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Duties and Responsibilities of DirectorsEffective date November 1995 Section 5000.1

INTRODUCTION

Directors are placed in a position of trust by the

bank’s shareholders, and both statutes and com-mon law place responsibility for the affairs of abank firmly and squarely on the board of direc-tors. The board of directors of a bank shoulddelegate the day-to-day routine of conductingthe bank’s business to its officers and employ-ees, but the board cannot delegate its respon-sibility for the consequences of unsound orimprudent policies and practices, whether theyinvolve lending, investing, protecting againstinternal fraud, or any other banking activity. The

board of directors is responsible to the bank’sdepositors, other creditors, and shareholders forsafeguarding their interests through the lawful,informed, efficient, and able administration of the institution. In the exercise of their duties,directors are governed by federal and statebanking, securities, and antitrust statutes, aswell as by common law, which imposes aliability on directors of all corporations. Direc-tors who fail to discharge their duties com-pletely or who are negligent in protecting the

interests of depositors or shareholders may besubject to removal from office, criminal pros-ecution, civil money penalties imposed by bank regulators, and civil liability. Title IX of theFinancial Institutions Reform, Recovery, andEnforcement Act of 1989 and the Comprehen-sive Thrift and Bank Fraud Prosecution andTaxpayer Recovery Act of 1990 greatly en-hanced the enforcement powers of the federalbank regulatory agencies, including the FederalReserve Board. Section 5040 of this manual,

‘‘Formal Corrective Actions,’’ describes thoseenforcement powers in greater detail.

DIRECTOR SELECTION

The affairs of each state member bank areoverseen by its board of directors. The initialdirectors are elected by the shareholders at a

meeting held before the bank is authorized tocommence business. Thereafter, they are electedat meetings held at least annually on a dayspecified in the bank’s bylaws. The directorshold office for a stated tenure, generally rangingfrom one to three years, or until their successors

are elected and have qualified. No state memberbank is to have less than five or more than25 directors as specified in section 31 of the

Banking Act of 1933. Various laws govern theelection, number, qualifications, oath, liability,and removal of directors and officers, as well asthe disclosure requirements for their outsidebusiness interests. Other laws pertain to certainrestrictions, prohibitions, and penalties for secu-rities dealers serving as directors, officers, oremployees; director interlocks; purchases of assets from, or sales to, directors; commissionsand gifts for procuring loans; embezzlement;abstraction; willful misapplication; false entries;

political contributions; and other matters. Theexaminer must be familiar with these laws andthe related regulations and interpretations.

DIRECTOR INDEPENDENCE

Directors must exercise their independent judgment when managing the bank’s affairs. A

responsible board will not merely rubber-stampmanagement’s recommendations, but will reviewthem carefully before deciding whether they arein the bank’s best interests. A board that isexcessively influenced by management, a singledirector, or a shareholder, or any combinationthereof, may not be fulfilling its responsibilitiesto depositors, other creditors, and sharehold-ers. Diversification of the board of directors isimportant and can be accomplished by includingdirectors with no ownership or family-ownership

interest in the bank and who are not employedby the bank.

A bank’s board of directors may include oneor more advisory directors. Advisory directorsgenerally do not vote but may provide additionalinformation or advice to the voting directors. Anadvisory director who functions in that capacityis generally not subject to the same regulatoryrequirements as voting members and has lessliability for the board’s actions. However, if anadvisory director exercises a degree of influenceor control over the board or the bank that is notcommensurate with that status, it is appropriatefor examiners to subject that individual to thesame standards as voting directors. Such aperson might also be subject to the same liabilitystandards as a voting director.

Commercial Bank Examination Manual November 1995



DIRECTORS’ RESPONSIBILITIES

Directors play a critical role in overseeing theaffairs of the bank. Directors should understandthat if they neglect to carry out their fiduciary

duties and responsibilities, they may be finan-cially liable if the bank fails or experiences loss.An examiner sometimes has to remind bank directors of the extent of their duties and respon-sibilities. Unless bank directors realize theimportance of their positions and act accord-ingly, they are failing to discharge their obliga-tions to the shareholders, depositors, other credi-tors, and the community.

Selection of Competent ExecutiveOfficers

One of the board’s most important duties is toselect and appoint executive officers who arequalified to administer the bank’s affairs effec-tively and soundly. The board is also responsiblefor removing officers who do not meet reason-able standards of honesty, competency, execu-tive ability, and efficiency. The responsibility for

selecting executive officers also entails retainingthem and ensuring that competent successorscan be promoted or hired to fill unanticipatedvoids. The board is responsible for evaluatingthe performance of the chief executive officerand approving the CEO’s compensation. Inmany banks, the board also approves compen-sation for other executive officers.

A state member bank that has been charteredor undergone a change of control within the lasttwo years, that is not in compliance with the

minimum capital adequacy guidelines or regu-lations of the Board, or that is in an otherwisetroubled condition must provide 30 days’ writ-ten notice to its regulating Reserve Bank beforeit can add a director, promote an internal staff member to senior executive officer, or employ anew senior executive officer.

Effective Supervision of Bank Affairs

The type and degree of supervision required of abank’s board of directors to ensure a bank issoundly managed involve reasonable business

judgment and competence and sufficient timeto become informed about the bank’s affairs.Directors ultimately are responsible for the

soundness of the bank. If negligence is involved,a director may be personally liable. The respon-sibility of directors to supervise the bank’saffairs may not be delegated to the active exec-utive officers or anyone else. Directors may

delegate to executive officers certain authority,but not the primary responsibility of ensuringthat the bank is operated in a sound and legalmanner.

Adoption and Adherence to SoundPolicies and Objectives

The directors’ role is to provide a clear frame-work of objectives and policies within which the

chief executive officer can operate and adminis-ter the bank’s affairs. This framework is oftenaccomplished through the use of strategic plansand budgets. The strategic plan would discusslong-term, and in some cases, short-term goalsand objectives as well as how progress towardtheir achievement will be measured. The objec-tives and policies should cover all areas of thebank’s operations. The board of directors isresponsible for establishing the policies thatgovern and guide the day-to-day operations of

the bank, so they should review and approvethem from time to time. These policies areprimarily intended to ensure that the risks under-taken by the banks are prudent and are beingproperly managed. This means that the board of directors must, as a group, have a fundamentalunderstanding of the various types of risksassociated with different aspects of the bankingbusiness, for example, credit risk, foreign-exchange risk, or interest-rate risk, and definethe types of risks the bank will undertake. Some

of the more important areas in which policiesand objectives must be established includeinvestments, loans, asset and liability manage-ment, profit planning and budgeting, capitalplanning, and personnel. Directors are alsoresponsible for adopting policies and proceduresrequired by law or regulation, such as real estatelending policies, a security program, an inter-bank liabilities policy, and a Bank Secrecy Actprogram. The examination of these policies iscovered in other sections of this manual.

Avoidance of Self-Serving Practices

A bank’s directors bear a greater than normalresponsibility for upholding safe and sound

5000.1 Duties and Responsibilities of Directors

November 1995 Commercial Bank Examination Manual



practices in dealing with transactions involvingother members of the directorate and theirrelated interests. Directors’ decisions must pre-clude the possibility of partiality or favoredtreatment. Unwarranted loans to a bank’s direc-

tors or their interests can be a serious safety-and-soundness concern for the bank. Directorswho become financially dependent on their bank normally lose their usefulness as directors. Otherself-serving practices the examiner should watchfor are—

• gratuities paid to directors to obtain theirapproval of financing arrangements or the useof particular services,

• the use of bank funds by directors, officers, or

shareholders to obtain loans or transact otherbusiness (Directors should be especially criti-cal of correspondent bank balances whenofficers, directors, or shareholders are borrow-ing from the depository bank. The Departmentof Justice’s position is that certain interbank deposits connected with a loan to officers,directors, or shareholders of the depositingbank might constitute a misapplication of funds in violation of 18 USC 656), and

• transactions involving conflicts of interest

(When board decisions involve a potentialconflict of interest, the director with thepotential conflict should fully disclose thenature of the conflict and abstain from votingon the matter. The abstention should berecorded in the minutes. The examiner shouldalso be aware that ethical conflicts of interestcan arise when a director or director-relatedfirm performs professional services for thebank. For example, a director who is also thebank’s legal counsel may not, in some situa-tions, be able to advise or represent the bank objectively.).

Awareness of the Bank’s FinancialCondition and Management Policies

Management Information Systems

A management information system (MIS) pro-vides the information, often originated from aninstitution’s mainframe and microcomputers,necessary to manage an organization effectively.MIS should have clearly defined guidelines,policies, practices, standards, and procedures forthe organization. These should be incorporated

in the development, maintenance, and use of MIS throughout the institution.

MIS is used by all levels of bank staff tomonitor various aspects of bank operations, upto and including its overall risk-management

process. Therefore, MIS should be supportive of the institution’s longer term strategic goals andobjectives. At the other extreme, these everydayfinancial accounting systems also are used toensure that basic control is maintained overfinancial recordkeeping activities. Since numer-ous decisions are based on MIS reports, appro-priate control procedures must be set up toensure that information is correct and relevant.

Audits

In May 1993, pursuant to requirements of theFederal Deposit Insurance Corporation Improve-ment Act of 1991 (FDICIA), the FDIC issuedrules and guidelines that require all banks withtotal assets in excess of $500 million to haveannual audits by an independent public accoun-tant. Copies of these audit reports are to be sentto the FDIC and the appropriate Federal ReserveBank. Furthermore, the Federal Reserve encour-

ages banks with assets of $500 million or less toprovide for annual audits by independent publicaccountants.

The board or a committee designated by theboard should review the audit reports with thebank’s management and the independent publicaccountants. The review should include—

• the scope of services required by the audit,significant accounting policies, and auditconclusions regarding significant accounting

estimates;• the adequacy of internal controls, and actions

necessary to ensure the resolution of anyproblems or deficiencies; and

• the institution’s compliance with applicablelaws and regulations.

Many states have laws requiring directors’examinations of the bank. When the directorslack adequate knowledge of examination tech-niques and procedures, they are encouraged toemploy a qualified accountant or other specialistto conduct all or part of this examination. Theexamining committee or the entire board shouldplay an active role. Directors should obtain aclear understanding of the scope of the proce-dures to be employed, and the final report of the

Duties and Responsibilities of Directors 5000.1




directors’ examination should be reviewed bythe board of directors.

Further guidance on the use of audit reportsand the reliance placed upon the work of exter-nal and internal auditors in the examination

process can be found in the ‘‘Internal andExternal Audit Section’’ of this manual.

Maintenance of ReasonableCapitalization

A board of directors has the responsibility formaintaining its bank on a sufficiently capitalizedbasis. Capital planning and capital adequacy arediscussed in the manual section ‘‘Assessment of Capital Adequacy,’’ and the examiner should befamiliar with this information.

Compliance with Banking Laws andRegulations

Directors must carefully observe that bankinglaws are not violated; they may be personallyliable for losses arising out of illegal actions. In

addition, civil money penalties can be assessedfor unsafe and unsound actions that do notnecessarily involve a violation of a banking law.

Guarantee of a Beneficial Influenceon the Community’s Economy

One reason for approving a newly charteredbank for Federal Reserve membership is to meet

a specific community need. Directors, therefore,have a continuing responsibility to provide thosebanking services which meet the legitimatecredit and other needs of the community beingserved. Directors should be certain that the bank attempts to satisfy all legitimate credit needs of the community.

BOARD MEETINGS

The board should conduct its business in meet-ings held as required by the bank’s bylaws orstate law. Regular meetings of the board shouldreview statements showing the bank’s financialcondition and earnings; the investment port-folio; and loan activity, including past-due and

nonaccrual loans, charged-off or recovered loans,large new loans, and loans to insiders. Directorsshould also review and approve all policiesannually, and review and approve all insurancepolicies as they are obtained or renewed. They

should also review audit and examination re-ports and initiate action to correct any deficien-cies noted, review correspondence with regula-tory agencies, review pending litigation, andkeep informed of any major prospective under-takings, such as mergers, acquisitions, or newbranches or construction.

Minutes of Board Meetings

The board should ensure that an accurate,adequate record of its actions is maintained.Such a record is usually kept in the form of minutes of the board meetings. The minutesshould document the board’s review of allregular items mentioned above as well as thereview and discussion of all significant itemsthat are not part of the regular meeting. Addi-tionally, at a minimum, the minutes shouldrecord the attendance or absence of each direc-tor at each meeting, detail the establishment andcomposition of any committees, and note theabstention of any director from any vote. Exam-iners should review the minutes of board meet-ings, as well as a sample package prepared fora board meeting, to determine that directorsare receiving adequate information to makeinformed, sound decisions. Meetings conductedby telephone, if allowable under state law,should be documented as thoroughly as regularmeetings.

BOARD COMMITTEES

Many boards elect to delegate some of theirworkload to committees. The extent and natureof the bank’s activities and the relative expertiseof each board member play key roles in theboard’s determination of which committees toestablish, who sits on them, and how muchauthority they have. Thus, there is no idealcommittee structure. However, committees fre-quently found in state member banks include thefollowing:

• Executive Committee—may be empowered toact when the full board is unable to meet, for





example, between regular meetings. Anexecutive committee is usually found in largeinstitutions, where it relieves the full board of the burden of reviewing the details of financialstatements and operational activities.

• Audit Committee—typically monitors compli-ance with bank policies and procedures, andreviews internal and external audit reportsand bank examination reports. Because it isresponsible for ensuring compliance, accu-racy, and integrity throughout the organiza-tion, the audit committee should consist onlyof outside directors. The audit committee maysupervise the bank’s internal auditor and hisor her staff directly by hiring personnel, eval-uating their performance, and setting their

compensation.• Loan Committee—may be established to moni-

tor underwriting standards and loan quality,and to ensure that lending policies and proce-dures are adequate. In most banks with loancommittees, all new loans are reviewed by theloan committee either before or after funding,with the threshold for prior approval being theamount of either the loan or the aggregate debtto the borrower. The loan committee may alsobe responsible for the loan review function

and for maintaining an adequate reserve forloan losses.

• Investment or Asset-Liability Management Committee—monitors the bank’s investmentpolicies, procedures, and holdings portfolio toensure that goals for diversification, creditquality, profitability, liquidity, communityinvestment, pledging requirements, and regu-latory compliance are met. In some bankswhose complexity warrants it, asset-liabilitymanagement committees have been estab-

lished to replace or supplement investmentcommittees. An asset-liability managementcommittee monitors the bank’s balance sheetand external forces, notably interest rates, tohelp coordinate asset acquisition and fundingsources.

• Other Committees—depending on the natureand complexity of the bank’s business, theboard may establish other committees to moni-tor such areas as trust, branching, new facili-ties construction, personnel/human resources,electronic data processing, and consumercompliance.

Minutes of all major actions taken by com-mittees that play a significant role in managingthe bank should be kept and meet the same

minimum standards used for minutes of meet-ings of the full board.

COMPLIANCE WITH FORMALAND INFORMALADMINISTRATIVE ACTIONS

Bank directors must ensure that managementcorrects deficiencies found in the bank. Instruc-tions to do so may come from the FederalReserve as a formal or informal administra-tive action, depending on the severity of theproblem.

Formal actions, which include cease-and-

desist orders and written agreements, are nor-mally exercised when banks have serious prob-lems. For less serious problems, the FederalReserve issues informal actions such as a‘‘memorandum of understanding.’’ Informalactions are an agreement between the ReserveBank and the bank that sets forth the requiredcorrective actions. The Reserve Banks are gen-erally responsible for monitoring compliancewith both types of administrative actions. Toassist in that process, the Reserve Bank nor-

mally receives and evaluates periodic progressreports from the bank. In addition, informationis provided by the examiner who checks thebank’s compliance with the action. The ReserveBanks may initiate additional supervisory actionagainst the bank or individuals associated with itwhen compliance is insufficient. Or, if the bank’scompliance with the action is satisfactory, theReserve Banks may recommend modifying orterminating the enforcement action.

Examiners should briefly discuss compliance

with any enforcement actions on the Examina-tion Conclusions and Comments page and directthe board of directors’ attention to the Compli-ance with Enforcement Actions page of theexamination report. The type and date of theaction or resolutions and parties to the actionshould be listed. In addition, the examiner shouldgenerally list each provision requiring action bythe bank and provide a comment addressingcompliance with that provision. The examinershould comment on how the bank accomplishedcompliance or the problems that have preventedcompliance. While certain information mightbe better discussed in the confidential section of the report, it is appropriate to make all salientnegative comments on the Compliance withEnforcement Actions page to ensure that the

Duties and Responsibilities of Directors 5000.1




directors are made aware of any deficienciesand/or exceptions that may exist.

The Reserve Bank may recommend termina-tion or modification of a formal administrativeaction whenever it determines that such re-

straints have satisfactorily served their purposeand should be removed or modified. In thesecases, the Reserve Bank will send a memoran-dum with the appropriate explanation to theBoard’s Division of Banking Supervision andRegulation (BS&R) for review and evaluation.BS&R and the Board’s Legal Division, whenappropriate, will prepare the documents neces-sary to terminate or modify the existing admin-istrative action.

DEPOSITORY INSTITUTIONMANAGEMENT INTERLOCKSACT

Under the Depository Institution ManagementInterlocks Act (Interlocks Act) as implementedby Regulation L, interlocking relationships of management officials of various nonaffiliated

depository institutions are prohibited, dependingon the asset size and geographical proximity of the organizations. The enforcement of the inter-lock provisions of the Interlocks Act encom-passes full cease-and-desist powers.

The intent of the Interlocks Act is to fostercompetition among various depository institu-tions by prohibiting interlocking relationships of management officials. The prohibitions, how-

ever, do not generally apply to the followingorganizations and their subsidiaries:

• a depository institution that does not do busi-ness in the United States except as an incident

to its activities outside the United States;• an Edge or agreement corporation;• a depository organization in formal liquida-

tion or a similar type situation;• a credit union being served by a management

official of another credit union;• a state-chartered savings and loan guaranty

corporation; or• a Federal Home Loan Bank or other bank

organized solely for the purpose of servingdepository institutions or solely for the pur-

pose of providing securities clearing servicesand related services related to other depositoryinstitutions.

In addition, five other exceptions are permit-ted, with Federal Reserve Board approval, basedon the public benefit that is derived from theinterlocking relationship and on the competitivenature of the institutions involved. These excep-tions are for—

• institutions located in low-income areas orcontrolled or managed by members of a mi-nority group or by women,

• newly chartered institutions,• institutions facing conditions endangering

safety and soundness,• institutions sponsoring a credit union, and• institutions affected by loss of management

officials due to changes in circumstances.





Duties and Responsibilities of DirectorsExamination ObjectivesEffective date November 1995 Section 5000.2

1. To determine whether the board of direc-tors fully understands its duties and

responsibilities.2. To determine if the board of directors isdischarging its responsibilities in an appro-priate manner.

3. To determine whether the board of directors

has developed adequate objectives andpolicies.

4. To determine the existence of any conflicts of interest or self-dealing.5. To determine compliance with laws and

regulations.

Commercial Bank Examination Manual November 1995Page 1



Duties and Responsibilites of DirectorsExamination ProceduresEffective date November 2003 Section 5000.3

1. Update the following and review for possi-ble violations of law—

a. A list of directors to include—• home address (If the director was

appointed or elected since the previousexamination, state the number of yearsresiding at present address.),

• date of birth,

• years as a director of the bank,

• approximate net worth,

• occupation,

• citizenship,

• common stock ownership (beneficial,

direct, and indirect), and• bonuses, fees, etc.

b. A list of embezzlements, defalcations,misappropriations, mysterious disappear-ances, or thefts that have occurred sincethe last examination. That list should besigned by the chief executive officer orthe auditor.

c. A list of management officials (as definedin the Depository Institution Manage-

ment Interlocks Act) of the bank, itsholding company, and holding companyaffiliates who are management officialsof other depository institutions.

d. A list of the indebtedness of directors,executives officers, and principal share-holders to the bank examined and anyother bank, along with a statement of theterms and conditions of each extensionof credit.

2. Obtain or update a listing of all areas of

the bank’s operations that are administeredunder the provisions of written objectivesand policies that have been developed by orwith the approval of the board. Inform theexaminers assigned to review those depart-ments that a policy has been developed oran update has occurred.

3. Analyze the listing obtained in step 2, andnote any area of banking activity for whichpolicies should be developed.

4. Determine that the board has accepted itsresponsibility to effectively supervise theaffairs of the bank and to be informed of thebank’s condition by performing thefollowing:

a. Obtain a complete set of the latest reportsfurnished to directors at the last meeting,

and list the areas of operation covered bythe reports.

b. Distribute copies of the reports to theexaminers in other areas, and requestthat they determine if reports furnishedto the board are prepared accurately,contain sufficient detail to allow thedirectors to make an intelligent decision,and are submitted on a timely basis.

c. Prepare a list of areas not reporting or of reports the board does not receive thatare considered necessary to maintainadequate supervision. As guidelines, con-

sider the following reports:• A monthly statement of condition or

balance sheet and a monthly statementof income. Those statements should bein reasonable detail and should becompared with the prior month, withthe same month of a prior year, andwith the budget. The directors shouldreceive explanations for all largevariances.

• Monthly statements of changes in allcapital and reserve accounts. Suchstatements should explain any changes.

• Investment reports that group the secu-rities by classifications; that reflect thebook value, fair market value, andyield; and that include a summary of purchases and sales.

• Loan reports that list significant past-due loans, trends in delinquencies, ratereductions, non-income-producing

loans, and large new loans grantedsince the last report.

• Audit and examination reports. Defi-ciencies in these reports should pro-duce a prompt and efficient responsefrom the board. The reports reviewedand actions taken should be reflectedin minutes of the board of directorsmeetings.

• A full report of all new executive-officer borrowing at any bank.

• A monthly listing of type and amountof borrowing by the bank.

• An annual presentation of bank insur-ance coverage.

• All correspondence addressed to theboard of directors from the Federal




Reserve and any other source.

• A monthly analysis of the bank ’sliquidity position.

• An annual projection of the bank ’scapital needs.

• A listing of any new litigation and astatus report on existing litigation andpotential exposure.

• A thorough report on any major bank endeavor that each bank director isexpected to make a decision on, includ-ing branch applications and majorbuilding plans.

d. Determine the mechanism used to assignresponsibility for correcting deficienciesnoted in regulatory reports, internal auditreports, external audit reports, or anyother reports to the board, and determinethe board’s system of determining com-pliance with such recommendations.

e. Determine how directors perform adirector’s examination, the frequency of such examinations, and what part thedirectors take in the process.

f. Review the bank ’s method of ensuringcontinued or resumed operations in the

event of a disaster. Complete theemergency preparedness measuresquestionnaire for inclusion in theworkpapers.

g. Review correspondence between the Fed-eral Reserve and the bank to determinethat it has been properly reported.

5. Determine evidence of conflicts of interestand self-dealing by—

a. obtaining and summarizing informationon the business interests of directors,

executive of ficers, and principal share-holders;

b. comparing that information to develop alist of directors who have business inter-ests in common;

c. analyzing the interests of directors todetermine if the board consists of avariety of individuals;

d. obtaining from the examiner assigned toassessment of capital adequacy a list of shareholders who own or control, eitherdirectly or indirectly, 5 percent or moreof any class of voting security;

e. distributing a list of the insiders (direc-tors, of ficers, and shareholders whoseownership of voting securities in theinstitution is more than 10 percent) and

their related interests to the appropriateexamining personnel to ascertain theextent of loans to or transactions withinsiders and their interests (Those exam-iners should be alert for any relationships

with insiders’ interests that are notincluded on the list.);f. requesting that the appropriate examin-

ers determine if any transactions withinsiders are on terms more favorablethan those offered to other customers (If so, determine whether the board hasapproved such transactions.);

g. determining that directors have reviewedtheir correspondent bank accounts inrelation to possible conflicts of interest

arising from directors’, of ficers’, or share-holders’ borrowing from depositorybanks; and

h. correlating all information on insidertransactions, and preparing appropriatereport comments.

6. Obtain the minutes of the meetings of theboard of directors, the charter, the bylaws,and the minutes of shareholders meetings.a. Review and summarize the bylaws and

charter of the organization, including

any specific provisions on the require-ments of directors. The resulting mate-rial should become a permanentpart of the workpapers and should beupdated at subsequent examinations.

b. Read and summarize the minutes of allmeetings of the board since the lastexamination, making certain to—• list any actions taken in contravention

of the bylaws;• record major actions taken by the board

that are not a part of a normal monthlymeeting;

• record any resolution or discussioncovering the development of or entranceinto a new area, such as a geographicarea, customer service, asset category,or liability category;

• record the creation of any special com-mittee and the area with which it isdesigned to deal;

• determine that actions taken by stand-ing committees are reviewed and rati-fied by the full board;

• if the minutes specify any transactionswith directors or their interests, deter-mine that the abstention of any inter-ested director from voting on the mat-

5000.3 Duties and Responsibilities of Directors: Examination Procedures


Page 2



ters is noted;• if the minutes do not mention any

director-related transactions that havebeen uncovered during the examina-tion, inquire if the interested director

did refrain from voting.c. Read and summarize the minutes of theboard’s annual organization meetingand—• list standing committees and their

members,• have examiners who are examining

areas that have standing-committeesupervision read and summarize theminutes of those committees, and

• prepare a list of major areas of opera-

tion that are not monitored by specificcommittees.

d. Read and summarize the minutes of anystockholders meetings. The summaryshould include a list of directors electedat the annual meeting, the number of shares present and voted, individualsacting as proxies, and specific actionapproved by shareholders.

e. Ascertain during the review of sharehold-ers meeting minutes that (1) sharehold-

ers’ approval has been received; (2) thebank ’s charter has been amended, if necessary; and (3) compliance withappropriate state or federal statutes hasbeen met for the following:• any establishment of or change of a

branch location• any issuance of preferred stock • any increase in capital stock, either

through sale or a stock dividend• any reduction in capital stock (and

ascertain whether the resultant capitalis not below what is required by thecapital adequacy guidelines)

• any stock split• any bank pension plan established since

the preceding examination• any bank involvement in a conversion,

merger, or consolidation• all other matters subject to vote

f. Determine the date of the annual share-holders meeting and if it was in compli-ance with the bylaws.

g. Review the charter and/or bylaws forquorum requirements of shareholdermeetings. Ascertain that, at any meeting,the quorum requirements were satisfiedaccording to recorded requirements or by

having more than one-half of the eligibleshareholders represented.

h. Review any stock option or stock pur-chase plan adopted since the precedingexamination, and review such action

for compliance with the various condi-tions involving charter and shareholderapproval.

i. Determine if any candidate was nomi-nated for director, other than the slatenominated by bank management, andreview for compliance with the appropri-ate state statute.

7. Determine that the directors have acceptedtheir responsibility for selecting competentof ficers by—

a. determining that the board or a commit-tee thereof reviews, at least annually, thechief executive of ficer’s performance inattaining or progressing toward attainingspecific objectives or goals set by theboard,

b. determining if a policy statement onpersonnel exists, and ascertaining whatprovisions the board has made for suc-cessor management,

c. determining if any management con-

tracts exist and, if one does, obtaining acopy, summarizing the pertinent points,and determining the reasonableness of terms,

d. determining by inquiry how the remu-neration of executive of ficers is set andwho makes decisions concerning execu-tive salaries, and

e. listing any titled individual who, by actionof the board, is specifically excludedfrom being an executive of ficer.

8. Determine compliance with laws and regu-lations by—a. reviewing workpapers of other examina-

tion areas or discussing compliance withother examiners to determine any viola-tions of laws or regulations concerningdirectors that were disclosed in theseexamination areas,

b. reviewing the nature and extent of vio-lations discovered at prior examinationsto determine if similar violations haveoccurred at this examination, and

c. correlating information obtained fromthe minutes of board meetings to thereports of of ficer borrowings that havebeen prepared at and forwarded fromother banks to determine that all such

Duties and Responsibilities of Directors: Examination Procedures 5000.3




borrowings have been reported to theboard.

9. Determine compliance with the ForeignCorrupt Practices Act (15 USC 78dd-1 and-2) by—

a. reviewing the bank ’s policy prohibitingimproper or illegal payments, bribes,kickbacks, etc., to any foreign govern-ment of ficial or other person or organi-zation covered by the law;

b. determining how that policy has beencommunicated to of ficers, employees, oragents of the bank;

c. reviewing any investigation or study doneby, or on behalf of, the board of directorson the bank ’s policies and operations

concerning the advance of funds in pos-sible violation of the act;

d. reviewing the work done by the exam-iner assigned to internal control to deter-mine whether internal or external audi-tors have established routines to discoverimproper or illegal payments;

e. analyzing the general level of internalcontrol to determine whether there issuf ficient protection against the inaccu-rate recording of improper or illegal

payments on the bank ’s books;f. requesting that examiners working in

other areas of the bank be alert for anytransactions that might violate the provi-sions of the act;

g. compiling any information discoveredthroughout the examination on possibleviolations; and

h. performing procedures on suspectedcriminal violations as outlined in section5020.3, ‘‘Overall Conclusions Regarding

Condition of the Bank: ExaminationProcedures.’’

10. Answer the following questions. (This ques-tionnaire is intended to be a quick reviewfor determining that all laws and regulationspertaining to directors have been compliedwith. Questions should be answered ‘‘no’’and sub-questions should be answered‘‘yes.’’ Any deviation from this patternindicates a violation or potential violation.Situations that are not judged to be viola-tions require comments stating the basis forthat judgment.)a. Is the number of directors less than 5 or

greater than 25 (section 31, Banking Actof June 16, 1933)?

b. Have any directors failed to qualify by

reason of insuf ficient stock ownership(12 USC 72)?

c. Are any directors noncitizens of theUnited States (12 USC 72)? If so, has thecitizenship requirement been waived?

d. Do more than one-third of the directorsfail to reside in the state, territory, ordistrict in which the bank is located, orwithin 100 miles of the bank ’s headof fice (12 USC 72)?

e. Did more than one-third of the directorsfail to reside in the state, territory ordistrict in which the bank is located, orwithin 100 miles of the bank ’s headof fice, for one year before election(12 USC 72)?

f. Are any transactions with directors ortheir related interests on more favorableterms than those offered to other custom-ers (Regulation O (12 CFR 215))?

g. Do the deposit accounts of directorsreceive greater interest than those of other customers (section 22(e), FederalReserve Act (12 USC 376))?

h. Have any provisions of a cease-and-desist agreement or order been violated(Rules of Practice for Hearings (12 CFR

263))?i. Has any director, of ficer, or employee

been convicted of a crime involving abreach of trust or act of dishonesty (sec-tion 8(g) of the Federal Deposit Insur-ance Act (12 USC 1829))? If so, has theFDIC approved his or her membershipon the board or employment?

j. Have any tie-ins of services been autho-rized by the board (Regulation Y (12CFR 225.7))?

k. Were any loans to bank examiners dis-closed (Criminal Code—18 USC 212and 213)?

l. Has the bank made any political contri-butions (Federal Election Campaign Act(12 USC 441b))?

m. Have any employees been found to havemisappropriated funds, made falseentries, or otherwise defrauded the bank (18 USC 656)?

n. Has an of ficer of the bank failed to makeappropriate written reports when anembezzlement, misapplication, or simi-lar transaction occurred (SR-579)?

o. Have any extortionate extensions of creditbeen discovered (18 USC 892–894)?

p. Have any checks been certified against



Page 4



uncollected funds (18 USC 1004)?q. Have unauthorized obligations of the

bank been issued (18 USC 1005 and1006)?

r. Has there been a change in control (Regu-

lation Y (12 CFR 225.41–225.43))? If so, was the Federal Reserve notified andwas the application approved?

s. Have any purchase-money loans beenmade that are secured by 25 percent ormore of the stock of another securedbank (Regulation Y (12 CFR 225.41))?If so, have the appropriate authoritiesbeen notified?

t. Has the bank failed to maintain recordsof directors, executive of ficers, and prin-

cipal shareholders and their related inter-ests (Regulation O (12 CFR 215.8))?

u. Are management of ficials of the bank,or its holding company or holding com-pany af filiates, also management of ficialsof an unaf filiated depository institutionor depository holding company (Regula-tion L (12 CFR 212))? If so—• was such relationship established prior

to November 10, 1978, and previouslypermitted by section 8, Clayton Anti-

Trust Act (15 USC 19)?• was prior approval of the Federal

Reserve obtained for a relationshipthat was developed since Novem-ber 10, 1978?

• does the interlocking relationship meetthe criteria of one of the exceptionspermitted by Regulation L (12 CFR212)?

• is the management relationship with aninstitution whose—

— principal of fices or branches,excluding electronic terminals, arelocated in a different RMSA fromthe bank ’s or its holding compa-ny’s of fices or branches (does notapply if either institution has assetsof less than $20 million) (12 CFR212.3(b))?

— principal of fices or branches,excluding electronic terminals, arelocated in another city, town, orvillage not contiguous or adjacentand 10 miles or more apart?

• if the bank or its holding company hasassets exceeding $2.5 billion, does theinterlocking management relationshipexist with a nonaf filiated depository

institution holding company with assetsof $1.5 billion or less?

v. Have any loans to executive of ficersbeen uncovered that were not reported tothe board (Regulation O (12 CFR 215)

and 12 USC 503)?w. Has a majority of the board failed topreapprove extensions of credit to any of the bank ’s executive of ficers, directors,or principal shareholders and their relatedinterests when the total loans to theindividual exceed the amount prescribedin Regulation O?

x. Has the bank notified executive of ficersand principal shareholders of their report-ing requirements (Regulation O (12 CFR

215))?11. Determine compliance with administrative

actions by—a. reviewing provisions of the document

andb. reviewing bank records and perform-

ing necessary procedures to isolatenoncompliance.

12. Evaluate the bank ’s compliance with formalor informal administrative actions and pre-pare comments for page one of the exami-

nation report (SR-02-17 and SR-92-21).(See also section 5040.1.)

13. Determine compliance with conditionsimposed in the approvals of corporate fil-ings for—a. branches and relocation applications,

including—• capital plans or capital injections,• fixed-asset limitations, and• CRA plans;

b. subordinated debt, operating subsidi-

aries, and interim bank applications,including—• capital plans and• prior review and appropriate clearance

of disclosures.14. On the basis of the information obtained by

performing the foregoing procedures, orany other procedures deemed appropriate,evaluate the adequacy and effectiveness of the board of directors. The evaluation shouldinclude, but is not limited to—a. the frequency and effectiveness of

meetings;b. the effectiveness of board committees;c. the directors’ role in establishing policy;d. the adequacy of the policies and major

inconsistencies therein;

Duties and Responsibilities of Directors: Examination Procedures 5000.3




e. the quality of reports for directors, not-ing any deficiencies in information flowsfrom operating management;

f. violations of laws and regulations;g. whether any one person or group appears

to control or dominate the board (if so,comment on any adverse effects onoperating policies, procedures, or the

overall financial condition of the bank);and

h. the board’s responsiveness to recommen-dations from the auditors and supervi-sory authorities.

15. Update the workpapers with any informa-tion that will facilitate future examinations.



Page 6



Management AssessmentEffective date March 1984 Section 5010.1

The purpose of this section is to guide theexaminer in evaluating bank management.Although the directorate is an integral part of the

overall management of a bank, the managementappraisal examination program is concernedprimarily with the active officers. A review of the quality of director guidance and supervisionis covered in ‘‘Duties and Responsibilities of Directors.’’

It is the responsibility of directors to employa competent chief executive officer. Thereafter,senior management normally assumes the respon-sibility to employ, maintain and educate a qual-ified staff. Since a direct relationship exists

between the overall condition of a bank and thequality of management, the first priority inevaluating the condition of the bank is to makean accurate appraisal of the competency of themanagement team.

Management is responsible, not only for theoperations of the bank and the quality of itsassets on a day-to-day basis, but also for plan-ning for the future. Senior management shouldbe evaluated on its plans for maintaining orimproving the condition of the bank in the future

as well as on the bank’s present condition. Thedepth of planning and a general forward lookingattitude of executive officers should be consid-ered when projecting future management impact.This should include an evaluation of manage-ment’s efforts to provide for succession of senior bank officials.

The projection of future management impactinvolves an appraisal of the quality and quantityof senior and middle management. This assess-ment of course must be relative to the size and

community circumstances of the bank. Examin-ers must not restrict their appraisals to the pastand present. The past and present certainly aresignificant, requiring an in-depth analysis of financial condition, earnings and capital ade-quacy, both on an absolute basis and as a trend,but, the determination of what the managementwill do for the bank in the future is mostsignificant. The System’s goal is to preventproblems from developing rather than waitingfor future examinations to identify deterioratingconditions.

Bank management receives strong pressurefrom customers, stockholders and competitors.Customers demand more for their money, in theform of both interest and services, and stock-holders demand higher returns on their invest-

ments, both in dividends and increased marketvalue of their stock. No bank is completely freefrom the pressure of competition and, for most

institutions, this is one of the strongest forcesfelt. In the midst of those pressures, the clearmandate to bank management is to ‘‘perform.’’Performance is measured in terms of long-runprofitability, liquidity and solvency. It is almostimpossible for a bank to achieve those long-range goals unless careful planning and coordi-nation bring efficiency to its activities. Manage-ment must recognize the bank’s position in themarket and make plans which will achieve theobjectives set for the institution by the directors.

It must be constantly alert to the need forcontinually upgrading and expanding servicesand facilities to support and encourage thebank’s growth.

Both the directors and senior managementhave important roles in a bank’s program of internal control and internal audit. Althoughdirectors have overall audit responsibility andshould require that the auditor report directly tothem, senior management normally is chargedwith the duty of maintaining a strong system of

internal control.The entire examination procedure, as outlined

throughout this manual, is designed to provide aclear picture of both the present and anticipatedfuture condition of the bank under examination.As a result, the reports and workpapers gener-ated by the examination process will serve as amajor tool for examiners in their evaluation of management. Examination procedures for vari-ous balance sheet accounts and departmentalareas are designed to effect a comprehensive

evaluation of internal control and internaland/or external audit, and will provide the ex-aminer with insight into the degree of compli-ance with the bank’s own written policies insuch areas. Similarly, the examination pro-cedures in ‘‘Loan Portfolio Management,’’‘‘Investment Securities,’’ ‘‘Funds Manage-ment,’’ ‘‘Assessment of Capital Adequacy,’’ and‘‘Analytical Review and Income and Expense’’are designed to lead to a detailed analysis of written objectives, policies and procedures inthose management areas.

The examiner must take a practical approachto evaluating these features depending on thebank’s characteristics. The examiner can havegreater confidence in the continuity of top andmiddle management when it is known that the

Commercial Bank Examination Manual March 1994Page 1



bank has an inflow of new personnel at variouslevels and that training procedures and advance-ment policies will keep the organization viableand dynamic.

The examiner must be concerned with salary

levels within the bank and must review infor-mation collected during the examination aboutthe bank’s employee benefits program. Salariespaid and benefits provided should be comparedwith those offered by an appropriate peer group,and inquiry should be made to determine therelationship between the bank’s payroll struc-ture and that offered by competitors for the samecaliber personnel.

The examiner must judge the appropriatenessof asset distribution in view of the bank’s

sources of funds. The examiner must evaluatethe adequacy of the bank’s capital position andexpectations in view of asset quality and plansfor growth and expansion. The overall manage-ment evaluation should be made by the examiner-in-charge, because he or she is in the bestposition to identify weaknesses and inconsisten-cies in policies. Although examiners-in-chargewill rely heavily upon the information receivedfrom assisting examining personnel in variousareas under review, it is their task to assemble

all of such information into a composite pictureof the quality of management.

Senior management is responsible for thequality of all bank personnel and for planning itsown replacement. A bank’s recruiting, training,and personnel development activities are vital tothe development and continuity of a quality

staff. The examiner must evaluate those areas todetermine the quality of overall management.Some features of good personnel managementare:

• An organizational structure.• Detailed position descriptions.

• Carefully planned recruiting.

• Appropriate training.

• Performance review.

• Salary administration.

• Provision for communication.

The examiner should identify and interprettrends that can reveal flaws in policy either as

written or as practiced. The examiner shouldquestion the quality of management in any areain which he or she finds serious shortcomings ormakes significant criticisms.

The examiner should be alert for situations inwhich top management dominates the board orwhere top management acts solely at the direc-tion of either the board or a dominant influenceon the board. Although it is extremely importantfor the directors to assume their appropriate rolein setting objectives and formulating policy

consistent with their responsibilities to thedepositors, shareholders and regulators, dia-logue with top management must occur. Inbanks where both directors and senior manage-ment recognize and assume their appropriateduties and responsibilities, areas for conflict aregreatly reduced.

5010.1 Management Assessment

March 1994 Commercial Bank Examination Manual

Page 2



Management AssessmentExamination ObjectivesEffective date March 1984 Section 5010.2

1. To determine the consistency of writtenobjectives, policies, and procedures in the

various asset, liability, and operational areas.2. To determine that policies are being adheredto throughout the system.

3. To determine that management plansadequately for future conditions anddevelopments.

4. To evaluate the adequacy of the bank’spersonnel practices as they relate to manage-ment continuity.

5. To evaluate management experience anddepth.

6. To determine that management has estab-lished systems which facilitate efficientoperation and communication.

7. To evaluate the propriety and soundness of management decisions.

8. To project the impact of management on thefuture condition of the bank.




Management AssessmentExamination ProceduresEffective date March 1984 Section 5010.3

In the following procedural steps examinersshould attempt to utilize already developed

material from internal or external audit sources.Also, the examining resources and circum-stances of the bank must be weighed in perspec-tive to set the depth of scope for this area.

1. Obtain the following, if available:a. Organization chart.b. Management plan.c. Administrative and personal manuals.d. Marketing plan.e. Resumes for all executive officers and

department or division heads whichhave not been obtained in previousexaminations.

f. A list of the salary of and other compen-sation paid to each executive officer.

g. A list of the salary ranges for otherofficers of the bank broken down byposition.

h. A description of other employee benefits.2. Become familiar with the quality of key

personnel by:a. Updating management briefs for all exec-utive officers and department or divisionheads.

b. Distributing the updated managementbriefs to appropriate examining person-nel and requesting that they be returnedupon completion.

3. Review administrative manuals and:a. Extract any policy statements contained

therein.

b. Extract any general information consid-ered relevant in appraising management.

c. Analyze the manual(s), in general, asuseful management tools.

4. Review management plan and extract infor-mation concerning:a. Areas of bank where increased or

decreased officer staffing is planned.b. Number of officers to be added or

removed.c. Qualification requirements for planned

additional officers.5. Establish the hierarchy of the organization

by determining the functional responsibilitylevels of various officers and whether linesof authority are drawn in accordance withthe organization chart.

6. Review the bank’s marketing plan for spe-cific programs being planned and general

applicability to the institution.7. Review the bank’s schedule of salaries andmake comparisons with similar informa-tion from an appropriate peer group. If deemed appropriate, compare salaries paidand benefits received in the bank to those of other institutions with which it competesdirectly. Determine whether the bank ispaying salaries or bonuses to inactive offi-cers or directors and, if so, determine thatsuch payments have been disclosed to

shareholders.8. Determine whether any executive incentive

compensation plans (performance bonuses)have been established and, if so;

a. Review specific provisions of the plansand determine the beneficiaries.

b. Review controls established to preventthe beneficiary(s) of the plan fromunderstating noncash expenses (accrualexpense accounts, provision for possibleloan losses, etc.) or overstating noncashincome (accrual income accounts).

9. Review the bank’s activities with regard todeveloping personnel for senior manage-ment succession. At a minimum, this reviewshould include:

a. An assessment of the quality of lowerlevels of management and the potentialfor advancement.

b. An assessment of the bank’s officer hir-ing policies to determine that it is appro-

priate to meet the bank’s current andfuture needs.

10. Obtain and analyze daily or other periodicreports submitted to executive managementwith the view of determining the usefulnessof the reports in monitoring the conditionand operation of the bank.

11. As the evaluation of the various areas of examination interest are being completed,discuss with assisting personnel:

a. Any of their observations indicative of

the general morale level.b. The technical proficiency of officers in

their area.c. The level of direct impact that officers

have on the condition of their areas.

12. Review the section on ‘‘Analytical Review




and Income and Expense’’ and extract anyinformation related to financial planningthat is considered relevant to evaluatingmanagement. Also consider the quality,depth and applicability of financial

planning.13. In conjunction with reviewing the work papers and comments generated during theexamination:a. Familiarize yourself with the bank’s

written objectives and policies.b. Analyze those policies and determine

any inconsistencies in management areas.c. Review any internal control and policy

exceptions and any other criticisms madein connection with the examination of all

areas of the bank.d. Determine the extent to which improper

implementation is negating the effect of written policies and procedures.

e. Review the appropriateness of assetdistribution in view of the bank’s sourcesof funds.

f. Review the evaluation of the bank’scapital position and expectations in viewof asset quality and plans for growth andexpansion.

14. In cases where previously obtained infor-mation is incomplete or where no recordscould be reviewed, interview appropriatemanagement in order to judge quality anddepth. The interview should be conductedin such a manner as to generate neces-sary information for determining:a. Sources of information used to keep

current.b. Stengths and weaknesses of lower level

personnel.

c. Succession of management and replace-ment of key personnel.

d. General management plan.e. Methods of control utilized.f. Workload factors and efficiency of

personnel.g. Frequency of staff meetings and how the

communications system works.h. Management projections for the institu-

tion over the next year.i. Any major new proposal being consid-

ered or changes in asset mix or services. j. The nature and degree of working rela-

tionship with directors.k. The existence of any time-consuming

o u ts i de a c ti v i ti e s o f e x ec u ti v emanagement.

15. By reviewing the results of the precedingsteps and performing any other proceduresdeemed appropriate, answer the followingquestions (normally these questions wills erve a s a s umma ry o f informa tion

obtained, thus compiling factual data tosupport your objective comments onmanagement):a. Have overall management objectives

been set?b. Does the bank forecast manpower

requirements?c. Are qualified people advanced from

within?d. Are supervisory personnel involved in

the selection of new employees and given

the right of acceptance or rejection?e. Is management training given to those

persons likely to assume higher levelpositions?

f. Are salaries competitive?g. Are employee benefit programs

competitive?16. Prepare comments on the quality of man-

agement supervision. The comments should,at a minimum, discuss the following:a. General and technical ability.

b. Effectiveness.c. Experience.d. Any inconsistencies in written objec-

tives, policies and procedures.e. Any serious or widespread lack of proper

implementation of written procedures.f. An evaluation of the bank’s salary

structure.g. The promptness with which management

addresses problems.h. T h e e x t e n t t o w h i c h e x e c u t i v e

management delegates and demandsaccountability.

i. Any evidence that executive manage-ment is more concerned with the opera-tion of a functional area than with overallsupervision of the bank.

j. The potential for upward movement of existing management personnel.

k. Management’s commitment to effectingcorrective action in problem areas.

l. Unsafe or unsound management.m. Any situation which might require close

monitoring or removal of management.17. For banks that are subsidiaries of bank

holding companies (BHCs), review therelative degree of centralized control byparent or the lead bank, and evaluate:

5010.3 Management Assessment: Examination Procedures


Page 2



a. The general level of management’s depen-dence on central BHC staff.

b. Independence on final credit decisions.c. Independence on investment decisions.d. Independence on operational practices or

service fee arrangements.

While examiners may expect that econo-mies of scale or optimization of tax, invest-ment, or credit considerations on a consoli-dated basis may be beneficial to the entire

organization, examiners must be alert to thedanger of such considerations becomingoverly burdensome or unfair to the subsid-iary bank being examined. (Reference Fed-eral Reserve Policy Statement on Inter-

c or po ra te I nc om e Ta x A cc ou nt in gTransactions of Bank Holding Companiesand State Member Banks.)


Management Assessment: Examination Procedures 5010.3




Management AssessmentInternal Control QuestionnaireEffective date March 1984 Section 5010.4

1. Does the bank have an organizational chart?2. If not, have lines of authority and reporting

responsibility been formally established?3. Does the bank have a full-time personnelmanager?

4. Does the bank utilize written personnelmanuals?

5. Does the bank utilize a system of written job descriptions, including descriptions forsupervisory personnel?

6. Does the bank actively recruit personnel?7. Does the bank perform background investi-

gations of new employees?

8. Does the bank have a formal trainingprogram?

9. Does the bank utilize other than on-the-jobtraining?

10. Does the bank utilize a graded salary scale?11. Does the bank consider competition in

preparing a salary range? If so, in whatmanner?

12. Does the top management at least annuallyreview lower management?

13. Does the bank prepare or utilize a long-

range forecast of economic conditions ger-mane to its trade area?

14. Does top management consult with direc-tors for their opinion of future condition?

15. Does the bank either employ an economistor utilize the services of an outside eco-nomic advisor?

16. Does senior management propose to thedirectors areas for policy decision?

17. Does the bank have a management succes-sion plan?

18. Does the bank employ a marketing managerand/or outside marketing consultant?

19. Does senior management receive:a. A brief statement of condition daily?

b. A daily liquidity report?c. A listing of assets subject to quality

limitations at least monthly?d. An earnings statement on a comparative

basis at least monthly?20. Does the bank’s auditing function audit the

officer’s adherence to general policy?21. Are staff meetings held on a regular basis?22. Are minutes kept for staff meetings?23. Does the bank use a system of progress

reports on specific projects?

24. Does the bank have a tax department or atax consultant?




Overall Conclusions Regarding Condition of the Bank Effective date May 2007 Section 5020.1

Throughout this manual, the examiner is encour-aged to use objective criteria in evaluatingvarious areas of the bank. However, there will

always be a need for subjective judgment in anexamination. Formulating an overall conclusionregarding the present and future condition of the bank requires the use of both objectivecriteria and subjective judgment. As experienceis essential in evaluating information in areasrequiring subjective judgment, the proceduresin this section should be performed by theexaminer-in-charge. In performing these proce-dures, the examiner’s primary concerns are—

• to make the ultimate determination as to—

— the solvency of the bank and its ability tomeet maturing and unusual demands in theordinary course of business,

— adherence to safe and sound bankingpractice,

— adherence to the law, and

— the continued viability of the institution,and

• to communicate the results of the examination

to the Federal Reserve System and the direc-tors of the bank.

The evaluation of the overall condition of thebank is based on conditions found throughoutthe institution. Considerations include internalcontrol and policy exceptions, violations of lawand regulations, quality of management, ade-quacy of earnings and capital, quantities of criti-cized assets, and other identified deficiencies orirregularities. An evaluation of the future con-dition of the bank is based on the analysis of—

• management’s plans as expressed by operat-ing plans, the capital plan, and otherprojections,

• factors such as competition and economicconditions, and

• the overall present condition of the bank.

The primary information for evaluating thepresent condition of a bank is the findings andconclusions of the assisting personnel. Theexaminer-in-charge should weigh the impor-tance and significance of all criticisms, excep-tions, and deficiencies in attempting to discoverany unfavorable trends or situations. Throughreview of the examination process, insight canbe gained into such central issues as—

• present asset quality;

• current liquidity position;• present capital adequacy;

• quality and performance of management;• earnings performance, both past and present;and

• sources and applications of funds.

The examiner-in-charge usually will includeremarks regarding those areas in the examina-tion report. Although procedural areas of thismanual deal specifically with each of those keyitems, the examiner-in-charge should useinformation from all phases of the examination.

For example, when reviewing the bank’s presentcapital position, the examiner-in-charge mayuse knowledge of the bank’s asset and manage-ment quality to modify the conclusions of assist-ing personnel. The important point is that theexaminer-in-charge is in the best position toassess all information provided by the examina-tion process.

Factors affecting the future condition of thebank can generally be categorized as internal orexternal. The examiner’s review of current con-

dition flows naturally into an evaluation of internal factors affecting the institution’s futureprospects and condition. Among the items pro-viding insight into future conditions are—

• earnings trends,

• successor-management plans,

• the budget or profit plan,

• the capital plan, and

• any other internally generated projections orforecasts.

Many banks will not have formal writtenplans or projections. In such cases, the examiner-in-charge must obtain from senior managementor the board of directors information on theirplans for matters such as—

• growth and expansion,

• capital,

• changes in the size and mix of assets, and

• changes in sources of funding.

In addition, examiners should remind seniormanagement that any change in the generalcharacter of a bank’s business or the scope of the corporate powers it exercises requires theprior approval of the Board under Regulation H.

The examiner should recommend that banks

Commercial Bank Examination Manual May 2007Page 1



that do not have formal plans or projections takeadvantage of any externally available tools toaid them in formulating these plans. In today’scompetitive market, strategic planning is anecessity for almost all banks, but especially for

banks that are losing their market share or inwhich inef ficiencies are depressing profitability.

If banks prepare budgets or profit plans,insight can be gained into the accuracy of balance-sheet and earnings projections by com-paring actual and projected account balances.It also is beneficial to compare original projec-tions with current projections to determine thatadjustments are made on a timely basis. Whenfour- or five-year projections are made, banksoften formulate several forecasts based on dif-

ferent sets of assumptions. In such a situation,the examiner should attempt to determine thebank ’s most likely future course.

The examiner should attempt to gain access toany of ficial material or internal workpapers thatdocument or illustrate the bank ’s rationale inplanning its future. The goal is to review theinstitution’s decision-making process.

Banks are turning increasingly to off-balance-sheet activities to deliver services, effect pay-ments, generate income, and hedge interest-raterisks. Banks have introduced a wide variety of new products and services to complement theirmore traditional activities. Although these newactivities are useful and profitable, they containan element of risk. Many of these new activi-ties involve a contingent liability or other risk that is not reflected on the bank ’s balance sheetand, indeed, may not even be fully recognizedby the bank. The examiner should be aware of how the bank manages and controls its off-

balance-sheet risks. Examples of off-balance-sheet activities include—

• electronic funds transfer systems,

• nontraditional lending activities (includingthe sale and servicing of mortgage andgovernment-guaranteed loans),

• innovative applications for standby letters of credit, and

• a wide variety of investment-security activi-ties (including futures and forwards, puts and

calls, and short sales).

Risk can be distinguished primarily as creditrisk, funding risk, rate risk, or risk resultingfrom internal control deficiencies. Examinersmust be aware of the nature and extent of off-balance-sheet risks. The risks that affect

capital, liquidity, and compliance with lawsshould be evaluated for their potential effect onthe safety and soundness of the bank.

In judging such controversial areas as capitaladequacy and liquidity, the examiner should

remember that, under ideal circumstances, man-agement should be the expert on the bank ’scapitalization and liquidity position. Judgmentson such matters should be generated internally,based on insight only management can possess.It is management that should know the bank ’scompetitive situation, the economics of theservice area, and the anticipated impact of thoseand other factors on its plans for growth andexpansion. It is also management that has thegreatest interest in the success of the bank.

Accordingly, management and the directorateshould choose a level of capitalization andliquidity consistent with their perception of thebank ’s situation rather than reacting to com-petitors or relying on pressures from regulators.However, specific judgments by the examinerare required, particularly in situations where acapital or liquidity position has fallen belowwhat examiners consider to be acceptable norms.Objective justification for lower levels of capitalor liquidity must be obtained and analyzed.

To properly evaluate the future prospects of abank, the examiner must review external factorsaffecting the institution. Significant among thosefactors are the characteristics of a bank ’s area.Area refers to the bank ’s primary service area,which is defined as that area from which thebank receives approximately 75 percent of itsdeposits. Demographics of the area generally areavailable, and every bank should accumulatesuch information to aid in analyzing its currentoperations and planning for future operations.

The absence of such information in an up-to-date form should be considered a deficiency.Included under examination procedures for thissection is a listing of minimum informationrequired to ascertain the demographics of aservice area. The examiner-in-charge shouldmake sure that information is compiled andshould analyze it to determine whether manage-ment expectations appear justifiable in thecircumstances.

In dealing with competitive factors, the exam-iner should review or compute the share of market for the bank under examination. Con-tinuing records in that area establish an analyz-able trend. Consideration also should be givento changes in the bank ’s statutory and regulatoryenvironment, such as—

5020.1 Overall Conclusions Regarding Condition of the Bank

May 2007 Commercial Bank Examination Manual

Page 2



• changes in branching laws,• changes in tax structure, and• changes in laws affecting competition with

other financial institutions.

Once the examiner has reached specifi

c con-clusions about the present condition and futureprospects of the bank, or has noted seriousdeficiencies or detrimental trends, his or herconclusions and suggestions should be commu-nicated to bank senior management, the board of directors, and the Federal Reserve Bank on atimely basis. In formulating discussion and writ-ten comments, the examiner should avoid theappearance of second-guessing management.Therefore, conclusions, judgments, and recom-

mendations should be based on objective infor-mation generated throughout the entire exam-ination process.

Before preparing examination report com-ments regarding the overall condition of thebank, the examiner-in-charge should considerthe reporting objective. Once it is determinedthat problems exist in a bank, the underlyingcauses must be identified. Those underlyingcauses as well as specific problems or deficien-cies should be covered in the comments. For

example, if deficiencies in written lendingobjectives or policies or noncompliance withsound policies has resulted in the acquisition of sub-quality assets, the examiner’s commentsmust address both cause and effect. The total of criticized assets should be cited as evidence of the underlying problem, and appropriate rem-edies, such as changing objectives or policies,should be suggested.

Examiners should remember that their abilityto reach accurate conclusions regarding the

overall present condition and future prospects of the bank and their skill in communicating theconclusions to management orally and in reportswill, to a great extent, determine the effective-ness of the entire examination process.

The examiner’s conclusions regarding theoverall condition of the bank are summarized ina composite rating assigned in accordance withguidelines provided under the Uniform Inter-agency Bank Rating System (CAMELS). Thecomposite rating represents an overall appraisalof six key assessment areas (components) cov-ered under the CAMELS rating system: Capital,Asset quality, Management, Earnings, Liquidity,and Sensitivity to market risk. The summary, orcomposite, rating, as well as each of the assess-ment areas, is delineated on a numerical scale of

one to five, one being the highest or bestpossible score. Thus, a bank with a compositerating of one requires the lowest level of super-visory attention, while a five-rated bank has themost critically deficient level of performance

and therefore requires the highest degree of supervisory attention. When appraising the sixkey assessment areas and assigning a compositerating, the examiner weighs and evaluates allrelevant factors. In general, these factors includethe adequacy of the capital base, net worth, andreserves for supporting present operations andfuture growth plans; the quality of loans, invest-ments, and other assets; the ability to generateearnings to maintain public confidence, coverlosses, and provide adequate security and return

to depositors; the ability to manage liquidity andfunding (in particular, during periods of increasedfinancial stress); the ability to meet the commu-nity’s legitimate needs for financial services andcover all maturing deposit obligations; and theability of management to properly administer allaspects of the financial business and plan forfuture needs and changing circumstances. Theassessment of management and administrationincludes the quality of internal controls, operat-ing procedures, and all lending, investment and

operating policies; compliance with relevantlaws and regulations; and the involvement of thedirectors, shareholders, and of ficials.

Although the composite rating is based looselyon the average of the six component scores, theexaminer’s judgment can and should play amajor role in its determination. Thus, the exam-iner must assess the severity, particularly thepotential impact, of individual weaknesses onthe present and future viability of the bank.Significant problems will provide suf ficient

basis for deviating from the numerical-averageapproach to assigning the composite rating.However, whenever deviation from the numeri-cal standards for the composite rating is neces-sary to accurately reflect the overall condition of the bank, the examiner must provide a fullexplanation of the reasons for such deviation.See the appendix (section A.5020.1) for a com-plete discussion of the uniform rating systemand considerations to be taken into accountwhen using it to evaluate the condition of abank.

SUBSIDIARIES OF BANKHOLDING COMPANIES

The composite rating of an individual subsidiary

Overall Conclusions Regarding Condition of the Bank 5020.1




bank should be based on the condition of thatsingle entity. The quality of management andthe financial condition of the consolidated orga-nization will be useful in assessing the prospectsand understanding the operations of the bank

being examined. However, banks with weak-nesses requiring corrective action should beidentified as such. Then, appropriate supervisoryfocus can also be made at the consolidated level.Also, banks should be identified by type on anindividual basis rather than by applying theconsolidated organization’s characteristic to eachbank. For example, the capital and condition of a community bank should be judged by commu-nity bank standards, not by multinational orregional standards, even if the bank is owned by

such an organization. This approach recognizesthat two consolidated organizations of similarsize may be composed of entirely different typesof banks. Proper evaluation of each bank com-ponent should lead a bank holding companyexaminer to the most appropriate conclusion onthe condition of the consolidated entity.

CONFIDENTIALITY OF THE

SUPERVISORY RATINGAND OTHER NONPUBLICSUPERVISORY INFORMATION

A February 28, 2005, interagency advisoryreminds banking organizations of the statutoryprohibitions on the disclosure of supervisoryratings and other confidential supervisory infor-mation to third parties. The agencies1 learnedthat some insurers had requested or requiredbanks and savings associations (financial insti-

tutions) to disclose their CAMELS rating duringthe underwriting process when those institutionshad sought directors’ and of ficers’ liability(D&O) coverage.2 The agencies responded byissuing the advisory specifically to remind allbanking organizations that, except in very lim-ited circumstances, they are prohibited by lawfrom disclosing their CAMELS rating and other

nonpublic supervisory information to insurers aswell as other nonrelated third parties withoutpermission from their appropriate federal bank-ing agency. (See SR-05-4, SR-98-21, SR-96-26,and SR-88-37.)

Federal banking regulations provide that thereport of examination, which contains theCAMELS rating, is nonpublic information andis the property of the agency issuing the report.3

These regulations specifically provide that,except in very limited circumstances, banks andother financial institutions may not disclose areport of examination or any portion of thereport, nor make any representations concerningthe report or the report’s findings, without theprior written permission of the appropriate fed-

eral banking agency.4

The circumstances forrelease of nonpublic supervisory informationmay include disclosure to a parent holdingcompany, a director, an of ficer, an attorney, anauditor, or another specified third party, asindicated in the regulations of the appropriatefederal banking agency.5 Any person who dis-closes or uses nonpublic information except asexpressly permitted by one of the appropriatefederal banking agencies or as provided by theagency’s regulations may be subject to the

criminal penalties provided in 18 USC 641.The legal prohibition on the release of non-

public supervisory information applies to allfinancial institutions supervised by the agencies,including bank and thrift holding companies,Edge corporations, and the U.S. branches oragencies of foreign banking organizations, whichreceive confidential supervisory ratings, includ-ing the RFI/C(D) rating, ROCA rating, CORErating, and CAMEO rating.6 As with the

1. The Board of Governors of the Federal Reserve System

(FRB), the Of fice of the Comptroller of the Currency (OCC),the Federal Deposit Insurance Corporation (FDIC), and theOf fice of Thrift Supervision (OCC).

2. As part of the examination process, a confidentialsupervisory rating, called a CAMELS rating, is assigned toeach depository institution regulated by the agencies. See theappendix section A.5020.1 for a complete description of therating system.

3. For the Federal Reserve, see 12 CFR 261.2(c)(1),261.20(g), and 261.22(e).

4. See 12 CFR 261.22.5. See 12 USC 326 and 12 CFR 261.20(b) (exceptions).6. RFI/C(D), ROCA, and CAMEO ratings are assigned by

the FRB as a result of an examination or inspection. As of January 1, 2005, the FRB adopted a new rating system,RFI/C(D) ratings, for bank holding companies that replacesthe former BOPEC rating system. RFI/C(D) ratings compo-nents are Risk management, Financial condition, potentialImpact of the parent and nondepository subsidiaries on thesubsidiary depository institutions, Composite, and Depositoryinstitution. For noncomplex bank holding companies with

assets of $1 billion or less, only risk-management and com-posite ratings are assigned. ROCA ratings are assigned to theU.S. branches, agencies, and commercial lending companiesof foreign banking organizations. The ROCA rating compo-nents are Risk management, Operational controls, Compli-ance, and Asset quality. CORE ratings are assigned tocomplex holding company enterprises. The CORE ratingcomponents are Capital, Organizational structure, Relation-



Page 4



CAMELS rating, these ratings are transmitted tothe regulated institutions in reports of inspectionor examination, which are the property of theagencies.

Financial institutions that receive requests for

confidential supervisory ratings should refer allrequesters to the following publicly availableinformation in lieu of disclosing any confiden-tial regulatory information, including theCAMELS rating. (See the National InformationCenter, on the Federal Financial InstitutionsExamination Council (FFIEC) web site,www.ffiec.gov/.)

• for banks, an institution’s quarterly reports of condition (Call Reports) (see 12 USC 1817)

• for holding companies or foreign banks withU.S. operations, an institution’s quarterly andannual FR Y or H-(b)11 reports (see 12 USC1844, 3106, 3108, 601–604a, and 611–631)

• for national banks, the annual disclosure state-ment (see 12 CFR 18.3)

• for banks, the institution’s Uniform Bank Performance Report (UBPR), which is avail-able to all interested parties at the web sitewww.ffiec.gov and is designed for summaryand in-depth analysis of banks; for savings

associations, the Uniform Thrift PerformanceReport (UTPR), available from the OTS uponrequest

• an institution’s publicly available filings, if any, filed with the appropriate federal bankingagency (15 USC 78(l)(i)) or with the U.S.Securities and Exchange Commission

• any reports or ratings on the institution com-piled by private companies that track theperformance of financial institutions7

• any reports or ratings issued by private rating

services on public debt issued by an institution• any publicly available cease-and-desist order

or enforcement proceeding against aninstitution8

• any reports or other sources of information oninstitution performance or internal matterscreated by the institution that does not containinformation prohibited from release by law orregulation

The National Association of Insurance Com-missioners (NAIC) was advised by the agenciesthat some insurers were inappropriately request-ing or requiring disclosure of CAMELS ratingsas a part of the underwriting process. Theagencies requested NAIC’s assistance in notify-ing insurance companies that this practice shouldbe discontinued because of the confidentialnature of the CAMELS rating.

FORMAL AND INFORMALSUPERVISORY ACTIONS

As a general rule, supervisory action shouldbe considered when other more routine mea-sures, such as formal discussions with a bank’sprincipals or directors and normal follow-upprocedures, have failed to resolve supervisory

concerns. The Uniform Interagency Bank Rat-ing System clearly identifies the more seriousproblem banks and distinguishes them frombanks whose weaknesses or deficiencies aresuch as to warrant a lower degree of supervisoryconcern.

For example, the application of prompt andeffective remedial action may keep the conditionof a composite 3 bank from deteriorating and thebank from becoming a problem institution. Toensure problem areas receive adequate attention,

all weaknesses should be clearly defined andcorrective measures should be properly struc-tured. This objective may best be achievedthrough the execution of a memorandum of understanding between the bank’s board of directors and Reserve Bank officials. A memo-randum of understanding is not a formal writtenagreement as prescribed in the Financial Insti-tutions Supervisory Act of 1966; it is a goodfaith understanding between the bank’s director-ate and the Reserve Bank concerning the prin-

cipal problems and the bank’s proposed remedies.

Banks rated composite 4 or 5 are clearlyproblem institutions that require close and con-stant supervisory attention. Unless specific cir-cumstances argue strongly to the contrary, suchbanks will be presumed to warrant formal super-

ship, and Earnings. CAMEO ratings are assigned to Edgecorporations and the overseas branches and subsidiaries of

U.S. banks. The CAMEO ratings components are Capital,Asset quality, Management, Earnings, and Operations andinternal controls.

7. For bank rating services, see the guidance at

www.fdic.gov/bank/individual/bank/index.html.8. Information on enforcement actions taken by the Federal

Reserve may be found at www.federalreserve.gov/boarddocs/ enforcement/search.cfm. Information on enforcement actionstaken by other federal agencies, such as the Securities and

Exchange Commission, the Financial Crimes EnforcementNetwork, and the Department of Justice, as well as foreignauthorities, may also be publicly available.





visory action, that is, a written agreement orcease-and-desist order, as provided for in theFinancial Institutions Supervisory Act of 1966.In addition, the Board of Governors is autho-rized to suspend and remove offending officers

and directors of banks for certain violations andactivities.

Although the decision to pursue formal orinformal supervisory actions belongs to theBoard of Governors or the Reserve Bank, theinitial consideration and determination of whetheraction is necessary usually results from theexamination process. Accurate and completereport comments that carefully delineate boththe bank’s weaknesses and deficiencies, as wellas management’s existing or planned corrective

measures, will allow the Reserve Bank to makethe most informed decision concerning appro-priate supervisory action.

CIVIL MONEY PENALTIES

Under provisions of the Financial InstitutionsRegulatory and Interest Rate Control Act of 1978 (FIRA) (P.L. 95–630), the Board of Gov-

ernors is authorized to assess civil money pen-alties for violation of the terms of a finalcease-and-desist order and violations of—

• sections 19, 22, and 23A of the FederalReserve Act (respectively, reserve require-ments and interest-rate limitations; limitationson loans by insured banks to their executiveofficers, directors, and principal shareholders;and limits on loans by insured banks to theiraffiliates);

• the prohibitions of title VIII of FIRA againstpreferential lending to bank executive officers,directors, and principal shareholders based ona correspondent-account relationship; and

• a willful violation of the change in Bank Control Act of 1978 (12 USC 1817(j)).

In determining the appropriateness of initiat-ing a civil money penalty assessment proceed-ing, the Board has identified a number of rel-evant factors (see Federal Reserve RegulatoryService, 3–1605). In assessing a civil moneypenalty, the Board is required to consider thesize of the financial resources and good faith of the respondent, the gravity of the violation, thehistory of previous violations, and such othermatters as justice may require.

Examiners are responsible for the initial analy-ses on potential civil money penalties. Civilmoney penalties should be proposed for seriousviolations and for violations which, because of their frequency or recurring nature, show a

general disregard for the law. After the examinerhas reviewed the facts and decided to recom-mend a civil money penalty, he or she shouldcontact the Reserve Bank for advice on properdocumentation and any other assistance.

SUSPICIOUS-ACTIVITY-REPORTING PROCEDURES

On April 2, 1985, the federal financial institu-tions supervisory agencies and the U.S. Depart-ment of Justice signed an agreement that requiresthe agencies to work toward improving thefederal government’s response to white-collarcrime in federally regulated financial institu-tions. The primary goal of the agreement is toensure full cooperation in the sharing of relevantinformation among the agencies—subject toexisting legal restrictions—so that all availableinformation may be used in criminal, civil, and

administrative proceedings. In keeping with thatgoal, in 1985 the Federal Reserve, along withthe other federal financial institutions regulatoryagencies, issued procedures to be used by banksand other financial institutions operating in theUnited States to report known or suspectedcriminal activities to the appropriate law enforce-ment authorities and bank supervisors. Since1996, the federal financial institutions supervi-sory agencies and the Department of the Trea-sury’s Financial Crimes Enforcement Network

(FinCEN) have required banking organizationsto report known or suspected violations of lawas well as suspicious transactions on a Suspi-cious Activity Report by Depository Institutions(SAR-DI). Law enforcement agencies use theinformation reported on the SAR-DI form toinitiate investigations, and Federal Reserve staff use the information in their examination andoversight of supervised institutions.

Suspicious Activity Report byDepository Institutions

Filing

A member bank must file a SAR-DI form with



Page 6



the appropriate federal law enforcement agen-cies and the Department of the Treasury. (Seesection 208.62 of the Board’s Regulation H.)9

Member banks must prepare a SAR-DI form inaccordance with the form’s instructions (see

SR-07-2 and the attached June 2007 SAR-DIform and instructions); the completed SAR-DIform is to be sent to the U.S. Treasury Depart-ment. A SAR-DI report form must be filed whenan institution detects—

• insider abuse involving any amount,• violations aggregating $5,000 or more in which

a suspect can be identified,• violations aggregating $25,000 or more regard-

less of a potential suspect, or

• transactions aggregating $5,000 or more thatinvolve potential money laundering or viola-tions of the Bank Secrecy Act.

The management of a member bank mustpromptly notify its board of directors, or acommittee thereof, of any SAR-DI form filed.

Time for Reporting

A member bank is required to file a SAR-DIform within 30 calendar days after the date of initial detection of the facts that may constitutea basis for filing a SAR-DI form. If no suspectwas identified on the date of detection of theincident requiring the filing, a member bank may delay filing a SAR-DI form for an addi-tional 30 calendar days in order to identify thesuspect. Reporting may not be delayed morethan 60 calendar days after the date of initialdetection of a reportable transaction. For viola-

tions requiring immediate attention, such aswhen a reportable violation is ongoing, thefinancial institution is required to immediatelynotify an appropriate law enforcement authorityand the Board by telephone, in addition to filinga timely SAR-DI form.

Retention of Records

A member bank must retain a copy of any

SAR-DI form filed, as well as the original orbusiness-record equivalent of any supportingdocumentation, for a period of five years fromthe date of the filing of the SAR-DI form.Supporting documentation is to be identified and

maintained by the bank, and it will be deemed tohave been filed with the SAR-DI form. Allsupporting documentation must be made avail-able to appropriate law enforcement agencies onrequest.

Referral of Criminal Matters and the Monitoring of SAR-DI Forms

The Enforcement Section of the Division of

Banking Supervision and Regulation has pri-mary responsibility for the referral of criminalmatters for the Federal Reserve System to theappropriate authorities. The Anti-Money-Laundering Policy and Compliance Section of the division develops, implements, and monitorsthe System’s suspicious-activity-reporting ex-amination procedures. SR-letters have been dis-tributed within the Federal Reserve System.Letters relevant to the reporting of suspiciousactivities include SR-07-2, SR-01-29, and SR-

03-17. Any inquiry relating to suspicious-activity reporting should refer to the applicableSR-letter.

Interagency Guidance on SharingSuspicious Activity Reports withHead Of fices and ControllingCompanies

On January 20, 2006, the federal banking agen-cies10 issued for banking organizations theInteragency Guidance on Sharing SuspiciousActivity Reports with Head Of fices and Control-ling Companies. The guidance confirms that(1) a U.S. branch or agency of a foreign bank may disclose a SAR-DI form to its head of ficeoutside the United States and (2) a U.S. bank orsavings association may disclose a SAR-DIform to controlling companies,11 whether

9. The Board’s SAR-DI form rules apply to state memberbanks, bank holding companies and their nonbank subsidiariesthat do not report on a different SAR-DI form (for example,broker-dealers), Edge and agreement corporations, and theU.S. branches and agencies of foreign banks supervised by theFederal Reserve.

10. The Board of Governors of the Federal Reserve Sys-tem, the Federal Deposit Insurance Corporation, the Of fice of the Comptroller of the Currency, and the Of fice of ThriftSupervision, along with the Department of Treasury’s Finan-cial Crimes Enforcement Network.

11. A controlling company is defined as (1) a bank holdingcompany, as defined in section 2 of the Bank Holding





domestic or foreign. The guidance notes thatbanking organizations must maintain appropri-ate arrangements for the protection of confiden-tiality of SAR-DI forms.12

The guidance does not address whether a

banking organization may share a SAR-DI formwith an af filiate other than a controlling com-pany or head of fice, whether located inside theUnited States or abroad. Until further guidanceon this topic is issued, banking organizationsshould not share SAR-DI forms with suchaf filiates.

Examination Objectives

The examiner should determine if an institutionhas established internal procedures to ensure theprompt and accurate submission of all reports of suspected criminal activity to the appropriateauthorities. The institution’s procedures mustcomply with the requirements for suspicious-activity reporting in section 208.62 of theBoard’s Regulation H (12 CFR 208.62) andwith the Bank Secrecy Act compliance program(12 CFR 208.63).

Examination Procedures

The examiner should—

• determine whether the institution has a policyof reporting suspected criminal activity,

• determine how the policy has been communi-cated to of ficers and employees, and

• determine whether a person or department in

the bank has been designated as being respon-sible for the filing of SAR-DI forms.

Reporting of Suspected CriminalViolations

During the course of an examination, if anexaminer (1) uncovers a situation that is known

or suspected to involve a criminal violation of any section of the United States Code or statelaw and (2) finds that no referral, or an inad-equate referral, has been made by the bank, heor she should report the situation immediately tothe appropriate Reserve Bank. If the situationwarrants, a telephone call should be made to theexaminer-in-charge (EIC) or the central point of contact (CPC), as applicable.

The examiner should follow up the call withthe submission of a detailed report. The EIC orthe CPC should promptly convey the informa-tion to the appropriate enforcement of ficer at theReserve Bank, who will expeditiously notifyand consult with the Enforcement Section in theBoard’s Division of Banking Supervision andRegulation. The examiner’s report to the EIC orthe CPC should be in the form of a memoran-dum that fully apprises the Reserve Bank of thesituation. All of the information reported in theSAR-DI form, as well as information held by the

institution to support the SAR-DI form, shouldbe included in the memorandum. Copies of pertinent exhibits or material should be attachedto the memorandum.

The examiner’s report should be confined toclear-cut statements of fact and must not containopinions as to the probability of indictment,conviction, or related matters. In all reports andworkpapers, the examiner should be as specificas possible. For example, rather than usingphrases such as ‘‘it is reported’’ or ‘‘the bank

indicates,’’ the examiner should identify whoreported the matter and how it occurred. Oneach transaction reported, copies of all documen-tation should be obtained and placed in a sepa-rate file detailing who handled the transaction inthe bank. The reporting of the matter within thebank should be chronologically referencedthroughout the documentation. The copies of documentation should be initialed and dated bythe examiner in case the original is destroyed.The documentation is extremely important to

proving a particular transaction.

The examiner’s initial notification of sus-pected criminal violations to the Reserve Bank and the transmittal of data should be accom-plished without informing bank personnel. Onlythe Reserve Bank or a designated representative

Company Act, or (2) a savings and loan holding company, asdefined in section 10(a) of the Home Owners’ Loan Act. Forpurposes of the guidance, a controlling company also includesa company having the power, directly or indirectly, to (1) di-

rect the management or policies of an industrial loan companyor a parent company or (2) vote 25 percent of any class of voting shares of an industrial loan company or a parentcompany.

12. FinCEN concurrently issued similar guidance forsecurities broker-dealers, futures commission merchants, andintroducing brokers in commodities. (See SR-06-1 and itsattachments.)



Page 8



should inform bank personnel or its board of directors of a suspected criminal violation thathad not been reported by the bank or that hadbeen inadequately reported by bank personnel.

After reviewing the information submitted by

the examiner, the Reserve Bank will decidewhether the facts support the examiner’s con-tention that a possible unreported violation of the criminal statutes exists. If the Reserve Bank,after consulting with the Board’s EnforcementSection, discovers that in a particular instance abank failed to report the suspected criminal

violation using the SAR-DI form or that thebank made an inadequate referral and, uponrequest, still fails to file a report, the ReserveBank ’s staff must then complete a SAR-DIform. Appropriate comments relating to a bank ’s

failure, if any, to file all necessary SAR-DIforms promptly and accurately must be made inthe report of examination of the bank. Repeatedor serious problems in this area should bedirected through the Reserve Bank to theEnforcement Section of the Division of BankingSupervision and Regulation.





Overall Conclusions Regarding Condition of the Bank Examination ObjectivesEffective date March 1984 Section 5020.2

1. To reach conclusions regarding the presentcondition of the bank.

2. To reach conclusions regarding the futureprospects of the bank.3. To determine the bank’s ability to meet

demands in the ordinary course of businessor reasonably unusual circumstances.

4. To determine the bank’s adherence to safeand sound banking practices.

5. To formulate recommended action, whenappropriate, based on those conclusions.6. To communicate conclusions and recommen-

dations both orally and in the examinationreport.




Overall Conclusions Regarding Condition of the Bank Examination ProceduresEffective date May 1988 Section 5020.3

Inasmuch as the following procedures arelargely dependent on information generated from

all phases of the examination, the examiner-in-charge should complete this program during thefinal stages of the examination. The completionof this program generally can be best accom-plished during the review of the workpapers.

1. Analyze any available information concern-ing the characteristics of the area in whichthe bank operates to determine the existenceof any unusual situations, any significanttrends, the potential impact on the bank of

any expected changes or any other signifi-cant information which could be detrimen-tal to the bank. The bank should be con-sulted for sources of information whichmight include the most recent census dataor data generated by organizations, such asthe Chamber of Commerce. In analyzingthe bank’s trade area:

a. Consider density, income levels, generalage group of the residents. Determine if there are significant changes in any of

the above factors.b. Determine the predominant living accom-

modations in the area (owner occupiedvs. rental), price/rent levels and avail-ability of residential units. Determinewhether there are any major residentialconstruction projects, re-zoning or con-versions of single to multiple units whichwill have a significant effect on the bank.

c. Consider the types of industry and the

number of firms in the area with empha-sis on determining concentrations or sea-sonality. Investigate any major laborcontract expirations, competitive factorsor other significant factors which couldhave a negative effect on the community.

d. Consider the types of major products,available markets and present and pro-

jected prices for the products.

e. Consider any expected changes instreet facilities which will significantly

affect bank’s accessibility/convenience.Determine the availability of publictransportation.

f. Review the number and types of institu-tions that provide similar financial ser-vices in the community. Consider the

aggressiveness, hours of business andadditional services offered by competitor

institutions.g. Determine the effect of government

employment or dependence on govern-ment contracts on the community.

h. Consider the condition of the nationaleconomy with particular attention to therate of inflation, national vs. local unem-ployment, current interest rates andgovernment fiscal and monetary policy.Specific problems, peculiar to a particu-lar area should be investigated more

thoroughly.2. Review comments and conclusions con-

tained in the workpapers which were gen-erated throughout the examination and per-form the following:

a. Compile all criticisms, exceptions anddeficiencies.

b. Determine the existence of contradictoryconclusions.

c. Consider the relative significance of

criticisms, exceptions, deficiencies andconclusions and segregate importantcriticisms for the final review with man-agement and for incorporation into thereport of examination.

3. Based on procedures performed and conclu-sions contained in the workpapers, answerthe following specific questions. These ques-tions are intended as guidelines to theexaminer-in-charge in formulating overallconclusions regarding the condition of the

bank and should be augmented by theexaminer’s knowledge of the bank. ‘‘Yes’’answers, in many instances, evidence theexistence of a ‘‘leading’’ indicator of dete-rioration of bank soundness. For any ques-tion with a ‘‘yes’’ answer, specify anymitigating circumstances in the commentscolumn. Sub-question answers are for infor-mation purposes.

a. Asset Quality

• Is there an increasing ratio of criticizedassets to total capital?

— If so, is it indicative of adverseeconomic conditions, poor credit




j u dg m en t , o r o t he r f a ct o rs(specify)?

• Has there been a material increase inthe quantity of non-earning assets?

• Is there any abnormally increasing

trend of past-due loans and/or interestearned but not collected?

— If so, is it indicative of generaleconomic conditions in the bank’strade area

— Is the trend indicative of a weak-ening of collection policies andprocedures, a slackening of creditstandards, the bank’s failure to rec-ognize an asset which should be ina non-earning category, or is it

caused by some other factor?• Has a trend developed wherein the

bank assumes increased risk withoutreceiving increased rewards?

• Do the portfolios exhibit high concen-trations in specific industries?

— If so, do the concentrations repre-sent a significant actual or contin-gent problem?

• Has the overall quality of assets dete-

riorated since the last examination?— If so, is the deterioration recog-nized by management and the boardof directors? Can the deteriorationbe attributed to factors beyond thecontrol of management or the boardof directors, such as a change inthe general economic conditions of the bank’s service area?

— If deterioration results from inter-nal factors, such as lowering of

credit standards or poor credit judg-ment, have steps been taken bymanagement to effectively reversenegative trends?

b. Quality of Management

• Has the executive management changedsince the last examination?

— If so, is the change detrimental to

the bank?• Has there been any change in the

general banking philosophy of execu-tive management?

— If so, is that detrimental to thebank?

• Do key bank officers have educationaland/or experience levels below thatconsidered minimal in the circum-stances?

• Is there any tendency toward over

reliance on essentially untrained andunskilled clerical staffs?• Is there a large disparity between the

compensation level of the chief exec-utive officer and other members of executive management?— If so, is that disparity an objective

indication of disproportional dom-ination of the bank’s affairs?

• Has the bank instituted any systemswhich directly reward managers for

increasing bank income from assets orservices subject to their control?— If so, has the bank failed to insti-

tute necessary control and auditprocedures to prevent abuses?

• Has the bank failed to institute anyprograms which would give officers avested interest in remaining with thebank?— If so, would the institution of such

a program offer a workable solu-tion to an actual or potential officerturnover problem?

• Is the bank’s strategic and operationalplanning inadequate?

• Is the board of directors unresponsiveto internal or external suggestions forimprovement in the bank?

• Are the following conditions present?

— Infrequent meetings of board of directors.

— Infrequent meetings of committeesof the board.

— Infrequent management committeemeetings.

— A directorate which is split intodistinct voting groups.

— If so, are directors viewed as fail-ing to perform their functionsadequately?

• Is the quality of management deemedinadequate to conduct the affairs of the bank in a reasonable and safemanner?

• Are training programs and compensa-tion increments deemed inadequate toattract and retain a staff capable of providing management succession?

5020.3 Overall Conclusions Regarding Condition of the Bank: Examination Procedures


Page 2



c. Earnings

• Are earnings static or moving down-w ar d a s a p er ce nt ag e o f t ot alresources?

• Is there a trend of decreasing incomebefore security gains and losses as apercentage of total revenues?— If so, is such a trend expected to

continue?— If so, has management determined

causes for any deterioration andtaken action to reverse the negativetrend?

• Has the ratio of operating expenses tooperating revenues been increasing?

• Are earnings trends consistent?• Has a decreasing spread between

interest earned and interest paiddeveloped?

• Are the bank’s earnings significantlyvulnerable to changes in interest ratelevels?

— If so, what are management’s plansand prospects for altering thevulnerability?

• Are there any significant structuralchanges in the balance sheet whichmay impact earnings?

• Has the bank experienced increasingactual loan losses and/or loan lossprovisions?

• Is there any evidence that sources of interest and other revenues havechanged since that last examination?

— If so, is that attributed to anunsound emphasis for increased

earnings?• Are earnings deemed inadequate to

provide increased capitalization com-mensurate with the bank’s growth?

d. Capital

• Has the bank been unable to maintaina normal growth rate for capital?

• Do the ratios of loans to capital, depos-its to capital or total assets to capitalexhibit a trend to abnormal increases?

• Is capital deemed inadequate to sup-port the present volume of business,including the volume of off-balance-sheet activities, in view of the amount

of criticized assets, the competency of management, etc.?

e. Liquidity

• Is there a trend toward decreasingbank liquidity?

• Has the bank been forced to increaseabnormally dependence on borrowedfunds to support existing assets?

• Does the bank depend excessively onpurchased funds?

• Is there a trend toward investing inter-est sensitive liabilities in non-interestsensitive assets?

• Do the present quantity and maturityof non-interest sensitive assets repre-sent a dangerous or potentially danger-ous situation?

f. Off-Balance-Sheet Risk

Loans Sold or Serviced

• Is the bank involved as the lead oragent in loan participations, syndica-tions, or servicing activities to theextent that management expertise isinadequate, or to the extent that thevolume exceeds the level which man-agement can capably handle?

• Does the bank’s record of pending orthreatened litigation indicate anyinstances where the bank, as lead oragent in a loan participation or syndi-

cation, has willfully misrepresentedthe credit to the other participants, orotherwise acted with gross negligencein handling the credit?

— If so, is there any indication thatthe participants intend to hold thebank liable for any loss incurred onthe credit?

• Did the examination reveal a practiceof improper origination and packagingof loans sold or serviced which could

cause:— The bank being compelled to

repurchase the package, or

— In the case of government guaran-teed loans, the complete or partialdishonor of the guaranty?

Overall Conclusions Regarding Condition of the Bank: Examination Procedures 5020.3




• Has the bank previously repurchasedp articipa tion s w he n a los s w asincurred, although it was not legallyrequired to do so?

Letters of Credit

• Is there a trend toward increasing theissuance of standby letters of creditor other similar credit instruments?— If so, has the bank failed to con-

sider the full impact of funding asignificant percentage of thoseinstruments?

• Are letters of credit excluded from the

bank’s internal loan review program?• Does the internal evaluation of letters

of credit include consideration of coun-try and currency risk as well as creditrisk?

• Is there a declining trend in the creditquality of letters of credit?

• Are standby letters of credit issued forpurposes not covered in the bank’slending policy, or for which manage-ment does not have the expertise to

handle?• If not authorized in the bank’s lending

policy, were proper approvals obtainedprior to issuance?

Wire Transfer Department

• Do internal control deficiencies in thewire transfer department pose a threatfor large potential losses through fraud

or error?• Are there internal control deficienciesin the receiving and conveying of mes-sages for other parties which mayexpose the bank to litigation forimproper handling of the messages?

Data Processing Department

• Are internal controls inadequate in thebank’s data processing area?— Are control deficiencies such that

the accuracy and/or timeliness of data is questionable?

— Are deficiencies such that the bank,in performing data processing ser-vices for others, could be liable for

misplacement or other improperhandling of source data?

• Are the bank’s computer hardware andsoftware systems inadequate to sup-port the present and anticipated level

of operations?— Are deficiencies such that hard-ware and systems will requirereplacement or upgrading in theshort term?

Settlement Procedures

• If the bank is a member of CHIPS,Fedwire or other clearinghouse sys-tem, are procedures inadequate for theproper monitoring of incoming andoutgoing wire transfers so that thebank is occasionally unprepared forsettlement?— Would earnings be significantly

affected if the immediate acquisi-tion of funds is required to meetsettlement?

— Is the bank aware of the creditwor-thiness and ability of the other

clearinghouse participants to makesettlement?• Are customers’ daylight overdrafts

allowed to exceed established creditlimits or are they otherwise being im-properly monitored?

• Is there a history of daylight overdraftswhich have not been covered beforethe close of business?

Investment Securities

• Are there significant internal controldeficiencies associated with thebank’s handling of ‘‘when issued’’trades, futures contracts and forwardplacements?— Is management’s knowledge of

interest rate hedging techniquesi ns uffi ci en t t o s up po rt s uc hactivity?

• D o e s t h e b a n k a c t a s a g e n t o nsecurities or repurchase agreementtransactions?

— If so, does the customer agreementspecifically designate liability forfailure or performance?



Page 4



Miscellaneous

• Did the analytical review of incomeand expenses disclose any additionaloff balance sheet activities for which

management does not exhibit the nec-essary expertise and does not haveadequate internal controls to handlethe service?

• Does a review of legal actions againstthe bank indicate any pattern of prac-tices which are caused by deficientinternal controls?— If so, have the deficiencies been

corrected?• Is the potential liability arising from

pending litigation considered signifi-cant in terms of capital adequacy andliquidity, considering the level of othercontingent liabilities?

• Are any of the bank’s affiliates orsubsidiaries experiencing unprofitabil-ity or liquidity problems which mayaffect the soundness of the bank?

• Are operating lease liabilities andannual lease payments significant interms of the bank’s other funding

requirements?• Is potential restitution resulting from

Truth in Lending Act violations signif-icant relative to capital and liquidity?

• Is the bank’s level of loan commit-ments, standby letters of credit, com-mitments to purchase securities andfutures/forward contracts imprudent inlight of overall circumstances withinthe bank?

g. Internal Controls and Audit Procedures

• Have internal controls deterioratedsince the last examination?

• Do any of the following exist at thebank?— L o w c o m p e n s a t i o n l e v e l o f

internal auditors.— Internal or external auditor who

reports directly to other than theboard of directors or a committeethereof.

— Internal auditors who perform orig-inal work versus monitoring theefforts of others.

— Abnormally low percentage of internal auditors to total personnel.

— Inadequate training or supervisionof internal auditors.

— Questionable independence of

external auditors.— Inadequate management responseto deficiencies cited by auditors.

If so, do these or other pertinent fac-tors indicate a less than adequate situ-ation in internal or external audit?

• Are internal controls and audit pro-grams deemed inadequate?

h. Ownership

• Have there been significant changes inownership since the last examination?— If so, could the change be detri-

mental to the soundness of thebank?

• Does any situation exist wherein oneindividual is capable of controlling thebank?— If so, is that detrimental to the

bank’s soundness?

• Is there any evidence of an impendingproxy fight?• Are ownership interests using bor-

rowed funds to carry the bank’s stock?— If so, is there an indication that

undue pressure for increasedearnings is being applied by theowners?

— If such pressure is being applied,does that have a detrimental impacton the general characteristics of

asset composition, as it exists, andasset composition, as it is expectedto develop?

i. Miscellaneous

• Does the bank exhibit a high depen-dence on purchasing or participatingin loans originated and managed byothers?— If so, is that attributable to a lack of

local loan demand or to a failure of the bank to service its trade area?

• Is there an increasing trend towardmaking loans and/or accepting depos-its from outside of areas in which thebank maintains offices?

Overall Conclusions Regarding Condition of the Bank: Examination Procedures 5020.3




— If so, does management and theboard fully understand the risksinherent in such activity?

• H a s a t r e n d t o w a r d i n c r e a s i n gadvances to affiliated companies

developed?— If so, does that presently representa dangerous situation?

• Has the bank experienced an abnor-mally fast rate of growth?— If so, is that growth reasonable and

does it therefore, have no signifi-cant impact on future soundness,based on:• Economic conditions within the

trade area?

• The bank’s increased marketingefforts?

• Offering improved services tothe community?

• Other factors?— If so, is the bank’s management

team capable of adequately admin-istering the growth?

• Does the bank have an imprudentinvestment in fixed assets?

• Does the bank depend to an excessive

degree on a small, local economy,which is subject to cyclical swings dueto local conditions and industries, asopposed to mirroring national eco-nomic trends?— If so, is that a source of criticism or

does it represent a potentially dan-gerous situation?

• Are there large fluctuations in the stock price of the bank or its parent?— I f s o , i s m a n a g e m e n t u n a b l e

t o di sce rn a c au se f or su chfluctuations?

• Is management giving inadequateattention to compliance with laws andregulations?

4. Have all questions raised by the UBPRspecialist been explored?

5. Complete workpapers.6. Organize general conclusions regarding the

present condition of the bank and:a. Correlate plans, projections, forecasts,

and budgets with present conditionalaspects, area characteristics, and manage-ment capability to determine which of the goals the bank has set you believe tobe unattainable.

b. Project the future condition of the bank based on its present financial condition,the economic expectations of the bank,the quality of management, directorsupervision and any other relevant

factors.c. Formulate recommendations for man-agement to consider when they initiatecorrective or preventative action.

7. Conduct a final summary discussion withmanagement to include:a. Criticisms noted during the examination.b. Conclusions reached about the bank in

general.c. Expected future condition:

• Management’s view.

• Examiner’s view.d. Review of other potential problems.e. Planned corrective action:

• Examiner recommendations.• Management commitments.

8. Update ‘‘Management Assessment’’ conclu-sion to add any relevant informationobtained as a result of procedures per-formed in this program.

9. Prepare recommendations for any necessary

supervisory action.10. Perform the following steps for suspectedviolations of criminal statutes:a. Determine that a Criminal Referral Form,

FR 2230, has been filed, if appropriate.b. Notify the Reserve Bank by telephone

immediately if warranted by the type andseriousness of the suspected violation.

c. Prepare a separate memorandum to theReserve Bank containing sufficient detailto be fully informative.

d. Prepare brief comments for the confiden-tial section of the report of examinationciting the date of the memorandum to theReserve Bank.

e. Segregate, identify, initial and date allappropriate workpapers and transmitthem to the Reserve Bank making certainthat the workpapers are factual, com-plete and do not contain expressions of examiner opinion.

11. Write, in appropriate report form, all com-ments and conclusions to be included in theconfidential section of the examinationreport.




Page 6



Meetings with Board of DirectorsEffective date May 1995 Section 5030.1

INTRODUCTION

The board of directors plays an essential role in

the management of a bank’s operations and isdirectly responsible for the soundness of thebank. As a result, in some cases, it is useful forFederal Reserve examiners and/or officers tomeet with boards of directors. These meetingsprovide examiners with the opportunity to informdirectors of examination findings, discuss thebank’s plans and prospects with the board, andhighlight important supervisory issues, particu-larly in cases that may require initiation of informal or formal supervisory actions. Meet-

ings with boards of directors also provide exam-iners with a limited opportunity to ascertain thedirectors’ knowledge of and interest in thebank’s operations.

If Federal Reserve examiners believe it isnecessary or desirable, they may conduct meet-ings with directors immediately after the on-siteportion of an examination and before an exami-nation report is completed and distributed. Suchmeetings are particularly encouraged when theycan be conducted as part of regularly scheduled

board meetings that coincide with the on-siteexamination.

When a bank is determined to be a problem orhas exhibited significant deterioration, FederalReserve examiners must conduct meetings withthe directors. Such meetings require the partici-pation of Federal Reserve officers and are typi-cally conducted after the report of examinationhas been distributed.

GENERAL GUIDELINES

Meetings with boards of directors must betailored to the individual circumstances of eachbank, as well as to the Reserve Bank’s supervi-sory objectives. As a result, uniform proceduresfor the conduct of these meetings cannot bespecified. Nonetheless, the following guidelinesshould be considered when planning and con-ducting meetings with bank directors.

Content of Meetings

When participating in meetings with bank boards, examiners should present only informa-

tion needed by, or relevant to, the directorate.This information varies depending on the bank’scircumstances; however, examiners should inform

the board of the examiner’s assessment of thebank’s condition; highlight any deficienciesrequiring the board’s attention; and solicit theboard’s views on the bank’s condition, opera-tions, and prospects. In addition, examinersshould obtain the board’s commitment to addresspromptly the deficiencies identified in the exam-ination. Examiners should encourage inquiriesand discussions with the directors to learn moreabout the directors’ roles and performance andto foster a good working relationship with them.

Data supporting the examiner’s conclusionsand comments should be prepared and presentedto board members in a professional manner.Slides, handouts, and other visual aids areencouraged. Comparative figures and ratios fromprevious and present examinations should bereviewed prior to the meeting, with handoutsand visual aids highlighting adverse trends.

Outlines for Meetings

Examiners should prepare detailed outlines of each meeting’s discussion points and goals.Following is a sample outline that examinersmay use as a guide to prepare for meetings withdirectors. It is not all-inclusive, and examinersshould not be limited by its content in devel-oping their own presentations. Generally, com-ments on these items are warranted whenconcerns have arisen during the current exami-nation, or when significant changes—positiveor negative—have occurred since the lastexamination.

I. Introductory remarks by Federal ReserveBank official or examiner

A. Federal Reserve Bank policy regardingboard meeting

B. Purpose of the meeting

II. Examiner’s presentation

A. Duties and responsibilities of directors1. Effectively supervise the bank’s

affairs

2. Select competent management

3. Adopt and follow sound, written poli-cies and objectives




4. Avoid self-serving practices5. Be informed of the bank’s financial

condition and management policies6. Maintain reasonable capitalization7. Observe banking laws and regulations

B. Adequacy and effectiveness of policiesand procedures1. Lending2. Investments3. Asset/liability management4. Personnel5. Operations

C. Adequacy and accuracy of bank’sreporting systems1. Reports of the board and committees2. Management reports to the board

3. Management information systems4. Regulatory reports

D. Condition of the bank/results of theexamination1. Asset quality2. Violations of law, evidence of self-

dealing3. Capital4. Management5. Liquidity6. Earnings7. Internal controls and audit coverage8. Future prospects9. Relationships with bank holding

companyE. Required corrective action on problems

and board commitmentIII. Summary of overall conclusionsIV. Questions from the board

Procedural Issues

In general, meetings with the full board arepreferable. In certain cases, however, a ReserveBank may determine that meeting with a boardcommittee, such as the executive or audit com-mittee, will fulfill the Reserve Bank’s supervi-sory objectives. Any person connected with thebank, such as an attorney, auditor, or holdingcompany representative, may attend the boardof directors meeting at which the overall find-ings and conclusions of the examination arediscussed. The attendance of any such partyshould be noted in the minutes of the meeting.However, the examiner may excuse such per-sons during any portion of his or her presenta-tion if deemed appropriate. Attendance by

honorary directors to participate in discussionsand review the examination report is alsopermitted.

Generally, at least one member of a ReserveBank’s official staff is expected to represent the

Federal Reserve at meetings with directors of banks. However, for meetings with the directorsof banks that have less than $500 million inassets, Reserve Banks are granted the discretionto have senior examination staff represent theReserve Bank. The participation of ReserveBank presidents in meetings with directors isleft to the discretion of the Reserve Bank.

To the extent possible, meetings with theboards of directors of state member banks shouldinclude representatives of the relevant state

banking authority. A meeting with the directorsof a bank that is owned by a holding companymay be held at the same time as a meeting withthe directors of the holding company, whenappropriate.

Whenever a meeting is held between anexaminer and a board, the examiner shouldprepare written comments on the meeting forexamination workpapers.

MEETINGS WITH BOARDS OFPROBLEM BANKS AND BANKSEXHIBITING SIGNIFICANTDETERIORATION

When an examination reveals that a bank hassignificant problems, Federal Reserve policyrequires that a meeting be held with its board of directors. The policy further requires that awritten summary of examination findings—separate from the complete examinationreport—be distributed to each director in suchcases. A senior Reserve Bank official also mustparticipate in communicating and presentingexamination findings on problem banks to theirboards of directors. This policy’s objective is toensure that each director of a state member bank considered to be a problem or to have a signifi-cant weakness clearly understands the natureand dimension of the problems, as well as the

joint and several responsibility of the directors

to effect correction.

Criteria Requiring Meetings withProblem Banks

A meeting with the board of directors is to be

5030.1 Meetings with Board of Directors


Page 2



held after any full-scope examination in whicha state member bank is assigned a CAMELScomposite rating of 4 or 5. A meeting is alsorequired if a bank is rated composite 3 and itscondition appears to be deteriorating or has

shown little improvement since a previousexamination in which it received a composite3 rating. Furthermore, a meeting should be heldafter a targeted examination if deemed appropri-ate and desirable by the Reserve Bank. Anofficial of the Reserve Bank and the examiner-in-charge should also meet with a board if anyof the following conditions exist:

• The bank is entering into a formal writtenagreement with the Federal Reserve, a cease-

and-desist order is being issued, or the bank is being placed under a memorandum of understanding.

• The bank is already operating under a super-visory action but is in noncompliance withsignificant provisions or has experienced sig-nificant deterioration since the action wasinitiated.

• Self-serving activities or other unsafe andunsound practices exist in the bank.

• Any other condition or practice that places, or

could place, the bank in a seriously weakenedor extended condition has been identifiedduring the examination.

Additional Guidelines

Senior Reserve Bank officials are expected toparticipate in meetings with the directors of problem banks, with the seniority of the partici-

pating official determined by the condition andsize of the bank. The larger the organization orthe more serious its problems, the more seniorthe Federal Reserve official should be.

A meeting with the board of directors of aproblem or deteriorating bank should include aformal, structured presentation with a clear state-ment that the bank is considered a ‘‘probleminstitution’’ or is about to become a probleminstitution if existing conditions deteriorate. Thepresentation should further make clear the natureof problems confronting the bank, citing exami-nation findings such as the following:

• deficiencies in capital, asset quality, earnings,or liquidity

• violations of law

• inadequacies in policies, practices, and report-ing systems necessary for proper risk manage-ment and organizational administration

• lack of well-documented lending, collection,investment, asset/liability management, and

risk-management policies or the failure toensure that such policies are being followed• failure of management to address previously

discussed deficiencies• lack of reporting systems sufficient to keep

senior management and the board of directorsfully informed

• failure of the board of directors to ensure theactive management of the organization

MEETINGS WITH BOARDS OFMULTINATIONAL AND MAJORREGIONAL BANKS

A meeting with the board of directors is requiredafter every full-scope examination of a multi-national organization or major regional organi-zation with assets in excess of $5 billion. ReserveBanks also are encouraged to conduct suchmeetings after every full-scope examination of a

regional bank with assets in excess of $1 billion.

MEETINGS WITH BOARDS OFDE NOVO BANKS

After the approval of a membership application,but before a de novo bank is opened, ReserveBank staff should meet with the full board of directors to discuss applicable statutes, regula-

tions, policies, and supervisory procedures. Aswith all meetings with directors, the agenda forthis meeting should be tailored to the individualcircumstances of the bank. At a minimum, theReserve Bank should apprise the directors of their responsibilities and emphasize their needto adhere to sound operating policies.

DIRECTOR’S SUMMARY OF

EXAMINATION FINDINGSIn addition to the report of examination, FederalReserve Banks must provide written reports todirectors summarizing the examination findingsfor all banks rated composite 3, 4, or 5, and forthose rated composite 1 or 2 that show signs of

Meetings with Board of Directors 5030.1




significant deterioration in condition or apparentviolations of law. The summary reports shouldfocus on identified problems—rather than on thestrength of the organization—and present thebank’s deficiencies succinctly and clearly. In all

cases, the types of actions directors and man-agement should take to address identified prob-lems should be specifically stated. Directors of institutions rated 4 or 5 are to be told their banksare ‘‘problem’’ institutions that warrant ‘‘specialsupervisory attention.’’ Directors of banks rated3 are to be informed that the bank’s condition is‘‘not satisfactory,’’ that the bank is subject to‘‘more-than-normal supervision,’’ and that thebank may become a ‘‘problem’’ if weaknessesare not addressed adequately.

Summary reports should emphasize theresponsibilities of the directors to ensure thatcorrective actions are taken to address all defi-ciencies noted in the pages of the full bank examination report entitled ‘‘Matters RequiringBoard Attention’’ and ‘‘Examination Conclu-sions and Comments.’’ In addition, the organi-zation, style, and content of the summary report

should be similar, if not identical, to the text of these report pages.

Summary reports should be sent directly tothe bank’s management for distribution to eachdirector. The transmittal letter to the bank should

state the report is a summary of identifiedproblems and contemplated supervisory actionsand direct bank management to distribute thesummary report to each director. The lettershould further instruct each director to read thereport, sign the introductory statement attestingto having read the report, and return the report tomanagement. Management should keep copiesof the directors’ signed statements on file, butshould destroy all but one file copy of thesummary report itself.

The summary report must be completed anddistributed before any meeting between ReserveBank officials and the bank’s board of directors,to provide the directors with prior notice of deficiencies to be discussed. Reserve Banksshould also make every effort to distribute thecomplete examination report to managementbefore meeting with a board of directors.

5030.1 Meetings with Board of Directors


Page 4



Meetings with Board of DirectorsExamination ObjectivesEffective date March 1984 Section 5030.2

1. To foster a better understanding of therespective roles of directors and examiners.

2. To inform the directors of the examinationscope and the bank’s condition.3. To obtain information concerning future plans

and proposed changes in bank policies that

may have significant impact on the futurecondition of the bank.

4. To reach an agreement on any significantproblems.5. To obtain a commitment to initiate appropri-

ate corrective action.




Meetings with Board of DirectorsExamination ProceduresEffective date March 1984 Section 5030.3

1. Inform management that a meeting will beheld with the board of directors. State the

Federal Reserve Bank’s policy and the pur-pose of the meeting and establish a tentativedate.

2. Finalize the time and place of the meetingwhen confident that a thorough understand-ing of the condition of the bank will bedeveloped. If the meeting is to be a ‘‘specialmeeting’’ resulting from serious areas of concern, perform procedure 7.

3. Develop an outline of matters to be coveredat the meeting by reviewing results of the

examination.4. Prepare supportive data for the meeting by:

a. Compiling a list of comments andcriticisms.

b. Preparing schedules of comparative fig-ures for discussion.

c. Affirming that the bank has respondedadequately to Reserve Bank requests.

d. Preparing questions to elicit opinionsand attitudes of individual boardmembers.

5. Prepare a brief formal agenda for the meet-ing and reproduce enough copies to distrib-ute to participants.

6. If it is decided that a meeting will be held:a. Communicate with Reserve Bank office

to:• Notify office staff of the proposed date

and place of the meeting. (Confirmtime and place when final.)

• Determine whether a Reserve Bank official will attend.

• Determine whether the Reserve Bank official has suggestions for the agenda.

b. Submit a copy of the agenda and outlinein advance to the Reserve Bank official.

c. Inform directors that the following mustbe submitted to the Reserve Bank office:• A copy of a board resolution stating

corrective action.• A written plan for corrective action to

be forwarded within a specified timeperiod.

• Periodic progress reports.

7. For ‘‘special meetings’’ resulting from ser-ious problems:

a. Communicate with the Reserve Bank to:• Notify office staff of the proposed dateand place of the meeting.

• Determine whether a Reserve Bank official will attend.

• Determine whether the Reserve Bank official has suggestions for the agenda.

b. Confirm the final time and place of themeeting with the Reserve Bank office.

c. Prepare any special supporting data forthe meeting, such as areas of noncompli-

ance with memorandums of understand-ing or cease and desist agreements ororders.

8. Conduct the board meeting in accordancewith the agenda and previously preparedoutline, being certain to discuss:a. Major criticisms noted during the

examination.b. Conclusions reached about the bank in

general.c. Expected future conditions.d. Potential problems.e. Planned corrective action:

• Examiner’s recommendations.• Management’s commitments.• Director’s commitments.

9. Obtain a definite agreement or commitmentfrom the board that appropriate correctiveaction will be taken.

10. Prepare a memorandum covering the meet-ing with the board to include, as a minimum:

a. The time and place of the meeting.b. The directors and guests in attendance.c. The matters subject to criticism that were

reviewed.d. A summary of the general discussion on

the matters presented to the board.e. A summary of the director’s reaction to

the situation and any commitmentsobtained from them.

11. Request that copies of the minutes of theboard meeting be forwarded to the ReserveBank and the examiner-in-charge.




Formal and Informal Corrective ActionsEffective date November 2003 Section 5040.1

INTRODUCTION

The Federal Reserve Board has a broad range of

enforcement powers over both domestic andforeign financial institutions and over the indi-viduals associated with them. Generally, formalor informal enforcement actions are taken afterthe completion of an on-site bank examination.These examinations include commercial, trust,electronic data processing, consumer, or othertypes of examinations. Formal or informalenforcement actions may also be taken when aReserve Bank becomes aware of a problem at abank that warrants immediate attention and

correction.Many of the Board’s enforcement powers

were initiated or enhanced by title IX of theFinancial Institutions Reform, Recovery, andEnforcement Act (FIRREA) and by the Com-prehensive Thrift and Bank Fraud Act (Bank Fraud Act).1 The Board’s jurisdiction over indi-viduals associated with financial institutions,that is, ‘‘institution-affiliated parties,’’ includesany officer, director, employee, controlling share-holder, or agent of a financial institution, and

any other person who has filed or is required tofile a change-in-control notice. The term‘‘institution-affiliated party’’ also includes anyshareholder, consultant, joint venture partner, orany other person who participates in the conductof the affairs of the financial institution, as wellas any independent contractors, including attor-neys, appraisers, and accountants, who know-ingly or recklessly participate in any violation of law or regulation, breach of fiduciary duty, orunsafe or unsound practice that causes (or is

likely to cause) more than a minimal financialloss to, or a significant adverse effect on, afinancial institution.2 The Board’s jurisdictionover an institution-affiliated party extends for upto six years after the party’s resignation, termi-nation of employment, or separation caused bythe closing of a financial institution, providedthat any notice (such as a notice of intent to

remove from office and of prohibition) is servedon the party before the end of a six-year period.

FORMAL SUPERVISORYACTIONS

The following statutory tools are available tothe Board in the event formal supervisory actionis warranted against a state member bank orany institution-affiliated party. The objective of formal action is to correct practices that theregulators believe to be unlawful, unsafe, orunsound.3 The initial consideration and determi-

nation of whether formal action is requiredusually results from examination findings. It isimportant to provide adequate workpaper docu-mentation to support all recommendations forboth formal and informal actions.

Types of Corrective Actions

Generally, under 12 USC 1818, the Board may

use its cease-and-desist authority and civil moneypenalty authority against any state member bank and any institution-affiliated party that meets thestatutory criteria for issuing such an order.Prohibition and removal actions may be takenagainst any institution-affiliated party who meetsthe statutory criteria to bring such an action.

Cease-and-Desist Orders

Generally, under 12 USC 1818(b), the Boardmay use its cease-and-desist authority against astate member bank and any institution-affiliatedparty when it finds that a bank or party isengaging, has engaged, or is about to engage in(1) a violation of law, rule, or regulation; (2) aviolation of a condition imposed in writing bythe Board in connection with the granting of anyapplication or any written agreement; or (3) anunsafe or unsound practice in conducting thebusiness of the institution. Under 12 USC1. The Financial Institutions Reform, Recovery, and

Enforcement Act was enacted on August 9, 1989; the Com-prehensive Thrift and Bank Fraud Act was enacted onNovember 27, 1990.

2. The Board is authorized to issue regulations furtherdefining which individuals should be considered institution-affiliated parties. Similarly, the Board may determine whetheran individual is an institution-affiliated party on a case-by-case basis. (See 12 USC 1813(u).)

3. An unsafe or unsound practice is defined as any actionthat is contrary to generally accepted standards of prudentoperation, the possible consequences of which, if continued,would be abnormal risk or loss or damage to an institution, itsshareholders, or the agencies administering the insurancefund.




1818(s), the Board must initiate a cease-and-desist action against a bank when it has failed toestablish Bank Secrecy Act procedures requiredby the Board’s Regulation H or has failed tocorrect any previously noted deficiencies related

to these procedures.A cease-and-desist order may require thebank or person subject to the order to (1) ceaseand desist from the practices or violations or(2) take af firmative action to correct the viola-tions or practices. Af firmative actions mightinclude returning the bank to its ‘‘original con-dition’’ before the practice or violation. Af fir-mative actions may also include restrictionson growth, debt, and dividends; the dispositionof any loan or asset; rescission of agreements or

contracts; employment of qualified of ficers oremployees; restitution, reimbursement, indem-nification, or guarantee against loss if the bank or person was unjustly enriched by the violationor practice, or if the violation or practiceinvolved a reckless disregard for the law orapplicable regulations or a prior order; andany other action the Board determines to beappropriate.

When Board staff, in conjunction with theappropriate Reserve Bank, determine that a

cease-and-desist action is necessary, the bank orperson is generally given an opportunity toconsent to the issuance of a cease-and-desistorder without the need for the issuance of anotice of charges and a contested administrativehearing. Generally, Board staff draft a proposedcease-and-desist order and, with Reserve Bank staff, present it to the bank or individual forconsent before submitting the case to the Board.Banks or individuals are advised that they mayhave legal counsel present at all meetings with

Board or Reserve Bank staff concerning formalcorrective actions. If the parties voluntarilyagree to settle the case by the issuance of aconsent cease-and-desist order, the proposedconsent order will be presented to Board of fi-cials for ratification and formal issuance of theorder, at which time the order will be final andbinding.

When a bank or person fails to consent to acease-and-desist order, the Board may issue anotice of charges and of hearing to the bank orparty. The notice of charges contains a detailedstatement describing the facts constituting thealleged violations or unsafe or unsound prac-tices. The issuance of the notice of charges andof hearing starts a formal process that includesthe convening of a public administrative hear-

ing4 conducted before an administrative law judge, appointed by the Board. After the hear-ing, the judge makes a recommended decision tothe Board. A hearing must be held within 30 to60 days of service of the notice of charges,

unless a later date is set by the administrativelaw judge. After the Board considers the recordof the proceeding, including the administrativelaw judge’s recommended decision, it deter-mines whether to issue a final cease-and-desistorder. Banks and individuals who are subject tocease-and-desist orders that were issued as aresult of contested proceedings may appeal theorder to the appropriate federal court of appeals.

Temporary Cease-and-Desist Orders

If a violation or threatened violation of law, rule,or regulation, or if engagement in an unsafe orunsound practice specified in the notice of charges, is likely to cause the bank ’s insolvency,cause significant dissipation of the bank ’s assetsor earnings, weaken the bank ’s condition, orotherwise prejudice the interests of depositorsbefore the completion of the proceedings (initi-ated by the issuance of the notice of charges),

the Board may, in conjunction with issuing anotice of charges, issue a temporary cease-and-desist order against the bank or any institution-af filiated party to effect immediate correction(pursuant to 12 USC 1818(c)). The Board mayalso issue a temporary order if it determines thatthe bank ’s books and records are so incompleteor inaccurate that the Board is unable to deter-mine, through the normal supervisory process,the bank ’s financial condition or the details orpurpose of any transaction that may have a

material effect on its condition. The temporaryorder may require the same corrections as aformal cease-and-desist order. The advantage of issuing a temporary cease-and-desist order isthat it becomes effective immediately after it isserved on the entity or individual. Within 10days after being served with a temporary order,however, the entity or individual may appeal toa U.S. district court for relief from the order.Unless set aside by the district court, the tem-porary order stays in effect until the Boardissues a final cease-and-desist order or dismissesthe action.

4. A private hearing may be held if the Board determinesthat holding a public hearing would be contrary to the publicinterest.

5040.1 Formal and Informal Corrective Actions


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Written Agreements

When circumstances warrant a less severe formof formal supervisory action, a written agree-ment may be used. A written agreement may

be with either the Board or with the ReserveBank under delegated authority (12 CFR265.11(a)(15)). All written agreements must beapproved by the Board’s director of the Divisionof Banking Supervision and Regulation and thegeneral counsel. The provisions of a writtenagreement may relate to any of the problemsfound at the bank or to any problems involvinginstitution-af filiated parties.

Prohibition and Removal Authority

The Board is authorized by 12 USC 1818(e) toremove any current institution-af filiated party of a bank for certain violations and misconduct andto prohibit permanently from the banking indus-try any current or former institution-af filiatedparty from future involvement with any insureddepository institution, bank or thrift holdingcompany, and nonbank subsidiary.5

The Board is authorized to initiate removal orprohibition actions when—

• the institution-af filiated party has directly orindirectly—— violated any law, regulation, cease-and-

desist order, condition imposed in writing,or written agreement;

— engaged in any unsafe or unsound prac-tice; or

— breached a fiduciary duty;

• the Board determines that, because of theviolation, unsafe or unsound practice, orbreach—— the institution has suffered or will prob-

ably suffer financial loss or other damage;— the interests of depositors have been or

could be prejudiced by the violation, prac-tice, or breach; or

— the institution-af filiated party has receivedfinancial gain or other benefit from theviolation, practice, or breach; and

• the violation, practice, or breach—— involves personal dishonesty or

— demonstrates a willful or continuing dis-regard for the safety or soundness of theinstitution.

The statute also authorizes the Board to ini-

tiate removal or prohibition actions against(1) any institution-af filiated party who has com-mitted a violation of any provision of the Bank Secrecy Act that was not inadvertent or uninten-tional, (2) any of ficer or director of a bank whohas knowledge that an institution-af filiated partyhas violated the money-laundering statutes anddid not take appropriate action to stop or preventthe reoccurrence of such a violation, or (3) anyof ficer or director of a bank who violates theprohibitions on management interlocks. These

removal or prohibition actions do not require afinding of gain to the individual, loss to theinstitution, personal dishonesty, or willful orcontinuing disregard for the safety or soundnessof the institution.6 Like a cease-and-desist order,a removal or prohibition order may be issuedeither by consent or after an administrativeprocess initiated by the issuance of a notice of intent to remove and prohibit.

If an institution-af filiated party’s actions war-rant immediate removal from a state member

bank, the Board is authorized to suspend theperson temporarily from that bank pending theoutcome of the complete administrative process.An institution-af filiated party presently associ-ated with a bank may also be suspended orremoved for cause based on actions taken whileformerly associated with a different insureddepository institution, bank holding company, or‘‘business institution.’’ Business institution isnot specifically defined in the statute so that itmay be interpreted to include any other business

interests of the institution-af filiated party.Under 12 USC 1818(g), the Board is autho-

rized to suspend from of fice or prohibit fromfurther participation any institution-af filiatedparty charged or indicted for the commission of a crime involving personal dishonesty or breachof trust that is punishable by imprisonment for aterm exceeding one year under state or federallaw, if the continued participation might threateneither the interests of depositors or public con-fidence in the bank. The Board may also sus-pend or prohibit any individual charged with aviolation of the money-laundering statutes. Thesuspension can remain in effect until the crimi-nal action is disposed of or until the suspension

5. This authority is distinct from the Board’s authorityunder prompt corrective action to dismiss senior of ficers froma particular bank. 6. See 12 USC 1818(e)(2).

Formal and Informal Corrective Actions 5040.1




is terminated by the Board. The Board may alsoinitiate a removal or prohibition action againstan institution-af filiated party who has been con-victed of, or pleaded to, a crime involvingpersonal dishonesty or breach of trust if his or

her continued service would threaten the inter-ests of the depositor or impair public confidencein the institution. The Board is required to issuesuch an order against any institution-af filiatedparty who has been convicted of, or pleaded to,a violation of the money-laundering statutes.

Furthermore, 12 USC 1829 prohibits anyindividual who has been convicted of a crimeinvolving dishonesty, breach of trust, or moneylaundering from (1) serving as an institution-af filiated party of, (2) directly or indirectly

participating in the affairs of, and (3) owning orcontrolling, directly or indirectly, an insureddepository institution without the FDIC’s priorapproval. Under certain circumstances, the stat-ute also prohibits a convicted person from hold-ing a position at a bank holding company ornonbank af filiate of a bank without the FDIC’sprior approval. The penalty for violation of thislaw is a potential fine for a knowing violation of up to $1 million per day, imprisonment for up tofive years, or both. The criminal penalty applies

to both the individual and the employinginstitution.

Violations of Final Orders andWritten Agreements

When any final order or temporary cease-and-desist order has been violated, the Board mayapply to a U.S. district court for enforcement of the action. The court may order and require

compliance.Violations of final orders and written agree-ments may also give rise to the assessment of civil money penalties against the offending bank or institution-af filiated party, as circumstanceswarrant. The civil money penalty is assessed inthe same manner as described in the ‘‘CivilMoney Penalties’’ subsection below. Anyinstitution-af filiated party who violates a suspen-sion or removal order is subject to a criminalfine of up to $1 million, imprisonment for up to

five years, or both.

Civil Money Penalties

The Board may assess civil money penalties of up to $5,000 per day against any institution or

institution-af filiated party for any violation of (1) law or regulation; (2) a final cease-and-desist, temporary cease-and-desist, suspension,removal, or prohibition order or for failure tocomply with a prompt-corrective-action-

directive;7

(3) a condition imposed in writing bythe Board in connection with the granting of anapplication or other request; and (4) a writtenagreement.

A fine of up to $25,000 per day can beassessed for a violation, an unsafe or unsoundpractice recklessly engaged in, or a breach of fiduciary duty when the violation, practice, orbreach is part of a pattern of misconduct, causesor is likely to cause more than a minimal loss tothe bank, or results in pecuniary gain or other

benefit for the offender. A civil money penaltyof up to $1 million per day can be assessed forany knowing violation, unsafe or unsound prac-tice, or breach of any fiduciary duty when theoffender knowingly or recklessly caused a sub-stantial loss to the financial institution or receiveda substantial pecuniary gain or other benefit.Civil money penalties may also be assessed,under the three-tier penalty framework describedabove, for any violation of the Change in Bank Control Act and for violations of the anti-tying

provisions of federal banking law, among otherprovisions.8

The Board may also assess civil money pen-alties for the submission of any late, false, ormisleading call reports. If a financial institutionmaintains procedures that are reasonably adaptedto avoid inadvertent errors, but unintentionallyfails to publish any report, submits any false ormisleading report or information, or is mini-mally late with the report, it can be assessed afine of up to $2,000 per day. The financial

institution has the burden of proving that theerror was inadvertent under these circum-stances. If the error was not inadvertent or thebank lacked the appropriate procedures, a pen-alty of up to $20,000 per day can be assessed forall false or misleading reports or informationsubmitted to the Board. If the submission was

7. Prompt-corrective-action directives may be enforced inthe federal courts, and they may cause any bank, company, orbank-af filiated party that violates the directive to be subject to

civil money penalties. The failure of a bank to implement acapital-restoration plan, or the failure of a company havingcontrol of a state member bank to fulfill a guarantee that thecompany has given in connection with a capital plan acceptedby the Federal Reserve, could subject the bank or company orany of their bank-af filiated parties to a civil money penaltyassessment. (See section 4133.1.)

8. See 12 USC 1972.



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done in a knowing manner or with recklessdisregard for the law, a fine of up to $1 millionor 1 percent of the institution’s assets, which-ever is less, can be assessed for each day of theviolation. Under its general civil money penalty

authority, the Board may also assess civil moneypenalties against any institution-affiliated partywho participates in a bank’s filing of late, false,or misleading call reports.

Administration of Formal Actions

Publication of Final Orders

Under 12 USC 1818(u), the Board is required to

publish and make publicly available any finalorder issued for any administrative enforcementproceeding it initiates. These orders includecease-and-desist, removal, prohibition, and civilmoney penalties. The Board is also required topublish and make publicly available any writtenagreement or other written statement that it mayenforce, unless the Board determines that pub-lication would be contrary to the public interest.

Public Hearings

Under 12 USC 1818(u), all formal hearings,including contested cease-and-desist, removal,and civil money penalty proceedings, are opento the public unless the Board determines that apublic hearing would be contrary to the publicinterest. Transcripts of all testimony; copies of all documents submitted as evidence in thehearing, which could include examination orinspection reports and supporting documents

(except those filed under seal); and all otherdocuments, such as the notice and the adminis-trative law judge’s recommended decision, areavailable to the public.

Appointment of Directors and Senior Executive Officers

Under section 32 of the Federal Deposit Insur-ance Act (12 USC 1831i) and subpart H of

Regulation Y (12 CFR 225.71 et seq.), any statemember bank or bank holding company that isin a troubled condition9 or does not meet mini-

mum capital standards must provide 30 days’written notice to the Board of Governors beforeappointing any new director or senior executiveofficer.10 This requirement also applies to anychange in the responsibilities of any current

senior executive officer who is proposing toassume a different senior officer position. Sub-part H of Regulation Y details the proceduresfor filing and the content of the notice. TheBoard may disapprove a notice if it finds that thecompetence, experience, character, or integrityof the proposed individual indicates that his orher service would not be in the best interest of the institution’s depositors or the public. Adisapproved individual or the institution thatfiled the notice may appeal the Federal Reserve’s

notice of disapproval under the proceduresdetailed in Regulation Y. The individual may notserve as a director or senior executive officerwhile the appeal is pending. In the event that astate member bank or bank holding companythat is in a troubled condition appoints a directoror senior officer without the required 30 days’prior written notice, appropriate follow-upsupervisory action should be taken.

Interagency Notification

Under interagency agreements, any federal bank-ing regulatory agency that proposes to take aformal enforcement action (such as a cease-and-desist order, civil money penalty, or removal)must notify the other federal financial institutionregulatory agencies (including the OTS) of theaction. For informal enforcement actions, suchas memoranda of understanding, notificationsmust be made when there is an affiliation or

interinstitution relationship. Notifications are tobe made to a designated contact person specifiedby each agency. To foster federal–state agencycoordination, the Federal Reserve provides theappropriate state supervisory authority with

9. As defined in section 225.71 of the Board’s RegulationY, a state menber bank or holding company is in troubled

condition if it (1) has a composite rating, determined at itsmost recent examination, of 4 or 5; (2) is subject to acease-and-desist order or formal written agreement thatrequires action to improve the bank’s financial condition; or(3) is expressly informed by the Board or Reserve Bank that

it is in troubled condition.10. The Board or Reserve Bank may permit, under extraor-

dinary circumstances, an individual to serve as a director orsenior executive officer before a notice is provided; however,this permission does not affect the Federal Reserve’s authorityto disapprove a notice within 30 days of its filing. The Boardmay extend the review period to a maximum of 90 days if needed to process the notice.





notice of its intent to institute a formal correc-tive action against a bank or its institution-af filiated parties, pursuant to 12 USC 1818(m).11

INFORMAL SUPERVISORYACTIONS

Informal supervisory tools are used when cir-cumstances warrant a less severe form of actionthan the formal supervisory actions describedabove. Informal actions are not enforceable, andtheir violation cannot serve as a basis for assess-ing a civil money penalty or initiating a removaland prohibition action. Informal actions are notpublished or publicly available. These informal

actions include the following:

• Commitments are generally used to correctminor problems or to request periodic reportsaddressing certain aspects of a bank ’s opera-tions. Commitments may be used when thereare no significant violations of law or unsafeor unsound practices and when the bank andits of ficers and directors are expected tocooperate and comply.12 Commitments aregenerally obtained by the Reserve Bank ’ssending a letter to the bank outlining therequest and asking for a response and anindication that the commitments are accepted.

• Board resolutions generally represent a num-ber of commitments made by the bank ’sdirectors and are incorporated into the bank ’scorporate minutes. The Reserve Bank mayrequest board resolutions in the examinationtransmittal letter, which asks the bank to

provide it with a signed copy of the corporateresolution.

• Memoranda of understanding (MOU)are highly structured written, but informal,agreements that are signed by both the ReserveBank and the bank ’s board of directors. AnMOU is generally used when a bank hasmultiple deficiencies that the Reserve Bank believes can be corrected by the present man-

agement. Although an informal action, impo-sition of an MOU may require disclosure tothe Securities and Exchange Commission andto the bank ’s liability bond issuer.

INDEMNIFICATION PAYMENTSAND GOLDEN PARACHUTEPAYMENTS

In general, an indemnification payment is apayment that reimburses an insider for a speci-fied liability or cost that the person incurred (forexample, a bank might indemnify a director forthe cost of legal fees or even, theoretically,penalties in connection with a Federal Reserveinvestigation or enforcement action). Goldenparachute payments are severance payments oragreements to make severance payments that arepaid or entered into at a time when the bank orholding company is in a troubled condition.These payments require the prior written approvalof the institution’s primary regulator and theFDIC. A golden parachute payment may includea glorified severance payment to a former insider

that is paid under specified circumstances.Although both types of payments fall under thesame statute, section 18(k) of the Federal DepositInsurance Act (the FDI Act) (12 USC 1828(k)),the two types of payments are quite different anddistinct. However, some of the restrictions onthese payments are the same or similar.

Indemnification Agreements and

Payments

State member banks may seek to indemnifytheir of ficers, directors, and employees from any

judgments, fines, claims, or settlements, whethercivil, criminal, or administrative. The bylaws of some state member banks may have broadlyworded indemnification provisions, or the bank may have entered into separate indemnificationagreements that cover the ongoing activities of its own institution-af filiated parties. Such indem-

nification provisions may be inconsistent withfederal banking law and regulations, as well aswith safe and sound banking practices.

Supervisory and examiner staff should bealert to the limitations and prohibitions onindemnification imposed by section 18(k) of the

11. The procedures for notification to state agencies andother federal banking regulatory agencies are outlined inSR-97-5, ‘‘Policy Statement on Interagency Notification andCoordination of Enforcement Action.’’

12. Informal commitments are distinct from conditionsimposed in writing in connection with the grant of anapplication or other request by an institution, which may beenforced through the imposition of a civil money penalty.



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FDI Act13 and the regulations issued thereunderby the FDIC. The law and regulations apply toindemnification agreements and payments madeby any bank to any institution-af filiated party,regardless of the condition of the financial

institution. The purpose of the law and regula-tions is to preserve the deterrent effects of administrative enforcement actions (by ensuringthat individuals subject to final enforcementactions bear the costs of any judgments, fines,and associated legal expenses) and to safeguardthe assets of financial institutions.

A prohibited indemnification payment includesany payment (or agreement to make a payment)by a bank to an institution-af filiated party to payor reimburse such person for any liability or

legal expense in any federal banking agencyadministrative proceeding that results in a finalorder or settlement in which the institution-af filiated party is assessed a civil money penalty,is removed or prohibited from banking, or isrequired to cease an action or take any af firma-tive action, including making restitution, withrespect to the bank.14 In cases in which theinstitution-afilliated party prevails, the institu-tion can make a payment if the board of direc-tors determines that it is in the best interest of

the institution and the payment does not mate-rially adversely affect the institution’s safety andsoundness.

The law and the FDIC’s regulations apply toall state member banks. They reinforce theFederal Reserve’s longstanding policy that aninstitution-af filiated party who engages in mis-conduct should not be insulated from the con-sequences of his or her misconduct. From asafety-and-soundness perspective, a state mem-ber bank should not divert its assets to pay a fine

or other final judgment issued against aninstitution-af filiated party for misconduct thatpresumably violates the bank ’s policy of com-pliance with applicable law, especially in caseswhere the individual’s misconduct has alreadyharmed the bank.

State member banks should review theirbylaws and any outstanding indemnificationagreements, as well as insurance policies, toensure that they conform with the requirementsof federal law and regulations. If a state memberbank fails to take appropriate action to bring itsindemnification provisions into compliance withfederal laws and regulations, appropriate

follow-up supervisory action may be taken. Aspart of the supervisory process, which willinclude merger and acquistion applications, theFederal Reserve’s supervisory and examinerstaff will review identified agreements having

indemnification-related issues for compliancewith federal law and regulations. (See SR-02-17.)

Golden Parachute Payments

‘‘Golden parachute’’ payment restrictions wereenacted as part of the Crime Control Act of 1990.15 The law added section 18(k) to theFederal Deposit Insurance Act (12 USC 1828(k))

and authorized the FDIC to issue implementingregulations. The FDIC’s golden parachute regu-lations may apply to an insured depositoryinstitution if the institution is in a troubledcondition as defined in Regulation Y. The pur-poses of the law and regulations include safe-guarding the assets of financial institutions andlimiting rewards to institution-af filiated partieswho may have contributed to the institution’scondition.

In general, the FDIC’s regulations prohibitinsured depository institutions and their holdingcompanies from making golden parachute pay-ments except in certain circumstances.16 Agolden parachute payment means any paymentin the nature of compensation (or agreement tomake such a payment) for the benefit of anycurrent or former institution-af filiated party of an insured depository institution or its holdingcompany that meets three criteria. First, thepayment or agreement must be contingent on the

termination of the institution-af filiated party’semployment or association. Second, the pay-ment or agreement is received on or after, ormade in contemplation of, among other things, adetermination that the institution or holdingcompany is in a troubled condition under theregulations of the applicable banking agency.Third, the payment or agreement must be pay-able to an institution-af filiated party who isterminated when the institution or holding com-pany meets certain specific conditions, includ-

ing being subject to a determination that it is ina troubled condition.

13. See 12 USC 1828(k).14. See 12 CFR 359.

15. SR-90-38 generally describes the provisions of theCrime Control Act of 1990.

16. See the FDIC’s golden parachute regulations in 12CFR 359.





The definition of a golden parachute paymentalso covers a payment made by a bank holdingcompany that is not in a troubled condition to aninstitution-af filiated party of an insured deposi-tory institution subsidiary that is in a troubled

condition, if the other criteria in the definitionare met. This circumstance may arise when abank holding company, as part of an agreementto acquire a troubled bank or savings associa-tion, proposes to make payments to the troubledinstitution’s institution-af filiated parties thatare conditioned on their termination of employment.17

A state member bank or bank holding com-pany may make or enter into an agreement tomake a golden parachute payment only (1) if the

Federal Reserve, with the written concurrence of the FDIC, determines that the payment or agree-ment is permissible; (2) as part of an agreementto hire competent management in certain condi-tions, with the consent of the Federal Reserveand the FDIC as to the amount and terms of theproposed payment; or (3) pursuant to an agree-ment to provide a reasonable severance not toexceed 12 months’ salary in the event of anunassisted change in control of the depositoryinstitution, with the consent of the Federal

Reserve. In determining the permissibility of thepayment, the Federal Reserve may consider avariety of factors, including the individual’sdegree of managerial responsibilities and lengthof service, the reasonableness of the payment,and any other factors or circumstances thatwould indicate that the proposed payment would

be contrary to the purposes of the statute orregulations.

A state member bank or bank holding com-pany requesting approval to make a goldenparachute payment or enter into an agreement to

make such a payment should submit its requestsimultaneously to the appropriate FDIC regionalof fice and Federal Reserve Bank. The requestmust detail the proposed payments and demon-strate that the state member bank or bank holding company does not possess and is notaware of any evidence that there is reasonablebasis to believe, at the time that the payment isproposed to be made, that the institution-af filiated party receiving such a payment hascommitted any fraud, breach of fiduciary duty,

or insider abuse or has materially violated anyapplicable banking law or regulation that had oris likely to have a material adverse effect on thebank or company; that the individual is substan-tially responsible for the institution’s insolvencyor troubled condition; and that the individual hasviolated specified banking or criminal laws.

If a state member bank or bank holdingcompany makes or enters into an agreement tomake a golden parachute payment without priorregulatory approval when such an approval is

required, appropriate follow-up supervisoryaction should be taken. This follow-up couldinclude an enforcement action requiring theoffending institution-af filiated party to reim-burse the institution for the amount of theprohibited payment. When state member banksor bank holding companies are identified ashaving golden parachute–related issues in thesupervisory process, those issues should becarefully reviewed for compliance with the lawand the FDIC’s regulations. The appropriate

Reserve Bank supervisory staff and the appro-priate staff of the Board’s Division of BankingSupervision and Regulation should be notifiedand consulted on the golden parachute–relatedissues. (See SR-03-06.)

17. The FDIC’s regulations exclude from the definition of a golden parachute payment several types of payments, suchas payments made pursuant to a qualified pension or retire-ment plan; a benefit plan or bona fide deferred compensationplan (which are further defined in the FDIC’s regulations); ora severance plan that provides benefits to all eligible employ-ees, does not exceed the base compensation paid over thepreceding 12 months, and otherwise meets the regulatorydefinition of nondiscriminatory and other conditions in theFDIC’s regulations.


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