HELFER ANNOUNCES NEW EFFORTS TO MONITOR RISK AT INSTITUTIONS
FOR IMMEDIATE RELEASE PR-11-96 (2-12-96)
FDIC Chairman Ricki Helfer has announced new efforts to
monitor and assess risk at insured institutions.
The announcement was made in a speech Friday at an FDIC
symposium on derivatives, held at FDIC offices in suburban
Washington. It is expected to be the first in a series of FDIC
conferences on key issues involving risks to the insurance funds.
Chairman Helfer told the symposium that FDIC examiners will be
given more specific guidelines about how to factor a variety of
relevant economic and other data into their risk evaluations. She
said the goal is to "bridge the gap that separates the macro from
the micro perspective -- to translate the data into directions that
examiners can use in institutions with differing levels and types
of risk exposures."
She added, "Leveraging our statistical and analytical
resources will help examiners focus their efforts so they can
increase the effectiveness of examinations and stay on site only as
long as necessary to address the risks that individual institutions
present. It will also provide a basis for supervisory notices to
banks on economic and other macro trends that may affect the way
that they do their business." This approach should give financial
institutions the opportunity to take effective evasive action when
the FDIC sees problems coming and before significant losses to the
insurance funds occur.
Chairman Helfer added that "using this approach, the scope and
focus of our bank examinations will become more a flow of risk
evaluations -- some based on economic data -- and less a checklist
of procedures to be followed."
Approximately 100 bankers and regulators from around the
country attended the one-day symposium. A copy of Chairman
Helfer's speech is attached.
# # #
Congress created the Federal Deposit Insurance Corporation in 1933
to maintain public confidence in the nation's banking system. The
FDIC insures deposits at the nation's 12,000 banks and savings
associations and it promotes the safety and soundness of these
institutions by identifying, monitoring and addressing risks to
which they are exposed.
Federal Deposit Insurance Corporation
Federal Deposit Insurance Corporation
Capital Markets Symposium
February 9, 1996
I see my job as Chairman of the FDIC as asking questions that may
lead our highly skilled professional staff to reflect on where new directions
are leading and how we should consider them. In that spirit, I see my role
at mid-day in this symposium as asking questions for all of you to
I will also throw out a few thoughts on supervisory issues that I
have been ruminating about in the bank regulatory community and some
thoughts about the progress we are making in risk assessment, as well.
It is clear that the development and use of derivatives have
increased the efficiency of financial markets. Of course, greater efficiency
may, paradoxically, also bring greater risk. Bank supervision inevitably
comes down to practice -- where the human element -- complete with
individual judgments and less than perfect knowledge -- comes into play.
Faster, more powerful automobiles are, by definition, a more efficient
means of transportation than slower ones, but improved drive-train
technology does not necessarily result in better drivers.
We have been throwing around a lot of different numbers today.
According to the definitions we at the FDIC use, in the last five years, the
notional amount of off-balance-sheet derivatives at commercial banks has
increased by more than 150 percent, from $6.8 trillion to $17.6 trillion. As
bank supervisors, what are we to make of this startling growth -- and what
-- if anything -- does it mean to the individual bank examiner evaluating
the condition of a specific institution?
Five hundred and ninety five banks hold at least some off-balance-
sheet securities, but the nine largest dealer/traders account for 94 percent
of all off-balance-sheet derivatives. About 92 percent of off-balance-sheet
derivatives are held for trading at some 159 banks. Another 436 banks
hold off-balance-sheet derivatives for other purposes. What are we bank
supervisors to make of this distribution -- and what -- if anything -- does it
mean to the individual bank examiner evaluating the condition of a
Both the income and balance sheet results of banks trading
activities in off-balance-sheet derivatives exhibit considerable volatility.
In the last eight quarters, trading gains and fee income attributable to these
activities have ranged from as much as $2.6 billion to as little as $1.1
billion. Revaluation gains and losses on these contracts have produced
shifts of tens of billions of dollars in asset and liability values in a single
quarter. What are we bank supervisors to make of this considerable
volatility -- and what -- if anything -- does it mean to the individual bank
examiner evaluating the condition of a specific institution?
The earnings impact of off-balance-sheet derivatives held for
purposes other than trading has been mixed. For example, through the
first nine months of 1995, 486 banks indicated that these contracts had
had an effect on their net interest income, suggesting that they were being
used to hedge against interest rate risk. Of those 486 banks, 315 reported
lower net interest income as a result of holding off-balance-sheet contracts,
while 171 banks reported higher net interest income. What are we bank
supervisors to make of this mixed performance -- and what -- if anything -
- does it mean to the individual bank examiner evaluating the condition of
a specific institution?
Most banks -- approximately 9,400 -- do not have any off-balance-
sheet derivatives, and any interest rate risk management takes place on-
balance-sheet. Many of these institutions hold on-balance-sheet derivative
securities. Holding on-balance-sheet derivatives can introduce considerable
interest-rate risk to bank balance sheets. In 1994, mid-term -- that is to
say, five-year -- interest rates rose about 150 basis points. This period of
rising rates witnessed a decline in the value of all bank securities of about
3.5 percent, with the sharpest declines coming in derivative securities. The
decline of industry-wide security values was equivalent to about 10 percent
of Tier 1 capital. What are we bank supervisors to make of the
considerable interest-rate risk that on-balance-sheet derivatives present
and what does it mean to the individual bank examiner evaluating the
condition of a specific institution?
These are not rhetorical questions -- we are working on the
The Federal Deposit Insurance Corporation -- and our sister
agencies the Federal Reserve Board, the Office of the Comptroller of the
Currency, and the Office of Thrift Supervision -- generate a treasury of
data on the banking and thrift industries as a byproduct of regulatory and
monetary policy functions. We also have an abundance of economic
Historically, however, we have found it difficult to bridge the gap
that separates the macro from the micro perspective, to translate the data
into directions that examiners can use in institutions with differing levels
and types of risk exposures. That is the reason I created the Division of
Insurance at the FDIC -- to help bridge that gap. It is an effort to find
ways to enhance the examination approach we take in bank supervision.
Leveraging our statistical and analytical resources will help
examiners focus their efforts so that they can increase the effectiveness of
examinations and stay on site only as long as necessary to address the risks
that individual institutions present. It will also provide a basis for
supervisory notices to banks on economic and other macro trends that may
affect the way that they do business.
At the FDIC, we have several initiatives underway to close the gap
between the macro and micro perspectives. As I noted earlier, the new
Division of Insurance will help join the picture of the industry that the
economic data provides with the traditional institution by institution
analysis of bank examination. The new division will work closely with our
examiners, economists, financial analysts and other FDIC staff -- as well as
with the same types of analysts in other regulatory agencies and in the
private sector -- to monitor, assess and address risk in the banking
As part of the effort to close the gap, the FDICs Division of
Supervision is developing ways to factor economic data into the process of
risk analysis. For example, one of our projects seeks to provide our
examiners with a structured and consistent approach to identifying and
quantifying the level and trends of risk, while encouraging analytical
thinking. Economic data would provide contexts to the examiner in
addressing such questions as: Is this banks balance sheet structure short
term in nature? and Do earnings and capital mitigate interest rate or
other risk concerns?
As part of this process, a flow or decision chart has been developed
to provide structured and consistent guidance to our examiners as they
assess the level of risk. In the case of interest rate risk, for example,
it will provide guidance as they assess the increase or decrease of risk that
is associated with capital market holdings. Further, we have at least three
corporate operating projects and one supervisory study that focus on
developing the best ways to aid examiners in identifying, quantifying and
communicating findings as to level and trends of risks -- be they credit
risk, interest rate risk, market risk or other risks.
We are working under the assumption that it is one thing to
identify the major areas of risk that financial institutions face, but it is a
more difficult task to develop a system that helps examiners identify,
quantify, and most importantly, explain the examiners view of the level
and direction of risk to bank managements and boards of directors.
A key consideration in this work is that, while our goal is to develop
a system that provides structure and consistency, we encourage examiners
to think analytically, as opposed to adherence to arbitrary parameters. A
simple example: We do not want a structured system for credit risk, say,
that has a decision point that states: Is the level of nonperforming loans
less than x percent? If so, no further action is necessary.
We do want a decision point that states: Is the level of
nonperforming loans increasing, decreasing or stable? This type of
decision point ensures that nonperforming levels and trends are included
in the analysis of credit risk, and serves as a talking point with the
bank. Examiners have access to a wide variety of data, but no specific
guidelines on how to factor this data into the decision making process of
In a credit risk decision chart, one decision point could be: What
are the results of relevant economic sector studies prepared by the Division
of Insurance? Does the bank utilize other sources of outside economic
studies? Do all relevant sector data indicate an improving, declining or
stable economic situation? Again, our projects are focusing on bringing
structure and consistency to the existing risk assessment process. In
addition, we are concentrating on developing systems that will encourage a
proactive look by building-in proactive decision points and asking
We can structure this process more effectively by thorough off-site
pre-examination planning in order to assure that on-site examination time
is used efficiently to analyze the effectiveness of a banks system of internal
controls for monitoring and assessing risk. In short, using this approach,
the scope and focus of our bank examinations will become more a flow of
risk evaluations -- some based on economic data -- and less a checklist of
procedures to be followed.
We have several other projects underway that will support this
One is a loan underwriting survey to develop information on the
level of -- and trends in -- credit risk. This survey would result in a
forward assessment of current underwriting standards.
We are reviewing whether to name case managers in our
supervisory regions to centralize responsibility for risk assessment
decisions, which would result in more timely and accurate risk assessments
and would provide one contact for bank management and other
regulators. Case managers would work closely with the Division of
Insurance regional economists.
Finally, a group of our field examiners is now working with our
information resources management staff to develop an automated
examination package, incorporating some sampling procedures. Sampling
data would be used to develop some of the data for our flow, or decision,
chart examination approach.
The projects I have described seek to marry concepts to practice in
This shifting of emphasis toward risk assessment, of course, is not
completely new at any of the bank regulatory agencies. These concepts
have been developed on an inter-agency basis over time. No one in this
group needs to be reminded that -- almost two years ago -- we instructed
our examiners to analyze derivatives and off-balance-sheet activities by
assessing the risks they pose to institutions, and in particular seven risks
we identified. We noted then that most of these risks are present in
varying degrees in more traditional financial institution products and
activities, and can largely be assessed and evaluated in similar fashion. All
bank supervisors are indeed turning toward that wider application.
The traditional CAMEL rating system involves risk analysis. The
analysis, however, is not as systematic as it could or should be. It can vary
by examiner, the field office or the regional office across the banking
agencies. I do not think that we should scrap the CAMEL rating system --
although we may want to produce the next generation of CAMEL. Its
contribution has been in providing a banks management and its board of
directors with a context in which to judge an institutions performance
against a benchmark standard, as well as serving as the strongest predictor
we have now of a banks likelihood of failure, even if the lead time is not
always as great as we would like.
I believe the system would be improved if our examiners disclosed
the individual component ratings of the overall CAMEL rating of an
institution to its management and board of directors -- as 12 states
currently do. I believe it would put boards of directors on notice of
problems in individual components before an overall rating drops and it
may add more discipline to board review of the management of individual
Derivatives -- a spectacular increase in the efficiency of financial
markets -- encouraged a re-examination of bank supervision.
The need to assess the risks that derivatives pose in some measure
has led us to take a new look at risk assessment generally. Innovation in
the market is bringing about innovation in supervision. This symposium is
an important part of that effort. It is providing the FDIC -- and our
colleagues at our sister agencies -- with a greater understanding of market
developments. That understanding will be put to good use in promoting
the safety of the deposit insurance funds and stability in the financial