Office of Inspector General’s Assessment of the Management and Performance Challenges Facing the FDIC 2009 Management and Performance Challenges
Unprecedented events and turmoil in the economy and financial services industry have impacted every facet of the FDIC’s mission and operations. In looking at the current environment and anticipating to the extent possible what the future holds, the Office of Inspector General (OIG) believes the FDIC faces challenges in the areas listed below. We would also point out that the Administration and the Congress continue to broadly consider a number of new programs to restore stability in the financial system and strengthen the economy. If the FDIC were to be made responsible for any or certain aspects of such programs, it could also be faced with a set of corresponding new challenges. While the Corporation’s most pressing priority may be on efforts to restore and maintain public confidence and stability, as outlined below, challenges will persist in the other areas described as the Corporation carries out its mounting resolution and receivership workload, meets its deposit insurance responsibilities, continues its supervision of financial institutions, protects consumers, and manages its internal workforce and other corporate resources in the months ahead. The Corporation will face daunting challenges as it carries out its longstanding mission, responds to new demands, and plays a key part in shaping the future of bank regulation.
Restoring and Maintaining Public Confidence and Stability in the Financial System
The FDIC is participating with other regulators, the Congress, banks, and other stakeholders in multiple new and changing initiatives, each with its unique challenges and risks, to address current crises. The initiatives have been formed in response to crisis conditions, are very large in scale, and the FDIC’s corresponding governance and supervisory controls, in many cases, are still under development. Among the initiatives are the following:
Temporarily increasing basic deposit insurance coverage limits from $100,000 to $250,000 per depositor through December 31, 2009. There is also a possibility of making this increase permanent to help restore public confidence and stability.
Implementing the Temporary Liquidity Guarantee Program. Designed to free up funding for banks to make loans to creditworthy businesses and borrowers, this program is entirely funded by industry fees that totaled $3.4 billion as of year-end. This program (1) guarantees senior unsecured debt of insured depository institutions and most depository institution holding companies and (2) guarantees noninterest bearing transaction deposit accounts in excess of deposit insurance limits. The guarantees can go out as many as 3 years under the current program, and we understand that the Corporation has proposed the guarantees be extended to 10 years if they are collateralized by new loans. At the end of December 2008, $224 billion in FDIC-guaranteed debt was outstanding, and more than half a million deposit accounts received over $680 billion in additional FDIC coverage through the transaction account guarantee.
Engaging in loan modification programs at IndyMac Federal Bank, for example, intended to achieve affordable and sustainable mortgage payments for borrowers and increase the value of distressed mortgages by rehabilitating them into performing loans. In the case of IndyMac, as of the end of 2008, the FDIC had sent approximately 30,000 proposals to borrowers and about 8,500 had accepted. Other institutions have agreed to implement loan modification programs as part of their financial stability agreements with the FDIC and other financial regulatory agencies.
Processing applications for those FDIC-supervised institutions applying to the Department of the Treasury’s Troubled Asset Relief Program (TARP) Capital Purchase Program (CPP). This program authorizes the Treasury to purchase up to $250 billion of senior preferred shares from qualifying insured depository institutions. As of January 15, 2009, the FDIC had received over 1,600 applications requesting nearly $34 billion in TARP funding.
Participating with the other federal bank regulatory agencies in conducting stress testing and a capital program to ensure that the largest institutions have sufficient capital to perform their role in the financial system on an on-going basis and can support economic recovery, even in more severe economic environments.
Participating in the government’s plan to remove toxic assets from banks by creating investment partnerships with private investors.
With so many new initiatives now set in motion to restore confidence and stability, multiple and sometimes interrelated new risks will present themselves, and demands will likely be placed on FDIC systems, processes, policies, and human resources to successfully manage and carry out the initiatives and achieve intended results. In that connection, the FDIC needs to ensure that institutions themselves carefully track the use of funds made available through federal programs and provide appropriate information on the use of such funds to the FDIC, the Congress, and the public. Such efforts will require vigilant oversight and effective controls to ensure transparency, accountability, and successful outcomes. The Treasury Secretary’s February 10, 2009, announcement of the Administration’s Financial Stability Plan also suggests that, in the months ahead, the FDIC may be further involved in new activities to restart the flow of credit, strengthen the financial system, and provide aid for homeowners and small businesses.
Additionally, continuous coordination and cooperation with the other federal regulators and parties throughout the banking and financial services industries will be critical in the months ahead. Given recent attention on the financial regulatory system in the United States and its ability to keep pace with major developments and risks in financial markets and products, the FDIC, along with other regulators, will likely be subject to increased scrutiny and possible corresponding regulatory reform proposals that may have a substantial impact on the regulatory entities.
Resolving Failed Institutions
A key aspect of the FDIC mission is to plan and efficiently handle the resolutions of failing FDIC-insured institutions and to provide prompt, responsive, and efficient administration of failing and failed financial institutions in order to maintain confidence and stability in our financial system. The resolution process involves valuing a failing federally insured depository institution, marketing it, soliciting and accepting bids for the sale of the institution, considering the least costly resolution method, determining which bid to accept, and working with the acquiring institution through the closing process. The receivership process involves performing the closing function at the failed bank; liquidating any remaining assets; and distributing any proceeds to the FDIC, the bank customers, general creditors, and those with approved claims. Challenges include the following:
Twenty-five financial institutions failed during 2008, with total assets at failure of $371.9 billion and total estimated losses to the Deposit Insurance Fund of approximately $17.9 billion.
Large, complex failures and facilitated transactions, such as IndyMac Bank, F.S.B. (estimated $10.7 billion loss to the insurance fund) and Washington Mutual Bank ($307 billion in assets) are challenging to resolve.
The FDIC’s problem institution list grew—from 171 to 252 during the fourth quarter of 2008—and total assets of problem institutions increased from $115.6 billion to $159 billion, indicating a probability of more failures to come and an increased asset disposition workload.
A reliable, accurate claims determination system is essential to resolving failures in the most cost-effective and least disruptive manner, and the Corporation is in the process of developing such a system.
The Corporation needs to ensure that receivership and resolution processes, negotiations, and decisions made related to the future status of the failed or failing institutions are marked by fairness, transparency, and integrity.
The FDIC is retaining large volumes of assets as part of purchase and assumption agreements with institutions that are assuming the insured deposits of failed institutions. The FDIC will be responsible for disposing of the assets over an extended period of time. The Division of Resolutions and Receiverships’ assets in inventory totaled about $15 billion as of the end of 2008.
Some FDIC-facilitated resolution and asset disposition agreements include loss-share provisions that involve pools of assets worth billions of dollars and extend up to 10 years. Citigroup, for example, involves $306 billion in loans and securities protected by loss-share provisions.
Ensuring the Viability of the Deposit Insurance Fund (DIF)
Federal deposit insurance remains at the core of the FDIC’s commitment to maintain stability and public confidence in the Nation’s financial system. A priority for the FDIC is to ensure that the DIF remains viable to protect insured depositors in the event of an institution’s failure. To maintain sufficient DIF balances, the FDIC collects risk-based insurance premiums from insured institutions and invests deposit insurance funds. A number of important factors have affected and will continue to affect the solvency of the fund, as follows:
A higher level of losses for actual and anticipated failures caused the DIF balance to decrease during the fourth quarter 2008 by $16 billion to $19 billion (unaudited) as of December 31, 2008.
Communication and coordination with other federal regulators is vital to the FDIC as deposit insurer in its efforts to protect and administer the DIF.
Off-site monitoring systems and processes must be effective and efficient to mitigate risks to the funds to the fullest extent possible.
The FDIC relies to varying degrees on call report data for monitoring the financial institutions it insures, assessing premiums for insurance, determining guarantees it provides for deposits and debt, and processing institution applications under the TARP’s CPP. The Corporation needs to ensure the reliability and accuracy of call report data reflecting an institution’s financial condition in the interest of making good decisions associated with risk at institutions and preventing potential losses to the DIF.
In February 2009, the FDIC Board took action to ensure the continued strength of the DIF by imposing a one-time emergency special assessment on institutions of 20 basis points—or 20 cents on every $100 of domestic deposits, to be paid on September 30, 2009. The Chairman subsequently considered lowering the assessment to 10 basis points, while seeking to expand the Corporation’s line of credit with the Treasury Department from its current $30 billion. The Congress is considering a permanent increase to $100 billion, and authority for the FDIC to request a temporary increase up to $500 billion with required approval from the Federal Reserve, the Treasury Department, and the President. The Board also set assessment rates that generally increase the amount that institutions pay each quarter for insurance and made adjustments that improve how the assessment system differentiates for risk. The FDIC will need to carefully manage these changes to the assessment process.
The Corporation adopted a restoration plan in October 2008 to increase the reserve ratio to the 1.15 percent threshold within 5 years. The ratio declined from 0.76 percent at September 30, 2008 to 0.40 percent at year-end. In February 2009, the Board invoked the “extenuating circumstances” provision in the Federal Deposit Insurance Act and voted to extend the restoration plan horizon to 7 years.
The Corporation will be continuing to play a leadership role in its work with global partners on such matters as Basel II to ensure strong regulatory capital standards to protect the international financial system from problems that might arise when a major bank or series of banks fail.
Ensuring Institution Safety and Soundness Through an Effective Examination and Supervision Program
The Corporation’s bank supervision program promotes the safety and soundness of FDIC-supervised insured depository institutions. As of December 31, 2008, the FDIC was the primary federal regulator for 5,116 FDIC-insured, state-chartered institutions that were not members of the Federal Reserve System (generally referred to as “state non-member” institutions). The Department of the Treasury (the Office of the Comptroller of the Currency and the Office of Thrift Supervision) or the Federal Reserve Board supervise other banks and thrifts, depending on the institution’s charter.
The examination of the banks that it regulates is a core FDIC supervisory function. The Corporation also has back-up examination authority to protect the interests of the Deposit Insurance Fund for about 3,200 national banks, state-chartered banks that are members of the Federal Reserve System, and savings associations. In the current environment, efforts to continue to ensure safety and soundness and carry out the examination function will be challenging in a number of ways.
The Corporation needs to ensure it has sufficient resources to keep pace with its rigorous examination schedule and the needed expertise to address complex transactions and new financial instruments that may affect an institution’s safety and soundness.
In light of the many and varied new programs that financial institutions may engage in, the FDIC’s examination workforce will be reviewing and commenting on a number of new issues when they assign examination ratings—both in terms of risk management and compliance examinations. For example, they will need to analyze banks’ compliance with TARP CPP securities purchase agreements, use of TARP funding, and use of capital subscriptions to promote lending to creditworthy borrowers and encourage foreclosure prevention efforts.
The FDIC’s follow-up processes must be effective to ensure institutions are promptly complying with any supervisory enforcement actions resulting from the FDIC’s risk-management examination process.
The FDIC must seek to minimize the extent to which the institutions it supervises are involved in or victims of financial crimes and other abuse. The rapid changes in the banking industry, increase in electronic and on-line banking, growing sophistication of fraud schemes, and the mere complexity of financial transactions and financial instruments all create potential risks at FDIC-insured institutions and their service providers. These risks could negatively impact the FDIC and the integrity of the U.S. financial system and contribute to institution failures if existing checks and balances falter or are intentionally bypassed. FDIC examiners need to be alert to the possibility of fraudulent activity in financial institutions, and make good use of reports, information, and other resources available to them to help detect such fraud.
Protecting and Educating Consumers and Ensuring an Effective Compliance Program
The FDIC’s efforts to ensure that banks serve their communities and treat consumers fairly continue to be a priority. The FDIC carries out its role by educating consumers, providing them with access to information about their rights and disclosures that are required by federal laws and regulations, and examining the banks where the FDIC is the primary federal regulator to determine the institutions’ compliance with laws and regulations governing consumer protection, fair lending, and community investment. It has challenging initiatives underway in these areas.
The FDIC’s compliance program, including examinations, visitations, and follow-up supervisory attention on violations and other program deficiencies, is critical to ensuring that consumers and businesses obtain the benefits and protections afforded them by law.
The FDIC will continue to conduct Community Reinvestment Act (CRA) examinations in accordance with the CRA, a 1977 law intended to encourage insured banks and thrifts to help meet the credit needs of the communities in which they are chartered to do business, including low- and moderate-income neighborhoods, consistent with safe and sound operations.
As part of the FDIC’s 75th anniversary year, the Corporation conducted a nationwide financial education program to promote the importance of personal savings and responsible financial management and launched a nationwide campaign to help consumers learn about the benefits and limitations of deposit insurance. It will continue such endeavors to disseminate updated information to all consumers, including the unbanked and underbanked, going forward. To protect consumer privacy, the FDIC also conducts periodic examinations to verify that institutions comply with laws designed to protect personal information. The FDIC evaluates the adequacy of financial institutions’ programs for securing customer data and may pursue informal or formal supervisory action if it finds a deficiency.
Effectively Managing the FDIC Workforce and Other Corporate Resources
The FDIC must effectively manage and utilize a number of critical strategic resources in order to carry out its mission successfully, particularly its human, financial, information technology, and physical resources. The FDIC will face challenges as it carries out activities to promote sound governance and effective stewardship of its core business processes and resources.
The FDIC continues work to ensure it has a sufficient, engaged, skilled, flexible workforce to handle its increased and changing workload. The Board approved an authorized FDIC staffing level of 6,269, reflecting an increase of 1,459 positions from the staffing level authorized at the beginning of 2008. These staff—mostly temporary—will perform bank examinations and other supervisory activities to address bank failures, including managing and selling assets retained by the FDIC when a failed bank is sold. The Board also approved opening a temporary West Coast Satellite Office for resolving failed financial institutions and managing the resulting receiverships. Rapidly hiring and training so many new staff along with expanded contracting activity will place heavy demands on the Corporation’s human resources staff and operations.
The FDIC’s numerous enterprise risk management activities need to consistently identify, analyze, and mitigate operational risks on an integrated, corporate-wide basis. Such risks need to be communicated throughout the Corporation and the relationship between internal and external risks and related risk mitigation activities should be understood by all involved.
With a new Administration and anticipated retirements in the executive ranks of the FDIC, Board make-up and composition of the FDIC’s senior leadership team could be altered at a tumultuous time when significant policy, operational, and other issues warrant the high-level focus and attention of the Board members and reliance on the institutional and historical knowledge of senior FDIC management.
The Deposit Insurance Fund totaled $19 billion at the end of the fourth quarter 2008, compared to $52 billion at year-end 2007. FDIC investment policies and controls must ensure that these funds be invested in accordance with applicable requirements and sound investment strategies.
The Board approved a $2.24 billion 2009 Corporate Operating Budget, approximately $1.03 billion higher than for 2008. The FDIC’s operating expenses are largely paid from the insurance fund, and consistent with sound corporate governance principles, the Corporation must continuously seek to be efficient and cost-conscious.
Ensuring the integrity, availability, and appropriate confidentiality of bank data, personally identifiable information, and other sensitive information in an environment of increasingly sophisticated security threats and global connectivity can pose challenges. Protecting the information that the FDIC possesses in its supervisory, resolution, and receivership capacities requires a strong records management program, a correspondingly effective enterprise-wide information security program, and continued attention to ensuring physical security for all FDIC resources.
The FDIC awarded approximately $500 million in contracts during 2008 as of September 30. Effective and efficient processes and related controls for identifying needed goods and services, acquiring them, and monitoring contractors after the contract award must be in place and operate well.
With increased resolution and receivership workload, the level of FDIC contracting for activities such as property management and marketing, loan servicing, due diligence, subsidiary management, financial advisory services, and legal services will increase significantly, and effective controls must be in place and operational. According to the Division of Resolutions and Receiverships, as of October 1, 2008, it had awarded $225.9 million in contracts during 2008, compared to $37.9 million in 2007.
The FDIC OIG is committed to its mission of assisting and augmenting the FDIC’s contribution to stability and public confidence in the nation’s financial system. Now more than ever, we have a crucial role to play to help ensure economy, efficiency, effectiveness, integrity, and transparency of programs and associated activities, and to protect against fraud, waste, and abuse that can undermine the FDIC’s success. Our management and performance challenges evaluation is based primarily on the FDIC operating environment as of the end of 2008, unless otherwise noted. We will continue to communicate and coordinate closely with the Corporation, the Congress, and other financial regulatory OIGs as we address these issues and challenges. Results of OIG work will be posted at www.fdicig.gov.