C. Office of Inspector
General’s Assessment of the Management and Performance Challenges
Facing the FDIC
Under the Reports Consolidation Act of 2000, the Office of Inspector General (OIG) is required to identify the most significant management and performance challenges facing the Corporation and provide its assessment to the Corporation for inclusion in the FDIC’s annual performance and accountability report. The OIG conducts this assessment annually and identifies specific areas of challenge facing the Corporation at the time. In identifying the challenges, the OIG keeps in mind the Corporation’s overall program and operational responsibilities; financial industry, economic, and technological conditions and trends; areas of congressional interest and concern; relevant laws and regulations; the Chairman’s priorities and corresponding corporate goals; and the ongoing activities to address the issues involved.
In looking at the recent past and the current environment and anticipating—to the extent possible—what the future holds, the OIG believes that the FDIC faces challenges in the areas listed below. While the Corporation will sustain its efforts to maintain public confidence and stability, particularly as it continues to implement key provisions and authorities of the Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), challenges will persist in other areas as well. We note in particular that the Corporation is continuing to carry out a massive resolution and receivership workload and at the same time is assuming a new resolution authority. Concurrently, the FDIC faces challenges in meeting its deposit insurance responsibilities, supervising financial institutions, protecting consumers, and managing its workforce and other corporate resources. It is conducting all of these activities in a corporate environment that has substantially changed over the past year and one that remains in constant flux.
As the FDIC and the banking industry emerge from the most severe crisis since the 1930s, the Corporation can take pride in having helped restore stability and confidence in the nation’s banking system. It has completed or sustained a number of new initiatives, responded to new demands, and played a key part in shaping bank regulation for the post-crisis period. Passage of the Dodd-Frank Act has presented new opportunities and challenges for the FDIC in its efforts to restore the vitality and stability of the financial system, and the Corporation has met these head-on. Perhaps the biggest uncertainty, and the backdrop against which the FDIC will operate going forward, is whether the U.S. economy can sustain current economic growth and what impact the outlook in Europe will have on the banking and financial services industry in the months ahead.
Carrying Out New Resolution Authority
Reforms under the Dodd-Frank Act involve far-reaching changes designed to restore market discipline, internalize the costs of risk-taking, protect consumers, and make the regulatory process more attuned to systemic risks. The Dodd-Frank Act created the Financial Stability Oversight Council (FSOC), of which the FDIC is a voting member. The FSOC monitors sources of systemic risk and promulgates rules that will be implemented by the various financial regulators represented on the FSOC. The Dodd-Frank Act also established an independent Consumer Financial Protection Bureau (CFPB) within the Federal Reserve System; abolished the Office of Thrift Supervision (OTS) and transferred its supervisory responsibilities for federal and state-chartered thrift institutions and thrift holding companies to the Office of the Comptroller of the Currency (OCC), the FDIC, and the Federal Reserve System, respectively; and has given the FDIC significant new authorities to help address the risks in systemically important financial companies or institutions (SIFIs).
To carry out its most critical responsibilities under the Dodd-Frank Act in an effective and credible manner, the FDIC established its Office of Complex Financial Institutions (OCFI). This office contnues to establish itself and will face challenges during the upcoming year as it continues to evolve. New responsibilities for OCFI in connection with SIFIs include an Orderly Liquidation Authority to resolve bank holding companies and nonbank financial institutions, if necessary, and a requirement for resolution plans that will give regulators additional tools with which to manage the failure of large, complex enterprises. The FDIC’s OCFI has taken steps in three key areas over the past year to carry out these responsibilities— monitoring risk within and across these large, complex firms from the standpoint of resolution; conducting resolution planning and developing strategies to respond to potential crisis situations; and coordinating with regulators overseas regarding the significant challenges associated with cross-border resolution.
OCFI has also been developing its own resolution plans in order to be ready to resolve a failing systemic financial company. These internal FDIC resolution plans— developed pursuant to the Orderly Liquidation Authority, provided under Title II of the Dodd-Frank Act—apply many of the same powers that the FDIC has long used to manage failed-bank receiverships to a failing SIFI. If the FDIC is appointed as receiver of such an institution, it will be required to carry out an orderly liquidation in a manner that maximizes the value of the company’s assets and ensures that creditors and shareholders appropriately bear any losses. The goal is to close the institution without putting the financial system at risk.
According to the Acting Chairman of the FDIC, this internal resolution planning work is the foundation of the FDIC’s implementation of its new responsibilities under the Dodd-Frank Act. In addition, the FDIC has largely completed the extensive related rulemaking necessary to carry out its responsibilities under Dodd-Frank. Notwithstanding such progress, the coming months will be challenging for the FDIC and all of the regulatory agencies as they work collaboratively to reposition themselves to carry out the mandates of the Dodd-Frank Act, continuing to develop rules to implement key sections, and undertaking their new responsibilities as members of the FSOC.
Resolving Failed Institutions and Managing Receiverships
In addition to the future challenges associated with exercising this new resolution authority, the Corporation is currently dealing with a daunting resolution and receivership workload. As of December 31, 2011, approximately 415 institutions had failed during the crisis, with total assets at inception of $664.3 billion. Estimated losses resulting from the failures total approximately $86.3 billion. As of year-end 2011, the number of institutions on the FDIC’s “Problem List” was 813, with $319.4 billion in assets, indicating the potential of more failures to come and corresponding challenges with regard to management and disposition of failed bank assets.
Franchise marketing activities are at the heart of the FDIC’s resolution and receivership work, and as failures persist, continue to challenge the Corporation. The FDIC must determine and pursue the least costly resolution to the Deposit Insurance Fund (DIF) for each failing institution. Each failing institution is subject to the FDIC’s franchise marketing process, which includes valuation, marketing, bidding and bid evaluation, and sale components. The FDIC is often able to market institutions such that all deposits, not just insured deposits, are purchased by acquiring institutions, thus avoiding losses to uninsured depositors.
Of special note, through purchase and assumption (P&A) agreements with acquiring institutions, the Corporation has entered into 272 shared-loss agreements (SLA) involving about $209.4 billion in initial covered assets. Under these agreements, the FDIC agrees to absorb a portion of the loss—generally 80-95 percent—which may be experienced by the acquiring institution with regard to those assets, for a period of up to 10 years. In addition, the FDIC has entered into 31 structured asset sales to dispose of about $25.4 billion in assets. Under these arrangements, the FDIC retains a participation interest in future net positive cash flows derived from third-party management of these assets.
Other post-closing asset management activities will continue to require much FDIC attention. FDIC receiverships manage assets from failed institutions, mostly those that are not purchased by acquiring institutions through P&A agreements or involved in structured sales. As of year-end 2011, the FDIC was managing 426 receiverships holding about $28.5 billion in assets, mostly securities, delinquent commercial real-estate and single-family loans, and participation loans. Post-closing asset managers are responsible for managing many of these assets and rely on receivership assistance contractors to perform day-to-day asset management functions. Since these loans are often sub-performing or nonperforming, workout and asset disposition efforts are intensive.
The FDIC increased its permanent resolution and receivership staffing and significantly increased its reliance on contractor and term employees to fulfill the critical resolution and receivership responsibilities associated with the ongoing FDIC interest in the assets of failed financial institutions. At the end of 2008, on-board resolution and receivership staff totaled 491, while onboard staffing as of November 30, 2011 was 1,858. As of year-end 2010, the dollar value of contracts awarded in the resolution and receivership functions accounted for approximately $2.4 billion of the total value of $2.6 billion. As of December 31, 2011, the dollar value of such contracts awarded for 2011 totaled $1.2 billion of a total $1.4 billion for all contracts.
The significant surge in failed-bank assets and associated contracting activities will continue to require effective and efficient contractor oversight management and technical monitoring functions. Bringing on so many contractors and new employees in a short period of time can strain existing controls and administrative resources in such areas as employee background checks, for example, which, if not timely and properly executed, can compromise the integrity of FDIC programs and operations.
Ensuring and Maintaining the Viability of the Deposit
Federal deposit insurance remains at the heart of the FDIC’s commitment to maintain stability and public confidence in the nation’s financial system. With enactment of the Emergency Economic Stabilization Act of 2008, the limit of the basic FDIC deposit insurance coverage was raised temporarily from $100,000 to $250,000 per depositor, through December 31, 2009. Such coverage was subsequently extended through December 31, 2013, and the Dodd-Frank Act made permanent the increase in the coverage limit to $250,000. It also provided deposit insurance coverage on the entire balance of non-interest bearing transaction accounts at all insured depository institutions until December 31, 2012. A priority and ongoing challenge for the FDIC is to ensure that the DIF remains viable to protect all insured depositors. To maintain sufficient DIF balances, the FDIC collects risk-based insurance premiums from insured institutions and invests deposit insurance funds.
Since year-end 2007, the failure of FDIC-insured institutions has imposed total estimated losses of more than $86 billion on the DIF. The sharp increase in bank failures over the past several years caused the fund balance to become negative. The DIF balance turned negative in the third quarter of 2009 and hit a low of negative $20.9 billion in the following quarter. As the DIF balance declined, the FDIC adopted a statutorily required Restoration Plan and increased assessments to handle the high volume of failures and begin replenishing the fund. The FDIC increased assessment rates at the beginning of 2009. In June 2009, the FDIC imposed a special assessment that brought in additional funding from the banking industry. Further, in December 2009, to increase the FDIC’s liquidity, the FDIC required that the industry prepay almost $46 billion in assessments, representing over 3 years of estimated assessments.
Since the FDIC imposed these measures, the DIF balance has steadily improved. It increased throughout 2010 and stood at negative $1.0 billion as of March 31, 2011. During the second quarter of 2011, the fund rose to a positive $3.9 billion. Under the Restoration Plan for the DIF, the FDIC has put in place assessment rates necessary to achieve a reserve ratio (the ratio of the fund balance to estimated insured deposits) of 1.35 percent by September 30, 2020, as the Dodd-Frank Act requires. FDIC analysis of the past two banking crises has shown that the DIF reserve ratio must be 2 percent or higher in advance of a banking crisis to avoid high deposit insurance assessment rates when banking institutions are strained and least able to pay. Consequently, the FDIC established a 2-percent reserve ratio target as a critical component of its long-term fund management strategy.
The FDIC has also implemented the Dodd-Frank Act requirement to redefine the base used for deposit insurance assessments as average consolidated total assets minus average tangible equity rather than an assessment based on domestic deposits. The FDIC does not expect this change to materially affect the overall amount of assessment revenue that otherwise would have been collected. However, as Congress intended, the change in the assessment base will generally shift some of the overall assessment burden from community banks to the largest institutions, which rely less on domestic deposits for their funding than do smaller institutions. The result will be a sharing of the assessment burden that better reflects each group’s share of industry assets. The FDIC estimates that aggregate premiums paid by institutions with less than $10 billion in assets will decline by approximately 30 percent, primarily due to the assessment base change.
The FDIC, in cooperation with the other primary federal regulators, proactively identifies and evaluates the risk and financial condition of every insured depository institution. The FDIC also identifies broader economic and financial risk factors that affect all insured institutions. The FDIC is committed to providing accurate and timely bank data related to the financial condition of the banking industry.
Industry-wide trends and risks are communicated to the financial industry, its supervisors, and policymakers through a variety of regularly produced publications and ad hoc reports. Risk-management activities include approving the entry of new institutions into the deposit insurance system, off-site risk analysis, assessment of risk-based premiums, and special insurance examinations and enforcement actions. In light of increasing globalization and the interdependence of financial and economic systems, the FDIC also supports the development and maintenance of effective deposit insurance and banking systems world-wide.
Primary responsibility for identifying and managing risks to the DIF lies with the FDIC’s Division of Insurance and Research (DIR), Division of Risk Management Supervision (RMS), Division of Resolutions and Receiverships, and now OCFI. The FDIC’s new Chief Risk Officer will also play a key role in identifying risks, and his office will have a greater role to play in the months ahead. To help integrate the risk management process, the Board authorized the creation of an Enterprise Risk Committee, as a cross-divisional body to coordinate risk assessment and response across the Corporation. Also, a Risk Analysis Center monitors emerging risks and recommends responses to the National Risk Committee. In addition, a Financial Risk Committee focuses on how risks impact the DIF and financial reporting. Challenges going forward will include efficiently and effectively leveraging the risk insights of all involved in corporate risk management activities.
Over recent years, the consolidation of the banking industry resulted in fewer and fewer financial institutions controlling an ever-expanding percentage of the nation’s financial assets. The FDIC has taken a number of measures to strengthen its oversight of the risks to the insurance fund posed by the largest institutions, and its key programs have included the Large Insured Depository Institution Program, Dedicated Examiner Program, Shared National Credit Program, and off-site monitoring systems.
Importantly, with respect to the largest institutions, and their risk to the DIF, Title II of the Dodd-Frank Act will help address the notion of “Too Big to Fail.” The largest institutions will be subjected to the same type of market discipline facing smaller institutions. Title II provides the FDIC authority to wind down systemically important bank holding companies and non-bank financial companies as a companion to the FDIC’s authority to resolve insured depository institutions. As noted earlier, the FDIC’s new OCFI is now playing a key role in overseeing these activities.
Ensuring Institution Safety and Soundness Through an Effective Examination and Supervision Program
The Corporation’s supervision program promotes the safety and soundness of FDIC-supervised insured depository institutions. As of year-end 2011, the FDIC was the primary federal regulator for approximately 4,625 FDIC-insured, state-chartered institutions that are not members of the Federal Reserve Board (FRB)—generally referred to as “state non-member” institutions. As such, the FDIC is the lead federal regulator for the majority of community banks. The Acting Chairman has made it clear that one of the FDIC’s most important priorities is the future of community banks and the critical role they play in the financial system and the U.S. economy as a whole. The Corporation plans a number of upcoming initiatives to further its understanding of the challenges and opportunities facing community banks, including a conference, a study by DIR, and an assessment of both risk-management and compliance supervision practices to see if there are ways to make processes more efficient.
Historically, the Department of the Treasury (the OCC and the OTS) and the FRB have supervised other banks and thrifts, depending on the institution’s charter. The recent winding down of the OTS under the Dodd-Frank Act resulted in the transfer of supervisory responsibility for about 60 state-chartered savings associations to the FDIC, all of which are considered small and that will be absorbed into the FDIC’s existing supervisory program.
About 670 federally chartered savings associations were transferred to the OCC. As insurer, the Corporation also has back-up examination authority to protect the interests of the DIF for about 2,800 national banks, state-chartered banks that are members of the FRB, and those savings associations now regulated by the OCC.
The examination of the institutions that it regulates is a critical FDIC function. Through this process, the FDIC assesses the adequacy of management and internal control systems to identify, measure, monitor, and control risks; and bank examiners judge the safety and soundness of a bank’s operations. The examination program employs risk-focused supervision for banks. According to examination policy, the objective of a risk-focused examination is to effectively evaluate the safety and soundness of the bank, including the assessment of risk management systems, financial condition, and compliance with applicable laws and regulations, while focusing resources on the bank’s highest risks. Part of the FDIC’s overall responsibility and authority to examine banks for safety and soundness relates to compliance with the Bank Secrecy Act (BSA), which requires financial institutions to develop and implement a BSA compliance program to monitor for suspicious activity and mitigate associated money laundering risks within the financial institution. This includes keeping records and filing reports on certain financial transactions. An institution’s level of risk for potential terrorist financing and money laundering determines the necessary scope of a Bank Secrecy Act examination.
As noted earlier, the passage of the Dodd-Frank Act brought about significant organizational changes to the FDIC’s supervision program in the FDIC’s former Division of Supervision and Consumer Protection (DSC). That is, the FDIC Board of Directors approved the establishment of OCFI and a Division of Depositor and Consumer Protection. In that connection, DSC was renamed RMS. OCFI began its operations and is focusing on overseeing bank holding companies with more than $100 billion in assets and their corresponding insured
depository institutions. OCFI is also responsible for non-bank financial companies designated as systemically important by FSOC. OCFI and RMS will coordinate closely on all supervisory activities for insured state nonmember institutions that exceed $100 billion in assets, and RMS is responsible for the overall Large Insured Depository Institution program.
As noted earlier, with the number of institutions on the FDIC’s “Problem List” as of December 31, 2011 at 813, there is a potential of more failures to come and an additional asset disposition workload. The FDIC is the primary federal regulator for 533 of the 813 problem institutions, with total assets of $175.4 billion and $319.4 billion, respectively. Importantly, however, during the second quarter of 2011, the number of institutions on the Problem List fell for the first time in 19 quarters—from 888 to 865—and total assets of problem institutions declined during the second quarter from $397 billion to $372 billion. Maintaining vigilant supervisory activities of all institutions, including problem institutions, and applying lessons learned in light of the recent crisis will be critical to ensuring stability and continued confidence in the financial system going forward.
Protecting and Educating Consumers and Ensuring an Effective Compliance Program
The FDIC serves a number of key roles in the financial system and among the most important is its work in ensuring that banks serve their communities and treat consumers fairly. The FDIC carries out its role by providing consumers 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. As a means of remaining responsive to consumers, the FDIC’s Consumer Response Center investigates consumer complaints about FDIC-supervised institutions and responds to consumer inquiries about consumer laws and regulations and banking practices.
Currently and going forward, the FDIC will be experiencing and implementing changes related to the Dodd-Frank Act that have direct bearing on consumer protections. As noted earlier, the Dodd-Frank Act established the new Consumer Financial Protection Bureau within the FRB and transferred to this bureau the FDIC’s examination and enforcement responsibilities over most federal consumer financial laws for insured depository institutions with over $10 billion in assets and their insured depository institution affiliates. Also during early 2011, the FDIC established its new Division of Depositor and Consumer Protection, responsible for the Corporation’s compliance examination and enforcement program as well as the depositor protection and consumer and community affairs activities supporting that program. These entities will face mutual challenges, and coordination will be critical.
Historically, turmoil in the credit and mortgage markets has presented regulators, policymakers, and the financial services industry with serious challenges. Many of these challenges persist, even as the economy shows signs of improvement. The FDIC has been committed to working with the Congress and others to ensure that the banking system remains sound and that the broader financial system is positioned to meet the credit needs of the economy, especially the needs of creditworthy households that may experience distress. Another important focus is financial literacy. The FDIC has promoted expanded opportunities for the underserved banking population in the United States to enter and better understand the financial mainstream. Economic inclusion continues to be a priority for the FDIC. A challenge articulated by the Acting Chairman as he looks to the future is to increase access to financial services for the unbanked and underbanked in the United States.
Consumers today are also concerned about data security and financial privacy. Banks are increasingly using third
party servicers to provide support for core information and transaction processing functions. The FDIC must continue to ensure that financial institutions protect the privacy and security of information about customers under applicable U.S. laws and regulations.
Effectively Managing the FDIC Workforce and Other Corporate Resources
The FDIC must effectively and economically manage and utilize a number of critical strategic resources and implement effective controls in order to carry out its mission successfully, particularly with respect to its human, financial, information technology (IT), and physical resources. These resources have been stretched during the past years of the recent crisis, and the Corporation will continue to face challenges as it seeks to return to a steadier state of operations. New responsibilities, reorganizations, and changes in senior leadership and in the makeup of the FDIC Board will continue to impact the FDIC workforce in the months ahead. Promoting sound governance and effective stewardship of its core business processes and human and physical resources will be key to the Corporation’s success.
Of particular note, in response to the crisis, FDIC staffing levels increased dramatically. The Board approved an authorized 2011 staffing level of 9,252 employees, up about 2.5 percent from the 2010 authorization of 9,029. On a net basis, all of the new positions were temporary, as were 39 percent of the total 9,252 authorized positions for 2011. Temporary employees were hired by the FDIC to assist with bank closings, management and sale of failed bank assets, and other activities that were expected to diminish substantially as the industry returns to more stable conditions. To that end, the FDIC opened three temporary satellite offices (East Coast, West Coast, and Midwest) for resolving failed financial institutions and managing the resulting receiverships. The FDIC closed the West Coast Office in January 2012 and plans to close the Midwest Office in September 2012.
The Corporation’s contracting level has also grown significantly, especially with respect to resolution and receivership work. Contract awards in DRR totaled $2.4 billion during 2010 and as of December 2011 totaled $1.2 billion. To support the increases in FDIC staff and contractor resources, the Board of Directors approved a $4.0 billion Corporate Operating Budget for 2011, down slightly from the 2010 budget the Board approved in December 2009. For 2012, the approved corporate budget was further reduced to $3.28 billion to support 8,704 staff. The FDIC’s operating expenses are paid from the DIF, and consistent with sound corporate governance principles, the Corporation’s financial management efforts must continuously seek to be efficient and cost conscious, particularly in a government-wide environment that is facing severe budgetary constraints.
Opening new offices, rapidly hiring and training many new employees, expanding contracting activity, and training those with contract oversight responsibilities placed heavy demands on the Corporation’s personnel and administrative staff and operations. Now, as conditions seem a bit improved throughout the industry and the economy, a number of employees will be released—as is the case in the two temporary satellite offices referenced earlier─ and staffing levels will move closer to a pre-crisis level, which may cause additional disruption to ongoing operations and introduce new risks to current workplaces and working environments. Among other challenges, pre- and post-employment checks for employees and contractors will need to ensure the highest standards of ethical conduct, and for all employees, in light of a transitioning workplace, the Corporation will seek to sustain its emphasis on fostering employee engagement and morale.
From an IT perspective, amidst the heightened activity in the industry and economy, the FDIC is engaging in massive amounts of information sharing, both internally and with external partners. This is also true with respect to sharing of highly sensitive information with other members of the newly formed FSOC and with the Council itself. FDIC systems contain voluminous amounts of critical data. The Corporation needs to ensure the integrity, availability, and appropriate confidentiality of bank data, personally identifiable information (PII), and other sensitive information in an environment of increasingly sophisticated security threats and global connectivity. Continued attention to ensuring the physical security of all FDIC resources is also a priority. The FDIC needs to be sure that its emergency response plans provide for the safety and physical security of its personnel and ensure that its business continuity planning and disaster recovery capability keep critical business functions operational during any emergency.
The FDIC is led by a five-member Board of Directors, all of whom are to be appointed by the President and confirmed by the Senate, with no more than three being from the same political party. For much of the past year, the FDIC had in place three internal directors—the Chairman, Vice Chairman, and one independent Director—and two ex officio directors, the Comptroller of the Currency and the Director of OTS. With the passage of the Dodd-Frank Act, the OTS no longer exists, and the Director of OTS has been replaced on the FDIC Board by the Director of the Consumer Financial Protection Bureau, Richard Cordray. Former FDIC Chairman Sheila Bair left the Corporation when her term expired—in early July 2011. Vice Chairman Martin Gruenberg was serving as Acting Chairman as of the end of 2011, and had been nominated by the President to serve as Chairman. In March 2012, the Senate extended the Board term for Acting Chairman Gruenberg but did not vote on his nomination to be Chairman. The internal Director, Thomas Curry, nominated by the President to serve as Comptroller of the Currency, was confirmed as Comptroller in late March 2012 and currently occupies that position. Thomas Hoenig, nominated by the President to serve as Vice Chairman of the FDIC, was confirmed as a Board member in March 2012 and was sworn in, though not as Vice Chairman, in April 2012. Finally, Jeremiah Norton was confirmed by the Senate in March 2012 and sworn in as Board Member in April 2012.
The Board is now at its full five-member capacity for the first time since July 2011. Given the relatively frequent turnover on the Board and the new configuration of the current Board, it is essential that strong and sustainable governance and communication processes be in place throughout the FDIC. Board members, in particular, need to possess and share the information needed at all times to understand existing and emerging risks and to make sound policy and management decisions.
Beyond the Board level, enterprise risk management is a key component of governance at the FDIC. The FDIC’s numerous enterprise risk management activities need to consistently identify, analyze, and mitigate operational risks on an integrated, corporate-wide basis. Additionally, 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. In that context, the new Office of Corporate Risk Management led by the FDIC’s first Chief Risk Officer will assess external and internal risks faced by the FDIC and will report to the FDIC Chairman and periodically report back to the FDIC Board an important organizational change that should serve the best interests of the Corporation.
2011 Federal Deposit Insurance Corporation
This Annual Report was produced by talented and dedicated staff. To these individuals, we would like to offer our sincere thanks and appreciation. Special recognition is given to the following individuals for their contributions.