The nearly 12,000 federally insured banks and thrifts in the United States, which hold more than $5 trillion in assets, are regulated and supervised by four federal agencies with similar and sometimes overlapping regulatory and supervisory responsibilities. Although many industry representatives, legislators, and regulators have in the past recognized the need for consolidation and modernization of federal bank oversight, major reform proposals changing the structure of bank and thrift oversight have not been adopted. This report was prepared in response to a request from Congressman Charles E. Schumer that we provide information to help evaluate efforts to modernize the U.S. system of financial industry oversight and identify potential avenues for such modernization. Much of the information in this report is based on our studies of the structures and operations of bank regulation and supervision (oversight) activities in Canada, France, Japan, Germany, and the United Kingdom. This report focuses on the oversight of two major categories of depository institutions: commercial banks and thrifts. Commercial banks and thrifts originally served very different purposes and markets. Commercial banks issued debt payable on demand, which was backed by short-term commercial loans. The customers of commercial banks tended to be businesses and wealthy individuals seeking liquid deposit accounts. Savings and loan associations, however, used deposits to fund home mortgages of their members. But, because of the long terms of mortgages, members were restricted in their ability to withdraw their funds. Savings banks were initially designed to provide a range of financial services to the small saver. Their asset portfolios were generally more diversified than those of savings and loan associations to enable them to provide more flexible deposit terms. Despite the historical differences between these institutions, the powers and services of banks and thrifts have converged over time with few practical differences remaining in their authorities, except that these institutions continue to be subject to different regulatory schemes. (See app. I for more information on the history of U.S. bank and thrift oversight.) At the end of 1995, the United States had nearly 12,000 banking institutions. In this report, we refer to commercial banks and thrifts collectively as banking institutions. These institutions held about $5.3 trillion in loans and other assets (see table 1.1). As shown in table 1.1, the 9,941 commercial banks held 81 percent of total bank and thrift assets at the end of 1995. The 2,029 thrifts held 19 percent. Holding companies, which are established for a variety of business, regulatory, and tax reasons, are the dominant form of banking structure in the United States. In fact, 96 percent of the assets of all U.S. commercial banks are in banks that are part of a holding company. As of December 31, 1995, about 6,122 bank holding companies and 895 thrift holding companies were operating in the United States. Of those, 4,494 bank holding companies and 833 thrift holding companies each held only 1 bank or thrift. Holding companies may consist of a parent company, banking subsidiaries, nonbanking subsidiaries, and even other holding companies—each of which may have its own banking or nonbanking subsidiaries. Figure 1.1 is a simplified illustration of a hypothetical holding company with wholly owned banking and nonbanking subsidiaries. Parent companies own or control subsidiaries through the ownership of voting stock and generally are “shell” corporations—that is, they do not have operations of their own. Banking subsidiaries are separately chartered banks subject to the same regulation and capital requirements that apply to other banking institutions. Nonbanking subsidiaries are companies that may be engaged in a variety of businesses other than banking; however, any nonbanking activities of a bank holding company subsidiary must be closely related to the business of banking and produce a public benefit. Thrift holding companies may be owned by or own any type of financial services or other business. Many bank holding companies have established nonbank subsidiaries engaged in consumer finance, trust services, leasing, mortgage lending, electronic data processing, insurance underwriting, management consulting services, and securities brokerage services. Holding companies in the United States may also have multiple tiers. For example, as we mentioned above, holding companies may have subsidiary holding companies that have their own banking or nonbanking subsidiaries. Banking subsidiaries may also have their own subsidiaries. However, the activities of these bank subsidiaries are limited to those allowable for their parent institution. The largest holding companies in the United States often have very complex, multitiered structures. Bank and thrift holding companies are particular to the U.S. financial system. In many other countries, nonbanking activities may be conducted either in a bank or in subsidiaries of a bank rather than in subsidiaries of a parent company. The structure of the U.S. banking industry has changed substantially over the past 10 years. The industry is consolidating in response to the removal of legal barriers to geographic expansion, advancing technologies, and the globalization of wholesale banking, among other things. Between 1985 and 1995, the number of banks and thrifts in the United States fell by about 34 percent due to consolidation through mergers and also bank and thrift failures. The number of banks decreased by 4,476—from 14,417 to 9,941. The number of thrifts decreased by 1,597—from 3,626 to 2,029. Industry consolidation has been characterized by a greater concentration of deposits among the largest banking companies in the country. For example, the 10 largest bank holding companies controlled 17.4 percent of bank deposits in 1984; they increased this share to 25.6 percent in 1994. Similarly, the 10 largest thrift institutions increased their share of deposits from 12.4 percent to 17 percent. However, although nationwide concentration has been increasing over the past 10 years, increases in local market concentration have been much more modest relative to the changes at the national level. According to industry analysts, this has occurred because banking institutions not located in the same local market have merged, and constraints imposed by antitrust laws have helped to prevent increases in concentration at the local level. The nature of the activities that banking institutions engage in has also changed drastically over the past several decades. Although traditional lending still dominates banking institutions’ balance sheets, banking institutions have been moving toward more nontraditional products, such as mutual funds, securities, and derivatives and other off-balance sheet products. Banking institutions, with about $5.3 trillion in assets at the end of 1995, constitute the largest single segment of the financial services industry. However, banking institutions’ share of the financial services industry shrank from about 45 percent in 1985 to about 30 percent in 1995. This decrease has been attributed to greater competition in the financial services industry. Consumers can now choose from a variety of providers in obtaining financial services once offered only by commercial banks and thrifts. For example, money market mutual funds, securities firms, and insurance companies all now offer interest-bearing transaction accounts. Further, although banks and thrifts were long regarded as the primary providers of consumer credit, such credit is now routinely provided by finance companies as well as by a wide variety of retail firms through credit cards and other means. The federal system of oversight of banking institutions in the United States is a highly complex system. Federal responsibilities for bank authorization, regulation, and supervision are assigned to three bank regulators and one thrift regulator that have jurisdiction over specific segments of the banking industry (see table 1.2). Although Treasury plays no formal role in bank oversight, it has some related responsibilities. The Office of the Comptroller of the Currency (OCC) currently has primary responsibility for regulating and supervising national banks—that is, banks with a federal charter. OCC also has primary responsibility for regulating and supervising federal branches and agencies of foreign banks operating in the United States. As of December 31, 1995, OCC was the primary federal supervisor of 2,861 of the 11,970 banking institutions in the United States. Those banks held about 45 percent of the total U.S. banking assets in the United States. The Federal Reserve System (FRS) is the federal regulator and supervisor for bank holding companies and their nonbank subsidiaries, and it is the primary federal regulator for state-chartered banks that are members of FRS. It is also a federal regulator for foreign banking organizations operating in the United States. In addition, it regulates foreign activities and investments of FRS member banks (national and state), Edge corporations, and holding companies. As of December 31, 1995, FRS had primary supervisory responsibility for 1,041 of the 11,970 banking institutions in the United States. The assets of these banks represented about 18 percent of the total U.S. banking assets. As of December 31, 1995, FRS also had responsibility for regulating 6,122 bank holding companies, 393 foreign branches, and 153 foreign agencies operating in the United States. The Federal Deposit Insurance Corporation (FDIC) is the primary federal regulator and supervisor for federally insured state-chartered banks that are not members of FRS and for state savings banks whose deposits are federally insured. FDIC is also responsible for administering the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF).Additionally, FDIC is responsible for resolving failed banks and for the disposition of assets from failed banking institutions. At the end of 1995, FDIC was the primary federal regulator and supervisor for 6,632 of the 11,970 insured banking institutions. These banking institutions represented 22 percent of the total U.S. banking assets. The Office of Thrift Supervision (OTS) is the primary regulator of all federally- and state-chartered thrifts whose deposits are federally insured and their holding companies. At the end of 1995, it was the primary federal regulator of 1,436 institutions, whose assets represented 14 percent of the total assets held by banking institutions. The Department of the Treasury (Treasury) is one of 14 executive departments that make up the Cabinet. It is headed by the Secretary of the Treasury and performs four basic functions, of which formulating and recommending economic, financial, tax, and fiscal policies is the one most directly related to bank oversight. Ultimately, Treasury is responsible for financially backing up the U.S. guarantee of the deposit insurance fundsand may also approve special resolution options for financial institutions whose failure “could threaten the entire financial system.” In addition, Treasury is a principal player in the development of legislation and policies affecting the financial services industries. Treasury also shares responsibility for managing any systemic financial crises, coordinating financial market regulation, and representing the United States on international financial markets issues. A primary objective of banking institution regulators is to ensure the safe and sound practices and operations of individual banking institutions through regulation, supervision, and examination. The intent of regulators under this objective is primarily to protect depositors and taxpayers from loss, not to prevent banking institutions from failing. To help accomplish this goal, the government has chosen to protect deposits through federal deposit insurance, which provides a safety net to depositors. Financial market stability is also considered a primary goal of banking institution regulators. Because banking institutions play an important role as financial intermediaries that borrow and lend funds, public confidence in banking institutions is critical to economic stability at local and national levels. In support of market stability, regulators seek to resolve problems of financially troubled institutions in ways that maintain confidence in banking institutions and thus prevent depositor runs that could jeopardize the stability of financial markets. Regulators are also aware that the stability of the banking industry depends both on the ability of banking institutions to compete in an increasingly competitive environment and on maintaining competition within the industry. Regulators recognize that although their supervisory oversight should be sufficient to oversee safe and sound bank operations and practices, it should not be so onerous as to stifle the industry and impair banks’ ability to remain competitive with financial institutions in other industries and in other countries. Bank regulators also seek to maintain competition by assessing compliance with antitrust laws. Fairness in, and equal access to, banking services is also an important goal of banking institution regulators. Bank regulators seek to ensure access by assessing institutions’ compliance with consumer protection laws. This goal of the banking regulators is unique to the U.S. bank regulatory structure. While the four federal banking regulators share many oversight responsibilities, some of the principal responsibilities of FDIC and FRS fall outside direct regulation and supervision but are related to the goals of bank oversight. For FDIC these include responsibility for administration of the federal deposit insurance funds, resolution of failing and failed banks, and disposition of failed bank assets. For FRS, these include responsibility for monetary policy development and implementation, liquidity lending, and payments and settlements systems operation and oversight. In addition, all four federal regulators may play a role in the management of financial crises, depending on the nature of the crisis. Although FDIC supervises a large number of banking institutions, its primary function is to insure banking institutions’ deposits up to $100,000. FDIC administers BIF—which predominantly protects depositors of commercial banks—and SAIF—which predominantly protects depositors of thrift institutions. FDIC receives no appropriated government funding. BIF is funded wholly through premiums paid on the deposits of member institutions and with some borrowing authority from the government under prescribed conditions, such as liquidity needs of the insurance funds. SAIF is primarily funded through premiums paid on the deposits of thrift institutions and has similar borrowing authority. Both BIF and SAIF are required by statute to have a minimum reserve ratio of 1.25 percent of insured deposits. According to FDIC, as of December 31, 1995, BIF’s fund balance exceeded the ratio 1.30, but SAIF was not fully capitalized. FDIC relies on primary regulators to verify that institutions outside its direct supervisory jurisdiction are operating in a safe and sound manner. Examinations are to be done by the institution’s primary regulators on all the institutions FDIC insures, and FDIC is to receive copies of all examination reports and enforcement actions. However, FDIC may also protect its interest as the deposit insurer through its backup authority. This allows FDIC to examine potentially troubled banking institutions and take enforcement actions, even when FDIC is not the institution’s primary regulator. Regardless of an institution’s primary regulator, only its chartering authority—the state banking commission, OCC, or OTS—has the formal authority to declare that the banking institution is insolvent. Once the chartering authority becomes aware that one of its institutions has deteriorated to the point of insolvency or imminent insolvency, it is to notify FDIC, which is responsible for arranging an orderly resolution. FDIC is required by law to generally select the resolution alternative it determines to be the least costly to BIF and SAIF. To make this least-cost determination, FDIC must (1) consider and evaluate all possible resolution alternatives by computing and comparing their costs on a present-value basis, using realistic discount rates; and (2) select the least costly alternative on the basis of that evaluation. If, however, the least-cost resolution would create a systemic problem—as determined by FDIC’s Board of Directors with the concurrence of the Federal Reserve Board and the Secretary of the Treasury, then, under the Federal Deposit Insurance Corporation Improvement Act (FDICIA), another resolution alternative could be selected. As of June 30, 1996, no systemic problem had been raised by FDIC in making its resolution decisions. Typically—and particularly in the case of large, known to be troubled, institutions—active communication has taken place among the chartering authorities, primary regulators, FDIC, and FRS as liquidity provider. The interaction and coordination typically includes the sharing of examination information, strategies, and economic information, for example. This communication most commonly takes place when the primary regulator considers failure likely so that all regulatory parties can discharge their responsibilities in an orderly manner. When banks fail, FDIC is appointed receiver, directly pays insured claims to depositors or the acquiring bank, and liquidates the remaining assets and liabilities not assumed by the acquiring bank. One of the principal responsibilities of FRS is conducting monetary policy. As stated in the Federal Reserve Act, FRS is “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” FRS conducts monetary policy by (1) using open market operations, the primary tool of monetary policy; (2) determining the reserve requirements that banking institutions must hold against deposits; and (3) determining the discount rate charged banking institutions when they borrow from FRS. FRS is to act independently in conducting its monetary policy. FRS also is to act as lender-of-last-resort to ensure that a temporary liquidity problem at a banking institution does not threaten the viability of the institution or the financial system. Using the discount window, FRS may lend to institutions that are experiencing liquidity problems—for example, when these institutions cannot meet deposit withdrawals. However, when acting in this capacity, FRS requires the lending to be collateralized, and it is to be assured by the banking institution’s primary regulator that the institution is solvent. According to FRS officials, institutions generally do not approach FRS for liquidity loans unless they have no alternative. Liquidity lending may be perceived as a sign that an institution is in trouble, despite the fact that FRS is prohibited from lending to nonviable institutions. In addition, FRS has broad responsibility in the nation’s payments and settlements systems. It is mandated by Congress to act as an intermediary in clearing and settling interbank payments by maintaining reserve or clearing accounts for the majority of banking institutions. As a result, it settles the payment transactions by debiting and crediting the appropriate accounts of banking institutions making payments. In addition, FRS also collects checks, processes electronic fund transfers, and provides net settlement services to private clearing arrangements. Depending on the nature of the situation, federal regulators may play a role in financial system crisis management. FRS, for example, often has a significant role in crisis management in its role as a major participant in financial markets through its liquidity lending, payments and settlements, and other responsibilities. A key role of any central bank is to supply sufficient liquidity to the financial system in a crisis. For example, during the 1987 stock market crash, FRS provided liquidity support to the financial system, encouraged major banks to lend to solvent securities firms, coordinated with Treasury, and encouraged officials to keep the New York Stock Exchange open. During the Ohio Savings and Loan crisis in 1985, FRS intervened with liquidity support until a permanent solution to the instability could be developed. Treasury is also involved in resolving major financial crises, while OCC, OTS, and FDIC have played significant roles involving large bank or thrift failures. Many nonbank subsidiaries of banks and bank holding companies are engaged in securities, futures, or insurance activities. These activities are subject to the oversight of the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), and state insurance regulators, respectively. These regulators may provide information to the Federal Reserve about nonbank subsidiaries of bank holding companies. They may also provide information about nonbank subsidiaries of banks to the responsible primary federal regulator of the parent bank. The primary goals of SEC and CFTC are to maintain fair and orderly markets and public confidence in the financial markets by protecting investors against manipulation, fraud, or other irresponsible practices. The aftermath of the stock market crash of 1929 created a demand for federal oversight of securities and futures activities. The Securities Exchange Act of 1934 created SEC with powers to oversee the securities market exchanges—also called self-regulatory organizations—and to intervene if the exchanges did not carry out their responsibilities for protecting investors. The Commodity Exchange Act of 1936, as amended, governs the trading of commodity futures contracts and options. The Commodity Futures Trading Commission Act of 1974 created the current regulatory structure, consisting of industry self-regulation with government oversight by CFTC. Securities broker-dealers must register with SEC and comply with its requirements for regulatory reporting, minimum capital, and examinations. They must also comply with requirements of the self-regulatory organizations, such as the New York Stock Exchange and the National Association of Securities Dealers. SEC is to monitor broker-dealer capital levels through periodic reporting requirements and regular examinations. CFTC is to review exchange rules, ensure consistent enforcement, and monitor the positions of large traders. CFTC also regulates the activities of various market participants, including futures commission merchants—which must comply with CFTC’s requirements for regulatory reporting, minimum capital, and examinations. In addition, they must comply with the rules imposed by the various exchanges, such as the Chicago Mercantile Exchange and the Chicago Board of Trade as well as the National Futures Association, all of which act as self-regulatory organizations. Regulation of the insurance industry and administration of insurance company receiverships and liquidations are primarily state responsibilities. In general, state legislatures set the rules under which insurance companies must operate. Among their other responsibilities, state insurance departments are to monitor the financial condition of insurers. States use a number of basic methods to assess the financial strength of insurance companies, including reviewing and analyzing annual financial statements, doing periodic on-site financial examinations, and monitoring key financial ratios. State insurance departments are generally responsible for taking action in the case of a financially troubled insurance company. If the insurance company is based in another state, the insurance department can suspend or revoke its license to sell insurance in the department’s state. If a home-based company is failing, the department can put it under state supervision or, in cases of irreversible insolvency, place a company in liquidation. State insurance regulators have established a central structure to help coordinate their activities. The National Association of Insurance Commissioners (NAIC) consists of the heads of the insurance departments of 50 states, the District of Columbia, and 4 U.S. territories. NAIC’s basic purpose is to encourage uniformity and cooperation among the various states and territories as they individually regulate the insurance industry. To that end, NAIC promulgates model insurance laws and regulations for state consideration and provides a framework for multistate “zone” examinations of insurance companies. Congressman Charles E. Schumer asked us to provide information to help Congress evaluate efforts to modernize the U.S. system of federal oversight of banks and thrifts. Our objectives were to (1) discuss previously reported problems with the bank oversight structure in the United States, (2) summarize those characteristics of the five countries’ regulatory structures that might be useful for Congress to consider in any U.S. modernization efforts, and (3) identify potential avenues for modernizing the U.S. banking oversight structure. This report does not address federal oversight of credit unions by the National Credit Union Administration (NCUA), which are also classified as depository institutions. Credit unions hold only a small percentage of all depository institution assets—about 5.5 percent. Also, although the legal and practical distinctions between thrifts and banks have all but disappeared in recent years, the core of credit union business remains traditional consumer lending activities. Finally, the most recent proposals to modernize oversight of financial institutions have not included oversight of credit unions within their scope. To address the objectives of this report, we conducted interviews with senior supervisory officials from the Board of Governors of FRS, Federal Reserve Bank of New York, FDIC, OCC, OTS, and SEC. They also provided us with various documents and statistics, including bank and thrift examination manuals, guidance to examiners and banking industry officials, and statistics on the banking industry. In addition to our interviews with U.S. supervisory officials, we met with officials representing the banking industry, including officials from the American Bankers Association, Independent Bankers Association of America, and Conference of State Bank Supervisors. We also met with officials from the accounting profession, including officials from the American Institute of Certified Public Accountants. In conducting our work we also gathered information from many other sources. These include studies of the history of the banking industry; records from congressional hearings related to regulatory restructuring; and professional literature concerned with the industry structure, regulation, and external audits. We also reviewed relevant banking acts and regulations. This review does not constitute a formal legal opinion on the requirements of the laws. Much of this report was based on our reports of the structures and operations of bank regulation and supervision activities in Canada, France, Japan, Germany, and the United Kingdom. When preparing these reports, we interviewed regulatory and industry officials in each country and reviewed relevant banking laws, regulations, industry statistics, and other industry studies. These reports did not assess the effectiveness or efficiency of bank oversight in the countries studied. This report also draws on extensive work that we have done over the past several years on depository institutions, the deposit insurance program, the securities and insurance industries, international competitiveness, and other aspects of the financial services system in the United States. A comprehensive list of our products addressing issues related to the financial services industry is included at the end of this report. (See Related GAO Products.) We conducted our work from July 1995 through June 1996 in accordance with generally accepted government auditing standards. We provided a draft of this report for comment to the heads of FRS, FDIC, OCC, OTS, and Treasury. FRS, FDIC, OCC, and OTS provided written comments, which are discussed at the end of chapter 4 and reprinted in appendixes IV to VII. Treasury did not provide written comments. Each agency also provided technical comments, which we incorporated where appropriate. All four federal oversight agencies share several supervisory and regulatory responsibilities, including developing and implementing regulations, taking enforcement actions, conducting examinations, and off-site monitoring. Chartering is the responsibility of 2 federal agencies, as well as all 50 states. This structure of shared responsibilities has been characterized by some observers as being inherently inefficient. Furthermore, our work has shown that despite good faith efforts to coordinate their policies and procedures, the four federal bank oversight agencies have often differed on important issues of bank supervision and regulation. The division of primary oversight responsibilities among the four oversight agencies is not based on specific areas of expertise, functions, or activities, either of the regulator or the banks for which they are responsible, but based on institution type—thrift or bank, bank charter type—national or state, and FRS membership. Consequently, the four oversight agencies share responsibility for developing and implementing regulations, taking enforcement actions, and conducting examinations and off-site monitoring. Regulations are the primary vehicle through which regulators elaborate on what the laws mean, clarify provisions of the laws, and provide guidance on how the laws are to be implemented. Regulations typically have the force of law—that is, they can be enforced through a court of law. Regulators have, in some cases, issued guidelines rather than regulations because guidelines provide them greater flexibility to change or update as experience dictates. Guidelines, however, are not directly enforceable in court. In most cases, each regulator is responsible for issuing its own regulations for the banking institutions under its jurisdiction. This may result in four sets of regulations implementing essentially the same provision of the law. Unless regulatory coordination in developing regulations is mandated by law, the regulators may develop regulations independently. Even if the regulators develop regulations jointly, on an interagency basis, they each still issue similar individual regulations under their own legal authority. In some instances, law designates a specific regulator to write the regulation for all banking institutions. For instance, FRS has sole rulemaking responsibility for many consumer protection laws. Each regulator has the authority to take enforcement actions against financial institutions under its jurisdiction. Regulators may initiate informal or formal enforcement actions to get bank management to correct unsafe and unsound practices or conditions identified during the banking institution examination. Regulators have broad discretion in deciding which, if any, regulatory action to choose, and they typically make such decisions on a case-by-case basis. Regulators have said that they prefer to work with cooperative banking institution managers to bring about necessary corrective actions as opposed to asserting formal actions. However, bank regulatory officials have also said that they may take more stringent action when the circumstances warrant it. Under agency guidelines, the regulators are to use informal actions for banking institutions if (1) the institution’s overall strength and financial condition make failure a remote possibility and (2) management has demonstrated a willingness to address supervisory concerns. Informal actions generally include meeting with banking institution officers or board of directors to obtain agreement on improvements needed in the safety and soundness of the institution’s operations, requiring banks to issue resolutions to issue commitment letters to the regulators specifying corrective actions to be taken, and initiating memorandums of understanding between regulators and banking institution officers on actions that are to be taken. Informal actions typically are used to advise banking institutions of noted weaknesses, supervisory concerns, and the need for corrective action. The regulators assume that banking institutions understand that if they do not comply with informal actions, regulators may take stronger enforcement actions. Under agency guidelines, the regulators use formal enforcement actions that are authorized in banking laws when informal actions have not been successful in getting management to address supervisory concerns, management is uncooperative, or the institution’s financial and operating weaknesses are serious and failure is more than a remote possibility. Formal enforcement actions generally include such actions as formal written agreements between regulators and bankers; orders to cease and desist unsafe practices or violations; assessments of civil money penalties; and orders for removal, suspension, or prohibition of individuals from banking institution operations. In addition, OCC and OTS may revoke national banking institutions’ charters and place institutions in conservatorship; FDIC may remove an institution’s deposit insurance. Under FDICIA, all insured banking institutions are to be examined once every 12 months by federal regulators. These examinations are to be conducted by the regulators with primary jurisdiction over the banking institutions. In addition, FDIC may conduct backup examinations of any bank, if necessary, for the purpose of protecting BIF. The full-scope examinations required under law are usually called safety-and-soundness examinations because their primary purpose is to assess the safety and soundness of a banking institution’s practices and operations. The objectives of these on-site examinations are to test and reach conclusions about the reliability of banking institutions’ systems, controls, and reports; investigate changes or anomalies disclosed by off-site monitoring and analysis; and evaluate those aspects of the institution’s operations for which portfolio managers cannot rely on the banks’ own systems and controls. Examinations have historically been extensive reviews of loan portfolios. Currently, according to officials with whom we spoke, regulators are moving toward a risk-management approach and concentrating on institutions’ risk profiles and internal controls. Examiners rate five critical areas of operations—capital adequacy (C), asset quality (A), management (M), earnings (E), and liquidity (L)—to determine an overall rating (CAMEL). They use a five-point scale (with one as the best rating and five as the worst) to determine a CAMEL rating that describes the condition of the institution. As a part of the examination process, regulators are to meet with banking institution officials after every examination. In addition, regulators are to hold separate meetings with the bank’s audit committee and management after each examination to discuss the results of the examination. FRS and OTS also conduct holding company inspections. Holding company inspections differ from bank examinations in that the focus of the inspection is to ascertain whether the strength of a bank holding company is being maintained and to determine the consequences of transactions between the parent company, its nonbanking subsidiaries, and the subsidiary banks. According to FRS and OTS guidelines, the major components of an inspection include an assessment of the financial condition of the parent company, its banking subsidiaries, and any nonbanking subsidiaries; a review of intercompany transactions and relationships; an evaluation of the current performance of the company and its a check of the company’s compliance with applicable laws and regulations. Examiners are to rate five critical areas of the bank holding company—bank subsidiaries (B), other nonbank subsidiaries (O), parent company (P), earnings (E), and capital adequacy (C)—to determine an overall rating referred to as BOPEC. Examiners use a five-point rating scale, similar to that used for CAMEL ratings on banks and thrifts. They also rate management separately as satisfactory, fair, or unsatisfactory. In addition to safety and soundness examinations, regulators are to conduct examinations of banking institutions focusing on compliance with various consumer protection laws and the Community Reinvestment Act (CRA). A consumer compliance examination results in a compliance rating for an institution’s overall compliance with consumer protection laws to ensure that the provision of banking services is consistent with legal and ethical standards of fairness, corporate citizenship, and the public interest. A compliance rating is to be given to the institution based on the numerical scale ranging from 1 for top-rated institutions to 5 for the lowest-rated institutions. Although the regulators may do a CRA compliance examination separately from a consumer compliance examination, officials from all four regulators said that they generally do both examinations at the same time. The purpose of the CRA examination is to evaluate the institution’s technical compliance with a set of specific rules and to qualitatively evaluate the institution’s efforts and performance in serving the credit needs of its entire community. The CRA examination rating consists of a four-part descriptive scale including “outstanding,” “satisfactory,” “needs to improve,” and “substantial noncompliance.” Under the Financial Institution Reform, Recovery, and Enforcement Act of 1989 (FIRREA), CRA was amended to require that the regulator’s examination rating and a written evaluation of each assessment factor be made publicly available—unlike the safety and soundness or compliance examination ratings, which are not made public by regulators. In addition to on-site examinations of banking institutions, each of the regulators engages in off-site monitoring activities. These activities—which generally consist of a review and analysis of bank-submitted data, including call reports, and discussions with bank management—are to help the regulators identify trends, areas of concern, and accounting questions; monitor compliance with requirements of enforcement actions; and formulate supervisory strategies, especially plans for on-site bank examinations. According to examination guidance issued by the regulators, off-site monitoring involves review and analysis of, among other things, quarterly financial reports that banks prepare for and submit to regulators and reports and management letters prepared for banking organizations by external auditors of banks. In general, meetings are not regularly held with banking institution management as part of normal off-site monitoring activities. If off-site monitoring reveals significant changes or issues that could have an impact on the bank, then examiners may meet with management or contact management by telephone to discuss relevant issues. Oversight agencies are focusing more on risk assessment in their off-site monitoring efforts. FDIC officials said that their off-site monitoring programs, such as quarterly reports and off-site reviews, help provide an early indication of a change in an institution’s risk profile. They also said that FDIC has developed new initiatives to improve identifying and monitoring risk. One initiative is the development of decision flowcharts that aid examiners in identifying risks in an institution as well as possible approaches to address them. Another initiative has included increasing the use of technology through the development of an automated examination package and expanding the access that examiners have to internal and external databases in order to provide relevant data to examiners prior to on-site examinations, enabling the examiner to identify specific risks areas. External auditors’ reports, originally prepared to ensure the accuracy of information provided to a banking organization’s shareholders, attest to the fairness of the presentation of the institution’s financial statements and, in the case of large institutions, to management’s assertions about the institution’s financial reporting controls and compliance with certain laws and regulations. Management letters describe important, but less significant, areas in which the banking institution’s management may need to improve controls to ensure reliable financial reporting. Supervisors generally require banking institutions that have an audit—regardless of the scope of the audit—to send the reports, including management letters and certain other correspondence, to the supervisor within a specified time period. Reviews of this information could lead examiners to focus on-site examinations on specific aspects of an institution—such as parts of an institution’s internal control system—or even to eliminate some procedures from the examination plan. The purposes of external audits and safety and soundness examinations differ in important respects and are guided by different standards, methodologies, and assumptions. Even so, external auditors and examiners may review much of the same information. To the extent that examiners could avoid duplicating work done by external auditors, examinations could be more efficient and less burdensome for financial institutions. Supervisors’ actual use of external auditors’ work has varied by agency as well as by individual examiner, according to supervisory officials we interviewed. Primary factors in limiting use, according to some officials we interviewed, include skepticism among examiners about the usefulness of the work of external auditors and concerns that the findings of an external audit could be outdated by the time the financial institution is examined by its federal supervisor. OCC and FDIC recently have undertaken initiatives to improve cooperation between external auditors and examiners and potentially to identify areas in which examiners could better use the work of external auditors. One impetus for improvement efforts was a 1995 report by the Group of Thirty—“Defining the Roles of Accountants, Bankers and Regulators in the United States.” This report recommended, among other things, joint identification by the accounting profession and regulators of areas of reliance on one another’s work; actions by independent audit committees to encourage interaction among regulators, external auditors, and banking institution management; routine use by examiners of audit workpapers; and a permanent board consisting of representatives from each of the federal banking agencies, SEC, the accounting profession, and the banking industry to recommend improvements in the relationship between regulators and external auditors. Regulatory officials we interviewed disagreed with some of the recommendations set out by the Group of Thirty report, and some officials said the report did not give sufficient credit to regulators’ past efforts to work with external auditors. However, regulators generally agreed that this report helped provide some needed momentum for their initiatives. In November 1995, OCC announced plans for a 1-year pilot program to promote greater cooperation between examiners and external auditors and reduce wasteful duplication and oversight burden. The program, which is to involve at least 10 large regional and multinational banks, is expected to result in nonmandatory guidelines on how and under what circumstances examiners and external auditors should work together and use each others’ work. Officials said that certain process-oriented functions where external auditors and examiners are tabulating or verifying the same information—such as documenting and flow-charting internal controls or confirming the existence and proper valuation of bank assets—may be an area where examiners could use the work of external auditors. FRS is also in the process of trying to establish procedures for cooperating more closely with external auditors. As of June 1996, FRS staff had prepared a draft recommendation for the FRS Board to explore opportunities to share information and analytic techniques with external auditors and to seek opportunities to benefit from the work of external auditors. According to FDIC officials, representatives of FDIC have regular meetings with external auditors, and examiners have also recently begun reviewing selected external auditors’ workpapers. Examiners we spoke with told us that information found in the workpapers can be useful because information considered immaterial for financial accounting purposes (which is therefore not discussed in the audit report) can be useful for regulatory purposes. They further found the auditors’ work useful for identifying issues needing management’s attention and providing indicators of management willingness or ability to address those issues. Finally, one of the most important benefits of this workpaper review, according to examiners, is that these reviews promoted expanded communication and interaction between examiners and external auditors and helped acquaint examiners and auditors with each other’s techniques, policies, procedures, and objectives. FDIC officials told us they plan to issue examiner guidance to implement procedures to expand their review of internal and external audit workpapers of institutions that have substantial exposure to higher risk activities, such as trading activities. Officials also said examiners will be expected to contact an institution’s auditor to solicit information that the auditor may have gained from his or her work at the institution since the last examination. Finally, they said that this guidance will require that all Division of Supervision Regional Offices institute a program whereby annual meetings are held between regulators and local accountants to informally discuss accounting, supervisory, and examination policy issues. According to industry officials, OTS—and its predecessor the Federal Home Loan Bank Board (FHLBB)—has had a long-standing history of working with external auditors, and its examiners frequently use the work of external auditors to adjust the scope of examinations. (See app. II for additional information on the use of external auditors in bank supervision.) Banking institutions have a choice of three chartering authorities: (1) state banking authorities, which charter state banks and thrifts and license state branches and agencies of foreign banks; (2) OTS, which charters national thrifts; and (3) OCC, which charters national banks and licenses federal branches and agencies of foreign banks. FRS and FDIC have no chartering authority. However, according to FDIC, all deposit-taking institutions are required to apply to FDIC for federal deposit insurance before they are chartered. Thus, FDIC may have a powerful influence over chartering decisions. Although the authority to charter is limited, each regulator has responsibility for approving mergers, branching, and change-of-control applications. FRS, FDIC, and OTS share their authority to approve branching and mergers of banking institutions under their jurisdictions with state authorities, while OCC alone reviews national bank branch and merger applications. FRS is responsible for approving bank holding company mergers even though the major banking institutions in the merging holding companies may be supervised by OTS, OCC, or FDIC. Likewise, OTS approves thrift holding company mergers. As described in chapter 1, in addition to their primary bank oversight functions, FRS and FDIC have other major responsibilities that include administration of the federal deposit insurance funds; failed or failing bank resolution; and asset disposition for FDIC and, for FRS, monetary policy development and implementation, payments and settlements systems operation and oversight, and liquidity lending. FRS and FDIC officials told us that to fulfill their duties, they rely on information obtained under their respective supervisory authorities. FRS officials said that to carry out their responsibilities effectively, they must have hands-on supervisory involvement with a broad cross-section of banks. FRS officials also said that the successful handling of financial crises often depends upon a combination of the insights and expertise gained through banking supervision and those gained from the pursuits of macroeconomic stability. Experience suggests that in times of financial stress, such as the 1987 stock market crash, FRS needs to work closely with the Department of the Treasury and others to maintain market stability. As we have pointed out in the past, the extent to which FRS needs to be a formal supervisor of financial institutions to obtain the requisite knowledge and influence for carrying out its role is an important question that involves policy judgments that only Congress can make. Nevertheless, past experience, as well as evidence from the five foreign oversight structures we studied (see ch. 3 for further discussion) provides support for the need for FRS to obtain direct access to supervisory information. In its comment letter, FRS stated that it needs active supervisory involvement in the largest U.S. banking organizations and a cross-section of others to carry out its key central banking functions. FDIC officials said that their formal supervisory responsibility enables them to maintain staff that can supervise and assess risk. In their view, this gives FDIC the expertise it requires when it needs to intervene to investigate a problem institution. In addition, FDIC officials said that the agency’s supervision of healthy institutions is useful because it increases their awareness of emerging and systemic issues, enabling them to be proactive in carrying out FDIC’s insurance responsibilities. In its comment letter, FDIC reiterated its need for information on the ongoing health and operations of financial institutions and stated that periodic on-site examination remains one of the essential tools by which such information may be obtained. Under FDICIA, FDIC was given backup examination and enforcement authority over all banks. On the basis of an examination by FDIC or the appropriate federal banking agency or “other information,” FDIC may recommend that the appropriate agency take enforcement action with respect to an insured depository institution. FDIC may take action itself if the appropriate federal banking agency does not take the recommended action or provide an acceptable plan for responding to FDIC’s concerns and if FDIC determines that the institution is in an unsafe or unsound condition, the institution is engaging in unsafe or unsound practices and the action will prevent it from continuing those practices, or the institution’s conduct or threatened conduct poses a risk to the deposit insurance fund or may prejudice the interests of depositors. We are on record as favoring a strong, independent deposit insurance function to protect the taxpayers’ interest in insuring more than $2.5 trillion in deposits. Previous work we have done suggests that a strong deposit insurance function can be ensured by providing FDIC with (1) the ability to go into any problem institution on its own, without having to obtain prior approval from another regulatory agency; (2) the capability to assess the quality of bank and thrift examinations, generally; and (3) backup enforcement authority. As described in chapter 1, Treasury also has several responsibilities related to bank oversight, including being the final decisionmaker in approving an exception to FDIC’s least-cost rule and a principal participant in the development of financial institution legislation and policies. These responsibilities require that Treasury regularly obtain information about the financial and banking industries, and, at certain times, institution-specific information. According to Treasury officials, Treasury’s current level of involvement, through its housing of OCC and OTS and their involvement on the FDIC Board of Directors, and the information it receives from the other agencies, like FDIC and FRS, as needed, is sufficient for it to carry out these responsibilities. For example, according to Treasury, officials at OCC and OTS meet regularly with senior Treasury officials to discuss general policy issues and market conditions. In addition, the Secretary of the Treasury meets regularly with the FRS Chairman, and other senior Treasury officials meet regularly with members of the FRS Board. Furthermore, Treasury officials are in frequent contact with FDIC officials about issues relevant to both organizations. Analysts, legislators, banking institution officials, and numerous past and present regulatory agency officials have identified weaknesses and strengths in the structure of the federal bank oversight system. Some representatives of these groups have broadly characterized the federal system as redundant, inconsistent, and inefficient. Some banking institution officials have also raised concerns about negative effects of the structure on supervisory effectiveness. At the same time, some agency and institution officials have credited the current structure with encouraging financial innovations and providing checks and balances to guard against arbitrary oversight decisions or actions. A principal concern associated with four regulators essentially conducting the same oversight functions for various segments of the industry is that the system is inefficient in numerous respects. For example, each agency has its own internal support and administrative functions, such as facilities, data processing, and training to support the basic regulatory and supervisory tasks it shares with three other agencies. Concerns about inefficiency have also been raised by banking industry officials and analysts because a number of federal regulatory agencies may oversee the banking and nonbanking subsidiaries in a bank holding company. Inefficiencies could result to the extent that the regulator responsible for supervision of the holding company itself, FRS, might duplicate work done by the primary regulator of the holding company subsidiaries—that is, OTS, OCC, or FDIC. According to SEC officials, another area of potential inefficiency is the lack of uniform regulations of bank securities activities. For example, banking institutions that are not part of a holding company are exempted from SEC filing requirements, such as registering their securities offerings and making periodic filings with SEC. This means that there is a duplication of expertise that both SEC and the federal banking institutions’ regulators must develop and maintain to oversee securities offerings and related activities. Overlapping authority and responsibility for examination of subsidiaries could also have the effect of clouding accountability to Congress in cases of weaknesses in oversight of such subsidiaries. According to testimony by the Comptroller of the Currency in 1994, “it is never entirely clear which agency is responsible for problems created by a faulty, or overly burdensome, or late regulation.” Regulators have also raised concerns about FDIC’s backup examination authority. The backup authority remains open to interpretation and, according to regulatory officials, gives FDIC the authority to examine banking institutions regardless of the examination coverage or conclusions of the primary regulator. Regulatory officials said that they were concerned about FDIC’s backup authority because of the possible duplication of effort and the resulting regulatory burden on the affected banks. FDIC’s Board of Directors has worked with FDIC officials in efforts to establish a policy statement clarifying how this authority will be applied in order to avoid inefficiency or undue burden while allowing FDIC to safeguard deposit insurance funds. Regulators, banking officials, and analysts alike assert that the multiplicity of regulators has resulted in inconsistent treatment of banking institutions in examinations, enforcement actions, and regulatory decisions, despite interagency efforts at coordination. For example, in previous studies, we have identified significant inconsistencies in examination policies and practices among FDIC, OCC, OTS, and FRS, including differences in examination scope, frequency, documentation, loan quality and loss reserve evaluations, bank and thrift rating systems, and examination guidance and regulations. To address some of these problems, the federal agencies have operated under a joint policy statement since June 1993 designed to improve coordination and minimize duplication in bank examination and bank holding company inspections. According to OTS, the oversight agencies have adopted a common examination rating system and have improved coordination of examinations, and some conduct joint examinations when feasible. Some of the differences among banking institution regulators result from differences in the way they interpret and apply regulations. Banking officials told us that the agencies sometimes apply different rules to similar situations and sometimes apply the same rules differently. A 1993 Congressional Budget Office (CBO) study cited frequent disagreements between OCC and FRS on the interpretation of laws governing the permissible activities of national banks. These disagreements resulted in a failed attempt by FRS to prevent one national bank from conducting OCC-approved activities in a bank subsidiary. The CBO study also detailed historical differences between the two agencies in other areas, such as merger approvals. In addition to interpreting regulations differently, the regulatory agencies sometimes enforced them differently as well. For example, we observed that regulatory agencies have given different priority to enforcing consumer protection and community lending legislation. Similarly, in our examination of regulatory impediments to small business lending we also found that the agencies had given conflicting advice to their institutions about the procedures for taking real estate as collateral to support traditional small business working capital and equipment loans. Inconsistency among the regulators in examinations as well as in interpreting, implementing, and enforcing regulations may encourage institutions to choose one charter over another to take advantage of these differences. For example, a merger of banking institutions with differing charters may be purposefully structured to place the application decision with the agency deemed most likely to approve the merger and expand permissible activities. According to some former agency officials, a regulatory agency’s desire to maintain or increase the number of institutions under its jurisdiction could inhibit the agency from taking the most appropriate enforcement action against an institution because that action could prompt a charter switch. Although the statutory mandates that define responsibilities of federal regulators help produce a common understanding of the principal goals of bank regulation, bank regulators may prioritize these goals differently, according to the mission of the particular regulatory agency, among other factors. As a result, a banking organization overseen by more than one of the regulators can have different, and sometimes conflicting, priorities placed on its institutions. Various functions within an agency may also differ in the priority they assign oversight goals. For instance, safety-and-soundness examiners from one agency focus on the goals of safety and soundness and the stability of the system and may emphasize high credit standards that could conflict with community development and investment goals. Other examiners from the same agency focus on consumer protection and community reinvestment performance of banking institutions. According to industry officials, the two types of examiners may have different priorities when assessing banking institution activities, even though each represents the same regulatory agency. As a result, industry officials have said that they are sometimes confused about how consistently the goals are applied to individual institutions as well as across the industry. Coordination among regulators to ensure consistent regulation and supervisory policies has been encouraged by Congress in FIRREA and FDICIA and, according to agency officials, has taken place through the Federal Financial Institutions Examination Council (FFIEC), various interagency committees or subcommittees, interagency task forces or study groups, or through agency officials working together. Many joint policies and regulations have been developed in this way. Currently, for example, according to several of the oversight agencies, the federal agencies are working to develop consistent regulations and guidelines that implement common statutory or supervisory policies, pursuant to Section 303 of the Riegle Community Development and Regulatory Improvement Act. How they are to coordinate and the degree to which coordination takes place is to be decided on a case-by-case basis. Although acknowledging the need for agency coordination, bank oversight officials have said that efforts to develop uniform policies and procedures—regardless of the coordination means used—can take months, involve scores of people, and still fail to result in uniformity. Further, they said the coordination process has often caused long delays in decisions on important policy issues. Implementation of FDICIA is such a case. Numerous staff from each of the regulatory agencies were involved over an extended period. However, despite this effort, the agencies missed the statutory deadline for the noncapital tripwire provision authorizing closure of banking institutions even when they still have positive capital levels (section 132 of the act) by several months. In addition, banking institution officials have stated that efforts to coordinate have usually led to what too often becomes the “least common denominator” agreement rather than more explicit uniform regulatory guidance. Certain aspects of the U.S. banking oversight structure may also negatively affect regulatory effectiveness. According to FRS testimony, as of April 30, 1996, about 60 percent of the nation’s bank and thrift organizations were supervised by at least two different federal banking agencies. Some holding companies may be subject to oversight by three or all four of the federal oversight entities (see fig. 2.2). The overlapping authority in bank holding company supervision has sometimes been a problem, according to regulatory officials, because each regulator examines only a segment of the holding company and so must rely upon other regulators for information about the remaining segments. Banking officials have said this not only results in a fragmented approach to supervising and examining institutions but also ignores how the banking organization operates and hinders regulators from obtaining a complete picture of what is going on in the organization. According to these officials, the regulatory structure may result in potential blind spots in supervisory oversight and, therefore, may not be the most effective way to guard against risk to banking institutions or the banking system as a whole. Work that we have done supports these assessments. Although banking officials have acknowledged weaknesses in the structure of the U.S. bank oversight system, they have also found strengths. For example, some regulatory officials believe that regulatory monopolies or single regulators run the risk of being inflexible and myopic; are slow to respond to changes in the marketplace; and, in the long term, are averse to risktaking and innovation by banking institutions. These officials have stated that having multiple federal regulators in the U.S. system has resulted in the diversity, inventiveness, and flexibility in the banking system that is important for responding to changes in market share and in technology. These officials consider the present system to be flexible enough to allow market-driven changes and innovations. The same officials have said that the present system of multiple regulators—with the ability of banking institutions to change charters—provides checks and balances against arbitrary actions and rigid and inflexible policies that could stifle healthy growth in the banking industry. On the basis of the extensive work we have done in areas such as bank supervision, enforcement, failure resolution, and innovative financial activities—such as derivatives—we have previously identified four fundamental principles that we believe Congress could use when considering the best approach for modernizing the current regulatory structure. We believe that the federal bank oversight structure should include consolidated and comprehensive oversight of companies owning federally insured banks and thrifts, with coordinated functional regulation and supervision of individual components; independence from undue political pressure, balanced by appropriate accountability and adequate congressional oversight; consistent rules, consistently applied for similar activities; and enhanced efficiency and as low a regulatory burden as possible consistent with maintaining safety and soundness. Aspects of bank oversight systems in Canada, France, Germany, Japan, and the United Kingdom (U.K.) may be useful to consider when addressing bank oversight modernization. All of the foreign systems had fewer total entities overseeing banking institutions than did the U.S. system of bank oversight—ranging from one (U.K.) to three (France). No more than two oversight entities in the foreign countries were responsible for any single major oversight activity—chartering, regulation, supervision, or enforcement. In all five countries we studied, banking organizations typically were subject to consolidated oversight, with one oversight entity being legally responsible and accountable for the entire banking organization, including its banking and nonbanking subsidiaries. The oversight systems in the countries we reviewed generally included roles for both central banks and finance ministries. This reflects a close relationship of traditional central bank responsibilities with oversight of commercial banks as well as the national government’s ultimate responsibility to maintain public confidence and stability in the financial system. At the same time, most of the foreign countries incorporated checks and balances to guard against undue political influence and to ensure sound supervisory decisionmaking. The other countries’ deposit insurers had narrower roles than that of FDIC and often were not government entities. Finally, foreign systems incorporated a variety of mechanisms and procedures to ensure consistent oversight and improve efficiency. Compared to the U.S. bank oversight structure, with four federal agencies performing many of the same oversight functions, the other countries’ structures looked less complex (see table 3.1 for a brief overview of the other countries’ oversight systems). The total number of bank oversight entities in each of the countries we studied ranged from one (U.K.) to three (France). At one end of the spectrum was the Bank of England, which performed all bank oversight functions. At the other end, in France, were the three independent decisionmaking committees—chartering, regulating, and supervising—all of which were supported by central bank staff. The foreign systems also had fewer oversight entities engaged in chartering, regulation, supervision, and enforcement activities compared to the U.S. system. Although all four U.S. agencies issue rules, conduct examinations, and take enforcement actions—OCC and OTS are the only federal chartering authorities in the United States—the foreign systems had authorized no more than two agencies to perform each of those functions. In each of the countries we studied, chartering of commercial banking institutions was the responsibility of only one entity. This differs markedly from the U.S. system, in which banking institutions may be chartered by state banking commissions, OTS, or OCC. As in the United States, the chartering entities in the other countries assessed applications on the basis of several factors. The most universal of the factors considered were the adequacy of capital resources and the expertise and character of financial institution management. In the United States, as noted in chapter 1, a banking institution’s federal oversight agency is largely determined by the institution’s charter, and under most circumstances an institution may switch its charter in order to come under the jurisdiction of an agency it may favor. Such switching of regulators is not a possibility in the countries we studied. In contrast to the U.S. system, in which each of the four banking institution oversight entities is generally authorized to issue its own regulations or regulatory guidelines, responsibility for issuing regulations in the countries we studied was usually limited to one entity. In France, this responsibility was assigned to the Bank Regulatory Committee; in Germany, to the Federal Bank Supervisory Office (FBSO); in Japan, to the Ministry of Finance; and in the U.K., to the Bank of England. In Canada, however, the bank supervisor and the deposit insurer were both authorized to issue regulations or standards. The insurer had the authority to issue standards pertaining to its operations and functions and those of its members. To guard against monolithic decisionmaking, the regulatory processes in all five countries were designed to include the views of other agencies involved in bank, securities and insurance oversight, and those of the regulated industry. The single-regulator approach in four of the foreign countries we studied and the coordination of regulation between the federal regulator and the deposit insurer in Canada meant that in all five countries, all banking institutions conducting the same lines of business were subject to the same safety and soundness standards, including rules related to permissible activities. This contrasts with the four regulator system in the United States, as discussed in chapter 2. In the countries we studied, major supervisory activities were never shared by more than two entities. For purposes of our analysis, we defined these activities as (1) monitoring banks’ financial condition and operations through on-site examinations or inspections, (2) monitoring through the collection and analysis of data in reports filed by banks and through meetings with bank officials and others, and (3) enforcing laws and regulations through formal or informal actions. In Canada, both the bank supervisor and the deposit insurer performed supervisory duties. In France, the supervisory duties were performed by the committee called the Banking Commission; in Germany, by the federal bank supervisor and the central bank; in Japan, by the Ministry of Finance and the Bank of Japan; and in the U.K., by the Bank of England. In four of the five countries we studied, the responsibility for taking formal enforcement actions was limited to one supervisor. For instance, in the U.K., the Bank of England was solely responsible for formal enforcement actions. In Germany, the federal supervisor was responsible for enforcement actions; in France, the Banking Commission; and, in Japan, the Ministry of Finance in Japan. Canada’s deposit insurer could take specific, narrowly defined enforcement actions to protect the deposit insurance fund, such as levying a premium surcharge on individual members or terminating an insured institution’s deposit insurance. Most of the other countries’ bank supervisors said they conducted on-site examinations less frequently than U.S. bank supervisors, and they said that the examinations conducted were often narrower in scope than U.S. examinations. In France, on-site examinations were conducted on average less frequently than every 4 years, depending on the institutions being examined. In Japan, examinations were conducted approximately every 1 to 3 years. Canada’s frequency of on-site examinations, like that of U.S. supervisors’, was to be once a year. Supervisors in Germany and the U.K. said they relied on information collected for them by external auditors rather than conducting their own regularly scheduled on-site examinations. In the three countries that conducted regular on-site examinations, the examinations were to primarily assess the safety and soundness of bank operations and verify the accuracy of data submitted for off-site monitoring purposes. Special purpose examinations, in Canada and elsewhere, were also to be conducted across the industry to determine how specific issues—such as corporate governance—were being handled across the banking system. In monitoring the financial conditions and operations of banks, most of the supervisory entities in other countries said they generally relied more extensively than supervisors in the United States on off-site information, primarily information in periodic reports submitted by banking institutions. Reporting by banks included information on assets, liabilities, and income, as is the case in the United States, as well as more detailed information. In France, for example, the Banking Commission had implemented a new reporting system for credit institutions for the purpose of collecting and analyzing information for prudential, monetary, and balance of payments purposes. The system was intended to provide an early warning of potential problems in individual banks or in the banking system as a whole. Indicators of potential safety and soundness problems were typically to be discussed with bank officials, whether in meetings or correspondence, and could trigger an on-site examination. Banks in several of the countries were also required to submit information on their major credit exposures, which the regulators could analyze for excessive growth or concentrations that might indicate safety and soundness problems for either the individual bank or the banking system. Other important sources of information included meetings with bank management. For example, supervisors said they often met with management to follow up on information collected through their off-site monitoring. Such meetings could include questions about potential informational discrepancies and any business implications, or they could provide an opportunity for discussions about the institution’s operations. In three countries (Canada, Germany, and the U.K.), work performed by banks’ external auditors also contributed significantly to supervisory information (see discussion below on the contribution of external auditors to bank supervision). As discussed in chapter 2, U.S. federal bank supervisors also monitor the condition of banks using information contained in periodic reports and discussions with bank management. However, U.S. regulators do not collect some of the information that is used for risk assessment purposes overseas, such as the reporting of large credit exposures. As has often been true in the United States, supervisors in each of the countries we reviewed said they preferred to rely principally on informal enforcement actions, such as warnings or persuasion and encouragement. Informal actions generally were regarded by supervisors as easier and faster to put into effect and sufficiently flexible to ensure that the institutions took timely corrective actions. Supervisors also told us that banking institutions understood that if they did not comply with informal actions and recommendations, formal actions were sure to follow. While authorization to take formal actions in most of the foreign countries was limited to the primary supervisor, informal actions sometimes could be taken by more than one oversight entity. In Germany, for example, the central bank could suggest to banks remedies for perceived shortcomings and recommend enforcement actions to the federal supervisor. In Japan, the Bank of Japan also could recommend informal enforcement actions, such as suggested remedies to perceived problems. In Canada, the deposit insurer could recommend enforcement actions to the supervisor as well as take some limited enforcement actions on its own if the insurance fund was considered at risk. The financial services industries in the five countries have, over time, experienced serious failures, control problems, or other financial difficulties that have resulted in significant changes or at least the consideration of such changes to bank oversight structures. These changes include a strengthened on-site examination capability and an increased formality in the supervisory process and use of enforcement actions in several countries. In the five countries we studied, banking organizations typically were subject to consolidated oversight, with an oversight entity responsible and accountable for an entire banking organization, including banking and nonbanking subsidiaries. For instance, if a bank had nonbank subsidiaries regulated by securities or insurance regulators, bank regulators nonetheless were responsible for supervisory oversight of the bank as a whole. The bank regulators would generally rely on the nonbank regulators’ expertise in overseeing the bank’s subsidiaries. For example, in France, the Banking Commission was responsible for the supervision of the parent bank and the consolidated entity, even though securities or insurance activities in bank subsidiaries were the responsibility of other regulators in those areas. In Canada, the federal supervisor was responsible for all federally incorporated financial institutions, such as banks, insurance companies, and trust companies. Securities subsidiaries of banks were the responsibility of provincial securities regulators who shared information with the bank regulator for purposes of consolidated oversight. Regulators in the U.K. also operated under the consolidated oversight approach. For a bank that owned nonbank subsidiaries, the Bank of England remained the lead regulator and had responsibility for the entity as a whole. However, it relied on the expertise of securities and insurance supervisors to provide information on subsidiaries conducting such activities. If the major top-level entity was a securities firm that owned a bank, then the securities regulator was the lead regulator of the entire entity and would rely on the bank regulator for information about the bank. If banks conducted securities or other activities within the bank department rather than in a nonbank subsidiary, then the bank regulator retained supervisory responsibility. In Germany, for example, where universal banks were able to conduct an array of activities from deposits to securities activities within the banking institutions, the federal supervisor was responsible for all bank and nonbank activities conducted within a bank. The oversight systems in the countries we reviewed generally included roles for both central banks and finance ministries, reflecting the close relationship of traditional central bank responsibilities with oversight of commercial banks as well as the national government’s ultimate responsibility to maintain public confidence and stability in the financial system. Central banks generally played significant roles in supervision and regulatory decisionmaking in the countries we studied, largely based on the premise that central bank responsibilities for monetary policy and other functions, such as crisis intervention, oversight of clearance and settlements systems, and liquidity lending, are interrelated with bank oversight. Although no two countries had identical structures for including central banks in bank oversight, they each accorded their central banks roles that ensured access to, and certain influence over, the banking industry. The central bank’s role was most direct in the U.K., where the Bank of England had sole responsibility for the authorization, regulation, and supervision of banks. Canada had a far less direct role for its central bank in supervision and regulation. Even so, the Bank of Canada influenced supervisory and regulatory decisionmaking as a member of (1) the deposit insurance board; (2) the Financial Institutions Supervisory Committee, an organization established to enhance communication among participants in financial institution regulation and supervision; and (3) the Senior Advisory Committee, which was to meet to discuss major policy changes or legislative proposals affecting bank oversight. However, it had no direct authority over supervisory or regulatory decisionmaking. In France, Germany, and Japan the central bank was one of two principal oversight agencies, but the countries had different structures for involving the central banks in bank oversight. In Germany, the primary supervisor, not the central bank, was authorized to issue banking regulations and, with few exceptions, issue or revoke bank licenses and take enforcement actions against banks. However, a sharp contrast existed between the legally assigned responsibilities of the central bank and its de facto sharing of oversight responsibilities with the federal bank supervisor. The central bank and the federal bank supervisor worked closely together and were considered partners in the formulation of regulatory and supervisory policies. The supervisor was to consult the central bank about all regulations; the central bank was substantively involved in the development of most of the regulations and could veto some. It also had the most active role in day-to-day bank supervision of banks and was very influential in determining the enforcement actions to be taken by the federal bank supervisor. The influence of the central bank in bank oversight arises from its detailed knowledge about banks in Germany, certain legal requirements that it be consulted before supervisory or regulatory action was taken, and the general perception that its nonoversight responsibilities were closely linked with bank oversight. The central bank of France was also very involved in bank oversight, but the structural basis for its involvement differed significantly from that in Germany. The decisionmaking responsibilities for supervision and regulation of banking institutions in France were divided among three different but interrelated oversight committees: one for chartering, one for regulation, and one for supervision. The Bank of France was a member of each of these committees. Its influence over bank oversight stemmed from its chairmanship of two of the three oversight committees—the committee for chartering and the committee for supervision (the Banking Commission); the fact that it staffed all three oversight committees and the examination teams; its authority in financial crises; and its importance in and influence over French financial markets. The Japanese central bank also had some oversight responsibilities derived principally from the contractual agreements it made with financial institutions that opened accounts with the Bank of Japan—including all commercial banks. As a result, it examined these banks on a rotational basis with the Ministry of Finance and also met regularly with bank management. Although only the Ministry had the legal authority to take formal enforcement actions, the central bank provided guidance that banks usually interpreted as binding. In all of the countries we reviewed finance ministries were included in oversight structures, although their roles varied. In some countries, the bank supervisors reported to the finance ministries and the finance ministries had final approval authority for regulations or enforcement actions. In other cases, the finance ministry acted as the principal supervisor or a representative of the finance ministry participated as a member of a decisionmaking committee. In most countries, the finance ministries received industrywide information to assist in discharging fiscal policy and other responsibilities. They often did not receive bank-specific information unless the regulator believed an institution to be a potential threat to system stability. In such situations, the finance ministry was to be apprised for crisis management and information purposes, as were the central bank and deposit insurer in order to ensure each could effectively carry out its respective responsibilities. In Canada and Germany, the principal bank supervisor reported to the Minister of Finance. The oversight entities that reported to the finance ministries said that on day-to-day issues they had a significant amount of independence—the government was generally informed only of key regulatory or supervisory decisions. However, the agreement of the finance ministry was usually necessary for these decisions to be carried out. In France, the Ministry of Economic Affairs was represented on each of the three independent oversight committees and chaired one of them. According to oversight and banking officials with whom we spoke, its influence over bank oversight was derived primarily from its chairmanship of the bank regulatory committee and its membership on the chartering and oversight committees, as well as from its position of power in the French cabinet, including its powers of final approval with regard to bank regulations. In Japan, the Minister of Finance was the formal supervisor of banking institutions. It was solely responsible for chartering banking institutions, taking formal enforcement actions, and developing and issuing regulations. In addition, it also examined banks and conducted off-site monitoring. In the U.K., the Bank of England reports to the Chancellor of the Exchequer, who heads the Treasury. The Treasury has no formal role in banking supervision, although it would expect to be consulted on any major regulatory or supervisory decision. The Chancellor does have the power to issue directions to the Bank of England after consultation with the Governor of the Bank, ensuring that the government would have the final say in the event of a disagreement. Historically, the Bank of England has been accorded a high degree of independence in bank regulation and supervision. Other countries’ systems of bank oversight incorporated various checks to guard against undue political influence in bank oversight and to ensure sound decisionmaking. These checks included shared responsibilities and decisionmaking and the involvement of banking institutions in the development of bank oversight policies and other decisionmaking. According to Canadian officials, a degree of overlapping authority of the federal supervisor and the deposit insurer (whose governing board is to include four directors from the private sector) plays a useful role in ensuring integrity in bank oversight. For example, the independent assessments of the deposit insurer could provide a constructive second look at the bank supervisor’s oversight practices. Similarly, the interactions of the supervisor with banking institutions could help the insurer assess risks of particular banking practices. Finally, the federal supervisor is required to consult extensively with banking industry representatives in developing regulations and guidelines. In Canada, the large size and small number of banks enabled banks to be influential players in the financial system, according to supervisory and central bank staff. The large banks believed they had a special responsibility for helping to ensure the stability of the financial system, as well as a self-interest in that stability. We were told by management of some of the major banks that they often related concerns and offered comments about other banks or financial institutions to the federal supervisor or the central bank. In France, a rationale for the committee oversight structure—with the Bank of France and the Ministry of Economic Affairs participating jointly on the committees—was to ensure that no single individual or agency could dominate or dictate oversight decisionmaking, according to Bank of France officials. In addition, the committee structure ensures that the interests of banks are represented. Each of the three bank oversight committees includes four members, including representatives of the banking industry, drawn from outside the Bank of France and the Ministry of Economic Affairs. In Germany, the decisionmaking power of the politically accountable federal bank supervisor was checked by the participation in bank oversight of the very independent central bank. Without the central bank’s accord, very few, if any, important supervisory or regulatory actions would be taken. The central bank’s express approval was legally required for certain regulations, such as those affecting liquidity and capital requirements, to take effect. In addition, the federal supervisor was required by law to consult with banking associations when changes to banking law or regulations were being considered and before banking licenses were issued. In Japan, the Ministry of Finance typically developed policy by consensus, according to Ministry officials—a process that usually involved the input of many parties, such as the central bank, other government agencies, industry groups, and governmental policy councils. In addition, the Japanese central bank’s participation in bank oversight could provide a second opinion on some oversight issues. In the U.K., the Banking Act of 1987 formally established an independent body, known as the Board of Banking Supervision, to bring independent commercial banking experience to bear on banking supervisory decisions at the highest level. In addition to three exofficio members from the Bank of England, the Board’s members are to include six independent members who are to advise the exofficio members on policymaking and enforcement issues. If the Bank decides not to accept the advice of the independent members of the Board, then the exofficio members are to give written notice of that fact to the Chancellor of the Exchequer. Deposit insurers in the countries we studied generally had more narrow roles than that of FDIC. This less substantial oversight role may be attributable to the fact that national governments provided no explicit guarantees of deposit insurance and that deposit insurers were often industry administered. The foreign deposit insurers we studied did not have a role in bank oversight as substantial as FDIC’s. As discussed in chapter 1, FDIC is the administrator of federal deposit insurance, the primary federal regulator and supervisor for state-chartered banks that are not members of FRS, and the entity with primary responsibility for determining the least costly resolution of failed banks. In most countries, by contrast, deposit insurers were viewed primarily as a source of funds to help resolve bank failures—either by covering insured deposits or by helping to finance acquisitions of failed or failing institutions by healthy institutions.Supervisory information was generally not shared with these deposit insurers, and resolution decisions for failed or failing banks were commonly made by the primary bank oversight entities with the insurer frequently involved only when its funds were needed to help finance resolutions. The broader role of FDIC as compared to deposit insurers in other countries may be attributable in part to the fact that deposit insurance is federally guaranteed in the United States. For example, FDIC’s involvement in bank resolutions—particularly its responsibility to determine the least costly of resolution methods—helps protect the interests of both the industry and potentially of taxpayers when a bank fails. None of the governments of the other countries we studied provided such an explicit guarantee. Four of the five deposit protection programs—Germany is the exception—also provide less coverage than does the U.S. system. In Germany and France, deposit protection systems were administered by banking associations, with no direct government involvement. The German commercial banking association administered Germany’s deposit protection plan for commercial banks. The association obtained independent information about its members through external audits conducted by an accounting firm affiliate. It also could play a significant role in resolving troubled institutions. It had the power to intervene and attempt to resolve a member bank’s difficulties and could be pressured by the central bank or bank supervisor to do so. Thus, the German banking industry generally resolved its own problems. In France, the deposit protection system—a loss-sharing agreement among member banks—was administered by the French Bank Association. The French Bank Association itself played a relatively minor role in resolving bank problems. Instead, the Banking Commission was responsible for resolving troubled institutions. In the U.K. and Japan, the responsibility for the administration of deposit insurance was shared by government and the banking industry. Deposit insurers were independent bodies whose boards of directors were headed by government officials and included members from the banking industries. In these countries, the government, not the banking associations, resolved banking institutions’ problems. Canada’s oversight system was most similar to that of the United States. The Canadian deposit insurer did not act as a primary supervisor for any banking institutions; however, like FDIC, it had examination and rulemaking authority—although its powers were more limited than those of FDIC’s. It could take limited enforcement action and was represented on two of Canada’s oversight-related committees. The Canadian deposit insurer generally relied on the primary banking supervisor for examination information it needed to safeguard insurance funds. Until a financially troubled institution was declared insolvent and was placed in liquidation, the bank supervisor had the lead role in resolving that institution. However, the supervisor was to continuously inform the deposit insurer of the institution’s status. The deposit insurer could order a special examination to determine its exposure and possible resolution options if the institution failed. In the case of a failure, the deposit insurer was responsible for developing resolution alternatives and for implementing the chosen resolution plan. Most of the foreign structures with multiple oversight entities incorporated mechanisms and procedures that could ensure consistent and efficient oversight. Some countries relied on the work of external auditors, at least in part, for purposes of efficiency. Unlike in the United States, bank oversight in these countries generally did not include consumer protection or social policy issues. Coordination mechanisms designed to ensure consistency and efficiency in oversight in the countries we studied included oversight committees or commissions with interlocking boards, shared staff, and mandates or mechanisms to share information and avoid duplication of effort. In Canada, the federal bank supervisor, central bank, and finance ministry each had a seat on the deposit insurer’s board of directors and participated with the deposit insurer on various advisory committees. Also, the Canadian deposit insurer, which had backup supervisory authority to request or undertake special examinations of high-risk institutions, was required to rely for much of its information on the primary supervisor, whose examiners conducted all routine bank examinations and engaged in other data collection activities. In France, central bank employees staffed all three committees charged with oversight responsibilities for chartering, rulemaking, and supervision. In addition, the central bank and the Ministry of Economic Affairs were represented on each of the three oversight committees. In Germany, the central bank and the federal bank supervisor used the same data collection instruments. They were also legally required to share information that could be significant in the performance of their duties. Bank supervisors in three of the five countries whose systems we reviewed used the work of the banks’ external auditors as an important source of supervisory information. In the most striking contrast with the United States’ system, supervisors in Germany and the U.K. used external auditors as the primary source of monitoring information. In Canada, as in the United States, the primary supervisor conducted examinations; information from the banks’ external auditors was to be used to supplement and guide these examinations. Supervisors in all three countries recognized that auditors’ objectives for reviewing a bank’s activities could differ from those of a supervisor, and they also recognized that a degree of conflict could exist between the external auditors’ responsibilities to report to both their bank clients and to the bank supervisory authorities. However, they generally believed that their authority over auditors’ engagements was sufficient to ensure that the external auditors properly discharged their responsibilities and openly communicated with both their bank clients and the oversight authorities. In both Germany and the U.K., supervisors’ use of external auditors’ work was adopted at least in part for purposes of efficiency. In Germany, the use was part of an explicit plan to minimize agency staffing and duplication of effort between examiners and auditors. In the U.K., the use was seen as the most efficient way of introducing the necessary checks on systems controls and as a method compatible with the Bank of England’s traditional approach of supervising banks “based on dialogue, prudential returns, and trust,” according to Bank of England officials. Canada, Germany, and the U.K. differed from the United States in three other important ways: All banking institutions in the three foreign countries were required to have external audits. As discussed in chapter 2, large U.S. banks are required by U.S. oversight agencies to have external audits, and others are encouraged to do so. Bank supervisors in the three foreign countries had more control than U.S. bank supervisors over the work performed by external auditors. In Germany and the U.K., external audits were conducted using specific guidelines developed by the bank regulators, and the scope of individual audits could be expanded by all three regulators, or special audits ordered, to address issues of regulatory concern. By contrast, U.S. supervisors have more limited authority over the scope of external audits. External auditors in the three foreign countries had affirmative obligations to report findings of concern to supervisors. In Canada, external auditors are required to report simultaneously to the institution’s CEO and the bank supervisor anything discovered that might affect the viability of the financial institution. In Germany, external auditors are required by law to immediately report to the bank supervisor information that might result in qualification of the report or a finding of a significant problem. In the U.K., external auditors are required to report to the central bank any breaches in the minimum authorization criteria as well as expectations of a qualified or adverse report. In the United States, however, external auditors are required merely to notify the appropriate banking agency if they withdraw from an engagement. External auditors are required to withdraw from an audit engagement if identified problems are not resolved or if bank management refuses to accept their audit report. Further detail about the role of external audits in U.S. bank supervision is provided in appendix II. Bank oversight in the countries we studied, was focused almost exclusively on ensuring the safety and soundness of banking institutions and the stability of financial markets and generally did not include consumer protection or social policy issues. The national governments of the countries we studied used other mechanisms to address these issues or to promote these goals. Consumer protection and antidiscrimination concerns were addressed in many of the other countries by industry associations and government entities other than bank regulators and supervisors. In addition, some of the policy mechanisms used to encourage credit and other services in low- and moderate-income areas in these countries included the chartering of specialized financial institutions and direct government subsidies for programs to benefit such areas. In Canada, for example, the banking industry developed voluntary guidelines related to consumer and small business lending, partly to prevent the need for legislated solutions to perceived problems. Similarly, the banking industries in France and the U.K. also developed industry guidelines on issues such as consumer protection. Bank supervisors in Canada and the U.K. were not responsible for enforcing compliance with these guidelines and best practices, but the bank supervisor in France did have such responsibility. In addition, bank supervisors in the countries we studied were not expressly responsible for assessing compliance with other consumer protection laws, like those involving discrimination or antitrust; but they were responsible, in some countries, for advising their Justice Department equivalents of potential violations identified in carrying out their bank oversight duties. Officials in these countries suggested that concern and attention to various consumer issues were increasing, but they did not anticipate bank regulators would assume any new responsibilities in this area. The division of responsibilities among the four federal bank oversight agencies in the United States—FDIC, FRS, OCC, and OTS—is not based on specific areas of expertise, functions or activities, either of the regulator or the banks for which they are responsible, but based on institution type—bank or thrift, bank charter type—national or state, and whether banks are members of the FRS. Consequently, the four oversight agencies share responsibility for developing and implementing regulations, taking enforcement actions, and conducting examinations and off-site monitoring. Analysts, legislators, banking institution officials, and numerous past and present agency officials have identified weaknesses and strengths in this oversight structure. Some representatives of these groups have broadly characterized the federal system as redundant, inconsistent, and inefficient. Some banking institution officials have also raised concerns about negative effects of the structure on supervisory effectiveness. Some regulators, banking institutions, and analysts alike have asserted that the multiplicity of regulators has resulted in inconsistent treatment of banking institutions in examinations, enforcement actions, and regulatory decisions, despite interagency efforts at coordination. We have cited significant inconsistencies in examination policies and practices among FDIC, OCC, OTS, and FRS, including differences in examination scope, frequency, documentation, loan quality and loss reserve evaluations, bank and thrift rating systems, and examination guidance and regulations. At the same time, some agency and institution officials have credited the current structure with encouraging financial innovations and providing checks and balances to guard against arbitrary oversight decisions or actions. As a result of concerns about the current oversight structure, many proposals have been made to restructure the multiagency system of bank regulation and supervision. These proposals have not been implemented, partly as a result of assertions by FRS and FDIC officials that they rely on information obtained under their respective supervisory authorities to fulfill their nonoversight duties: monetary policy development and implementation, liquidity lending, and operation and oversight of the nation’s payment and clearance systems for FRS; administration of the deposit insurance funds, resolution of failing or failed banks, and disposition of failed bank assets for FDIC. As we have pointed out in the past, the extent to which FRS needs to be a formal supervisor of financial institutions to obtain the requisite knowledge and influence for carrying out its role is an important question that involves policy judgments that only Congress and the President can make. Nevertheless, past experience, as well as evidence from the five foreign oversight structures we studied (see below for further discussion) provides support for the need for FRS to obtain direct access to supervisory information. We have also favored a strong, independent deposit insurance function to protect the taxpayers’ interest in insuring more than $2.5 trillion in deposits. Nonetheless, previous work we have done suggests that a strong deposit insurance function can be ensured by providing FDIC with (1) the ability to go into any problem institution on its own, without having to obtain prior approval from another regulatory agency; (2) the capability to assess the quality of bank and thrift examinations, generally; and (3) backup enforcement authority. Treasury also has several responsibilities related to bank oversight, including being the final decisionmaker in approving an exception to FDIC’s least-cost rule. In addition, Treasury plays a major role in developing legislative and other policy initiatives with regard to financial institutions. Such responsibilities require that Treasury regularly obtain information about the financial and banking industries and, at certain times, institution-specific information. According to Treasury officials, Treasury’s current level of involvement, through its housing of OCC and OTS and their involvement on the FDIC Board of Directors, and the information it receives from the other agencies as needed, is sufficient for it to carry out these responsibilities. On the basis of the work we have done in areas such as bank supervision, enforcement, failure resolution, and innovative financial activities—such as derivatives—we have previously identified four fundamental principles that we believe Congress could use when considering the best approach for modernizing the current regulatory structure. We believe that the federal bank oversight structure should include: (1) clearly defined responsibility for consolidated and comprehensive oversight of entire banking organizations, with coordinated functional regulation and supervision of individual components; (2) independence from undue political pressure, balanced by appropriate accountability and adequate congressional oversight; (3) consistent rules, consistently applied for similar activities; and (4) enhanced efficiency and reduced regulatory burden, consistent with maintaining safety and soundness. In five recent reports, we reviewed the structure and operations of bank regulation and supervision activities in Canada, France, Germany, Japan, and the U.K. Each of the oversight structures of these five countries reflects a unique history, culture, and banking industry, and, as a result, no two of the five oversight structures are identical. Also, all of the countries we reviewed had more concentrated banking industries than does the United States, and all but Japan had authorized their banks to conduct broad securities and insurance activities in some manner. Nevertheless, certain aspects of these structures may be useful to consider in future efforts to modernize banking oversight in the United States, even though no structure as a whole likely would be appropriate to adopt in the United States. In the five countries we studied, banking organizations typically were subject to consolidated oversight, with an oversight entity being legally responsible and accountable for the entire banking organization, including its subsidiaries. If securities, insurance, or other nontraditional banking activities were permissible in bank subsidiaries, functional regulation of those subsidiaries was generally to be provided by the supervisory authority with the requisite expertise. Bank supervisors generally relied on those functional regulators for information but remained responsible for ascertaining the safety and soundness of the consolidated banking organization as a whole. The number of national bank oversight entities in the countries we studied was fewer than in the United States, ranging from one in the U.K. to three in France. Furthermore, in all five countries no more than two national agencies were ever significantly involved in any one major aspect of bank oversight, such as chartering, regulation, supervision, or enforcement. Commercial bank chartering, for example, was the direct responsibility of only one entity in each country. In those countries where two entities were involved in the same aspect of oversight, the division of oversight responsibilities generally was based on whichever entity had the required expertise. The central banks in the countries we studied generally had significant roles in supervisory and regulatory decisionmaking; that is, with the exception of the Canadian central bank, their staffs were directly involved in aspects of bank oversight, and all central banks had the ability to formally or informally influence bank behavior. In large part, central bank involvement was based on the premise that traditional central bank responsibilities for monetary policy, payment systems, liquidity lending, and crisis intervention are closely interrelated with oversight of commercial banks. While no two countries had identical oversight roles for their central banks, each country had an oversight structure that ensured that its central bank had access to information about, and certain influence over, the banking industry. In each of the five countries, the national government recognized that it had the ultimate responsibility to maintain public confidence and stability in the financial system. Thus, each of the bank oversight structures that we reviewed also provided the Ministry of Finance, or its equivalent, with some degree of influence over bank oversight and access to information. Although each country included its finance ministry in some capacity in its oversight structure, most also recognized the need to guard against undue political influence by incorporating checks and balances unique to each country. While central banks and finance ministries generally had substantial roles in bank oversight, deposit insurers, with the exception of the Canada Deposit Insurance Corporation, did not. Their less substantial oversight role may be attributable to the fact that national governments provided no explicit guarantees of deposit insurance and that deposit insurers were often industry-administered. Thus, in most of these countries, deposit insurers were viewed primarily as a source of funds to help resolve bank failures—either by covering insured deposits or by helping to finance acquisitions of failed or failing institutions by healthy institutions. Supervisory information was generally not shared with these deposit insurers, and resolution decisions for failed or failing banks were commonly made by the primary bank oversight entities. Most of the foreign structures with multiple oversight entities incorporated mechanisms and procedures that could ensure consistent and efficient oversight. As a result, banking institutions that were conducting the same lines of business were generally subject to a single set of rules, standards, or guidelines. Coordination mechanisms included having oversight committees or commissions with interlocking boards, shared staff, or mandates to share information. Some countries relied on the work of external auditors, at least in part, for purposes of efficiency. Bank oversight in these countries generally did not include consumer protection or social policy issues. There are many practical problems associated with creating a new agency or consolidating existing functions. Although such issues were beyond the scope of this report, it remains important that transition and implementation issues be thoroughly considered in deliberations about any modernization of bank oversight. GAO’s work on the five foreign oversight systems showed that there are a number of different ways to simplify bank oversight in the United States in accordance with the four principles of consolidated oversight, independence, consistency, and enhanced efficiency and reduced burden. GAO recognizes that only Congress can make the ultimate policy judgments in deciding whether, and how, to restructure the existing system. If Congress does decide to modernize the U.S. system, GAO recommends that Congress: Reduce the number of federal agencies with primary responsibilities for bank oversight. GAO believes that a logical step would be to consolidate OTS, OCC, and FDIC’s primary supervisory responsibilities into a new, independent federal banking agency or commission. Congress could provide for this new agency’s independence in a variety of ways, including making it organizationally independent like FDIC or FRS. This new independent agency, together with FRS, could be assigned responsibility for consolidated, comprehensive supervision of those banking organizations under its purview, with appropriate functional supervision of individual components. Continue to include both FRS and Treasury in bank oversight. To carry out its primary responsibilities effectively, FRS should have direct access to supervisory information as well as influence over supervisory decisionmaking and the banking industry. The foreign oversight structures GAO viewed showed that this could be accomplished by having FRS be either a direct or indirect participant in bank oversight. For example, FRS could maintain its current direct oversight responsibilities for state chartered member banks or be given new responsibility for some segment of the banking industry, such as the largest banking organizations. Alternatively, FRS could be represented on the board of directors of a new consolidated banking agency or on FDIC’s board of directors. Under this alternative, FRS’ staff could help support some of the examination or other activities of a consolidated banking agency to better ensure that FRS receives first hand information about, and access to, the banking industry. To carry out its mission effectively, Treasury also needs access to supervisory information about the condition of the banking industry as well as the safety and soundness of banking institutions that could affect the stability of the financial system. GAO’s reviews of foreign regulatory structures provided several examples of how Treasury might obtain access to such information, such as having Treasury represented on the board of the new banking agency or commission and perhaps on the board of FDIC as well. Continue to provide FDIC with the necessary authority to protect the deposit insurance funds. Under any restructuring, GAO believes FDIC should still have an explicit backup supervisory authority to enable it to effectively discharge its responsibility for protecting the deposit insurance funds. Such authority should require coordination with other responsible regulators, but should also allow FDIC to go into any problem institution on its own without the prior approval of any other regulatory agency. FDIC also needs backup enforcement power, access to bank examinations, and the capability to independently assess the quality of those examinations. Incorporate mechanisms to help ensure consistent oversight and reduce regulatory burden. Reducing the number of federal bank oversight agencies from the current four should help improve the consistency of oversight and reduce regulatory burden. Should Congress decide to continue having more than one primary federal bank regulator, GAO believes that Congress should incorporate mechanisms into the oversight system to enhance cooperation and coordination between the regulators and reduce regulatory burden. Although GAO does not recommend any particular action, such mechanisms—which could be adopted even if Congress decides not to restructure the existing system—could include expanding the current mandate of FFIEC to help ensure consistency in rulemaking for similar activities in addition to consistency in examinations; assigning specific rulemaking authority in statute to a single agency, as has been done in the past when Congress gave FRS statutory authority to issue rules for several consumer protection laws that are enforced by all of the bank regulators; requiring enhanced cooperation between examiners and banks’ external auditors; (While GAO strongly supports requirements for annual full-scope, on-site examinations for large banks, GAO believes that examiners could take better advantage of the work already being done by external auditors to better plan and target their examinations.) requiring enhanced off-site monitoring to better plan and target examinations as well as to identify and raise supervisory concerns at an earlier stage. FRS, FDIC, OCC, and OTS provided written comments on a draft of this report, which are described below and reprinted in appendixes IV through VII. Treasury also reviewed a draft and provided oral technical comments, which we incorporated where appropriate. FRS agreed that it is useful to consider the experience of other countries in making policy determinations. It also agreed that there are different ways to accommodate the policy goal of modernizing the U.S. supervisory structure. FRS reiterated its opinion that the purpose of bank supervision is to enhance the capability of the banking system to contribute to long-term national economic growth and stability. FRS agreed with our description of the direct involvement of central bank staff in bank oversight in the countries we studied and our recommendation that FRS continue to be included in bank oversight. However, it felt that we should be more specific in stating that FRS needs “active supervisory involvement in the largest U.S. banking organizations and a cross-section of other banking institutions” to carry out its key central banking functions. To clarify what was meant by this statement, a senior FRS official advised us that FRS’ present regulatory authority gives it the access and influence it needs. But if the regulatory structure were changed so that there is only one federal regulator for each banking organization—holding company and all bank subsidiaries—then FRS feels that it would have to be the regulator for the largest banking organizations and a cross-section of others in order to carry out its key central banking functions. We agree that FRS needs to have direct access to supervisory information as well as the ability to influence supervisory decisionmaking and the banking industry if the oversight structure is changed. However, in our studies of foreign oversight structures we found that direct central bank involvement in bank oversight, and access to and influence over the banking industry, could be accomplished in several ways. These could include giving the central bank a formal role as bank supervisor, participating on oversight boards with staff involvement in examination and other areas of supervision, and serving in informal yet influential roles that included participation in oversight by central bank staff. FRS also noted that 88 percent of U.S. banks are part of banking organizations that are actively supervised by no more than two oversight agencies. The portion of activities supervised by the third or fourth agency in holding companies where more than two agencies are involved in oversight is generally small. We acknowledge that most U.S. banks are supervised by no more than two federal banking supervisory agencies. Nevertheless, as the table provided by FRS shows (see app. IV), more than 50 percent of bank assets are held in companies that are supervised by three or four of these agencies. Furthermore, it is the larger, more complex banking institutions—whose failure could pose the greatest danger to the financial system—that are likely to be subject to oversight by more than two agencies, with the potential attendant oversight problems described in our report. In addition, the percentage of assets supervised by additional agencies—which may be relatively small—does not indicate their importance or potential risk to the banking organization. FDIC provided four fundamental principles for an effective bank regulatory structure, which are generally consistent with the principles and recommendations that we advocate. These principles include providing FDIC with an explicit backup supervisory authority, backup enforcement power, and the capability to assess the quality of bank and thrift examinations. We also support providing FDIC with such backup authority. FDIC also noted that the broader regulatory responsibilities related to the role of the deposit insurer require current and sufficient information on the ongoing health and operations of financial institutions. In FDIC’s judgment, periodic on-site examination remains one of the essential tools by which such information may be obtained. FDIC commented on the mechanisms we described that Congress might consider to enhance regulators’ cooperation and coordination and reduce regulatory burden, noting that the current processes for coordinating regulation allow for the consideration of the unique regulatory perspectives of each agency. We agree that the present practice of cooperation, coordination, and communication among the agencies in rulemaking allows the unique viewpoints of each of the oversight agencies to be considered. The assignment of rulemaking authority to a single agency would not preclude incorporating other viewpoints, as evidenced by the current rulemaking process with regard to some consumer protection regulations, where a single agency has been assigned such authority. We believe assigning rulemaking authority for safety and soundness regulations could be one way to attain a more efficient regulatory process. OCC described our report as comprehensive and conveying more about the foreign regulatory structures than has been available to the public, albeit not exhaustive. OCC agreed with us that the foreign structures are not readily adaptable to the United States and described some of its observations about the differences among the five countries’ regulatory structures. Consequently, OCC suggested that Congress consider our suggestions very carefully in making any changes to the oversight structure in the United States. We agree that Congress should be cautious in any consideration it gives to changing the regulatory structure. OTS generally concurred with our principal recommendations and restated its position that consolidation will make the bank oversight system more efficient and effective. It added that reducing the number of federal oversight agencies should be done in a way that preserves a strong and stable regulatory environment and protects agency employees. We agree that the consolidation of any oversight agencies should be done in a way that preserves a strong and stable regulatory environment that is effective, efficient, and responsive to the needs and risks of the supervised institutions. FRS, FDIC, and OTS also noted several regulatory actions and other initiatives underway that are designed to improve coordination—including joint or coordinated examinations—and reduce regulatory and supervisory redundancy and overlap. We believe such efforts are important to the consistency and efficiency of the regulatory structure and have incorporated this information into our report where appropriate. The comment letters from FRS, FDIC, and OTS attest to the unique perspectives of each of the oversight agencies, which we believe provide valuable insights to Congress. As we describe in our report, there is a range of ways to address our recommendations and to capture these perspectives in any congressional consideration of changing the current U.S. bank oversight structure. Therefore, we have incorporated the agencies’ insights in the report where appropriate. In addition, we have included descriptions of the interagency efforts discussed in the agencies’ responses to improve coordination and cooperation and reduce regulatory burden.

Summary: Pursuant to a congressional request, GAO reviewed its previous work on the structure and operations of bank oversight in five countries, focusing on: (1) aspects of those systems that may be useful for Congress to consider in any future modernization efforts; (2) perceived problems with federal bank oversight in the United States; and (3) principles for modernizing the U.S. federal bank oversight structure. GAO found that: (1) the five foreign banking systems reviewed had less complex and more streamlined oversight structures than the United States; (2) in all five countries, fewer national agencies were involved with bank regulation and supervision than in the United States; (3) in all but one of these countries, both the central bank and the ministry of finance had some role in bank oversight, and several of these countries relied on the work of the banks' external auditors to perform certain oversight functions; (4) in all cases, there was one entity that was clearly responsible and accountable for consolidated oversight of banking organizations as a whole; (5) the bank oversight structure in the United States is relatively complex, with four different federal agencies having the same basic oversight responsibilities for those banks under their respective purview; (6) industry representatives and expert observers have contended that multiple examinations and reporting requirements resulting from the shared oversight responsibilities of four different regulators contribute to banks' regulatory burden, and that the federal oversight structure is inherently inefficient; (7) having one agency responsible for examining all U.S. bank holding companies, with a different agency or agencies responsible for examining the holding companies' principal banks, could result in overlap and a lack of clear responsibility and accountability for consolidated oversight of U.S. banking operations; and (8) any modernized banking structure should provide for clearly defined responsibility and accountability for consolidated and comprehensive oversight, independence from undue political pressure, consistent rules, consistently applied for similar activities, and enhanced efficiency and reduced regulatory burden.