Federal Register: September 25, 2009 (Volume 74, Number 185)
DOCID: fr25se09-72 FR Doc E9-23208
FEDERAL DEPOSIT INSURANCE CORPORATION
Thrift Supervision Office
Docket ID: [Docket No. OP-1369]
NOTICE: NOTICES
DOCID: fr25se09-72
DOCUMENT ACTION: Proposed guidance and request for comment.
SUBJECT CATEGORY:
DEPARTMENT OF THE TREASURY
DATES: Comments must be submitted on or before October 26, 2009.
DOCUMENT SUMMARY:
The FDIC, Board, OCC, and OTS (the Agencies) request comment on proposed guidance on correspondent concentration risks (Proposed Guidance). The Proposed Guidance outlines the Agencies' expectations for financial institutions with respect to identifying, monitoring, and managing correspondent concentration risks between financial institutions, and performing appropriate due diligence on all credit exposures to and funding transactions with other financial institutions. The Agencies expect financial institutions to identify, monitor, and manage the totality of the institution's aggregate credit and funding exposures to other institutions on a standalone basis, and take into account exposures to other institutions' affiliates. In addition, the institution should be aware of exposures of its affiliates to other institutions and their affiliates.
SUMMARY:
Correspondent Concentration Risks
DOCUMENT BODY 2:
Office of the Comptroller of the Currency
[Docket ID OCC20090013]
DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
[Docket ID OTS200920016]
Correspondent Concentration Risks
SUPPLEMENTAL INFORMATION
I. Background
Concentration risks can occur in correspondent relationships when an institution engages in a significant volume of activities with another financial institution. A financial institution's relationship with a correspondent may result in credit (asset) and funding (liability) concentration risks.
Credit risk is the potential that an obligation will not be paid in a timely manner or in full. Credit risk arises whenever an institution advances or commits funds to another financial institution, as the advancing institution's assets are at risk of loss if the recipient institution fails. Some institutions conceivably could have a credit concentration arising from the need to maintain large due from balances with the correspondent to facilitate account clearing activities.
Funding risk arises when an institution depends heavily on the liquidity provided by a limited number of other institutions to meet its funding needs. Funding risk can create an immediate threat to an institution's viability if the advancing entity suddenly reduces the institution's access to liquid funds. Institutions might abruptly limit the availability of liquid funding sources as part of a prudent program for limiting credit exposure or as required by regulation when the financial condition of either counterparty declines rapidly. II. Proposed Guidance
The Agencies developed this Proposed Guidance to outline their expectations for financial institutions with respect to identifying, monitoring, and managing correspondent concentration risks between financial institutions; and for performing appropriate due diligence on all credit exposures to and funding transactions with other financial institutions. Correspondent concentrations represent a lack of diversification that adds a dimension of risk that management should consider when formulating strategic plans and internal risk limits. The Proposed Guidance focuses on the risks in credit and funding exposures inherent in interbank activities and how those exposures should be calculated.
The Agencies generally consider credit exposures arising from
direct and indirect obligations owed by individual borrowers, a small
interrelated group of individuals, or a single repayment source greater
than 25 percent of Tier 1 capital as concentrations. The Proposed
Guidance clarifies that to assist management in assessing how significant economic events or abrupt deterioration in a
correspondent's risk profile might affect their financial condition,
institutions should identify the totality of the institution's
aggregate credit and funding exposure to other institutions on a
standalone basis, and take into account exposures to other
institutions' affiliates.\1\ In addition, the institution should be
aware of exposures of its affiliates to other institutions and their affiliates.
\1\ Institutions should monitor all direct or indirect
relationships with the other institution and its subsidiaries, any
parent bank holding companies of the other institution, and other
entities controlled by that parent company. An institution should
also take into account exposures of its own affiliates to the same
institution (including that same institution's affiliates), and how
those may affect the institution's exposure. While each institution
is responsible for monitoring its own credit and funding exposures,
bank holding companies with exposures in more than one entity should
be managing the organization's concentration risk on a consolidated
basis. In situations where there are no parent bank holding
companies, institutions should monitor all direct or indirect
relationships with that institution and its subsidiaries and any other entities that are under common control.
The credit exposure of the advancing institution and its organization represents a funding exposure to the recipient organization. While the Agencies have not established a liability concentration threshold, the Agencies have seen instances where funding exposures as low as 5 percent of an institution's total liabilities have posed an elevated risk to the recipient. An example of how these interbank correspondent risks can become concentrated is illustrated below:
Respondent Institution (RI) has $500 million in total assets and is Well Capitalized with $40 million (8 percent) of Tier 1 capital. RI maintains $10 million in its due from account held at Correspondent Bank (CB) and sold $20 million in unsecured overnight Federal funds to CB. These relationships collectively result in RI having an aggregate risk exposure of 75 percent of its Tier 1 capital to CB. CB, which has $2 billion in total assets, $1.8 billion in total liabilities, and is Well Capitalized with $200 million (10 percent) Tier 1 capital, has 20 respondent banks (RB) with the same credit exposures as RI. The 20 RBs' $600 million aggregate relationship represents onethird (33 percent) of CB's total liabilities. These relationships could create significant funding risk for CB if three or more of the RBs withdraw their funds in close proximity of each other.
These relationships also could threaten the viability of the 20 RBs. The loss of all or a significant portion of the RBs' due from balances and the unsecured Federal funds sold to CB could deplete a significant portion of their capital base, resulting in multiple failures. The RBs' viability also could be jeopardized if CB, in turn, had sold a significant portion of the Federal funds from the RBs to another financial institution that abruptly failed. In addition, the financial institutions that rely on CB for account clearing services may find it difficult to quickly transfer processing services to another provider.
Although these interbank exposures may comply with regulations
governing individual relationships, collectively they pose significant correspondent concentration risks that need to be
[[Page 48957]]
monitored and managed consistent with the institutions overall risk
management policies and procedures. The following discussion summarizes the major components of the Proposed Guidance.
Identifying Correspondent Concentrations
The Proposed Guidance details the Agencies' expectations that institutions implement procedures for identifying correspondent concentrations on a standalone basis, as well as taking into account exposures to the other institution's affiliates. These procedures should include all assets advanced or committed to another organization, as these credit exposures are at risk of loss. The Proposed Guidance specifies that institutions should calculate both gross and net credit exposures. Exposures are reduced to net positions to the extent they are secured by the net realizable proceeds from readily marketable collateral.
Monitoring Correspondent Concentrations
The Board's Regulation F mandates that an institution's policies
and procedures must require periodic reviews of a correspondent's
financial condition and must take into account any deterioration in the
correspondent's financial condition.\2\ In monitoring correspondent
relationships, the Proposed Guidance details the Agencies' expectation
that institutions specify what information, ratios, and trends
management will review for each correspondent on an ongoing basis. The
Proposed Guidance also stresses that an institution's policies should
include procedures that ensure ongoing, timely reviews of correspondent
relationships, establish documentation requirements for the reviews,
and specify when relationships that meet or exceed internal criteria
are to be reported to the Board of Directors or the appropriate
management committee for an assessment of risk and risk reducing strategies.
\2\ 12 CFR Part 206. All depository institutions insured by the
FDIC are subject to the Board's Limitation on Interbank Liabilities (Regulation F).
Managing Correspondent Concentrations
The Proposed Guidance discusses an institution's obligation to
establish prudent correspondent concentration limits, as well as ranges
or tolerances for each factor being monitored, consistent with the
Board's Regulation F and sound banking practice. Prudent risk
management of correspondent concentrations should include procedures
for reducing concentrations that meet or exceed established limits,
ranges, or tolerances in an orderly manner over reasonable timeframes.
Contingency plans for managing risk when these limits, ranges, or
tolerances are met or exceeded, either on an individual or collective
basis, should provide for a variety of actions that can be considered
relative to changes in the correspondent's financial condition.\3\
Contingency plans should not rely on temporary deposit insurance programs for mitigating concentration risk.
\3\ Regulation F requires institutions' policies and procedures
to limit exposure to the correspondent, either by the establishment
of internal limits or by other means, when the correspondent's
financial condition and the form or maturity of the bank's exposure
create a significant risk that payment will not be made in full or
in a timely manner. Regulation F also requires institutions to
reduce credit exposure to below 25 percent of total capital within
120 days after the date when the current Report of Condition or other relevant report normally would be available if the
correspondent is no longer at least adequately capitalized. More
information on Regulation F is available at: http:// www.federalreserve.gov/bankinforeg/reglisting.htm.
Performing Appropriate Due Diligence
The Proposed Guidance also reinforces the Agencies' ongoing expectation that financial organizations with credit or funding exposures to other financial organizations have effective risk management programs for these credit and funding activities. Credit or funding exposures may include, for example, due from bank accounts, Federal funds sold as principal, direct or indirect loans (including participations and syndications), and trust preferred securities, subordinated debt, and stock purchases of the correspondent, its holding company, or any affiliated entity. An institution that maintains or contemplates entering into any credit or funding transaction with another financial institution should have written investment, lending, and funding policies and procedures, including appropriate limits, that govern these activities. In addition, these procedures should ensure the institution conducts an independent analysis of credit transactions prior to committing to engage in the transactions. The terms for all such credit and funding transactions should strictly be on an arm's length basis, conform to sound investment, lending, and funding practices, and avoid potential conflicts of interest.
III. Request for Comment
The Agencies are requesting public comment on all aspects of the Proposed Guidance. The Agencies also request comment on the appropriateness of aggregating all credit and funding exposures that an institution or its organization has advanced or committed to another financial institution or its affiliated entities when calculating concentrations. In particular, should some types of advances or commitments be excluded?
The Agencies further request comment on the types of factors
institutions should consider when assessing correspondents' financial
condition. The Agencies also seek comment on the need to establish
internal limits as well as ranges or tolerances for each factor being
monitored. In addition, the Agencies request comment on the types of
actions that should be considered for contingency planning and the
timeframes for implementing those actions to ensure concentrations that
meet or exceed organizations' established internal limits, ranges, or
tolerances are reduced in an orderly manner. Finally, the Agencies seek
comment on whether there are operational issues the Agencies should
consider when finalizing the Proposed Guidance. For example, do
institutions anticipate that operational issues will arise in light of
the Board's policy to limit eligible institutions to participation in
one excess balance account (EBA)? \4\ If so, identify the issues that
could arise in managing correspondent concentration risks while subject to the single EBA limitation.
\4\ The Board recently amended its Regulation D (12 CFR Part
204) to authorize Federal Reserve Banks to offer EBAs to eligible
institutions. 74 FR 25620 (May 29, 2009). These accounts were
intended to permit eligible institutions to earn interest on their
excess balances without significantly disrupting established
business relationships with their correspondents. Under the terms of
the EBA account agreement, an eligible institution is permitted to
participate in one EBA at a Federal Reserve Bank. Each EBA
Participant, however, can choose each day whether to sell funds in
the Federal funds market through any number of correspondent
institutions, to place the funds at a Federal Reserve Bank through
their single EBA agent, or to select a combination of the two. As a
result, EBA Participants may maintain relationships with more than
one correspondent notwithstanding the fact that an EBA Participant participates in only one EBA at a Reserve Bank.
The text of the Proposed Guidance, entitled Correspondent Concentration Risks, is as follows:
Correspondent Concentration Risks
A financial institution's relationship with a correspondent may
result in credit (asset) and funding (liability) concentrations. On the
asset side, a credit concentration represents a significant volume of
credit exposure that a financial institution has advanced or committed
to one entity or affiliated group. On the liability side, a funding concentration exists when an institution
[[Page 48958]]
depends on one or a small group of institutions for a disproportionate
share of its total funding. Correspondent concentrations represent a
lack of diversification, which adds a dimension of risk that management
should consider when formulating strategic plans and internal risk limits.
The Agencies have generally considered credit exposures greater
than 25 percent of Tier 1 capital as concentrations. While the Agencies
have not established a liability concentration threshold, the Agencies
have seen instances where funding exposures as low as 5 percent of an
institution's total liabilities have posed an elevated liquidity risk
to the recipient institution. The Agencies expect financial
institutions to identify, monitor, and manage both asset and liability
correspondent concentrations and implement procedures to perform
appropriate due diligence on all credit exposures to and funding transactions with other financial institutions.\1\
\1\ The Agencies consist of the Federal Deposit Insurance
Corporation (FDIC), Board of Governors of the Federal Reserve System
(Board), Office of the Comptroller of the Currency, Treasury (OCC),
and Office of Thrift Supervision, Treasury (OTS) (collectively, the Agencies).
Identifying Correspondent Concentrations
Institutions should implement procedures for identifying
correspondent concentrations with other financial organizations.
Accordingly, an institution should have procedures that encompass the
totality of the institution's aggregate credit and funding exposures to
the other institution on a standalone basis, as well as taking into
account exposures to the other institution's affiliates. In addition,
the institution should be aware of exposures of its affiliates to the other institution and its affiliates.\2\
\2\ Institutions should monitor all direct or indirect
relationships with the other institution and its subsidiaries, any
parent bank holding companies of the other institution, and other
entities controlled by that parent company. An institution should
also take into account exposures of its own affiliates to the same
institution (including that same institution's affiliates), and how
those may affect the institution's exposure. While each institution
is responsible for monitoring its own credit and funding exposures,
bank holding companies with exposures in more than one entity should
be managing the organization's concentration risk on a consolidated
basis. In situations where there are no parent bank holding
companies, institutions should monitor all direct or indirect
relationships with that institution and its subsidiaries and any other entities that are under common control.
Credit Concentrations
Credit exposures can consist of a variety of assets. For example,
an institution (either a client bank or a correspondent) could have due
from bank accounts, Federal funds sold on a principal basis, and direct
or indirect loans to or investments in another institution, its holding
company, or an affiliated entity. These assets represent credit
exposures to the institution that advanced them, as they are at risk of
loss. The Agencies realize some exposures meet certain business needs
or purposes, such as a credit concentration arising from the need to
maintain large due from balances to facilitate accounting clearing
activities. In identifying credit concentrations, institutions should aggregate all exposures, including, but not limited to:
Funding Concentrations
Conversely, asset accounts such as those noted above represent funding sources to the recipient institution or correspondent. The primary risk of a funding concentration is that an institution will have to replace those advances on short notice. This risk may be more pronounced if the funds are credit sensitive, and the advancing institution's financial condition has deteriorated.
The percentage of liabilities or other measurements that may constitute a concentration of funding is likely to vary depending on the type and maturity of the funding, and the structure of the receiving institution's sources of funds. For example, a concentration in overnight unsecured funding from one institution likely would warrant a much lower concentration threshold than unsecured term funding, assuming compliance with covenants and diversification with short and longterm maturities. Similarly, assuming the same, term funding in the form of senior or subordinated debt may not present a funding concentration risk.
Calculating Credit and Funding Exposures
When identifying credit and funding exposures, institutions should calculate both gross and net exposures. Exposures are reduced to net positions to the extent they are secured by the net realizable proceeds from readily marketable collateral. For example, $10 million in Federal funds sold to a correspondent with $3 million secured by U.S. Treasury notes represents a $10 million gross exposure, but a $7 million net exposure after consideration of the pledged collateral.
Monitoring Correspondent Relationships
The Federal Reserve Board's Regulation F requires institutions to establish and maintain written policies and procedures to prevent excessive exposure to any individual correspondent in relation to the correspondent's financial condition.\3\ In cases where an institution's exposure to a correspondent is significant, Regulation F mandates that an institution's policies and procedures must require periodic reviews of the correspondent's financial condition and must take into account any deterioration in the correspondent's financial condition.\4\ \3\ 12 CFR part 206. All depository institutions insured by the FDIC are subject to the Board's Limitations on Interbank Liabilities (Regulation F).
\4\ 12 CFR 206.3.
Regulation F provides that such monitoring efforts must take into
account the correspondent's capital level, level of nonaccrual and
pastdue loans and leases, level of earnings, and other factors
affecting its financial condition. While not specified, these other factors could include, but are not limited to:
In monitoring correspondent relationships for riskmanagement
purposes as well as for compliance with Regulation F, institutions
should specify what information, ratios, or trends will be reviewed for
each correspondent on an ongoing basis. Institutions' policies should include procedures that ensure
[[Page 48959]]
ongoing, timely reviews of correspondent relationships. Such reviews
should be conducted on a quarterly basis at a minimum and more
frequently when appropriate. The procedures also should establish
documentation requirements for the reviews conducted. In addition, the
procedures should specify when relationships that meet or exceed
internal criteria are to be brought to the attention of the Board of Directors or the appropriate management committee.
Managing Correspondent Concentrations
Pursuant to Regulation F, institutions should establish prudent
correspondent concentration limits, as well as ranges or tolerances for
each factor being monitored. Institutions should develop plans for
managing risk when these limits, ranges or tolerances are met or
exceeded, either on an individual or collective basis. Consistent with
the requirements of Regulation F, contingency plans should provide a
variety of actions that can be considered relative to changes in the correspondent's financial condition.\5\
\5\ Regulation F requires institutions' policies and procedures
to limit exposure to the correspondent, either by the establishment
of internal limits or by other means, when the correspondent's
financial condition and the form or maturity of the bank's exposure
create a significant risk that payment will not be made in full or
in a timely manner. Regulation F also requires institutions to
reduce credit exposure to below 25 percent of total capital within
120 days after the date when the current Report of Condition or other relevant report normally would be available if the
correspondent is no longer at least Adequately Capitalized. More
information on Regulation F is available at: http:// www.federalreserve.gov/bankinforeg/reglisting.htm.
Contingency plans should not rely on temporary deposit insurance
programs for mitigating concentration risk. Prudent risk management of
correspondent concentrations should include procedures for reducing
exposures that meet or exceed established limits, ranges, or tolerances
in an orderly manner over reasonable timeframes. Such actions could include, but are not limited to:
Examiners will review correspondent relationships during examinations to ascertain whether an institution's policies and procedures identify and monitor correspondent concentrations on an organizationwide basis. Examiners also will review the adequacy and reasonableness of institutions' contingency plans to manage correspondent concentrations.
Performing Appropriate Due Diligence
The Agencies expect financial organizations that maintain credit exposures in or provide funding to other financial organizations to have effective risk management programs for these activities. For this purpose, credit or funding exposures may include, but are not limited to, due from bank accounts, Federal funds sold as principal, direct or indirect loans (including participations and syndications), and trust preferred securities, subordinated debt, and stock purchases of the correspondent, its holding company, or any affiliated entity.
An institution that maintains or contemplates entering into any credit or funding transactions with another financial institution should have written investment, lending, and funding polices and procedures, including appropriate limits, that govern these activities. In addition, these procedures should ensure the institution conducts an independent analysis of credit transactions prior to committing to engage in the transactions. The terms for all such credit and funding transactions should strictly be on an arm's length basis, conform to sound investment, lending, and funding practices, and avoid potential conflicts of interest.
This concludes the text of the Proposed Guidance.
Dated at Washington, DC, the 18th day of September 2009.
By order of the Federal Deposit Insurance Corporation. Robert E. Feldman,
Executive Secretary.
By order of the Board of Governors of the Federal Reserve System, September 18, 2009.
Jennifer J. Johnson,
Secretary of the Board.
Dated: September 8, 2009.
Office of the Comptroller of the Currency.
John C. Dugan,
Comptroller of the Currency.
Dated: September 17, 2009.
By the Office of Thrift Supervision.
John E. Bowman,
Acting Director.
[FR Doc. E923208 Filed 92409; 8:45 am]
BILLING CODE 671401P