of BHCs Having $50 Billion or More in Total Assets

4070.2 Reserved

4070.3 Revising Supervisory Ratings

4070.4 Reserved

4071.0 Supervisory Guidance for Assessing Risk Management at Supervised Institutions With Total Consolidated Assets Less than $50 Billion 4080.0 Federal Reserve System BHC Surveillance Program

4080.1 Surveillance Program for Small Holding Companies

4090.0 Country Risk

5000 BHC INSPECTION PROGRAM

5000.0 BHC Inspection Program—General

5010.0 Procedures for Inspection Report Preparation— Inspection Report References

5010.1 General Instructions to FR 1225

5010.2 Cover

5010.3 Page i—Table of Contents

5010.4 Core Page 1—Examiner’s Comments and Matters Requiring Special Board Attention

5010.5 Core Page 2—Scope of Inspection and Abbreviations

BHC Supervision Manual February 2020 Page 13 General Table of Contents Section 1010.0

Sections Title

5010.6 Core Page 3—Analysis of Financial Factors

5010.7 Core Page 4—Audit Program

5010.8 Appendix Page 5—Parent Company Comparative Balance Sheet

5010.9 Appendix Page 6—Comparative Statement of Income and Expenses (Parent)

5010.10 Appendix Page 7—Consolidated Classified and Special Mention Assets

5010.11 Appendix Page 8—Consolidated Comparative Balance Sheet

5010.12 Appendix Page 9—Comparative Consolidated Statement of Income and Expenses

5010.13 Capital Structure

5010.14 Page—Policies and Supervision

5010.15 Page—Violations

5010.16 Page—Other Matters

5010.17 Page—Classified Assets and Capital Ratios of Subsidiary Banks

5010.18 Page—Organization Chart

5010.19 Page—History and Structure

5010.20 Page—Investment in and Advances to Subsidiaries

5010.21 Page—Commercial Paper (Parent)

5010.22 Page—Lines of Credit (Parent)

5010.23 Page—Questions on Commercial Paper and Lines of Credit (Parent)

5010.24 Page—Contingent Liabilities and Other Accounts

5010.25 Page—Statement of Changes in Stockholders’ Equity (Parent)

5010.26 Page—Income from Subsidiaries

5010.27 Page—Cash Flow Statement (Parent)

5010.28 Page—Parent Company Liquidity Position

5010.29 Page—Classified Parent Company and Nonbank Assets

5010.30 Page—Bank Subsidiaries

5010.31 Page—Nonbank Subsidiary

BHC Supervision Manual February 2020 Page 14 General Table of Contents Section 1010.0

Sections Title

5010.32 Page—Nonbank Subsidiary Financial Statements

5010.33 Page—Fidelity and Other Indemnity Insurance

5010.34 Reserved

5010.35 Page—Other Supervisory Issues

5010.36 Page—Extensions of Credit to BHC Officials . . .

5010.37 Page—Interest Rate Sensitivity—Assets and Liabilities

5010.38 Treasury Activities/Capital Markets

5010.39 Reserved

5010.40 Confidential Page A—Principal Officers and Directors

5010.41 Confidential Page B— Condition of BHC

5010.42 Confidential Page C—Liquidity and Debt Information

5010.43 Confidential Page D—Administrative and Other Matters

5020.1 Bank Subsidiary (FR 1241)

5020.2 Other Supervisory Issues (FR 1241)

5030.0 BHC Inspection Report Forms

5040.0 Procedures for “Limited-Scope” Inspection Report Preparation— General Instructions

5050.0 Procedures for “Targeted” Inspection Report Preparation—General Instructions

5052.0 Targeted MIS Inspection

5060.0 Portions of Bank Holding Company Inspections Conducted in Federal Reserve Bank Office

BHC Supervision Manual February 2020 Page 15 Bank Holding Company Examination and Inspection Authority Section 1040.0

WHAT’S NEW IN THIS REVISED 1040.0.1.1 Authority for Bank Holding SECTION Company Inspections

Effective July 2012, this section has been revised Section 5 of the BHC Act of 1956 authorizes the to discuss the current authority for the Federal Board to require reports and to conduct inspec- Reserve (FR) to conduct BHC inspections (ex- tions of bank holding companies and their affili- aminations) under section 5(c) of the Bank ates.1 Subject to the limitations discussed below, Holding CompanyAct of 1956 (12 U.S.C. 1844(c)) Section 5 authorizes the Board to examine each and also 12 U.S.C. 5361(a)–(c). The section also bank holding company and nonbank subsidiary is revised to include provisions of the Dodd- thereof. Within those limitations, the Federal Frank Wall Street Reform and Consumer Pro- Reserve System’s supervisory staff (includes tection Act (section 604(c )(2)), which removed BHC inspection and examination staff) may the enforcement provisions of section 10A of the review all books and records of a banking orga- Bank Holding Company Act that limited the nization that is subject to Federal Reserve (FR) FR’s rulemaking and enforcement authority. supervision.2 Previously, the FR was only able to take enforce- ment actions against a functionally regulated subsidiary when its actions posed a threat to the safety and soundness of a depository institution affiliate. 1040.0.2 FOCUS AND SCOPE OF BHC INSPECTIONS

1040.0.1 BHC INSPECTIONS The focus and scope of an inspection is to be limited, to the fullest extent possible, to the The Gramm-Leach-Bliley Act (GLB Act) BHC and any subsidiary of the BHC that could amended section 5(c) of the Bank Holding Com- have a materially adverse effect on the safety pany Act (BHC Act) pertaining to BHC reports and soundness of any DI subsidiary of the hold- and examinations (or inspections, in the case of ing company due to (1) the size, condition, or BHCs). The GLB Act provides specific supervi- activities of the subsidiary, or (2) the nature or sory guidance to the Board of Governors (Board) size of the transactions between the subsidiary of the Federal Reserve System (and the Federal and any DI subsidiary of the BHC. Reserve Banks via delegated authority) with The Board is to use, to the fullest extent respect to the breadth of BHC inspections. It possible, the bank examination reports of DIs also emphasized the focus and scope of BHC prepared by the appropriate federal or state DI inspections and the inspections of BHC subsidi- supervisory authority. The Board also is to use, aries. An inspection is to be conducted to— to the fullest extent possible, the examination reports for non-DIs prepared by the following: 1. inform the board of the nature of the opera- tions and financial condition of each BHC 1. the Securities and Exchange Commission and its subsidiaries, including— (SEC) for any registered broker or dealer a. the financial and operational risks within 2. the SEC or any state for any investment the holding company system that may adviser registered under the Investment Com- pose a threat to the safety and soundness pany Act of 1940 of any depository institution (DI) subsidi- 3. any state insurance regulatory authority for ary of such bank holding company, and any licensed insurance company b. the systems for monitoring and control- 4. any federal or state authority for any other ling such financial and operational risks; subsidiary that the Board finds to be compre- and hensively supervised 2. monitor compliance by any entity with the provisions of the BHC Act or any other federal law that the Board has specific juris- 1. See 12 U.S.C. 1844. diction to enforce against the entity, and to 2. Supervisory staff includes individuals that are on and/or monitor compliance with any provisions of off site. federal law governing transactions and rela- tionships between any DI subsidiary of a BHC Supervision Manual July 2012 BHC and its affiliates. Page 1 Bank Holding Company Examination-Inspection Authority 1040.0

1040.0.3 EXAMINATIONS OF 1040.0.3.2 Coordination with Other FUNCTIONALLY REGULATED Regulators SUBSIDIARIES The Board is to In general, the Board may examine (inspect) any BHC and each subsidiary to inform the • provide reasonable notice to, and to consult Board of with, the primary financial regulatory agency for any subsidiary before requiring a report or • the nature of the operations and financial con- commencing an examination of such subsidi- dition of the company and such subsidiary; ary under this section; and • the financial, operational, and other risks of • avoid duplication of examination activities, the company or such subsidiary that may pose reporting requirements, and requests for infor- a threat to the safety and soundness of such mation, to the fullest extent possible. company or subsidiary or to the financial sta- bility of the United States; (See 12 U.S.C. 5361(c).) • the systems for monitoring and controlling such risks; and • compliance by the company or such subsidi- 1040.0.4 SUPERVISION OF A ary with the requirements of 12 U.S.C. 5361(b) NONBANK FINANCIAL COMPANY and other provisions of the BHC Act and certain other federal statutes. The FR, as the appropriate federal supervisory banking agency, must, to the fullest extent pos- sible, rely on (1) reports and other supervisory information that the BHC, or any subsidiary 1040.0.3.1 Use of Examination Reports thereof, has been required to provide to other and Information federal and state regulatory agencies; (2) exter- nally audited financial statements of the BHC or The Board is required, to the fullest extent pos- subsidiary; (3) information that is otherwise sible, to rely on reports of examination of any available from federal and state regulatory agen- subsidiary depository institution or functionally cies; and (4) information that is required to be regulated subsidiary made by the primary finan- reported publicly. (See 12 U.S.C. 1844(c)(1) or cial regulatory agency for that subsidiary, and section 5(c) of the BHC Act.) on information described for reports under 12 U.S.C. 5361(a)(2). (See 12 U.S.C. 5361(b)(2).)

BHC Supervision Manual July 2012 Page 2 Supervision of Holding Companies with Total Consolidated Assets of $10 Billion or Less Section 1045.0

1045.0.1 OVERVIEW AND inspections conducted at holding companies RELIANCE ON THE INSURED with total consolidated assets between $3 bil- DEPOSITORY INSTITUTION lion and $10 billion; and REGULATOR • modify the requirement for targeted inspec- tions for “3,” “4,” and “5”-rated holding com- The Federal Reserve’s approach to the supervi- panies with total consolidated assets between sion of holding companies with total consoli- $3 billion and $10 billion. dated assets of $10 billion or less is primarily described in SR-13-21, “Inspection Frequency These frequency and scope requirements vary and Scope Requirements for Bank Holding Com- depending on whether a holding company has panies and Savings and Loan Holding Compa- been designated as “complex,” with more com- nies with Total Consolidated Assets of $10 Bil- plex holding companies subject to more fre- lion or Less.” Reserve Banks, in the vast majority quent and in-depth review. If needed for super- of cases, conduct abbreviated off-site reviews of visory purposes, Reserve Banks may inspect a small, noncomplex holding companies with total holding company with greater frequency and consolidated assets of up to $3 billion upon scope. receipt of examination reports from the insured depository institution (IDI) regulator of the lead subsidiary IDI. 1045.0.2 DEFINITION OF COMPLEX These Reserve Bank reviews assess activities HOLDING COMPANIES conducted outside of the subsidiary IDI and rely substantially on the findings of the IDI regulator The determination of whether a holding com- to evaluate the overall condition of the institu- pany is “complex” should be made at least tion. For larger holding companies in the com- annually by the responsible Reserve Bank. Uti- munity banking organization (CBO) supervision lizing surveillance screens and other informa- portfolio, Reserve Banks conduct point-in-time tion obtained through supervisory or applica- on- or off-site reviews that are coordinated with, tions processes, Reserve Banks should update or closely follow, onsite examinations of the the complexity designation of a company as its lead subsidiary IDI by its IDI regulator. The activities or condition changes. The determina- Reserve Bank reviews of larger CBO holding tion of a holding company’s complexity should companies are targeted toward assessing parent take into account a number of factors. These company and nonbank activities and their poten- factors include the tial effect on the safety and soundness of the subsidiary IDI. • size and structure of the company; The Reserve Bank evaluates the condition, • theextentofintercompanytransactionsbetween performance, and prospects of the subsidiary IDI subsidiaries and the holding company or IDI based on the conclusions of the IDI regula- uninsured subsidiaries of the holding com- tor and makes best efforts not to duplicate the pany; work of other prudential regulators. Refer to • the risk, scale, and complexity of activities of SR-16-4. any nondepository subsidiaries;1 and The Federal Reserve relies on periodic on- • the degree of leverage at the holding com- and off-site inspections to assess the safety and pany, including the extent of its debt outstand- soundness of supervised bank holding compa- ing to the public. nies (BHCs) and savings and loan holding com- panies (SLHCs) (collectively referred to as “hold- Companies should also be designated “com- ing companies”). The guidance in SR-13-21 plex” if material risk-management processes for outlines the minimum inspection frequency and the holding company and its affiliates are con- scope requirements for supervised holding com- solidated at the parent company. panies with total consolidated assets of $10 bil- lion or less to 1. For SLHCs, consideration should be given to whether the holding company is a grandfathered unitary SLHC, and if • conform inspection frequency and scope re- so, the type and extent of the activities in which the company quirements for SLHCs with total consolidated engages. assets of $10 billion or less to those applicable to BHCs of the same size; BHC Supervision Manual February 2020 • clarify the scoping requirements for targeted Page 1 Supervision of Holding Companies with Total Consolidated Assets of $10 Billion or Less 1045.0

1045.0.3 SUPERVISION AND be inspected every other year. The Reserve SURVEILLANCE APPROACH Banks should attempt to conduct inspections of holding companies between $3 billion and The frequency and scope of on- and off-site $10 billion in total consolidated assets shortly inspections should be adjusted based on the after the examination of the lead depository results of examinations of a company’s deposi- subsidiary is completed. Holding companies tory institution subsidiaries and off-site quar- between $3 billion and $10 billion in total con- terly surveillance. Whether the inspection is solidated assets are assigned a complete RFI conducted on- or off-site will depend on the rating (component ratings, subcomponent rat- level and nature of the risks involved, the hold- ings, and a composite rating) regardless of their ing company’s ability to manage those risks, complexity.2 and the Reserve Bank’s ability to acquire the Depending on their condition and complexity, necessary information to analyze the activity holding companies in this category will receive off-site. If information obtained off-site is not full-scope inspections or targeted inspections. sufficient for the Reserve Bank to determine the At a minimum, a full-scope inspection should condition or assess the activity of the company include sufficient procedures to reach an in- to assign a rating, the Reserve Bank should formed judgment regarding the assigned ratings conduct an on-site inspection (full-scope or tar- for the factors addressed by the RFI rating sys- geted, as appropriate). tem, evaluating the organization’s methods of To facilitate prompt follow-up on changes in managing and controlling its risk exposures, and a company’s performance and condition, the ascertaining whether management and directors Federal Reserve maintains distinct surveillance fully understand and are actively monitoring the programs for small holding companies (less than organization’s exposure to those risks. $3 billion in total consolidated assets) and all A targeted inspection is designed to focus other holding companies. Surveillance screens intensively on one or more specific areas, activi- for holding companies with $3 billion or more ties, or problems relating to a holding company. in total consolidated assets focus on identifying Targeted inspections of holding companies with those companies reporting financial results that total consolidated assets between $3 billion and seem to be inconsistent with their current super- $10 billion should focus primarily on parent visory ratings, as well as activities conducted company leverage, parent company cash flow, outside of depository institution subsidiaries. nondepository subsidiaries, consolidated capital For small holding companies, quarterly surveil- (when applicable), and intercompany transac- lance screens focus on the identification of po- tions. Targeted inspections may also cover other tential parent company and nondepository sub- applicable areas, such as deficient risk- sidiary issues that may adversely affect affiliated management practices at the holding company. depositoryinstitutions. Inparticular,thesescreens In addition, because compliance with laws address parent company cash flow, intercom- and regulations is a statutory factor that must be pany transactions, parent company leverage, and considered as part of any supervisory review of consolidated capital ratios, when applicable. an application or notice by the holding com- Screens also assist in maintaining up-to-date pany, it is important that Reserve Bank staff complexity designations and are updated peri- ensure that compliance with relevant laws and odically to reflect industry trends and conditions regulations, including any commitments pro- as well as changes in regulatory reporting require- vided by a holding company in connection with ments. an application or notice, is evaluated and ad- dressed in written inspection reports.

1045.0.4 FREQUENCY AND SCOPE OF INSPECTIONS OF HOLDING 1045.0.4.1 Complex Holding Companies COMPANIES WITH TOTAL CONSOLIDATED ASSETS BETWEEN • If a complex holding company is rated com- $3–10 BILLION posite “1” or “2,” a full-scope, on-site inspec- tion is required annually. Complex holding companies in satisfactory con- • The following apply for a complex holding dition are inspected at least once per calendar company rated composite “3,” “4,” or “5.” year, while noncomplex holding companies may 2. See SR-19-4/CA-19-3, “Supervisory Rating Systems for BHC Supervision Manual February 2020 Holding Companies with Consolidated Assets Less Than Page 2 $100 billion,” and section 1062.0 of this manual. Supervision of Holding Companies with Total Consolidated Assets of $10 Billion or Less 1045.0

— A full-scope, on-site inspection is required assigned only a risk-management rating and a annually. composite rating. All ratings assigned should — If the primary supervisor has conducted be promptly entered into the National Examina- an interim examination or changed the tion Database (NED) and communicated to the rating at the lead depository institution, company, Board staff, and appropriate state and Reserve Bank staff should conduct an federal regulatory authorities as soon as pos- additional targeted inspection and update sible, but generally no later than 90 days after the rating if necessary. The targeted inspec- receipt of the lead depository institution exami- tion may be conducted off-site and should nation report. start within 60 days of receiving the exami- Although an off-site review of small holding nation report for the lead depository insti- companies will be appropriate in many cases, in tution. some instances it may be necessary to conduct • Interim inspections between regular full- an on-site review for complex holding compa- scope, on-site inspections are not required. nies, as discussed below. In those cases when an However, additional follow-up, including in- on-site review is required, the findings of that terim inspections, may be necessary in response review and the assigned ratings should be com- to off-site surveillance program results. municated to the company no later than 120 days after receipt of the lead depository institution examination report. Documentation for the rat- 1045.0.4.2 Noncomplex Holding ings and off-site or on-site reviews will gener- Companies ally consist of the examination reports for the depository institution subsidiaries, a copy of the • If a noncomplex holding company is rated transmittal letter communicating the ratings to composite “1” or “2,” an off-site targeted the company, information related to relevant inspection is required every two years. System surveillance results, and memoranda • The following apply for a noncomplex hold- supporting any on-site review conducted. A ing company rated composite “3,” “4,” or “5.” meeting between Reserve Bank staff and the — A full-scope, off-site inspection is required company’s board of directors to communicate annually. findings is not required, but should be con- — If the primary supervisor has conducted ducted when warranted by supervisory con- an interim examination or changed the cerns. rating at the lead depository institution, Reserve Bank staff should conduct an additional targeted inspection and update the rating if necessary. This targeted inspec- 1045.0.5.1 Complex Holding Companies tion may be conducted off-site and should start within 60 days of receiving the exami- • An off-site review should be conducted upon nation report for the lead depository insti- receipt of the lead depository institution exami- tution. nation report or an updated rating from the • Interim inspections between regular full-scope primary supervisor using surveillance results inspections are not required. However, addi- and relevant supervisory and financial infor- tional follow-up, including interim inspec- mation. If the information obtained off-site is tions, may be necessary in response to off-site not sufficient for the Reserve Bank to deter- surveillance program results. mine the overall condition of the company and to assign a complete RFI rating, the Reserve Bank should conduct an on-site review 1045.0.5 FREQUENCY AND SCOPE of the company. OF REVIEW OF HOLDING • Any on-site review should be targeted at those COMPANIES WITH LESS THAN areas where additional information or analysis $3 BILLION IN TOTAL is needed to assign a complete supervisory CONSOLIDATED ASSETS rating.

The supervisory cycle for holding companies with less than $3 billion in total consolidated assets generally is determined by the examina- tion frequency of the lead depository institu- tion. Complex companies in this size category BHC Supervision Manual February 2020 are assigned a complete RFI rating; others are Page 3 Supervision of Holding Companies with Total Consolidated Assets of $10 Billion or Less 1045.0

1045.0.5.2 Noncomplex Holding rated composite “3,” “4,” or “5,” Reserve Banks Companies are encouraged to adopt an internal target of 45 calendar days from the close date for sending • If all subsidiary depository institutions have a the reports. management component rating and a compos- The “close date” of an on-site examination ite supervisory rating of “1” or “2” and no and inspection is defined as the last date that the material holding company issues are other- examination team is physically on-site at the wise indicated, the Reserve Bank should as- institution. For examinations and inspections for sign only a composite rating and risk manage- which all or a portion of the work is performed ment rating to the holding company based on off-site, the “close date” is defined as the earlier the ratings of the lead depository institution. of the following dates: (1) the date when the • If one or more subsidiary depository institu- analysis (including loan file review) is com- tions have a management component rating or pleted and ready for the examiner-in-charge’s a composite supervisory rating of “3,” “4,” or review or (2) the date when the preliminary exit “5” or a material holding company issue is meeting is held with management, which can be otherwise indicated, an off-site review is re- conducted either on-site or off-site by confer- quired upon receipt of the lead depository ence call. institution examination report or an updated Further, to ensure that findings are communi- rating from the primary supervisor using sur- cated to a supervised institution in a timely veillance results and relevant supervisory and manner, Reserve Banks should ensure that the financial information. If the information ob- duration between the start of an tained off-site is not sufficient for the Reserve examination/inspection to the completion and Bank to determine the overall condition of the delivery of an examination/inspection report company and to assign a risk-management does not exceed 90 days.5 In cases when reports rating and a composite rating, Reserve Bank are subject to statutory requirements for other staff should contact the holding company to state or federal agency review, such as by the obtain more information. Consumer Financial Protection Bureau • Any off-site review should be targeted, as (CFPB),6 Reserve Banks may exceed these guide- appropriate, at those areas where additional lines at the discretion of senior management. information or analysis is needed to develop However, deviations from these guidelines are the risk-management and composite ratings. expected to be rare. At the discretion of senior Reserve Bank management, additional exemp- tions from this 90-day guideline may be consid- 1045.0.6 COMPLETION STANDARD ered for examinations that are conducted simul- FOR EXAMINATION AND taneously on multiple affiliated banks or INSPECTION REPORTS examinations of larger complex CBOs that re- quire additional time on-site to review special- Safety-and-soundness examination and inspec- ized or complex business lines. tion reports for CBOs issued by the Federal Findings and conclusions delivered to a super- Reserve should be completed and sent to the vised institution at the close date and exit meet- supervised institution within 60 calendar days ings for examinations and inspections must be following the “close date” of the examination.3 consistently documented in workpapers.7 At a These standards apply to formal examination and inspection reports for institutions super- $3 billion or less are subject to a separate program that has vised by the Federal Reserve with $10 billion or different requirements for the issuance of reports of inspec- less in total consolidated assets including state tion. member banks, BHCs, SLHCs, Edge Act and 5. The start date is the date that Reserve Bank examiners agreement corporations, U.S. branches and agen- and supervisory staff commence the examination and inspec- tion work, excluding pre-examination visitations and prepara- cies of foreign banks, and foreign subsidiaries tion. and branches of U.S. banks.4 For institutions 6. See sections 1022, 1024, and 1025 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. For more information on the coordination of supervisory activities with 3. This completion standard gives recognition to the con- the CFPB, see also the “Memorandum of Understanding on tinuous monitoring and roll-up supervisory process for larger Supervisory Coordination” and the June 4, 2012, joint press organizations having consolidated assets in excess of $10 bil- release. lion. 7. In some cases, Reserve Bank examiners or supervisory 4. Most BHCs and SLHCs with total consolidated assets of staff may conduct a pre-exit meeting with the institution’s management at the close date of the examination or inspec- BHC Supervision Manual February 2020 tion. Representatives from the on-site examination or inspec- Page 4 tion team may also hold a final exit meeting with the institu- Supervision of Holding Companies with Total Consolidated Assets of $10 Billion or Less 1045.0 minimum, documentation should include To the extent conclusions in the final report differ from those discussed at the close date and 1. a list of attendees at the meetings; exit meetings, Reserve Bank examiners and 2. a description of significant examination and supervisory staff should communicate the rea- inspection findings discussed, including pre- sons for the differences to the supervised institu- liminary ratings; and tion and document these discussions in their 3. a summary of the bank management’s views workpapers. See SR-13-14, “Timing Standards on the findings and, if applicable, the views for the Completion of Safety-and-Soundness of the board of directors. Examination and Inspection Reports for Com- munity Banking Organizations,” for more infor- mation.

tion after vetting examination or inspection findings with the responsible Reserve Bank officer(s). An “exit meeting” is defined as an examiner’s meeting with the institution’s man- agement or management and board of directors to communi- BHC Supervision Manual February 2020 cate preliminary supervisory findings and conclusions. Page 5 Consolidated Supervision of Bank Holding Companies and the Combined U.S. Operations of Foreign Banking Organizations Section 1050.0

WHAT’S NEW IN THIS REVISED the importance of coordination with, and reli- SECTION ance on, the work of other relevant primary supervisors and functional regulators. Effective January 2015, this section was revised The Federal Reserve’s enhanced approach to to delete a reference to SR-99-15, which was consolidated supervision emphasizes several superseded by SR-12-17/CA-12-14, “Consoli- elements that should help make the financial dated Supervision Framework for Large Finan- system more resilient. These include focus on cial Institutions.” corporate governance, capital adequacy, funding and liquidity management, and the supervision The continuing growth in the size and complex- of material nonbank subsidiaries,2 as well as ity of many banking organizations exposes other aspects of the Federal Reserve’s consoli- these firms to a wide array of potential risks, dated supervision activities designed to further while at the same time making it more challeng- the objectives of fostering financial stability and ing for a single supervisor to have a complete deterring or managing financial crises. In addi- view of firmwide risks and controls. In response tion, the Federal Reserve continues to work, to these trends, and to better fulfill both its both independently and in conjunction with responsibilities as consolidated supervisor and other domestic and foreign bank supervisors and its other central bank objectives, the Federal functional regulators, on a number of other ini- Reserve continues to refine and enhance its tiatives to strengthen supervisory approaches programs for the consolidated supervision of and reinforce expectations for sound practices in bank holding companies (BHCs) and the response to recent lessons learned. combined U.S. operations of foreign banking organizations (FBOs). The Federal Reserve has set forth its consoli- 1050.0.1 SUPERVISION AND dated supervision program for bank holding REGULATION FRAMEWORK FOR companies and the combined U.S. Operations of COMPANIES THAT CONTROL A Foreign Banking Organizations in SR-08-9/CA- BANK AND THE SUBSIDIARIES OF 08-12 and its attachments. (See sections 1050.1 SUCH COMPANIES for the consolidated supervision of large com- plex banking organizations and see 1050.2 for The Bank Holding Company Act (BHC Act), the consolidated supervision of regional bank- originally enacted in 1956, provides a federal ing organizations.) The primary objectives of framework for the supervision and regulation of this supervisory guidance are to specify princi- all domestic and foreign companies that control pal areas of focus for consolidated supervision a bank and the subsidiaries of such companies. activities and thereby provide for consistent Among the principal purposes of the BHC Act Federal Reserve supervisory practices and assess- is to protect the safety and soundness of corpo- ments across organizations with similar activi- rately controlled banks. Financial trouble in one ties and risks. Consistent with these objectives, part of an organization can spread rapidly to the SR letter and its attached guidance detail other parts of the organization; moreover, large specific expectations for Federal Reserve staff BHCs increasingly operate and manage their for understanding and assessing primary gover- businesses on an integrated basis across corpo- nance functions and risk controls, material busi- rate boundaries. Risks that cross legal entities or ness lines, nonbank operations, financial condi- that are managed on a consolidated basis cannot tion, and other key activities and risks at banking be monitored properly through supervision organizations; address unique aspects of super- directed at any one of the legal entity subsidi- vising the combined U.S. operations of FBOs; aries within the overall organization. and highlight the supervisory attention that should The BHC Act provides for all BHCs, includ- be paid to risk-management systems and inter- ing financial holding companies formed under nal controls used by BHCs and FBOs that pro- vide core clearing and settlement services (core settlement organizations,’’ ‘‘critical financial markets,’’ and clearing and settlement organizations) or that ‘‘key financial markets.’’ 2. The term ‘‘nonbank subsidiaries’’ as used in SR-08- have a significant presence in critical or key 9/CA-08-12 and its attachments does not include savings financial markets.1 The guidance also reiterates associations.

1. See Attachment C to SR-08-9/CA-08-12 or this sec- BHC Supervision Manual January 2015 tion’s appendix for the definitions of ‘‘core clearing and Page 1 Consolidated Supervision of BHCs and the Combined U.S. Operations of FBOs 1050.0 the Gramm-Leach-Bliley Act (GLBA), to be established by the International Banking Act of supervised on a consolidated basis by the Fed- 1978, which introduced a policy of national eral Reserve. Consolidated supervision of a treatment3 promoting competitive equality BHC encompasses the parent company and its between FBOs operating in the United States subsidiaries, and allows the Federal Reserve to and domestic banking organizations. The For- understand the organization’s structure, activi- eign Bank Supervision Enhancement Act of ties, resources, and risks, as well as to address 1991 established uniform federal standards for financial, managerial, operational, or other defi- entry, expansion, and supervision of FBOs in ciencies before they pose a danger to the BHC’s the United States and increased the Federal subsidiary depository institutions. Reserve’s supervisory responsibility and author- To carry out these responsibilities, the BHC ity over the U.S. operations of FBOs. This act Act grants the Federal Reserve broad authority also introduced the requirement that the Federal to inspect and obtain reports from a BHC and its Reserve approve the establishment of all U.S. subsidiaries concerning, among other things, the banking offices of foreign banks and, in that company’s financial condition, systems for regard, take into account whether the foreign monitoring and controlling financial and bank is subject to comprehensive, consolidated operational risks, and compliance with the BHC supervision by its home-country supervisor. Act and other federal law (including consumer The Federal Reserve’s consolidated supervi- protection laws) that the Board has specific sion activities closely complement its other cen- jurisdiction to enforce. In addition, federal law tral bank responsibilities, including the objec- authorizes the Federal Reserve to take action tives of fostering financial stability and deterring against a BHC or nonbank subsidiary to prevent or managing financial crises. The information, these entities from engaging in unsafe or expertise, and powers that the Federal Reserve unsound practices or to address violations of derives from its supervisory authority enhance law that occur in connection with their own its ability to help prevent financial crises and to business operations even if those operations are manage such crises (in consultation and con- not directly connected to the BHC’s subsidiary junction with the Treasury Department and other depository institutions. Using its authority, the U.S. and foreign authorities) should they occur. Federal Reserve also has established consoli- Similarly, the supervisory responsibilities of the dated capital standards for BHCs, helping to Federal Reserve benefit from its responsibilities ensure that a BHC maintains adequate capital to for financial stability. For example, knowledge support its groupwide activities, does not gained about financial market developments become excessively leveraged, and is able to through interactions with primary dealers in serve as a source of strength for its depository government securities and capital market exper- institution subsidiaries. tise derived from nonsupervisory activities The Federal Reserve’s consolidated supervi- improve the Federal Reserve’s ability to under- sion program has served as the benchmark for stand and evaluate the activities of banking many of the current and evolving international organizations and otherwise enhance its contri- standards for the consolidated supervision of butions to supervisory and regulatory policy financial groups. Key concepts that have been initiatives. part of the Federal Reserve’s approach to con- Effective consolidated supervision requires solidated supervision for many years are reflected strong, cooperative relationships between the in the Basel Committee on Banking Supervi- Federal Reserve and relevant primary supervi- sion’s Minimum Standards for Internationally sors and functional regulators.4 These relation- Active Banks (1992), capital accords (1988 and 2006), and Core Principles for Effective Bank- 3. ‘‘National treatment’’ refers to a policy that generally ing Supervision (1997 and 2006), and are now gives foreign banks operating in the United States the same used by the International Monetary Fund and powers as U.S. banking organizations and subjects them to the same restrictions and obligations. the World Bank in connection with their assess- 4. The term ‘‘primary supervisor’’ as used in this document ments of countries’ bank supervisory regimes. refers to the primary federal banking or thrift supervisor (for In addition to its role as consolidated supervi- example, the Office of the Comptroller of the Currency for a sor of BHCs, the Federal Reserve also is respon- nationally chartered bank) of a depository institution subsidi- ary of a BHC, or of a U.S. banking office of an FBO. For sible for the overall supervision of the U.S. state-chartered depository institutions or banking offices, this operations of foreign banks that have a banking term also includes the relevant bank supervisory authority of presence in the United States. This role was the institution’s chartering/licensing state. Where a BHC has multiple depository institution subsidiaries or an FBO has multiple U.S. banking offices, there may also be multiple BHC Supervision Manual January 2015 primary banking supervisors, depending on how the subsidi- Page 2 aries are chartered/licensed. The term ‘‘functional regulator’’ Consolidated Supervision of BHCs and the Combined U.S. Operations of FBOs 1050.0 ships respect the individual statutory authorities policies, and operations of a banking organiza- and responsibilities of the respective supervisors tion that may have a material impact on regu- and regulators and provide for appropriate infor- lated subsidiaries, as well as information con- mation flows and coordination so that individual cerning transactions or relationships between responsibilities can be carried out effectively, regulated subsidiaries and their affiliates. while limiting the potential for duplication or undueburden.Informationsharingamongdomes- tic and foreign supervisors, consistent with appli- 1050.0.2 KEY OBJECTIVES FOR, AND cable law and the jurisdiction of each supervi- APPROACHES TO, CONSOLIDATED sor, is essential to ensure that a banking SUPERVISION organization’s global activities are supervised on a consolidated basis. The Federal Reserve uses a systematic approach These concepts underlie the provisions of the to develop an assessment of a BHC on a consoli- GLBA governing the interaction between the dated basis and of the combined U.S. operations Federal Reserve, as consolidated supervisor, and of an FBO. These assessments are reflected in the other primary supervisors or functional regu- the RFI (Risk-Management, Financial Condi- lators that may be involved in supervising one tion, and Impact) rating assigned to a BHC6 and or more subsidiaries of a BHC.5 Under these the combined U.S. operations rating assigned to provisions, the Federal Reserve, in conducting an FBO with multiple U.S. operations.7 The itsconsolidatedsupervisoryresponsibilities,relies Federal Reserve utilizes three principal pro- to the fullest extent possible on (1) the reports cesses to understand, supervise, and assess BHCs that a BHC or subsidiary has provided to another and FBOs: continuous monitoring activities,8 federal or state supervisor or to an appropriate discovery reviews,9 and testing.10 self-regulatory organization, (2) information that is otherwise required to be reported publicly, and (3) externally audited financial statements. 6. The RFI rating system for BHCs is discussed in SR-04- 18, ‘‘Bank Holding Company Rating System’’ and section In addition, the Federal Reserve relies to the 4070.0. RFI ratings are assigned at least annually for BHCs fullest extent possible on the reports of examina- with $1 billion or more in consolidated assets, and are com- tion of a depository institution made by its municated via a comprehensive summary supervisory report appropriate federal or state bank supervisor, of a that supports the BHC’s assigned ratings and encompasses the results of the entire supervisory cycle. broker–dealer or investment adviser made by or 7. SR-00-14, ‘‘Enhancements to the Interagency Program on behalf of the SEC or relevant state regulatory for Supervising the U.S. Operations of Foreign Banking Orga- authority, or of a licensed insurance company nizations,’’ discusses the U.S. combined operations rating for made by or on behalf of its appropriate state an FBO and other aspects of the FBO Supervision Program. The Federal Reserve’s rating and assessment, as well as a regulatory authority. In developing its overall summary of condition analysis describing the strengths and assessment of a BHC or the combined U.S. weaknesses of the FBO’s combined U.S. operations, are pro- operations of an FBO, the Federal Reserve also vided to the head office of each FBO. This information is also relies to the fullest extent possible on the infor- shared with the FBO’s home-country supervisor so that it may assess the impact of U.S. operations on the parent banking mation gathered and assessments developed by organization in its role as consolidated supervisor of the these other supervisors and regulators. banking organization’s global operations. Similarly, the Federal Reserve seeks to assist 8. ‘‘Continuous monitoring activities’’ are nonexamination/ relevant primary supervisors and functional regu- inspection supervisory activities primarily designed to develop and maintain an understanding of the organization, its risk lators in performing their supervisory responsi- profile, and associated policies and practices. These activities bilities with respect to regulated subsidiaries by also provide information that is used to assess inherent risks sharing pertinent information that relates to these and internal control processes. Such activities include meet- regulated subsidiaries consistent with each agen- ings with banking organization management; analysis of man- agement information systems (MIS) and other internal and cy’s supervisory responsibilities and applicable external information; review of internal and external audit law. Examples include shared information relat- findings; and other efforts to coordinate with, and utilize the ing to the financial condition, risk-management work of, other relevant supervisors and functional regulators (including analysis of reports filed with, or prepared by, these supervisors or regulators, or appropriate self-regulatory orga- nizations, as well as related surveillance results). as used in this document refers to the appropriate federal 9. A ‘‘discovery review’’ is an examination/inspection (examples include the U.S. Securities and Exchange Commis- activity designed to improve the understanding of a particular sion and the U.S. Commodity Futures Trading Commission) business activity or control process—for example, to address or state regulator for a functionally regulated nondepository a knowledge gap identified during the risk assessment or other subsidiary or affiliate of a BHC or FBO. (See SR-00-13, supervisory process. ‘‘Framework for Financial Holding Company Supervision.’’) For U.S. operations of FBOs, the U.S. supervisor of a U.S. banking office is referred to as a domestic primary supervisor. BHC Supervision Manual January 2015 5. See SR-00-13. Page 3 Consolidated Supervision of BHCs and the Combined U.S. Operations of FBOs 1050.0

The Federal Reserve’s supervisory objectives 1050.0.2.1.1 Understanding the Bank are the same for all BHCs and FBOs. However, Holding Company on a Consolidated the type and amount of information and the Basis and the Combined U.S. Operations scope and extent of Federal Reserve supervisory of an FBO and examination11 work that are necessary to understand, supervise, and develop an assess- Supervisory Objective: The Federal Reserve ment of an individual BHC or the U.S. opera- develops a comprehensive understanding of each tions of an individual FBO vary. Federal Reserve BHC and the combined U.S. operations of each supervisory activities are tailored for each orga- FBO. Key elements in developing this under- nization based on a variety of factors, including standing include the organization’s legal entity and regulatory structure;12 the risks posed by the organization’s • corporate strategy and significant activities; specific activities and systems; and the potential • business line, legal entity, and regulatory struc- effect of weaknesses in control functions on the ture, including interrelationships and depen- organization, its subsidiary depository institu- dencies across multiple legal entities; tions, or key financial markets. For example, • corporate governance, risk management, and additional supervisory activities, including trans- internal controls for managing risks; and action testing in appropriate circumstances, may • for certain organizations, presence in critical be conducted when there are information gaps or key financial market activities. relating to material risks or activities, indica- tions of weaknesses in risk-management sys- tems or internal controls, or indications of viola- 1050.0.2.1.2 Assessing the Bank Holding tions of consumer protection or other laws, or Company on a Consolidated Basis and when a consolidated organization or subsidiary the Combined U.S. Operations of an FBO depository institution is in less-than-satisfactory condition. Supervisory Objective: The Federal Reserve supervises each BHC on a consolidated basis and assigns an RFI rating through an evaluation and assessment of the following areas 1050.0.2.1 Key Supervisory Objectives • key corporate governance, risk management, In fulfilling its responsibilities for supervising a and control functions (including, where appli- BHC on a consolidated basis and the combined cable, such functions as they relate to core U.S. operations of an FBO, the Federal Reserve clearing and settlement activities and activi- is guided by the following key supervisory ties where the organization has a significant objectives. presence in critical or key financial markets); • the adequacy of the financial condition of the consolidated organization; and • the potential negative impact of nonbank enti- ties on subsidiary depository institutions. 10. ‘‘Testing’’ is an examination/inspection activity to assess whether a control process is appropriately designed and The Federal Reserve also supervises and achieving its objectives or to validate a management assertion about an organization’s operations. Activities may include the assesses the combined U.S. operations of each review and validation of internal MIS, such as business FBO and assigns a U.S. combined operations records related to an internal control process; audit findings rating based on analysis of these same elements. and processes; or a sample of transactions that have been entered into by a banking organization. 11. While by definition ‘‘examination’’ activities are appli- cable to the supervision of banks and other depository institu- 1050.0.2.1.3 Interagency Coordination tions, as well as U.S. banking offices of FBOs, and ‘‘inspec- tion’’ activities are applicable to the supervision of BHCs and Supervisory Objective: As noted earlier, effec- nonbank subsidiaries and affiliates, the term ‘‘examination’’ is generally used throughout this guidance to refer to both tive consolidated supervision requires strong, examination and inspection activities. cooperative relationships between the Federal 12. An organization’s ‘‘regulatory structure’’ refers to the Reserve and relevant domestic and foreign super- various legal entities within the organization that are subject visors and functional regulators. To achieve this to oversight by different domestic and foreign supervisors or functional regulators. objective, while limiting the potential for dupli- cation or undue burden, the nature and scope of BHC Supervision Manual January 2015 Federal Reserve work is tailored to the organiza- Page 4 tion’s legal entity and regulatory structure as Consolidated Supervision of BHCs and the Combined U.S. Operations of FBOs 1050.0 well as the risks associated with the organiza- impact across the banking and financial system, tion’sactivities.Inthisregard,theFederalReserve these activities pose special legal, reputational, and other risks to the banking organization and • relies to the fullest extent possible on assess- its depository institution subsidiaries. The Fed- ments and information developed by other eral Reserve has unique expertise and perspec- relevant domestic and foreign supervisors and tive in these areas based on its broader central functional regulators; bank responsibilities and functions. • focuses supervisory attention on material risks Unlike banks, nonbank subsidiaries of a bank- from activities that are not supervised by ing organization may not accept FDIC-insured another supervisor or regulator or that cut deposits and do not have routine access to the across legal entities; and Federal Reserve’s discount window and pay- • participatesinthesharingofinformationamong ment system. As a result, certain laws and super- domestic and foreign supervisors and func- visory policies that apply to banks (e.g., the tional regulators, consistent with applicable prompt-corrective-action framework13) do not law, to provide for the comprehensive, con- apply to nonbank subsidiaries, and the manner solidated supervision of each banking organi- in which the Federal Reserve supervises the zation’s global activities. nonbank subsidiaries of a banking organization reflects these differences. The Federal Reserve’s Since coordination with, and reliance on, the supervision of nonbank subsidiaries under the work of other relevant primary supervisors and BHC Act is primarily directed toward, and functional regulators is so central to the Federal focused on, ensuring that the nonbank subsidi- Reserve’s conduct of consolidated supervision, ary does not present material financial, legal, or direction for achieving these objectives is closely reputational risks to affiliated depository institu- integrated into the attached guidance for under- tions or to the BHC’s or FBO’s ability to sup- standing and assessing consolidated BHCs and port these depository institutions. The Federal the combined U.S. operations of FBOs. Reserve also may interact with nonbank entities, such as primary dealers in government securi- ties, in connection with its other central bank 1050.0.2.2 Risk-Focused Approach to functions and responsibilities, including con- Consolidated Supervision ducting monetary policy, fostering financial sta- bility, and deterring or managing financial crises. The Federal Reserve uses a risk-focused approach As part of the supervisory process, the Fed- to supervision of banking organizations in gen- eral Reserve reviews the systems and controls eral and to each organization individually. In used by BHCs and the U.S. operations of FBOs this regard, the Federal Reserve focuses supervi- to monitor and ensure that the organization, sory activities on identifying the areas of great- including its nonbank subsidiaries, complies est risks to a banking organization and assessing with applicable laws and regulations, including the ability of the organization’s management to those related to consumer protection. The Fed- identify, measure, monitor, and control these eral Reserve develops and maintains an under- risks. In addition, the Federal Reserve typically standing and assessment of consumer compli- is more actively and comprehensively engaged ance risk at nonbank subsidiaries of a BHC or in the supervision of the largest and most com- FBO primarily through continuous monitoring plex BHCs and FBOs, as well as those with the activities, relying to the fullest extent possible most dynamic risk profiles. By paying particular on work performed by the relevant functional attention to these organizations, the Federal regulator, if any. While the Federal Reserve Reserve aims to minimize significant adverse routinely conducts examinations of the compli- effects on the public (including consumers), the ance function at the BHC, including its systems financial markets, and the financial systems in for monitoring and ensuring compliance with the United States and abroad, as well as on consumer and other applicable laws, the Federal taxpayers, who provide the ultimate resources Reserve currently does not routinely conduct behind the federal safety net. examinations for the purpose of determining The Federal Reserve also focuses special supervisory attention on the risk-management 13. For more information on the prompt-corrective-action systems and internal controls used by core clear- framework for banks, see section 4133.1 of the Federal Reserve’s Commercial Bank Examination Manual, or see ing and settlement organizations or organiza- 12 C.F.R. 208, Subpart D. tions that have a significant presence in key financial markets. In light of the potential for BHC Supervision Manual January 2015 problems in these areas to transmit an adverse Page 5 Consolidated Supervision of BHCs and the Combined U.S. Operations of FBOs 1050.0 compliance with specific consumer laws enforced (multi-office FBOs) primarily by other supervisors regarding non- • single-office foreign banking organizations bank subsidiaries of BHCs and FBOs. When (single-office FBOs) consumer compliance-related deficiencies are noted as part of the ongoing supervision of a LCBOs are characterized by the scope and com- BHC or FBO, however, consumer compliance plexity of their domestic and international opera- examiners may conduct onsite examinations tions; their participation in large volume pay- (including transaction testing, if appropriate) of ment and settlement systems; the extent of their nonbank subsidiaries to resolve significant issues custody operations and fiduciary activities; and that have the potential for widespread violations the complexity of their regulatory structures, or harm to consumers.14 both domestically and in foreign jurisdictions. The Federal Reserve also seeks to reinforce To be designated as an LCBO, a banking organi- market discipline by encouraging public disclo- zation must meet specified criteria to be consid- sures that balance quantitative and qualitative ered a significant participant in at least one key information with clear discussions about risk- financial market. management processes and that reflect evolving Banking organizations that are not designated disclosure practices for peer organizations. as LCBOs belong to the portfolios of regional or community BHCs, or multi-office or single- office FBOs. While there is considerable variety 1050.0.2.3 Supervisory Portfolios among organizations across these portfolios, the simpler regulatory structure of most non-LCBO An important aspect of the Federal Reserve’s organizations increases the likelihood that a consolidated supervision programs for BHCs single primary supervisor has a substantially and the combined U.S. operations of FBOs is complete view of, and ability to address, signifi- the assessment and evaluation of practices across cant areas of firmwide (or combined U.S. opera- groups of organizations with similar characteris- tions for FBOs) activities, risks, risk manage- tics and risk profiles. This ‘‘portfolio approach’’ ment, and controls. to consolidated supervision facilitates greater consistency of supervisory practices and assess- ments across comparable organizations and enhances the Federal Reserve’s ability to iden- 1050.0.3 SUPERVISORY GUIDANCE tify outlier organizations among established peer groups. The supervisory portfolios that the Fed- The guidance attached to SR-08-9/CA-08-12 eral Reserve currently uses in structuring its (e.g., sections 1050.1 and 1050.2) describes how supervisory programs for BHCs and the U.S. Federal Reserve staff will develop an under- operations of FBOs are as follows: standing and assessment of a BHC or the U.S. operations of an FBO through continuous moni- BHC Portfolios: toring activities, discovery reviews, and testing activities, as well as through interaction with, • large complex banking organizations (LCBO and reliance to the fullest extent possible on, BHCs) other relevant primary supervisors and func- • regional bank holding companies (regional tional regulators. Because the Federal Reserve’s BHCs) supervisory activities are tailored in the manner • community bank holding companies (commu- described above, separate guidance documents nity BHCs) are provided for four different supervisory port- folios to promote appropriate and consistent FBO Portfolios: supervision of organizations that broadly share similar characteristics and risk profiles. The • large complex foreign banking organizations documents’ guidance addresses (LCBO FBOs) • multi-office foreign banking organizations • consolidated supervision of LCBO BHCs (Attachment A.1) (See section 1050.1); • consolidated supervision of regional BHCs 14. See SR-03-22/CA-03-15, ‘‘Framework for Assessing (Attachment A.2) (See section 1050.2); Consumer Compliance Risk at Bank Holding Companies,’’ and section 2124.01.6.1.2. • supervision of the combined U.S. operations of LCBO FBOs (Attachment B.1); and BHC Supervision Manual January 2015 • supervision of the combined U.S. operations Page 6 of multi-office FBOs (Attachment B.2). Consolidated Supervision of BHCs and the Combined U.S. Operations of FBOs 1050.0

As a supplement to these four guidance docu- cial markets in which the organization plays ments, definitions of key terms for consolidated a significant role, as well as related risk supervision are provided in Attachment C to management and internal controls; SR-08-9/CA-08-12 (See appendix, section 5. where applicable, areas of emerging interest 1050.0.4). with potential financial market conse- Consolidated supervision of community BHCs quences; follows the procedures contained in SR-02-1 6. consolidated financial strength (in the case of and section 5000.0.4.3, ‘‘Revisions to Bank FBOs, the financial strength of combined Holding Company Supervision Procedures for U.S. operations); Organizations with Total Consolidated Assets of 7. risk management and financial condition of $5 Billion or Less,’’ while supervision of single- significant nonbank subsidiaries; and office FBOs follows the procedures contained in 8. parent company and nonbank funding and SR-00-14. liquidity (in the case of FBOs, funding and liquidity of U.S. operations).

1050.0.3.1 Overview of Significant By their nature, understanding and assessing Federal Reserve Supervisory Activities some areas—such as the risk management and financial condition of significant nonbank sub- The Federal Reserve will maintain for each sidiaries that are not functionally regulated— BHC and the combined U.S. operations of each will typically require more independent Federal FBO Reserve supervisory work. Other areas—such as primary firmwide risk management and con- • an understanding of key elements of the bank- trol functions—typically will require a greater ing organization’s strategy, primary revenue degree of coordination with other relevant pri- sources, risk drivers, business lines, legal entity mary supervisors or functional regulators, who structure, governance and internal control will likely have information or assessments upon framework, and presence in key financial mar- which the Federal Reserve can draw. kets; and The guidance in the attachments to SR-08- • an assessment of (1) the effectiveness of risk- 9/CA-08-12 outlines when the Federal Reserve management systems and controls over the will conduct (i.e., participate in or lead) testing primary risks inherent in the organization’s activities in order to determine whether a con- activities, (2) the organization’s financial con- trol process is appropriately designed and achiev- dition, and (3) the potential negative impact of ing its objectives or to otherwise validate man- nonbank operations on affiliated depository agement assertions. Testing activities are an institutions. important element of the Federal Reserve’s con- solidated supervision program for BHCs and the This understanding and assessment will combined U.S. operations of FBOs. They supple- encompass both prudential and consumer ment ongoing continuous monitoring activities compliance supervision and reflect judgments and periodic discovery reviews necessary to developed by Federal Reserve staff drawing maintain an understanding and assessment for from all available sources, including the work each of these key functions. of other relevant primary supervisors and The guidance in the SR letter’s attachments functional regulators and the organization’s also discusses in greater detail control processes internal control functions. Primary areas of for several areas subject to testing on at least a focus will include three-year cycle, supplemented by a reassess- ment on at least an annual basis to identify 1. key corporate governance functions, includ- whether changes in inherent risk or control ing internal audit; structures, or potential concerns regarding con- 2. risk management and internal control func- trols, merit interim targeted testing activities. tions for primary risks of the consolidated These areas are organization (or combined U.S. operations for FBOs), and supporting MIS; • internal audit infrastructure; 3. where applicable, core clearing and settle- • parent company and nonbank funding and ment activities and related risk management liquidity (in the case of FBOs, funding and and internal controls of firms that are large- liquidity of U.S. operations); value payment system operators and market utilities; BHC Supervision Manual January 2015 4. for LCBOs, activities in critical or key finan- Page 7 Consolidated Supervision of BHCs and the Combined U.S. Operations of FBOs 1050.0

• where applicable, core clearance and settle- ary if, after reviewing relevant reports, it reason- ment activities; and, ably determines that the examination is neces- • where applicable, activities in critical finan- sary to adequately inform the Federal Reserve cial markets in which the organization plays a about the systems used to monitor and control significant role.15 financial and operational risks within the con- solidated organization that may pose a direct or There may also be instances when additional indirect threat to the safety and soundness of a supervisory activities are necessary to improve depository institution subsidiary. the understanding and/or to assess the adequacy of key corporate governance functions or risk management or internal control functions for primary risks due to significant changes, poten- 1050.0.3.2 Application of Supervisory tial concerns, or the absence of recent testing. Guidance All cycle times set forth in the guidance for testing represent maximum periods between test- As a general matter, the supervisory expecta- ing activities. Shorter cycle times should be tions and processes of the guidance documents utilized whenever significant changes occur in, that are attached to SR-08-9/CA-08-12 are or material concern exists regarding, a key gov- intended for use in supervising BHCs and the ernance, risk-management, or internal control combined U.S. operations of FBOs in circum- function. stances where both the banking organization In conducting the activities described in the and its subsidiary depository institutions are in guidance, the Federal Reserve will rely to the at least satisfactory condition and there are no fullest extent possible on the information and indications of material weakness in the organi- assessments of relevant primary supervisors and zation’s risk management or internal controls. functional regulators, and will work with such Additional Federal Reserve supervisory activi- supervisors and regulators to align each agen- ties may be necessary or appropriate if the bank- cy’s assessment of key corporate governance ing organization is facing, or is expected to face, functions, risk-management and internal control material financial, managerial, operational, legal, functions for primary risks, financial condition, or reputational difficulties, or is the subject of an and other areas of consolidated BHC or com- investigation or formal or informal enforcement bined U.S. FBO operations, as applicable. In action. addition, because of the specific statutory limita- Section IV of each of the documents attached tions that apply with respect to functionally to SR-08-9/CA-08-12 (see sections 1050.1.4 and regulated subsidiaries of a BHC or FBO, the section 1050.2.4) provides additional guidance Federal Reserve will continue to adhere to the on the steps the Federal Reserve will take to procedures and limits described in SR-00-13 coordinate with other supervisors in certain spe- (see sections 3900.0 and 1040.0) in conducting cial situations. This guidance does not limit any any examination of, or requesting a specialized authority that the Federal Reserve may have report from, a functionally regulated subsidiary under applicable law and regulations, including of a BHC or FBO.16 Under these provisions, for the authority to obtain reports or conduct exami- example, the Federal Reserve may conduct an nations or inspections. Moreover, because this examination of a functionally regulated subsidi- guidance relates to supervisory practices, it does not address or limit the circumstances under 15. For these activities, the three-year testing cycle focuses which the Federal Reserve may take formal or on adherence with expectations of the Interagency Paper on informal enforcement action against a banking Sound Practices to Strengthen the Resilience of the U.S. organization or other person. Financial System (see SR-03-9), including the geographic diversity and resiliency of data centers and operations, and This supervisory guidance is not intended to testing of recovery and resumption arrangements. comprehensively describe all elements of an 16. For these purposes, a ‘‘specialized report’’ means a effective supervision program for BHCs or U.S. report that the functionally regulated subsidiary is not required operations of FBOs. Rather, the guidance supple- to prepare for another federal or state regulatory authority or an appropriate self-regulatory organization. Consistent with ments, and should be used in conjunction with, the GLBA, if the Federal Reserve seeks to obtain a special- existing Federal Reserve guidance, including ized report from a functionally regulated subsidiary, the Fed- among others the Bank Holding Company Super- eral Reserve will first request that the subsidiary’s appropriate vision Manual; the Examination Manual for regulatory authority or self-regulatory organization obtain the report and make it available to the Federal Reserve. U.S. Branches and Agencies of Foreign Banking Organizations; SR-04-18; SR-03-22/CA-03-15; BHC Supervision Manual January 2015 SR-00-14; and SR-00-13. Page 8 Consolidated Supervision of BHCs and the Combined U.S. Operations of FBOs 1050.0

1050.0.4 APPENDIX—DEFINITIONS Discovery review:Anexamination/inspection OF KEY TERMS FOR supervisory activity designed to improve the CONSOLIDATED SUPERVISION understanding of a particular business activity or control process—for example, to address a 1050.0.4.1 Supervisory Objectives knowledge gap identified during the risk assess- ment or other supervisory process. If questions Assessing: To go beyond developing an under- regarding the adequacy of practices or suffi- standing by making supervisory judgments ciency of information are raised during this regarding the degree of inherent risks or evaluat- review, it will likely be necessary to conduct ing whether risk-management and internal con- further and more in-depth examination activity trol practices are functioning as intended, and (e.g., testing). whether they are adequate relative to the risk taken. It is often necessary for bank supervisors Examination/inspection: Examination activities or functional regulators to conduct testing activi- are applicable to the supervision of banks and ties as a means to arrive at an assessment. other depository institutions, as well as U. S. banking offices of FBOs, and inspection activi- Understanding: To gain comprehensive insight ties are applicable to the supervision of BHCs into the nature of a business activity, its related and nonbank subsidiaries and affiliates. Exami- risks, and the design of risk-management and nation and inspection activities are generally compensating controls. Understanding also described as examinations throughout this involves comprehending the significance of such guidance. activities, risks, and controls for the institution’s safety and soundness. Continuous monitoring or Testing:Anexamination/inspection supervisory discovery reviews are often utilized to develop activity designed to go beyond a discovery an understanding of a banking organization’s review, as it will result in an assessment of operations and the related inherent risk and whether a control process is appropriately controls. designed and achieving its objectives, or valida- tion of a management assertion about an organi- zation’s operations. Such activities may include the review and validation of internal MIS, such 1050.0.4.2 Supervisory Activities as business records related to an internal control process; audit findings and processes; or a sample Active participation: When the Federal Reserve of transactions that have been entered into by a has input into determining the objectives, final banking organization. conclusions, and related communications to institution management for an examination led by another relevant primary supervisor or func- 1050.0.4.3 Foreign Banking Organization tional regulator. Supervision

Continuous monitoring: Non-examination/ Booked in: Recorded on the books and records inspection supervisory activities primarily of the legal entity in question. For supervisory designed to develop and maintain an purposes, the U.S. operations of FBOs include understanding of the organization, its risk activities that are booked in or traded through profile, and associated policies and practices. U.S. operations. These activities also provide information that is used to assess inherent risks and internal control Comprehensive, consolidated supervision:An processes. Such activities include meetings with FBO is supervised or regulated in such a man- banking organization management; analysis of ner that its home-country supervisor receives management information systems (MIS) and sufficient information on the worldwide opera- other internal and external information; review tions of the FBO (including the relationship of of internal and external audit findings; and other the bank to any affiliate) to assess the FBO’s efforts to coordinate with, and utilize the work overall financial condition and compliance with of, other relevant supervisors and functional law and regulation. The Foreign Bank Supervi- regulators, including analysis of reports filed sion Enhancement Act of 1991 introduced the with, or prepared by, these supervisors or requirement that the Federal Reserve approve regulators, or appropriate self-regulatory organizations, as well as related surveillance BHC Supervision Manual January 2009 results. Page 9 Consolidated Supervision of BHCs and the Combined U.S. Operations of FBOs 1050.0 the establishment of all U.S. banking offices of subsidiaries of FBOs and branches/agencies of FBOs, and in that connection, take into account FBOs. whether the FBO is subject to comprehensive, consolidated supervision by its home-country U.S. nonbank affiliates of U.S. banking offices: supervisor. U.S. BHC parent companies and their nonbank subsidiaries, as well as other U.S. nonbank affili- Multi-office foreign banking organizations: All ates and representative offices held directly by FBOs except for (1) those that are designated as the FBO. being part of the portfolio of LCBOs and (2) FBOs whose U.S. operations consist solely of a single U.S. banking office. 1050.0.4.4 Other Terms

National treatment: As established by the Banking Organization National Desktop International Banking Act of 1978 (IBA), a pol- (BOND): A Federal Reserve information tech- icy that requires nondiscrimination between nology platform providing secure interagency domestic and foreign firms or treatment of for- access to documents, supervisory and financial eign entities that is no less favorable than that data, and other information utilized in the con- accorded to domestic enterprises in like solidated supervision of individual BHCs and circumstances. This policy generally gives for- FBOs, and in developing comparative analyses eign banks operating in the United States the of institutions with similar business lines and same powers as U.S. banking organizations and risk characteristics. subjects them to the same restrictions and obligations. College of supervisors: A multilateral group of supervisors that discusses issues related to spe- Net due to / from positions: Net due to and from cific internationally active banking organiza- positions refer to the flow of funds between a tions. The Federal Reserve participates in col- U.S. branch or agency and its parent FBO (includ- leges of supervisors as both a home-country ing other affiliated depository institutions). For supervisor of internationally active U.S. BHCs example, a U.S. branch is in a net due from and as a host-country supervisor of the U.S. position with its parent FBO if the parent owes operations of FBOs. funds to the branch once all transactions between the branch and the parent are netted. Consolidated supervision (also known as ‘‘umbrella’’ or ‘‘groupwide’’ supervision): Qualifying foreign banking organizations Supervision of a BHC on a groupwide basis, (QFBOs): FBOs that are entitled to certain including its nonbanking subsidiaries, provid- exemptions from the nonbanking activities ing important protection to its subsidiary banks restrictions of the Bank Holding Company Act, and to the federal safety net beyond that af- including for certain limited commercial and forded by supervision of a bank individually. industrial activities in the United States. The Consolidated supervision allows the Federal Federal Reserve does not examine or supervise Reserve to understand the financial and these commercial/industrial activities. The Fed- managerial strength and risks within the eral Reserve monitors the extensions of credit consolidated organization as a whole, provid- by U.S. banking offices of foreign banks to U.S. ing the ability to address significant manage- companies held directly under this authority to ment, operational, capital, or other deficiencies ensure that such loans are made on market within the overall organization before they pose terms. a threat to subsidiary banks.

Traded through: Transacted or arranged by the Core clearing and settlement organizations:As personnel of the institution in question (in an defined in the ‘‘Interagency Paper on Sound agent role), but booked at a different related Practices to Strengthen the Resilience of the legal entity. For supervisory purposes, the U.S. U. S. Financial System’’ (SR-03-9), two groups operations of FBOs include activities that are of organizations that provide clearing and settle- booked in or traded through U.S. operations. ment services for critical financial markets or act as large-value payment system operators, U.S. banking offices: U.S. depository institution and present the potential for systemic risk should they be unable to perform. The first group con- BHC Supervision Manual January 2009 sists of market utilities (government-sponsored Page 10 services or industry-owned organizations), whose Consolidated Supervision of BHCs and the Combined U.S. Operations of FBOs 1050.0 primary purpose is to clear and settle transac- Key financial markets: Includes critical finan- tions for critical markets or transfer large-value cial markets as well as (1) broader U.S. capital wholesale payments. The second group consists market activity, including underwriting, securiti- of those private-sector firms that provide clear- zation, derivatives, and trading; (2) retail finan- ing and settlement services that are integral to a cial services; and (3) international financial critical market (i.e., their aggregate market share markets. is significant enough to present the potential for systemic risk in the event of their sudden failure Key models and processes: Those where evalua- to carry out those activities because there are no tion of the model/process will influence the Fed- viable immediate substitutes). eral Reserve’s assessment of the activity or con- trol area that is supported by the model/process. Critical financial markets:Asdefined in the ‘‘Interagency Paper on Sound Practices to Large complex banking organizations (LCBOs): Strengthen the Resilience of the U. S. Financial LCBOs are characterized by the scope and com- System,’’ the markets for federal funds, foreign plexity of their domestic and international opera- exchange, and commercial paper; U.S. govern- tions; their participation in large volume pay- ment and agency securities; and corporate debt ment and settlement systems; the extent of their and equity securities. custody operations and fiduciary activities; and the complexity of their regulatory structure, Domestic BHC: A BHC incorporated in the both domestically and in foreign jurisdictions. United States that is not controlled by an FBO. To be designated as an LCBO, a banking organi- zation must meet specified criteria to be consid- Double leverage: Situations in which debt is ered a significant participant in at least one key issued by the parent company and the proceeds financial market. are invested in subsidiaries as equity. Material portfolios or business lines: Portfolio Financial instability: When external events or risk areas (such as retail or wholesale credit market behavior in the financial system are sub- risk) or individual business lines (such as mort- stantial enough to significantly distort or impair gage lending or leveraged lending) that are pri- national or global financial markets or to create mary drivers of risk or revenue for the BHC, or significant risks for real aggregate economic that otherwise materially contribute to under- performance. Banking organizations with a con- standing inherent risk or assessing related con- siderable presence in activities that are poten- trols for a broader corporate function (such as tially vulnerable to such externalities—or that consolidated credit-risk management). When are capable of contributing to financial instabil- identifying these areas during the development ity if not adequately managed—require supervi- of the institutional overview and risk assess- sors to develop an understanding of these activi- ment, as well as during other supervisory pro- ties and their risk profile. cesses, consideration is given to all associated risk elements, including legal and compliance Functional regulator: With respect to domestic risks. authorities, the appropriate federal (examples include the U.S. Securities and Exchange Com- Net debit cap: The maximum dollar amount of mission and the U.S. Commodity Futures Trad- uncollateralized daylight overdrafts that an insti- ing Commission) or state regulator for a func- tution may incur in its Federal Reserve account. tionally regulated nondepository subsidiary or affiliate of a BHC or FBO. Nonmaterial business lines: Business lines that are not primary drivers of risk or revenue for the Key corporate governance functions: Primary BHC, and are not principal contributing fac- firmwide governance mechanisms relied upon tors to either understanding risk inherent in a by the board of directors and senior manage- broader corporate function or to assessing ment. This includes the board and its commit- related controls. tees, senior management and its executive com- mittees, internal audit, and other functions (e.g., Nontraditional BHCs: BHCs in which most or corporate finance and treasury functions), whose all of the organization’s significant nondeposi- effectiveness is essential to sustaining the con- tory subsidiaries are regulated by a functional solidated organization as well as a firm’s busi- ness resiliency and crisis management BHC Supervision Manual January 2009 capabilities. Page 11 Consolidated Supervision of BHCs and the Combined U.S. Operations of FBOs 1050.0 regulator, and subsidiary depository institu- tions of FBOs, the U.S. supervisor of a U. S. tion(s) are small in relation to nondepository banking office is referred to as a domestic pri- subsidiaries. mary supervisor.

Other relevant primary supervisors: Primary Regional bank holding companies: BHCs with bank or thrift supervisors of BHC subsidiaries, $10 billion or more in consolidated assets (includ- including host-country supervisors (or home- ing nontraditional BHCs) that are not desig- country supervisors for FBOs), whose under- nated as LCBOs. standing and assessments are key to effective firmwide consolidated supervision. Regulatory structure: The various legal entities within the organization that are subject to over- Primary firmwide risk management and control sight by different domestic and foreign primary functions: Mechanisms relied upon by the board supervisors or functional regulators. of directors and senior management for identify- ing, measuring, monitoring, and controlling pri- Significant nonbank activities and risks: Where mary risks to the consolidated organization. This the parent company or nonbank subsidiaries includes risk management and control functions engage in risk-taking activities or hold expo- for primary credit, legal and compliance, liquid- sures that are material to the risk management ity, market, operational, and reputational risks or financial condition of the consolidated orga- for the consolidated organization. nization or a depository institution affiliate.

Primary supervisor: The primary federal bank- Specialized report from a functionally regulated ing or thrift supervisor (for example, the Office subsidiary: As discussed in the GLBA, a report of the Comptroller of the Currency for a nation- that the functionally regulated subsidiary is not ally chartered bank) of a depository institution required to prepare by another federal or state subsidiary of a BHC, or of a U.S. banking office regulatory authority or an appropriate self- of an FBO. For state-chartered depository insti- regulatory organization. tutions or banking offices, this term also includes the relevant bank supervisory authority of the Systemic risk: The risk that the failure of one institution’s chartering/licensing state. Where a participant to meet its required obligations in a BHC has multiple depository institution subsid- transfer system or financial market will cause iaries, or an FBO has multiple U.S. banking other participants to be unable to meet their offices, there may also be multiple primary obligations when due, causing significant liquid- banking supervisors, depending on how the sub- ity or credit problems or threatening the stability sidiaries are chartered/licensed. For U.S. opera- of national or global financial markets.

BHC Supervision Manual January 2009 Page 12 Guidance for the Consolidated Supervision of Domestic Bank Holding Companies That Are Large Complex Banking Organizations Section 1050.1

WHAT’S NEW IN THIS REVISED 1050.1.1.1 Federal Reserve Activities and SECTION Those Activities of Other Supervisors and Regulators Effective January 2015, this section is revised for the adoption of a new consolidated supervi- The nature and scope of independent Federal sion framework for large banking organiza- Reserve supervisory work required to develop tions. Refer to SR-12-17/CA-12-14, ‘‘Consoli- and maintain an understanding and assessment dated Supervision Framework for Large of a large complex BHC depends largely on the Financial Institutions.’’ SR-99-15 was super- extent to which other relevant primary supervi- seded by SR-12-17/CA-12-14. sors or functional regulators have information or assessments upon which the Federal Reserve can draw. By their nature, understanding and 1050.1.1 ACTIVITIES OF THE assessing some areas—such as the risk manage- FEDERAL RESERVE AND OTHER ment and financial condition of significant non- SUPERVISORS AND REGULATORS, bank subsidiaries that are not functionally AND FUNCTIONAL REGULATION regulated—typically will require more indepen- dent Federal Reserve supervisory work. Other In 1999, the Federal Reserve established its areas—such as primary firmwide risk- supervisory program for large complex banking management and control functions—typically 1 organizations (LCBOs). LCBOs are character- will require a greater degree of coordination ized by the scope and complexity of their domes- with other relevant primary supervisors or func- tic and international operations; their participa- tional regulators, who will likely have informa- tion in large volume payment and settlement tion or assessments upon which the Federal systems; the extent of their custody operations Reserve can draw. and fiduciary activities; and the complexity of The following sections provide further detail their regulatory structure, both domestically and on how the Federal Reserve will develop, work- in foreign jurisdictions. To be designated as an ing in coordination with other relevant primary LCBO, a banking organization must meet speci- supervisors and functional regulators, an under- fied criteria to be considered a significant par- standing and assessment of a large complex 2 ticipant in at least one key financial market. BHC. In conducting the activities described As outlined in the following sections, a range throughout this document, the Federal Reserve of continuous monitoring activities is utilized, will, to the fullest extent possible along with discovery reviews and testing activi- 3 ties (examination/inspection activities), to • rely on the information and assessments of develop and maintain an understanding and relevant primary supervisors and functional assessment of each domestic bank holding com- regulators, including the information and 4 pany (BHC) that is an LCBO. These organiza- assessments reflected in the reports of exami- tions are collectively referred to as large com- nation of such supervisors and regulators; plex BHCs. • focus its supervisory activities on the bank holding company, as well as on those of its nonbank subsidiaries that could have a direct 1. With the implementation of the ‘‘Consolidated Supervi- or indirect materially adverse effect on the sion Framework for Large Financial Institutions’’ (refer to SR-12-17/CA-12-14), SR-99-15, ‘‘Risk-Focused Supervision safety and soundness of a depository institu- of Large Complex Banking Organizations,’’ was superseded. tion subsidiary of the BHC due to the size, (Refer to section 2124.05 of this manual). condition, or activities of the nonbank subsid- 2. See section 1050.0.4, Appendix, for the definitions of iary, or the nature or size of its transactions terms commonly used in this section and sections 1050.1 and 1050.2. with the depository institution; and 3. The term ‘‘examination’’ is generally used throughout • use publicly reported information (including this guidance to refer to both commercial bank examination externally audited financial statements), as and BHC inspection activities. well as reports that a large complex BHC or a 4. The term ‘‘domestic BHC’’ refers to a BHC incorpo- rated in the United States that is not controlled by a foreign subsidiary prepares for other primary supervi- banking organization (FBO). Attachment B.1. to SR-08-9/CA- sors, functional regulators, or self-regulatory 08-12 addresses—in the context of supervising the combined organizations. U.S. operations of FBOs—how the Federal Reserve will develop and maintain an understanding and assessment of a BHC that is, or is controlled by, an FBO that is itself an BHC Supervision Manual January 2015 LCBO. Page 1 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs

1050.1.1.2—Functionally Regulated organization and its primary strategies, business Subsidiaries lines, and risk-management and internal control functions.6 This understanding will inform the As discussed below, in certain situations, the development of a risk assessment and supervi- Federal Reserve may find it necessary to con- sory plan for the BHC. Typically, the informa- duct an examination of a functionally regulated tion necessary to gain this understanding may nonbank subsidiary in order to fulfill the Federal be obtained from the organization’s manage- Reserve’s responsibilities as supervisor of the ment, public reports, regulatory reports, surveil- consolidated organization. In any such case, the lance screens, third-party sources (e.g., credit Federal Reserve will continue to adhere to the rating agency and market analyst reports), and procedural and other requirements governing other relevant primary supervisors or functional examinations of, or requests for a specialized regulators. Key elements that should be identi- report from, a functionally regulated subsidiary fied and understood include the following: as discussed in SR-00-13 and sections 1040.0 and 3900.0. Under these provisions, for exam- • Corporate strategy. Primary business strate- ple, the Federal Reserve may conduct an exami- gies; institutional risk tolerance; key changes nation of a functionally regulated subsidiary if, in strategic direction or risk profile; signifi- after reviewing relevant reports, it reasonably cant new business activities, areas of growth determines that the examination is necessary to and emerging areas with potential to become adequately inform the Federal Reserve about the primary drivers of risk or revenue; and plans systems used to monitor and control financial for expansion through mergers or acquisitions. and operational risks within the consolidated • Significant activities. Key revenue and risk organization that may pose a direct or indirect drivers; primary business lines; product mix; threat to the safety and soundness of a deposi- budget and internal capital allocations; market tory institution subsidiary.5 share for revenue and customers served; key external trends, including competitive pres- sures; and areas that are vulnerable to volatil- 1050.1.2 UNDERSTANDING THE ity in revenue, earnings, capital, or liquidity. ORGANIZATION • Structure. Business line and legal entity struc- ture; domestic and foreign regulatory respon- For each large complex BHC, the Federal Reserve sibilities for legal entities and business lines; will develop an understanding of the legal, oper- key interrelationships and dependencies ating, and corporate governance structure of the between depository institution subsidiaries and nonbank affiliates; material business lines op- 5. The Federal Reserve also may examine a functionally erated across multiple legal entities for account- regulated subsidiary of a large complex BHC if, after review- ing or risk-management purposes; and the ing relevant reports and other information, it has reasonable activities and risk profiles of Edge and agree- cause to believe that the subsidiary is engaged in an activity ment corporation subsidiaries. that poses a material risk to an affiliated depository institution, or that the subsidiary is not in compliance with any federal • Corporate governance, risk management, and law that the Federal Reserve Board has specific jurisdiction to internal controls for primary risks. Board of enforce against the subsidiary (and the Federal Reserve can- directors (board) and executive-level commit- not determine compliance by examining the BHC or its affili- tees; senior management and management ated depository institutions). Similarly, before requiring a specialized report from a func- committees; key risk-management and inter- tionally regulated subsidiary, the Federal Reserve first will nal control functions, and associated manage- request that the subsidiary’s appropriate functional regulator ment information systems (MIS), relied upon obtain the report and make it available to the Federal Reserve. by the board, senior management, and senior In the event that the report is not obtained or made available as requested, the Federal Reserve may, consistent with the risk managers and committees; and consis- Bank Holding Company Act, obtain the report directly from tency of public disclosures with how the board the functionally regulated subsidiary if the report is necessary and senior management assess and manage to allow the Federal Reserve to adequately assess (1) a mate- risks. rial risk to the BHC or any of its depository institution subsidiaries, (2) the systems used to monitor and control financial and operational risks within the consolidated organi- 6. This understanding is formally documented during devel- zation that may pose a threat to the safety and soundness of a opment of the institutional overview, which coincides with depository institution subsidiary, or (3) compliance with any creation of the annual risk assessment. SR-97-24, ‘‘Risk- federal law that the Federal Reserve Board has specific juris- Focused Framework for Supervision of Large Complex Insti- diction to enforce against the BHC or a subsidiary. tutions’’ (see section 2124.01), describes processes for devel- opinganinstitutionaloverview,riskassessment,andsupervisory BHC Supervision Manual January 2015 plan. Each of these products is kept current to reflect signifi- Page 2 cant changes in an organization’s risks or activities. 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs

• Presence in critical or key financial markets.7 operate the organization in a safe and sound Core clearing and settlement activities; busi- manner, and regularly evaluating senior man- ness lines with a significant presence in criti- agers’ performance; cal or key national or global financial mar- 2. establishing, communicating, and monitoring kets; and related risk-management and (for example, by reviewing comprehensive disclosure practices. MIS reports produced by senior manage- ment) institutional risk tolerances and a cor- To ensure the quality and consistency of con- porate culture that emphasizes the impor- solidated supervision across the large complex tance of compliance with the law and ethical BHC portfolio, it also is necessary to understand business practices; how these key elements compare with industry 3. approving significant strategies and policies; trends and with evolving practices of well- 4. demonstrating leadership, expertise, and managed organizations with similar effectiveness; characteristics. 5. ensuring the organization has an effective and independent internal audit function; 6. ensuring the organization has appropriate 1050.1.3 ASSESSING THE policies governing the segregation of duties LARGE COMPLEX BHC ON A and avoiding conflicts of interest; and CONSOLIDATED BASIS 7. ensuring that public disclosures • are consistent with how the board and The Federal Reserve uses a systematic approach senior management assess and manage the to develop an assessment of a BHC on a consoli- risks of the organization, dated basis. This assessment is reflected in the • balance quantitative and qualitative infor- RFI (Risk Management, Financial Condition, mation with clear discussions about risk- and Impact) rating assigned to a BHC.8 management processes, and • reflect evolving disclosure practices for peer organizations. 1050.1.3.1 Risk Management A large complex BHC’s senior management 1050.1.3.1.1 Key Corporate Governance and its committees should be able to clearly Functions communicate risk tolerances and measures, con- trol risks, hire and retain competent staff, and Objectives: One of the primary areas of focus respond to changes in the organization’s risk for consolidated supervision of large complex profile and the external environment. Members BHCs is the adequacy of governance provided of senior management are expected to have by the board and senior management. The cul- qualifications and experience commensurate with ture, expectations, and incentives established by the size and complexity of the organization. the highest levels of corporate leadership set the Primary expectations for senior management tone for the entire organization and are essential include determinants of whether a banking organization is capable of maintaining fully effective risk- 1. establishing effective oversight and an appro- management and internal control processes. priate risk culture; The board and its committees should have an 2. appropriately delegating authority and over- ongoing understanding of key inherent risks, seeing the establishment and implementation associated trends, primary control functions, and of effective policies for the proper segrega- senior management capabilities. Primary expec- tion of duties and for the avoidance or man- tations for the board and its committees include agement of conflicts of interest; 3. establishing and implementing an effective 1. selecting competent senior managers, ensur- risk-management framework capable of iden- ing that they have the proper incentives to tifyingandcontrollingbothcurrentandemerg- ing risks, and effective independent control 7. See sections 1050.1.3.1.6 and 1050.1.3.1.7 for defini- functions that ensure risk taking is consistent tionsof‘‘criticalfinancialmarkets’’and‘‘keyfinancialmarkets.’’ 8. The RFI rating system for BHCs is discussed in SR-04- with the organization’s established risk 18, ‘‘Bank Holding Company Rating System’’ (see section appetite; 4070.0). RFI ratings are assigned for BHCs that are complex 4. establishing and implementing incentives for or that have $1 billion or more in consolidated assets, and are communicated via a comprehensive summary supervisory report that supports the BHC’s assigned ratings and encom- BHC Supervision Manual January 2015 passes the results of the entire supervisory cycle. Page 3 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs

personnel that are consistent with institu- The results of continuous monitoring activi- tional risk tolerances, compliance with the ties, as documented in the institutional over- law, and ethical business practices; view, risk assessment, and other supervisory 5. promoting a continuous dialogue between products, may identify certain corporate gov- and across business areas and risk- ernance functions that will require more inten- management functions to help align the orga- sive supervisory focus due to (1) significant nization’s established risk appetite and risk changes in corporate strategy, activities, orga- controls; nizational structure, oversight mechanisms, or 6. ensuring that the board and its committees key personnel; (2) potential concerns regard- are provided with timely, accurate, and com- ing the adequacy of a specific governance prehensive MIS reports that are adaptive to function; or (3) the absence of sufficiently changing circumstances regarding risks and recent examination activities for a key func- controls; and tion by the Federal Reserve or another pri- 7. ensuring timely resolution of audit, compli- mary supervisor or functional regulator. ance, and regulatory issues. • Internal audit. Continuous monitoring and examination activities will be used to An effective internal audit function plays an understand and assess key elements of essential role by providing an independent and internal audit governance for the organiza- objective evaluation of all key governance, risk- tion on a consolidated basis, including (1) the management, and internal control processes. As adequacy and independence of the audit com- the complexity of financial products and sup- mittee; (2) the independence, professional porting technology has grown, in combination competence, and quality of the internal audit with greater reliance on third-party service pro- function; (3) the quality and scope of the audit viders, the importance of internal audit’s role in methodology, audit plan, and risk- identifying risks and testing internal controls assessment process; and (4) the adequacy of has increased. audit programs and workpaper standards. On In addition, the extent to which supervisors at least an annual basis, the results of these can rely on or utilize the work of internal audit supervisory activities will be reviewed to is an essential determinant of the risk-focused determine whether there have been significant supervisory program that is tailored to the activi- changes in the internal audit infrastructure or ties and risks of each large complex BHC. whether there are potential concerns regard- ing the adequacy of key elements of internal Supervisory Activities: For each large complex audit. In addition to this periodic audit BHC, the Federal Reserve will understand and infrastructure review, testing activities for assess the adequacy of oversight provided by specific control functions or business lines the board and senior management, as well as the should include an assessment of internal adequacy of internal audit and associated MIS. audit’s recent work in these areas to the extent The Federal Reserve also will understand and possible as a means of validating internal assess other key corporate governance functions audit’s findings. (e.g., corporate finance and treasury functions), • Additional supervisory activities. If continu- whose effectiveness is essential to sustaining ous monitoring activities identify a key corpo- consolidated holding company operations, as rate governance function or element of inter- well as the organization’s business resiliency nal audit requiring more intensive supervisory and crisis management capabilities. focus due to significant changes, potential concerns, or the absence of sufficiently recent • Board, senior management, and other key cor- examination activities, the Federal Reserve porategovernancefunctions.Continuousmoni- will work with other relevant primary supervi- toring activities—which draw from all avail- sors or functional regulators (where applica- able sources, including internal control ble) in developing discovery reviews or test- functions, the work of other relevant primary ing activities focusing on the area of concern. supervisors and functional regulators, regula- In situations where another primary supervi- tory reports, and related surveillance results— sor or functional regulator leads the examina- will be used to understand and assess the tion activities, the Federal Reserve will par- effectiveness of board and senior management ticipate as actively as appropriate in those resources and oversight. activities.9

BHC Supervision Manual January 2015 9. Active participation by the Federal Reserve in an exami- Page 4 nation led by another primary supervisor or functional regula- 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs

If the area of concern is not within the oversight of another primary supervisor or functional regulator, or if the supervisor or regulator does not conduct or coordinate the examination activities in a reasonable period

tor includes having input into determining the examination objectives, final conclusions, and related communications to the organization’s management. In the event that a material aspect of the Federal Reserve’s input is not reflected in the examination’s objectives, conclusions, or related communica- tions with the organization, the Federal Reserve will review the situation to determine whether additional steps are appro- priate to address any remaining concerns.

BHC Supervision Manual January 2015 Page 4.1 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs

of time, the Federal Reserve will lead the For example, for large complex BHCs with necessary examination activities in coordina- particularly dynamic corporate strategies, the tion with other relevant primary supervisors Federal Reserve will understand and assess the and functional regulators to the extent possible. adequacy of the control mechanisms relevant to • Additional required audit testing activities. In such strategies, including strategic planning, all instances, the Federal Reserve will conduct merger integration, new business approval, and testing activities as part of its audit infrastruc- processes for ensuring that risk management ture review (either by leading the activities and controls keep pace with areas of growing and coordinating with other relevant primary inherent risk. Furthermore, large complex BHCs supervisors or functional regulators or partici- operating across a range of financial intermedi- pating as actively as appropriate in activities ary activities are more likely to face potential led by other relevant supervisors or regula- conflicts of interest due to their greater likeli- tors) on at least a three-year cycle to ensure hood of acting as agents for both issuers and that the internal audit program is appropri- investors. For these holding companies, it is ately designed and achieving its objectives. necessary to assess the adequacy of processes for identifying and avoiding or managing con- In all cases involving a functionally regulated flicts of interest. subsidiary, the Federal Reserve will conduct its In all instances, the adequacy of each primary supervisory and testing activities in accordance firmwide risk management or control mecha- with the provisions described above in section nism depends on the appropriateness of the 1050.1.1.2. following:

1. control infrastructure and governance, includ- 1050.1.3.1.2 Risk Management and ing degree of oversight by the board and Internal Control Functions for Primary senior management; Risks to the Consolidated Organization 2. development, maintenance, and communica- tion of appropriate policies, procedures, and Objectives: Underlying the risk-focused approach internal controls; to consolidated supervision of large complex 3. risk identification and measurement systems BHCs is the premise that it is each organiza- and processes, and associated MIS, that are tion’s responsibility to develop an appropriate adaptive to changing circumstances and controlstructureforidentifying,measuring,moni- capable of providing timely, accurate, and toring, and controlling key risks as measured comprehensive information to senior man- against supervisory standards and expectations, agement and the board; applicable laws and regulations, and evolving 4. monitoring and testing the effectiveness of practices of well-managed organizations. controls; The Federal Reserve will understand and 5. processes for identifying, reporting, and esca- assess risk-management and control functions lating issues and emerging risks; for primary risks to the consolidated organiza- 6. ability to implement corrective actions in a tion (primary firmwide risk-management and timely manner; control functions), and associated MIS, for each 7. appropriate authority and independence of large complex BHC. This will include risk- staff to carry out responsibilities; and management and control functions for primary 8. integration of risk-management and control credit, legal and compliance,10 liquidity, market, objectives within management goals and the operational, and reputational risks for the con- organization’s compensation structure. solidated organization. The Federal Reserve also will understand and assess other risk- MostlargecomplexBHCshaveevolvedtoward management and control functions that, based comprehensive, consolidated risk management on the specific characteristics and activities of to measure and assess the range of their expo- the individual BHC, relate to primary risks to sures and the way these exposures interrelate. the organization as a whole. Nonetheless, a variety of control structures are inplaceacrossthisportfolio,andinsomeinstances 10. Federal Reserve processes for understanding and assess- there is not a firmwide mechanism in place to ing legal and compliance risk management apply to the oversee and manage a key control function domestic and international operations of large complex BHCs across the organization’s business lines and and, as described in SR-03-22/CA-03-15, ‘‘Framework for Assessing Consumer Compliance Risk at Bank Holding Com- panies,’’ (see section 2124.01) encompass consumer compli- BHC Supervision Manual January 2009 ance risk inherent in the organization’s business activities. Page 5 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs legal entities. nificant changes in inherent risk, control pro- In all instances, the Federal Reserve will cesses, or key personnel; (2) potential concerns focus on individual control structures in place regarding the adequacy of controls; or (3) the for primary business lines or legal entities as absence of sufficiently recent examination activi- needed to reach an understanding and assess- ties for a primary firmwide risk-management or ment of the consolidated organization. When control function by the Federal Reserve or another applicable, the Federal Reserve also will assess relevant primary supervisor or functional whether a decentralized approach to a key con- regulator. trol function is sufficient by evaluating the effec- In these instances, the Federal Reserve will tiveness of such an approach in controlling pri- work with other relevant primary supervisors or mary risks to the consolidated organization.11 functional regulators (where applicable) to develop discovery reviews or testing activities Supervisory Activities: The Federal Reserve will focusing on the area of concern. In situations use continuous monitoring activities to under- where another primary supervisor or functional stand and assess each primary firmwide risk- regulator leads the examination activities, the management or control function. This process Federal Reserve will participate as actively as begins with the overarching design and architec- appropriate in those activities. ture of each primary firmwide risk-management If the primary firmwide risk-management or or control function, and drills down, as appropri- control function is not within the oversight of ate, through analysis of risk management and another primary supervisor or functional regula- controls for material portfolio areas and busi- tor, or if the primary supervisor or functional ness lines (described in section 1050.1.3.1.3 regulator does not conduct or coordinate the below). Activities will verify the sufficiency of examination activities in a reasonable period of fundamental aspects of internal controls in rela- time, the Federal Reserve will lead the neces- tion to the holding company’s current risk pro- sary examination activities in coordination with file and in comparison with supervisory expecta- other relevant supervisors and regulators to the tions and evolving sound practices and assess extent possible. In all cases involving a func- the capability of these primary functions (whether tionally regulated subsidiary, the Federal Reserve centralized or decentralized) to remain effective will conduct its supervisory and testing activi- in the face of growth, changing strategic direc- ties in accordance with the provisions described tion, significant market developments, and other above in section 1050.1.1.2. internal or external factors. The results of continuous monitoring activi- ties, as documented in the institutional over- 1050.1.3.1.3 Risk Management of view, risk assessment, and other supervisory Material Portfolios and Business Lines products, may identify certain primary firmwide risk-management or control functions that require Objectives: For each large complex BHC, there more intensive supervisory focus due to (1) sig- are selected portfolio risk areas (such as retail or wholesale credit risk) or individual business 11. As outlined in SR-08-8/CA-08-11, ‘‘Compliance Risk- lines (such as mortgage lending or leveraged Management Programs and Oversight at Large Banking Orga- lending) that are primary drivers of risk or rev- nizations with Complex Compliance Profiles’’ (see section enue, or that otherwise materially contribute to 2124.07), while the Federal Reserve does not prescribe a particular organizational structure for primary firmwide risk- understanding inherent risk or assessing con- management and control functions, establishment of a firm- trols for a broader corporate function (such as wide function that is dedicated to managing and overseeing consolidated credit-risk management). compliance risk, and that promotes a strong compliance cul- During the development of the institutional ture, is particularly important for large banking organizations with complex compliance profiles, due to the unique chal- overview and risk assessment, as well as during lenges associated with compliance risk management for these other supervisory processes, the Federal Reserve organizations. In addition to the oversight provided by the will analyze external factors and internal trends board and various executive and management committees, a in the BHC’s strategic initiatives—as evidenced key component of firmwide compliance oversight for these organizations is a corporate compliance function that has by budget and internal capital allocations and day-to-day responsibility for overseeing and supporting the other factors—to identify significant activities implementation of the organization’s firmwide compliance and areas vulnerable to volatility in revenue, risk-management program, and that plays a key role in con- earnings, capital, or liquidity that represent mate- trolling compliance risks that transcend business lines, legal entities, and jurisdictions of operation. rial risks of the organization. This determination of material portfolios and business lines consid- BHC Supervision Manual January 2009 ers all associated risk elements, including legal Page 6 and compliance risks. For example, when evalu- 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs ating whether retail activities such as mortgage focus will be on identifying and understanding or credit card lending are material to a banking those business lines that are increasing in impor- organization, the extent of inherent consumer tance and have the potential to become material. compliance and reputational risks, as well as credit and market risks, should be considered. Supervisory Activities: When a primary supervi- sor or functional regulator has a sufficient view Supervisory Activities: Because an understand- of nonmaterial business lines, the Federal Reserve ing of material risks and activities is needed to will, to the fullest extent possible, use informa- assess the primary firmwide risk-management tion developed by that supervisor or regulator to and control functions (as discussed in preceding monitor areas of increasing importance with the section 1050.1.3.1.2), the Federal Reserve will potential to become material. The Federal Reserve maintain an understanding of inherent risk and also will maintain an ability to access internal assess the adequacy of risk-management and MIS for these businesses to facilitate a more internal controls for material portfolios and busi- in-depth analysis of a business line, if appropri- ness lines. To form this understanding and assess- ate, to understand its growing importance to the ment, the Federal Reserve will rely primarily on organization. continuous monitoring activities, supplemented For nonmaterial business lines that are not as appropriate by examination activities. subject to oversight by a single primary supervi- To the fullest extent possible, the Federal sor or functional regulator, the Federal Reserve Reserve will draw its understanding and assess- will engage in continuous monitoring activities ment of these risks and risk-management prac- to identify meaningful trends in risks and risk- tices from the information and assessments of a management practices, initiate discovery reviews primary supervisor or functional regulator where (in coordination with relevant primary supervi- the BHC’s legal and operating structure pro- sors or functional regulators as appropriate and vides the supervisor or regulator a sufficient in accordance with section 1050.1.1.2 above if view of these areas. In these instances, the Fed- relevant) to increase understanding of selected eral Reserve will undertake continuous monitor- business lines that have the potential to become ing and participate in activities led by primary material, and maintain an understanding of asso- supervisors and functional regulators as neces- ciated MIS to facilitate more in-depth analysis sary to maintain an understanding and assess- of a business line, if appropriate, to understand ment of related firmwide risk-management and its growing importance to the organization. control functions. Many activities of large complex BHCs span legal entities that are subject to oversight by 1050.1.3.1.5 Core Clearing and multiple supervisors or regulators or that are Settlement Activities (Where Applicable) outside the oversight of other supervisors or regulators. If this is the case, or if the primary Objectives: The Federal Reserve will under- supervisor or functional regulator does not con- stand and assess the adequacy of risk- duct or coordinate the necessary continuous management and internal controls—including monitoring or examination activities in a reason- creditrisk-managementpractices—relatedtocore able period of time, the Federal Reserve will clearing and settlement organizations.12 In light initiate and lead these activities in coordination with other relevant primary supervisors and 12. Core clearing and settlement organizations, as defined functional regulators to the extent possible. In in the Interagency Paper on Sound Practices to Strengthen all cases involving a functionally regulated sub- the Resilience of the U.S. Financial System (interagency sound sidiary, the Federal Reserve will conduct its practices paper, see SR-03-9), consist of two groups of organi- zations that provide clearing and settlement services for criti- supervisory and testing activities in accordance cal financial markets or act as large-value payment system with the provisions described above in section operators, and that present the potential for systemic risk 1050.1.1.2. should they be unable to perform. These organizations are (1) market utilities (government-sponsored services or industry- owned organizations) whose primary purpose is to clear and settle transactions for critical markets (see section 1050.1.3.1.6) 1050.1.3.1.4 Risk Management of or transfer large-value wholesale payments, and (2) private- Nonmaterial Business Lines sector firms that provide clearing and settlement services that are integral to a critical market (i.e., their aggregate market share is significant enough to present the potential for sys- Objectives: For nonmaterial business lines iden- temic risk in the event of their sudden failure to carry out tified during the development of the institutional overview and risk assessment, as well as during BHC Supervision Manual January 2009 othersupervisoryprocesses,theFederalReserve’s Page 7 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs of the potential for problems in these areas to participating as actively as appropriate in transmit an adverse impact across the banking activities led by other relevant supervisors or and financial system, and given the Federal regulators) on at least a three-year cycle to Reserve’s unique expertise and perspective with ensure that these control mechanisms are respect to these activities, the Federal Reserve appropriately designed and achieving their focuses special supervisory attention on the risk- objectives. In addition to assessing the adequacy management and internal control practices and of risk-management and internal controls, test- the public disclosures made by an organization ing activities will focus on assessing the with respect to these activities. contribution of the organization to the resilience or fragility of the clearance and settlement Supervisory Activities: Continuous monitoring system as a whole, and on the organization’s and examination activities will be used to main- adherence to the expectations of the interagency tain an understanding of inherent risk and assess sound practices paper. Key expectations include risk-management and internal controls, includ- geographic diversity and resiliency of data ing related credit risk-management practices. centers and operations, testing of recovery and On at least an annual basis, the results of these resumption arrangements, and identification of supervisory activities will be reviewed to deter- downstream implications of failure of a major mine whether there is (1) a significant change in counterparty or clearing organization. inherent risk for core clearing and settlement In all cases involving a functionally regulated activities stemming from changing strategies or subsidiary, the Federal Reserve will conduct its activities; (2) a significant change in organiza- activities in accordance with the provisions tional structure, oversight mechanisms, key per- described above in section 1050.1.1.2. sonnel, or other key elements of related risk- management or internal controls; or (3) any potential concern regarding the adequacy of 1050.1.3.1.6 Significant Presence in related risk-management or internal controls. Critical Financial Markets (Where If significant changes or potential concerns Applicable) are identified, the Federal Reserve will work with other relevant primary supervisors or func- Objectives: The Federal Reserve will under- tional regulators (where applicable) to design stand and assess the adequacy of risk manage- testing activities focused on understanding and ment and controls for LCBO business lines with assessing areas of change and/or concern, as a significant presence in critical financial mar- well as ensure that risk-management and control kets. functions are appropriately designed and achiev- ‘‘Critical financial markets’’ are defined in ing their intended objectives. In situations where the interagency sound practices paper as the another primary supervisor or functional regula- markets for federal funds, foreign exchange, and tor leads the discovery review or testing activi- commercial paper; U.S. government and agency ties, the Federal Reserve will participate as securities; and corporate debt and equity securi- actively as appropriate in those activities. ties. A business line may have a significant If the area of change and/or concern is not presence in a critical financial market even within the oversight of another primary supervi- though the business line accounts for a rela- sor or functional regulator, or if the primary tively small portion of the organization’s total supervisor or functional regulator does not con- consolidated assets or revenues. These business duct or coordinate the examination activities in lines are subject to special supervisory focus by a reasonable period of time, the Federal Reserve the Federal Reserve in light of their potential to will lead the examination activities in coordina- transmit a collective adverse impact across mul- tion with other relevant primary supervisors and tiple firms and financial markets and the result- functional regulators to the extent possible. ing significant reputational and other risks they In all instances, the Federal Reserve will pose to the organization. conduct testing activities (either by leading the activities and coordinating with other relevant Supervisory Activities: Continuous monitoring primary supervisors or functional regulators, or and examination activities will be used to under- stand inherent risk and assess risk-management and internal controls for business lines with a those activities because there are no viable immediate substitutes). significant presence in a critical financial mar- ket. On at least an annual basis, the results of BHC Supervision Manual January 2009 these supervisory activities will be reviewed to Page 8 determine whether there is (1) a significant 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs change in inherent risk stemming from changing market.13 For each key financial market activ- strategies or activities; (2) a significant change ity where the large complex BHC is a in organizational structure, oversight mecha- significant participant, the Federal Reserve will nisms, key personnel, or other key elements of maintain an understanding of inherent risk, related risk-management or internal controls; or assess the adequacy of related risk- (3) any potential concern regarding the adequacy management and internal controls (including the of related risk-management or internal controls. sufficiency of business continuity planning), and If significant changes or potential concerns understand the organization’s potential impact are identified in these business lines, the Fed- on the overall functioning of the market. eral Reserve will work with other relevant primary supervisors or functional regulators Supervisory Activities: Continuous monitoring (where applicable) to design testing activities and examination activities will be used to under- focused on understanding and assessing areas of stand inherent risk for key financial market change and/or concern, as well as ensure that activities and assess related risk-management risk-management and control functions are and internal controls. appropriately designed and achieving their To the fullest extent possible, the Federal intended objectives. In situations where another Reserve will draw its understanding and assess- primary supervisor or functional regulator leads ment of these risks and risk-management prac- the testing activities, the Federal Reserve will tices from the information and assessments of a participate as actively as appropriate in those primary supervisor or functional regulator where activities. the BHC’s legal and operating structure pro- If the area of change and/or concern is not vides the supervisor or regulator a sufficient within the oversight of another primary supervi- view of these areas. In these instances, the Fed- sor or functional regulator, or if the primary eral Reserve will undertake continuous monitor- supervisor or functional regulator does not con- ing and participate in activities led by primary duct or coordinate the examination activities in supervisors and functional regulators as neces- a reasonable period of time, the Federal Reserve sary to maintain an understanding and assess- will lead the testing activities and will coordi- ment of risk-management and control functions nate these activities with other relevant primary for key financial market activities. supervisors and functional regulators to the extent For activities that span legal entities subject possible. to oversight by multiple supervisors or regula- In all instances, the Federal Reserve will con- tors, or that are outside the oversight of other duct testing activities (either by leading the supervisors or regulators, the Federal Reserve activities and coordinating with other relevant will develop and conduct—in coordination with primary supervisors or functional regulators, or other relevant primary supervisors and func- participating as actively as appropriate in activi- tional regulators to the extent possible and in ties led by other relevant supervisors or regula- accordance with the provisions described above tors) on at least a three-year cycle. These activi- in section 1050.1.1.2 if relevant—testing and ties will focus on the organization’s adherence discovery review activities as necessary to to the expectations set forth in the interagency complement continuous monitoring work. sound practices paper, including geographic diversity and resiliency of data centers and operations, and testing of recovery and resump- 1050.1.3.1.8 Issues and Developments in tion arrangements. Areas of Emerging Interest with Potential In all cases involving a functionally regulated Financial Market Consequences subsidiary, the Federal Reserve will conduct its activities in accordance with the provisions Objectives: The Federal Reserve will use infor- described above in section 1050.1.1.2. mation obtained in the course of supervising LCBOs, as well as information and analysis

1050.1.3.1.7 Risk Management of 13. ‘‘Key financial markets’’ include the critical financial Activities in Key Financial Markets markets defined in section 1050.1.3.1.6 above as well as (1) broader U.S. capital market activity, including underwrit- ing, securitization, derivatives, and trading; (2) retail financial Objectives: To be designated as an LCBO by services; and (3) international financial markets. Each LCBO the Federal Reserve, a banking organization meets at least one of these key market thresholds. must meet specified criteria as a significant participant in at least one key financial BHC Supervision Manual January 2009 Page 9 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs obtained through relationships with other domes- obtained from other Federal Reserve functions, tic and foreign supervisors and regulators or such as monetary policy and payments activi- other sources, to ties, to help mitigate the likelihood or consequences of a financial crisis and to help 1. identify potential vulnerabilities across the develop sound policy responses to market portfolio of LCBOs and their nonbank developments. Periodic examination activities peers—such as the operational infrastructure also may be used to review a specific activity or that underpins the credit derivatives risk-management practice across a group of peer market—that have the potential to affect bank- organizations to obtain a more complete ing organizations generally, financial stabil- understanding of industry practice.14 ity, systemic risk, or domestic or global finan- These activities will be designed and con- cial markets; ducted in coordination with other relevant pri- 2. identify areas of supervisory focus—such as mary supervisors and functional regulators to counterparty credit risk-management the fullest extent possible and in accordance practices—to further the Federal Reserve’s with the provisions described above in section understanding of markets, their linkages with 1050.1.1.2, where relevant. Coordination oppor- banking organizations, and potential implica- tunities, however, may be limited in special tions for financial stability; circumstances, such as when addressing urgent 3. understand the activities of nonbank counter- matters with potentially adverse financial mar- parties of LCBOs and the implications of ket consequences, due to the inherent time con- such activities on the risks, risk management, straints when information must be gathered and internal controls of banking organiza- quickly. tions; and 4. enhance the Federal Reserve’s ability to act effectively during periods of financial stress 1050.1.3.2 Financial Condition by combining timely and reliable informa- tion on conditions in the banking system and Objectives: The Federal Reserve’s evaluation of capital markets that is obtained through its a large complex BHC’s consolidated financial supervisory activities with information condition focuses on the ability of the organiza- obtained through the Federal Reserve’s mone- tion’s resources to support the level of risk tary policy and payments activities. associated with its activities. Assessments are developed for each ‘‘CAEL’’ subcomponent— Supervisory Activities: During each supervisory Capital Adequacy (C), Asset Quality (A), Earn- planning cycle, and more frequently as required, ings (E), and Liquidity (L).15 continuous monitoring opportunities will be iden- In developing this evaluation, the Federal tified that utilize information gained through Reserve’s primary focus is on developing an LCBO supervision to further the Federal understanding and assessment of Reserve’s understanding of risks and activities that could adversely affect LCBOs or the stabil- 1. the sufficiency of the BHC’s consolidated ity of domestic or global financial markets. capital to support the level of risk associated Activities will include meetings with chief risk with the organization’s activities and provide officers, chief financial officers, and other LCBO a sufficient cushion to absorb unanticipated senior management, as well as collaboration losses; with other domestic and foreign supervisors and 2. the capability of liquidity levels and funds- regulators and foreign central banks. management practices to allow reliable access These activities also will be used to review to sufficient funds to meet present and future areas of specific supervisory interest; answer ad liquidity needs; and hoc information requests related to areas of 3. other aspects of financial strength that need emerging interest or concern; help in to be assessed on a consolidated basis across understanding the contribution of the entity to the organization’s various legal entities, or the resilience or fragility of key markets as a that relate to the financial soundness of the whole; and provide insights into interdependen- parent company and significant nonbank sub- cies across firms, markets, and the real econ- omy. During periods of financial stress, this 14. In order to minimize burden while obtaining informa- information will be combined with knowledge tion necessary to understand market developments, these activities will focus on those organizations that are most active in the area of interest or concern. BHC Supervision Manual January 2009 15. See SR-04-18 and section 4070.0.2.3.1 for more infor- Page 10 mation about the CAEL subcomponents. 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs

sidiaries, as discussed in section 1050.1.3.3 correlated market conditions for the organi- below. zation and/or across financial markets; and 3. the sufficiency of liquidity planning tools, In assessing consolidated regulatory capital, such as stress testing, scenario analysis, and the Federal Reserve looks to ensure that the contingency planning efforts, including BHC demonstrates the effectiveness of its (1) whether liquidity buffers—comprised of framework for complying with relevant capital unencumbered liquid assets as well as access adequacy guidelines and meeting supervisory to stable funding sources—adequately reflect expectations, and focuses on analyzing key the possibility and duration of severe liquid- models and processes7 that influence this ity shocks; (2) the reasonableness of assump- assessment. This assessment utilizes results tions about the stability of secured funding in from examinations led by the Federal Reserve circumstances in which the liquidity of or other primary supervisors or functional markets for the underlying collateral regulators, as well as information gained from becomes impaired; and (3) whether these the BHC’s internal control functions and from efforts adequately reflect the potential for the market-based assessments. organization to be called on in stressed Capital planning activities for large complex environments to provide contingent liquid- BHCs should be forward looking and provide ity support to off-balance-sheet entities or for a sufficient range of stress scenarios com- bring additional assets on the balance sheet mensurate with the organization’s activities. (even if not legally or contractually obligated Many LCBOs require more rigorous and to do so). structured internal processes for assessing capital adequacy beyond regulatory capital Beyond capital adequacy and liquidity, the measures, as these measures often do not nature of independent Federal Reserve supervi- adequately capture the full spectrum of risk- sory work required to evaluate a large complex taking activities for these organizations.8 For BHC’s consolidated financial condition depends these organizations, the Federal Reserve focuses largely on the extent to which other relevant on whether internal processes for assessing primary supervisors or functional regulators have capital adequacy ensure that all risks are information or assessments upon which the Fed- properly identified, reliably quantified (where eral Reserve can draw. For example, more inde- possible) across the entire organization, and pendent Federal Reserve work typically will be supported by adequate capital. required to assess consolidated asset quality or When assessing the adequacy of a BHC’s earnings for large complex BHCs with signifi- liquidity levels and funds management prac- cant nonbank activities that are not functionally tices, areas of focus include9 regulated. However, where all material holding company assets are concentrated in a single 1. the extent to which the treasury function is depository institution subsidiary, a minimal level aligned with risk-management processes, and of incremental Federal Reserve efforts typically whether incentives are in place for business will be required to assess consolidated asset lines to compile and provide information on quality and earnings. expected liquidity needs and contingency funding plans so that the treasury function is Supervisory Activities: The Federal Reserve will able to develop a firmwide perspective and primarily utilize continuous monitoring activi- incorporate business-line information into ties to assess a large complex BHC’s financial assessments of actual and contingent liquid- strength. Such activities will include periodic ity risk; meetings with BHC management (such as the 2. whether funds management practices pro- chief financial officer); review of regulatory vide sufficient funding flexibility to respond reports, surveillance screens, and internal MIS; to unanticipated, evolving, and potentially and analysis of market indicators, including external debt ratings, subordinated debt spreads, and credit default swap spreads. Testing and 16. ‘‘Key models and processes’’ are those where evalua- discovery activities will be used as necessary to tion of the model/process will influence the Federal Reserve’s assessment of the activity or control area that is supported by assist in the understanding and assessment of the model/process. areas of concern. 17. Footnote reserved. 18. Assessing liquidity levels and funding practices for a consolidated BHC also incorporates elements presented in section 1050.1.3.3.2, ‘‘Parent company and nonbank funding BHC Supervision Manual January 2016 and liquidity.’’ Page 11 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs

Testing and discovery activities also will be tory institution; a depository institution provid- used to understand and assess the sufficiency of ing funding for nonbank affiliates; and risk- the BHC’s consolidated capital and liquidity management or internal control functions being positions to support the level of risk associated shared between depository and nonbank with its activities, including (1) regulatory operations. capital calculation methodologies10 and internal Due to these interrelationships, financial, assessments of capital adequacy and (2) funds legal, compliance, or reputational troubles in management and liquidity planning tools and one part of a BHC can spread rapidly to other practices. The Federal Reserve will work with parts of the organization. Even absent these other relevant primary supervisors and interactions, the parent or nonbank subsidiaries functional regulators to participate as actively as of an organization may present financial, legal, appropriate in or, if necessary, to coordinate compliance, or reputational risk to the consoli- activities designed to analyze key capital and dated entity, and thus directly or indirectly to its liquidity models or processes of a depository depository institution subsidiaries. As the fed- institution or functionally regulated subsidiary eral banking agency charged with supervising that are of such significance that they will influ- the organization on a consolidated basis, the ence the Federal Reserve’s assessment of these Federal Reserve is responsible for understand- areas. In all cases involving a functionally ing and assessing the risks that the parent bank regulated subsidiary, the Federal Reserve will holding company and its nonbank subsidiaries conduct its activities in accordance with the may pose to the BHC itself or its depository provisions described above in section institution subsidiaries. 1050.1.1.2. The primary objectives of Federal Reserve supervision of the nonbank subsidiaries of a bank holding company are to 1050.1.3.3 Impact 1. identify significant nonbank activities and 1050.1.3.3.1 Risk Management and risks—where the parent company or non- Financial Condition of Significant bank subsidiaries engage in risk-taking activi- Nonbank Subsidiaries ties or hold exposures that are material to the risk management or financial condition of Objectives: Most large complex BHCs engage the consolidated organization or a depository in activities and manage control functions on a institution subsidiary—by developing an firmwide basis, spanning depository institution understanding of the size and nature of pri- and nonbank legal entities. These BHCs often mary activities and key trends, and the extent have considerable intra-group exposures and to which business lines, risks, or control servicing arrangements across affiliates, present- functions are shared with or may impact a ing increased potential risks for depository insti- depository institution affiliate; tution subsidiaries and a higher likelihood of 2. evaluate the financial condition and the aggregate risk concentrations across the organi- adequacy of risk-management practices of zation’s legal entities. Common interactions the parent and significant nonbank subsidi- between a large complex BHC’s depository aries, including the ability of nonbank sub- institution subsidiaries and their nonbank affili- sidiaries to repay advances provided by the ates (including the parent company) include parent, using benchmarks and analysis appro- assets originating in, or being marketed by, a priate for those businesses; nonbank affiliate that are booked in the deposi- 3. evaluate the degree to which nonbank entity risks may present a threat to the safety and 19. Assessments of the adequacy of regulatory capital for soundness of subsidiary depository institu- large complex BHCs that have received Federal Reserve tions, including through transmission of legal, supervisory approval to use internal estimates of risk in their compliance, or reputational risks; regulatory capital calculations should include, among other 4. identify and assess any intercompany rela- things, regular verification that these organizations continue to meet on an ongoing basis all applicable requirements tionships, dependencies, or exposures—or associated with internal estimates. See, for example, the capi- aggregate firmwide concentrations—with the tal adequacy guidelines for market risk at BHCs (Regulation potential to threaten the condition of a deposi- Y: 12 C.F.R. 225, Appendix E) and the new advanced capital tory institution affiliate; and adequacy framework for BHCs (Regulation Y: 12 C.F.R. 225, Appendix G). 5. evaluate the effectiveness of the policies, procedures, and systems that the holding BHC Supervision Manual January 2016 company and its nonbank subsidiaries use to Page 12 ensure compliance with applicable laws and 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs

regulations, including consumer protection supervisor) whether compliance issues are laws.20 present; and 8. understand and assess the sufficiency, relia- Supervisory Activities: For all significant non- bility, and timeliness of associated MIS relied bank subsidiaries and activities of the parent upon by the board, senior management, and BHC, the Federal Reserve will use continuous senior risk managers and committees to moni- monitoring activities and discovery reviews to tor key nonbank activities and risks.

1. maintain an understanding of the holding Periodic testing may be used to supplement company’s business line and legal entity continuous monitoring and discovery reviews to structure, including key interrelationships and (1) ensure that key risk-management and dependencies between depository institution internal control practices conform to internal subsidiaries and nonbank affiliates, utilizing policies and/or are designed to ensure compli- regulatory structure reports, internal MIS, ance with the law and (2) understand and assess and other information sources; operations presenting a moderate or greater 2. understand and assess the exposure to, and likelihood of significant negative impact to a tolerance for, legal, compliance, and reputa- subsidiary depository institution or the consoli- tional risks, as well as the extent to which dated organization. Areas of potential negative potential conflicts of interest are identified impact include financial or operational risks that and avoided or managed; pose a potential threat to the safety and sound- 3. understand the scope of intercompany trans- ness of a depository institution subsidiary, or to actions and aggregate concentrations, and the holding company’s ability to serve as a assess the adequacy of risk-management pro- source of financial and managerial strength to cesses, accounting policies, and operating its depository institution subsidiaries. Testing procedures to measure and manage related will focus on controls for identifying, monitor- risks; ing, and controlling such risks. In all cases 4. identify and assess key interrelationships and involving a functionally regulated subsidiary, dependencies between subsidiary depository the Federal Reserve will conduct its activities in institutions and nonbank affiliates, such as accordance with the provisions described above the extent to which a depository institution in section 1050.1.1.2. subsidiary is reliant on services provided by the parent company or other nonbank affili- ates and the reasonableness of associated 1050.1.3.3.2 Parent Company and management fees; Nonbank Funding and Liquidity 5. identify those nonbank subsidiaries whose activities present material financial, legal, Objectives: One of the Federal Reserve’s pri- compliance, or reputational risk to the con- mary responsibilities as consolidated supervisor solidated entity and/or a depository institu- is to help ensure that the parent company and its tion subsidiary; nonbank subsidiaries do not have an adverse 6. identify significant businesses operated impact on the organization’s depository institu- across multiple legal entities for account- tion subsidiaries. To meet this objective, the ing, risk management, or other purposes, as Federal Reserve will assess the extent to which well as activities that functionally operate as funding and liquidity policies and practices of separate business units for legal or other the parent company or nonbank subsidiaries reasons; may undermine the BHC’s ability to act as a 7. identify intercompany transactions subject to source of strength to the organization’s deposi- Regulation W—utilizing information submit- tory institution subsidiaries. ted on quarterly regulatory reporting form Areas of focus will include an assessment of FR Y-8 (‘‘The Bank Holding Company Report of Insured Depository Institutions’ Section 1. the ability of the parent company and non- 23A Transactions with Affiliates’’), internal bank subsidiaries to maintain sufficient liquid- MIS, and other information sources—and ity, cash flow, and capital strength to service determine (in conjunction with the primary their debt obligations and cover fixed charges; 2. the likelihood that parent company or non- 20. The Federal Reserve’s supervisory objectives and bank funding strategies could undermine pub- activities related to the effectiveness of consumer compliance policies, procedures, and systems at nonbank subsidiaries of a BHC currently are under review, and additional or modified BHC Supervision Manual January 2009 guidance on this topic may be issued in the future. Page 13 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs

lic confidence in the liquidity or stability of basis, the results of these supervisory activities subsidiary depository institutions; will be reviewed to determine whether there is 3. policies and practices that are aimed at ensur- (1) a significant change in inherent funding or ing the stability of parent company funding liquidity risk stemming from changing strate- and liquidity, as evidenced by the utilization gies or activities; (2) a significant change in of long-term or permanent financing to sup- organizational structure, oversight mechanisms, port capital investments in subsidiaries and key personnel, or other key elements of related other long-term assets, and the degree of risk-management or internal controls; or (3) any dependence on short-term funding mecha- potential concern regarding the adequacy of nisms such as commercial paper; related risk-management or internal controls. 4. the extent of ‘‘double leverage’’21 and the If significant changes or potential concerns organization’s capital-management policies, are identified, the Federal Reserve will design including the distribution and transferability and conduct testing activities focused on under- ofcapitalacrossjurisdictionsandlegalentities; standing and assessing the areas of change and/or 5. the parent company’s ability to provide finan- concern in order to ensure that funding and cial and managerial support to its depository liquidity risk-management and control functions institution subsidiaries during periods of finan- are appropriately designed and achieving their cial stress or adversity, including the suffi- intended objectives. ciency of related stress testing, scenario analy- In all instances the Federal Reserve will under- sis, and contingency planning efforts; and take testing activities on at least a three-year 6. intraday liquidity management policies and cycle, assessing the individual elements of risk practices, and compliance with the ‘‘Federal management for parent company and nonbank Reserve Policy on Payments System Risk,’’22 funding and liquidity: board and senior manage- including expectations for depository institu- ment oversight; policies, procedures, and limits; tions with a self-assessed net debit cap (the risk-monitoring and management information maximum dollar amount of uncollateralized systems; and related internal controls. daylight overdrafts that the institution may For large complex BHCs with a depository incur in its Federal Reserve account). institution that has a self-assessed net debit cap, the Federal Reserve will conduct an annual The Federal Reserve also will remain apprised review of the self-assessment file to ensure that of the funding profile and market access of the institution has appropriately applied the pay- material depository institution subsidiaries, as in ment system risk guidelines. The Federal Reserve most instances these entities represent the con- will either lead this review and coordinate its solidated BHC’s primary and most active vehi- activities with other relevant primary supervi- cles for external funding and liquidity manage- sors or participate as actively as appropriate in ment. The primary supervisor retains the related work of such supervisors. In all cases responsibility for assessing liquidity risk- involving a functionally regulated subsidiary, management practices with respect to the deposi- the Federal Reserve will conduct its activities in tory institution subsidiary. accordance with the provisions described above in section 1050.1.1.2. Supervisory Activities: The Federal Reserve will use continuous monitoring activities—including monitoring market conditions and indicators 1050.1.4 INTERAGENCY where available—and discovery reviews to COORDINATION understand and assess parent company and non- bank subsidiary funding and liquidity policies 1050.1.4.1 Coordination and Information and practices, as well as any potential negative Sharing Among Domestic Primary Bank impact these policies and practices might have Supervisors and Functional Regulators on a subsidiary depository institution or the Objective: Effective consolidated supervision consolidated organization. On at least an annual requiresstrong,cooperativerelationshipsbetween the Federal Reserve and other relevant domestic 21. ‘‘Double leverage’’ refers to situations in which debt is issued by the parent company and the proceeds are invested in primary bank supervisors and functional regula- subsidiaries as equity. tors.23 To achieve this objective, the Federal 22. This policy statement is available on the Board’s pub- Reserve has worked over the years to enhance lic website at www.federalreserve.gov/paymentsystems/psr.

BHC Supervision Manual January 2009 23. Section 1050.1.4.2 discusses cross-border cooperation Page 14 and information sharing among foreign supervisors. 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs interagency coordination through the develop- The Federal Reserve also will continue to use ment and use of information-sharing protocols a variety of formal and informal channels to and mechanisms. These protocols and mecha- facilitate interagency information sharing and nisms respect the individual statutory authorities coordination consistent with the principles out- and responsibilities of the respective supervisors lined above, including and regulators, provide for appropriate informa- tion flows and coordination to limit unnecessary • supervisory protocols, agreements, and MOUs duplication or burden, comply with restrictions with primary supervisors and functional regu- governing access to information, and ensure that lators that allow the coordination of supervi- the confidentiality of information is maintained. sory activities and that permit the ongoing For example, the Federal Reserve and the U.S. exchange of information, including confiden- Securities and Exchange Commission entered tial information on a confidential basis; into a memorandum of understanding (MOU) in • bilateral exchanges of letters to facilitate infor- July 2008 that, among other things, provides for mation sharing on a situation-specific basis; the parties to share specific types of information • periodic and as-needed contacts with primary concerning entities under the parties’ respective supervisors and functional regulators to dis- supervision as well as information on other cuss and coordinate matters of common inter- areas of mutual regulatory or supervisory interest. est, including the planning and conduct of As discussed in section 1050.1.3, in under- examinations and continuous monitoring standing and assessing the activities and risks of activities; the organization as a whole, the Federal Reserve • the use of information technology platforms, will rely to the fullest extent possible on the such as the Banking Organization National examination and other supervisory work con- Desktop (BOND),25 to provide secure auto- ducted by the domestic primary bank supervi- mated access to examination/inspection reports sors and functional regulators of a BHC’s sub- and other supervisory information prepared sidiaries. In addition, the Federal Reserve will by the Federal Reserve and other relevant seek to coordinate its supervisory activities with supervisors and regulators; and relevant supervisors and regulators and will • participation in a variety of interagency forums work to align each agency’s assessment of key that facilitate the discussion of broad industry corporate governance functions, risk- issues and supervisory strategies, including management and internal control functions for the Federal Financial Institutions Examination primary risks, financial condition, and other Council, the President’s Working Group on areas of the consolidated BHC’s operations as Financial Markets, and the Federal Reserve- applicable. sponsored cross-sector meetings of financial supervisors and regulators. Supervisory Activities. The Federal Reserve will continue to work with the relevant primary supervisors and functional regulators of a large 1050.1.4.1.1 Coordination of complex BHC’s subsidiaries to ensure that the Examination Activities at a Supervised necessary information flows and coordination BHC Subsidiary mechanisms exist to permit the effective super- vision of the BHC on a consolidated basis. The As discussed in section 1050.1.3, the Federal Federal Reserve will continue to share informa- Reserve will seek to work cooperatively with tion, including confidential supervisory informa- the relevant primary supervisor or functional tion, obtained or developed through its consoli- regulator to address information gaps or indica- dated supervisory activities with other relevant tions of weakness or risk identified in a super- primary supervisors or functional regulators when vised BHC subsidiary that are material to the appropriate and permitted by applicable laws Federal Reserve’s understanding or assessment and regulations.24 of the consolidated organization’s risks, activi-

25. BOND is a Federal Reserve information technology 24. Among the federal laws that may limit the sharing of platform providing secure interagency access to documents, information among supervisors are the Right to Financial supervisory and financial data, and other information utilized Privacy Act (12 U.S.C. 3401 et seq.) and the Trade Secrets in the consolidated supervision of individual BHCs and FBOs, Act (18 U.S.C. 1905). The Federal Reserve has established and in developing comparative analyses of organizations with procedures to authorize the sharing of confidential supervi- similar business lines and risk characteristics. sory information, and Federal Reserve staff must ensure that appropriate approvals are obtained prior to releasing such information. See Subpart C of the Board’s Rules Regarding BHC Supervision Manual January 2009 the Availability of Information (12 C.F.R. 261.20 et seq.). Page 15 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs ties, or key corporate governance, risk- often facilitated by an MOU that establishes a management, or control functions. Prior to con- framework for bilateral relationships and includes ducting discovery reviews or testing activities at provisions for cooperation during the licensing a depository institution (other than where the process, in the supervision of ongoing activities, Federal Reserve is the primary federal supervi- and in the handling of problem institutions. The sor) or functionally regulated subsidiary of a Federal Reserve has established bilateral and BHC, the Federal Reserve will multilateral information-sharing MOUs and other arrangements with numerous host-country for- • review available information sources as part eign supervisors. The Federal Reserve also moni- of its continuous monitoring activities, includ- tors changes in foreign bank regulatory and ing examination reports and the BHC’s inter- supervisory systems and seeks to understand nal MIS, to determine whether such informa- how these systems affect supervised banking tion addresses the Federal Reserve’s organizations. In addition to its longstanding information needs or supervisory concerns; cooperative relationships with home- and host- and country foreign supervisors, the Federal Reserve • if needed, seek to gain a better understanding expects to increasingly lead and participate in of the primary supervisor’s or functional regu- ‘‘colleges of supervisors’’ and other multilateral lator’s basis for its supervisory activities and groups of supervisors that discuss issues related assessment of the subsidiary. This may include to specific internationally active banking a request to review related examination work. organizations. The Federal Reserve also is a member of the If, following these activities, the Federal Basel Committee on Banking Supervision, which Reserve’s information needs or supervisory con- is a forum for supervisors from member coun- cerns remain, the Federal Reserve will work tries to discuss important supervisory issues, cooperatively with the relevant primary supervi- foster consistent supervision of organizations sor or functional regulator in the manner dis- with similar business and risk profiles, promote cussed in section 1050.1.3 above. 26 the sharing of leading supervisory practices, and formulate guidance to enhance and refine bank- ing supervision globally. 1050.1.4.2 Cooperation and Information The Federal Reserve’s processes for under- Sharing With Host-Country Foreign standing and assessing firmwide legal and com- Supervisors pliance risk management, as described earlier, encompass both domestic and international Objectives: Many large complex BHCs have operations. Most areas of supervisory focus for considerable international banking and other management of legal and compliance risks are operations that are licensed and supervised by applicable to both domestic and international foreign host-country authorities. As home- entities, and include proper oversight of licensed country supervisor for domestic BHCs, the Fed- operations, compliance with supervisory and eral Reserve is responsible for the comprehen- regulatory requirements, and the sufficiency of sive, consolidated supervision of these global associated MIS. organizations, while each host country is respon- There are, however, areas of focus for the sible for supervision of the legal entities (includ- Federal Reserve that are unique to a holding ing foreign subsidiaries of U.S. BHCs) in its company’s international operations. For exam- jurisdiction. ple, some host-country legal and regulatory Information sharing among domestic and for- structures and supervisory approaches are fun- eign supervisors, consistent with applicable laws, damentally different from those in the United is essential to ensure that a large complex BHC’s States. As a result, the banking organization global activities are supervised on a consoli- often must devote additional resources to main- dated basis. Cross-border information sharing is tain expertise in local regulatory requirements. In some instances, privacy concerns have led to 26. As outlined in section 1050.1.3, certain Federal Reserve limits on the information a BHC’s foreign office examination activities are to be conducted on a minimum may share with its parent company, thereby three-year cycle to verify, through testing, the sufficiency of limiting the parent company’s ability to exercise key control processes. These activities are to be conducted consolidated risk management on a global basis. regardless of whether or not there is an information gap or indication of weakness or risk. Additionally, while considerable progress has been made to strengthen supervisory cross- BHC Supervision Manual January 2009 border cooperation and information sharing, the Page 16 Federal Reserve and other U.S. supervisors have, 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs at times, faced challenges in accessing informa- 1050.1.4.3 Indications of Weakness or tion on a bank’sorBHC’s foreign operations or Risk Related to Subsidiary Depository in carrying out examinations of cross-border or Institutions foreign activities. These circumstances are to be taken into account when developing a supervi- Objectives: For areas beyond those specifically sory strategy for a large complex BHC with addressed in section 1050.1.3, there may be cross-border or foreign operations. circumstances where the Federal Reserve has indications of material weakness or risk in a Supervisory Activities: Continuous monitoring depository institution subsidiary of a BHC that will be used to understand and assess each large is supervised by another primary supervisor, and complex BHC’s international strategy, trends, it is not clear that the weakness or risk is operations, and legal entity structure, as well as adequately reflected in the assessment or super- related governance, risk-management, and inter- visory activities of that supervisor. Because a nal controls. For a large complex BHC with primary objective of consolidated supervision is significant international operations or risks, an to protect the BHC’s depository institution sub- assessment of cross-border and foreign opera- sidiaries, the Federal Reserve will follow up tions will be incorporated into the evaluation of with the appropriate primary supervisor in these key corporate governance functions and pri- circumstances to help ensure that, to the extent mary firmwide risk-management and internal that a material weakness or risk exists, it is control functions, including legal and regulatory addressed appropriately. risk management. Continuous monitoring activities will include Supervisory Activities: The Federal Reserve will review of materials prepared by host-country take the following steps if it has indications of supervisors, including examination reports and material weakness or risk in a depository institu- assessments, and ongoing communication with tion subsidiary (other than where the Federal relevant foreign and domestic supervisors regard- Reserve is the primary federal supervisor) in an ing trends and assessments of cross-border and area beyond those specifically addressed in sec- foreign operations. These continuous monitor- tion 1050.1.3, and it is not clear that the weak- ing activities may be supplemented, as appropri- ness or risk is adequately reflected in the assess- ate, by examination activities to understand and ment or supervisory activities of the depository assess the large complex BHC’s international institution’s primary supervisor. strategy, trends, operations, and legal entity structure, as well as related governance, risk- • The Federal Reserve will first review avail- management, and internal controls. able information sources, discuss the areas of When assessing the sufficiency of a large concern with the primary supervisor, and seek complex BHC’s management of its interna- to review the supervisor’s related work. tional operations, consideration is given to the • If concerns remain following these activities, extent that foreign laws restrict the transmission the Federal Reserve will request that the pri- of information to the BHC’s head office. Impedi- mary supervisor conduct a discovery review ments to sharing information imposed by a host or testing activity at the depository institution country may constrain the BHC’s ability to to address the area of concern. effectively oversee its international operations • In the event the primary supervisor does not and globally manage its risks, and the material- undertake activities to address the concern in ity of such impediments should be a determi- a reasonable period of time, the Federal Reserve nant of whether the organization should be con- will design and lead an examination of the ducting operations in that host country. depository institution to address the matter in In addition, any limits placed on the Federal consultation with the primary supervisor. A Reserve’s ability to access information on host- senior Federal Reserve official will communi- country operations, or to engage in onsite activi- cate this decision in writing to a senior official ties at the organization’s operations in the host of the primary supervisor. country, should be considered when assessing whether the organization’s activities in that juris- diction are appropriate.

BHC Supervision Manual January 2009 Page 17 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs

1050.1.4.4 Condition or Management of to determine if the holding company is provid- BHC Subsidiary is Less-than-Satisfactory ing appropriate support to the depository insti- tution. The Federal Reserve will coordinate its Objectives: As noted above, a primary activities with those of the primary supervisor responsibility of the Federal Reserve as consoli- to the extent appropriate. dated BHC supervisor is to ensure that a hold- • Nonbank subsidiary. When any nonbank sub- ing company’s activities, policies, and practices sidiary faces financial stress or material risks, do not undermine its ability to serve as a source the Federal Reserve will seek to ensure that its of financial and managerial strength to its condition and activities do not jeopardize the depository institution subsidiaries. In situations safety and soundness of the BHC or its deposi- where the condition or management of a tory institution subsidiaries, as discussed above supervised or functionally regulated BHC sub- in sections 1050.1.3.3.1, ‘‘Risk Management sidiary is determined to be less-than- and Financial Condition of Significant Non- satisfactory, the Federal Reserve’s focus as bank Subsidiaries’’ and 1050.1.3.3.2, ‘‘Parent consolidated supervisor is on complementing Company and Nonbank Funding and Liquid- the efforts of the primary supervisor or ity.’’ The Federal Reserve also will take appro- functional regulator. In doing so, the Federal priate steps to ensure that any actions taken by Reserve will seek to ensure that the parent com- the parent company to assist a nonbank sub- pany provides appropriate support to the sub- sidiary do not impair the BHC’s continuing sidiary and does not take actions that may ability to serve as a source of strength to its further weaken the parent company’s deposi- depository institution subsidiaries. The Fed- tory institution subsidiaries or its ability to act eral Reserve will coordinate its activities with as a source of strength for such subsidiaries. those of any relevant functional regulator to Beyond the specific activities noted below, the extent appropriate. these circumstances also may require the Fed- eral Reserve to enhance the activities addressed in section 1050.1.3 for understanding and assess- 1050.1.4.5 Edge and Agreement ing key corporate governance functions or pri- Corporations mary firmwide risk-management and internal controls. In addition, the Federal Reserve will Objectives: Many large complex BHCs control adjust its supervisory activities as necessary an Edge or agreement corporation subsidiary. when the consolidated BHC is in weakened The Federal Reserve serves as the primary condition or when there are questions regarding supervisor of each Edge and agreement corpora- the capabilities of the holding company’s tion subsidiary in addition to its role as consoli- management. dated BHC supervisor.27 When the Edge or agreement corporation is held by a U.S. bank, Supervisory Activities: the primary supervisor often relies on informa- tion provided by the Federal Reserve in • Depository institution subsidiary. In instances developing its own understanding and assess- when a depository institution subsidiary’s con- ment of the parent bank. dition or management is rated less than satis- During each calendar year, the Federal factory, or when the depository institution Reserve performs an examination of each Edge subsidiary otherwise faces financial stress or and agreement corporation, assesses the Bank material risks, the Federal Reserve’s primary Secrecy Act/Anti-Money Laundering supervisory objectives as consolidated super- (BSA/AML) compliance program, and assigns a visor are to ensure that the parent company CAMEO rating. In addition, the Federal (1) provides appropriate support to the deposi- Reserve periodically conducts assessments of tory institution and (2) does not take action Edge and agreement corporations to determine that could harm the depository institution. The whether a consumer compliance examination is Federal Reserve will work closely with the warranted, in which case a compliance primary supervisor to understand whether the BHC or a nonbank affiliate has contributed to 27. The Federal Reserve is solely responsible for approv- the depository institution’s weakened condi- ing, and supervising the activities of, U.S. Edge and agree- tion, to understand the impact of the deposi- ment corporations. As discussed in SR-90-21, ‘‘Rating Sys- tory institution on the BHC’s condition, and tem For International Examinations,’’ one of the Federal Reserve’s supervisory responsibilities is the assignment of a CAMEO rating (Capital, Asset Quality, Management, Earn- BHC Supervision Manual January 2009 ings, and Operations and Internal Controls) to each Edge and Page 18 agreement corporation. 1050.1 Guidance for the Consolidated Supervision of Domestic BHCs That Are LCBOs examination is conducted and a consumer Supervisory Activities: The Federal Reserve will compliance rating is assigned. maintain an understanding and perform an annual The Federal Reserve will coordinate the con- examination of each Edge and agreement corpo- duct of its activities as Edge and agreement ration. While the examination scope will be risk corporation supervisor with its activities as con- focused to reflect the organization’s scale, activi- solidated supervisor. To this end, the extent and ties, and risk profile, in all cases the Federal scopeofFederalReservesupervisoryworkrelated Reserve will assess the adequacy of processes to to an Edge or agreement corporation will be ensure compliance with BSA/AML require- tailored to the entity’s activities, risk profile, ments and other applicable U.S. laws and regula- and other attributes. A number of specific ele- tions and with applicable foreign laws and ments will be considered when developing a regulations. supervisory approach, including In developing its supervisory strategy, the Federal Reserve will identify those elements 1. structure and attributes, including whether that are unique to the Edge or agreement corpo- the Edge or agreement corporation is a bank- ration and those that are shared with the parent ing or investment organization; bank or BHC and will coordinate fulfillment of 2. the size, nature, and location of its primary the Federal Reserve’s responsibilities as Edge activities, as well as key financial and other and agreement corporation supervisor with trends; execution of its consolidated supervision role. 3. the business lines and risks, and associated This strategy will reflect the extent to which trends, of the Edge or agreement corpora- reliancecanbeplacedon(1)theFederalReserve’s tion’s primary activities on a standalone basis, understanding and assessments of key corporate as well as their significance to the risk profile governance, risk-management, and control func- of the parent bank (if applicable) and BHC; tions, as well as material portfolios and business 4. the extent to which risk-management and lines, of the consolidated BHC; (2) assessments internal control functions are unique to the developed by the primary supervisor (when Edge or agreement corporation, or are shared applicable) for business lines, risk management, with a parent bank, another affiliate, or the control functions, or financial factors that are consolidated BHC; common to the Edge or agreement corporation 5. any potential Regulation K limitations or and its parent bank; and (3) findings developed other U.S. compliance issues, and the adequacy by host-country supervisors for activities under of processes to ensure ongoing compliance; their jurisdiction. and In addition, where the primary supervisor of 6. the adequacy of processes for ensuring com- an Edge or agreement corporation’s parent bank pliance with all applicable laws and regula- relies on the Federal Reserve’s understanding tions imposed by host-country supervisors and assessment in order to develop its CAMELS for the Edge or agreement corporation’s inter- rating,28 the Federal Reserve will work to fulfill national operations. that supervisor’s information needs.

28. The U.S. banking agencies assign CAMELS (Capital Adequacy, Asset Quality, Management, Earnings, Liquidity, and Sensitivity to Market Risk) ratings to U.S. banking orga- nizations as part of the ongoing supervision of these organiza- tions. See SR-96-38, ‘‘Uniform Financial Institutions Rating System,’’ (see section A.5020.1 of the Commercial Bank Examination Manual.) and SR-97-4, ‘‘Interagency Guidance on Common Questions About the Application of the Revised CAMELS Rating System.’’

BHC Supervision Manual January 2009 Page 19 Guidance for the Consolidated Supervision of Regional Bank Holding Companies Section 1050.2

WHAT’S NEW IN THIS REVISED each regional BHC. For organizations within SECTION this portfolio, continuous monitoring activities typically take the form of meetings with BHC Effective July 2016, this section is revised to management, analysis of internal management include SR-16-4, “Relying on the Work of the information system (MIS) reports and regula- Regulators of the Subsidiary Insured Depository tory reports, review of surveillance screens, and Institutions of Bank Holding Companies and discussions and coordination with other relevant Savings and Loan Holding Companies with primary supervisors and functional regulators Total Consolidated Assets of Less than $50 Bil- and review of their work. The scale and fre- lion.” This guidance provides an explanation of quency of monitoring activities will differ by the Federal Reserve’s expectations for its exam- organization. For many regional BHCs that are iners’ reliance on the work of the regulators of in sound condition, monitoring activities typi- insured depository institution subsidiaries (IDI cally are performed on a periodic or quarterly regulators) in the supervision of bank holding basis, supplemented by more frequent or inten- companies (BHCs) and savings and loan hold- sive activities as necessary, and, in most instances, ing companies (SLHCs). SR-16-4 presents a tai- Federal Reserve staff do not maintain a day-to- lored supervisory approach for regional bank- day onsite presence at the organization. ing organizations (RBOs), which are defined as companies with total consolidated assets between $10 billion and $50 billion. 1050.2.1.1 Federal Reserve Activities and Those Activities of Other Supervisors and Regulators 1050.2.1 ACTIVITIES OF THE FEDERAL RESERVE AND OTHER The nature and scope of independent Federal SUPERVISORS AND REGULATORS, Reserve supervisory work required to develop AND FUNCTIONAL REGULATION and maintain an understanding and assessment of a regional BHC depend largely on the extent The objectives of the Federal Reserve’s consoli- to which other relevant primary supervisors or dated supervision program for the portfolio of functional regulators have information or assess- regional bank holding companies (‘‘regional ments upon which the Federal Reserve can BHCs,’’ defined as non-LCBO BHCs with draw. Many regional BHCs conduct the major- $10 billion or more in total consolidated assets, ity of their business operations through a single including nontraditional organizations1) are the bank subsidiary, increasing the likelihood that a same as those applicable to other portfolios. The single primary supervisor has a complete view manner in which the Federal Reserve achieves of, and ability to address, major aspects of the these objectives, however, is tailored to the char- organization’s business activities and related acteristics and risk profiles of regional bank risks, risk management, and controls. In these holding companies.2 instances, the Federal Reserve typically will be As outlined in the following sections, a range able to use the information and assessments of continuous monitoring activities is utilized, developed by this primary supervisor to develop along with discovery reviews and testing activi- its understanding and assessment of significant ties (examination activities),3 to develop and aspects of the consolidated organization. Simi- maintain an understanding and assessment of larly, for regional BHCs with limited nonbank activities, the Federal Reserve typically will 1. Nontraditional BHCs, as defined in SR-04-18, ‘‘Bank need to conduct less work to understand and Holding Company Rating System,’’ (see section 4070.0) are assess the risk-management systems and finan- bank holding companies where most or all of the organiza- tion’s significant nondepository subsidiaries are regulated by cial condition of nonbank subsidiaries than the a functional regulator, and subsidiary depository institution(s) level of monitoring and examination work are small in relation to nondepository subsidiaries. required for organizations with more-extensive 2. See section 1050.0.4, appendix, for definitions of terms or complex nonbank activities. commonly used in this section. 3, While by definition ‘‘examination’’ activities are appli- By their nature, understanding and assessing cable to the supervision of banks and other depository institu- some areas—such as the risk management and tions, as well as U.S. banking offices of FBOs, and ‘‘inspec- financial condition of significant nonbank tion’’ activities are applicable to the supervision of BHCs and nonbank subsidiaries and affiliates, the term ‘‘examination’’ is generally used throughout this section to refer to both exami- BHC Supervision Manual July 2016 nation and inspection activities. Page 1 Consolidated Supervision of Regional BHCs 1050.2 subsidiaries that are not functionally and 3900.0. Under these provisions, for exam- regulated—typically will require more indepen- ple, the Federal Reserve may conduct an exami- dent Federal Reserve supervisory work. Other nation of a functionally regulated subsidiary if, areas—such as primary firmwide risk- after reviewing relevant reports, it reasonably management and control functions—typically determines that the examination is necessary to will require a greater degree of coordination with adequately inform the Federal Reserve about the other relevant primary supervisors or functional systems used to monitor and control financial regulators, who will likely have information or and operational risks within the consolidated assessments upon which the Federal Reserve can organization that may pose a direct or indirect draw. threat to the safety and soundness of a deposi- The following sections provide further detail tory institution subsidiary.4 on how the Federal Reserve will develop, work- ing in coordination with other relevant primary supervisors and functional regulators, an under- 1050.2.2 UNDERSTANDING THE standing and assessment of a regional BHC. In ORGANIZATION conducting the activities described throughout this document, the Federal Reserve will, to the For each regional BHC, the Federal Reserve fullest extent possible will develop an understanding of the legal, operating, and corporate governance structure • rely on the information and assessments of of the organization and its primary strategies, relevant primary supervisors and functional business lines, and risk-management and regulators, including the information and internal control functions.5 This understanding assessments reflected in the reports of exami- will inform the development of a risk- nation of such supervisors and regulators; assessment and supervisory plan for the BHC. • focus its supervisory activities on the bank The extent of information necessary to gain this holding company, as well as on those of its understanding is tailored to the scope and nonbank subsidiaries that could have a direct complexity of the regional BHC’s operations, or indirect materially adverse effect on the and typically may be obtained from the safety and soundness of a depository institu- organization’s management, public reports, tion subsidiary of the BHC due to the size, condition, or activities of the nonbank subsid- iary, or the nature or size of its transactions 4. The Federal Reserve also may examine a functionally regulated subsidiary of a regional BHC if, after reviewing with the depository institution; and relevant reports and other information, it has reasonable cause • use publicly reported information (including to believe that the subsidiary is engaged in an activity that externally audited financial statements) as well poses a material risk to an affiliated depository institution, or as reports that a large complex BHC or a that the subsidiary is not in compliance with any federal law that the Federal Reserve Board has specific jurisdiction to subsidiary prepares for other primary supervi- enforce against the subsidiary (and the Federal Reserve can- sors, functional regulators, or self-regulatory not determine compliance by examining the BHC or its affili- organizations. ated depository institutions). Similarly, before requiring a specialized report from a functionally regulated subsidiary, the Federal Reserve first will request that the subsidiary’s appropriate functional regu- 1050.2.1.2 Functionally Regulated lator obtain the report and make it available to the Federal Reserve. In the event that the report is not obtained or made Subsidiaries available as requested, the Federal Reserve may, consistent with the Bank Holding Company Act, obtain the report As discussed below, in certain situations, the directly from the functionally regulated subsidiary if the report Federal Reserve may find it necessary to con- is necessary to allow the Federal Reserve to adequately assess duct an examination of a functionally regulated (1) a material risk to the BHC or any of its depository institution subsidiaries, (2) the systems used to monitor and nonbank subsidiary in order to fulfill the Federal control financial and operational risks within the consolidated Reserve’s responsibilities as supervisor of the organization that may pose a threat to the safety and sound- consolidated organization. In any such case, the ness of a depository institution subsidiary, or (3) compliance Federal Reserve will continue to adhere to the with any federal law that the Federal Reserve Board has specific jurisdiction to enforce against the BHC or a subsidiary. procedural and other requirements governing 5. This understanding is formally documented during devel- examinations of, or requests for a specialized opment of the institutional overview, which coincides with report from, a functionally regulated subsidiary creation of the annual risk assessment. SR-97-24, ‘‘Risk- as discussed in SR-00-13 and sections 1040.0 Focused Framework for Supervision of Large Complex Insti- tutions,’’ (see section 2124.01) describes processes for devel- opinganinstitutionaloverview,riskassessment,andsupervisory BHC Supervision Manual July 2016 plan. Each of these products is kept current to reflect signifi- Page 2 cant changes in an organization’s risks or activities. Consolidated Supervision of Regional BHCs 1050.2 regulatory reports, surveillance screens, third- RFI (Risk Management, Financial Condition, party sources (e.g., credit-rating agency and and Impact) rating assigned to a BHC.6 market analyst reports), and other relevant primary supervisors or functional regulators. Key elements that should be identified and 1050.2.3.1 Risk Management understood include the following: 1050.2.3.1.1 Key Corporate Governance • Corporate strategy. Primary business strate- Functions gies; institutional risk tolerance; key changes Objectives: One of the primary areas of focus in strategic direction or risk profile; signifi- for consolidated supervision of regional BHCs cant new business activities; areas of growth is the adequacy of governance provided by the and emerging areas with potential to become board and senior management. The culture, primary drivers of risk or revenue; and plans expectations, and incentives established by the for expansion through mergers or acquisitions. highest levels of corporate leadership set the • Significant activities. Key revenue and risk tone for the entire organization and are essential drivers; primary business lines; product mix; determinants of whether a banking organization budget and internal capital allocations (as is capable of maintaining fully effective risk- applicable); market share for revenue and cus- management and internal control processes. tomers served; key external trends, including The board and its committees should have an competitive pressures; and areas that are vul- ongoing understanding of key inherent risks, nerable to volatility in revenue, earnings, capi- associated trends, primary control functions, tal, or liquidity. and senior management capabilities. Primary • Structure. Business line and legal entity struc- expectations for the board and its committees ture; domestic and foreign regulatory respon- include sibilities for legal entities and business lines; key interrelationships and dependencies 1. selecting competent senior managers, ensur- between depository institution subsidiaries and ing that they have the proper incentives to nonbank affiliates; material business lines operate the organization in a safe and sound operated across multiple legal entities for manner, and regularly evaluating senior man- accounting or risk-management purposes; and agers’ performance; the activities and risk profile of Edge and 2. establishing, communicating, and monitoring agreement corporation subsidiaries. (for example, by reviewing comprehensive • Corporate governance, risk management, and MIS reports produced by senior manage- internal controls for primary risks. Board of ment) institutional risk tolerances and a cor- directors (board) and executive-level commit- porate culture that emphasizes the impor- tees; senior management and management tance of compliance with the law and ethical committees; key risk-management and inter- business practices; nal control functions and associated MIS relied 3. approving significant strategies and policies; upon by the board, senior management, and 4. demonstrating leadership, expertise, and senior risk managers and committees; and effectiveness; consistency of public disclosures with how 5. ensuring the organization has an effective the board and senior management assess and and independent internal audit function; manage risks. 6. ensuring the organization has appropriate policies governing the segregation of duties To ensure the quality and consistency of con- and avoiding conflicts of interest; and solidated supervision across the regional BHC 7. for publicly held organizations, ensuring that portfolio, it also is necessary to understand how public disclosures these key elements compare with industry trends • are consistent with how the board and and with evolving practices of well-managed organizations with similar characteristics. 6. The RFI rating system for BHCs is discussed in SR- 04-18 and section 4070.0. RFI ratings are assigned at least annually for BHCs that are complex or that have $1 billion or 1050.2.3 ASSESSING THE REGIONAL more in consolidated assets, and are communicated via a comprehensive summary supervisory report that supports the BHC ON A CONSOLIDATED BASIS BHC’s assigned ratings and encompasses the results of the entire supervisory cycle. The Federal Reserve uses a systematic approach to develop an assessment of a BHC on a consoli- BHC Supervision Manual July 2016 dated basis. This assessment is reflected in the Page 3 Consolidated Supervision of Regional BHCs 1050.2

senior management assess and manage the porting technology has grown, in combination risks of the organization, with greater reliance on third-party service pro- • balance quantitative and qualitative infor- viders, the importance of internal audit’s role in mation with clear discussions about risk- identifying risks and testing internal controls management processes, and has increased. • reflect evolving disclosure practices for In addition, the extent to which supervisors peer organizations. can rely on or utilize the work of internal audit is an essential determinant of the risk-focused A regional BHC’s senior management and its supervisory program that is tailored to the activi- committees should be able to clearly communi- ties and risks of individual regional BHCs. cate risk tolerances and measures, control risks, hire and retain competent staff, and respond to Supervisory Activities: For each regional BHC, changes in the organization’s risk profile and the Federal Reserve will understand and assess the external environment. Members of senior the adequacy of oversight provided by the board management are expected to have qualifications and senior management, as well as the adequacy and experience commensurate with the size and of internal audit and associated MIS. The Fed- complexity of the organization. Primary expec- eral Reserve also will understand and assess tations for senior management include other key corporate governance functions (e.g., corporate finance and treasury functions), whose 1. establishing effective oversight and an appro- effectiveness is essential to sustaining consoli- priate risk culture; dated holding company operations, as well as 2. appropriately delegating authority and over- the organization’s business resiliency and crisis seeing the establishment and implementation management capabilities.7 of effective policies for the proper segrega- tion of duties and for the avoidance or man- • Board, senior management, and other key cor- agement of conflicts of interest; porategovernancefunctions.Continuousmoni- 3. establishing and implementing an effective toring activities—which draw from all avail- risk-management framework capable of iden- able sources on an as-needed basis, including tifyingandcontrollingbothcurrentandemerg- internal control functions, the work of other ing risks, and effective independent control relevant primary supervisors and functional functions that ensure risk taking is consistent regulators, regulatory reports, and related sur- with the organization’s established risk veillance results—will be used to understand appetite; and assess the effectiveness of board and 4. establishing and implementing incentives for senior management resources and oversight.8 personnel that are consistent with institu- The results of continuous monitoring activi- tional risk tolerances, compliance with the ties, as documented in supervisory products law, and ethical business practices; that reflect the Federal Reserve’s overview 5. promoting a continuous dialogue between and risk assessment of the organization, may and across business areas and risk- identify certain corporate governance func- management functions to help align the orga- tions that will require more intensive supervi- nization’s established risk appetite and risk sory focus due to (1) significant changes in controls; corporate strategy, activities, organizational 6. ensuring that the board and its committees structure, oversight mechanisms, or key per- are provided with timely, accurate, and com- sonnel; (2) potential concerns regarding the prehensive MIS reports that are adaptive to adequacy of a specific governance function; changing circumstances regarding risks and or (3) the absence of sufficiently recent exami- controls; and 7. ensuring timely resolution of audit, compli- 7. As discussed further in section 1050.2.4.6, because of ance, and regulatory issues. the special structure of nontraditional BHCs and the relatively small size of their depository institution subsidiaries, much of An effective internal audit function plays an the information necessary to develop the assessments of the essential role by providing an independent and risk-management (as described in this section 1050.2.3.1) and financial condition elements (as described in section 1050.2.3.2) objective evaluation of all key governance, risk- typically may be obtained or drawn from the work of the management, and internal control processes. As relevant functional regulator. the complexity of financial products and sup- 8. As noted in section 1050.2.1 above, the scale and fre- quency of monitoring activities will differ by organization. For many regional BHCs in sound condition, these activities BHC Supervision Manual July 2016 are typically performed on a periodic or quarterly basis and Page 4 supplemented as necessary. Consolidated Supervision of Regional BHCs 1050.2 nation activities for a key function by the Fed- independence, professional competence, and eral Reserve or another primary supervisor or the quality of the internal audit function; (3) the functional regulator. quality and scope of the audit methodology, • Internal audit. Continuous monitoring activi- audit plan, and risk-assessment process; and ties will be used to understand and assess key (4) the adequacy of audit programs and elements of internal audit governance for the organization on a consolidated basis, including (1) the adequacy (and, where applicable, Act of 2002,” section 301 of the Sarbanes-Oxley Act requires independence9) of the audit committee; (2) the that each public company (including banks and bank holding companies that are public companies) have an audit commit- tee composed entirely of independent directors. (See 15 U.S.C. 9. As outlined in section 2060.05, “The Sarbanes-Oxley 78j-1.)

BHC Supervision Manual July 2016 Page 4.1 Consolidated Supervision of Regional BHCs 1050.2

workpaper standards. On at least an annual In all cases involving a functionally regulated basis, the results of these supervisory activities subsidiary, the Federal Reserve will conduct its will be reviewed to determine whether there supervisory and testing activities in accordance have been significant changes in the internal with the provisions described above in section audit infrastructure or whether there are 1050.2.1.2. potential concerns regarding the adequacy of key elements of internal audit. In addition to this periodic audit infrastructure review, 1050.2.3.1.2 Risk-Management and testing activities for specific control functions Internal Control Functions for Primary or business lines should include an assessment Risks to the Consolidated Organization of internal audit’s recent work in these areas to the extent possible as a means of validating Objectives: Underlying the risk-focused approach internal audit’s findings. to consolidated supervision of regional BHCs is • Additional supervisory activities. If continu- the premise that it is each organization’s respon- ous monitoring activities identify a key corpo- sibility to develop an appropriate control struc- rate governance function or element of inter- ture for identifying, measuring, monitoring, and nal audit requiring more intensive supervisory controlling key risks as measured against super- focus due to significant changes, potential visory standards and expectations, applicable concerns, or the absence of sufficiently recent laws and regulations, and evolving practices of examination activities, the Federal Reserve well-managed organizations. will work with other relevant primary supervi- The Federal Reserve will understand and sors or functional regulators (where applica- assess risk-management and control functions ble) in developing discovery reviews or test- for primary risks to the consolidated organiza- ing activities focusing on the area of concern. tion (primary firmwide risk-management and In situations where another primary supervi- control functions), and associated MIS, for each sor or functional regulator leads the examina- regional BHC. This will include risk- tion activities, the Federal Reserve may con- management and control functions for primary duct portions of the examination, or otherwise credit, legal and compliance,11 liquidity, market, participate as necessary (e.g., in determining operational, and reputational risks for the con- the examination objectives and scope), to solidated organization. The Federal Reserve also ensure that the review provides sufficient infor- will understand and assess other risk- mation on the specific area of concern to form management and control functions that, based a comprehensive and timely understanding on the specific characteristics and activities of and assessment. the individual BHC, relate to primary risks to If the area of concern is not within the the organization as a whole. oversight of another primary supervisor or For example, for regional BHCs with particu- functional regulator, or if the supervisor or larly dynamic corporate strategies, the Federal regulator does not conduct or coordinate the Reserve will understand and assess the adequacy examination activities in a reasonable period of the control mechanisms relevant to such strat- of time, the Federal Reserve will lead the egies, including strategic planning, merger inte- necessary examination activities in coordina- gration, new business approval, and processes tion with other relevant primary supervisors for ensuring that risk management and controls and functional regulators to the extent possible. keep pace with areas of growing inherent risk. • Additional required audit testing activities.In In all instances, the adequacy of each primary all instances, the Federal Reserve will conduct firmwide risk-management or control mecha- testing activities as part of its audit infrastruc- nism depends on the appropriateness of the ture review (either by leading the activities following: and coordinating with other relevant primary supervisors or functional regulators, or partici- pating in activities led by other relevant super- lator has not developed—or, because of the organization’s legal, operating, and regulatory structure, is not able to visors or regulators) on at least a three-year develop—a comprehensive understanding and assessment of cycle to ensure that the internal audit program the internal audit infrastructure. is appropriately designed and achieving its 11. Federal Reserve processes for understanding and assess- objectives.10 ing legal and compliance risk management encompass con- sumer compliance risk inherent in the organization’s business activities. 10. For nontraditional BHCs, the Federal Reserve will routinely conduct testing activities on at least a three-year BHC Supervision Manual January 2009 cycle in instances where the BHC’s relevant functional regu- Page 5 Consolidated Supervision of Regional BHCs 1050.2

1. control infrastructure and governance, includ- Supervisory Activities: The Federal Reserve will ing degree of oversight by the board and use continuous monitoring activities to under- senior management; stand and assess each primary firmwide risk- 2. development, maintenance, and communica- management and control function. This process tion of appropriate policies, procedures, and begins with the overarching design and architec- internal controls; ture of each primary firmwide risk-management 3. risk identification and measurement systems or control function, and drills down, as appropri- and processes, and associated MIS, that are ate, through analysis of risk management and adaptive to changing circumstances and controls for material portfolio areas and busi- capable of providing timely, accurate, and ness lines (described in section 1050.2.3.1.3 comprehensive information to senior man- below). Activities will verify the sufficiency of agement and the board; fundamental aspects of internal controls in rela- 4. monitoring and testing the effectiveness of tion to the holding company’s current risk pro- controls; file and in comparison with supervisory expecta- 5. processes for identifying, reporting, and esca- tions and evolving sound practices, and assess lating issues and emerging risks; the capability of these primary functions (whether 6. ability to implement corrective actions in a centralized or decentralized) to remain effective timely manner; in the face of growth, changing strategic direc- 7. appropriate authority and independence of tion, significant market developments, and other staff to carry out responsibilities; and internal or external factors. 8. integration of risk-management and control The results of continuous monitoring activi- objectives within management goals and the ties, as documented in supervisory products that organization’s compensation structure. reflect the Federal Reserve’s overview and risk assessment of the organization, may identify Organizations in the regional BHC portfolio certain primary firmwide risk-management or use a variety of control structures to monitor, control functions that require more intensive manage, and control firmwide risks. A number supervisory focus due to (1) significant changes of larger organizations have implemented firm- in inherent risk, control processes, or key per- wide risk-management functions to measure and sonnel; (2) potential concerns regarding the assess the range of their exposures across busi- adequacy of controls; or (3) the absence of ness lines and legal entities and the way these sufficiently recent examination activities for a exposures interrelate. However, many organiza- primary firmwide risk-management or control tions within the portfolio effectively control function by the Federal Reserve or another rel- risks using a decentralized approach that relies evant primary supervisor or functional regulator. on individual control structures for the organiza- In these instances, the Federal Reserve will tion’s primary business lines or legal entities. In work with other relevant primary supervisors or all instances, the Federal Reserve will assess functional regulators (where applicable) to whether the approach to a key control function develop discovery reviews or testing activities used by a particular organization is effective in focusing on the area of concern. In situations controlling primary risks to the consolidated where another primary supervisor or functional organization.12 regulator leads the examination activities, the Federal Reserve may conduct portions of the 12. As outlined in SR-08-8/CA-08-11, ‘‘Compliance Risk- examination, or otherwise participate as neces- Management Programs and Oversight at Large Banking Orga- sary (e.g., in determining the examination objec- nizations with Complex Compliance Profiles,’’ (see section tives and scope), to ensure that the review pro- 2124.07), while the Federal Reserve does not prescribe a vides sufficient information on the specific area particular organizational structure for primary firmwide risk- management and control functions, establishment of a firm- of concern to form a comprehensive and timely wide function that is dedicated to managing and overseeing understanding and assessment. compliance risk, and that promotes a strong compliance cul- If the primary firmwide risk-management or ture, is particularly important for large banking organizations control function is not within the oversight of with complex compliance profiles, due to the unique chal- lenges associated with compliance risk management for these another primary supervisor or functional regula- organizations. In addition to the oversight provided by the tor, or if the primary supervisor or functional board and various executive and management committees, a regulator does not conduct or coordinate the key component of firmwide compliance oversight for these organizations is a corporate compliance function that has day-to-day responsibility for overseeing and supporting the implementation of the organization’s firmwide compliance risk-management program and that plays a key role in control- BHC Supervision Manual January 2009 ling compliance risks that transcend business lines, legal Page 6 entities, and jurisdictions of operation. Consolidated Supervision of Regional BHCs 1050.2 examination activities in a reasonable period of To the fullest extent possible, the Federal time, the Federal Reserve will lead the neces- Reserve will draw its understanding and assess- sary examination activities in coordination with ment of these risks and risk-management prac- other relevant supervisors and regulators to the tices from the information and assessment of the extent possible. In all cases involving a func- primary supervisor or functional regulator where tionally regulated subsidiary, the Federal Reserve the BHC’s legal and operating structure pro- will conduct its supervisory and testing activi- vides the supervisor or regulator a sufficient ties in accordance with the provisions described view of these areas. In these instances, the Fed- above in section 1050.2.1.2. eral Reserve will undertake continuous monitor- ing and participate in activities led by primary supervisors and functional regulators, as neces- 1050.2.3.1.3 Risk Management of sary, to maintain an understanding and assess- Material Portfolios and Business Lines ment of related firmwide risk-management and control functions. Objectives: For each regional BHC, there are A regional BHC’s activities may span legal selected portfolio risk areas (such as retail or entities that are subject to oversight by multiple wholesale credit risk) or individual business supervisors or regulators or that are outside the lines (such as residential mortgage or com- oversight of other supervisors or regulators. If mercial real estate lending) that are primary this is the case, or if the primary supervisor or drivers of risk or revenue, or that otherwise functional regulator does not conduct or coor- materially contribute to either understanding dinate the necessary continuous monitoring or inherent risk within the consolidated organiza- examination activities in a reasonable period of tion or assessing controls for a broader time, the Federal Reserve will initiate and lead corporate function (such as consolidated credit- these activities in coordination with other risk management). relevant primary supervisors and functional During the development of supervisory prod- regulators to the extent possible. In all cases ucts that reflect the Federal Reserve’s overview involving a functionally regulated subsidiary, and risk assessment of the organization, the the Federal Reserve will conduct its supervisory Federal Reserve will analyze external factors and testing activities in accordance with the and internal trends in the BHC’s strategic provisions described above in section initiatives—as evidenced by budget and (where 1050.2.1.2. applicable) internal capital allocations and other factors—to identify significant activities and areas vulnerable to volatility in revenue, earn- 1050.2.3.1.4 Risk Management of ings, capital, or liquidity that represent material Nonmaterial Business Lines risks or activities of the organization. This deter- mination of material portfolios and business Objectives: For nonmaterial business lines iden- lines considers all associated risk elements, tified during the development of supervisory including legal and compliance risks. For exam- products that reflect the Federal Reserve’s over- ple, when evaluating whether retail activities view and risk assessment of the organization, such as mortgage or automobile lending are the Federal Reserve’s focus will be on identify- material to a banking organization, the extent of ing and understanding those business lines that inherent consumer compliance and reputational are increasing in importance and have the poten- risks, as well as interest rate and credit risks, tial to become material. should be considered. Supervisory Activities: When a primary supervi- Supervisory Activities: Because an understand- sor or functional regulator has a sufficient view ing of material risks and activities is needed to of nonmaterial business lines, the Federal Reserve assess the primary firmwide risk-management will, to the fullest extent possible, use informa- and control functions (as discussed in preceding tion developed by that supervisor or regulator to section 1050.2.3.1.2), the Federal Reserve will monitor areas of increasing importance with the maintain an understanding of inherent risk and potential to become material. The Federal Reserve assess the adequacy of risk-management and also will maintain an ability to access internal internal controls for material portfolios and busi- MIS for these businesses to facilitate a more ness lines. To form this understanding and assess- in-depth analysis of a business line, if appropri- ment, the Federal Reserve will rely primarily on continuous monitoring activities, supplemented, BHC Supervision Manual January 2009 as appropriate, by examination activities. Page 7 Consolidated Supervision of Regional BHCs 1050.2 ate, to understand its growing importance to the els and processes14 that influence this assess- organization. ment. This assessment utilizes results from For nonmaterial business lines that are not examinations led by the Federal Reserve or subject to oversight by a single primary supervi- other primary supervisors or functional regula- sor or functional regulator, the Federal Reserve tors, as well as information gained from the will engage in continuous monitoring activities BHC’s internal control functions and from to identify meaningful trends in risks and risk- market-based assessments, where available. management practices, and will maintain an When assessing the adequacy of a BHC’s understanding of associated MIS to facilitate liquidity levels and funds-management prac- more in-depth analysis of a business line, if tices, areas of focus include15 appropriate, to understand its growing impor- tance to the organization. 1. the extent to which the treasury function is aligned with risk-management processes, and whether incentives are in place for business 1050.2.3.2 Financial Condition lines to compile and provide information on expected liquidity needs and contingency funding plans so that the treasury function is Objectives: The Federal Reserve’s evaluation of able to develop a firmwide perspective and a regional BHC’s consolidated financial condi- incorporate business line information into tion focuses on the ability of the organization’s assessments of actual and contingent liquid- resources to support the level of risk associated ity risk; with its activities. Assessments are developed 2. whether funds-management practices pro- for each ‘‘CAEL’’ subcomponent: Capital vide sufficient funding flexibility to respond Adequacy (C), Asset Quality (A), Earnings (E), to unanticipated, evolving, and potentially and Liquidity (L).13 correlated market conditions for the organi- In developing this evaluation, the Federal zation and/or across financial markets; and Reserve’s primary focus is on developing an 3. the sufficiency of liquidity planning tools, understanding and assessment of such as stress testing, scenario analysis, and contingency planning efforts, including 1. the sufficiency of the BHC’s consolidated (1) whether liquidity buffers—comprised of capital to support the level of risk associated unencumbered liquid assets as well as access with the organization’s activities and provide to stable funding sources—adequately reflect a sufficient cushion to absorb unanticipated the possibility and duration of severe liquid- losses; ity shocks; (2) the reasonableness of assump- 2. the capability of liquidity levels and funds- tions about the stability of secured funding in management practices to allow reliable access circumstances in which the liquidity of mar- to sufficient funds to meet present and future kets for the underlying collateral becomes liquidity needs; and impaired; and (3) whether these efforts 3. other aspects of financial strength that need adequately reflect the potential for the orga- to be assessed on a consolidated basis across nization to be called on in stressed environ- the organization’s various legal entities, or ments to provide contingent liquidity support that relate to the financial soundness of the to off-balance-sheet entities or bring addi- parent company and significant nonbank sub- tional assets on the balance sheet (even if not sidiaries, as discussed in section 1050.2.3.3 legally or contractually obligated to do so). below. Beyond capital adequacy and liquidity, the In assessing consolidated regulatory capital, nature of independent Federal Reserve supervi- the Federal Reserve looks to ensure that the sory work required to evaluate a regional BHC’s BHC demonstrates the effectiveness of its frame- consolidated financial condition depends largely work for complying with relevant capital on the extent to which other relevant primary adequacy guidelines and meeting supervisory expectations, and focuses on analyzing key mod- 14. ‘‘Key models and processes’’ are those where evalua- tion of the model/process will influence the Federal Reserve’s assessment of the activity or control area that is supported by 13. See SR-04-18 and section 4070.0 for more information the model/process. about the CAEL subcomponents. 15. Assessing liquidity levels and funding practices for a consolidated BHC also incorporates elements presented in BHC Supervision Manual January 2009 section 1050.2.3.3.2 below on ‘‘Parent Company and Non- Page 8 bank Funding and Liquidity.’’ Consolidated Supervision of Regional BHCs 1050.2 supervisors or functional regulators have infor- ally regulated subsidiary that are of such signifi- mation or assessments upon which the Federal cance that they will influence the Federal Reserve can draw. For example, more indepen- Reserve’s assessment of these areas. In all cases dent Federal Reserve work typically will be involving a functionally regulated subsidiary, required to assess consolidated asset quality or the Federal Reserve will conduct its activities in earnings for regional BHCs with significant accordance with the provisions described above nonbank activities that are not functionally regu- in section 1050.2.1.2. lated. However, where all material holding com- pany assets are concentrated in a single deposi- tory institution subsidiary, a minimal level of 1050.2.3.3 Impact incremental Federal Reserve efforts typically will be required to assess consolidated asset quality and earnings. 1050.2.3.3.1 Risk Management and Financial Condition of Significant Supervisory Activities: The Federal Reserve will Nonbank Subsidiaries primarily utilize continuous monitoring activi- ties to assess a regional BHC’s financial strength. Objectives: Many regional BHCs engage in Such activities will include periodic meetings activities and manage control functions on a with BHC management (such as the chief finan- firmwide basis, spanning depository institution cial officer); review of regulatory reports, sur- and nonbank legal entities. In some instances, veillance screens, and internal MIS; and analy- these BHCs have intra-group exposures and ser- sis of market indicators (where available), vicing arrangements across affiliates, presenting including external debt ratings, subordinated increased potential risks for depository institu- debt spreads, and credit default swap spreads. tion subsidiaries and a higher likelihood of Testing and discovery activities will be used as aggregate risk concentrations across the organi- necessary to assist in the understanding and zation’s legal entities. Common interactions assessment of areas of concern. between a regional BHC’s depository institution Testing and discovery activities also will be subsidiaries and their nonbank affiliates (includ- used to understand and assess the sufficiency of ing the parent company) include assets originat- the BHC’s consolidated capital and liquidity ing in, or being marketed by, a nonbank affiliate positions to support the level of risk associated that are booked in the depository institution; a with its activities, including (1) regulatory capi- depository institution providing funding for non- tal calculation methodologies16 and, where appli- bank affiliates; and risk-management or internal cable, internal assessments of capital adequacy17 control functions being shared between deposi- and (2) funds-management and liquidity plan- tory and nonbank operations. ning tools and practices. The Federal Reserve Due to these interrelationships, financial, legal, will work with other relevant primary supervi- compliance, or reputational troubles in one part sors and functional regulators to participate in of a BHC can spread rapidly to other parts of the or, if necessary, to coordinate activities designed organization. Even absent these interactions, the to analyze key capital and liquidity models or parent or nonbank subsidiaries of an organiza- processes of a depository institution or function- tion may present financial, legal, compliance, or reputational risk to the consolidated entity, and thus directly or indirectly to its depository insti- 16. Assessments of the adequacy of regulatory capital for tution subsidiaries. As the federal banking agency BHCs that have received Federal Reserve supervisory approval to use internal estimates of risk in their regulatory capital charged with supervising the organization on a calculations should include, among other things, regular veri- consolidated basis, the Federal Reserve is respon- fication that these organizations continue to meet on an ongo- sible for understanding and assessing the risks ing basis all applicable requirements associated with internal that the parent bank holding company and its estimates. See, for example, the capital adequacy guidelines for market risk at BHCs (Regulation Y: 12 C.F.R. 225, Appen- nonbank subsidiaries may pose to the BHC itself dix E) and the new advanced capital adequacy framework for or its depository institution subsidiaries. BHCs (Regulation Y: 12 C.F.R. 225, Appendix G). The primary objectives of Federal Reserve 17. Capital planning activities for all BHCs should be supervision of the nonbank subsidiaries of a forward looking and provide for a sufficient range of stress scenarios commensurate with the organization’s activities. bank holding company are to For those regional BHCs that utilize more-rigorous and struc- tured internal processes for assessing capital adequacy beyond regulatory capital measures, the Federal Reserve focuses on whether such internal processes ensure that all risks are prop- erly identified, reliably quantified (where possible) across the BHC Supervision Manual January 2016 entire organization, and supported by adequate capital. Page 9 Consolidated Supervision of Regional BHCs 1050.2

1. identify significant nonbank activities and tional risks, as well as the extent to which risks—where the parent company or non- potential conflicts of interest are identified bank subsidiaries engage in risk-taking activi- and avoided or managed; ties or hold exposures that are material to the 3. understand the scope of intercompany trans- risk management or financial condition of actions and aggregate concentrations, and the consolidated organization or a depository assess the adequacy of risk-management pro- institution subsidiary—by developing an un- cesses, accounting policies, and operating derstanding of the size and nature of primary procedures to measure and manage related activities and key trends, and the extent to risks; which business lines, risks, or control func- 4. identify and assess key interrelationships and tions are shared with or may impact a deposi- dependencies between subsidiary depository tory institution affiliate; institutions and nonbank affiliates, such as 2. evaluate the financial condition and the the extent to which a depository institution adequacy of risk-management practices of subsidiary is reliant on services provided by the parent and significant nonbank subsidi- the parent company or other nonbank affili- aries, including the ability of nonbank sub- ates and the reasonableness of associated sidiaries to repay advances provided by the management fees; parent, using benchmarks and analysis appro- 5. identify those nonbank subsidiaries whose priate for those businesses; activities present material financial, legal, 3. evaluate the degree to which nonbank entity compliance, or reputational risk to the con- risks may present a threat to the safety and solidated entity and/or a depository institu- soundness of subsidiary depository institu- tion subsidiary; tions, including through transmission of legal, 6. identify significant businesses operated across compliance, or reputational risks; multiple legal entities for accounting, risk 4. identify and assess any intercompany rela- management, or other purposes, as well as tionships, dependencies, or exposures—or activities that functionally operate as sepa- aggregate firmwide concentrations—with the rate business units for legal or other reasons; potential to threaten the condition of a deposi- 7. identify intercompany transactions subject to tory institution affiliate; and Regulation W—utilizing information submit- 5. evaluate the effectiveness of the policies, ted on quarterly regulatory reporting form procedures, and systems that the holding FR Y-8 (‘‘TheBank Holding Company Report company and its nonbank subsidiaries use to of Insured Depository Institutions’ Section ensure compliance with applicable laws and 23A Transactions with Affiliates’’), internal regulations, including consumer protection MIS, and other information sources—and laws.18 determine (in conjunction with the primary supervisor) whether compliance issues are Supervisory Activities: For all significant non- present; and bank subsidiaries and activities of the parent 8. understand and assess the sufficiency, relia- BHC, the Federal Reserve will use continuous bility, and timeliness of associated MIS relied monitoring activities and discovery reviews to upon by the board, senior management, and senior risk managers and committees to moni- 1. maintain an understanding of the holding tor key activities and risks. company’s business line and legal entity structure, including key interrelationships and Periodic testing may be used to supplement dependencies between depository institution continuous monitoring and discovery reviews to subsidiaries and nonbank affiliates, utilizing (1) ensure that key risk-management and inter- regulatory structure reports, internal MIS, nal control practices conform to internal poli- and other information sources; cies and/or are designed to ensure compliance 2. understand and assess the exposure to, and with the law and (2) understand and assess tolerance for, legal, compliance, and reputa- operations presenting a moderate or greater like- lihood of significant negative impact to a subsid- 18. The Federal Reserve’s supervisory objectives and iary depository institution or the consolidated activities related to the effectiveness of consumer compliance organization. Areas of potential negative impact policies, procedures, and systems at nonbank subsidiaries of a include financial or operational risks that pose a BHC currently are under review, and additional or modified guidance on this topic may be issued in the future. potential threat to the safety and soundness of a depository institution subsidiary, or to the hold- BHC Supervision Manual January 2016 ing company’s ability to serve as a source of Page 10 financial and managerial strength to its deposi- Consolidated Supervision of Regional BHCs 1050.2 tory institution subsidiaries. Testing will focus of the funding profile—including intraday liquid- on controls for identifying, monitoring, and con- ity management policies and practices, and com- trolling such risks. In all cases involving a func- pliance with the ‘‘Federal Reserve Policy on tionally regulated subsidiary, the Federal Reserve Payments System Risk’’20—and market access will conduct its activities in accordance with the of material depository institution subsidiaries, provisions described above in section 1050.2.1.2. as in most instances these entities represent the consolidated BHC’s primary and most active vehicles for external funding and liquidity man- 1050.2.3.3.2 Parent Company and agement. The primary supervisor retains respon- Nonbank Funding and Liquidity sibility for assessing liquidity risk-management practices with respect to the depository institu- Objectives: One of the Federal Reserve’s pri- tion subsidiary. mary responsibilities as consolidated supervisor is to help ensure that the parent company and its Supervisory Activities: The Federal Reserve will nonbank subsidiaries do not have an adverse use continuous monitoring activities—including impact on the organization’s depository institu- monitoring market conditions and indicators tion subsidiaries. To meet this objective, the where available—and discovery reviews to Federal Reserve will assess the extent to which understand and assess parent company and funding and liquidity policies and practices of nonbank subsidiary funding and liquidity poli- the parent company or nonbank subsidiaries cies and practices, as well as any potential nega- may undermine the BHC’s ability to act as a tive impact these policies and practices might source of strength to the organization’s deposi- have on a subsidiary depository institution or tory institution subsidiaries. the consolidated organization. On at least an Areas of focus will include an assessment of annual basis, the results of these supervisory activities will be reviewed to determine whether 1. the ability of the parent company and non- there is (1) a significant change in inherent bank subsidiaries to maintain sufficient liquid- funding or liquidity risk stemming from chang- ity, cash flow, and capital strength to service ing strategies or activities; (2) a significant their debt obligations and cover fixed charges; change in organizational structure, oversight 2. the likelihood that parent company or non- mechanisms, key personnel, or other key ele- bank funding strategies could undermine pub- ments of related risk-management or internal lic confidence in the liquidity or stability of controls; or (3) any potential concern regard- subsidiary depository institutions; ing the adequacy of related risk-management or 3. policies and practices that are aimed at ensur- internal controls. ing the stability of parent company funding If significant changes or potential concerns and liquidity, as evidenced by the utilization are identified, the Federal Reserve will design of long-term or permanent financing to sup- and conduct testing activities focused on under- port capital investments in subsidiaries and standing and assessing the areas of change and/or other long-term assets, and the degree of concern in order to ensure that funding and dependence on short-term funding mecha- liquidity risk-management and control functions nisms such as commercial paper; are appropriately designed and achieving their 4. the extent of ‘‘double leverage’’19 and the intended objectives. organization’s capital management policies, For regional BHCs where parent company or including the distribution and transferability nonbank subsidiary third-party debt obligations of capital across jurisdictions and legal enti- are deemed to be material in relation to equity ties; and or may otherwise have a potentially negative 5. the parent company’s ability to provide finan- impact on the BHC’s ability to serve as a source cial and managerial support to its depository of strength for its depository institution subsidi- institution subsidiaries during periods of finan- aries, the Federal Reserve will undertake testing cial stress or adversity, including the suffi- activities on at least a three-year cycle, assess- ciency of related stress testing, scenario analy- ing the individual elements of risk management sis, and contingency planning efforts. for parent company and nonbank funding and

The Federal Reserve also will remain apprised 20. This policy statement is available on the Board’s pub- lic website at www.federalreserve.gov/paymentsystems/psr. 19. ‘‘Double leverage’’ refers to situations in which debt is issued by the parent company and the proceeds are invested in BHC Supervision Manual January 2009 subsidiaries as equity. Page 11 Consolidated Supervision of Regional BHCs 1050.2 liquidity: board and senior management over- BHC’s subsidiaries to ensure that the necessary sight; policies, procedures, and limits; risk moni- information flows and coordination mechanisms toring and management information systems; exist to permit the effective supervision of the and related internal controls. In all cases involv- BHConaconsolidatedbasis.TheFederalReserve ing a functionally regulated subsidiary, the Fed- will continue to share information, including eral Reserve will conduct its activities in accor- confidential supervisory information, obtained dance with the provisions described above in or developed through its consolidated supervi- section 1050.2.1.2. sory activities with other relevant primary super- visors or functional regulators when appropriate and permitted by applicable laws and 1050.2.4 INTERAGENCY regulations.22 COORDINATION The Federal Reserve also will continue to use a variety of formal and informal channels to 1050.2.4.1 Coordination and Information facilitate interagency information sharing and Sharing Among Domestic Primary Bank coordination consistent with the principles out- Supervisors and Functional Regulators lined above, including Objectives: Effective consolidated supervision • supervisory protocols, agreements, and memo- requiresstrong,cooperativerelationshipsbetween randa of understanding (MOUs) with primary the Federal Reserve and other relevant domestic supervisors and functional regulators that allow primary bank supervisors and functional regula- the coordination of supervisory activities and tors.21 To achieve this objective, the Federal that permit the ongoing exchange of informa- Reserve has worked over the years to enhance tion, including confidential information on a interagency coordination through the develop- confidential basis; ment and use of information-sharing protocols • bilateral exchanges of letters to facilitate infor- and mechanisms. These protocols and mecha- mation sharing on a situation-specific basis; nisms respect the individual statutory authorities • periodic and as-needed contacts with primary and responsibilities of the respective supervisors supervisors and functional regulators to dis- and regulators, provide for appropriate informa- cuss and coordinate matters of common inter- tion flows and coordination to limit unnecessary est, including the planning and conduct of duplication or burden, comply with restrictions examinations and continuous monitoring governing access to information, and ensure that activities; the confidentiality of information is maintained. • the use of information technology platforms, As discussed in section 1050.2.3, in such as the Banking Organization National understanding and assessing the activities and Desktop (BOND),23 to provide secure auto- risks of the organization as a whole, the Fed- mated access to examination/inspection reports eral Reserve will rely to the fullest extent pos- and other supervisory information prepared sible on the examination and other supervisory by the Federal Reserve and other relevant work conducted by the domestic primary bank supervisors and regulators; and supervisors and functional regulators of a • participation in a variety of interagency forums BHC’s subsidiaries. In addition, the Federal that facilitate the discussion of broad industry Reserve will seek to coordinate its supervisory issues and supervisory strategies, including activities with relevant supervisors and regula- the Federal Financial Institutions Examination tors, and will work to align each agency’s Council, the President’s Working Group on assessment of key corporate governance func- Financial Markets, and the Federal Reserve- tions, risk-management and internal control functions for primary risks, financial condition, 22. Among the federal laws that may limit the sharing of and other areas of the consolidated BHC’s information among supervisors are the Right to Financial operations as applicable. Privacy Act (12 U.S.C. 3401 et seq.) and the Trade Secrets Act (18 U.S.C. 1905). The Federal Reserve has established procedures to authorize the sharing of confidential supervi- Supervisory Activities: The Federal Reserve will sory information, and Federal Reserve staff must ensure that continue to work with the relevant primary appropriate approvals are obtained prior to releasing such supervisors and functional regulators of a regional information. See Subpart C of the Board’s Rules Regarding the Availability of Information (12 C.F.R. 261.20 et seq.). 23. BOND is a Federal Reserve information technology 21. Section 1050.2.4.2 discusses cooperation and informa- platform providing secure interagency access to documents, tion sharing among foreign supervisors. supervisory and financial data, and other information utilized in the consolidated supervision of individual BHCs and FBOs, BHC Supervision Manual January 2009 and in developing comparative analyses of organizations with Page 12 similar business lines and risk characteristics. Consolidated Supervision of Regional BHCs 1050.2

sponsored cross-sector meetings of financial country authorities. As home-country supervi- supervisors and regulators. sor for domestic BHCs, the Federal Reserve is responsible for the comprehensive, consolidated supervision of these organizations, while each 1050.2.4.1.1 Coordination of host country is responsible for supervision of Examination Activities at a Supervised the legal entities (including foreign subsidiaries BHC Subsidiary of U.S. BHCs) in its jurisdiction. Information sharing among domestic and for- As discussed in section III, the Federal Reserve eign supervisors, consistent with applicable laws, will seek to work cooperatively with the rel- is essential to ensure that a regional BHC’s evant primary supervisor or functional regulator global activities are supervised on a consoli- to address information gaps or indications of dated basis. Cross-border information sharing is weakness or risk identified in a supervised BHC often facilitated by an MOU that establishes a subsidiary that are material to the Federal framework for bilateral relationships and includes Reserve’s understanding or assessment of the provisions for cooperation during the licensing consolidated organization’s risks, activities, or process, in the supervision of ongoing activities, key corporate governance, risk-management, or and in the handling of problem institutions. The control functions. Prior to conducting discovery Federal Reserve has established bilateral and reviews or testing activities at a depository insti- multilateral information-sharing MOUs and other tution (other than where the Federal Reserve is arrangements with numerous host-country for- the primary federal supervisor) or functionally eign supervisors. The Federal Reserve also moni- regulated subsidiary of a BHC, the Federal tors changes in foreign bank regulatory and Reserve will supervisory systems and seeks to understand how these systems affect supervised banking • review available information sources as part organizations. In addition to its longstanding of its continuous monitoring activities, includ- cooperative relationships with home- and host- ing examination reports and the BHC’s inter- country foreign supervisors, the Federal Reserve nal MIS, to determine whether such informa- expects to increasingly lead and participate in tion addresses the Federal Reserve’s ‘‘colleges of supervisors’’ and other multilateral information needs or supervisory concerns; groups of supervisors that discuss issues related and to specific, internationally active banking • if needed, seek to gain a better understanding organizations. of the primary supervisor’s or functional regu- The Federal Reserve also is a member of the lator’s basis for its supervisory activities and Basel Committee on Banking Supervision, which assessment of the subsidiary. This may include is a forum for supervisors from member coun- a request to review related examination work. tries to discuss important supervisory issues, foster consistent supervision of organizations If, following these activities, the Federal with similar business and risk profiles, promote Reserve’s information needs or supervisory con- the sharing of leading supervisory practices, and cerns remain, the Federal Reserve will work formulate guidance to enhance and refine bank- cooperatively with the relevant primary supervi- ing supervision globally. sor or functional regulator in the manner dis- The Federal Reserve’s processes for under- cussed in section 1050.2.3.24 standing and assessing firmwide legal and com- pliance risk management, as described earlier, encompass both domestic and international 1050.2.4.2 Cooperation and Information operations. Most areas of supervisory focus for Sharing With Host-Country Foreign management of legal and compliance risks are Supervisors applicable to both domestic and international entities, and include proper oversight of licensed Objectives: A number of regional BHCs have operations, compliance with supervisory and international banking and other operations that regulatory requirements, and the sufficiency of are licensed and supervised by foreign host- associated MIS. There are, however, areas of focus for the 24. As outlined in section 1050.2.3, certain Federal Reserve Federal Reserve that are unique to a holding examination activities are to be conducted on a minimum company’s international operations. For exam- three-year cycle to verify, through testing, the sufficiency of key control processes. These activities are to be conducted regardless of whether or not there is an information gap or BHC Supervision Manual January 2009 indication of weakness or risk. Page 13 Consolidated Supervision of Regional BHCs 1050.2 ple, some host-country legal and regulatory whether the organization should be conducting structures and supervisory approaches are operations in that host country. fundamentally different from those in the In addition, any limits placed on the Federal United States. As a result, the banking organiza- Reserve’s ability to access information on host- tion often must devote additional resources to country operations, or to engage in onsite activi- maintain expertise in local regulatory require- ties at the organization’s operations in the host ments. In some instances, privacy concerns country, should be considered when assessing have led to limits on the information a BHC’s whether the organization’s activities in that juris- foreign office may share with its parent com- diction are appropriate. pany, thereby limiting the parent company’s ability to exercise consolidated risk manage- ment on a global basis. 1050.2.4.3 Indications of Weakness or Additionally, while considerable progress has Risk Related to Subsidiary Depository been made to strengthen supervisory cross- Institutions border cooperation and information sharing, the Federal Reserve and other U.S. supervisors have Objectives: For areas beyond those specifically at times faced challenges in accessing informa- addressed in section 1050.2.3, there may be tion on a bank’sorBHC’s foreign operations or circumstances where the Federal Reserve has in carrying out examinations of cross-border or indications of material weakness or risk in a foreign activities. These circumstances are to be depository institution subsidiary of a BHC that taken into account when developing a supervi- is supervised by another primary supervisor, and sory strategy for a regional BHC with cross- it is not clear that the weakness or risk is border or foreign operations. adequately reflected in the assessment or super- visory activities of that supervisor. Because a Supervisory Activities: For regional BHCs with primary objective of consolidated supervision is international operations, continuous monitoring to protect the BHC’s depository institution sub- will be used to understand and assess each sidiaries, the Federal Reserve will follow up BHC’s international strategy, trends, opera- with the appropriate primary supervisor in these tions, and legal entity structure, as well as circumstances to help ensure that, to the extent related governance, risk-management, and that a material weakness or risk exists, it is internal controls. For a regional BHC with addressed appropriately. significant international operations or risks, an assessment of cross-border and foreign opera- Supervisory Activities: The Federal Reserve will tions will be incorporated into the evaluation of take the following steps if it has indications of key corporate governance functions and primary material weakness or risk in a depository institu- firmwide risk-management and internal control tion subsidiary (other than where the Federal functions, including legal and regulatory risk Reserve is the primary federal supervisor) in an management. area beyond those specifically addressed in sec- Continuous monitoring activities will include tion 1050.2.3, and it is not clear that the weak- review of materials prepared by host-country ness or risk is adequately reflected in the assess- supervisors, including examination reports and ment or supervisory activities of the depository assessments, and ongoing communication with institution’s primary supervisor. relevant foreign and domestic supervisors regard- ing trends and assessments of cross-border and • The Federal Reserve will first review avail- foreign operations. able information sources, discuss the areas of When assessing the sufficiency of a regional concern with the primary supervisor, and seek BHC’s management of its international opera- to review the supervisor’s related work. tions, consideration is given to the extent that • If concerns remain following these activities, foreign laws restrict the transmission of infor- the Federal Reserve will request that the pri- mation to the BHC’s head office. Impediments mary supervisor conduct a discovery review to sharing information imposed by a host coun- or testing activity at the depository institution try may constrain the BHC’s ability to effec- to address the area of concern. tively oversee its international operations and • In the event the primary supervisor does not globally manage its risks, and the materiality of undertake activities to address the concern in such impediments should be a determinant of a reasonable period of time, the Federal Reserve will design and lead an examination of the BHC Supervision Manual January 2009 depository institution to address the matter in Page 14 consultation with the primary supervisor. A Consolidated Supervision of Regional BHCs 1050.2

senior Federal Reserve official will communi- tory institution on the BHC’s condition, and cate this decision in writing to a senior official to determine if the holding company is provid- of the primary supervisor. ing appropriate support to the depository insti- tution. The Federal Reserve will coordinate its activities with those of the primary supervisor 1050.2.4.4 Condition or Management of to the extent appropriate. BHC Subsidiary is Less than Satisfactory • Nonbank subsidiary. When any nonbank sub- sidiary faces financial stress or material risks, Objectives: As noted above, a primary responsi- the Federal Reserve will seek to ensure that its bility of the Federal Reserve as consolidated condition and activities do not jeopardize the BHC supervisor is to ensure that a holding safety and soundness of the BHC or its deposi- company’s activities, policies, and practices do tory institution subsidiaries, as discussed above not undermine its ability to serve as a source of in sections 1050.2.3.3.1, ‘‘Risk Management financial and managerial strength to its deposi- and Financial Condition of Significant Non- tory institution subsidiaries. In situations where bank Subsidiaries’’ and 1050.2.3.3.2, ‘‘Parent the condition or management of a supervised or Company and Nonbank Funding and Liquid- functionally regulated BHC subsidiary is deter- ity.’’ The Federal Reserve also will take appro- mined to be less than satisfactory, the Federal priate steps to ensure that any actions taken by Reserve’s focus as consolidated supervisor is on the parent company to assist a nonbank sub- complementing the efforts of the primary super- sidiary do not impair the BHC’s continuing visor or functional regulator. In doing so, the ability to serve as a source of strength to its Federal Reserve will seek to ensure that the depository institution subsidiaries. The Fed- parent company provides appropriate support to eral Reserve will coordinate its activities with the subsidiary and does not take actions that those of any relevant functional regulator to may further weaken the parent company’s deposi- the extent appropriate. tory institution subsidiaries or its ability to act as a source of strength for such subsidiaries. Beyond the specific activities noted below, 1050.2.4.5 Edge and Agreement these circumstances also may require the Fed- Corporations eral Reserve to enhance the activities addressed in section 1050.2.3 for understanding and assess- Objectives: Some regional BHCs control an ing key corporate governance functions, or pri- Edge or agreement corporation subsidiary. The mary firmwide risk-management and internal Federal Reserve serves as the primary supervi- controls. In addition, the Federal Reserve will sor of each Edge and agreement corporation adjust its supervisory activities as necessary subsidiary in addition to its role as consolidated when the consolidated BHC is in weakened BHC supervisor.25 When the Edge or agreement condition or when there are questions regarding corporation is held by a U.S. bank, the primary the capabilities of the holding company’s supervisor often relies on information provided management. by the Federal Reserve in developing its own understanding and assessment of the parent bank. Supervisory Activities: During each calendar year, the Federal Reserve performs an examination of each Edge and • Depository institution subsidiary. In instances agreement corporation, assesses the Bank Secrecy when a depository institution subsidiary’s con- Act/Anti-Money-Laundering (BSA/AML) com- dition or management is rated less than satis- pliance program, and assigns a CAMEO rating. factory, or when the depository institution In addition, the Federal Reserve periodically subsidiary otherwise faces financial stress or conducts assessments of Edge and agreement material risks, the Federal Reserve’s primary supervisory objectives as consolidated super- visor are to ensure that the parent company 25. The Federal Reserve is solely responsible for approv- ing, and supervising the activities of, U.S. Edge and agree- (1) provides appropriate support to the deposi- ment corporations. As discussed in SR-90-21, ‘‘Rating Sys- tory institution and (2) does not take action tem For International Examinations,’’ one of the Federal that could harm the depository institution. The Reserve’s supervisory responsibilities is the assignment of a Federal Reserve will work closely with the CAMEO rating (Capital, Asset Quality, Management, Earn- ings, and Operations and Internal Controls) to each Edge and primary supervisor to understand whether the agreement corporation. BHC or a nonbank affiliate has contributed to the depository institution’s weakened condi- BHC Supervision Manual January 2009 tion, to understand the impact of the deposi- Page 15 Consolidated Supervision of Regional BHCs 1050.2 corporations to determine whether a consumer ration and those that are shared with the parent compliance examination is warranted, in which bank or BHC, and will coordinate fulfillment of case a compliance examination is conducted and the Federal Reserve’s responsibilities as Edge a consumer compliance rating is assigned. and agreement corporation supervisor with The Federal Reserve will coordinate the con- execution of its consolidated supervision role. duct of its activities as Edge and agreement This strategy will reflect the extent to which corporation supervisor with its activities as con- reliancecanbeplacedon(1)theFederalReserve’s solidated supervisor. To this end, the extent and understanding and assessments of key corporate scopeofFederalReservesupervisoryworkrelated governance, risk-management, and control func- to an Edge or agreement corporation will be tions, as well as material portfolios and business tailored to the entity’s activities, risk profile, lines, of the consolidated BHC; (2) assessments and other attributes. A number of specific ele- developed by the primary supervisor (when ments will be considered when developing a applicable) for business lines, risk management, supervisory approach, including control functions, or financial factors that are common to the Edge or agreement corporation 1. structure and attributes, including whether and its parent bank; and (3) findings developed the Edge or agreement corporation is a bank- by host-country supervisors for activities under ing or investment organization; their jurisdiction. 2. the size, nature, and location of its primary In addition, where the primary supervisor of activities, as well as key financial and other an Edge or agreement corporation’s parent bank trends; relies on the Federal Reserve’s understanding 3. the business lines and risks, and associated and assessment in order to develop its CAMELS trends, of the Edge or agreement corpora- rating,26 the Federal Reserve will work to fulfill tion’s primary activities on a standalone basis, that supervisor’s information needs. as well as their significance to the risk profile of the parent bank (if applicable) and BHC; 4. the extent to which risk-management and 1050.2.4.6 Nontraditional Bank Holding internal control functions are unique to the Companies Edge or agreement corporation, or are shared with a parent bank, another affiliate, or the Objectives: A small number of regional BHCs consolidated BHC; are considered to be nontraditional bank holding 5. any potential Regulation K limitations or companies because most or all of their signifi- other U.S. compliance issues, and the adequacy cant nondepository subsidiaries are regulated by of processes to ensure ongoing compliance; a functional regulator, and subsidiary depository and institutions are small in relation to the nonde- 6. the adequacy of processes for ensuring com- pository entities. As with all BHCs, the level of pliance with all applicable laws and regula- analysis conducted and resources needed to tions imposed by host-country supervisors supervise and assess nontraditional BHCs should for the Edge or agreement corporation’s inter- be commensurate with the level of risk posed by national operations. the organization’s depository institution subsidi- aries to the federal safety net and the level of Supervisory Activities: The Federal Reserve will risk posed by the parent or its nonbank subsidi- maintain an understanding and perform an annual aries to the BHC’s subsidiary depository examination for each Edge and agreement cor- institutions. poration. While the examination scope will be Due to the unique structure of nontraditional risk focused to reflect the organization’s scale, BHCs, it is likely that a single functional regula- activities, and risk profile, in all cases the Fed- tor will have a complete view of, and ability to eral Reserve will assess the adequacy of pro- address, significant aspects of the organization’s cesses to ensure compliance with BSA/AML requirements and other applicable U.S. laws and regulations, and with applicable foreign laws 26. The U.S. banking agencies assign CAMELS (Capital and regulations. Adequacy, Asset Quality, Management, Earnings, Liquidity, and Sensitivity to Market Risk) ratings to U.S. banking orga- In developing its supervisory strategy, the nizations as part of their ongoing supervision of these organi- Federal Reserve will identify those elements zations. See SR-96-38, ‘‘Uniform Financial Institutions Rat- that are unique to the Edge or agreement corpo- ing System,’’ (see A.5020.1 of the Commercial Bank Examination Manual and sections 4020.9, 4070.0.4, and 4080.0) Also see SR-97-4, ‘‘Interagency Guidance on Com- BHC Supervision Manual January 2009 mon Questions About the Application of the Revised CAM- Page 16 ELS Rating System.’’ Consolidated Supervision of Regional BHCs 1050.2

firmwide activities, risks, risk management, and on the assessment of the IDI as reflected in the controls. Therefore, assessments and informa- examination work performed by the IDI reg- tion developed by the primary functional regula- ulator(s). tor typically will be the main tool utilized by the The Federal Reserve tailors its supervision of Federal Reserve in developing and assigning the holding companies based on the size of the ‘‘R’’ and ‘‘F’’ components of the consolidated organization, complexity, and the degree of sys- RFI rating. More independent Federal Reserve temic risk that the organization poses to the U.S. work typically will be required to understand financial system and the economy, including the and assess the impact of the nondepository enti- deposit insurance fund. Within this framework ties on the subsidiary depository institutions in of tailored supervision, the Federal Reserve order to assign the ‘‘I’’ rating. focuses on the goals of both macroprudential and microprudential supervision for systemati- Supervisory Activities: The Federal Reserve will cally important institutions, and microprudential primarily utilize continuous monitoring activi- supervisory goals for BHCs and SLHCs with ties to maintain its assessments of risk manage- total consolidated assets of less than $50 bil- ment and financial condition for nontraditional lion.28 BHCs, relying on the assessments and informa- The BHC Act and the HOLA authorize the tion developed by the primary functional regula- Federal Reserve to conduct examinations of tor to the fullest extent possible. BHCs and SLHCs, and certain subsidiaries of In addition to continuous monitoring, discov- such holding companies, to obtain information ery reviews and periodic testing will be used to needed to assess the safety and soundness of maintain an understanding and assessment of the supervised financial institutions.29 At the same potential negative impact of nonbank entities on time, the Dodd-Frank Act requires the Federal subsidiary depository institutions as discussed Reserve, to the fullest extent possible, to rely on above in sections 1050.2.3.3.1 and 1050.2.3.3.2 the reports and supervisory information from on, respectively, ‘‘Risk Management and other regulatory agencies to avoid duplication of Financial Condition of Significant Nonbank examination activities, reporting requirements, Subsidiaries’’ and ‘‘Parent Company and and requests for information. Supervisory over- Nonbank Funding and Liquidity.’’ In all cases lap at the level of the IDI can be avoided involving a functionally regulated subsidiary, the through reliance on the examination work per- Federal Reserve will conduct its activities in formed by the IDI regulators, as each agency accordance with the provisions described above follows similar rules and supervisory guidance in section 1050.2.1.2. when assessing the financial and managerial condition of an insured depository institution. Consistent with this mandate to rely on the 1050.2.5 Relying on the Work of work of the IDI regulators, the IDI regulators Regulators of Subsidiary Insured and the Federal Reserve have the mutual respon- Depository Institutions sibility to foster the timely sharing of informa- tion, including their risk-focused supervisory The principle of relying on the work of the Insured Depository Institution (IDI) regulators 28. While recognizing that a large number of smaller is a well-established tenet of Federal Reserve BHCs and SLHCs simultaneously experiencing financial dis- tress could have a harmful effect on a local economy’s avail- 27 supervisory policy and is required by statute. ability of credit or on certain sectors or regions of the U.S. BHC and SLHC supervision focuses on the economy, institutions that are not systemically important do Federal Reserve’s assessment of the consoli- not have the size or degree of interconnectedness to the dated organization based on a review of parent financial system to individually pose macroprudential risk. 29. 12 U.S.C. 1844(c)(2); 12 U.S.C. 1467a(b)(4)(A). This and nonbank activities, together with an assess- information pertains to the nature of the operations and finan- ment of the organization’s IDI subsidiaries. cial condition of the holding company and its subsidiaries; the When assigning Federal Reserve supervisory financial, operational, and other risks within the holding com- ratings to BHCs and SLHCs where the Federal pany system that may pose a threat to the safety and sound- ness of the holding company or of any depository institution Reserve is not the IDI regulator, the Federal subsidiary of the holding company, or the stability of the Reserve will rely to the fullest extent possible financial system of the United States; the systems of the holding company for monitoring and controlling any such risks; and the holding company’s and subsidiaries’ compli- 27. Refer to sections 5(c)(1)–(2) of the Bank Holding ance with federal law, other than in the case of an insured Company Act of 1956 (BHC Act) and sections 10(b)(2) and depository institution or functionally regulated subsidiary. (b)(4) of the Home Owners’ Loan Act (HOLA), as amended by section 604 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). 12 U.S.C. BHC Supervision Manual July 2016 1844(c)(1)–(2); 12 U.S.C 1467a(b)(2), (b)(4). Page 17 Consolidated Supervision of Regional BHCs 1050.2 analysis and conclusions. Moreover, the sharing er’s inspections and examinations to support ofinformationisnecessarysothatFederalReserve and complement each other’s work as neces- staff have an adequate basis for relying on the sary. Through ongoing dialogue and exchange IDI regulators’ work. While exercising the Fed- of supervisory documents and information, eral Reserve’s responsibility to assess and assign Federal Reserve staff are expected to: appropriate supervisory ratings to the consoli- • understand the IDI regulators’ risk assess- dated holding company, the microprudential su- ment and supervisory plan for each IDI, to pervision framework for smaller BHCs and include this information into the Federal SLHCs provides the Federal Reserve with the Reserve’s evaluation of consolidated hold- flexibility to rely on the assessment of an IDI’s ing company risk, and to support develop- condition by another regulator. ment of the Federal Reserve’s supervisory The following guidance explains the Federal plan for the holding company; Reserve’s expectations for its examiners’ reli- • understand the IDI regulators’ examination ance on the work of the regulators of insured work, including the scope, basis for, and depository institution subsidiaries (IDI regula- support of conclusions reached, and the tors30) in the supervision of regional bank hold- goal of any supervisory action; ing companies (BHCs) and savings and loan • communicate to the IDI regulators the Fed- holding companies (SLHCs) with total consoli- eral Reserve’s supervision goals and ap- dated assets of between $10 billion and $50 proach with respect to the holding com- billion.31 Refer to SR-16-4. pany and any subsidiaries not subject to the supervision of IDI regulators; and • use all information made available from 1050.2.5.1 Relying on the Work of IDI the IDI regulators to reach conclusions Regulators for RBOs regarding the consolidated holding com- pany’s overall condition and to assign ap- The Federal Reserve supervises RBOs using a propriate Federal Reserve supervisory rat- program of continuous oversight which is char- ings. acterized by a series of targeted examinations 3. Federal Reserve staff should verify that the during the annual supervisory cycle, a roll-up Federal Reserve’s supervisory ratings of the examination at the end of the cycle, and continu- consolidated holding company are ad- ous monitoring between examination events dur- equately supported by information that is ing the cycle. timely and complete, including the informa- tion received from the IDI regulators. 1. Taking into account a holding company’s 4. Federal Reserve staff will scale their supervi- complexity, risk profile, and condition, the sory approach, including the review of and Federal Reserve will rely to the fullest extent reliance on the IDI regulators’ work, accord- possible on the work of the IDI regulators to ing to the complexity,32 risk, and condition supplement its own supervisory work regard- of the consolidated organization, and to the ing the consolidated holding company and its timeliness of information available from the nonbank subsidiaries. IDI regulators. For noncomplex holding com- 2. Federal Reserve staff will promote the shar- panies with satisfactory supervisory ratings, ing of information with the IDI regulators Federal Reserve consolidated ratings should throughout the supervisory cycle, which will rely heavily on the IDI regulators’ work for foster collaborative interagency relation- IDI subsidiaries exhibiting the following char- ships. Federal Reserve staff and the IDI regu- acteristics: lators generally may participate on each oth- • CAMELS Composite 1 or 2; • low or moderate risk profiles; 30. For the purpose of this guidance, “IDI regulator” is • stable financial condition; defined as the prudential bank regulator(s) other than the Federal Reserve, which includes the Federal Deposit Insur- 32. The Federal Reserve distinguishes between complex ance Corporation, the Office of the Comptroller of the Cur- and noncomplex holding companies by evaluating a number rency, and the state banking supervisory authorities. of factors, including: the size and structure of the company; 31. “[A]ll bank holding companies{with total consolidated the extent of intercompany transactions between IDI subsidi- assets of less than $50 billion” includes by definition any U.S. aries and the holding company or its non-depository subsidi- bank holding company with total consolidated assets of less aries; the risk, scale, and complexity of activities of any than $50 billion that is owned or controlled by a foreign non-depository subsidiaries; and the degree of leverage at the banking organization. holding company, including the extent of debt outstanding to the public. Companies are also designated “complex” if mate- BHC Supervision Manual July 2016 rial risk management processes for the holding company and Page 18 its affiliates are consolidated at the parent company. Consolidated Supervision of Regional BHCs 1050.2

• satisfactory management practices and an company’s complexity, risk, condition of the associated satisfactory management com- consolidated organization, and timeliness of ponent rating; and information available from the IDI regulator. • IDI regulator examination reports issued For example, a holding company with the within the past year. following characteristics is a candidate for In these situations, the Federal Reserve closer Federal Reserve supervision to ensure expects to limit its supervisory work to verify the conclusions reached by the IDI regulators that the holding company can serve as a remain a valid basis for assigning the super- source of strength to, and the non-bank sub- visory ratings to the consolidated holding sidiaries do not pose a threat to, the safety company: and soundness of the IDI(s). Thus, Federal • the IDI examination reports are not cur- Reserve staff will likely need to perform only rent;33 limited analysis outside of the required annual • the composite rating for the holding com- on-site holding company inspection of the pany or any of its IDI subsidiaries is less parent and nonbank subsidiaries. In addition, than satisfactory; or this analysis will be supplemented by the • the holding company has deteriorating finan- Federal Reserve’s continuous monitoring cial or risk trends that are not reflected in process. the most current IDI regulators’ examina- In other situations, the Federal Reserve will tion reports. scale its supervisory approach, including per- 5. If Federal Reserve staff do not have an ad- forming more detailed monitoring of a con- equate basis for relying on the IDI regula- solidated holding company’s internal man- tors’ supervisory findings, the Federal Reserve agement information systems, internal audit, will work to resolve information gaps with and loan review reports, depending on the the IDI regulators.34

33. For the purpose of this guidance, RBO IDI examina- tion reports that are not current are defined as reports older than one year, measured from the mailing date of a IDI regulator’s report to the start date of the Federal Reserve supervisory evaluation. 34. In rare and limited circumstances, where unresolved information gaps exist or reliance upon information obtained from the IDI regulators does not sufficiently support the Federal Reserve’s supervision of a consolidated holding com- pany, the Federal Reserve would consider invoking its expanded examination authority under section 5(c)(2) of the BHC Act and section 10(b)(4) of the HOLA, as amended by section 604 of the Dodd-Frank Act, to examine IDIs for which the Federal Reserve is not the primary regulator. 12 U.S.C. 1844(c)(2); 12 U.S.C. 1467a(b)(4).

BHC Supervision Manual July 2016 Page 19 Large Financial Institution Rating System Section 1060.0

1060.0.1 OVERVIEW AND • U.S. intermediate holding companies of for- APPLICABILITY eign banking organizations with combined U.S. assets of $50 billion or more established Each large financial institution (LFI) is expected pursuant to the Federal Reserve’s Regula- to ensure that the consolidated organization (or tion YY.5 the combined U.S. operations in the case of foreign banking organizations), including its The Federal Reserve will assign initial LFI critical operations and banking offices, remain ratings to firms in the LISCC portfolio in safe and sound and in compliance with laws and early 2019. For all other firms subject to the LFI regulations, including those related to consumer rating system, the Federal Reserve will assign protection.1 On November 21, 2018, the Board initial LFI ratings in early 2020. adopted a specific rating system for LFIs in Federal Reserve supervision staff will con- order to align with the Federal Reserve’s super- tinue to use the RFI rating system in assessing visory programs and practices for these firms.2 bank holding companies with less than $100 bil- The LFI rating system provides a supervisory lion in consolidated assets. For noncomplex evaluation of whether a covered firm possesses holding companies with less than $3 billion in sufficient financial and operational strength and assets, Reserve Bank supervisory staff will as- resilience to maintain safe-and-sound operations sign only a composite RFI rating and risk- through a range of conditions, including stress- management rating to the firm following an ful ones.3 inspection.

The LFI rating system applies to: The LFI rating system is designed to:

• bank holding companies with total consoli- • Fully align with the Federal Reserve’s current dated assets of $100 billion or more; supervisory programs and practices, which are • all non-insurance, non-commercial savings based upon the LFI supervision framework’s and loan holding companies with total con- core objectives of reducing the probability of solidated assets of $100 billion or more;4 and LFIs failing or experiencing material distress and reducing the risk to U.S. financial stabil- ity; 1. See SR letter 12-17/CA letter 12-14, “Consolidated Supervisory Framework for Large Financial Institutions.” • Enhance the clarity and consistency of super- Hereinafter, when “safe and sound” or “safety and soundness” visory assessments and communications of is used in this framework, related expectations apply to the supervisory findings and implications; and consolidated organization and the firm’s critical operations • Provide transparency related to the supervi- and banking offices. “Critical operations” are a firm’s opera- tions, including associated services, functions and support, the sory consequences of a given rating. failure or discontinuance of which, in the view of the firm or the Federal Reserve, would pose a threat to the financial assets or total revenues from activities that are not financial in stability of the United States. “Banking offices” are defined as nature under section 4(k) of the Bank Holding Company Act U.S. depository institution subsidiaries, as well as the U.S. of 1956, as amended (12 USC 1843(k)). SLHCs are consid- branches and agencies of foreign banking organizations. ered to be engaged in significant insurance underwriting 2. See 83 Fed. Reg. 58,724 (November 21, 2018) and activities if they are either insurance companies or hold 84 Fed. Reg. 4309 (February 15, 2019). The final rule is 25 percent or more of their total consolidated assets in subsid- effective on February 1, 2019. iaries that are insurance companies. SLHCs that meet these 3. “Financial strength and resilience” is defined as main- criteria are excluded from the definition of “covered savings taining effective capital and liquidity governance and plan- and loan holding company” in section 217.2 of the Board’s ning processes, and sufficiency of related positions, to provide Regulation Q. See 12 CFR 217.2. for the continuity of the consolidated organization (including 5. Total consolidated assets will be calculated based on the its critical operations and banking offices) through a range of average of the firm’s total consolidated assets in the four most conditions. recent quarters as reported on the firm’s quarterly financial “Operational strength and resilience” is defined as main- reports filed with the Federal Reserve. A firm will continue to taining effective governance and controls to provide for the be rated under the LFI rating system until it has less than continuity of the consolidated organization (including its criti- $95 billion in total consolidated assets, based on the average cal operations and banking offices) and to promote compli- total consolidated assets as reported on the firm’s four most ance with laws and regulations, including those related to recent quarterly financial reports filed with the Federal Reserve. consumer protection, through a range of conditions. The Federal Reserve may determine to apply the RFI rating References to “financial or operational” weaknesses or system or another applicable rating system in certain limited deficiencies implicate a firm’s financial or operational strength circumstances. and resilience. 4. Savings and loan holding companies (SLHCs) are con- sidered to be engaged in significant commercial activities if BHC Supervision Manual February 2019 they derive 50 percent or more of their total consolidated Page 1 Large Financial Institution Rating System 1060.0

The LFI rating system is comprised of three ing effective and independent risk- components: management and control functions, includ- ing internal audit; promoting compliance — Capital Planning and Positions: an evalu- with laws and regulations, including those ation of (1) the effectiveness of a firm’s related to consumer protection; and other- governance and planning processes used wise planning for the ongoing resiliency to determine the amount of capital neces- of the firm.9 sary to cover risks and exposures, and to support activities through a range of con- ditions and events; and (2) the sufficiency 1060.0.2 ASSIGNMENT OF THE LFI of a firm’s capital positions to comply COMPONENT RATINGS with applicable regulatory requirements and to support the firm’s ability to con- Each LFI component rating is assigned along a tinue to serve as a financial intermediary four-level scale: through a range of conditions. — Liquidity Risk Management and Positions: • Broadly Meets Expectations: A firm’s prac- an evaluation of (1) the effectiveness of a tices and capabilities broadly meet supervi- firm’s governance and risk-management sory expectations, and the firm possesses suf- processes used to determine the amount of ficient financial and operational strength and liquidity necessary to cover risks and ex- resilience to maintain safe-and-sound opera- posures, and to support activities through tions through a range of conditions. The firm a range of conditions; and (2) the suffi- may be subject to identified supervisory issues ciency of a firm’s liquidity positions to requiring corrective action. These issues are comply with applicable regulatory require- unlikely to present a threat to the firm’s ability ments and to support the firm’s ongoing to maintain safe-and-sound operations through obligations through a range of conditions. a range of conditions. — Governance and Controls: an evaluation • Conditionally Meets Expectations: Certain, of the effectiveness of a firm’s (1) board material financial or operational weaknesses of directors,6 (2) management of business in a firm’s practices or capabilities may place lines and independent risk management the firm’s prospects for remaining safe and and controls,7 and (3) recovery planning sound through a range of conditions at risk if (only for domestic firms that are subject to not resolved in a timely manner during the the Board’s Large Institution Supervision normal course of business. Coordinating Committee (LISCC) Frame- The Federal Reserve does not intend for a work).8 This rating assesses a firm’s effec- firm to be assigned a “Conditionally Meets tiveness in aligning strategic business ob- Expectations” rating for a prolonged period, jectives with the firm’s risk appetite and and will work with the firm to develop an risk-management capabilities; maintain- appropriate timeframe to fully resolve the issues leading to the rating assignment and 6. References to “board” or “board of directors” in this merit upgrade to a “Broadly Meets Expecta- framework includes the equivalent to a board of directors, as tions” rating. appropriate, as well as committees of the board of directors or A firm is assigned a “Conditionally Meets the equivalent thereof, as appropriate. At this time, recovery planning expectations only apply to Expectations” rating-as opposed to a “Defi- domestic bank holding companies subject to the Federal cient” rating-when it has the ability to resolve Reserve’s LISCC supervisory framework. Should the Federal these issues through measures that do not Reserve expand the scope of recovery planning expectations require a material change to the firm’s busi- to encompass additional firms, this rating will reflect such expectations for the broader set of firms. ness model or financial profile, or its gover- 7. The evaluation of the effectiveness of management of nance, risk management or internal control business lines would include management of critical opera- structures or practices. Failure to resolve the tions. issues in a timely manner would most likely 8. There are eight domestic firms in the LISCC portfolio: (1) Bank of America Corporation; (2) Bank of New York result in the firm’s downgrade to a “Defi- Mellon Corporation; (3) Citigroup, Inc.; (4) Goldman Sachs cient” rating, since the inability to resolve the Group, Inc.; (5) JP Morgan Chase & Co.; (6) Morgan Stanley; issues would indicate that the firm does not (7) State Street Corporation; and (8) Wells Fargo & Company. In this guidance, these eight firms may collectively be referred 9. “Risk appetite” is defined as the aggregate level and to as “domestic LISCC firms.” types of risk the board and senior management are willing to assume to achieve the firm’s strategic business objectives, BHC Supervision Manual February 2019 consistent with applicable capital, liquidity, and other require- Page 2 ments and constraints. Large Financial Institution Rating System 1060.0

possess sufficient financial or operational ca- with this rating to engage in new or expan- pabilities to maintain its safety and soundness sionary activities. through a range of conditions. It is recognized that completion and valida- The Federal Reserve will take into account a tion of remediation activities for select super- number of individual elements of a firm’s prac- visory issues-such as those involving infor- tices, capabilities, and performance when mak- mation technology modifications-may require ing each component rating assignment. The an extended time horizon. In all instances, weighting of an individual element in assigning appropriate and effective risk-mitigation tech- a component rating will depend on its impact on niques must be utilized in the interim to main- the firm’s safety, soundness, and resilience as tain safe-and-sound operations under a range provided for in the LFI rating system defini- of conditions until remediation activities are tions. For example, for purposes of the Gover- completed, validated, and fully operational. nance and Controls rating, a limited number of significant deficiencies-or even just one signifi- • Deficient-1: Financial or operational deficien- cant deficiency-noted for management of a single cies in a firm’s practices or capabilities put the material business line could be viewed as suffi- firm’s prospects for remaining safe and sound ciently important to warrant a “Deficient-1” for through a range of conditions at significant the Governance and Controls component rating, risk. The firm is unable to remediate these even if the firm meets supervisory expectations deficiencies in the normal course of business, under the Governance and Controls component and remediation would typically require the in all other respects. firm to make a material change to its business Under the LFI rating system, a firm must be model or financial profile, or its practices or rated “Broadly Meets Expectations” or “Condi- capabilities. tionally Meets Expectations” for each of the A firm’s failure to resolve the issues in a three component ratings (Capital, Liquidity, Gov- timely manner that gave rise to a “Condition- ernance and Controls) to be considered “well ally Meets Expectations” rating would most managed” in accordance with various statutes likely result in its downgrade to a “Deficient” and regulations.10 A “well managed” firm has rating. sufficient financial and operational strength and A firm with a “Deficient-1” rating is re- resilience to maintain safe-and-sound operations quired to take timely corrective action to cor- through a range of conditions, including stress- rect financial or operational deficiencies and ful ones. to restore and maintain its safety and sound- ness and compliance with laws and regula- tions, including those related to consumer protection. There is a strong presumption that 1060.0.3 LFI RATING COMPONENTS a firm with a “Deficient-1” rating will be subject to an informal or formal enforcement The LFI rating system is comprised of three action, and this rating assignment could be a component ratings: (1) capital planning and barrier for a firm seeking Federal Reserve positions, (2) liquidity risk management and approval to engage in new or expansionary positions, and (3) governance and controls.11 activities.

• Deficient-2: Financial or operational deficien- cies in a firm’s practices or capabilities pres- ent a threat to the firm’s safety and soundness, or have already put the firm in an unsafe and unsound condition. 10. 12 USC 1841 et. seq. and 12 USC 1461 et seq. See, A firm with a “Deficient-2” rating is re- e.g., 12 CFR 225.4(b)(6), 225.14, 225.22(a), 225.23, 225.85, quired to immediately implement comprehen- and 225.86; 12 CFR 211.9(b), 211.10(a)(14), and 211.34; and 12 CFR 223.41. sive corrective measures, and demonstrate the 11. There may be instances where deficiencies or supervi- sufficiency of contingency planning in the sory issues may be relevant to the Federal Reserve’s assess- event of further deterioration. There is a strong ment of more than one component area. As such, the LFI presumption that a firm with a “Deficient-2” rating will reflect these deficiencies or issues within multiple rating components when necessary to provide a comprehen- rating will be subject to a formal enforcement sive supervisory assessment. action, and the Federal Reserve would be unlikely to approve any proposal from a firm BHC Supervision Manual February 2019 Page 3 Large Financial Institution Rating System 1060.0

1060.0.3.1 Capital Planning and Positions through a range of conditions. Component Rating A firm rated “Broadly Meets Expectations” The Capital Planning and Positions component may be subject to identified supervisory issues rating evaluates (1) the effectiveness of a firm’s requiring corrective action. However, these issues governance and planning processes used to deter- are unlikely to present a threat to the firm’s mine the amount of capital necessary to cover ability to maintain safe-and-sound operations risks and exposures, and to support activities through a range of potentially stressful condi- through a range of conditions; and (2) the suffi- tions. ciency of a firm’s capital positions to comply A firm that does not meet the capital planning with applicable regulatory requirements and to and position expectations associated with a support the firm’s ability to continue to serve as “Broadly Meets Expectations” rating will be a financial intermediary through a range of con- rated “Conditionally Meets Expectations,” ditions. “Deficient-1,” or “Deficient-2,” and subject to potential consequences as outlined below. In developing this rating, the Federal Reserve evaluates: Conditionally Meets Expectations

• Capital Planning: The extent to which a firm Certain material financial or operational weak- maintains sound capital planning practices nesses in a firm’s capital planning or positions through effective governance and oversight; may place the firm’s prospects for remaining effective risk management and controls; main- safe and sound through a range of conditions at tenance of updated capital policies and contin- risk if not resolved in a timely manner during gency plans for addressing potential short- the normal course of business. falls; and incorporation of appropriately stressful conditions into capital planning and Specifically, if left unresolved, these weak- projections of capital positions; and nesses: • Capital Positions: The extent to which a firm’s capital is sufficient to comply with • May threaten the firm’s ability to produce regulatory requirements, and to support its sound assessments of capital adequacy through ability to meet its obligations to depositors, a range of conditions; and/or creditors, and other counterparties and con- • May result in the firm’s projected capital posi- tinuetoserveasafinancialintermediarythrough tions being insufficient to absorb potential a range of conditions. losses, comply with regulatory requirements, and support the firm’s ability to meet current and prospective obligations and to continue to 1060.0.3.1.1 Definitions for the Capital serve as a financial intermediary through a Planning and Positions Component range of conditions. Rating The Federal Reserve does not intend for a Broadly Meets Expectations firm to be rated “Conditionally Meets Expecta- tions” for a prolonged period. The firm has the A firm’s capital planning and positions broadly ability to resolve these issues through measures meet supervisory expectations and support main- that do not require a material change to the tenance of safe-and-sound operations. Specifi- firm’s business model or financial profile, or its cally: governance, risk management, or internal con- trol structures or practices. The Federal Reserve • The firm is capable of producing sound assess- will work with the firm to develop an appropri- ments of capital adequacy through a range of ate timeframe during which the firm would be conditions; and required to resolve each supervisory issue lead- • The firm’s current and projected capital posi- ing to the “Conditionally Meets Expectations” tions comply with regulatory requirements, rating. and support its ability to absorb current and The Federal Reserve will closely monitor the potential losses, to meet obligations, and to firm’s remediation and mitigation activities; in continue to serve as a financial intermediary most instances, the firm will either:

BHC Supervision Manual February 2019 1. Resolve the issues in a timely manner and, Page 4 if no new material supervisory issues arise, Large Financial Institution Rating System 1060.0

be upgraded to a “Broadly Meets Expecta- tively assess capital adequacy through a range tions” rating because the firm’s capital plan- of conditions; and/or ning practices and related positions would • The firm’s projected capital positions may be broadly meet supervisory expectations; or insufficient to absorb potential losses and to 2. Fail to resolve the issues in a timely manner support its ability to meet current and prospec- and be downgraded to a “Deficient-1” rat- tive obligations and serve as a financial inter- ing, because the inability to resolve the mediary through a range of conditions. issues would indicate that the firm does not possess sufficient financial or operational Supervisory issues that place the firm’s safety capabilities to maintain its safety and sound- and soundness at significant risk, and where ness through a range of conditions. resolution is likely to require steps that clearly go beyond the normal course of business-such It is possible that a firm may be close to as issues requiring a material change to the completing resolution of the supervisory issues firm’s business model or financial profile, or its leading to the “Conditionally Meets Expecta- governance, risk management or internal con- tions” rating, but new issues are identified that, trol structures or practices-would generally war- taken alone, would be consistent with a “Condi- rant assignment of a “Deficient-1” rating. tionally Meets Expectations” rating. In this event, A “Deficient-1” rating may be assigned to a the firm may continue to be rated “Condition- firm regardless of its prior rating. A firm previ- ally Meets Expectations,” provided the new ously rated “Broadly Meets Expectations” may issues do not reflect a pattern of deeper or be downgraded to “Deficient-1” when supervi- prolonged capital planning or position weak- sory issues are identified that place the firm’s nesses consistent with a “Deficient” rating. prospects for maintaining safe-and-sound opera- A “Conditionally Meets Expectations” rating tions through a range of potentially stressful may be assigned to a firm that meets the above conditions at significant risk. A firm previously definition regardless of its prior rating. A firm rated “Conditionally Meets Expectations” may previously rated “Deficient-1” may be upgraded be downgraded to “Deficient-1” when the firm’s to “Conditionally Meets Expectations” if the inability to resolve supervisory issues in a timely firm’s remediation and mitigation activities are manner indicates that the firm does not possess sufficiently advanced so that the firm’s pros- sufficient financial or operational capabilities to pects for remaining safe and sound are no lon- maintain its safety and soundness through a ger at significant risk, even if the firm has out- range of conditions. standing supervisory issues or is subject to an To address these financial or operational defi- active enforcement action. ciencies, the firm is required to take timely corrective action to restore and maintain its Deficient-1 capital planning and positions consistent with supervisory expectations. There is a strong pre- Financial or operational deficiencies in a firm’s sumption that a firm rated “Deficient-1” will be capital planning or positions put the firm’s pros- subject to an informal or formal enforcement pects for remaining safe and sound through a action by the Federal Reserve. range of conditions at significant risk. The firm A firm rated “Deficient-1” for any rating com- is unable to remediate these deficiencies in the ponent would not be considered “well man- normal course of business, and remediation aged,” which would subject the firm to various would typically require a material change to the consequences. A “Deficient-1” rating could be a firm’s business model or financial profile, or its barrier for a firm seeking Federal Reserve ap- capital planning practices. proval of a proposal to engage in new or expan- sionary activities, unless the firm can demon- Specifically, although the firm’s current condi- strate that (1) it is making meaningful, sustained tion is not considered to be materially threat- progress in resolving identified deficiencies and ened: issues; (2) the proposed new or expansionary activities would not present a risk of exacerbat- • Deficiencies in the firm’s capital planning pro- ing current deficiencies or issues or lead to new cesses are not effectively mitigated. These concerns; and (3) the proposed activities would deficiencies limit the firm’s ability to effec- not distract the firm from remediating current deficiencies or issues.

BHC Supervision Manual February 2019 Page 5 Large Financial Institution Rating System 1060.0

Deficient-2 In developing this rating, the Federal Reserve evaluates: Financial or operational deficiencies in a firm’s capital planning or positions present a threat to • Liquidity Risk Management: The extent to the firm’s safety and soundness, or have already which a firm maintains sound liquidity-risk put the firm in an unsafe and unsound condition. management practices through effective gov- ernance and oversight; effective risk manage- Specifically, as a result of these deficiencies: ment and controls; maintenance of updated liquidity policies and contingency plans for • The firm’s capital planning processes are insuf- addressing potential shortfalls; and incorpora- ficient to effectively assess the firm’s capital tion of appropriately stressful conditions into adequacy through a range of conditions; and/or liquidity planning and projections of liquidity • The firm’s current or projected capital posi- positions; and tions are insufficient to absorb current or • Liquidity Positions: The extent to which a potential losses, and to support the firm’s abil- firm’s liquidity is sufficient to comply with ity to meet current and prospective obliga- regulatory requirements, and to support its tions and serve as a financial intermediary ability to meet current and prospective obliga- through a range of conditions. tions to depositors, creditors and other coun- terparties through a range of conditions. To address these deficiencies, the firm is required to immediately (1) implement compre- hensive corrective measures sufficient to restore 1060.0.3.2.1 Definitions for the Liquidity and maintain appropriate capital planning capa- Risk Management and Positions bilities and adequate capital positions; and Component Rating (2) demonstrate the sufficiency, credibility and readiness of contingency planning in the event Broadly Meets Expectations of further deterioration of the firm’s financial or operational strength or resiliency. There is a A firm’s liquidity risk management and posi- strong presumption that a firm rated “Defi- tions broadly meet supervisory expectations and cient-2” will be subject to a formal enforcement support maintenance of safe-and-sound opera- action by the Federal Reserve. tions. Specifically: A firm rated “Deficient-2” for any rating com- ponent would not be considered “well man- • The firm is capable of producing sound assess- aged,” which would subject the firm to various ments of liquidity adequacy through a range consequences. The Federal Reserve would be of conditions; and unlikely to approve any proposal from a firm • The firm’s current and projected liquidity rated “Deficient-2” to engage in new or expan- positions comply with regulatory require- sionary activities. ments, and support its ability to meet current and prospective obligations and to continue to serve as a financial intermediary through a range of conditions. 1060.0.3.2 Liquidity Risk Management and Positions Component Rating A firm rated “Broadly Meets Expectations” may be subject to identified supervisory issues The Liquidity Risk Management and Positions requiring corrective action. However, these issues component rating evaluates (1) the effectiveness are unlikely to present a threat to the firm’s of a firm’s governance and risk-management ability to maintain safe-and-sound operations processes used to determine the amount of liquid- through a range of potentially stressful condi- ity necessary to cover risks and exposures, and tions. to support activities through a range of condi- A firm that does not meet the liquidity risk tions; and (2) the sufficiency of a firm’s liquidity management and position expectations associ- positions to comply with applicable regulatory ated with a “Broadly Meets Expectations” rating requirements and to support the firm’s ongoing will be rated “Conditionally Meets Expecta- obligations through a range of conditions. tions,” “Deficient-1,” or “Deficient-2,” and sub- ject to potential consequences as outlined below.

BHC Supervision Manual February 2019 Conditionally Meets Expectations Page 6 Large Financial Institution Rating System 1060.0

Certain material financial or operational weak- tionally Meets Expectations” rating. In this event, nesses in a firm’s liquidity risk management or the firm may continue to be rated “Condition- positions may place the firm’s prospects for ally Meets Expectations,” provided the new remaining safe and sound through a range of issues do not reflect a pattern of deeper or conditions at risk if not resolved in a timely prolonged liquidity-risk management and posi- manner during the normal course of business. tions weaknesses consistent with a “Deficient” rating. Specifically, if left unresolved, these weak- A “Conditionally Meets Expectations” rating nesses: may be assigned to a firm that meets the above definition regardless of its prior rating. A firm • May threaten the firm’s ability to produce previously rated “Deficient-1” may be upgraded sound assessments of liquidity adequacy to “Conditionally Meets Expectations” if the through a range of conditions; and/or firm’s remediation and mitigation activities are • May result in the firm’s projected liquidity sufficiently advanced so that the firm’s pros- positions being insufficient to comply with pects for remaining safe and sound are no lon- regulatory requirements, and support its abil- ger at significant risk, even if the firm has out- ity to meet current and prospective obliga- standing supervisory issues or is subject to an tions and to continue to serve as a financial active enforcement action. intermediary through a range of conditions. Deficient-1 The Federal Reserve does not intend for a firm to be rated “Conditionally Meets Expecta- Financial or operational deficiencies in a firm’s tions” for a prolonged period. The firm has the liquidity risk management or positions put the ability to resolve these issues through measures firm’s prospects for remaining safe and sound that do not require a material change to the through a range of conditions at significant risk. firm’s business model or financial profile, or its The firm is unable to remediate these deficien- governance, risk management or internal con- cies in the normal course of business, and reme- trol structures or practices. The Federal Reserve diation would typically require a material change will work with the firm to develop an appropri- to the firm’s business model or financial profile, ate timeframe during which the firm would be or its liquidity risk-management practices. required to resolve each supervisory issue lead- ing to the “Conditionally Meets Expectations” Specifically, although the firm’s current condi- rating. tion is not considered to be materially threat- ened: The Federal Reserve will closely monitor the firm’s remediation and mitigation activities; in • Deficiencies in the firm’s liquidity risk- most instances, the firm will either: management processes are not effectively miti- gated. These deficiencies limit the firm’s abil- 1. Resolve the issues in a timely manner and, if ity to effectively assess liquidity adequacy no new material supervisory issues arise, and through a range of conditions; and/or be upgraded to a “Broadly Meets Expecta- • The firm’s projected liquidity positions may tions” rating because the firm’s liquidity risk- be insufficient to support its ability to meet management practices and related positions prospective obligations and serve as a finan- would broadly meet supervisory expecta- cial intermediary through a range of condi- tions; or tions. 2. Fail to resolve the issues in a timely manner and be downgraded to a “Deficient-1” rating, Supervisory issues that place the firm’s safety because the firm’s inability to resolve those and soundness at significant risk, and where issues would indicate that the firm does not resolution is likely to require steps that clearly possess sufficient financial or operational ca- go beyond the normal course of business-such pabilities to maintain its safety and sound- as issues requiring a material change to the ness through a range of conditions. firm’s business model or financial profile, or its governance, risk management or internal con- It is possible that a firm may be close to trol structures or practices-would generally war- completing resolution of the supervisory issues rant assignment of a “Deficient-1” rating. leading to the “Conditionally Meets Expecta- tions” rating, but new issues are identified that, BHC Supervision Manual February 2019 taken alone, would be consistent with a “Condi- Page 7 Large Financial Institution Rating System 1060.0

A “Deficient-1” rating may be assigned to a ability to meet current and prospective obliga- firm regardless of its prior rating. A firm previ- tions and serve as a financial intermediary ously rated “Broadly Meets Expectations” may through a range of conditions. be downgraded to “Deficient-1” when supervi- sory issues are identified that place the firm’s To address these deficiencies, the firm is prospects for maintaining safe-and-sound opera- required to immediately (1) implement compre- tions through a range of potentially stressful hensive corrective measures sufficient to restore conditions at significant risk. A firm previously and maintain appropriate liquidity risk manage- rated “Conditionally Meets Expectations” may ment capabilities and adequate liquidity posi- be downgraded to “Deficient-1” when the firm’s tions; and (2) demonstrate the sufficiency, cred- inability to resolve supervisory issues in a timely ibility and readiness of contingency planning in manner indicates that the firm does not possess the event of further deterioration of the firm’s sufficient financial or operational capabilities to financial or operational strength or resiliency. maintain its safety and soundness through a There is a strong presumption that a firm rated range of conditions. “Deficient-2” will be subject to a formal enforce- To address these financial or operational defi- ment action by the Federal Reserve. ciencies, the firm is required to take timely A firm rated “Deficient-2” for any rating com- corrective action to restore and maintain its ponent would not be considered “well man- liquidity risk management and positions consis- aged,” which would subject the firm to various tent with supervisory expectations. There is a consequences. The Federal Reserve would be strong presumption that a firm rated “Defi- unlikely to approve any proposal from a firm cient-1” will be subject to an informal or formal rated “Deficient-2” to engage in new or expan- enforcement action by the Federal Reserve. sionary activities. A firm rated “Deficient-1” for any rating com- ponent would not be considered “well man- aged,” which would subject the firm to various 1060.0.3.3 Governance and Controls consequences. A “Deficient-1” rating could be a Component Rating barrier for a firm seeking Federal Reserve ap- proval of a proposal to engage in new or expan- The Governance and Controls component rating sionary activities, unless the firm can demon- evaluates the effectiveness of a firm’s (1) board strate that (1) it is making meaningful, sustained of directors, (2) management of business lines progress in resolving identified deficiencies and and independent risk management and controls, issues; (2) the proposed new or expansionary and (3) recovery planning (for domestic LISCC activities would not present a risk of exacerbat- firms only). This rating assesses a firm’s effec- ing current deficiencies or issues or lead to new tiveness in aligning strategic business objectives concerns; and (3) the proposed activities would with the firm’s risk appetite and risk manage- not distract the firm from remediating current ment capabilities; maintaining effective and in- deficiencies or issues. dependent risk management and control func- tions, including internal audit; promoting Deficient-2 compliance with laws and regulations, including those related to consumer protection; and other- Financial or operational deficiencies in a firm’s wise providing for the ongoing resiliency of the liquidity risk management or positions present a firm. threat to the firm’s safety and soundness, or have already put the firm in an unsafe and In developing this rating, the Federal Reserve unsound condition. evaluates:

Specifically, as a result of these deficiencies: • Effectiveness of the Board of Directors: The extent to which the board exhibits attributes • The firm’s liquidity risk-management pro- that are consistent with those of effective cesses are insufficient to effectively assess the boards in carrying out its core roles and respon- firm’s liquidity adequacy through a range of sibilities, including: (1) setting a clear, aligned, conditions; and/or and consistent direction regarding the firm’s • The firm’s current or projected liquidity posi- strategy and risk appetite; (2) directing senior tions are insufficient to support the firm’s management regarding the board’s informa- tion; (3) overseeing and holding senior man- BHC Supervision Manual February 2019 agement accountable, (4) supporting the inde- Page 8 pendence and stature of independent risk Large Financial Institution Rating System 1060.0

management and internal audit; and (5) main- nance of safe-and-sound operations. taining a capable board composition and gov- Specifically, the firm’s practices and capabili- ernance structure. ties are sufficient to align strategic business • Management of Business Lines and Indepen- objectives with its risk appetite and risk- dent Risk Management and Controls management capabilities,12 maintain effective The extent to which: and independent risk management and control — Senior management effectively and pru- functions, including internal audit; promote com- dently manages the day-to-day operations pliance with laws and regulations (including of the firm and provides for ongoing resil- those related to consumer protection); and other- iency; implements the firm’s strategy and wise provide for the firm’s ongoing financial risk appetite; maintains an effective risk- and operational resiliency through a range of management framework and system of conditions. internal controls; and promotes prudent A firm rated “Broadly Meets Expectations” risk-taking behaviors and business prac- may be subject to identified supervisory issues tices, including compliance with laws and requiring corrective action. However, these issues regulations, including those related to con- are unlikely to present a threat to the firm’s sumer protection. ability to maintain safe-and-sound operations — Business line management executes busi- through a range of potentially stressful condi- ness line activities consistent with the tions. firm’s strategy and risk appetite; identifies A firm that does not meet supervisory expec- and manages risks; and ensures an effec- tations associated with a “Broadly Meets Expec- tive system of internal controls for its tations” rating will be rated “Conditionally Meets operations. Expectations,” “Deficient-1,” or “Deficient-2,” — Independent risk management effectively and subject to potential consequences, as out- evaluates whether the firm’s risk appetite lined below. appropriately captures material risks and is consistent with the firm’s risk manage- Conditionally Meets Expectations ment capacity; establishes and monitors risk limits that are consistent with the Certain material financial or operational weak- firm’s risk appetite; identifies and mea- nesses in a firm’s governance and controls prac- sures the firm’s risks; and aggregates, tices may place the firm’s prospects for remain- assesses and reports on the firm’s risk ing safe and sound through a range of conditions profile and positions. Additionally, the at risk if not resolved in a timely manner during firm demonstrates that its internal con- the normal course of business. trols are appropriate and tested for effec- Specifically, if left unresolved, these weak- tiveness. Finally, internal audit effectively nesses may threaten the firm’s ability to align and independently assesses the firm’s risk- strategic business objectives with the firm’s risk management framework and internal con- appetite and risk-management capabilities; main- trol systems, and reports findings to senior tain effective and independent risk management management and the firm’s audit commit- and control functions, including internal audit; tee. promote compliance with laws and regulations • Recovery Planning (domestic LISCC firms (including those related to consumer protec- only): The extent to which recovery planning tion); or otherwise provide for the firm’s ongo- processes effectively identify options that pro- ing resiliency through a range of conditions. vide a reasonable chance of a firm being able The Federal Reserve does not intend for a to remedy financial weakness and restore mar- firm to be rated “Conditionally Meets Expecta- ket confidence without extraordinary official tions” for a prolonged period. The firm has the sector support. ability to resolve these issues through measures that do not require a material change to the firm’s business model or financial profile, or its 1060.0.3.3.1 Definitions for the governance, risk management or internal con- Governance and Controls Component Rating 12. References to risk-management capabilities includes risk management of business lines and independent risk man- Broadly Meets Expectations agement and control functions, including internal audit.

A firm’s governance and controls broadly meet BHC Supervision Manual February 2019 supervisory expectations and support mainte- Page 9 Large Financial Institution Rating System 1060.0 trol structures or practices. The Federal Reserve normal course of business, and remediation will work with the firm to develop an appropri- would typically require a material change to the ate timeframe during which the firm would be firm’s business model or financial profile, or its required to resolve each supervisory issue lead- governance, risk management or internal con- ing to the “Conditionally Meets Expectations” trol structures or practices. rating. Specifically, although the firm’s current con- dition is not considered to be materially threat- The Federal Reserve will closely monitor the ened, these deficiencies limit the firm’s ability firm’s remediation and mitigation activities; in to align strategic business objectives with its most instances, the firm will either: risk appetite and risk-management capabilities; maintain effective and independent risk manage- 1. Resolve the issues in a timely manner and, if ment and control functions, including internal no new material supervisory issues arise, be audit; promote compliance with laws and regu- upgraded to a “Broadly Meets Expectations” lations (including those related to consumer pro- rating because the firm’s governance and tection); or otherwise provide for the firm’s controls would broadly meet supervisory ex- ongoing resiliency through a range of condi- pectations; or tions. 2. Fail to resolve the issues in a timely manner A “Deficient-1” rating may be assigned to a and be downgraded to a “Deficient-1” rating, firm regardless of its prior rating. A firm previ- because the firm’s inability to resolve those ously rated “Broadly Meets Expectations” may issues would indicate that the firm does not be downgraded to “Deficient-1” when supervi- possess sufficient financial or operational ca- sory issues are identified that place the firm’s pabilities to maintain its safety and sound- prospects for maintaining safe-and-sound opera- ness through a range of conditions. tions through a range of potentially stressful conditions at significant risk. A firm previously It is possible that a firm may be close to rated “Conditionally Meets Expectations” may completing resolution of the supervisory issues be downgraded to “Deficient-1” when the firm’s leading to the “Conditionally Meets Expecta- inability to resolve supervisory issues in a timely tions” rating, but new issues are identified that, manner indicates that the firm does not possess taken alone, would be consistent with a “Condi- sufficient financial or operational capabilities to tionally Meets Expectations” rating. In this event, maintain its safety and soundness through a the firm may continue to be rated “Condition- range of conditions. ally Meets Expectations,” provided the new To address these financial or operational defi- issues do not reflect a pattern of deeper or ciencies, the firm is required to take timely prolonged governance and controls weaknesses corrective action to restore and maintain its gov- consistent with a “Deficient” rating. ernance and controls consistent with supervi- A “Conditionally Meets Expectations” rating sory expectations. There is a strong presumption may be assigned to a firm that meets the above that a firm rated “Deficient-1” will be subject to definition regardless of its prior rating. A firm an informal or formal enforcement action by the previously rated “Deficient” may be upgraded to Federal Reserve. “Conditionally Meets Expectations” if the firm’s A firm rated “Deficient-1” for any rating com- remediation and mitigation activities are suffi- ponent would not be considered “well man- ciently advanced so that the firm’s prospects for aged,” which would subject the firm to various remaining safe and sound are no longer at sig- consequences. A “Deficient-1” rating could be a nificant risk, even if the firm has outstanding barrier for a firm seeking Federal Reserve ap- supervisory issues or is subject to an active proval of a proposal to engage in new or expan- enforcement action. sionary activities, unless the firm can demon- strate that (1) it is making meaningful, sustained Deficient-1 progress in resolving identified deficiencies and issues; (2) the proposed new or expansionary Financial or operational deficiencies in a firm’s activities would not present a risk of exacerbat- governance and controls put the firm’s pros- ing current deficiencies or issues or lead to new pects for remaining safe and sound through a concerns; and (3) the proposed activities would range of conditions at significant risk. The firm not distract the firm from remediating current is unable to remediate these deficiencies in the deficiencies or issues.

BHC Supervision Manual February 2019 Page 10 Large Financial Institution Rating System 1060.0

Deficient-2 A firm rated “Deficient-2” for any rating com- ponent would not be considered “well man- Financial or operational deficiencies in gover- aged,” which would subject the firm to various nance or controls present a threat to the firm’s consequences. The Federal Reserve would be safety and soundness, or have already put the unlikely to approve any proposal from a firm firm in an unsafe and unsound condition. Spe- rated “Deficient-2” to engage in new or expan- cifically, as a result of these deficiencies, the sionary activities. firm is unable to align strategic business objec- tives with its risk appetite and risk-management capabilities; maintain effective and independent 1060.0.4 COMMUNICATION OF risk management and control functions, includ- RATINGS ing internal audit; promote compliance with laws and regulations (including those related to In accordance with the Federal Reserve’s regu- consumer protection); or otherwise provide for lations governing confidential supervisory infor- the firm’s ongoing resiliency. mation, ratings assigned under the LFI rating To address these deficiencies, the firm is system will be communicated by the Federal required to immediately (1) implement compre- Reserve to the firm, but individual ratings are hensive corrective measures sufficient to restore not disclosed publicly. The Federal Reserve will and maintain appropriate governance and con- assign LFI ratings and communicate ratings to trol capabilities; and (2) demonstrate the suffi- large firms on an annual basis and more fre- ciency, credibility, and readiness of contingency quently as warranted. Under the LFI rating sys- planning in the event of further deterioration of tem, the Federal Reserve will continue to rely to the firm’s financial or operational strength or the fullest extent possible on the information resiliency. There is a strong presumption that a and assessments developed by other relevant firm rated “Deficient-2” will be subject to a supervisors and functional regulators. formalenforcementactionbytheFederalReserve.

BHC Supervision Manual February 2019 Page 11 RFI Rating System Section 1062.0

1062.0.1 RFI RATING SYSTEM 1062.0.3 RFI RATING AND SAVINGS INTRODUCTION AND LOAN HOLDING COMPANIES

Since 2004, the Federal Reserve has used the The Dodd-Frank Wall Street Reform and Con- “RFI/C(D)” rating system (referred to as the sumer Protection Act transferred to the Federal “RFI rating system”) to communicate its super- Reserve the supervisory functions of the Office visory assessment of bank holding companies of Thrift Supervision related to SLHCs and their (BHCs) regardless of their asset size, complex- nondepository subsidiaries beginning on July 21, ity, or systemic importance.1 In 2018, the Board 2011. At that time, the Federal Reserve decided adopted the RFI rating system for non-insurance to issue “indicative RFI ratings” to SLHCs until and non-commercial savings and loan holding such time that a rating system was formally companies (SLHCs) with less than $100 billion adopted for these companies. in total consolidated assets.2 At the same time, In November 2018, the Federal Reserve ad- the Board also adopted a rating system for opted a final rule to apply the RFI rating system BHCs and non-insurance and non-commercial on a fully implemented basis to SLHCs with savings and loan holding companies with total less than $100 billion in total consolidated assets, consolidated assets of $100 billion or more excluding SLHCs engaged in significant insur- (referred to as the “LFI rating system”).3 As a ance or commercial activities.4 Therefore, start- result, the Federal Reserve has two frameworks ing on February 1, 2019, the Federal Reserve for rating holding companies. will assign an RFI rating to non-insurance and non-commercial SLHCs with less than $100 billion in total consolidated assets. Non- insurance and non-commercial SLHCs face simi- lar risks and engage largely in the same activi- 1062.0.2 RFI RATING SYSTEM ties as BHCs. As such, it is appropriate for the APPLICABILITY RFI rating system to apply to non-insurance and non-commercial SLHCs to ensure that they are The RFI rating system generally applies to BHCs subject to standards and supervisory programs and non-insurance and non-commercial savings that are consistent with those that apply to and loan holding companies with less than $100 BHCs. Inspection frequency and scope guid- billion in total consolidated assets. Examination ance for non-insurance and non-commercial staff assign and communicate ratings to BHCs SLHCs with $10 billion or less in total consoli- and non-insurance and non-commercial savings dated assets are described in SR letter 13-21, and loan holding companies with total consoli- “Inspection Frequency and Scope Requirements dated assets between $10 billion and $100 bil- for Bank Holding Companies and Savings and lion assets on at least an annual basis, and more Loan Holding Companies with Total Consoli- frequently as warranted. However, U.S. interme- dated Assets of $10 Billion or Less.” Further, in diate holding companies of foreign banking November 2018, the Federal Reserve adopted organizations (FBOs) established under the the LFI rating system for non-insurance or non- Board’s Regulation YY that have $50 billion or commercial SLHCs with total consolidated assets more in total consolidated assets would be sub- of $100 billion or more. ject to the LFI rating system. The Federal Reserve will continue to assign an indicative RFI rating to SLHCs engaged in significant insurance or commercial activities, regardless of asset size. The Federal Reserve is 1. 69 Fed. Reg. 70,444 (December 6, 2004). in the process of reviewing whether a modified 2. SLHCs that are excluded from the definition of “covered holding company” in section 217.2 of the Board’s Regula- version of the RFI rating system, LFI rating tion Q receive indicative supervisory ratings. Section 271.2 system, or some other supervisory rating system excludes the following SLHCs: (1) SLHCs that derive 50 per- is appropriate for these firms on a permanent cent or more of their total consolidated assets or total rev- basis. enues from activities that are not financial in nature under section 4(k) of the Bank Holding Company Act of 1956, as amended (12 USC 1843(k)) (commercial SLHCs), and (2) SLHCs that are insurance companies or hold 25 percent or 4. 83 Fed. Reg. 56,081 (November 7, 2018). more of their total consolidated assets in subsidiaries that are insurance companies (insurance SLHCs). 3. See 83 Fed. Reg. 58,724 (November 21, 2018) and 84 BHC Supervision Manual February 2019 Fed. Reg. 4309 (February 15, 2019). Page 1 RFI Rating System 1062.0

1062.0.4 RFI RATING SYSTEM tion(s).7 A fourth rating, Depository Institu- tion(s) (D), will generally mirror the primary The RFI rating system provides an assessment regulator’s assessment of the subsidiary deposi- of certain risk management and financial condi- tory institution(s). Thus, the primary component tion factors that are common to holding compa- and composite ratings are displayed: nies,5 as well as an assessment of the potential R F I / C (D) impact of the parent holding company and its In order to provide a consistent framework for nondepository subsidiaries (collectively, nonde- assessing risk management, the R component is pository entities) on the holding company’s sub- supported by four subcomponents that reflect sidiary depository institutions. Under this sys- the effectiveness of the organization’s risk man- tem, the Federal Reserve endeavors to ensure agement and controls. The subcomponents are that applicable BHCs, including financial hold- Board and Senior Management Oversight; Poli- ing companies, and non-insurance and non- cies, Procedures, and Limits; Risk Monitoring commercial SLHCs are evaluated in a compre- and Management Information Systems (MIS); hensive and uniform manner, and that supervisory and Internal Controls. The F component is also attention is appropriately focused on the holding supported by four subcomponents reflecting an companies that exhibit financial and operational assessment of the quality of the consolidated weaknesses or adverse trends. The RFI rating organization’s Capital, Asset Quality, Earnings, system serves as a useful vehicle for identifying and Liquidity. problem or deteriorating holding companies, as Composite, component, and subcomponent well as for categorizing holding companies with ratings are assigned based on a 1 to 5 numeric deficiencies in particular areas. Further, the RFI scale. A 1 numeric rating indicates the highest rating system assists the Federal Reserve in rating, strongest performance and practices, and following safety-and-soundness trends and in least degree of supervisory concern, whereas a assessing the aggregate strength and soundness 5 numeric rating indicates the lowest rating, of the financial industry. weakest performance, and the highest degree of Each holding company subject to the RFI supervisory concern. rating system is assigned a composite rating (C) The sections that follow contain detailed de- based on an overall evaluation and rating of its scriptions of the composite, component, and managerial and financial condition and an assess- subcomponent ratings; implementation guidance ment of future potential risk to its subsidiary by holding company type; and definitions of the depository institution(s).6 The main components ratings. of the rating system represent: Risk Manage- ment (R); Financial Condition (F); and Im- pact (I) of the nondepository entities on the 1062.0.5 DESCRIPTION OF THE RFI subsidiary depository institutions. While the RATING SYSTEM ELEMENTS Federal Reserve expects holding companies to act as a source of strength to their subsidiary depository institutions, the Impact rating focuses 1062.0.5.1 The Composite (C) Rating on downside risk—that is, on the likelihood of C is the overall composite assessment of the significant negative impact by the nondeposi- holding company as reflected by consolidated tory entities on the subsidiary depository institu- risk management, consolidated financial strength, and the potential impact of the nondepository entities on the subsidiary depository institutions. 5. The information in this manual section largely conveys The composite rating encompasses both a the information in the original 2004 RFI rating system docu- forward-looking and static assessment of the ment conveyed in 69 Fed. Reg. 70,444 (December 6, 2004). consolidated organization, as well as an assess- However, the information was revised to clarify the applica- bility of the rating system and to provide current references to ment of the relationship between the depository regulations and guidance. The elements of the RFI rating and nondepository entities. The C rating is not system and the ratings’ definitions are unchanged. See SR derived as a simple numeric average of the R, F, letter 19-4, “Supervisory Rating System for Holding Compa- and I components; rather, it reflects examiner nies with Total Consolidated Assets Less Than $100 billion.” 6. A simplified version of the rating system that includes judgment with respect to the relative importance only the R and C components will be applied to noncomplex holding companies with assets at or below $3 billion. See 7. In 2004, this risk-management rating replaced the risk- SR-13-21 for more information. management rating required for bank holding companies by SR letter 95-51, “Rating the Adequacy of Risk Management BHC Supervision Manual February 2019 Processes and Internal Controls at State Member Banks and Page 2 Bank Holding Companies.” RFI Rating System 1062.0 of each component to the safe-and-sound opera- tion’s risk profile or innovations in the banking tion of the holding company. sector.

1062.0.5.2 The Risk Management (R) Policies, Procedures, and Limits Component This subcomponent evaluates the adequacy of a R represents an evaluation of the ability of the holding company’s policies, procedures, and holding company’s board of directors and senior limits given the risks inherent in the activities of management, as appropriate for their respective the consolidated organization and its stated goals positions, to identify, measure, monitor, and and objectives. This analysis will include con- control risk. The R rating underscores the impor- sideration of the adequacy of the institution’s tance of the control environment, taking into accounting and risk disclosure policies and pro- consideration the complexity of the organization cedures. and the risk inherent in its activities. The R rating is supported by four subcompo- nents that are each assigned a separate rating. Risk Monitoring and Management Information The four subcomponents are as follows: (1) Board Systems and Senior Management Oversight; (2) Policies, Procedures and Limits; (3) Risk Monitoring and This subcomponent assesses the adequacy of a Management Information Systems; and (4) Inter- holding company’s risk measurement and moni- nal Controls. The subcomponents are evaluated toring, and the adequacy of its management in the context of the risks undertaken by and reports and information systems. This analysis inherent in an organization and the overall level will include a review of the assumptions, data, of complexity of the holding company’s opera- and procedures used to measure risk and the tions. They provide the Federal Reserve System consistency of these tools with the level of with a consistent framework for evaluating risk complexity of the organization’s activities. management and the control environment. More- over, the subcomponents provide a clear struc- ture and basis for discussion of the R rating with Internal Controls holding company management, reflect the prin- ciples in supervisory guidance that are familiar This subcomponent evaluates the adequacy of a to examiners, and parallel the existing risk assess- holding company’s internal controls and inter- ment process.8 nal audit procedures, including the accuracy of financial reporting and disclosure and the strength and influence, within the organization, of the 1062.0.5.2.1 Risk Management internal audit team. This analysis will also include Subcomponents a review of the independence of control areas from management and the consistency of the scope coverage of the internal audit team with Board and Senior Management Oversight the complexity of the organization.

This subcomponent evaluates the adequacy and effectiveness of board and senior management’s 1062.0.5.3 The Financial Condition (F) understanding and management of risk inherent Component in the holding company’s activities, as well as the general capabilities of management.9 It also F represents an evaluation of the consolidated includes consideration of management’s ability organization’s financial strength. The F rating to identify, understand, and control the risks focuses on the ability of the holding company’s undertaken by the institution, to hire competent resources to support the level of risk associated staff, and to respond to changes in the institu- with its activities. The F rating is supported by four subcomponents: capital (C), asset qual- 8. See SR-95-51 and SR letter 16-11, “Supervisory Guid- ity (A), earnings (E), and liquidity (L). The ance for Assessing Risk Management at Supervised Institu- CAEL subcomponents can be evaluated along tions with Total Consolidated Assets Less than $50 Billion.” individual business lines, product lines, or on a SR-95-51 and SR-16-11 contain a detailed description of the four risk-management subcomponents. 9. The board of directors is considered separate from man- BHC Supervision Manual February 2019 agement. Page 3 RFI Rating System 1062.0 legal entity basis, depending on what is most Earnings appropriate given the structure of the organiza- tion. The assessment of the CAEL components E reflects the quality of consolidated earnings. should utilize benchmarks and metrics appropri- The evaluation considers the level, trend, and ate to the business activity being evaluated. sources of earnings, as well as the ability of Examination staff should continue to review earnings to augment capital as necessary, to relevant market indicators, such as external debt provide ongoing support for a holding com- ratings, credit spreads, debt and equity prices, pany’s activities. and qualitative rating agency assessments as a source of information complementary to exami- nation findings. Liquidity

L reflects the consolidated organization’s ability 1062.0.5.3.1 Financial Condition to attract and maintain the sources of funds Subcomponents (CAEL) necessary to support its operations and meet its obligations. The funding conditions for each of the material legal entities in the holding com- Capital Adequacy pany structure should be evaluated to determine if any weaknesses exist that could affect the C reflects the adequacy of an organization’s funding profile of the consolidated organization. consolidated capital position, from a regulatory capital perspective and an economic capital per- spective, as appropriate to the holding com- 1062.0.5.4 The Impact (I) Component pany.10 The evaluation of capital adequacy should consider the risk inherent in an organization’s Like the other components and subcomponents, activities and the ability of capital to absorb the I component is rated on a five-point numeri- unanticipated losses, to provide a base for growth, cal scale. However, the descriptive definitions of and to support the level and composition of the the numerical ratings for I are different than parent company and subsidiaries’ debt. those of the other components and subcompo- nents. The I ratings are defined as follows:

Asset Quality 1—low likelihood of significant negative im- pact; A reflects the quality of an organization’s con- 2—limited likelihood of significant negative solidated assets. The evaluation should include, impact; as appropriate, both on-balance sheet and off- 3—moderate likelihood of significant nega- balance sheet exposures, and the level of criti- tive impact; cized and nonperforming assets. Forward- 4—considerable likelihood of significant nega- looking indicators of asset quality, such as the tive impact; and adequacy of underwriting standards, the level of 5—high likelihood of significant negative im- concentration risk, the adequacy of credit admin- pact. istration policies and procedures, and the ad- equacy of management information systems for The I component is an assessment of the poten- credit risk may also inform the Federal Reserve’s tial impact of the nondepository entities on the view of asset quality. subsidiary depository institution(s). The I assess- ment will evaluate both the risk-management practices and financial condition of the nonde- pository entities—an analysis that will borrow heavily from the analysis conducted for the R and F components. Nondepository entities will 10. The regulatory minimum capital ratios for covered holding companies subject to the Board’s Regulation Q (12 be evaluated using benchmarks and analysis CFR part 217) are (1) a common equity tier 1 capital ratio of appropriate for those businesses. In addition, for 4.5 percent; (2) a tier 1 capital ratio of 6 percent; (3) a total functionally regulated nondepository subsidi- capital ratio of 8 percent; (4) a leverage ratio of 4 percent, aries, examination staff will continue to rely, to and (5) for advanced approaches Board-regulated institutions, a supplementary leverage ratio of 3 percent. the extent possible, on the work of those func- tional regulators to assess the risk management BHC Supervision Manual February 2019 practices and financial condition of those enti- Page 4 ties. In rating the I component, examination RFI Rating System 1062.0 staff is required to evaluate the degree to which pact on the subsidiary depository institution(s) current or potential issues within the nondeposi- from actual losses, a poor control environ- tory entities present a threat to the safety and ment, or an operational loss history in the soundness of the subsidiary depository institu- nondepository entities; tion(s). • Legal and Reputational Considerations: The The I component focuses on the aggregate spillover effect on the subsidiary depository impact of the nondepository entities on the sub- institution(s) of complaints and litigation that sidiary depository institution(s). In this regard, name one or more of the nondepository enti- the I rating does not include individual subcom- ties as defendants, or violations of laws or ponent ratings for the parent company and non- regulations, especially pertaining to intercom- depository subsidiaries. An I rating is always pany transactions where the subsidiary deposi- assigned for each holding company; however, tory institution(s) is involved; and nonmaterial nondepository subsidiaries may be • Concentration Considerations: The potential excluded from the I analysis at examiner discre- risks posed to the subsidiary depository insti- tion.11 tution(s) by concentrations within the nonde- Any risk-management and financial issues at pository entities in business lines, geographic the nondepository entities that potentially im- areas, industries, customers, or other factors. pact the safety and soundness of the subsidiary depository institution(s) should be identified in the written comments under the I rating. This 1062.0.5.4.2 Financial Factors approach is consistent with the Federal Reserve’s objective not to extend bank-like supervision to • CapitalDistribution:Thedistributionandtrans- nondepository entities. ferability of capital across the legal entities; The analysis of the parent company for the • Intra-Group Exposures: The extent to which purpose of assigning an I rating should empha- intra-group exposures, including servicing size weaknesses that could directly impact the agreements, have the potential to undermine risk-management or financial condition of the the condition of subsidiary depository institu- subsidiary depository institution(s). Similarly, tion(s); and the analysis of the nondepository subsidiaries • Parent Company Cash Flow and Leverage: for the purpose of assigning an I rating should The extent to which the parent company is emphasize weaknesses that could negatively dependent on dividend payments, from both impact the parent company’s relationship with the nondepository subsidiaries and the subsid- its subsidiary depository institution(s) and weak- iary depository institution(s), to service debt nesses that could have a direct impact on the and cover fixed charges. Also, the effect that risk-management practices or financial condi- these upstreamed cash flows have had, or can tion of the subsidiary depository institution(s). be expected to have, on the financial condition The analysis under the I component should con- of the holding company’s nondepository sub- sider existing as well as potential issues and sidiaries and subsidiary depository institu- risks that may impact the subsidiary depository tion(s). institution(s) now or in the future. Particular attention should be paid to the following risk- management and financial factors in assigning 1062.0.5.5 The Depository Institution(s) the I rating: (D) Component

The (D) component will generally reflect the 1062.0.5.4.1 Risk-Management Factors composite CAMELS rating assigned by the sub- sidiary depository institution’s primary supervi- • Strategic Considerations: The potential risks sor. In a multi-depository institution holding posed to the subsidiary depository institu- company, the (D) rating will reflect a weighted tion(s) by the nondepository entities’ strategic average of the CAMELS composite ratings of plans for growth in existing activities and the individual subsidiary depository institutions, expansion into new products and services; weighted by both asset size and the relative • Operational Considerations: The spillover im- importance of each depository institution within the holding company structure. In this regard, the CAMELS composite rating for a subsidiary 11. Ingeneral,nondepositorysubsidiariesshouldbeincluded in the I analysis whenever their assets exceed 5 percent of the holding company’s consolidated capital or $10 million, BHC Supervision Manual February 2019 whichever is lower. Page 5 RFI Rating System 1062.0 depository institution that dominates the corpo- “complex” or “noncomplex.”12 In addition, the rate culture may figure more prominently in the resources dedicated to the inspection of each assignment of the (D) rating than would be holding company will continue to be deter- dictated by asset size, particularly when prob- mined by the risk posed by the subsidiary deposi- lems exist within that depository institution. tory institution(s) to the federal safety net and The (D) component conveys important super- the risk posed by the holding company to the visory information, reflecting the primary super- subsidiary depository institution(s).13 visor’s assessment of the legal entity. The (D) component stands outside of the composite rat- ing although significant risk-management and 1062.0.6.1 Noncomplex Holding financial condition considerations at the deposi- Companies with Assets of $3 Billion tory institution level are incorporated in the or Less (Shell Holding Companies) consolidated R and F ratings, which are then Rating: R and C factored into the C rating. In the process of analyzing the financial con- Examination staff will assign only an R and C dition and risk-management programs of the rating for all noncomplex holding companies consolidated organization, a major difference of with assets under $3 billion.14 The R rating is opinion regarding the safety and soundness of the M rating from the subsidiary depository the subsidiary depository institution(s) emerges institution’s CAMELS rating. The C rating is between the Federal Reserve and the depository the subsidiary depository institution’s compos- institution’s primary regulator, then the (D) rat- ite CAMELS rating. ing should reflect the Federal Reserve’s evalua- tion. To highlight the presence of one or more 1062.0.6.2 Noncomplex Holding problem depository institution(s) in a multi- Companies with Assets Greater than depository institution holding company whose $3 Billion depository institution component, based on weighted averages, might not otherwise reveal their presence (i.e., depository institution ratings 1062.0.6.2.1 One-Depository Institution of 1, 2, or 3), a problem modifier, “P” would be Holding Company Rating: RFI/C(D) attached to the depository institution rating (e.g., 1P, 2P, or 3P). Thus, 2P would indicate that, For all noncomplex, one-depository institution while on balance the depository subsidiaries are holding companies with assets of greater than rated satisfactory, there exists a problem deposi- $3 billion, examination staff will assign all com- tory institution (composite 4 or 5) among the ponent and subcomponent ratings; however, ex- subsidiary depository institutions. The problem amination staff should rely heavily on informa- identifier is unnecessary when the depository tion and analysis contained in the primary institution component is rated 4 or 5. regulator’s report of examination for the subsid- iary depository institution to assign the R and F ratings. If examination staff have reviewed the 1062.0.6 IMPLEMENTATION OF THE primary regulator’s examination report and are RFI RATING SYSTEM BY HOLDING 12. The determination of whether a holding company is COMPANY TYPE “complex” versus “noncomplex” is made at least annually on a case-by-case basis taking into account and weighing a Since 2004, the Federal Reserve has used the number of considerations, such as: the size and structure of RFI rating system to communicate its supervi- the holding company; the extent of intercompany transactions sory assessment of BHCs regardless of their between depository institution subsidiaries and the holding company or nondepository subsidiaries of the holding com- asset size, complexity, or systemic importance. pany; the nature and scale of any nondepository activities, In 2018, the Board adopted the RFI rating sys- including whether the activities are subject to review by tem for non-insurance and non-commercial another regulator and the extent to which the holding com- SLHCs with less than $100 billion in total con- pany is conducting Gramm-Leach-Bliley authorized activities (e.g., insurance, securities, merchant banking); whether risk- solidated assets. The scope and frequency of management processes for the holding company are consoli- inspections of holding companies under the RFI dated; and whether the holding company has material debt rating system will vary based upon whether a outstanding to the public. Size is a less important determinant holding company has been determined to be of complexity than many of the factors noted above. 13. The federal safety net includes the federal deposit insurance fund, the payments system, and the Federal Reserve’s BHC Supervision Manual February 2019 discount window. Page 6 14. Refer to SR-13-21. RFI Rating System 1062.0 comfortable with the analysis and conclusions coordination with the primary regulator(s). The contained in that report, then the holding com- assessment for the I rating requires an indepen- pany ratings should be supported with concise dent assessment by Federal Reserve examina- language that indicates that the conclusions are tion staff. based on the analysis of the primary regulator. No additional analysis will be required. Please note, however, in cases where the 1062.0.6.3 Complex Holding Companies analysis and conclusions of the primary regula- Rating: RFI/C(D) tor are insufficient to assign the ratings, the primary regulator should be contacted to ascer- For complex holding companies, examination tain whether additional analysis and support staff will assign all component and subcompo- may be available. Further, if discussions with nent ratings of the RFI rating system. The rat- the primary regulator do not provide sufficient ings analysis should be based on the primary information to assign the ratings, discussions and functional regulators’ assessment of the with holding company management may be subsidiary entities, as well as on the examiners’ warranted to obtain adequate information to assessment of the consolidated organization as assign the ratings. In most cases, additional determined through off-site review and the hold- information or support obtained through these ing company inspection process, as appropriate. steps will be sufficient to permit the assignment The resources needed for the inspection and the of the R and F ratings. To the extent that addi- level of support needed for developing a full tional analysis is deemed necessary, the level of rating will depend on the complexity of the analysis and resources spent on this assessment organization, including structure and activities, should be in line with the level of risk the and should be commensurate with the level of subsidiary depository institution poses to the risk posed by the subsidiary depository institu- federal safety net. In addition, any activities that tion(s) to the federal safety net and the level of involve information gathering with respect to risk posed by the holding company to the sub- the subsidiary depository institution should be sidiary depository institution(s). coordinated with and, if possible, conducted by, the primary regulator of that institution. Examination staff are required to make an 1062.0.6.4 Nontraditional Holding independent assessment in order to assign the Companies Rating: RFI/C(D) I rating, which provides an evaluation of the impact of the holding company on the subsidi- Examination staff are required to assign the ary depository institution. Analysis for the I rat- full-rating system for nontraditional holding com- ing in non-complex one-depository institution panies.Nontraditionalholdingcompaniesinclude holding companies should place particular em- holding companies in which most or all nonde- phasis on issues related to parent company cash pository entities are regulated by a functional flow and compliance with sections 23A and 23B regulator and in which the subsidiary depository of the Federal Reserve Act. institution(s) are small in relation to the nonde- pository entities.15 The rating system is not intended to introduce significant additional work 1062.0.6.2.2 Multi-Depository Institution in the rating process for these organizations. As Holding Company Rating: RFI/C(D) discussed above, the level of analysis conducted and resources needed to inspect the holding For all noncomplex holding companies with company and to assign the consolidated R and F assets of greater than $3 billion and more than ratings should be commensurate with the level one subsidiary depository institution, examina- of risk posed by the subsidiary depository insti- tion staff will assign all component and subcom- ponent ratings of the RFI rating system. Exam- iners should rely, to the extent possible, on the 15. SLHCs that derive 50 percent or more of their total consolidated assets or total revenues from activities that are work conducted by the primary regulators of the not financial in nature under section 4(k) of the Bank Holding subsidiary depository institutions to assign the R Company Act of 1956, as amended (12 USC 1843(k)) (com- and F ratings. However, any risk management mercial SLHCs), and SLHCs that are insurance companies or or other important functions conducted by the hold 25 percent or more of their total consolidated assets in subsidiaries that are insurance companies (insurance SLHCs) nondepository entities of the holding company, will receive an “indicative” RFI rating regardless of size. or conducted across legal entity lines, should be subject to review by Federal Reserve examina- BHC Supervision Manual February 2019 tion staff. These reviews should be conducted in Page 7 RFI Rating System 1062.0 tution(s) to the federal safety net and the level of to the component ratings assigned. risk posed by the holding company to the sub- sidiary depository institution(s). The report of examination by, and other information obtained 1062.0.7.1 Composite Rating from, the functional and primary bank regula- tors should provide the basis for the consoli- Rating 1 (Strong). Holding companies in this dated R and F ratings. On-site work, to the group are sound in almost every respect; any extent it involves areas that are the primary negative findings are basically of a minor nature responsibility of the functional or primary deposi- and can be handled in a routine manner. Risk tory institution(s) regulator, should be coordi- management practices and financial condition nated with and, if possible, conducted by, those provide resistance to external economic and regulators. Examination staff should concentrate financial disturbances. Cash flow is more than their independent analysis for the R and F rat- adequate to service debt and other fixed obliga- ings around activities and risk management con- tions, and the nondepository entities pose little ducted by the parent company and non- risk to the subsidiary depository institution(s). functionallyregulatednondepositorysubsidiaries, Rating 2 (Satisfactory). Holding companies as well as around activities and risk manage- in this group are fundamentally sound but may ment functions that are related to the subsidiary have modest weaknesses in risk-management depository institution(s), for example, audit func- practices or financial condition. The weaknesses tions for the depository institution(s) and com- could develop into conditions of greater concern pliance with sections 23A and 23B. but are believed correctable in the normal course Examination staff are required to make an of business. As such, the supervisory response independent assessment of the impact of the is limited. Cash flow is adequate to service nondepository entities on the subsidiary deposi- obligations, and the nondepository entities are tory institution(s) in order to assign the I rating. unlikely to have a significant negative impact on the subsidiary depository institution(s). 1062.0.7 RATING DEFINITIONS FOR Rating 3 (Fair). Holding companies in this THE RFI/C(D) RATING SYSTEM group exhibit a combination of weaknesses in risk-management practices and financial condi- All component and subcomponent ratings are tion that range from fair to moderately severe. rated on a five-point numeric scale. With the These companies are less resistant to the onset exception of the I component, ratings will be of adverse business conditions and would likely assigned in ascending order of supervisory con- deteriorate if concerted action is not effective in cern as follows: correcting the areas of weakness. Consequently, these companies are vulnerable and require more 1—Strong; 2—Satisfactory; 3—Fair; 4— Mar- than normal supervisory attention and financial ginal; and 5—Unsatisfactory. surveillance. However, the risk management and A description of the I component ratings can be financial capacity of the company, including the found below in subsection 1062.0.7.4, “Impact potential negative impact of the nondepository Component.” entities on the subsidiary depository institu- The component ratings are not derived as a tion(s), pose only a remote threat to its contin- simple numeric average of the subcomponent ued viability. ratings; rather, weight afforded to each subcom- Rating 4 (Marginal). Holding companies in ponent in the overall component rating will this group have an immoderate volume of risk depend on the severity of the condition of that management and financial weaknesses, which subcomponent and the relative importance of may pose a heightened risk of significant nega- that subcomponent to the consolidated organiza- tive impact on the subsidiary depository institu- tion. Similarly, some components may be given tion(s). The holding company’s cash flow needs more weight than others in determining the may be being met only by upstreaming impru- composite rating, depending on the situation of dent dividends and/or fees from its subsidiaries. the holding company. Assignment of a compos- Unless prompt action is taken to correct these ite rating may incorporate any factor that bears conditions, the organization’s future viability significantly on the overall condition and sound- could be impaired. These companies require ness of the holding company, although generally close supervisory attention and substantially the composite rating bears a close relationship increased financial surveillance. Rating 5 (Unsatisfactory). The critical vol- BHC Supervision Manual February 2019 ume and character of the risk management and Page 8 financial weaknesses of holding companies in RFI Rating System 1062.0 this category, and concerns about the nondeposi- management weaknesses, these problems have tory entities negatively impacting the subsidiary been recognized and are in the process of being depository institution(s), could lead to insol- resolved. Overall, board and senior management vency without urgent aid from shareholders or oversight, policies and limits, risk monitoring other sources. The imminent inability to prevent procedures, reports, and management informa- liquidity and/or capital depletion places the hold- tion systems are considered satisfactory and ing company’s continued viability in serious effective in maintaining a safe and sound institu- doubt. These companies require immediate cor- tion. Risks are controlled in a manner that does rective action and constant supervisory atten- not require more than normal supervisory atten- tion. tion. Theholdingcompany’srisk-managementprac- tices and infrastructure are satisfactory and gen- 1062.0.7.2 Risk-Management Component erally are adjusted appropriately in response to changing industry practices and current regula- Rating 1 (Strong). A rating of 1 indicates that tory guidance. Staff experience, expertise and management effectively identifies and controls depth are generally appropriate to manage the all major types of risk posed by the holding risks assumed by the institution. company’s activities. Management is fully pre- Internal controls may display modest weak- pared to address risks emanating from new nesses or deficiencies, but they are correctable products and changing market conditions. The in the normal course of business. The examiner board and management are forward-looking and may have recommendations for improvement, active participants in managing risk. Manage- but the weaknesses noted should not have a ment ensures that appropriate policies and limits significant effect on the safety and soundness of exist and are understood, reviewed, and ap- the institution. proved by the board. Policies and limits are Rating 3 (Fair). A rating of 3 signifies that supported by risk-monitoring procedures, re- risk-management practices are lacking in some ports, and management information systems that important ways and, therefore, are a cause for provide management and the board with the more than normal supervisory attention. One or information and analysis that is necessary to more of the four elements of sound risk manage- maketimelyandappropriatedecisionsinresponse ment (active board and senior management over- to changing conditions. Risk-management prac- sight; adequate policies, procedures, and limits; tices and the organization’s infrastructure are adequate risk-management monitoring and man- flexible and highly responsive to changing indus- agement information systems; comprehensive try practices and current regulatory guidance. internal controls) is considered less than accept- Staff has sufficient experience, expertise and able,16 and has precluded the institution from depth to manage the risks assumed by the insti- fully addressing one or more significant risks to tution. its operations. Certain risk-management prac- Internal controls and audit procedures are suf- tices are in need of improvement to ensure that ficiently comprehensive and appropriate to the management and the board are able to identify, size and activities of the institution. There are monitor, and control all significant risks to the few noted exceptions to the institution’s estab- institution. Also, the risk-management structure lished policies and procedures, and none are may need to be improved in areas of significant material. Management effectively and accu- business activity, or staff expertise may not be rately monitors the condition of the institution commensurate with the scope and complexity of consistent with the standards of safety and sound- business activities. In addition, management’s ness, and in accordance with internal and super- response to changing industry practices and visory policies and practices. Risk-management regulatory guidance may need to improve. processes are fully effective in identifying, moni- The internal control system may be lacking in toring, and controlling the risks to the institu- some important aspects, particularly as indi- tion. cated by continued control exceptions or by a Rating 2 (Satisfactory). A rating of 2 indi- failure to adhere to written policies and proce- cates that the institution’s management of risk is dures. The risk-management weaknesses could largely effective, but lacking in some modest have adverse effects on the safety and sound- degree. Management demonstrates a responsive- ness and ability to cope successfully with exist- 16. See SR - 95-51 and SR-16-11. ing and foreseeable risks that may arise in carry- ing out the institution’s business plan. While the BHC Supervision Manual February 2019 institution may have some minor risk- Page 9 RFI Rating System 1062.0 ness of the institution if corrective action is not strategies and significant policies, and ensures taken by management. that senior management is fully capable of man- Rating 4 (Marginal). A rating of 4 represents aging the activities that the holding company deficient risk-management practices that fail to conducts. Consistent with the standards of safety identify, monitor, and control significant risk and soundness, oversight of risk-management exposures in many material respects. Generally, practices is strong and the organization’s overall such a situation reflects a lack of adequate guid- business strategy is effective. ance and supervision by management and the Senior management ensures that risk- board. One or more of the four elements of management practices are rapidly adjusted in sound risk management is deficient and requires accordance with enhancements to industry prac- immediate and concerted corrective action by tices and regulatory guidance, and exposure lim- the board and management. its are adjusted as necessary to reflect the institu- The institution may have serious identified tion’s changing risk profile. Policies, limits, and weaknesses, such as an inadequate separation of tracking reports are appropriate, understood, and duties, that require substantial improvement in regularly reviewed. internal control or accounting procedures, or Management provides effective supervision improved adherence to supervisory standards or of the day-to-day activities of all officers and requirements. The risk-management deficien- employees, including the supervision of the cies warrant a high degree of supervisory atten- senior officers and the heads of business lines. It tion because, unless properly addressed, they hires staff that possess experience and expertise could seriously affect the safety and soundness consistent with the scope and complexity of the of the institution. organization’s business activities. There is a suf- Rating 5 (Unsatisfactory). A rating of 5 indi- ficient depth of staff to ensure sound operations. cates a critical absence of effective risk- Management ensures compliance with laws and management practices with respect to the identi- regulations and that employees have the integ- fication, monitoring, or control over significant rity, ethical values, and competence consistent risk exposures. One or more of the four ele- with a prudent management philosophy and ments of sound risk management is considered operating style. wholly deficient, and management and the board Managementrespondsappropriatelytochanges have not demonstrated the capability to address in the marketplace. It identifies all risks associ- these deficiencies. ated with new activities or products before they Internal controls are critically weak and, as are launched, and ensures that the appropriate such, could seriously jeopardize the continued infrastructure and internal controls are estab- viability of the institution. If not already evi- lished. dent, there is an immediate concern as to the Rating 2 (Satisfactory). An assessment of reliability of accounting records and regulatory “Satisfactory” indicates that board and senior reports and the potential for losses if corrective management have an adequate understanding of measures are not taken immediately. Deficien- the organization’s risk profile and provide largely cies in the institution’s risk-management proce- effective oversight of risk-management prac- dures and internal controls require immediate tices. In this regard, the board has approved all and close supervisory attention. major business strategies and significant poli- cies, and ensures that senior management is capable of managing the activities that the hold- 1062.0.7.2.1 Risk Management ing company conducts. Oversight of risk- Subcomponents management practices is satisfactory and the organization’s overall business strategy is gener- ally sound. Board and Senior Management Oversight Senior management generally adjusts risk- management practices appropriately in accor- Rating 1 (Strong). An assessment of “Strong” dance with enhancements to industry practices signifies that the board and senior management and regulatory guidance, and adjusts exposure are forward-looking, fully understand the types limits as necessary to reflect the institution’s of risk inherent in the holding company’s activi- changing risk profile, although these practices ties, and actively participate in managing those may be lacking in some modest degree. Poli- risks. The board has approved overall business cies, limits, and tracking reports are generally appropriate, understood, and regularly reviewed, BHC Supervision Manual February 2019 and the new product approval process ad- Page 10 equately identifies the associated risks and nec- RFI Rating System 1062.0 essary controls. respect to the organization’s risk profile, largely Senior management’s day-to-day supervision insufficient oversight of risk-management prac- of management and staff at all levels is gener- tices, ineffective policies or limits, inadequate ally effective. The level of staffing, and its expe- or considerably under-utilized management re- rience, expertise, and depth, is sufficient to oper- porting, an inability to respond to industry en- ate the business lines in a safe and sound manner. hancements and changes in regulatory guidance, Minor weaknesses may exist in the staffing, or failure to execute appropriate business strate- infrastructure, and risk-management processes gies. Staffing may not be adequate or possess for individual business lines or products, but the experience and expertise needed for the these weaknesses have been identified by man- scope and complexity of the organization’s busi- agement, are correctable in the normal course of ness activities, and the day-to-day supervision business, and are in the process of being ad- of officer and staff activities, including the man- dressed. Weaknesses noted should not have a agement of senior officers or heads of business significant effect on the safety and soundness of lines, may be considerably lacking. These con- the institution. ditions warrant a high degree of supervisory Rating 3 (Fair). An assessment of “Fair” sig- attention because, unless properly addressed, nifies that board and senior management over- they could seriously affect the safety and sound- sight is lacking in some important way and, ness of the institution. therefore, is a cause for more than normal super- Rating 5 (Unsatisfactory). An assessment of visory attention. The weaknesses may involve a “Unsatisfactory” indicates a critical absence of broad range of activities or be material to a effective board and senior management over- major business line or activity. Weaknesses in sight practices. Problems may include a severe one or more aspect of board and senior manage- lack of knowledge with respect to the organiza- ment oversight have precluded the institution tion’s risk profile, insufficient oversight of risk- from fully addressing one or more significant management practices, wholly ineffective poli- risks to the institution. The deficiencies may cies or limits, critically inadequate or under- include a lack of knowledge with respect to the utilized management reporting, a complete organization’s risk profile, insufficient oversight inability to respond to industry enhancements of risk-management practices, ineffective poli- and changes in regulatory guidance, or failure to cies or limits, inadequate or under-utilized man- execute appropriate business strategies. Staffing agement reporting, an inability to respond to may be inadequate, inexpert, and/or inad- industry enhancements and changes in regula- equately supervised. The deficiencies require tory guidance, or failure to execute appropriate immediate and close supervisory attention, as business strategies. Staffing may not be adequate management and the board have not demon- or staff may not possess the experience and strated the capability to address them. Weak- expertise needed for the scope and complexity nesses could seriously jeopardize the continued of the organization’s business activities. The viability of the institution. day-to-day supervision of officer and staff activi- ties, including the management of senior offi- cers or heads of business lines, may be lacking. Policies, Procedures, and Limits Certain risk-management practices are in need of improvement to ensure that management and Rating 1 (Strong). An assessment of “Strong” the board is able to identify, monitor, and con- indicates that the policies, procedures, and lim- trol all significant risks to the institution. Weak- its provide for effective identification, measure- nesses noted could have adverse effects on the ment, monitoring, and control of the risks posed safety and soundness of the institution if correc- by all significant activities, including lending, tive action is not taken by management. investing, trading, trust, and fiduciary activities. Rating 4 (Marginal). An assessment of “Mar- Policies, procedures, and limits are consistent ginal” represents deficient oversight practices with the institution’s goals and objectives and that reflect a lack of adequate guidance and its overall financial strength. The policies clearly supervision by management and the board. A delineate accountability and lines of authority number of significant risks to the institution across the institution’s activities. The policies have not been adequately addressed, and the also provide for the review of new activities to board and senior management function warrants ensure that the infrastructure necessary to iden- a high degree of supervisory attention. Multiple tify, monitor, and control the associated risks is board and senior management weaknesses are in need of immediate improvement. They may BHC Supervision Manual February 2019 include a significant lack of knowledge with Page 11 RFI Rating System 1062.0 in place before the activities are initiated. dressed, they could seriously affect the safety Rating 2 (Satisfactory). An assessment of and soundness of the institution. “Satisfactory” indicates that the policies, proce- Rating 5 (Unsatisfactory). An assessment of dures, and limits cover all major business areas, “Unsatisfactory” indicates a critical absence of are thorough and substantially up-to-date, and effective policies, procedures, and limits. Poli- provide a clear delineation of accountability and cies, procedures, or limits (or the lack thereof) lines of authority across the institution’s activi- are largely or entirely ineffective with regard to ties. Policies, procedures, and limits are gener- identifying, measuring, monitoring, or control- ally consistent with the institution’s goals and ling the risks posed by significant activities; are objectives and its overall financial strength. completely inconsistent with the experience of Also, the policies provide for adequate due dili- staff, the organization’s strategic goals and ob- gence before engaging in new activities or prod- jectives, or the financial strength of the institu- ucts. Any deficiencies or gaps that have been tion; or do not delineate accountability or lines identified are minor in nature and in the process of authority. Also, policies may be completely of being addressed. Weaknesses should not have lacking with regard to providing for effective a significant effect on the safety and soundness due diligence before engaging in new activities of the institution. or products. Critical weaknesses could seriously Rating 3 (Fair). An assessment of “Fair” sig- jeopardize the continued viability of the institu- nifies that deficiencies exist in policies, proce- tion and require immediate and close supervi- dures, and limits that require more than normal sory attention. supervisory attention. The deficiencies may in- volve a broad range of activities or be material to a major business line or activity. The deficien- Risk Monitoring and MIS cies may include policies, procedures, or limits (or the lack thereof) that do not adequately Rating 1 (Strong). An assessment of “Strong” identify, measure, monitor, or control the risks indicates that risk-monitoring practices and MIS posed by significant activities; are not consistent reportsaddressallmaterialrisks.Thekeyassump- with the experience of staff, the organization’s tions, data sources, and procedures used in mea- strategic goals and objectives, or the financial suring and monitoring risk are appropriate, thor- strength of the institution; or do not clearly oughly documented, and frequently tested for delineate accountability or lines of authority. reliability. Reports and other forms of communi- Also, the policies may not provide for adequate cation are consistent with activities, are struc- due diligence before engaging in new activities tured to monitor exposures and compliance with or products. Weaknesses noted could have ad- established limits, goals, or objectives, and com- verse effects on the safety and soundness of the pare actual versus expected performance when institution unless corrective action is taken by appropriate. Management and board reports are management. accurate and timely and contain sufficient infor- Rating 4 (Marginal). An assessment of “Mar- mation to identify adverse trends and to thor- ginal” indicates deficient policies, procedures, oughly evaluate the level of risk faced by the and limits that do not address a number of institution. significant risks to the institution. Multiple prac- Rating 2 (Satisfactory). An assessment of tices are in need of immediate improvement, “Satisfactory”indicatesthatrisk-monitoringprac- which may include policies, procedures, or lim- tices and MIS reports cover major risks and its (or the lack thereof) that ineffectively iden- business areas, although they may be lacking in tify, measure, monitor, or control the risks posed some modest degree. In general, the reports by significant activities; are not commensurate contain valid assumptions that are periodically with the experience of staff, the institution’s tested for accuracy and reliability and are ad- strategic goals and objectives, or the financial equately documented and distributed to the ap- strength of the institution; or do not delineate propriate decisionmakers. Reports and other accountability or lines of authority. Moreover, forms of communication generally are consis- policies may be considerably lacking with re- tent with activities; are structured to monitor gards to providing for effective due diligence exposures and compliance with established lim- before engaging in new activities or products. its, goals, or objectives; and compare actual These conditions warrant a high degree of super- versus expected performance when appropriate. visory attention because, unless properly ad- Management and board reports are generally accurate and timely, and broadly identify ad- BHC Supervision Manual February 2019 verse trends and the level of risk faced by the Page 12 institution. Any weaknesses or deficiencies that RFI Rating System 1062.0 have been identified are in the process of being the nature and scope of the organization’s activi- addressed. ties. The organizational structure establishes Rating 3 (Fair). An assessment of “Fair” sig- clear lines of authority and responsibility for nifies that weaknesses exist in the institution’s monitoring adherence to policies, procedures, risk-monitoring practices or MIS reports that and limits, and wherever applicable, exceptions require more than normal supervisory attention. are noted and promptly investigated. Reporting The weaknesses may involve a broad range of lines provide clear independence of the control activities or be material to a major business line areas from the business lines and separation of or activity. They may contribute to ineffective duties throughout the organization. Robust pro- risk identification or monitoring through inap- cedures exist for ensuring compliance with appli- propriate assumptions, incorrect data, poor docu- cable laws and regulations, including consumer mentation, or the lack of timely testing. In addi- laws and regulations. Financial, operational, and tion, MIS reports may not be distributed to the regulatory reports are reliable, accurate, and appropriate decisionmakers, adequately monitor timely. Internal audit or other control review significant risks, or properly identify adverse practices provide for independence and objectiv- trends and the level of risk faced by the institu- ity. Internal controls and information systems tion.Weaknessesnotedcouldhaveadverseeffects are thoroughly tested and reviewed; the cover- on the safety and soundness of the institution if age, procedures, findings, and responses to au- corrective action is not taken by management. dits and review tests are well documented; iden- Rating 4 (Marginal). An assessment of “Mar- tified material weaknesses are given thorough ginal” represents deficient risk-monitoring prac- and timely high-level attention; and manage- tices or MIS reports that, unless properly ad- ment’s actions to address material weaknesses dressed, could seriously affect the safety and are objectively reviewed and verified. The board soundness of the institution. A number of sig- or its audit committee regularly reviews the nificant risks to the institution are not adequately effectiveness of internal audits and other control monitored or reported. Ineffective risk identifi- review activities. cation may result from notably inappropriate Rating 2 (Satisfactory). An assessment of assumptions, incorrect data, poor documenta- “Satisfactory” indicates that the system of inter- tion, or the lack of timely testing. In addition, nal controls adequately covers major risks and MIS reports may not be distributed to the appro- business areas, with some modest weaknesses. priate decisionmakers, may inadequately moni- In general, the control functions are independent tor significant risks, or fail to identify adverse from the business lines, and there is appropriate trends and the level of risk faced by the institu- separation of duties. The control system sup- tion. The risk monitoring and MIS deficiencies ports accuracy in record-keeping practices and warrant a high degree of supervisory attention reporting systems, is adequately documented, because, unless properly addressed, they could and verifies compliance with laws and regula- seriously affect the safety and soundness of the tions, including consumer laws and regulations. institution. Internal controls and information systems are Rating 5 (Unsatisfactory). An assessment of adequately tested and reviewed, and the cover- “Unsatisfactory” indicates a critical absence of age, procedures, findings, and responses to au- risk monitoring and MIS. They are wholly defi- dits and review tests are documented. Identified cient due to inappropriate assumptions, incor- material weaknesses are given appropriate atten- rect data, poor documentation, or the lack of tion and management’s actions to address mate- timely testing. Moreover, MIS reports may not rial weaknesses are objectively reviewed and be distributed to the appropriate decisionmak- verified. The board or its audit committee reviews ers, fail to monitor significant risks, or fail to the effectiveness of internal audits and other identify adverse trends and the level of risk control review activities. Any weaknesses or faced by the institution. These critical weak- deficiencies that have been identified are modest nesses require immediate and close supervisory in nature and in the process of being addressed. attention, as they could seriously jeopardize the Rating 3 (Fair). An assessment of “Fair” sig- continued viability of the institution. nifies that weaknesses exist in the system of internal controls that require more than normal supervisory attention. The weaknesses may in- Internal Controls volve a broad range of activities or be material to a major business line or activity. The weak- Rating 1 (Strong). An assessment of “Strong” indicates that the system of internal controls is BHC Supervision Manual February 2019 robust for the type and level of risks posed by Page 13 RFI Rating System 1062.0 nesses may include insufficient oversight of ment review and correction of identified weak- internal controls and audit by the board or its nesses. Such deficiencies require immediate and audit committee; unclear or conflicting lines of close supervisory attention, as they could seri- authority and responsibility; a lack of indepen- ously jeopardize the continued viability of the dence between control areas and business activi- institution. ties; or ineffective separation of duties. The internal control system may produce inadequate or untimely risk coverage and verification, includ- 1062.0.7.3 Financial Condition ing monitoring compliance with both safety and Component soundness and consumer laws and regulations; inaccurate records or financial, operational, or Rating 1 (Strong). A rating of 1 indicates that regulatory reporting; a lack of documentation the consolidated holding company is financially for work performed; or a lack of timeliness in sound in almost every respect; any negative management review and correction of identified findings are basically of a minor nature and can weaknesses. Weaknesses noted could have ad- be handled in a routine manner. The capital verse effects on the safety and soundness of the adequacy, asset quality, earnings, and liquidity institution if corrective action is not taken by of the consolidated holding company are more management. than adequate to protect the company from rea- Rating 4 (Marginal). An assessment of “Mar- sonably foreseeable external economic and finan- ginal” represents a deficient internal control sys- cial disturbances. The company generates more tem that does not adequately address a number than sufficient cash flow to service its debt and of significant risks to the institution. The defi- fixed obligations with no harm to subsidiaries of ciencies may include neglect of internal controls the organization. and audit by the board or its audit committee; Rating 2 (Satisfactory). A rating of 2 indi- conflicting lines of authority and responsibility; cates that the consolidated holding company is a lack of independence between control areas fundamentally financially sound, but may have and business activities; or no separation of du- modest weaknesses correctable in the normal ties in critical areas. The internal control system course of business. The capital adequacy, asset may produce inadequate, untimely, or nonexis- quality, earnings and liquidity of the consoli- tent risk coverage and verification in certain dated holding company are adequate to protect areas, including monitoring compliance with the company from external economic and finan- both safety and soundness and consumer laws cial disturbances. The company also generates and regulations; inaccurate records or financial, sufficient cash flow to service its obligations; operational, or regulatory reporting; a lack of however, areas of weakness could develop into documentation for work performed; or infre- areas of greater concern. To the extent minor quent management review and correction of adjustments are handled in the normal course of identified weaknesses. The internal control defi- business, the supervisory response is limited. ciencies warrant a high degree of supervisory Rating 3 (Fair). A rating of 3 indicates that attention because, unless properly addressed, the consolidated holding company exhibits a they could seriously affect the safety and sound- combination of weaknesses ranging from fair to ness of the institution. moderately severe. The company has less than Rating 5 (Unsatisfactory). An assessment of adequate financial strength stemming from one “Unsatisfactory” indicates a critical absence of or more of the following: modest capital defi- an internal control system. There may be no ciencies, substandard asset quality, weak earn- oversight by the board or its audit committee; ings, or liquidity problems. As a result, the conflicting lines of authority and responsibility; holding company and its subsidiaries are less no distinction between control areas and busi- resistant to adverse business conditions. The ness activities; or no separation of duties. The financial condition of the holding company will internal control system may produce totally likely deteriorate if concerted action is not taken inadequate or untimely risk coverage and verifi- to correct areas of weakness. The company’s cation, including monitoring compliance with cash flow is sufficient to meet immediate obliga- both safety and soundness and consumer laws tions, but may not remain adequate if action is and regulations; completely inaccurate records not taken to correct weaknesses. Consequently, or regulatory reporting; a severe lack of docu- the holding company is vulnerable and requires mentation for work performed; or no manage- more than normal supervision. Overall financial strength and capacity are still such as to pose BHC Supervision Manual February 2019 only a remote threat to the viability of the com- Page 14 pany. RFI Rating System 1062.0

Rating 4 (Marginal). A rating of 4 indicates a sufficient cushion to absorb unanticipated losses that the consolidated holding company has either arising from the parent and subsidiary activities; inadequate capital, an immoderate volume of and support the level and composition of parent problem assets, very weak earnings, serious and subsidiary borrowing. In addition, a com- liquidity issues, or a combination of factors that pany assigned a rating of 2 has sufficient capital are less than satisfactory. An additional weak- to provide a base for the growth of risk assets ness may be that the holding company’s cash and the entry into capital markets as the need flow needs are met only by upstreaming impru- arises for the parent company and subsidiaries. dent dividends and/or fees from subsidiaries. Rating 3 (Fair). A rating of 3 indicates that Unless prompt action is taken to correct these the consolidated holding company may not main- conditions, they could impair future viability. tain sufficient capital to ensure support for the Holding companies in this category require close volume and risk characteristics of all parent and supervisory attention and increased financial subsidiary business lines and products; the unan- surveillance. ticipated losses arising from the parent and sub- Rating 5 (Unsatisfactory). A rating of 5 indi- sidiary activities; or the level and composition cates that the volume and character of financial of parent and subsidiary borrowing. In addition, weaknesses of the holding company are so criti- a company assigned a rating of 3 may not main- cal as to require urgent aid from shareholders or tain a sufficient capital position to provide a other sources to prevent insolvency. The immi- base for the growth of risk assets and the entry nent inability of such a company to service its into capital markets as the need arises for the fixed obligations and/or prevent capital deple- parent company and subsidiaries. The capital tion due to severe operating losses places its position of the consolidated holding company viability in serious doubt. Such companies re- could quickly become inadequate in the event of quire immediate corrective action and constant asset deterioration or other negative factors and supervisory attention. therefore requires more than normal supervisory attention. Rating 4 (Marginal). A rating of 4 indicates 1062.0.7.3.1 The Financial Condition that the capital level of the consolidated holding Subcomponents companyissignificantlybelowtheamountneeded to ensure support for the volume and risk char- The financial condition subcomponents can be acteristics of all parent and subsidiary business evaluated along business lines, product lines, or lines and products; the unanticipated losses aris- legal entity lines—depending on which type of ing from the parent and subsidiary activities; review is most appropriate for the holding com- and the level and composition of parent and pany structure. subsidiary borrowing. In addition, a company assigned a rating of 4 does not maintain a suffi- cient capital position to provide a base for the Capital Adequacy growth of risk assets and the entry into capital markets as the need arises for the parent com- Rating 1 (Strong). A rating of 1 indicates that pany and subsidiaries. If left unchecked, the the consolidated holding company maintains consolidated capital position of the company more than adequate capital to support the vol- might evolve into weaknesses or conditions that ume and risk characteristics of all parent and could threaten the viability of the institution. subsidiary business lines and products; provide The capital position of the consolidated holding a sufficient cushion to absorb unanticipated losses company requires immediate supervisory atten- arising from the parent and subsidiary activities; tion. and support the level and composition of parent Rating 5 (Unsatisfactory). A rating of 5 indi- and subsidiary borrowing. In addition, a com- cates that the level of capital of the consolidated pany assigned a rating of 1 has more than suffi- holding company is critically deficient and in cient capital to provide a base for the growth of need of immediate corrective action. The con- risk assets and the entry into capital markets as solidated capital position threatens the viability the need arises for the parent company and of the institution and requires constant supervi- subsidiaries. sory attention. Rating 2 (Satisfactory). A rating of 2 indi- cates that the consolidated holding company maintains adequate capital to support the vol- ume and risk characteristics of all parent and BHC Supervision Manual February 2019 subsidiary business lines and products; provide Page 15 RFI Rating System 1062.0

Asset Quality absorption of losses and/or accretion of capital when due consideration is given to asset quality Rating 1 (Strong). A rating of 1 indicates that and holding company growth. Generally, hold- the holding company maintains strong asset ing companies with a 1 rating have earnings quality across all parts of the organization, with well above peer-group averages. a very low level of criticized and nonperforming Rating 2 (Satisfactory). A rating of 2 indi- assets. Credit risk across the organization is cates that the quantity and quality of the holding commensurate with management’s abilities and company’s consolidated earnings over time are modest in relation to credit risk-management generally adequate to make provision for the practices. absorption of losses and/or accretion of capital Rating 2 (Satisfactory). A rating of 2 indi- when due consideration is given to asset quality cates that the holding company maintains satis- and holding company growth. Generally, hold- factory asset quality across all parts of the orga- ing companies with a 2 rating have earnings that nization, with a manageable level of criticized are in line with or slightly above peer-group and nonperforming assets. Any identified weak- averages. nesses in asset quality are correctable in the Rating 3 (Fair). A rating of 3 indicates that normal course of business. Credit risk across the the holding company’s consolidated earnings organization is commensurate with manage- are not fully adequate to make provisions for the ment’s abilities and generally modest in relation absorption of losses and the accretion of capital to credit risk-management practices. in relation to company growth. The consoli- Rating 3 (Fair). A rating of 3 indicates that dated earnings of companies rated 3 may be the asset quality across all or a material part of further clouded by static or inconsistent earn- the consolidated holding company is less than ings trends, chronically insufficient earnings, or satisfactory. The holding company may be fac- less than satisfactory asset quality. Holding com- ing a decrease in the overall quality of assets panies with a 3 rating generally have earnings currently maintained on and off balance sheet. below peer-group averages. Such holding com- The holding company may also be experiencing panies require more than normal supervisory an increase in credit-risk exposure that has not attention. been met with an appropriate improvement in Rating 4 (Marginal). A rating of 4 indicates risk-management practices. Holding companies that the holding company’s consolidated earn- assigned a rating of 3 require more than normal ings, while generally positive, are clearly not supervisory attention. sufficient to make full provision for losses and Rating 4 (Marginal). A rating of 4 indicates the necessary accretion of capital. Holding com- that the holding company’s asset quality is defi- panies with earnings rated 4 may be character- cient. The level of problem assets and/or unmiti- ized by erratic fluctuations in net income, poor gated credit risk subjects the holding company earnings (and the likelihood of the development to potential losses that, if left unchecked, may of a further downward trend), intermittent losses, threaten its viability. Holding companies as- chronically depressed earnings, or a substantial signed a rating of 4 require immediate supervi- drop from the previous year. The earnings of sory attention. such companies are generally substantially be- Rating 5 (Unsatisfactory). A rating of 5 indi- low peer-group averages. Such holding compa- cates that the holding company’s asset quality is nies require immediate supervisory attention. critically deficient and presents an imminent Rating 5 (Unsatisfactory). A rating of 5 indi- threat to the institution’s viability. Holding com- cates that the holding company is experiencing panies assigned a rating of 5 require immediate losses or a level of earnings that is worse than remedial action and constant supervisory atten- that described for the 4 rating. Such losses, if tion. not reversed, represent a distinct threat to the holding company’s solvency through erosion of capital. Such holding companies require imme- Earnings diate and constant supervisory attention.

Rating 1 (Strong). A rating of 1 indicates that the quantity and quality of the holding com- Liquidity pany’s consolidated earnings over time are more than sufficient to make full provision for the Rating 1 (Strong). A rating of 1 indicates that the holding company maintains strong liquidity BHC Supervision Manual February 2019 levels and well-developed funds-management Page 16 practices. The parent company and subsidiaries RFI Rating System 1062.0 have reliable access to sufficient sources of tive impact; and funds on favorable terms to meet present and 5—high likelihood of significant negative im- anticipated liquidity needs. pact. Rating 2 (Satisfactory). A rating of 2 indi- cates that the holding company maintains satis- Rating 1 (Low Likelihood of Significant Nega- factory liquidity levels and funds-management tive Impact). A rating of 1 indicates that the practices. The parent company and subsidiaries nondepository entities of the holding company have access to sufficient sources of funds on are highly unlikely to have a significant nega- acceptable terms to meet present and anticipated tive impact on the subsidiary depository institu- liquidity needs. Modest weaknesses in funds- tion(s) due to the sound financial condition of management practices may be evident, but those the nondepository entities, the strong risk- weaknesses are correctable in the normal course management practices within the nondepository of business. entities, or the corporate structure of the holding Rating 3 (Fair). A rating of 3 indicates that company. The holding company maintains an the holding company’s liquidity levels or funds- appropriate capital allocation across the organi- management practices are in need of improve- zation commensurate with associated risks. Intra- ment. Holding companies rated 3 may lack group exposures, including servicing agree- ready access to funds on reasonable terms or ments, areveryunlikelytounderminethefinancial may evidence significant weaknesses in funds- condition of the subsidiary depository institu- management practices at the parent company or tion(s). Parent company cash flow is sufficient subsidiary levels. However, these deficiencies and not dependent on excessive dividend pay- are considered correctable in the normal course ments from subsidiaries. The potential risks of business. Such holding companies require posed to the subsidiary depository institution(s) more than normal supervisory attention. by strategic plans, the control environment, risk Rating 4 (Marginal). A rating of 4 indicates concentrations, or legal or reputational issues that the holding company’s liquidity levels or within or facing the nondepository entities are funds-management practices are deficient. Insti- minor in nature and can be addressed in the tutions rated 4 may not have or be able to obtain normal course of business. a sufficient volume of funds on reasonable terms Rating 2 (Limited Likelihood of Significant to meet liquidity needs at the parent company or Negative Impact). A rating of 2 indicates a subsidiary levels and require immediate supervi- limited likelihood that the nondepository enti- sory attention. ties of the holding company will have a signifi- Rating 5 (Unsatisfactory). A rating of 5 indi- cant negative impact on the subsidiary deposi- cates that the holding company’s liquidity levels tory institution(s) due to the adequate financial or funds-management practices are critically condition of the nondepository entities, the satis- deficient and may threaten the continued viabil- factory risk-management practices within the ity of the institution. Institutions rated 5 require parent nondepository entities, or the corporate constant supervisory attention and immediate structure of the holding company. The holding external financial assistance to meet maturing company maintains adequate capital allocation obligations or other liquidity needs. across the organization commensurate with asso- ciated risks. Intra-group exposures, including servicing agreements, are unlikely to undermine 1062.0.7.4 Impact Component the financial condition of the subsidiary deposi- tory institution(s). Parent company cash flow is The I component rating reflects the aggregate satisfactory and generally does not require exces- potential impact of the nondepository entities on sive dividend payments from subsidiaries. The the subsidiary depository institution(s). It is potential risks posed to the subsidiary deposi- rated on a five-point numerical scale. Ratings tory institution(s) by strategic plans, the control will be assigned in ascending order of supervi- environment, risk concentrations, or legal or sory concern as follows: reputational issues within the nondepository en- tities are modest and can be addressed in the 1—low likelihood of significant negative im- normal course of business. pact; Rating 3 (Moderate Likelihood of Significant 2—limited likelihood of significant negative Negative Impact). A rating of 3 indicates a impact; moderate likelihood that the aggregate impact of 3—moderate likelihood of significant nega- tive impact; BHC Supervision Manual February 2019 4—considerable likelihood of significant nega- Page 17 RFI Rating System 1062.0 the nondepository entities of the holding com- Rating 5 (High Likelihood of Significant Nega- pany on the subsidiary depository institution(s) tive Impact). A rating of 5 indicates a high will have a significant negative impact on the likelihood that the aggregate impact of the non- subsidiary depository institution(s) due to weak- depository entities of the holding company on nesses in the financial condition and/or risk the subsidiary depository institution(s) is or will management practices of the nondepository enti- become significantly negative due to substantial ties. The holding company may have only mar- weaknesses in the financial condition and/or ginally sufficient allocation of capital across the risk-management practices of the nondepository organization to support risks. Intra-group expo- entities. Strategic growth plans, a deficient con- sures, including servicing agreements, may have trol environment, risk concentrations or legal or the potential to undermine the financial condi- reputational issues within the nondepository en- tion of the subsidiary depository institution(s). tities may pose critical risks to the subsidiary Parent company cash flow may at times require depository institution(s). The parent company excessive dividend payments from subsidiaries. also may be unable to meet its obligations with- Strategic growth plans, weaknesses in the con- out excessive support from the subsidiary deposi- trol environment, risk concentrations or legal or tory institution(s). The holding company re- reputational issues within the nondepository en- quires immediate and close supervisory attention, tities may pose significant risks to the subsidiary as the nondepository entities seriously jeopar- depository institution(s). A holding company dize the continued viability of the subsidiary assigned a 3 impact rating requires more than depository institution(s). normal supervisory attention, as there could be adverse effects on the safety and soundness of the subsidiary depository institution(s) if correc- 1062.0.7.5 (D) Depository Institutions tive action is not taken by management. Component Rating 4 (Considerable Likelihood of Signifi- cant Negative Impact). A rating of 4 indicates The (D) component identifies the overall condi- that there is a considerable likelihood that the tion of the subsidiary depository institution(s) of nondepository entities of the holding company the holding company. For holding companies will have a significant negative impact on the with only one subsidiary depository institution, subsidiary depository institution(s) due to weak- the (D) component rating generally will mirror nesses in the financial condition and/or risk- the CAMELS composite rating for that deposi- management practices of the nondepository enti- tory institution. To arrive at a (D) component ties. A 4-rated holding company may have rating for holding companies with multiple sub- insufficient capital within the nondepository en- sidiary depository institutions, the CAMELS tities to support their risks and activities. Intra- composite ratings for each of the depository group exposures, including servicing agree- institutions should be weighted, giving consider- ments, may also have the immediate potential to ation to asset size and the relative importance of undermine the financial condition of the subsid- each depository institution within the overall iary depository institution(s). Parent company structure of the organization. In general, it is cash flow may be dependent on excessive divi- expected that the resulting (D) component rating dend payments from subsidiaries. Strategic will reflect the lead depository institution’s growth plans, weaknesses in the control envi- CAMELS composite rating. ronment, risk concentrations or legal or reputa- If in the process of analyzing the financial tional issues within the nondepository entities condition and risk-management programs of the may pose considerable risks to the subsidiary consolidated organization, a major difference of depository institution(s). A holding company opinion regarding the safety and soundness of assigned a 4 impact rating requires immediate the subsidiary depository institution(s) emerges remedial action and close supervisory attention between the Federal Reserve and the depository because the nondepository entities could seri- institution’s primary regulator, then the (D) rat- ously affect the safety and soundness of the ing should reflect the Federal Reserve’s evalua- subsidiary depository institution(s). tion.

BHC Supervision Manual February 2019 Page 18 Holding Company Ratings Applicability and Inspection Frequency Section 1063.0

The purpose of this section is to provide an total consolidated assets only receive the risk- overview of the inspection scope and frequency management rating and composite rating from expectations for bank holding companies (BHCs) the RFI rating system. and savings and loan holding companies (SLHCs) BHCs exempt from the prohibitions of sec- supervised by the Federal Reserve. The Federal tion 4 of the Bank Holding Company Act of 1956, Reserve utilizes two rating systems to assess as amended, as a result of any of the following these and other holding companies. exemptions, will not be subject to any required BHCs and non-insurance, non-commercial periodic inspection: SLHCs with total consolidated assets of $100 bil- lion or more generally are subject to the large 1. section 4(a)(2)—permanent grandfather rights financial institution (LFI) rating system. (See 2. section 4(c)(i)—labor, agricultural, or horti- section 1060.0 of this manual.) U.S. intermedi- cultural organization ate holding companies of foreign banking orga- 3. section 4(c)(ii)—85 percent family-owned nizations with combined U.S. assets of $50 bil- 4. section 4(c)(12)—irrevocable declaration to lion or more established pursuant to the Federal cease to be a BHC Reserve’s Regulation YY are also subject to the 5. section 4(d)—hardship exemption LFI rating system. BHCs and non-insurance and non- However, the Reserve Bank should continue commercial SLHCs with less than $100 billion to monitor the financial condition of such hold- in total consolidated assets generally are subject ing companies and should conduct inspections to the RFI rating system. (See section 1062.0 of whenever there is any indication of a potential this manual.) However, noncomplex holding problem in a subsidiary bank. companies with less than $3 billion in

BHC Supervision Manual February 2020 Page 1 Holding Company Ratings Applicability and Inspection Frequency 1063.0

1063.0.1 RATING SYSTEMS FOR HOLDING COMPANIES Total consolidated asset size Between Between Less than Less than $100 billion $10 billion $3 billion $3 billion Type of holding company $3 billion or more and and (non (complex) $100 billion $10 billion complex) Modified RFI Bank holding company LFI rating RFI rating rating1 Non-insurance and Modified RFI non-commercial savings and LFI rating RFI rating rating loan holding company Insurance savings and 2 Indicative RFI rating loan holding company Commercial savings and loan Indicative RFI rating holding company3 Intermediate holding 4 LFI rating Not applicable company

1. The Modified RFI rating includes a composite rating and risk-management rating to the holding company. See SR letter 13-21, “Inspection Frequency and Scope Requirements for Bank Holding Companies and Savings and Loan Holding Companies with Total Consolidated Assets of $10 Billion or Less.” 2. Savings and loan holding companies (SLHCs) are considered to be “insurance savings and loan holding companies” if they are either insurance companies or hold 25 percent or more of their total consolidated assets in subsidiaries that are insurance companies. 3. SLHCs are considered to be “commercial savings and loan holding companies” if they derive 50 percent or more of their total consolidated assets or total revenues from activities that are not financial in nature under section 4(k) of the Bank Holding Company Act of 1956, as amended (12 USC 1843(k)). 4. U.S. intermediate holding companies of foreign banking organizations established under the Board’s Regulation YY that have $50 billion or more in total consolidated assets would be subject to the LFI rating system.

BHC Supervision Manual February 2020 Page 2 Holding Company Ratings Applicability and Inspection Frequency 1063.0

1063.0.2 GENERAL INSPECTION FREQUENCY FOR A HOLDING COMPANY Total consolidated asset size Type of holding company $100 billion Between Between Less than Less than or more $10 billion $3 billion $3 billion $3 billion and and (complex) (non- $100 billion $10 billion complex) Bank holding company1 See the below table and SR letter 13-21, Non-insurance and Ratings (or indicative “Inspection Frequency and Scope Require- non-commercial savings and ratings) assigned and com- ments for Bank Holding Companies and loan holding company municated to firms on at Savings and Loan Holding Companies Insurance savings and loan least an annual basis, and with Total Consolidated Assets of 2 holding company more frequently as $10 Billion or Less,” and its attachment warranted. for more information in inspection Commercial savings and loan frequency and scope. holding company3 Intermediate holding U.S. intermediate holding companies of foreign banking organizations 4 company established under the Board’s Regulation YY that have $50 billion or more in total consolidated assets are assigned an LFI rating on at least an annual basis, and more frequently as warranted.

1. Bank holding companies exempt from the prohibitions of section 4 of the Bank Holding Company Act of 1956, as amended, are not subject to any required periodic inspection. 2. Savings and loan holding companies (SLHCs) are considered to be “insurance savings and loan holding companies” if they are either insurance companies or hold 25 percent or more of their total consolidated assets in subsidiaries that are insurance companies. 3. SLHCs are considered to be “commercial savings and loan holding companies” if they derive 50 percent or more of their total consolidated assets or total revenues from activities that are not financial in nature under section 4(k) of the Bank Holding Company Act of 1956, as amended (12 USC 1843(k)).

BHC Supervision Manual February 2020 Page 3 odn opn aig plcblt n npcinFeuny1063.0 Frequency Inspection and Applicability Ratings Company Holding ae4 Page Manual Supervision BHC

1063.0.3 Small Holding Company Inspection Scope and Frequency Asset size $3–$10 billion Less than $3 billion Complexity2 Complex Noncomplex Complex Noncomplex Risk-management rating Type of rating Complete RFI rating Complete RFI rating Complete RFI rating and composite rating only Full scope on-site inspection is Off-site targeted inspection is Off-site review should be If all subsidiary DIs have a management component required annually. required every two years. conducted upon receipt of the lead rating and a composite supervisory rating of “1” Additional targeted follow-up may Additional targeted follow-up may DI exam report or an updated or “2” and no material holding company issues Rating of be needed in response to off-site be needed in response to off-site rating from the primary supervisor are otherwise indicated, the Reserve Bank should 1 or 2 surveillance program results. surveillance program results. using surveillance results and assign only a composite rating and risk-manage- relevant supervisory and financial ment rating to the holding company based on the information. If the information ratings of the lead DI. eray2020 February obtained off-site is not sufficient for the Reserve Bank to determine the 1 Full scope on-site inspection is overall condition of the company If one or more subsidiary DIs have a management required annually. Full-scope off-site inspection is component rating or a composite supervisory rating required annually. and to assign a complete RFI rating, If the primary supervisor has the Reserve Bank should conduct an of “3,” “4,” or “5” or a material holding company conducted an interim examination If the primary supervisor has on-site review of the company. issue is otherwise indicated, an off-site review is conducted an interim examination required upon receipt of the lead DI exam report or changed the rating at the lead Any on-site review should be depository institution (DI), the or changed the rating at the lead DI, or an updated rating from the primary supervisor the Reserve Bank staff should targeted at those areas where using surveillance results and relevant supervisory Reserve Bank should conduct an additional information or analysis is additional targeted inspection and conduct an additional targeted and financial information. If the information Rating of inspection and update the rating if needed to assign a complete obtained off-site is not sufficient for the Reserve Scope and frequency update the rating if necessary. The supervisory rating. 3, 4, or 5 targeted inspection may be necessary. This targeted inspection Bank to determine the overall condition of the conducted off-site and should start may be conducted off-site and company and to assign a risk-management rating within 60 days of receiving the should start within 60 days of and a composite rating, contact the holding company examination report for the lead DI. receiving the examination report for to obtain more information. the lead DI. Additional targeted follow-up may be needed in response to off-site Additional targeted follow-up may surveillance program results. be needed in response to off-site surveillance program results.

Rating of A letter-format report template has been developed for supervision staff completing reports for holding Off-site reviews culminate in the issuance of a 1, 2, or 3 companies that receive a complete RFI rating and have a composite rating of 1, 2, or 3. transmittal letter communicating the ratings to the company. Information in the transmittal letter review focuses on parent and nonbanking activities. Letter-format report of inspection may be prepared as indicated in SR-13-10, “Format for Safety-and-Soundness Report Rating of Examiners also rely on the primary regulator’s work Reports of Examination and Inspection for Community State Member Banks and Holding Companies Rated

expectations 4 or 5 on the subsidiary insured depository institution and Composite ’4’ or ’5’.” relevant surveillance results.

1. Full-scope inspection covers all areas of interest to the Federal Reserve in depth; targeted inspections will focus intensely on one or two activities. 2. Complexity factors include the size and structure of the company; the extent of intercompany transactions between insured depository institution subsidiaries and the holding company or uninsured subsidiaries of the holding company; the risk, scale and complexity of activities of any nondepository subsidiaries; and the degree of leverage at the holding company, including the extent of its debt outstanding to the public. Other factors are also noted in the text of SR-13-21. Nondisclosure of Supervisory Ratings and Confidential Supervisory Information Section 1065.0

1065.0.1 LIMITED DISCLOSURE OF ratings to the holding company’s directors and CONFIDENTIAL COMPOSITE AND management until preliminary approval has been COMPONENT RATINGS IN received from the appropriate senior Reserve INSPECTIONS AND EXAMINATIONS Bank supervisory officials.

The Federal Reserve provides senior manage- ment and directors of supervised financial insti- 1065.0.2 CONFIDENTIALITY OF THE tutions the numeric and alphabetic component SUPERVISORY RATING AND OTHER ratings assigned under various supervisory rat- NONPUBLIC SUPERVISORY ing systems.1 (See SR-96-26, “Provision of Indi- INFORMATION vidual Components of Supervisory Rating Sys- tems to Management and Boards of Directors.”) The holding company inspection report and This disclosure includes the ratings assigned to other supervisory communications constitute or management under the holding company rating contain the Board’s confidential supervisory systems.2 information (CSI), which is nonpublic informa- Depending upon the size and complexity of tion belonging to the Board.4 The Board’s Rules the organization, the disclosure of the rating and Regarding Availability of Information specifi- its components is made to the holding company cally provide that, except in very limited cir- in writing through formal examination or inspec- cumstances, supervised financial institutions may tion reports, reports summarizing the results of not disclose CSI outside of the financial institu- targeted reviews, a roll-up of those reviews into tion, including inspection or examination find- a comprehensive report, any other supervisory ings, nor make any representations concerning communication, or some combination thereof. an examination or inspection report or the re- In conjunction with disclosing the ratings and port’s findings, without the prior written permis- their components to a holding company, exam- sion of the Board.5 Any person who discloses or iners or supervisory officials should clearly ex- uses CSI except as expressly permitted by the plain what the ratings mean to the board of appropriate federal banking agency or as pro- directors and management. During the exit meet- vided by the agency’s regulations may be sub- ing, the examiner should discuss key overall ject to the criminal penalties provided in inspection findings, including preliminary com- 18 USC 641. posite and component numeric ratings. The legal prohibition on the release of CSI Indisclosingtheassignedratings,theexaminer- applies to all financial institutions examined by in-charge should remind the board of directors the agencies, including bank and savings and and management that the ratings are part of the loan holding companies, Edge corporations, and findings of the inspection or supervisory activity the U.S. branches or agencies of foreign banking and are privileged and confidential under appli- organizations that receive confidential supervi- cable law.3 When examiners change a firm’s sory ratings, including the LFI rating, RFI/C(D) ratings, examiners need to inform the firm’s rating, ROCA rating, and CAMEO rating.6 As board of directors and management about the rating change. Examiners should not disclose 4. See, e.g., 12 CFR 261.2(c)(1), 261.20(g), and 261.22(e). 1. The supervisory ratings are disclosed for the following 5. 12 CFR part 261, subpart C. The regulation authorizes rating systems: supervised financial institutions to disclose CSI to their direc- • CAMELS (state member banks) tors, officers, and employees and to the directors, officers, and • RFI/C(D) and Large Financial Institution (LFI) rating employees of their parent holding companies. 12 CFR system (bank holding companies, and savings and 261.20(b)(1). In addition, institutions may also disclose CSI loan holding companies) to their outside counsel and auditors on the premises of the • CAMEO (Edge and agreement corporations and over- institution. 12 CFR 261.20(b)(2). seas subsidiaries of U.S. banks) • ROCA (U.S. branches and agencies of foreign bank- 6. RFI/C(D), LFI, ROCA, and CAMEO ratings are as- ing organizations) signed by the Federal Reserve Board as a result of an exami- • Uniform Interagency Trust Rating System (UITRS) nation or inspection. For noncomplex holding companies with • The interagency Uniform Rating System for Informa- assets of $3 billion or less, only risk-management and com- tion Technology (URSIT) posite ratings are assigned. ROCA ratings are assigned to the 2. See SR-19-3 / CA-19-2, “Large Financial Institution U.S. branches, agencies, and commercial lending companies (LFI) Rating System” and SR-19-4 / CA-19-3, “Supervisory of foreign banking organizations. The ROCA rating compo- Rating System for Holding Companies with Total Consoli- nents are risk management, operational controls, compliance, dated Assets Less Than $100 billion.” 3. The inspection report should also include appropriate language stating that the findings of the inspection are privi- BHC Supervision Manual February 2020 leged and confidential under applicable law. Page 1 Nondisclosure of Supervisory Ratings and Confidential Supervisory Information 1065.0 with the CAMELS rating, examiners communi- 1065.0.3 CONFIDENTIALITY cate these ratings to the regulated institutions in PROVISIONS IN THIRD-PARTY reports or other supervisory communications, AGREEMENTS which are the property of the Board. Financial institutions that receive requests for Under the Federal Reserve’s statutory examina- confidential supervisory ratings should refer all tion authority, examiners may review all books requesters to the following publicly available and records maintained on the premises of a information in lieu of disclosing any CSI, includ- financial institution that is subject to Federal ing the CAMELS rating: Reserve supervision. This authority extends to any and all documents on the premises. In addi- • for banks and savings associations, an institu- tion, under the Board’s Rules Regarding Avail- tion’s quarterly reports of condition (Call Re- ability of Information, other than as set forth in ports) (see 12 USC 1817) the rules, Board-supervised organizations are • for holding companies or foreign banks with prohibited from disclosing CSI to third parties U.S. operations, an institution’s quarterly and without prior written permission of the Board’s annual FR Y or H-(b)11 reports (see 12 General Counsel. CSI is defined to include any USC 1844, 3106, 3108, 601–604a, information related to the examination or inspec- and 611–631) tion of a banking organization, including super- • for national banks, the annual disclosure state- visory ratings.8 Significantly, Board staff has ment (see 12 CFR 18.3) taken the position that identification of informa- • for banks, an institution’s Uniform Bank Per- tion requested by, or provided to, supervisory formance Report (UBPR), which is available staff—including the fact that an inspection has to all interested parties at www.ffiec.gov and taken or will take place—is related to an inspec- is designed for summary and in-depth analy- tion and falls within the definition of CSI. Ac- sis of banks; cordingly, it is contrary to Federal Reserve regu- • an institution’s publicly available filings, if lation and policy for agreements between a any, filed with the appropriate federal banking banking organization and its counterparties (for agency (15 USC 78(I)(i)) or with the U.S. Se- example, mutual funds, hedge funds, and other curities and Exchange Commission trading counterparties) or other third parties to • any reports or ratings on the institution com- contain confidentiality provisions that piled by private companies that track the per- formance of financial institutions 1. restrict the banking organization from pro- • any reports or ratings issued by private rating viding information to Federal Reserve super- services on public debt issued by an institu- visory staff; tion 2. require or permit, without the prior approval • any publicly available cease-and-desist order of the Federal Reserve, the banking organiza- or enforcement proceeding against an institu- tion to disclose to a counterparty that any tion7 information will be or was provided to Fed- • any reports or other sources of information on eral Reserve supervisory staff; or institution performance or internal matters 3. require or permit, without the prior approval created by the institution that do not contain of the Federal Reserve, the banking organiza- information prohibited from release by law or tion to inform a counterparty of a current or regulation upcoming Federal Reserve inspection or any nonpublic Federal Reserve supervisory ini- tiative or action. and asset quality. CAMEO ratings are assigned to Edge corpo- rations and the overseas branches and subsidiaries of U.S. banks. The CAMEO ratings components are capital, asset Banking organizations that have entered into quality, management, earnings, and operations and internal agreements containing such confidentiality controls. provisions are subject to legal risk. (See SR-07- 7. Information on enforcement actions taken by the Fed- 19, “Confidentiality Provisions in Third-Party eral Reserve may be found at https://www.federalreserve.gov/ apps/enforcementactions/search.aspx. Agreements,” and SR-97-17, “Access to Books Information on enforcement actions taken by other federal and Records of Financial Institutions During agencies, such as the Securities and Exchange Commission, Examinations and Inspections.”) the Financial Crimes Enforcement Network, and the Depart- ment of Justice, as well as foreign authorities, may also be publicly available.

BHC Supervision Manual February 2020 Page 2 8. See 12 CFR 261.2(c)(1)(i). Communication of Supervisory Findings Section 1070.1

1070.1.1 INTRODUCTION management to take corrective action and will provide management with appropriate oversight, This section on the communication of supervi- including approvals of proposed management sory findings is based on the guidance in SR-13- actions as necessary. 13/CA-13-10, “Supervisory Considerations for To be effective, the communication of super- the Communication of Supervisory Findings,” visory findings must be (1) written in clear and which applies to all Federal Reserve-supervised concise language, (2) prioritized based upon banking organizations. In a supervisory finding, degree of importance, and (3) focused on any examiners should convey, if evident, both the significant matters that require attention. Reserve root cause of the finding and the potential effect Banks must formally communicate matters re- of the finding on the organization. Examiners quiring immediate attention (MRIAs) and mat- should also consider the guidance in SR-18-5/ ters requiring attention (MRAs) resulting from CA-18-7, “Interagency Statement Clarifying the any supervisory activity to the organization in Role of Supervisory Guidance,” for more infor- these written reports. In order to promote an mation on communication of supervisory find- understanding of these terms, examiners should ings, including the appropriate identification of include definitions of MRIAs and MRAs in all unsafe or unsound practices or other deficien- supervisory documents communicating supervi- cies in risk management, including compliance sory findings.2 When included in a safety-and- risk management, or other areas that do not soundness examination or inspection report, constitute violations of law or regulation. MRIAsandMRAsshouldbelistedinthe“Matters Requiring Attention” section. In the case of findings from consumer compliance examina- 1070.1.2 COMMUNICATION OF tions, MRIAs and MRAs should be reflected in SUPERVISORY FINDINGS the “Executive Summary and Examination Ratings” section of the consumer affairs report Communication of supervisory findings to the of examination. Only outstanding MRIAs and organization’s board of directors is an important MRAs are required to be discussed in the report; part of the supervision of a banking organiza- however, examiners have discretion to discuss tion. While the board itself may not directly closed MRIAs and MRAs in the report if such undertake the work to remediate supervisory discussion would be meaningful. findings as senior management is responsible For large banking organizations, an annual for the organization’s day-to-day operations, it roll-up report summarizes the significant find- is nevertheless important that the board be made ings, based on outstanding MRIAs or MRAs, aware of significant supervisory issues and ulti- included in the reports of targeted reviews or mately be accountable for the safety and sound- other supervisory activities conducted during ness and assurance of compliance with applica- the supervisory cycle. These findings may be ble laws and regulations of the organization. grouped by major supervisory issues, rating Depending upon the size and complexity of components, risks, or themes. This information the organization, supervisory findings are com- should enable the banking organization’s board municated in writing through formal examina- of directors and any executive-level committee tion or inspection reports, reports summarizing of the board to understand the substance and the results of targeted reviews, a roll-up of those status of outstanding MRIAs or MRAs and reviews into a comprehensive report, any other focus their attention on the most critical and supervisory communication, or some combina- time-sensitive issues. tion thereof. These written communications (re- Communicationstobankingorganizationscon- ferred to collectively as “reports” in this sec- cerning safety-and-soundness or consumer com- tion) are generally directed to the board of pliance MRIAs or MRAs must specify a time- directors, or an executive-level committee of the board as appropriate.1 In turn, the board of 2. In a safety-and-soundness report, these definitions could directors (or executive-level committee of the be included on the “Scope” page, in an appendix, or as a board) typically will direct the organization’s footnote on the “Matters Requiring Attention” section. In a consumer compliance report, these definitions could be included on the “Executive Summary and Examination Ratings” section. 1. An executive-level committee of the board (such as, the audit committee or risk committee) typically meets regularly, keeps minutes of those meetings, and is accountable to and BHC Supervision Manual February 2020 routinely reports to the board of directors. Page 1 Communication of Supervisory Findings 1070.1 frame within which the banking organization organization, the timeframe should take into must complete the corrective actions. In certain account any potential losses to the Federal De- circumstances, examiners may require the bank- posit Insurance Corporation’s Deposit Insurance ing organization to submit an action plan that Fund, including the possibility that a delay in identifies remedial actions to be completed within action will increase the potential for loss or the specified timeframes. Action plans with cost of resolution. intermediate- and long-term timeframes that span more than one supervisory or examination Organization response. Following its review of cycle with regard to safety-and-soundness mat- MRIAs discussed in the report, the banking ters, or a 12-month period with regard to con- organization’s board of directors is required to sumer compliance issues, should include interim respond to the Reserve Bank in writing regard- progress targets. Both safety-and-soundness and ing corrective action taken or planned along consumer protection or compliance consider- with a commitment to corresponding time- ations will remain a priority in determining frames. whether the organization’s timeframes to cor- rect the matter are reasonable. Supervisory follow-up. The Reserve Bank must follow up on MRIAs to assess progress and verify satisfactory completion. The timeframe 1070.1.2.1 Matters Requiring Immediate for follow-up should correspond with the time- Attention frame specified for the action being required, and should be appropriate for the severity of the MRIAs arising from an examination, inspection, matter requiring the corrective action. The means or any other supervisory activity are matters of of follow-up may vary depending upon the significant importance and urgency that the Fed- nature and severity of the matter requiring the eral Reserve requires banking organizations to action. Follow-up may take the form of a subse- address immediately and include (1) matters quent examination, a targeted review, or any that have the potential to pose significant risk to other supervisory activity deemed suitable for the safety and soundness of the banking organi- evaluating the issue at hand. zation; (2) matters that represent significant non- In some cases, when follow-up indicates the compliance with applicable laws or regulations; organization’s corrective action has not been (3) repeat criticisms that have escalated in impor- satisfactory, the initiation of additional formal tance due to insufficient attention or inaction by or informal investigation or enforcement action the banking organization; and (4) in the case of may be necessary. In such cases, examiners consumer compliance examinations, matters that should consult with enforcement staff.3 In all have the potential to cause significant consumer instances, examiners are expected to exercise harm. An MRIA will remain an open issue until judgment as to the supervisory activities best resolution and examiners confirm the banking suited for evaluating a particular issue. Once organization’s corrective actions. follow-up is completed, examiners are expected to clearly and fully document the rationale for Required language. Federal Reserve examiners their decision to close any issue. Examiners are are expected to use the following standardized also expected to communicate in writing the language to communicate MRIAs to the board results of their work and findings to the banking of directors (or executive-level committee of the organization. board):

“The board of directors (or executive-level 1070.1.2.2 Matters Requiring Attention committee of the board), or banking organiza- tion is required to immediately...” MRAs constitute matters that are important and that the Federal Reserve is expecting a banking Timeframe. The expected timeframe for a bank- organization to address over a reasonable period ing organization to address MRIAs is generally of time but when the timing need not be “imme- short, and may be “immediate,” in the case of diate.” While issues giving rise to MRAs must heightened safety-and-soundness or consumer be addressed to ensure the banking organization compliance risk. For MRIAs that are necessary to preserve or restore the viability of a banking 3. Such consultation should be made in accordance with existing guidance to Reserve Bank supervisory staff on the processing of enforcement actions, which provides that rec- BHC Supervision Manual February 2020 ommendations concerning formal enforcement actions should Page 2 be submitted to the Board’s Legal Division. Communication of Supervisory Findings 1070.1 operates in a safe and sound and compliant For intermediate- or long-term corrective actions manner, the threat to safety and soundness is for MRAs, Reserve Bank follow-up may consist less immediate than with issues giving rise to of assessing the organization’s progress to ad- MRIAs. Likewise, consumer compliance con- dress the MRAs, whether satisfactory or unsatis- cerns that require less immediate resolution factory, and noting whether the initial estimated should be communicated as an MRA. An MRA timeframe continues to be reasonable or war- typically will remain an open issue until resolu- rants adjustment. tion and confirmation by examiners that the The means of supervisory follow-up may banking organization has taken corrective action. vary based upon the nature and severity of the If a banking organization does not adequately matter for which corrective action is expected. address an MRA in a timely manner, examiners Follow-up may take the form of a subsequent may elevate an MRA to an MRIA. Similarly, a examination, targeted review, continuous moni- change in circumstances, environment, or strat- toring, reliance on validation work conducted egy can also lead to an MRA becoming an by internal audit function, reliance on the results MRIA. The key distinction between MRIAs and of examinations conducted by other supervisors, MRAs is the nature and severity of matters or any other supervisory activity deemed suit- requiring corrective action as well as the imme- able for evaluating the issue at hand.4 diacy with which the banking organization must In some cases, when follow-up indicates the begin and complete corrective actions. organization’s corrective action has not been satisfactory, the initiation of additional formal Required language. Federal Reserve examiners or informal investigation or enforcement action are expected to use the following standardized may be necessary. In all instances, examiners language to communicate MRAs to the board of are expected to exercise judgment regarding the directors (or executive-level committee of the supervisory activities best suited for evaluating board): a particular issue. Once follow-up is complete, examiners are expected to clearly and fully “The board of directors (or executive-level document the rationale for their decision to committee of the board), or banking organiza- close any issue. Examiners also are expected to tion is required to...” communicate in writing the results of their work and findings to the organization. Timeframe. Communications to banking organi- zations about MRAs must specify a timeframe within which the corrective action is expected to 1070.1.2.3 Supervisory Considerations be completed. The timeframe, at least initially, may require estimation because the banking The volume of MRIAs and MRAs should be organization may first need to complete prelimi- one of the many considerations in assigning a nary planning to establish the timeframe for supervisory rating to a banking organization. initiating and completing the corrective action. The presence of a large number of MRIAs or The timeframes for MRAs are likely to become MRAs may indicate that additional formal or more precise over time as planning evolves and informal investigation may be necessary or that circumstances make the completion of the MRAs the initiation of a formal or informal enforce- more urgent. Timeframes that span more than ment action may be warranted. one examination cycle for safety-and-soundness Irrespective of the number of MRIAs or issues or that exceed 12 months for consumer MRAs, in some cases, additional formal or compliance issues should include appropriate informal investigation may be necessary or the interim progress reports. initiation of a formal or informal enforcement

Organization response. Following its review of 4. Examiners may choose to rely on the work of internal the report, the banking organization’s board of audit when internal audit’s overall function and related pro- directors is required to provide a written response cesses are effective, as discussed in SR-13-1/CA-13-1, “Supple- mental Policy Statement on the Internal Audit Function and to the Reserve Bank regarding its plan, prog- Its Outsourcing.” (See this manual’s section entitled “Internal ress, and resolution of the MRA. Control and Audit Function, Oversight, and Outsourcing.”) When relying on internal audit to follow up on MRAs, exam- Supervisory follow-up. The Reserve Bank must iners are expected to review the relevant workpapers and, when necessary, meet with internal audit staff who docu- follow-up on MRAs to assess progress and mented the resolution of the issue. verify satisfactory completion. The timeframe for follow-up should correspond with the time- BHC Supervision Manual February 2020 frame during which actions are to be completed. Page 3 Communication of Supervisory Findings 1070.1 action may be warranted based on the severity • the severity or repetitive or intentional nature of the issues, the repeat nature of issues, lack of of the issues; responsiveness of management, violations of • management’s willingness and ability to cor- law, insider abuse, fraud, or other material defi- rect the issues; ciency. In any of these cases, examiners should • management’s history of instituting timely consult with the Board’s enforcement staff. remedial or corrective actions; • whether management already initiated correc- tive action or established procedures to pre- 1070.1.3 FACTORS IN ESCALATING vent future deficiencies; ISSUES INTO ENFORCEMENT • whether criminal or other regulatory authori- ACTIONS ties are taking a formal enforcement or pros- ecutorial action against the same institution; The volume of open MRIAs and MRAs and the • the organization’s history of violations of materiality of the issues therein to the safety and laws, noncompliance with regulations and un- soundness of the banking organization are impor- safe and unsound unsatisfactory practices; and tant overarching considerations in determining • any other circumstances that warrant use of an whether examiners need to consult with the enforcement action. Board’s enforcement staff in escalating issues into enforcement actions.5 In addition to the This manual’s section, “Formal Corrective guidance presented in SR-13-13/CA-13-10, ex- Actions,” provides more information on formal aminers should consider the following key fac- supervisory actions, which regulators issue to tors in determining whether to recommend addi- correct practices that the regulators believe to be tional formal or informal investigation or unlawful, unsafe, or unsound. See also the Com- enforcement action: mercial Bank Examination Manual’s section entitled, “Formal and Informal Supervisory • the organization’s supervisory ratings and Actions,” for more information. financial condition;6 • whether the issues involve unsafe or unsound practices, violations of laws, noncompliance with regulations, insider abuse, fraud, or other material deficiencies;7

5. Issues are considered closed if the banking organization implements and examiners verify and validate the effective- ness of the corrective action, or if the organization’s practices are no longer a concern because of a change in the organiza- tion’s circumstances. 6. See SR-19-3/CA-19-2, “Large Financial Institution (LFI) Rating System,” and SR-19-4/CA 19-3, “Supervisory Rating System for Holding Companies with Total Consolidated Assets Less Than $100 billion.” 7. See 12 USC 1818(b)(1).

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