I. Management’s Discussion and Analysis - The Year in Review
Supervision and Consumer Protection
Supervision and consumer protection are cornerstones of the FDIC’s efforts to ensure the stability of and public confidence in the nation’s financial system. At year-end 2004, the Corporation was the primary federal regulator for 5,272 FDICinsured, state-chartered institutions that are not members of the Federal Reserve System (generally referred to as “state non-member” institutions). Through safety and soundness, consumer compliance and Community Reinvestment Act (CRA) examinations of these FDIC-supervised institutions, the FDIC assesses their operating condition, management practices and policies, and their compliance with applicable laws and regulations. The FDIC also educates bankers and consumers on matters of interest and addresses consumers’ questions and concerns.
Safety and Soundness
During 2004, the Corporation conducted all 2,515 statutorily required safety and soundness examinations. The number and total assets of FDIC-supervised institutions identified as “problem” institutions (defined as having a composite CAMELS1 rating of “4” or “5”) decreased during 2004. As of December 31, 44 institutions with total assets of $5.3 billion were identified as problem institutions compared to 73 institutions with total assets of $8.2 billion on December 31, 2003. These changes represent a decrease of 39.7 percent and 35.4 percent, respectively, in the number and assets of problem institutions. During 2004, 57 institutions were removed from problem institution status due to composite rating upgrades, mergers, consolidations or sales, and 28 were newly identified as problem institutions. The FDIC is required to conduct follow-up examinations of all designated problem institutions within 12 months of the last examination. As of December 31, 2004, all follow-up examinations for problem institutions had been performed on schedule.
Compliance and Community Reinvestment Act (CRA) Examinations
The FDIC conducted 1,459 comprehensive compliance-CRA examinations, 673 compliance-only examinations2, and four CRA-only examinations in 2004, compared to 1,610 joint compliance-CRA examinations, 307 compliance-only examinations, and two CRA-only examinations in 2003. The FDIC conducted all joint and comprehensive examinations within established time frames. As of December 31, 2004, five institutions were assigned a “4” rating for compliance, and no institutions were rated “5.” Of the five institutions rated “4” as of December 31, 2004, four are within the 12 month window following issuance of an enforcement action.
Of these four, two entered into Memorandums of Understanding with the FDIC and two are subject to outstanding Cease and Desist Orders. A Cease and Desist Order for the fifth institution will likely be issued during the first quarter of 2005.
Examination Program Efficiencies
The FDIC continued in 2004 to implement measures to improve examination efficiency by maximizing the use of risk-focused examination procedures at well-managed banks. Based on experience with the Maximum Efficiency Risk-Focused Institution Target (MERIT) Program implemented in 2002, the FDIC raised the threshold for well-rated, well-capitalized banks qualifying for streamlined examinations under the MERIT Program to $1 billion, up from $250 million. Use of the MERIT Program allows the FDIC to direct more examination resources to institutions posing the most risks to the insurance funds. The FDIC also implemented more risk-focused examinations for the trust and information technology specialty areas. The FDIC continued to emphasize the revised compliance examination approach implemented during the second half of 2003. During 2004, the FDIC convened six focus groups with bankers across the country to discuss their experience with the revised compliance examination process. The bankers strongly supported the new process, reporting that it had resulted in a more efficient examination and that compliance examiners provided more constructive feedback than in the past.
In keeping with other recent strategic initiatives to enhance supervisory processes, the FDIC conducted a pilot program to test a new approach to bank supervision. The primary purpose of the “relationship manager program” pilot was to determine the extent to which designation of a relationship manager for each bank would enhance risk-focused assessments and improve communications with financial institutions.
The pilot explored alternatives to the traditional point-in-time examination by allowing supervisory activities to be conducted over the appropriate 12- or 18-month supervisory cycle at selected institutions, based on their risk profiles. Relationship managers developed supervisory plans for their designated banks and served as the institution's local primary point-ofcontact. Benefits of the pilot included ongoing “real time” assessments, as well as improved communications with financial institutions. Preliminary results of the pilot were favorable. Results will be further evaluated in 2005 to determine the feasibility of implementing some or all aspects of the program nationwide.
FDIC Examinations 2002-2004
Safety and Soundness:
State Nonmember Banks
State Member Banks
Subtotal - Safety and Soundness Examinations
Compliance - Community Reinvestment Act
Compliance - only
CRA - only
Subtotal CRA/Compliance Examinations
Data Processing Facilities
New Supervisory Journal
The FDIC released in June the inaugural issue of Supervisory Insights, a professional journal providing a forum for discussing how bank regulation and policy are put into practice in the field, sharing best practices, and communicating about the emerging issues bank supervisors are facing. A second issue was published in December. Supervisory Insights is available on the FDIC’s internal and external Web sites. The journal, which will be published twice yearly, includes regular features, such as “Accounting News” and “From the Examiner's Desk,” as well as articles discussing areas of current supervisory focus at the FDIC.
Shared National Credit Modernization
The Shared National Credit (SNC) program is an interagency effort designed to provide a review and credit quality assessment of many of the largest and most complex (syndicated) bank credits. The purpose of the program is to gain efficiencies and consistencies in the review of credits shared by multiple institutions under a formal lending agreement. The program is governed by an interagency agreement between the Federal Reserve Board, the FDIC, and the Office of the Comptroller of the Currency (OCC).
During 2004, the agencies initiated a SNC Data Collection Modernization project (SNC Modernization). The project seeks to enhance and streamline this effective supervision program by standardizing the SNC data collection system, applying more advanced credit risk analytics and benchmarking techniques across bank portfolios, and providing participating banks with feedback on their SNC portfolios across those metrics. In December, the agencies published a Notice for Public Comment in the Federal Register requesting the industry's feedback on the SNC Modernization project. The notice describes the changes to the reporting system the agencies contemplate and identifies new data elements the agencies propose to collect. In the notice, the agencies present a series of questions to elicit comment on the expanded program and to help the agencies refine the design of the expanded data collection system.
The financial sector is a critical component of the infrastructure in the United States, and the FDIC has taken a leadership role in assisting part of the financial sector in preparing for emergencies. As a member of the Financial and Banking Information Infrastructure Committee (FBIIC), the FDIC sponsored a series of outreach meetings in 21 cities across the United States in 2004 on Protecting the Financial Sector: A Public and Private Partnership. These meetings provided financial sector leaders with the opportunity to communicate with senior government officials, law enforcement members, and emergency management and private sector leaders about protecting the financial sector. Additional outreach meetings will be scheduled for 2005.
Bank Secrecy Act
The FDIC is also fully committed to assisting in efforts designed to thwart the inappropriate use of the banking system through activities conducted by criminals and terrorists. Our supervisory program, in conjunction with strong law enforcement efforts, creates an environment where criminals and terrorists who use the U.S. financial system to fund their operations will risk being discovered.
Since the passage of the USA PATRIOT Act (Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001), the FDIC has been actively engaged in a number of Bank Secrecy Act (BSA), anti-money laundering (AML), and counter-financing of terrorism (CFT) initiatives. During the past year, the FDIC contributed to joint industry and interagency working groups for the development of rules and interpretive guidance; incorporated rules and guidance into examination procedures and industry resources; refined the process for referring BSA violations and other significant matters to the U.S. Department of the Treasury’s FinCEN; assisted in global AML and CFT efforts; dedicated more staff to BSA/AML oversight; provided BSA/AML/CFT training to all risk management professionals; and participated in numerous industry outreach sessions.
In September 2004, the FDIC, the other Federal banking agencies, and FinCEN entered into an information-sharing Memorandum of Understanding to enhance communication and coordination to help financial institutions identify, detect, and interdict terrorist financing and money laundering. The FDIC also issued 20 formal actions and entered into 83 informal agreements that contained provisions regarding BSA compliance.
The FDIC serves as a member of the Consultative Group (CG) with respect to Middle East North Africa Partnership for Financial Excellence (PFE) initiative sponsored by the State Department (State) and the Department of the Treasury (Treasury). Under the PFE, the federal banking agencies in the U.S. (the FDIC, the Federal Reserve and the OCC) are working with Treasury, State and the U.S. Agency for International Development (USAID) in developing a training initiative to assist in the development of bank supervision in the Middle East and North Africa (MENA) region. The CG consists of representatives from the bank supervisory bodies in the MENA region, training institutions and banker associations in that region, and the U.S. supervisory and regulatory community. The CG serves as the advisory body and coordinating entity to facilitate the design, development and implementation of the training initiative. The objective of this initiative is to help foster economic growth in the region through the implementation of sound financial supervisory systems. The federal banking agencies are delivering technical assistance programs to meet needs in the MENA region. The FDIC is scheduled to deliver training focused on bank supervision and resolutions in 2005.
As a member of the Association of Supervisors of Banks of the Americas (ASBA) Strategic Planning Implementation Committee, the FDIC helped develop specific action plans for ASBA’s 2004 – 2008 strategic plan. This plan will help ASBA deliver more relevant and timely support to its member countries. The strategic plan is focused on ensuring ASBA member countries effectively implement legal and regulatory frameworks, as well as bank supervisory policies, procedures and programs that are in line with the Basel core principles.
The FDIC fulfilled 16 technical assistance missions in 2004. Beneficiaries of these missions included Morocco, Kyrgyz Republic, Iraq, Georgia, Russia, Jordan, Argentina, Serbia, Romania, several countries in Latin America, and countries involved in the Partnership for Financial Excellence Program in the Middle East and North Africa. In 2004, the FDIC also held 51 meetings with representatives from foreign countries. The visitors usually represented a country's central bank or deposit insurance agency. The most frequent visitors were: China (7), Korea (6), Russia (4), Indonesia (3), Jamaica (3), Taiwan (3), and Japan (3).
During 2004, the FDIC was active in addressing several complex accounting issues of interest to depository institutions. In February, the FDIC, in conjunction with the other financial institution regulators, issued guidance on the proper accounting and regulatory reporting for certain types of deferred compensation arrangements. In order to address the industry’s concerns about potential changes in the accounting for allowances for loans and lease losses, the FDIC joined other financial institution regulators in March to advise the industry on the status of the American Institute of Certified Public Accountants’ work on this important subject and to remind institutions of the current accounting and regulatory reporting guidance in this area. In addition, in an effort to avoid adverse changes in the accounting for loan participations, the FDIC worked extensively with the Financial Accounting Standards Board (FASB) to ensure FASB fully understood the treatment of loan participations in receiverships for its consideration and further deliberation on the proper accounting for this critical lending activity.
Financial Education and Community Development
During 2004, the Corporation continued to expand the scope and impact of its efforts to increase the availability of financial services to lowand moderate-income populations, as well as to those outside the financial mainstream.
The Corporation has worked diligently to form partnerships with financial institutions, bank trade associations, non-profit organizations, community and consumer-based groups and federal, state and local agencies to promote financial education. In 2004, the FDIC added over 200 partners to its Money Smart alliance, increasing its total to over 900 partnerships nationally. Through its Money Smart financial education program, the FDIC has provided training to an estimated 8,300 volunteer instructors, reached more than 294,000 consumers, disseminated an additional 20,000 copies of the Money Smart curriculum, and seen the establishment of more than 40,000 bank accounts. The Money Smart curriculum is available in five languages: English, Spanish, Chinese, Korean, and Vietnamese. The FDIC launched a new interactive computer-based version of Money Smart in English and Spanish in September 2004. The target to conduct and participate in 125 outreach and technical assistance activities in 2004 was exceeded.
The FDIC is one of 20 agencies that are members of the Financial Literacy Education Commission, which was established by Congress in 2003 to educate Americans about the importance of personal finances. The FDIC chairs one of two subcommittees formed by the Commission, a subcommittee to develop a national toll-free hotline (1-888-mymoney) that consumers can use to obtain information on personal finance topics. The Commission launched the hotline in late 2004.
During 2004, the FDIC also continued to lead a Chicago-based pilot project called the New Alliance Task Force (NATF), which is focused on increasing access to bank products and services for Latino immigrants. NATF is a broad-based coalition of 63 member organizations, comprised of the Mexican Consulate, banks, community-based organizations, federal bank regulatory agencies, government agencies, and representatives from the secondary market and private mortgage insurance companies. In 2004, NATF-member banks opened 50,000 new accounts throughout the Midwest, totaling about $100 million in new deposits, with an average account balance of $2,000.
Leaders gather at Commission’s first meeting (l to r): Federal Reserve Board Chairman Alan Greenspan, FDIC Chairman Donald E. Powell, National Credit Union Administration Chairman Dennis Dollar and Treasury Secretary John Snow.
Consumer Privacy and Identity Theft
The FDIC has taken a leading role in helping banks combat identity theft. In November 2004, the FDIC published a study entitled Stop, Thief! Putting an End to Account- Hijacking Identity Theft. The study took an in-depth look at identity theft, focusing on account hijacking (the unauthorized use of deposit accounts). The study found account hijacking fraud could be significantly reduced if banks upgraded the security measures they use to authenticate customers who access their accounts remotely via computers and used specialized software to proactively detect and defend against account hijacking. The study also concluded that increased consumer education and information-sharing could reduce identity theft. The FDIC is currently investigating the most appropriate ways to follow up on the study’s findings.
The FDIC conducted a study on offshore outsourcing following Chairman Powell's March 4, 2004, testimony before the House Subcommittee on Oversight and Investigations on Financial Services and the Senate Banking Committee. The purpose of the study was to identify risks to consumer privacy and identity theft from foreign outsourcing. The study also identified best practices that financial institutions can use to mitigate the risk inherent in foreign outsourcing relationships.
The study recommended that the banking agencies expand the scope of examination procedures to include identification of undisclosed thirdparty contracting arrangements and conduct an analysis of the feasibility of using the FFIEC as a central location for the Bank Service Company Act notices filed by financial institutions. This information could then be used for analysis, monitoring and tracking by the supervisory agencies. The FDIC is working with the other banking agencies to implement these recommendations.
The FDIC is one of several federal agencies charged with implementing the provisions of the Fair and Accurate Credit Transactions Act of 2003 (FACT Act), which substantially amended the Fair Credit Reporting Act, particularly in the areas of consumer access to and quality of credit information, privacy, and identity theft. The FACT Act:
preserves uniform national standards for the content of consumer report information and creditor access to such information,
improves consumer access to credit information,
improves the quality of reported credit information,
combats identity theft, and
promotes financial literacy.
Consistent with the privacy requirements of the FACT Act, the FDIC worked with other federal agencies to issue draft rules in 2004: (1) permitting creditors to obtain, use and share medical information only to the degree necessary to facilitate legitimate operational needs; and (2) providing consumers with the ability to limit the circumstances under which affiliated financial institutions may use certain information in connection with marketing activities. These rules will be issued in final form once the agencies fully consider the comments received in response to the proposals. In the meantime, the FDIC is training its examiners on the concepts underlying these rules, and is developing examination procedures to evaluate industry compliance.
Consistent with the identity theft provision of the FACT Act, the FDIC worked with other federal agencies in 2004 to propose rules that would require banks to implement a written identity theft protection program which includes procedures to evaluate red flags that might indicate identity theft. The FDIC, with the other agencies, also finalized rules requiring institutions to properly dispose of consumer information derived from credit reports in order to prevent identity theft and other fraud. The rules on disposal of consumer information become effective on July 1, 2005.
Curbing Unfair and Deceptive Practices
In March 2004, the FDIC and the Federal Reserve Board (FRB) jointly published guidance for state-chartered institutions on unfair or deceptive acts or practices prohibited by Section 5 of the Federal Trade Commission (FTC) Act. This guidance explains how institutions may avoid engaging in practices that might be viewed as unfair or deceptive. The FDIC also joined with the FFIEC agencies to propose guidance on overdraft protection programs in June 2004. The proposed guidance discusses:
approaches to providing consumers with protection against account overdrafts;
existing and potential concerns about offering and administering overdraft protection services;
key legal issues, including compliance with the FTC Act and other applicable federal and state laws;
safety and soundness considerations, such as whether institutions offering overdraft protection services have adopted adequate policies and procedures to address the credit, operational and other risks associated with these services; and
best practices in use or recommended by the industry, including those relating to marketing overdraft protection services and communicating with customers about the features of such programs.
The agencies received about 300 comments on the proposed guidance. We expect the final guidance to be issued in 2005.
Consumer Complaints and Inquiries
The FDIC investigates and responds to complaints and inquiries from consumers, financial institutions and other parties about potential violations of consumer protection and fair lending laws, as well as deposit insurance matters. The FDIC’s centralized Consumer Response Center (CRC) is responsible for investigating all types of consumer complaints about FDIC-supervised institutions and for answering inquiries about consumer protection laws and banking practices. During 2004, the FDIC received 8,804 complaints, of which 3,791 were against state-chartered nonmember banks. Approximately 41 percent of the state nonmember bank consumer complaints concerned credit card accounts, with the most frequent complaints involving loan denials, billing disputes and account errors, terms and conditions, collection practices, reporting of erroneous information, identity theft, and credit card fees and service charges. The FDIC also responded to 2,947 deposit insurance and 5,087 consumer protection inquiries from consumers and members of the banking community. The FDIC responded to over 90 percent of written complaints on a timely basis.
Deposit Insurance Education
An important part of the FDIC’s role in insuring deposits and protecting the rights of depositors is its responsibility to ensure that bankers and consumers have access to accurate information about FDIC deposit insurance rules. To that end, the FDIC has an expansive deposit insurance education program consisting of seminars for bankers, electronic tools for calculating deposit insurance coverage, and written and electronic information targeting both bankers and consumers. During 2004, the FDIC completed a digital video for bank employees and customers explaining how FDIC deposit insurance works and issued a new edition of our Electronic Deposit Insurance Estimator (EDIE) for Bankers. The video, which is available on DVD and can also be viewed through the FDIC’s Web site, provides an overview of deposit insurance coverage rules and requirements, with specific emphasis on the most common account ownership categories used by individuals and families. The EDIE software update met a 2004 performance target to provide improved resources to bankers on deposit insurance rules. It allows bankers to calculate their customers’ insurance coverage for nearly all types of deposit accounts an individual or business may have at an insured bank or savings association. Consumers can also access EDIE directly through the FDIC’s Web site.
High school senior Christopher Perry (with Chairman Don Powell, left, and Chief of Staff Jodey Arrington, right) said “he left with a positive outlook on the role of the FDIC and its duty to insure depositors' money.”
In 2004, the FDIC continued to expand its educational tools for consumers by issuing two new brochures for bank customers. Insuring Your Deposits describes insurance coverage rules for deposit accounts most commonly owned by individuals and families. Your Insured Deposits - FDIC’s Guide to Deposit Insurance Coverage, an update of the 1999 version, provides an in-depth explanation of the FDIC’s account ownership categories and includes the FDIC’s new rules for insurance coverage of living trust accounts that became effective on April 1, 2004.
The FDIC also conducted 38 deposit insurance seminars for financial institution employees, consumer organizations, and bank regulatory agencies. These seminars, which were conducted in a variety of formats, including internet, phone conference, and classroom, provided an in-depth review of how FDIC insurance works, including the FDIC’s rules for coverage of different types of deposit accounts.
Office of the Ombudsman (OO) Services to the Banking Industry
The OO was established by federal statute to serve as a confidential, neutral, and independent resource and liaison for bankers with the FDIC on regulatory matters. The OO ensures the fair and consistent application of FDIC rules and regulations, and the fair treatment of institutions throughout the FDIC’s examination, assessment, application, enforcement, rule-making and other processes. The OO works with financial institutions and the FDIC to informally resolve problems and disputes at the earliest possible stages. During 2004, bankers and members of the public contacted the OO, voicing questions and seeking problem or complaint resolution. Cumulatively, these contacts provided the FDIC with an important perspective on general and specific matters of importance, concern, or uncertainty to bankers.
1 The CAMELS composite rating represents the adequacy of Capital, the quality of Assets, the capability of Management, the quality and level of Earnings, the adequacy of Liquidity, and the Sensitivity to market risk, and ranges from “1” (strongest) to “5” (weakest).
2 Compliance-only examinations are conducted for most institutions at or near the mid-point between joint compliance-CRA examinations under the Community Reinvestment Act of 1977, as amended by the Gramm-Leach-Bliley Act of 1999. CRA examinations of financial institutions with aggregate assets of $250 million or less are subject to a CRA examination no more than once every five years if they receive a CRA rating of “Outstanding” and no more than once every four years if they receive a CRA rating of “Satisfactory.”