PART 2: OUR WORK
Keeping a Watchful Eye
BANKING SUPERVISORS TAKE ON NEW CHALLENGES
By Julie Stackhouse, Senior Vice President, Banking Supervision and Regulation
Banking supervision has changed considerably over the past 100 years. While the work of banking supervisors has always been different from the portrayal in Frank Capra's 1946 film, It's a Wonderful Life, the process has evolved from a point-in-time examination—during which even the bank's cash was counted—to a sophisticated approach—whereby part of the examination might be conducted off-site using electronic records from the institution.
Perhaps the greatest changes have come in the past five years. As a result of the Dodd-Frank Act, which was signed into law in 2010, the Federal Reserve now supervises and regulates all bank holding companies, savings and loan holding companies, state-chartered banks that are members of the Federal Reserve System, and any nonbank that is designated as a systemically important financial institution by the Financial Stability Oversight Council. Institutions and industries previously outside of the Fed's purview now must be supervised with the same amount of skill, critical analysis and depth of knowledge that is employed in our banking examination processes.
The changes in our financial and regulatory systems can be seen in many attributes, many of which are integral to the banking supervision function of the Federal Reserve Bank of St. Louis:
The Fed is focused on forward-looking risk analysis and is as concerned with systemic risk as it is with institutional risk: Supervising a spectrum of institutions—from large and complex to small and community-oriented—requires the Fed to be adequately prepared to address the challenges of today and to be able to anticipate, and effectively identify, the risks of tomorrow. While examiners continue to review the financial health and compliance effectiveness of each institution, they also look across institutions and business lines to identify risks. For example, supervisors today not only will look at the loan portfolio and compensation practices of an individual institution, but also may conduct a horizontal review of executive compensation or commercial real estate lending.
In today's dynamic environment, banking supervisors also recognize that risks are not inherent solely in a bank's loan book. There are risks related to the processing of payments for third-party vendors, risks related to fair lending and risks involving cybersecurity, to name a few. Banking supervisors must understand and be able to integrate all sorts of risks, even those that can emerge from consumer or service operations or through inadequate infrastructure investments.
Banking supervisors strive for a regulatory system that is balanced relative to institutional risk: Banking supervisors understand that banks are natural innovators and need to be able to respond to changing consumer demands and changing economic factors to be successful. But the operations of a community bank are not the same as the operations of a large bank. Community banks typically have a traditional risk profile that is easy to understand and examine. Systemically important financial institutions, on the other hand, are far more complex and subject to many additional regulations, including enhanced prudential standards under the Dodd-Frank Act, capital stress testing and liquidity regulation.
Banking Supervision: The Basics
The Fed has supervisory and regulatory authority over a variety of financial institutions and activities. In general, the Fed's supervision staff works to promote: 1) a safe, sound and stable financial system that supports the growth and stability of the U.S. economy, and 2) a fair and transparent market for consumer financial services. These efforts are accomplished through:
- Assessing the safety and soundness of supervised financial institutions
- Carrying out consumer compliance supervisory activities to protect consumers and promote a fair and transparent market for the services they need
- Processing applications to acquire or merge with other institutions or to change ownership
- Ensuring enforcement of laws and regulations
Banking supervisors work closely with their regulatory and functional counterparts: In today's environment, banking supervisors must maintain open lines of communication with other state and federal regulators, banking trade associations and community organizations that operate in markets served by these institutions. They must understand the Fed's traditional role in promoting U.S. financial stability and the risks posed by payment and settlement activities, and they must interact with colleagues in lending and payment risk functions.
The Fed ensures that both examiners and financial institutions understand the laws, regulations and industry issues facing them: This responsibility is significant. The Dodd-Frank Act alone has 848 pages and, by some estimates, has resulted in more than 400 new rules for the financial services industry. The St. Louis Fed has taken a leadership role in aiding the banking supervision staff and the financial industry in understanding the expectations contained within laws and regulations through its Ask the Fed program (for bankers only) and Rapid Response program (for examination staff only). These programs, which were largely originated during the financial crisis, allow for important supervisory and regulatory information to be communicated, in nearly real time, to state and federal regulators and financial institutions. Effective communication is paramount to promoting financial stability and ensuring the safety and soundness of the U.S. banking system.
The Federal Reserve's centennial commemoration reminds us that the reason we've been effective as an organization is that we've changed to meet the challenges of our financial system. The challenges of today will not be the challenges of tomorrow. Banking supervision has evolved to keep up with the speed of change and innovation in the banking industry. Although this has never been a perfect process, the lessons we've learned over the past 100 years, including during the most recent financial crisis, position us for superior effectiveness in the next 100 years.