restate financial results because of inappropriate accounting. both corporate financial officers and outside auditors failed to effectively evaluate the sophisticated nature of the underlying transactions and arrive at the appropriate accounting policy. at a few banks, the evaluations were ineffective for special - purpose entities and derivatives. you have all read accounts of these incidents, and i will not dwell on them. rather, i want to illustrate operational risk in relation to a basic accounting concept by discussing another area of weakness that bank regulators determined needed attention - accounting for subprime credit card activity. the accounting concept is not new or esoteric. rather, the nature of the subprime credit card business, compared with that of the prime card business, is to rely much more on fee income than on interest income for revenue. for subprime accounts, rapid growth of the account base can mask underlying revenue trends. some financial institutions did not have management information that allowed them to track the percentage of delinquent accounts that were not paying late fees and other charges that had been billed. in such situations, the accounting is very straightforward. even if you have billed a customer for services, if you do not think you are going to collect the fee, you should not recognize the revenue and should set up a reserve for bad debt. some financial institutions with a large subprime client base did not have adequate accounting systems to disclose that a significant amount in fees was not being collected. by recording revenue on the basis of billed fees, these institutions were overstating income. new guidance issued jointly by the bank regulators clarifies these accounting standards. further, at some subprime banks, management information did not reflect the level of charge - offs of fees and advances as accounts aged. by relying on charge - off reports for the portfolio as a whole, portfolio growth was masking the increasing amount of loan losses. this is a good example of how changes in the customer mix and profit drivers of an existing product can lead to unintended loss exposures if management information and accounting do not reflect the economics and risks of the product when it is altered. fdicia : internal controls other areas of operational risk have come to light as a result of the events and debate surrounding the sarbanes - oxley act. i want to talk about a couple of these areas - internal control assessments and the role of outside auditors. since 1991, the federal deposit insurance corporation improvement act ( fdicia ) has required that the chief executive officer ( ceo

susan s bies : managing business risks speech by ms susan s bies, member of the board of governors of the us federal reserve system, before the oregon bankers association, independent community banks of oregon, and idaho bankers association ; sunriver, oregon, 16 june 2003. * * * thank you for inviting me to participate in the joint annual convention of the oregon bankers association, the independent community banks of oregon and the idaho bankers association. one of my responsibilities as a governor on the federal reserve board is to chair the board's committee on supervisory and regulatory affairs. in that role i apply my knowledge of banking to the continuing task of adapting the federal reserve's supervision process to meet the needs of the evolving financial services industry. today i want to explore some issues of joint interest to us, as bankers and supervisors, and to think about how we can better manage the risks inherent in banks. first i'll focus on some of issues arising from events at public companies and banks in the past eighteen months that have shown weaknesses in risk management practices. and then i'll talk about how operational risk management is evolving into a discipline that can strengthen the corporate governance process at banks. bank earnings and performance banks in the united states have experienced two consecutive years of record earnings, despite the recession and slow recovery, losses due to exposures to bankruptcies arising from corporate fraud, and record low interest rates. in 2002, the return on assets rose 16 basis points, to 1. 33 percent, the highest level in three decades. the improvements in earnings and roa are even more remarkable in that they occurred while banks were strengthening their capital ratios. thus, banks'performance was driven by increased net interest margins, lower relative costs and comparatively constant loan loss provisions. the ability of bankers to achieve record earnings during a recession and the early part of the recovery reflects the improvement in risk management that occurred in the 1990s. this is especially true in relation to credit and asset / liability risks. operational risks are a different matter : banks have had to deal with losses arising from operational issues, as a few well - publicized events have shown. operational risk " operational risk " is a relatively new term that has no unique definition. in the mid - 1990s the concept began to receive attention at banks and nonfinancial firms as enterprise - risk management began to evolve. for purposes of my talk today, i am going to refer to operational risk as any risk that arises from inadequate or failed internal processes, people, or