their structure. in short, the structure of large financial firms has become much more complex and varied over time and is increasingly reflecting the business strategy of the organization. banking supervision at the federal reserve has long taken a consolidated view of risk management and internal controls, a focus that the 1999 passage of the gramm - leach - bliley act ( glba ) reinforced. under glba, the federal reserve, as umbrella supervisor of banking organizations, has a special responsibility to determine whether bank holding companies are operated in a safe and sound manner so that their financial condition does not threaten the viability of affiliated depository institutions. consolidated oversight of bank holding companies, and in particular the subset of bank holding companies that have elected financial holding company status in order to engage in a broader range of activities, is important because the risks associated with those activities can transcend legal entities and business lines. that is, risks in one entity can have an impact on another entity or functional area - and ultimately on the enterprise as a whole. supervisory oversight at the bank holding company level is particularly critical because public disclosure and market discipline are exerted largely at the consolidated level. therefore, the regulatory constraints imposed at the bank holding company level can be the most binding on the organization. financial institution supervision in the united states generally is determined by type of charter - state or federal - and federal reserve membership. the dual banking system of state and federal banks has encouraged innovation and is an important contributor to the strength and flexibility of the u. s. financial system. however, supervision by charter can create an uneven playing field for competitors that offer similar services but are subject to different regulatory requirements. supervision by function can ensure that competitors have a similar regulatory environment. but functional supervision has a weakness common to entity supervision. that is, business processes are often designed without regard to management organization or legal entity. this is becoming more common as technology is used to integrate varied activities and internal control systems are used to aggregate information across business lines. thus, a supervisor that focuses on one part of the business process may not understand how activities earlier or later in the process flow may affect internal controls and risk exposures. further, as we have seen in some notable public enforcement actions taken in the last couple of years, supervision of only a portion of the organization can leave gaps in risk coverage. organizations that are run by business line, including risk management and compliance, can miss inherent conflicts of interest between lines of business. thus, individuals can be motivated to

support their line of business without due regard for the increased risk or potential for compliance failure that their actions create in other parts of the organization. in today ’ s regulatory environment, the focus is increasingly on supervision of the full enterprise. an example is the federal reserve ’ s umbrella supervision of financial and bank holding companies in the united states. another is the consolidated supervision of financial institutions operating in the european union resulting from implementation of the new basel ii capital accord. enterprise supervision certainly provides a more integrated view of risks and internal controls. but the umbrella supervisor is still challenged if the supervisors of entities or functions have different prudential supervision frameworks. in this case, the umbrella supervisor, to be effective, must assess the gaps and inconsistencies in the supervisory process. an enhanced framework for looking at the consolidated banking organization : the new bank holding company rating system as the activities of banking organizations have increased in complexity over time, the focus of the federal reserve ’ s supervision of bank and financial holding companies has moved from historical analyses of financial condition on a separate legal entity basis toward more forward - looking assessments of the adequacy of risk management and financial factors of the consolidated organization. while the supervision of holding companies has been evolving, the rating system has not changed. to replace the bopec bank holding company rating system, which has served the federal reserve system well for twenty - five years, a proposal has been issued for comment to move to a new rating system that encompasses ratings for risk management, financial strength, and the impact of nondepository legal entities on affiliated depository institutions ; a composite rating ; and a depository institution rating. the proposed new rating system was published for comment in july of this year, and the system is expected to become effective in january 2005. the proposed bank holding company rating system is expected to ( 1 ) better emphasize risk management and the importance of the control environment ; ( 2 ) introduce a more comprehensive, more adaptable framework for analyzing and rating financial factors based on the unique structure of each holding company ; and ( 3 ) for the first time, provide an explicit framework for rating the impact of the nondepository entities of a holding company on its affiliated depository institutions. this new structure will better align the bank holding company rating system with our current supervisory practices. the proposed risk management and financial condition components are each supported by four subcomponents, which provide granularity and structure to their analysis. specifically, the risk management component