Duties and Responsibilities of Directors Effective date April 2020 … · 2020-05-19 · Duties and Responsibilities of Directors Effective date April 2020 Section 5000.1 Directors

Duties and Responsibilities of DirectorsEffective date April 2020 Section 5000.1

Directors are placed in a position of trust by thebank’s shareholders, and both statutes and com-mon law place responsibility for the affairs of abank firmly and squarely on the board of direc-tors. The board of directors of a bank shoulddelegate the day-to-day routine of conductingthe bank’s business to its officers and employ-ees, but the board cannot delegate its respon-sibility for the consequences of unsound orimprudent policies and practices, whether theyinvolve lending, investing, protecting againstinternal fraud, or any other banking activity. Theboard of directors is responsible to the bank’sdepositors, other creditors, and shareholders forsafeguarding their interests through the lawful,informed, efficient, and able administration ofthe institution. In the exercise of their duties,directors are governed by federal and statebanking, securities, and antitrust statutes, aswell as by common law, which imposes aliability on directors of all corporations. Direc-tors who fail to discharge their duties com-pletely or who are negligent in protecting theinterests of depositors or shareholders may besubject to removal from office, criminal pros-ecution, civil money penalties imposed by bankregulators, and civil liability. See section 5040of this manual, “Formal Corrective Actions,”which describes those enforcement powers ingreater detail.

DIRECTOR SELECTION

The affairs of each state member bank areoverseen by its board of directors. The initialdirectors are elected by the shareholders at ameeting held before the bank is authorized tocommence business. Thereafter, they are electedat meetings held at least annually on a dayspecified in the bank’s bylaws. The directorshold office for a stated tenure, generally rangingfrom one to three years, or until their successorsare elected and have qualified. No state memberbank is to have less than five or more than25 directors as specified in section 31 of theBanking Act of 1933. Various laws govern theelection, number, qualifications, oath, liability,and removal of directors and officers, as well asthe disclosure requirements for their outsidebusiness interests. Other laws pertain to certainrestrictions, prohibitions, and penalties for secu-

rities dealers serving as directors, officers, oremployees; director interlocks; purchases ofassets from, or sales to, directors; commissionsand gifts for procuring loans; embezzlement;abstraction; willful misapplication; false entries;political contributions; and other matters. Theexaminer must be familiar with these laws andthe related regulations and interpretations.

DIRECTOR INDEPENDENCE

Directors must exercise their independentjudgment when managing the bank’s affairs. Aresponsible board will not merely rubber-stampmanagement’s recommendations, but will reviewthem carefully before deciding whether they arein the bank’s best interests. A board that isexcessively influenced by management, a singledirector, or a shareholder, or any combinationthereof, may not be fulfilling its responsibilitiesto depositors, other creditors, and sharehold-ers. Diversification of the board of directors isimportant and can be accomplished by includingdirectors with no ownership or family-ownershipinterest in the bank and who are not employedby the bank.

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

DIRECTORS’ RESPONSIBILITIES

Directors play a critical role in overseeing theaffairs of the bank. Directors should understandthat if they neglect to carry out their fiduciaryduties and responsibilities, they may be finan-cially liable if the bank fails or experiences loss.An examiner sometimes has to remind bank

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directors of the extent of their duties and respon-sibilities. Unless bank directors realize theimportance of their positions and act accord-ingly, they are failing to discharge their obliga-tions to the shareholders, depositors, other credi-tors, and the community.

Selection of Competent ExecutiveOfficers

One of the board’s most important duties is toselect and appoint executive officers who arequalified to administer the bank’s affairs effec-tively and soundly. The board is also responsiblefor removing officers who do not meet reason-able standards of honesty, competency, execu-tive ability, and efficiency. The responsibility forselecting executive officers also entails retainingthem and ensuring that competent successorscan be promoted or hired to fill unanticipatedvoids. The board is responsible for evaluatingthe performance of the chief executive officerand approving the CEO’s compensation. Inmany banks, the board also approves compen-sation for other executive officers.

A state member bank that has been charteredor undergone a change of control within the lasttwo years, that is not in compliance with theminimum capital adequacy guidelines or regu-lations of the Board, or that is in an otherwisetroubled condition must provide 30 days’ writ-ten notice to its regulating Reserve Bank beforeit can add a director, promote an internal staffmember to senior executive officer, or employ anew senior executive officer.

Effective Supervision of Bank Affairs

The type and degree of supervision required of abank’s board of directors to ensure a bank issoundly managed involve reasonable businessjudgment and competence and sufficient timeto become informed about the bank’s affairs.Directors ultimately are responsible for thesoundness of the bank. If negligence is involved,a director may be personally liable. The respon-sibility of directors to supervise the bank’saffairs may not be delegated to the active exec-utive officers or anyone else. Directors maydelegate to executive officers certain authority,but not the primary responsibility of ensuring

that the bank is operated in a sound and legalmanner.

Adoption and Adherence to SoundPolicies and Objectives

The directors’ role is to provide a clear frame-work of objectives and policies within which thechief executive officer can operate and adminis-ter the bank’s affairs. This framework is oftenaccomplished through the use of strategic plansand budgets. The strategic plan would discusslong-term, and in some cases, short-term goalsand objectives as well as how progress towardtheir achievement will be measured. The objec-tives and policies should cover all areas of thebank’s operations. The board of directors isresponsible for establishing the policies thatgovern and guide the day-to-day operations ofthe bank, so they should review and approvethem from time to time. These policies areprimarily intended to ensure that the risks under-taken by the banks are prudent and are beingproperly managed. This means that the board ofdirectors must, as a group, have a fundamentalunderstanding of the various types of risksassociated with different aspects of the bankingbusiness, for example, credit risk, foreign-exchange risk, or interest-rate risk, and definethe types of risks the bank will undertake. Someof the more important areas in which policiesand objectives must be established includeinvestments, loans, asset and liability manage-ment, profit planning and budgeting, capitalplanning, and personnel. Directors are alsoresponsible for adopting policies and proceduresrequired by law or regulation, such as real estatelending policies, a security program, an inter-bank liabilities policy, and a Bank Secrecy Actprogram. The examination of these policies iscovered in other sections of this manual.

Avoidance of Self-Serving Practices

A bank’s directors bear a greater than normalresponsibility for upholding safe and soundpractices in dealing with transactions involvingother members of the directorate and theirrelated interests. Directors’ decisions must pre-clude the possibility of partiality or favoredtreatment. Unwarranted loans to a bank’s direc-tors or their interests can be a serious safety-and-soundness concern for the bank. Directors

5000.1 Duties and Responsibilities of Directors

April 2020 Commercial Bank Examination Manual

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who become financially dependent on their banknormally lose their usefulness as directors. Otherself-serving practices the examiner should watchfor are—

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

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

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

Awareness of the Bank’s FinancialCondition and Management Policies

Management Information Systems

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

MIS is used by all levels of bank staff tomonitor various aspects of bank operations, upto and including its overall risk-managementprocess. Therefore, MIS should be supportive ofthe institution’s longer term strategic goals and

objectives. At the other extreme, these everydayfinancial accounting systems also are used toensure that basic control is maintained overfinancial recordkeeping activities. Since numer-ous decisions are based on MIS reports, appro-priate control procedures must be set up toensure that information is correct and relevant.

Audits

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

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

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

• the adequacy of internal controls, and actionsnecessary to ensure the resolution of anyproblems or deficiencies; and

• the institution’s compliance with applicablelaws and regulations.

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

Further guidance on the use of audit reportsand the reliance placed upon the work of exter-nal and internal auditors in the examinationprocess can be found in the “Internal andExternal Audit Section” of this manual.

Duties and Responsibilities of Directors 5000.1


Maintenance of ReasonableCapitalization

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

Compliance with Banking Laws andRegulations

Directors must carefully observe that bankinglaws are not violated; they may be personallyliable for losses arising out of illegal actions. Inaddition, civil money penalties can be assessedfor unsafe and unsound actions that do notnecessarily involve a violation of a banking law.

Guarantee of a Beneficial Influenceon the Community’s Economy

One reason for approving a newly charteredbank for Federal Reserve membership is to meeta specific community need. Directors, therefore,have a continuing responsibility to provide thosebanking services which meet the legitimatecredit and other needs of the community beingserved. Directors should be certain that the bankattempts to satisfy all legitimate credit needs ofthe community.

BOARD MEETINGS

The board should conduct its business in meet-ings held as required by the bank’s bylaws orstate law. Regular meetings of the board shouldreview statements showing the bank’s financialcondition and earnings; the investment port-folio; and loan activity, including past-due andnonaccrual loans, charged-off or recovered loans,large new loans, and loans to insiders. Directorsshould also review and approve all policiesannually, and review and approve all insurancepolicies as they are obtained or renewed. Theyshould also review audit and examination re-ports and initiate action to correct any deficien-cies noted, review correspondence with regula-tory agencies, review pending litigation, and

keep informed of any major prospective under-takings, such as mergers, acquisitions, or newbranches or construction.

Minutes of Board Meetings

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

BOARD COMMITTEES

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

• Executive Committee—may be empowered toact when the full board is unable to meet, forexample, between regular meetings. Anexecutive committee is usually found in largeinstitutions, where it relieves the full board ofthe burden of reviewing the details of financialstatements and operational activities.

• Audit Committee—typically monitors compli-ance with bank policies and procedures, andreviews internal and external audit reportsand bank examination reports. Because it is



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responsible for ensuring compliance, accu-racy, and integrity throughout the organiza-tion, the audit committee should consist onlyof outside directors. The audit committee maysupervise the bank’s internal auditor and hisor her staff directly by hiring personnel, eval-uating their performance, and setting theircompensation.

• Loan Committee—may be established to moni-tor underwriting standards and loan quality,and to ensure that lending policies and proce-dures are adequate. In most banks with loancommittees, all new loans are reviewed by theloan committee either before or after funding,with the threshold for prior approval being theamount of either the loan or the aggregate debtto the borrower. The loan committee may alsobe responsible for the loan review functionand for maintaining an adequate reserve forloan losses.

• Investment or Asset-Liability ManagementCommittee—monitors the bank’s investmentpolicies, procedures, and holdings portfolio toensure that goals for diversification, creditquality, profitability, liquidity, communityinvestment, pledging requirements, and regu-latory compliance are met. In some bankswhose complexity warrants it, asset-liabilitymanagement committees have been estab-lished to replace or supplement investmentcommittees. An asset-liability managementcommittee monitors the bank’s balance sheetand external forces, notably interest rates, tohelp coordinate asset acquisition and fundingsources.

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

Minutes of all major actions taken by com-mittees that play a significant role in managingthe bank should be kept and meet the sameminimum standards used for minutes of meet-ings of the full board.

COMPLIANCE WITH FORMALAND INFORMALSUPERVISORY ACTIONS

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

Formal actions, which include cease-and-desist orders and written agreements, are nor-mally exercised when banks have serious prob-lems. For less serious problems, the FederalReserve issues informal actions such as a“memorandum of understanding.” Informalactions are an agreement between the ReserveBank and the bank that sets forth the requiredcorrective actions. The Reserve Banks are gen-erally responsible for monitoring compliancewith both types of supervisory actions. To assistin that process, the Reserve Bank normallyreceives and evaluates periodic progress reportsfrom the bank. In addition, information is pro-vided by the examiner, who checks the bank’scompliance with the action. The Reserve Banksmay initiate additional supervisory action againstthe bank or individuals associated with it whencompliance is insufficient.

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

The Reserve Bank may recommend termina-tion or modification of a formal supervisoryaction whenever it determines that the action hassatisfactorily served its purpose and should beremoved or modified. In these cases, the Reserve

Duties and Responsibilities of Directors 5000.1


Bank will send a memorandum with the appro-priate explanation to the Board’s Division ofSupervision and Regulation (S&R) for reviewand evaluation. S&R and the Board’s Legal

Division, when appropriate, will prepare thedocuments necessary to terminate or modify theexisting formal supervisory action.



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Duties and Responsibilities of DirectorsExamination ObjectivesEffective date November 1995 Section 5000.2

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

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

3. To determine whether the board of directors

has developed adequate objectives andpolicies.

4. To determine the existence of any conflicts ofinterest or self-dealing.

5. To determine compliance with laws andregulations.

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Duties and Responsibilites of DirectorsExamination ProceduresEffective date November 2003 Section 5000.3

1. Update the following and review for possi-ble violations of law—a. A list of directors to include—

• home address (If the director wasappointed or elected since the previousexamination, state the number of yearsresiding at present address.),

• date of birth,• years as a director of the bank,• approximate net worth,• occupation,• citizenship,• common stock ownership (beneficial,

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

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

c. A list of management officials (as definedin the Depository Institution Manage-ment Interlocks Act) of the bank, itsholding company, and holding companyaffiliates who are management officialsof other depository institutions.

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

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

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

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

furnished to directors at the last meeting,

and list the areas of operation covered bythe reports.

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

c. Prepare a list of areas not reporting or ofreports the board does not receive thatare considered necessary to maintainadequate supervision. As guidelines, con-sider the following reports:• A monthly statement of condition or

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

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

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

• Loan reports that list significant past-due loans, trends in delinquencies, ratereductions, non-income-producingloans, and large new loans grantedsince the last report.

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

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

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

• An annual presentation of bank insur-ance coverage.

• All correspondence addressed to theboard of directors from the Federal


Reserve and any other source.• A monthly analysis of the bank’ s

liquidity position.• An annual projection of the bank’s

capital needs.• A listing of any new litigation and a

status report on existing litigation andpotential exposure.

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

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

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

f. Review the bank’s method of ensuringcontinued or resumed operations in theevent of a disaster. Complete theemergency preparedness measuresquestionnaire for inclusion in theworkpapers.

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

5. Determine evidence of conflicts of interestand self-dealing by—a. obtaining and summarizing information

on the business interests of directors,executive officers, and principal share-holders;

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

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

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

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

their related interests to the appropriateexamining personnel to ascertain theextent of loans to or transactions withinsiders and their interests (Those exam-iners should be alert for any relationshipswith insiders’ interests that are notincluded on the list.);

f. requesting that the appropriate examin-ers determine if any transactions withinsiders are on terms more favorablethan those offered to other customers (Ifso, determine whether the board hasapproved such transactions.);

g. determining that directors have reviewedtheir correspondent bank accounts inrelation to possible conflicts of interestarising from directors’ , officers’ , or share-holders’ borrowing from depositorybanks; and

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

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

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

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

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

that are not a part of a normal monthlymeeting;

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

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

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

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

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

director-related transactions that havebeen uncovered during the examina-tion, inquire if the interested directordid refrain from voting.

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

members,• have examiners who are examining

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

• prepare a list of major areas of opera-tion that are not monitored by specificcommittees.

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

e. Ascertain during the review of sharehold-ers meeting minutes that (1) sharehold-ers’ approval has been received; (2) thebank’s charter has been amended, ifnecessary; and (3) compliance withappropriate state or federal statutes hasbeen met for the following:• any establishment of or change of a

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

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

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

• any stock split• any bank pension plan established since

the preceding examination• any bank involvement in a conversion,

merger, or consolidation• all other matters subject to vote

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

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

having more than one-half of the eligibleshareholders represented.

h. Review any stock option or stock pur-chase plan adopted since the precedingexamination, and review such actionfor compliance with the various condi-tions involving charter and shareholderapproval.

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

7. Determine that the directors have acceptedtheir responsibility for selecting competentofficers by—a. determining that the board or a commit-

tee thereof reviews, at least annually, thechief executive officer’s performance inattaining or progressing toward attainingspecific objectives or goals set by theboard,

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

c. determining if any management con-tracts exist and, if one does, obtaining acopy, summarizing the pertinent points,and determining the reasonableness ofterms,

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

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

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

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

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

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

Duties and Responsibilities of Directors: Examination Procedures 5000.3


borrowings have been reported to theboard.

9. Determine compliance with the ForeignCorrupt Practices Act (15 USC 78dd-1 and-2) by—a. reviewing the bank’s policy prohibiting

improper or illegal payments, bribes,kickbacks, etc., to any foreign govern-ment official or other person or organi-zation covered by the law;

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

c. reviewing any investigation or study doneby, or on behalf of, the board of directorson the bank’s policies and operationsconcerning the advance of funds in pos-sible violation of the act;

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

e. analyzing the general level of internalcontrol to determine whether there issufficient protection against the inaccu-rate recording of improper or illegalpayments on the bank’s books;

f. requesting that examiners working inother areas of the bank be alert for anytransactions that might violate the provi-sions of the act;

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

h. performing procedures on suspectedcriminal violations as outlined in section5020.3, ‘‘ Overall Conclusions RegardingCondition of the Bank: ExaminationProcedures.’’

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

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

b. Have any directors failed to qualify by

reason of insufficient stock ownership(12 USC 72)?

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

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

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

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

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

h. Have any provisions of a cease-and-desist agreement or order been violated(Rules of Practice for Hearings (12 CFR263))?

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

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

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

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

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

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

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

p. Have any checks been certified against



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

bank been issued (18 USC 1005 and1006)?

r. Has there been a change in control (Regu-lation Y (12 CFR 225.41–225.43))? Ifso, was the Federal Reserve notified andwas the application approved?

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

t. Has the bank failed to maintain recordsof directors, executive officers, and prin-cipal shareholders and their related inter-ests (Regulation O (12 CFR 215.8))?

u. Are management officials of the bank,or its holding company or holding com-pany affiliates, also management officialsof an unaffiliated depository institutionor depository holding company (Regula-tion L (12 CFR 212))? If so—• was such relationship established prior

to November 10, 1978, and previouslypermitted by section 8, Clayton Anti-Trust Act (15 USC 19)?

• was prior approval of the FederalReserve obtained for a relationshipthat was developed since Novem-ber 10, 1978?

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

• is the management relationship with aninstitution whose—— principal offices or branches,

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

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

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

institution holding company with assetsof $1.5 billion or less?

v. Have any loans to executive officersbeen uncovered that were not reported tothe board (Regulation O (12 CFR 215)and 12 USC 503)?

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

x. Has the bank notified executive officersand principal shareholders of their report-ing requirements (Regulation O (12 CFR215))?

11. Determine compliance with administrativeactions by—a. reviewing provisions of the document

andb. reviewing bank records and perform-

ing necessary procedures to isolatenoncompliance.

12. Evaluate the bank’s compliance with formalor informal administrative actions and pre-pare comments for page one of the exami-nation report (SR-02-17 and SR-92-21).(See also section 5040.1.)

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

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

b. subordinated debt, operating subsidi-aries, and interim bank applications,including—• capital plans and• prior review and appropriate clearance

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

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

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

inconsistencies therein;

Duties and Responsibilities of Directors: Examination Procedures 5000.3


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

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

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

overall financial condition of the bank);and

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

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



Management AssessmentEffective date March 1984 Section 5010.1

The purpose of this section is to guide theexaminer in evaluating bank management.Although the directorate is an integral part of theoverall management of a bank, the managementappraisal examination program is concernedprimarily with the active officers. A review ofthe quality of director guidance and supervisionis covered in ‘‘Duties and Responsibilities ofDirectors.’’It is the responsibility of directors to employ

a competent chief executive officer. Thereafter,senior management normally assumes the respon-sibility to employ, maintain and educate a qual-ified staff. Since a direct relationship existsbetween the overall condition of a bank and thequality of management, the first priority inevaluating the condition of the bank is to makean accurate appraisal of the competency of themanagement team.Management is responsible, not only for the

operations of the bank and the quality of itsassets on a day-to-day basis, but also for plan-ning for the future. Senior management shouldbe evaluated on its plans for maintaining orimproving the condition of the bank in the futureas well as on the bank’s present condition. Thedepth of planning and a general forward lookingattitude of executive officers should be consid-ered when projecting future management impact.This should include an evaluation of manage-ment’s efforts to provide for succession ofsenior bank officials.The projection of future management impact

involves an appraisal of the quality and quantityof senior and middle management. This assess-ment of course must be relative to the size andcommunity circumstances of the bank. Examin-ers must not restrict their appraisals to the pastand present. The past and present certainly aresignificant, requiring an in-depth analysis offinancial condition, earnings and capital ade-quacy, both on an absolute basis and as a trend,but, the determination of what the managementwill do for the bank in the future is mostsignificant. The System’s goal is to preventproblems from developing rather than waitingfor future examinations to identify deterioratingconditions.Bank management receives strong pressure

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

ments, both in dividends and increased marketvalue of their stock. No bank is completely freefrom the pressure of competition and, for mostinstitutions, this is one of the strongest forcesfelt. In the midst of those pressures, the clearmandate to bank management is to ‘‘perform.’’Performance is measured in terms of long-runprofitability, liquidity and solvency. It is almostimpossible for a bank to achieve those long-range goals unless careful planning and coordi-nation bring efficiency to its activities. Manage-ment must recognize the bank’s position in themarket and make plans which will achieve theobjectives set for the institution by the directors.It must be constantly alert to the need forcontinually upgrading and expanding servicesand facilities to support and encourage thebank’s growth.Both the directors and senior management

have important roles in a bank’s program ofinternal control and internal audit. Althoughdirectors have overall audit responsibility andshould require that the auditor report directly tothem, senior management normally is chargedwith the duty of maintaining a strong system ofinternal control.The entire examination procedure, as outlined

throughout this manual, is designed to provide aclear picture of both the present and anticipatedfuture condition of the bank under examination.As a result, the reports and workpapers gener-ated by the examination process will serve as amajor tool for examiners in their evaluation ofmanagement. Examination procedures for vari-ous balance sheet accounts and departmentalareas are designed to effect a comprehensiveevaluation of internal control and internaland/or external audit, and will provide the ex-aminer with insight into the degree of compli-ance with the bank’s own written policies insuch areas. Similarly, the examination pro-cedures in ‘‘Loan Portfolio Management,’’‘‘Investment Securities,’’ ‘‘Funds Manage-ment,’’ ‘‘Assessment of Capital Adequacy,’’ and‘‘Analytical Review and Income and Expense’’are designed to lead to a detailed analysis ofwritten objectives, policies and procedures inthose management areas.The examiner must take a practical approach

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

Commercial Bank Examination Manual March 1994Page 1

bank has an inflow of new personnel at variouslevels and that training procedures and advance-ment policies will keep the organization viableand dynamic.The examiner must be concerned with salary

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

of asset distribution in view of the bank’ssources of funds. The examiner must evaluatethe adequacy of the bank’s capital position andexpectations in view of asset quality and plansfor growth and expansion. The overall manage-ment evaluation should bemadeby the examiner-in-charge, because he or she is in the bestposition to identify weaknesses and inconsisten-cies in policies. Although examiners-in-chargewill rely heavily upon the information receivedfrom assisting examining personnel in variousareas under review, it is their task to assembleall of such information into a composite pictureof the quality of management.Senior management is responsible for the

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

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

• An organizational structure.• Detailed position descriptions.• Carefully planned recruiting.• Appropriate training.• Performance review.• Salary administration.• Provision for communication.

The examiner should identify and interprettrends that can reveal flaws in policy either aswritten or as practiced. The examiner shouldquestion the quality of management in any areain which he or she finds serious shortcomings ormakes significant criticisms.The examiner should be alert for situations in

which top management dominates the board orwhere top management acts solely at the direc-tion of either the board or a dominant influenceon the board. Although it is extremely importantfor the directors to assume their appropriate rolein setting objectives and formulating policyconsistent with their responsibilities to thedepositors, shareholders and regulators, dia-logue with top management must occur. Inbanks where both directors and senior manage-ment recognize and assume their appropriateduties and responsibilities, areas for conflict aregreatly reduced.

5010.1 Management Assessment

March 1994 Commercial Bank Examination ManualPage 2

Management AssessmentExamination ObjectivesEffective date March 1984 Section 5010.2

1. To determine the consistency of writtenobjectives, policies, and procedures in thevarious asset, liability, and operational areas.

2. To determine that policies are being adheredto throughout the system.

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

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

5. To evaluate management experience anddepth.

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

7. To evaluate the propriety and soundness ofmanagement decisions.

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


Management AssessmentExamination ProceduresEffective date March 1984 Section 5010.3

In the following procedural steps examinersshould attempt to utilize already developedmaterial from internal or external audit sources.Also, the examining resources and circum-stances of the bank must be weighed in perspec-tive to set the depth of scope for this area.

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

department or division heads whichhave not been obtained in previousexaminations.

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

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

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

personnel by:a. Updating management briefs for all exec-

utive officers and department or divisionheads.

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

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

therein.b. Extract any general information consid-

ered relevant in appraising management.c. Analyze the manual(s), in general, as

useful management tools.4. Review management plan and extract infor-

mation concerning:a. Areas of bank where increased or

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

removed.c. Qualification requirements for planned

additional officers.5. Establish the hierarchy of the organization

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

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

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

8. Determine whether any executive incentivecompensation plans (performance bonuses)have been established and, if so;a. Review specific provisions of the plans

and determine the beneficiaries.b. Review controls established to prevent

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

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

levels of management and the potentialfor advancement.

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

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

11. As the evaluation of the various areas ofexamination interest are being completed,discuss with assisting personnel:a. Any of their observations indicative of

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

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

have on the condition of their areas.12. Review the section on ‘‘Analytical Review


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

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

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

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

exceptions and any other criticisms madein connection with the examination of allareas of the bank.

d. Determine the extent to which improperimplementation is negating the effect ofwritten policies and procedures.

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

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

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

current.b. Stengths and weaknesses of lower level

personnel.c. Succession of management and replace-

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

personnel.g. Frequency of staff meetings and how the

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

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

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

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

outs ide act iv i t ies of execut ivemanagement.

15. By reviewing the results of the precedingsteps and performing any other proceduresdeemed appropriate, answer the followingquestions (normally these questions willserve as a summary of informationobtained, thus compiling factual data tosupport your objective comments onmanagement):a. Have overall management objectives

been set?b. Does the bank forecast manpower

requirements?c. Are qualified people advanced from

within?d. Are supervisory personnel involved in

the selection of new employees and giventhe right of acceptance or rejection?

e. Is management training given to thosepersons likely to assume higher levelpositions?

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

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

agement supervision. The comments should,at a minimum, discuss the following:a. General and technical ability.b. Effectiveness.c. Experience.d. Any inconsistencies in written objec-

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

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

structure.g. The promptness with which management

addresses problems.h. The ex ten t to wh ich execu t i ve

management delegates and demandsaccountability.

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

j. The potential for upward movement ofexisting management personnel.

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

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

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

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

5010.3 Management Assessment: Examination Procedures


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

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

service fee arrangements.

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

organization, examiners must be alert to thedanger of such considerations becomingoverly burdensome or unfair to the subsid-iary bank being examined. (Reference Fed-eral Reserve Policy Statement on Inter-corporate Income Tax AccountingTransactions of Bank Holding Companiesand State Member Banks.)


Management Assessment: Examination Procedures 5010.3


Management AssessmentInternal Control QuestionnaireEffective date March 1984 Section 5010.4

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

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

manager?4. Does the bank utilize written personnel

manuals?5. Does the bank utilize a system of written

job descriptions, including descriptions forsupervisory personnel?

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

gations of new employees?8. Does the bank have a formal training

program?9. Does the bank utilize other than on-the-job

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

preparing a salary range? If so, in whatmanner?

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

13. Does the bank prepare or utilize a long-range forecast of economic conditions ger-mane to its trade area?

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

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

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

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

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

19. Does senior management receive:a. A brief statement of condition daily?b. A daily liquidity report?c. A listing of assets subject to quality

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

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

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

reports on specific projects?24. Does the bank have a tax department or a

tax consultant?


Internal Controls—Procedures, Processes, and Systems(Required Absences from Sensitive Positions)Effective date April 2009 Section 5017.1

Examiners are expected to assess the adequacyof an institution’s internal controls—the involvedprocedures, processes, and systems of its inter-nal control structure. In so doing, they may referto the available Internal Control Question-naire(s) pertaining to the various transactionsand activities discussed at the end of mostsections of the manual. (See also section 1010.1.)When assessing the adequacy of a bank’s inter-nal control system and structure, the examinerneeds to have a good understanding of themeaning of internal control and be able toevaluate its design and effectiveness. Internalcontrol is a process initiated by a bank’s boardof directors, management, and other personnel,and is designed to provide reasonable assurancethat specific objectives are achieved as to thebank’s (1) effectiveness and efficiency of opera-tions, (2) reliability of financial reporting, and(3) extent of compliance with applicable lawsand regulations.1

The concept of control structure involves thecontrols that have been established and thecontrol environment—management’s monitor-ing of procedures, activities, and attitudes.Internal control is part of the bank’s basicoperations.

The components of internal control are

• Control environment—the environment estab-lished by the bank’s employees who areresponsible for its operations, including theirethical values, integrity, and competence

• Risk assessment—the identification, analysis,and management of risks

• Control activities—the institution’s estab-lished policies and procedures that are designedto provide assurance that appropriate actions,which are determined by management, aretaken to address identified risks

• Information and communication—the bank’sactivities that provide the basis for the gath-ering and exchange of information that isneeded to conduct, manage, and control theorganization

• Monitoring—the bank’s continuous monitor-

ing of the internal controls system and struc-ture to allow for appropriate and necessarychanges.

The components of internal control overlapthe internal control objectives. The componentsof internal control must be addressed individu-ally to assess their effectiveness relative to aspecific objective.

The bank’s board of directors and seniormanagement have an important role in ensuringthe adequate development, execution, mainte-nance, and compliance monitoring of the bank’sinternal controls. When determining the adequacyof a bank’s management, examiners shouldcarefully analyze and review its internal controlsystems, processes, and procedures.

STATEMENT ON REQUIREDABSENCES FROM SENSITIVEPOSITIONS

One of the many basic tenets of internal controlis that a bank needs to ensure that its employeesin sensitive positions are absent from theirduties for a minimum of two consecutive weeks.Such a requirement enhances the viability of asound internal control environment because mostfrauds or embezzlements require the continuouspresence of the wrongdoer. After making thisassessment, the bank should require that employ-ees in sensitive key positions, such as tradingand wire transfer, not be allowed to transact orotherwise carry out, either physically or throughelectronic access, their assigned duties for aminimum of two consecutive weeks per year.The prescribed period of absence should besufficient to allow all pending transactions toclear. The bank should also require that anindividual’s daily work be processed by anotheremployee during the employee’s absence. SeeSR-96-37, which emphasizes the need for abank to conduct an assessment of significant riskareas before developing a policy on requiredabsences from sensitive positions.

A comprehensive system of internal controlsis essential for a bank to safeguard its assets andcapital, and to avoid undue reputational andlegal risk. Senior management is responsible forestablishing an appropriate system of internal

1. For additional information on internal controls, see theCommittee of Sponsoring Organizations of the TreadwayCommission’s study on internal controls,Internal Control—Integrated Framework (AICPA, 1992).


controls and monitoring compliance with thatsystem. Although no single control elementshould be relied on to prevent fraud and abuse,these acts are more easily perpetrated whenproper segregation and rotation of duties do notexist. As a result, the Federal Reserve reempha-sizes the following prudent banking practicesthat should be incorporated into a bank’s inter-nal control procedures. These practices aredesigned to enhance the viability of a soundinternal control environment, as most internalfrauds or embezzlements necessitate the con-stant presence of the offender to prevent thedetection of illegal activities.

When developing comprehensive internal con-trol procedures, each bank should first make acritical assessment of its significant areas andsensitive positions. This assessment should con-sider all employees, but should focus more onthose with authority to execute transactions,those with signing authority and access to thebooks and records of the bank, as well as thoseemployees who can influence or cause suchactivities to occur. Particular attention should bepaid to areas engaged in trading and wire-transfer operations, including personnel whomay have reconciliation or other back-officeresponsibilities.

After producing a profile of high-risk areasand activities, it would be expected that aminimum absence of two consecutive weeks peryear be required of employees in sensitivepositions. The prescribed period of absenceshould, under all circumstances, be sufficient toallow all pending transactions to clear and toprovide for an independent monitoring of thetransactions that the absent employee wasresponsible for initiating or processing. Thispractice could be implemented through a require-ment that affected employees take vacation orleave, the rotation of assignments in lieu ofrequired vacation, or a combination of both sothe prescribed level of absence is attained. Some

banks, particularly small community banks,might consider compensating controls such ascontinuous rotation of assignments in lieu ofrequired absences to avoid placing an undueburden on the bank or its employees.

For the policy to be effective, individualshaving electronic access to systems and recordsfrom remote locations must be denied this accessduring their absence. Similarly, indirect accesscan be controlled by not allowing others to takeand carry out instructions from the absentemployee. Of primary importance is the require-ment that an individual’s daily work be pro-cessed by another employee during his or herabsence; this process is essential to bring to theforefront any unusual activity of the absentemployee.

Exceptions to the required-absence policymay be necessary from time to time. However,management should exercise the appropriatediscretion and properly document any waiversthat are granted. Internal auditing should bemade aware of individuals who receive waiversand the circumstances necessitating theexceptions.

If a bank’s internal control procedures do notinclude the above practices, they should bepromptly amended. After the procedures havebeen enhanced, they should be disseminated toall employees, and the documentation regardingtheir receipt and acknowledgment maintained.Additionally, adherence to the procedures shouldbe included in the appropriate audit schedules,and the auditors should be cognizant of potentialelectronic access or other circumventingopportunities.

The development and implementation of pro-cedures on required absences from sensitivepositions is just one element of an adequatecontrol environment. Each bank should take allmeasures to establish appropriate policies, lim-its, and verification procedures for an effectiveoverall risk-management system.

5017.1 Internal Controls—Procedures, Processes, and Systems

April 2009 Commercial Bank Examination ManualPage 2

Internal Controls—Procedures, Processes, and Systems(Required Absences from Sensitive Positions)Examination ObjectivesEffective date April 2009 Section 5017.2

1. To determine whether a critical assessmenthas been performed of a bank’s significantareas and sensitive positions.

2. To ascertain that sound internal controlsexist, including policies and procedures thatprovide assurances that employees in sensi-tive positions are absent from their duties fora minimum of two consecutive weeks peryear.

3. To ascertain whether the bank has taken allmeasures to establish appropriate policies,limits, and verification procedures for aneffective overall risk-management system.

4. To establish that the appropriate audit sched-ules and the audits include a review ofminimum absence policies and procedures,including potential electronic access or othercircumventing actions by employees.


Internal Controls—Procedures, Processes, and Systems(Required Absences from Sensitive Positions)Examination ProceduresEffective date April 2009 Section 5017.3

1. Determine that a profile of high-risk areasand activities is performed on a regular,periodic basis.

2. Ascertain if employees assigned to sensitivepositions are required to be absent for aminimum of two weeks per year while—a. pending, sensitive transactions are moni-

tored while they clear, andb. daily work is monitored and processed by

another employee during the regularlyassigned employee’s absence.

3. Determine if required internal control proce-dures for minimum absences (for example,rotation of assignments, vacation or leave, ora combination of both) are being used insensitive operations such as trading, trust,wire transfer, reconciliation, or other sensi-tive back-office responsibilities.

4. Ascertain if appropriate policies, limits, andverification procedures have been established

and maintained for an effective overall risk-management system.

5. Determine whether the bank—a. prohibits others from taking and carrying

out instructions from the absent employ-ees, and

b. prevents remote electronic access to sys-tems and records involving sensitive trans-actions during the regularly assigned em-ployee’s required minimum two-weekabsence.

6. Ascertain if waivers from the bank’s two-week minimum absence policies and proce-dures involving sensitive positions aredocumented.

7. Determine that the appropriate audit sched-ules and the audits include a review of suchprocedures, including potential electronicaccess or other circumventing actions byemployees.


Overall Conclusions Regarding Condition of the BankEffective date April 2020 Section 5020.1

The examiner is encouraged to use objectivecriteria in evaluating various areas of the bank.However, there will always be a need for sub-jective judgment in an examination. Formulat-ing an overall conclusion regarding the presentand future condition of the bank requires the useof both objective criteria and subjective judg-ment. As experience is essential in evaluatinginformation in areas requiring subjective judg-ment, the procedures in this section should beperformed by the Central Point of Contact(CPC) or the examiner-in-charge (EIC) (EIC ismeant to include the CPC). When performingthese procedures, the examiner’s primary con-cerns are—

• to make the ultimate determination as to—

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

— adherence to safe and sound bankingpractice,

— adherence to the law, and

— the continued viability of the institution,and

• to communicate the results of the examinationto the Federal Reserve System and the direc-tors of the bank.

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

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

• factors such as competition and economicconditions, and

• the overall present condition of the bank.

The primary information for evaluating thepresent condition of a bank is the findings andconclusions of the examination staff. The EICshould weigh the importance and significance ofall criticisms, exceptions, and deficiencies inattempting to discover any unfavorable trends orsituations. Through review of the examination

process, insight can be gained into such centralissues as—

• present asset quality;• current liquidity position;• present capital adequacy position;• quality and performance of management,

including the management of the bank’s risk;• earnings performance, both past and present;

and• sources and applications of funds.

The EIC usually will include remarks regard-ing those areas in the examination report.Although procedural areas of this manual dealspecifically with each of those key items, theEIC should use information from all phases ofthe examination. For example, when reviewingthe bank’s present capital position, the EIC mayuse knowledge of the bank’s asset and manage-ment quality to modify the conclusions of assist-ing personnel. The important point is that theEIC is in the best position to assess all informa-tion provided by the examination process.

Factors affecting the future condition of thebank can generally be categorized as internal orexternal. The examiner’s review of the currentcondition flows naturally into an evaluation ofinternal factors affecting the institution’s futureprospects and condition. Among the items pro-viding insight into future conditions are—

• earnings trends,• successor-management plans,• the budget or profit plan,• the capital plan, and• any other internally generated projections or

forecasts.

Many banks will not have formal writtenplans or projections. In such cases, the EIC mustobtain from senior management or the board ofdirectors information on their plans for matterssuch as—

• growth and expansion,• capital,• changes in the size and mix of assets and

liabilities, and• changes in sources of funding.

In addition, examiners should remind seniormanagement that any change in the generalcharacter of a bank’s business or the scope of


the corporate powers it exercises requires theprior approval of the Board under Regulation H.

The examiner should recommend that banksthat do not have formal plans or projections takeadvantage of any externally available tools toaid them in formulating these plans. In today’scompetitive market, strategic planning is anecessity for almost all banks, but especially forbanks that are losing their market share or inwhich inefficiencies are depressing profitability.

If banks prepare budgets or profit plans,insight can be gained into the accuracy ofbalance-sheet and earnings projections by com-paring actual and projected account balances.It also is beneficial to compare original projec-tions with current projections to determine thatadjustments are made on a timely basis. Whenfour- or five-year projections are made, banksoften formulate several forecasts based on dif-ferent sets of assumptions. In such a situation,the examiner should attempt to determine thebank’s most likely future course.

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

Banks are increasingly engaging in off-balance- sheet activities to deliver services,effect payments, generate income, and to hedgeinterest-rate risks. Banks have introduced a widevariety of new products and services to comple-ment their more traditional activities. Althoughthese new activities are useful and profitable,they contain elements of risk. Many of thesenew activities involve a contingent liability orother risk that is not reflected on the bank’sbalance sheet and, indeed, may not even be fullyrecognized by the bank. The examiner should beaware of how the bank manages and controls itsrisks. Examples of off-balance-sheet activitiesinclude—

• guarantee contracts, retained or contingentinterests, and variable interests,

• commitments and innovative applications forstandby letters of credit, and

• a wide variety of financial instruments andinvestment-security activities (including futuresand forwards, warrants, puts, and calls).

Risk can be distinguished primarily as creditrisk, liquidity, market (price, interest rate, for-eign exchange), operational, reputational, andlegal risk. Risk can also result from internal

control deficiencies. Examiners must also beaware of the nature and extent of off-balance-sheet risks. The risks that affect capital, liquid-ity, and compliance with laws should be evalu-ated for their potential effect on the safety andsoundness of the bank.

In judging such controversial areas as capitaladequacy and liquidity, the examiner shouldremember that, under ideal circumstances, man-agement should be the expert on the bank’scapitalization and liquidity position. Judgmentson such matters should be generated internally,based on insight only management can possess.It is management that should know the bank’scompetitive situation, the economics of theservice area, and the anticipated impact of thoseand other factors on its plans for growth andexpansion. It is also management that has thegreatest interest in the success of the bank.Accordingly, management and the directorateshould choose a level of capitalization andliquidity consistent with their perception of thebank’s situation rather than reacting to com-petitors or relying on pressures from regulators.However, specific judgments by the examinerare required, particularly in situations where acapital or liquidity position has fallen belowwhat examiners consider to be acceptable norms.Objective justification for lower levels of capitalor liquidity must be obtained and analyzed.

To properly evaluate the future prospects of abank, the examiner must review external factorsaffecting the institution. Significant among thosefactors are the characteristics of a bank’s pri-mary service area. The bank’s primary servicearea is defined as that area from which the bankreceives approximately 75 percent of its depos-its. Demographics of the area generally areavailable, and every bank should accumulatesuch information to aid in analyzing its currentoperations and planning for future operations.The absence of such information in an up-to-date form should be considered a deficiency.Included under examination procedures for thissection is a listing of minimum informationrequired to ascertain the demographics of aservice area. The EIC should make sure thatinformation is compiled and should analyze it todetermine whether management expectationsappear justifiable in the circumstances.

In dealing with competitive factors, the exam-iner should review or compute the share ofmarket for the bank under examination. Con-tinuing records in that area establish an analyz-able trend. Consideration also should be given

5020.1 Overall Conclusions Regarding Condition of the Bank


Page 2

to changes in the bank’s statutory and regulatoryenvironment, such as—

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

other financial institutions.

Once the examiner has reached specific con-clusions about the present condition and futureprospects of the bank, or has noted seriousdeficiencies or detrimental trends, his or herconclusions and suggestions should be commu-nicated to the bank’s senior management, theboard of directors, and the Federal ReserveBank on a timely basis. In formulating discus-sion and written comments, the examiner shouldavoid the appearance of second-guessing man-agement. Therefore, conclusions, judgments, andrecommendations should be based on objectiveinformation generated throughout the entire exam-ination process.

Before preparing examination report com-ments regarding the overall condition of thebank, the EIC should consider the reportingobjective. Once it is determined that problemsexist in a bank, the underlying causes must beidentified. Those underlying causes as well asspecific problems or deficiencies should be cov-ered in the comments. For example, if deficien-cies in written lending objectives or policies ornoncompliance with sound policies has resultedin the acquisition of sub-quality assets, theexaminer’s comments must address both causeand effect. The total of classified assets shouldbe cited as evidence of the underlying problem,and appropriate remedies, such as changingobjectives or policies, should be suggested.

Examiners should remember that their abilityto reach accurate conclusions regarding theoverall present condition and future prospects ofthe bank and their skill in communicating theconclusions to management orally and in reportswill, to a great extent, determine the effective-ness of the entire examination process.

The examiner’s conclusions regarding theoverall condition of the bank are summarized ina composite rating assigned in accordance withguidelines provided under the Uniform FinancialInstitution Rating System (CAMELS). Thecomposite rating represents an overall appraisalof six key assessment areas (components)covered under the CAMELS rating system:Capital, Asset quality, Management, Earnings,Liquidity, and Sensitivity to market risk. Addi-

tionally, and separate from the interagencyUFIRS, the Federal Reserve assigns a RiskManagement Rating to all state member banks.The summary, or composite, rating, as well aseach of the assessment areas, including riskmanagement, is delineated on a numerical scaleof one to five, one being the highest or bestpossible score. Thus, a bank with a compositerating of one requires the lowest level ofsupervisory attention, while a five-rated bank hasthe most critically deficient level of performanceand therefore requires the highest degree ofsupervisory attention. When appraising the sixkey assessment areas and assigning a compositerating, the examiner weighs and evaluates allrelevant factors for downgrades and upgrades ofsupervisory ratings. (For more informationregarding composite rating considerations, seeSR-96-38, SR-95-51, SR-16-11, and the appen-dix section A.5020.1 and also SR-12-4 withregard to CAMELS rating upgrades.) In general,these factors include the adequacy of the capitalbase, net worth, and reserves for supportingpresent operations and future growth plans; thequality of loans, investments, and other assets;the ability to generate earnings to maintain publicconfidence, cover losses, and provide adequatesecurity and return to depositors; the ability tomanage liquidity and funding (in particular,during periods of increased financial stress); theability to meet the community’s legitimate needsfor financial services and cover all maturingdeposit obligations; and the ability of manage-ment to properly administer all aspects of thefinancial business and plan for future needs andchanging circumstances. The assessment ofmanagement and administration includes thequality of internal controls, operating proce-dures, and all lending, investment and operatingpolicies; compliance with relevant laws andregulations; and the involvement of the directors,shareholders, and officials.

In addition to the factors discussed above, theEIC should also consider whether risk-management capabilities have improved toaddress identified principal weaknesses that con-tributed to the institution’s prior ratings, andwhether any policies and practices had beenimplemented that focused on sustainability com-mensurate with the bank’s risk profile. The EICshould also make a determination as to whetherthe board provided strategic review and over-sight of the bank’s core financial factors and riskmanagement and if the board actively engagedin the process of correcting deficiencies.

Overall Conclusions Regarding Condition of the Bank 5020.1


Although the composite rating is based looselyon the average of the six component scores, theexaminer’s judgment can and should play amajor role in its determination. Thus, the exam-iner must assess the severity, particularly thepotential impact, of individual weaknesses onthe present and future viability of the bank.Significant problems will provide sufficientbasis for deviating from the numerical-averageapproach to assigning the composite rating.However, whenever deviation from the numeri-cal standards for the composite rating is neces-sary to accurately reflect the overall condition ofthe bank, the examiner must provide a fullexplanation of the reasons for such deviation.See the appendix section A.5020.1 for a com-plete discussion of the uniform rating systemand considerations to be taken into accountwhen using it to evaluate the condition of abank.

SUPERVISORY RATINGSUPGRADES

When in a period of stabilized or generallyimproving economic conditions, there may besome consideration given to ratings upgrades.(See SR-12-4 “Upgrades of Supervisory Ratingsfor Banking Organizations with $10 Billion orLess in Total Consolidated Assets.”) (See alsoSR-96-38, SR-95-51, and SR-16-11.)

SUBSIDIARIES OF BANKHOLDING COMPANIES

The composite rating of an individual subsidiarybank should be based on the condition of thatsingle entity. The quality of management andthe financial condition of the consolidated orga-nization will be useful in assessing the prospectsand understanding the operations of the bankbeing examined. However, banks with weak-nesses requiring corrective action should beidentified as such. Then, appropriate supervisoryfocus can also be made at the consolidated level.Also, banks should be identified by type on anindividual basis rather than by applying theconsolidated organization’s characteristic to eachbank. For example, the capital and condition ofa community bank should be judged by commu-nity bank standards, not by multinational orregional standards, even if the bank is owned by

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

CONFIDENTIALITY OF THESUPERVISORY RATINGAND OTHER NONPUBLICSUPERVISORY INFORMATION

A February 28, 2005, interagency advisoryreminds banking organizations of the statutoryprohibitions on the disclosure of supervisoryratings and other confidential supervisory infor-mation to third parties. The agencies1 learnedthat some insurers had requested or requiredbanks and savings associations (financial insti-tutions) to disclose their CAMELS rating duringthe underwriting process when those institutionshad sought directors’ and officers’ liability(D&O) coverage.2 The agencies responded byissuing the advisory specifically to remind allbanking organizations that, except in very lim-ited circumstances, they are prohibited by lawfrom disclosing their CAMELS rating and othernonpublic confidential supervisory informationto insurers as well as other nonrelated thirdparties without permission from their appropri-ate federal banking agency. (See SR-07-19,SR-05-4, and SR-96-26.)

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

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

1. The Board of Governors of the Federal Reserve System(FRB), the Office of the Comptroller of the Currency (OCC),and the Federal Deposit Insurance Corporation (FDIC).

2. As part of the examination process, a confidentialsupervisory rating, called a CAMELS rating, is assigned toeach depository institution regulated by the agencies. See theappendix section A.5020.1 for a complete description of theUniform Financial Institutions Rating System or CAMELSrating system.

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



Page 4

prior written permission of the appropriate fed-eral banking agency.4 The circumstances forrelease of nonpublic supervisory informationmay include disclosure to a parent holdingcompany, a director, an officer, an attorney, anauditor, or another specified third party, asindicated in the regulations of the appropriatefederal banking agency.5 Any person who dis-closes or uses nonpublic information except asexpressly permitted by one of the appropriatefederal banking agencies or as provided by theagency’s regulations may be subject to thecriminal penalties provided in 18 USC 641.

The legal prohibition on the release of non-public supervisory information applies to allfinancial institutions supervised by the agencies,including bank, savings and loan, or other hold-ing companies; Edge corporations; and the U.S.branches or agencies of foreign banking organi-zations, which receive confidential supervisoryratings, including the RFI/C(D) rating, ROCArating, and CAMEO rating.6 As with theCAMELS rating, these ratings are transmitted tothe regulated institutions in reports of inspectionor examination, which are the property of theagencies.

Financial institutions that receive requests forconfidential supervisory ratings should refer allrequesters to the following publicly availableinformation in lieu of disclosing any confidentialregulatory information, including the CAMELSrating. (See the National Information Center, onthe Federal Financial Institutions ExaminationCouncil (FFIEC) website, https://www.ffiec.gov.)

• for banks, an institution’s quarterly reports ofcondition and income (Call Reports) (see 12USC 1817)

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

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

• for banks, the institution’s Uniform BankPerformance Report (UBPR), which is avail-able to all interested parties at the websitehttps://www.ffiec.gov and is designed for sum-mary and in-depth analysis of banks

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

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

• any reports or ratings issued by private ratingservices on public debt issued by an institution

• any publicly available cease-and-desist orderor enforcement proceeding against aninstitution8

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

FORMAL AND INFORMALSUPERVISORY ACTIONS

In general, supervisory action should be consid-ered when other more routine measures, such asformal discussions with a bank’s principals ordirectors and normal follow-up procedures, havefailed to resolve supervisory concerns. The Uni-form Financial Institution Rating System clearlyidentifies the more serious problem banks anddistinguishes them from banks whose weak-nesses or deficiencies are such as to warrant alower degree of supervisory concern.

For example, the application of prompt andeffective remedial action may keep the conditionof a composite 3-rated bank from deterioratingand the bank from becoming a problem institu-

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

the FRB as a result of an examination or inspection. As ofJanuary 1, 2005, the FRB adopted a new rating system,RFI/C(D) ratings, for bank holding companies. RFI/C(D)ratings components are Risk management, Financial condi-tion, potential Impact of the parent and nondepository subsid-iaries on the subsidiary depository institutions, Composite,and Depository institution. For noncomplex bank holdingcompanies with assets of $1 billion or less, only risk-management and composite ratings are assigned. ROCAratings are assigned to the U.S. branches, agencies, andcommercial lending companies of foreign banking organiza-tions. The ROCA rating components are Risk management,Operational controls, Compliance, and Asset quality. CAMEOratings are assigned to Edge corporations and the overseasbranches and subsidiaries of U.S. banks. The CAMEO ratingscomponents are Capital, Asset quality, Management, Earn-ings, and Operations and internal controls.

7. For bank rating services, see the guidance at https://www.fdic.gov/bank/index.html.

8. Information on enforcement actions taken by the FederalReserve may be found on the Board’s public website. Infor-mation on enforcement actions taken by other federal agen-cies, such as the Securities and Exchange Commission, theFinancial Crimes Enforcement Network (FinCEN), and theDepartment of Justice, as well as foreign authorities, may alsobe publicly available.

Overall Conclusions Regarding Condition of the Bank 5020.1


https://www.ffiec.gov

https://www.ffiec.gov

https://www.fdic.gov/bank/index.html

https://www.fdic.gov/bank/index.html

tion. To ensure problem areas receive adequateattention, all weaknesses should be clearlydefined and corrective measures should be prop-erly structured. This objective may best beachieved through the execution of a memoran-dum of understanding (MOU) between thebank’s board of directors and Reserve Bankofficials. In instances where there are only a fewminor issues, an informal action such as acommitment letter or a board resolution couldbe issued. A MOU is not a formal writtenagreement as prescribed in the Financial Insti-tutions Supervisory Act of 1966 (as amended); itis a good faith understanding between the bank’sdirectorate and the Reserve Bank concerning theprincipal problems and the bank’s proposedremedies. MOUs, commitment letters, and, i.e.,Board resolutions, are all normal actions.

Banks rated composite 4 or 5 are clearlyproblem institutions that require close and con-stant supervisory attention. Unless specific cir-cumstances argue strongly to the contrary, suchbanks will be presumed to warrant formal super-visory action, that is, a written agreement or acease-and-desist order, as provided for in theFinancial Institutions Supervisory Act of 1966.In addition, the Board of Governors is autho-rized to suspend and remove offending officersand directors of banks for certain violations andactivities.

Although the decision to pursue formal orinformal supervisory actions belongs to theBoard of Governors or the Reserve Bank, theinitial consideration and determination of whetheraction is necessary usually results from theexamination process. Accurate and completeexamination report comments that carefullydelineate both the bank’s weaknesses and defi-ciencies, as well as management’s existing orplanned corrective measures, will allow theReserve Bank to make the most informed deci-sion concerning appropriate supervisory actionIn addition to the results of the examinationprocess leading to an enforcement action, some-times an enforcement action is the result of aninvestigation or reporting of a violation of lawor regulation.

CIVIL MONEY PENALTIES

Under provisions of the Financial InstitutionsRegulatory and Interest Rate Control Act of1978 (FIRA) (P.L. 95–630), the Board of Gov-ernors is authorized to assess civil money pen-alties for violation of the terms of a finalcease-and-desist order and violations of—

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

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

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

In determining the appropriateness of initiat-ing a civil money penalty assessment proceed-ing, the Board has identified a number of rel-evant factors (see the June 3, 1998, FFIEC“Interagency Policy Regarding Assessment ofCivil Money Penalties” found in the FederalReserve Regulatory Service, 3–1605). In assess-ing a civil money penalty, the Board is requiredto consider the size of the financial resourcesand good faith of the respondent, the gravity ofthe violation, the history of previous violations,and such other matters as justice may require.

Examiners are responsible for the initial analy-ses on potential civil money penalties. Civilmoney penalties should be proposed for seriousviolations and for violations which, because oftheir frequency or recurring nature, show ageneral disregard for the law. After the examinerhas reviewed the facts and decided to recom-mend a civil money penalty, he or she shouldcontact the Reserve Bank for advice on properdocumentation and any other assistance.



Page 6

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

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

2. To reach conclusions regarding the futureprospects of the bank.

3. To determine the bank’s ability to meetdemands in the ordinary course of businessor reasonably unusual circumstances.

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

5. To formulate recommended action, whenappropriate, based on those conclusions.

6. To communicate conclusions and recommen-dations both orally and in the examinationreport.


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

Inasmuch as the following procedures arelargely dependent on information generated fromall phases of the examination, the examiner-in-charge should complete this program during thefinal stages of the examination. The completionof this program generally can be best accom-plished during the review of the workpapers.

1. Analyze any available information concern-ing the characteristics of the area in whichthe bank operates to determine the existenceof any unusual situations, any significanttrends, the potential impact on the bank ofany expected changes or any other signifi-cant information which could be detrimen-tal to the bank. The bank should be con-sulted for sources of information whichmight include the most recent census dataor data generated by organizations, such asthe Chamber of Commerce. In analyzingthe bank’s trade area:a. Consider density, income levels, general

age group of the residents. Determine ifthere are significant changes in any ofthe above factors.

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

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

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

e. Consider any expected changes instreet facilities which will significantlyaffect bank’s accessibility/convenience.Determine the availability of publictransportation.

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

aggressiveness, hours of business andadditional services offered by competitorinstitutions.

g. Determine the effect of governmentemployment or dependence on govern-ment contracts on the community.

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

2. Review comments and conclusions con-tained in the workpapers which were gen-erated throughout the examination and per-form the following:a. Compile all criticisms, exceptions and

deficiencies.b. Determine the existence of contradictory

conclusions.c. Consider the relative significance of

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

3. Based on procedures performed and conclu-sions contained in the workpapers, answerthe following specific questions. These ques-tions are intended as guidelines to theexaminer-in-charge in formulating overallconclusions regarding the condition of thebank and should be augmented by theexaminer’s knowledge of the bank. ‘‘Yes’’answers, in many instances, evidence theexistence of a ‘‘leading’’ indicator of dete-rioration of bank soundness. For any ques-tion with a ‘‘yes’’ answer, specify anymitigating circumstances in the commentscolumn. Sub-question answers are for infor-mation purposes.

a. Asset Quality

• Is there an increasing ratio of criticizedassets to total capital?— If so, is it indicative of adverse

economic conditions, poor credit


judgment, or other factors(specify)?

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

• Is there any abnormally increasingtrend of past-due loans and/or interestearned but not collected?— If so, is it indicative of general

economic conditions in the bank’strade area

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

• Has a trend developed wherein thebank assumes increased risk withoutreceiving increased rewards?

• Do the portfolios exhibit high concen-trations in specific industries?— If so, do the concentrations repre-

sent a significant actual or contin-gent problem?

• Has the overall quality of assets dete-riorated since the last examination?— If so, is the deterioration recog-

nized bymanagement and the boardof directors? Can the deteriorationbe attributed to factors beyond thecontrol of management or the boardof directors, such as a change inthe general economic conditions ofthe bank’s service area?

— If deterioration results from inter-nal factors, such as lowering ofcredit standards or poor credit judg-ment, have steps been taken bymanagement to effectively reversenegative trends?

b. Quality of Management

• Has the executive management changedsince the last examination?— If so, is the change detrimental to

the bank?• Has there been any change in thegeneral banking philosophy of execu-tive management?— If so, is that detrimental to the

bank?

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

• Is there any tendency toward overreliance on essentially untrained andunskilled clerical staffs?

• Is there a large disparity between thecompensation level of the chief exec-utive officer and other members ofexecutive management?— If so, is that disparity an objective

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

• Has the bank instituted any systemswhich directly reward managers forincreasing bank income from assets orservices subject to their control?— If so, has the bank failed to insti-

tute necessary control and auditprocedures to prevent abuses?

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

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

• Is the bank’s strategic and operationalplanning inadequate?

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

• Are the following conditions present?— Infrequent meetings of board of

directors.— Infrequent meetings of committees

of the board.— Infrequent management committee

meetings.— A directorate which is split into

distinct voting groups.— If so, are directors viewed as fail-

ing to perform their functionsadequately?

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

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

5020.3 Overall Conclusions Regarding Condition of the Bank: Examination Procedures


c. Earnings

• Are earnings static or moving down-ward as a percentage of totalresources?

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

continue?— If so, has management determined

causes for any deterioration andtaken action to reverse the negativetrend?

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

• Are earnings trends consistent?• Has a decreasing spread betweeninterest earned and interest paiddeveloped?

• Are the bank’s earnings significantlyvulnerable to changes in interest ratelevels?— If so, what are management’s plans

and prospects for altering thevulnerability?

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

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

• Is there any evidence that sources ofinterest and other revenues havechanged since that last examination?— If so, is that attributed to an

unsound emphasis for increasedearnings?

• Are earnings deemed inadequate toprovide increased capitalization com-mensurate with the bank’s growth?

d. Capital

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

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

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

of criticized assets, the competency ofmanagement, etc.?

e. Liquidity

• Is there a trend toward decreasingbank liquidity?

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

• Does the bank depend excessively onpurchased funds?

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

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

f. Off-Balance-Sheet Risk

Loans Sold or Serviced

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

• Does the bank’s record of pending orthreatened litigation indicate anyinstances where the bank, as lead oragent in a loan participation or syndi-cation, has willfully misrepresentedthe credit to the other participants, orotherwise acted with gross negligencein handling the credit?— If so, is there any indication that

the participants intend to hold thebank liable for any loss incurred onthe credit?

• Did the examination reveal a practiceof improper origination and packagingof loans sold or serviced which couldcause:— The bank being compelled to

repurchase the package, or— In the case of government guaran-

teed loans, the complete or partialdishonor of the guaranty?

Overall Conclusions Regarding Condition of the Bank: Examination Procedures 5020.3


• Has the bank previously repurchasedparticipations when a loss wasincurred, although it was not legallyrequired to do so?

Letters of Credit

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

sider the full impact of funding asignificant percentage of thoseinstruments?

• Are letters of credit excluded from thebank’s internal loan review program?

• Does the internal evaluation of lettersof credit include consideration of coun-try and currency risk as well as creditrisk?

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

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

• If not authorized in the bank’s lendingpolicy, were proper approvals obtainedprior to issuance?

Wire Transfer Department

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

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

Data Processing Department

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

the accuracy and/or timeliness ofdata is questionable?

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

misplacement or other improperhandling of source data?

• Are the bank’s computer hardware andsoftware systems inadequate to sup-port the present and anticipated levelof operations?— Are deficiencies such that hard-

ware and systems will requirereplacement or upgrading in theshort term?

Settlement Procedures

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

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

— Is the bank aware of the creditwor-thiness and ability of the otherclearinghouse participants to makesettlement?

• Are customers’ daylight overdraftsallowed to exceed established creditlimits or are they otherwise being im-properly monitored?

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

Investment Securities

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

interest rate hedging techniquesinsufficient to support suchactivity?

• Does the bank act as agent onsecurities or repurchase agreementtransactions?— If so, does the customer agreement

specifically designate liability forfailure or performance?



Miscellaneous

• Did the analytical review of incomeand expenses disclose any additionaloff balance sheet activities for whichmanagement does not exhibit the nec-essary expertise and does not haveadequate internal controls to handlethe service?

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

corrected?• Is the potential liability arising frompending litigation considered signifi-cant in terms of capital adequacy andliquidity, considering the level of othercontingent liabilities?

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

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

• Is potential restitution resulting fromTruth in Lending Act violations signif-icant relative to capital and liquidity?

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

g. Internal Controls and AuditProcedures

• Have internal controls deterioratedsince the last examination?

• Do any of the following exist at thebank?— Low compensat ion leve l o f

internal auditors.— Internal or external auditor who

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

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

— Abnormally low percentage ofinternal auditors to total personnel.

— Inadequate training or supervisionof internal auditors.

— Questionable independence ofexternal auditors.

— Inadequate management responseto deficiencies cited by auditors.

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

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

h. Ownership

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

mental to the soundness of thebank?

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

bank’s soundness?• Is there any evidence of an impendingproxy fight?

• Are ownership interests using bor-rowed funds to carry the bank’s stock?— If so, is there an indication that

undue pressure for increasedearnings is being applied by theowners?

— If such pressure is being applied,does that have a detrimental impacton the general characteristics ofasset composition, as it exists, andasset composition, as it is expectedto develop?

i. Miscellaneous

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

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

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

Overall Conclusions Regarding Condition of the Bank: Examination Procedures 5020.3


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

• Has a t rend toward increas ingadvances to affiliated companiesdeveloped?— If so, does that presently represent

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

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

• The bank’s increased marketingefforts?

• Offering improved services tothe community?

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

team capable of adequately admin-istering the growth?

• Does the bank have an imprudentinvestment in fixed assets?

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

does it represent a potentially dan-gerous situation?

• Are there large fluctuations in the stockprice of the bank or its parent?— If so, is management unable

to discern a cause for suchfluctuations?

• Is management giving inadequateattention to compliance with laws andregulations?

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

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

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

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

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

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

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

general.c. Expected future condition:

• Management’s view.• Examiner’s view.

d. Review of other potential problems.e. Planned corrective action:

• Examiner recommendations.• Management commitments.

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

9. Prepare recommendations for any necessarysupervisory action.

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

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

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

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

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

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

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




Meetings with Board of DirectorsEffective date May 1995 Section 5030.1

INTRODUCTION

The board of directors plays an essential role inthe management of a bank’s operations and isdirectly responsible for the soundness of thebank. As a result, in some cases, it is useful forFederal Reserve examiners and/or officers tomeet with boards of directors. These meetingsprovide examiners with the opportunity to informdirectors of examination findings, discuss thebank’s plans and prospects with the board, andhighlight important supervisory issues, particu-larly in cases that may require initiation ofinformal or formal supervisory actions. Meet-ings with boards of directors also provide exam-iners with a limited opportunity to ascertain thedirectors’ knowledge of and interest in thebank’s operations.If Federal Reserve examiners believe it is

necessary or desirable, they may conduct meet-ings with directors immediately after the on-siteportion of an examination and before an exami-nation report is completed and distributed. Suchmeetings are particularly encouraged when theycan be conducted as part of regularly scheduledboard meetings that coincide with the on-siteexamination.When a bank is determined to be a problem or

has exhibited significant deterioration, FederalReserve examiners must conduct meetings withthe directors. Such meetings require the partici-pation of Federal Reserve officers and are typi-cally conducted after the report of examinationhas been distributed.

GENERAL GUIDELINES

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

Content of Meetings

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

tion needed by, or relevant to, the directorate.This information varies depending on the bank’scircumstances; however, examiners should informthe board of the examiner’s assessment of thebank’s condition; highlight any deficienciesrequiring the board’s attention; and solicit theboard’s views on the bank’s condition, opera-tions, and prospects. In addition, examinersshould obtain the board’s commitment to addresspromptly the deficiencies identified in the exam-ination. Examiners should encourage inquiriesand discussions with the directors to learn moreabout the directors’ roles and performance andto foster a good working relationship with them.Data supporting the examiner’s conclusions

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

Outlines for Meetings

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

I. Introductory remarks by Federal ReserveBank official or examinerA. Federal Reserve Bank policy regarding

board meetingB. Purpose of the meeting

II. Examiner’s presentationA. Duties and responsibilities of directors

1. Effectively supervise the bank’saffairs

2. Select competent management3. Adopt and follow sound, written poli-

cies and objectives

Commercial Bank Examination Manual May 1995Page 1

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

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

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

C. Adequacy and accuracy of bank’sreporting systems1. Reports of the board and committees2. Management reports to the board3. Management information systems4. Regulatory reports

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

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

companyE. Required corrective action on problems

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

Procedural Issues

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

honorary directors to participate in discussionsand review the examination report is alsopermitted.Generally, at least one member of a Reserve

Bank’s official staff is expected to represent theFederal Reserve at meetings with directors ofbanks. However, for meetings with the directorsof banks that have less than $500 million inassets, Reserve Banks are granted the discretionto have senior examination staff represent theReserve Bank. The participation of ReserveBank presidents in meetings with directors isleft to the discretion of the Reserve Bank.To the extent possible, meetings with the

boards of directors of state member banks shouldinclude representatives of the relevant statebanking authority. A meeting with the directorsof a bank that is owned by a holding companymay be held at the same time as a meeting withthe directors of the holding company, whenappropriate.Whenever a meeting is held between an

examiner and a board, the examiner shouldprepare written comments on the meeting forexamination workpapers.

MEETINGS WITH BOARDS OFPROBLEM BANKS AND BANKSEXHIBITING SIGNIFICANTDETERIORATION

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

Criteria Requiring Meetings withProblem Banks

A meeting with the board of directors is to be

5030.1 Meetings with Board of Directors

May 1995 Commercial Bank Examination ManualPage 2

held after any full-scope examination in whicha state member bank is assigned a CAMELScomposite rating of 4 or 5. A meeting is alsorequired if a bank is rated composite 3 and itscondition appears to be deteriorating or hasshown little improvement since a previousexamination in which it received a composite3 rating. Furthermore, a meeting should be heldafter a targeted examination if deemed appropri-ate and desirable by the Reserve Bank. Anofficial of the Reserve Bank and the examiner-in-charge should also meet with a board if anyof the following conditions exist:

• The bank is entering into a formal writtenagreement with the Federal Reserve, a cease-and-desist order is being issued, or the bankis being placed under a memorandum ofunderstanding.

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

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

• Any other condition or practice that places, orcould place, the bank in a seriously weakenedor extended condition has been identifiedduring the examination.

Additional Guidelines

Senior Reserve Bank officials are expected toparticipate in meetings with the directors ofproblem banks, with the seniority of the partici-pating official determined by the condition andsize of the bank. The larger the organization orthe more serious its problems, the more seniorthe Federal Reserve official should be.

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

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

• violations of law

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

• lack of well-documented lending, collection,investment, asset/liability management, andrisk-management policies or the failure toensure that such policies are being followed

• failure of management to address previouslydiscussed deficiencies

• lack of reporting systems sufficient to keepsenior management and the board of directorsfully informed

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

MEETINGS WITH BOARDS OFMULTINATIONAL AND MAJORREGIONAL BANKS

A meeting with the board of directors is requiredafter every full-scope examination of a multi-national organization or major regional organi-zation with assets in excess of $5 billion. ReserveBanks also are encouraged to conduct suchmeetings after every full-scope examination of aregional bank with assets in excess of $1 billion.

MEETINGS WITH BOARDS OFDE NOVO BANKS

After the approval of a membership application,but before a de novo bank is opened, ReserveBank staff should meet with the full board ofdirectors to discuss applicable statutes, regula-tions, policies, and supervisory procedures. Aswith all meetings with directors, the agenda forthis meeting should be tailored to the individualcircumstances of the bank. At a minimum, theReserve Bank should apprise the directors oftheir responsibilities and emphasize their needto adhere to sound operating policies.

DIRECTOR’S SUMMARY OFEXAMINATION FINDINGS

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

Meetings with Board of Directors 5030.1

Commercial Bank Examination Manual May 1997Page 3

significant deterioration in condition or apparentviolations of law. The summary reports shouldfocus on identified problems—rather than on thestrength of the organization—and present thebank’s deficiencies succinctly and clearly. In allcases, the types of actions directors and man-agement should take to address identified prob-lems should be specifically stated. Directors ofinstitutions rated 4 or 5 are to be told their banksare ‘‘problem’’ institutions that warrant ‘‘specialsupervisory attention.’’ Directors of banks rated3 are to be informed that the bank’s condition is‘‘not satisfactory,’’ that the bank is subject to‘‘more-than-normal supervision,’’ and that thebank may become a ‘‘problem’’ if weaknessesare not addressed adequately.

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

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

Summary reports should be sent directly tothe bank’s management for distribution to eachdirector. The transmittal letter to the bank shouldstate the report is a summary of identifiedproblems and contemplated supervisory actionsand direct bank management to distribute thesummary report to each director. The lettershould further instruct each director to read thereport, sign the introductory statement attestingto having read the report, and return the report tomanagement. Management should keep copiesof the directors’ signed statements on file, butshould destroy all but one file copy of thesummary report itself.

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

5030.1 Meetings with Board of Directors

May 1997 Commercial Bank Examination ManualPage 4

Meetings with Board of DirectorsExamination ObjectivesEffective date March 1984 Section 5030.2

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

2. To inform the directors of the examinationscope and the bank’s condition.

3. To obtain information concerning future plansand proposed changes in bank policies that

may have significant impact on the futurecondition of the bank.

4. To reach an agreement on any significantproblems.

5. To obtain a commitment to initiate appropri-ate corrective action.


Meetings with Board of DirectorsExamination ProceduresEffective date March 1984 Section 5030.3

1. Inform management that a meeting will beheld with the board of directors. State theFederal Reserve Bank’s policy and the pur-pose of the meeting and establish a tentativedate.

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

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

4. Prepare supportive data for the meeting by:a. Compiling a list of comments and

criticisms.b. Preparing schedules of comparative fig-

ures for discussion.c. Affirming that the bank has responded

adequately to Reserve Bank requests.d. Preparing questions to elicit opinions

and attitudes of individual boardmembers.

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

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

to:• Notify office staff of the proposed dateand place of the meeting. (Confirmtime and place when final.)

• Determine whether a Reserve Bankofficial will attend.

• Determine whether the Reserve Bankofficial has suggestions for the agenda.

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

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

• A written plan for corrective action tobe forwarded within a specified timeperiod.

• Periodic progress reports.

7. For ‘‘special meetings’’ resulting from ser-ious problems:a. Communicate with the Reserve Bank to:

• Notify office staff of the proposed dateand place of the meeting.

• Determine whether a Reserve Bankofficial will attend.

• Determine whether the Reserve Bankofficial has suggestions for the agenda.

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

c. Prepare any special supporting data forthe meeting, such as areas of noncompli-ance with memorandums of understand-ing or cease and desist agreements ororders.

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

examination.b. Conclusions reached about the bank in

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

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

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

10. Prepare a memorandum covering the meet-ing with the board to include, as a minimum:a. The time and place of the meeting.b. The directors and guests in attendance.c. The matters subject to criticism that were

reviewed.d. A summary of the general discussion on

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

the situation and any commitmentsobtained from them.

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


Formal and Informal Supervisory ActionsEffective date April 2013 Section 5040.1

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

In addition to the Board’s jurisdiction overfinancial institutions, the Board also has juris-diction over individuals associated with finan-cial institutions. The term ‘‘institution-affiliatedparty’’ includes any officer, director, employee,controlling shareholder, or agent of a financialinstitution, and any other person who has filed oris required to file a change-in-control notice. Italso includes any shareholder, consultant, joint-venture partner, or any other person who partici-pates in the conduct of the affairs of the financialinstitution as well as any independent contrac-tors, including attorneys, appraisers, and accoun-tants, who knowingly or recklessly participate inany violation of law or regulation, breach offiduciary duty, or unsafe or unsound practicethat causes (or is likely to cause) more than aminimal financial loss to, or a significant ad-verse effect on, a financial institution.1 TheBoard’s jurisdiction over an institution-affiliatedparty extends for up to six years after the party’sresignation, termination of employment, or sepa-ration caused by the closing of a financialinstitution, provided that any notice (such as anotice of intent to remove from office and ofprohibition) is served on the party before the endof a six-year period.

FORMAL SUPERVISORYACTIONS

The following statutory tools are available to theBoard in the event formal supervisory action is

warranted against a state member bank or anyinstitution-affiliated party. The objective of for-mal action is to correct practices that the regu-lators believe to be unlawful, unsafe, or unsound.2The initial consideration and determination ofwhether formal action is required usually resultsfrom examination findings. It is important toprovide adequate support for all recommenda-tions for both formal and informal actions in theexamination report and associated workpapers.

Types of Supervisory Actions

Generally, under section 8 of the Federal DepositInsurance Act (FDI Act) (12 USC 1818(b), theBoard may use its cease-and-desist authorityand civil money penalty authority against anystate member bank and any institution-affiliatedparty that meets the statutory criteria for issuingsuch an order. Prohibition and removal actionsmay be taken against any institution-affiliatedparty who meets the statutory criteria to bringsuch an action.

Cease-and-Desist Orders

Generally, under 12 USC 1818(b), the Boardmay use its cease-and-desist authority against astate member bank and any institution-affiliatedparty when it finds that a bank or party isengaging, has engaged, or is about to engage in(1) a violation of law, rule, or regulation; (2) aviolation of a condition imposed in writing bythe Board in connection with the granting of anyapplication or any written agreement; or (3) anunsafe or unsound practice in conducting thebusiness of the institution. Separately, under 12USC 1818(s), the Board must initiate a cease-and-desist action against a bank when it hasfailed to establish and maintain the Bank SecrecyAct procedures required by the Board’s Regu-lation H or has failed to correct any previouslynoted deficiencies related to these procedures.

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

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


A cease-and-desist order may require thebank or person subject to the order to (1) ceaseand desist from the practices or violations or(2) take affirmative action to correct the viola-tions or practices. Affirmative actions includeactions necessary to restore the bank to a safeand sound condition, such as measures toimprove asset quality. The order may also includerestrictions on growth, debt, and dividends;require the disposition of any loan or asset;require the employment of qualified officers oremployees; require restitution, reimbursement,indemnification, or guarantee against loss if thebank or person was unjustly enriched by theviolation or practice or if the violation or prac-tice involved a reckless disregard for the law orapplicable regulations or a prior order; and anyother action the Board determines to beappropriate.

Most cease-and-desist orders are issued byconsent. When Board staff, in conjunction withthe appropriate Reserve Bank, determines that acease-and-desist action is necessary, the bank orperson is generally given an opportunity toconsent to the issuance of the order without theneed for the issuance of a notice of charges anda contested administrative hearing. Board staffdrafts the proposed cease-and-desist order and,with Reserve Bank staff, presents it to the bankor individual for consent. Banks or individualsare advised that they may have legal counselpresent at all meetings with Board or ReserveBank staff concerning formal supervisory actions.If the parties voluntarily agree to settle the caseby the issuance of a consent cease-and-desistorder, the proposed consent order will be pre-sented to senior Board officials for approval, atwhich time the order will be final and binding.

When a bank or person fails to consent to acease-and-desist order, the Board may issue anotice of charges and of hearing to the bank orparty. The notice of charges contains a detailedstatement describing the facts constituting thealleged violations or unsafe or unsound prac-tices. The issuance of the notice of charges andof hearing starts a formal process that includesthe convening of a public administrative hear-ing3 conducted before an administrative lawjudge, appointed by the Board. After the hear-ing, the judge makes a recommended decision tothe Board. A hearing must be held within 30 to

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

Temporary Cease-and-Desist Orders

If a violation or threatened violation of law, rule,or regulation, or if engaging in an unsafe orunsound practice that is specified in the notice ofcharges, is likely to cause the bank’s insolvency,cause significant dissipation of the bank’s assetsor earnings, weaken the bank’s condition, orotherwise prejudice the interests of depositorsbefore the completion of the proceedings (initi-ated by the issuance of the notice of charges),the Board may, in conjunction with issuing anotice of charges, issue a temporary cease-and-desist order against the bank to effect immediatecorrection (pursuant to 12 USC 1818(c)).

The Board may also issue a temporary orderif it determines that the bank’s books andrecords are so incomplete or inaccurate that theBoard is unable to determine, through the nor-mal supervisory process, the bank’s financialcondition or the details or purpose of anytransaction that may have a material effect onthe bank’s condition. The temporary order mayrequire the bank to take the same correctiveactions as a cease-and-desist order. The advan-tage of issuing a temporary cease-and-desistorder is that it becomes effective immediatelyafter it is served on the bank or individual.Within 10 days after being served with a tem-porary order, however, the entity or individualmay appeal to a U.S. district court for relief fromthe order. Unless set aside by the district court,the temporary order stays in effect until theBoard issues a final cease-and-desist order ordismisses the action.

Written Agreements

When circumstances warrant a less severe formof formal supervisory action, a written agree-ment may be used. A written agreement isgenerally with the Reserve Bank under del-

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

5040.1 Formal and Informal Supervisory Actions


egated authority (12 CFR 265.11(a)(15)). Writ-ten agreements are drafted by Board staff, inconsultation with Reserve Bank staff, and mustbe approved by the Board’s Director of theDivision of Banking Supervision and Regula-tion and the General Counsel before issuance.The provisions of a written agreement mayrelate to any of the problems found at the bankor to any problems involving institution-affiliatedparties.

Prompt-Corrective-Action Directives

Please see section 4133.1 for a discussion ofprompt-corrective-action directives, which are atype of formal supervisory action issued when abank’s capital ratios fall below certain specifiedlevels.

Prohibition and Removal Authority

The Board is authorized by 12 USC 1818(e) toremove any current institution-affiliated party ofa bank for certain violations and misconduct andto prohibit permanently from the banking indus-try any current or former institution-affiliatedparty from future involvement with any insureddepository institution, bank or thrift holdingcompany, and nonbank subsidiary.4

The Board is authorized to initiate removal orprohibition actions when

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

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

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

— breached a fiduciary duty;• the Board determines that, because of the

violation, unsafe or unsound practice, orbreach—— the institution has suffered or will prob-

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

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

— the institution-affiliated party has received

financial gain or other benefit from theviolation, practice, or breach; and

• the violation, practice, or breach—— involves personal dishonesty or— demonstrates a willful or continuing dis-

regard for the safety or soundness of theinstitution.

The statute also authorizes the Board to initi-ate removal or prohibition actions against (1) anyinstitution-affiliated party who has committed aviolation of any provision of the Bank SecrecyAct that was not inadvertent or unintentional,(2) any officer or director of a bank who hasknowledge that an institution-affiliated party hasviolated the money-laundering statutes and didnot take appropriate action to stop or prevent thereoccurrence of such a violation, or (3) anyofficer or director of a bank who violates theprohibitions on management interlocks. Theseremoval or prohibition actions for these viola-tions do not require a finding of gain to theindividual, loss to the institution, personal dis-honesty, or willful or continuing disregard forthe safety or soundness of the institution.5

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

Under 12 USC 1818(g), the Board is autho-rized to suspend from office or prohibit fromfurther participation any institution-affiliatedparty charged or indicted for the commission ofa crime involving personal dishonesty or breachof trust that is punishable by imprisonment for aterm exceeding one year under state or federallaw, if the continued participation might threateneither the interests of depositors or public con-fidence in the bank. The Board may also sus-pend or prohibit any individual charged with aviolation of the money-laundering statutes. Thesuspension can remain in effect until the crimi-nal action is disposed of or until the suspension

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

Formal and Informal Supervisory Actions 5040.1


is terminated by the Board. The Board may alsoinitiate a removal or prohibition action againstan institution-affiliated party who has been con-victed of, or pleaded to, a crime involvingpersonal dishonesty or breach of trust if his orher continued service would threaten the inter-ests of the depositor or impair public confidencein the institution. The Board is required to issuesuch an order against any institution-affiliatedparty who has been convicted of, or pleaded to,a violation of the money-laundering statutes.

Furthermore, 12 USC 1829 prohibits anyindividual who has been convicted of a crimeinvolving dishonesty, breach of trust, or moneylaundering from (1) serving as an institution-affiliated party of, (2) directly or indirectlyparticipating in the affairs of, and (3) owning orcontrolling, directly or indirectly, an insureddepository institution without the Federal DepositInsurance Corporation’s (FDIC’s) prior approval.The statute also prohibits a convicted personfrom holding a position at a bank holdingcompany or nonbank affiliate of a bank withoutthe prior approval of the Board of Governors ofthe Federal Reserve System. The penalty forviolation of this law is a potential fine for aknowing violation of up to $1 million per day,imprisonment for up to five years, or both. Thecriminal penalty applies to both the individualand the employing institution.

Violations of Final Orders andWritten Agreements

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

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

Civil Money Penalties

The Board may assess civil money penalties ofup to $7,500 per day against any institution orinstitution-affiliated party for any violation of(1) law or regulation; (2) a final cease-and-desist, temporary cease-and-desist, suspension,removal, or prohibition order or for failure tocomply with a prompt-corrective-action direc-tive; (3) a condition imposed in writing by theBoard in connection with the granting of anapplication or other request; and (4) a writtenagreement.

A fine of up to $37,500 per day can beassessed for a violation, an unsafe or unsoundpractice recklessly engaged in, or a breach offiduciary duty when the violation, practice, orbreach is part of a pattern of misconduct, causesor is likely to cause more than a minimal loss tothe bank, or results in pecuniary gain or otherbenefit for the offender. A civil money penaltyof up to $1.375 million per day can be assessedfor any knowing violation, unsafe or unsoundpractice, or breach of any fiduciary duty whenthe offender knowingly or recklessly caused asubstantial loss to the financial institution orreceived a substantial pecuniary gain or otherbenefit. Civil money penalties may also beassessed, under the three-tier penalty frameworkdescribed above, for any violation of the Changein Bank Control Act and for violations of theanti-tying provisions of federal banking law,among other provisions.6

The Board may also assess civil money pen-alties for the submission of any late, false, ormisleading call reports. If a financial institutionmaintains procedures that are reasonably adaptedto avoid inadvertent errors, but unintentionallyfails to publish any report, submits any false ormisleading report or information, or is mini-mally late with the report, it can be assessed afine of up to $2,200 per day. The financialinstitution has the burden of proving that theerror was inadvertent under these circum-stances. If the error was not inadvertent or thebank lacked the appropriate procedures, a pen-alty of up to $32,000 per day can be assessed forall false or misleading reports or informationsubmitted to the Board. If the submission wasdone in a knowing manner or with recklessdisregard for the law, a fine of up to $1.375million or 1 percent of the institution’s assets,whichever is less, can be assessed for each day

6. See 12 USC 1972.



of the violation. Under its general civil moneypenalty authority, the Board may also assesscivil money penalties against any institution-affiliated party who participates in a bank’sfiling of late, false, or misleading call reports.

Administration of Formal Actions

Publication of Final Orders

Under 12 USC 1818(u), the Board is required topublish and make publicly available any finalorder issued for any administrative enforcementproceeding it initiates. These orders includecease-and-desist, removal, prohibition, and civilmoney penalty assessments. The Board is alsorequired to publish and make publicly availableany written agreement or other written statementthat it may enforce, unless the Board determinesthat publication of the order or agreement wouldbe contrary to the public interest.

Public Hearings

Under 12 USC 1818(u), all formal hearings,including contested cease-and-desist, removal,and civil money penalty proceedings, are opento the public unless the Board determines that apublic hearing would be contrary to the publicinterest. Transcripts of all testimony; copies ofall documents submitted as evidence in thehearing, which could include examination orinspection reports and supporting documents(except those filed under seal); and all otherdocuments, such as the notice and the adminis-trative law judge’s recommended decision, areavailable to the public. These documents couldinclude examiners’ workpapers, file memoran-dums, reports of examination and inspection,and correspondence between a problem institu-tion or wrongdoer and the Federal ReserveBank. Appropriate actions should always betaken to ensure that all written material preparedin connection with any supervisory matter beaccurate and free of insupportable conclusionsor opinions.

Appointment of Directors and SeniorExecutive Officers

Under section 32 of the FDI Act (12 USC 1831i)and subpart H of Regulation Y (12 CFR 225.71et seq.), any state member bank or bank holding

company that is in a troubled condition7 or doesnot meet minimum capital standards must pro-vide 30 days’ written notice to the Board ofGovernors before appointing any new directoror senior executive officer.8 This requirementalso applies to any change in the responsibilitiesof any current senior executive officer who isproposing to assume a different senior officerposition. Subpart H of Regulation Y details theprocedures for filing and the content of thenotice. The Board may disapprove a notice if itfinds that the competence, experience, character,or integrity of the proposed individual indicatesthat his or her service would not be in the bestinterest of the institution’s depositors or thepublic. A disapproved individual or the institu-tion that filed the notice may appeal the FederalReserve’s notice of disapproval under the pro-cedures detailed in Regulation Y. The individualmay not serve as a director or senior executiveofficer while the appeal is pending. In the eventthat a state member bank or bank holdingcompany that is in a troubled condition appointsa director or senior officer without the required30 days’ prior written notice, appropriatefollow-up supervisory action should be taken.

INFORMAL SUPERVISORYACTIONS

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

7. As defined in section 225.71 of the Board’s RegulationY, a state member bank or holding company is in troubledcondition if it (1) has a composite rating, determined at itsmost recent examination, of 4 or 5; (2) is subject to acease-and-desist order or formal written agreement that re-quires action to improve the bank’s financial condition; or(3) is expressly informed by the Board or Reserve Bank thatit is in troubled condition.

8. The Board or Reserve Bank may permit, under extraor-dinary circumstances, an individual to serve as a director orsenior executive officer before a notice is provided; however,this permission does not affect the Federal Reserve’s authorityto disapprove a notice within 30 days of its filing. The Boardmay extend the review period to a maximum of 90 days ifneeded to process the notice.



• Commitments are generally used to correctminor problems or to request periodic reportsaddressing certain aspects of a bank’s opera-tions. Commitments may be used when thereare no significant violations of law or unsafeor unsound practices and when the bank andits officers and directors are expected to co-operate and comply.9 Commitments are gen-erally obtained by the Reserve Bank’s sendinga letter to the bank outlining the request andasking for a response and an indication thatthe commitments are accepted.

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

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

INDEMNIFICATION PAYMENTSAND GOLDEN PARACHUTEPAYMENTS

In general, an indemnification payment is apayment that reimburses an insider for a speci-fied liability or cost that the person incurred inconnection with a Federal Reserve investigationor enforcement action. Golden parachute pay-ments are severance payments or agreements tomake severance payments that are paid or enteredinto at a time when the bank or holding com-pany is in a troubled condition. These paymentsrequire the prior written approval of the institu-tion’s primary federal regulator and the concur-rence of the FDIC. Although both types ofpayments fall under the same statute—section18(k) of the FDI Act (12 USC 1828(k)) and theFDIC’s accompanying regulations10—the two

types of payments are quite different and dis-tinct. However, some of the restrictions on thesepayments are the same or similar.

Indemnification Agreements andPayments

State member banks may seek to indemnifytheir officers, directors, and employees from anyjudgments, fines, claims, or settlements, whethercivil, criminal, or administrative. The bylaws ofsome state member banks may have broadlyworded indemnification provisions, or the bankmay have entered into separate indemnificationagreements that cover the ongoing activities ofits own institution-affiliated parties. Such indem-nification provisions may be inconsistent withfederal banking law and regulations, as well aswith safe and sound banking practices.

Supervisory and examiner staff should bealert to the limitations and prohibitions onindemnification imposed by section 18(k) of theFDI Act and the regulations issued thereunderby the FDIC. The law and regulations apply toindemnification agreements and payments madeby any bank to any institution-affiliated party,regardless of the condition of the financialinstitution. The purpose of the law and regula-tions is to preserve the deterrent effects ofadministrative enforcement actions (by ensuringthat individuals subject to final enforcementactions bear the costs of any judgments, fines,and associated legal expenses) and to safeguardthe assets of financial institutions.

A prohibited indemnification payment includesany payment (or agreement to make a payment)by a state member bank to an institution-affiliated party to pay or reimburse such personfor any liability or legal expense incurred in anyBoard administrative proceeding that results in afinal order or settlement in which the institution-affiliated party is assessed a civil money penalty,is removed or prohibited from banking, or isrequired to cease an action or take any affirma-tive action, including making restitution, withrespect to the bank.

The FDIC’s regulations provide criteria formaking permissible indemnification payments.A bank may make or agree to make a reasonableindemnification payment if all of the followingconditions are met: (1) the institution’s board ofdirectors determines in writing that the institution-affiliated party acted in good faith and the best

9. Informal commitments are distinct from conditions im-posed in writing in connection with the grant of an applicationor other request by an institution, which may be enforcedthrough the imposition of a civil money penalty.

10. See 12 CFR 359.



interests of the institution; (2) the board ofdirectors determines that the payment will notmaterially affect the institution’s safety andsoundness; (3) the payment does not fall withinthe definition of a prohibited indemnificationpayment; and (4) the institution-affiliated partyagrees in writing to reimburse the institution, tothe extent not covered by permissible insurance,for payments made in the event that theinstitution-affiliated party does not prevail.

The law and the FDIC’s regulations apply toall state member banks. They reinforce theFederal Reserve’s longstanding policy that aninstitution-affiliated party who engages in mis-conduct should not be insulated from the con-sequences of his or her misconduct. From asafety and soundness perspective, a state mem-ber bank should not divert its assets to pay a fineor other final judgment issued against aninstitution-affiliated party for misconduct thatpresumably violates the bank’s policy of com-pliance with applicable law, especially in caseswhere the individual’s misconduct has alreadyharmed the bank.

State member banks should review their by-laws and any outstanding indemnification agree-ments, as well as insurance policies, to ensurethat they conform with the requirements offederal law and regulations. If a state memberbank fails to take appropriate action to bring itsindemnification provisions into compliance withfederal laws and regulations, appropriatefollow-up supervisory action may be taken. Aspart of the supervisory process, which willinclude merger and acquisition applications, theFederal Reserve’s supervisory and examinerstaff will review identified agreements havingindemnification-related issues for compliancewith federal law and regulations. (See SR-02-17.)

Golden Parachute Payments

The FDIC’s golden parachute regulations applyto an insured depository institution that is in atroubled condition as defined in Regulation Y.The purposes of the law and regulations are tosafeguard the assets of financial institutions andlimit rewards to institution-affiliated parties whocontributed to the institution’s troubled condition.

In general, the FDIC’s regulations (12 CFR359) prohibit insured depository institutions andtheir holding companies from making golden

parachute payments except in certain circum-stances. A golden parachute payment means anypayment in the nature of compensation (or anagreement to make such a payment) for thebenefit of any current or former institution-affiliated party of an insured depository institu-tion or its holding company that meets threecriteria. First, the payment or agreement must becontingent on the termination of the institution-affiliated party’s employment or association.Second, the payment or agreement is receivedon or after, or made in contemplation of, amongother things, a determination that the institutionor holding company is in a troubled conditionunder the regulations of the applicable bankingagency. Third, the payment or agreement mustbe payable to an institution-affiliated party whois terminated when the institution or holdingcompany meets certain specific conditions,including being subject to a determination that itis in a troubled condition.

The definition of a golden parachute paymentalso covers a payment made by a bank holdingcompany that is not in a troubled condition to aninstitution-affiliated party of an insured deposi-tory institution subsidiary that is in a troubledcondition, if the other criteria in the definitionare met. This circumstance may arise when abank holding company, as part of an agreementto acquire a troubled bank or savings associa-tion, proposes to make payments to the troubledinstitution’s institution-affiliated parties that areconditioned on their termination ofemployment.11

A state member bank or bank holding com-pany may make or enter into an agreement tomake a golden parachute payment only (1) if theFederal Reserve, with the written concurrence ofthe FDIC, determines that the payment or agree-ment is permissible; (2) as part of an agreementto hire competent management in certain condi-tions, with the consent of the Federal Reserveand the FDIC as to the amount and terms of theproposed payment; or (3) pursuant to an agree-ment to provide a reasonable severance not toexceed 12 months’ salary in the event of an

11. The FDIC’s regulations exclude from the definition ofa golden parachute payment several types of payments, suchas payments made pursuant to a qualified pension or retire-ment plan; a benefit plan or bona fide deferred compensationplan (which are further defined in the FDIC’s regulations); ora severance plan that provides benefits to all eligible employ-ees, does not exceed the base compensation paid over thepreceding 12 months, and otherwise meets the regulatorydefinition of nondiscriminatory and other conditions in theFDIC’s regulations.



unassisted change in control of the depositoryinstitution, with the consent of the FederalReserve. In determining the permissibility of thepayment, the Federal Reserve may consider avariety of factors, including the individual’sdegree of managerial responsibilities and lengthof service, the reasonableness of the payment,and any other factors or circumstances thatwould indicate that the proposed payment wouldbe contrary to the purposes of the statute orregulations.

A state member bank or bank holding com-pany requesting approval to make a goldenparachute payment or enter into an agreement tomake such a payment should submit its requestsimultaneously to the appropriate FDIC regionaloffice and the Reserve Bank. The request mustdetail the proposed payments and demonstratethat the state member bank or bank holdingcompany does not possess and is not aware ofany evidence that there is reasonable basis tobelieve, at the time that the payment is proposedto be made, that (1) the institution-affiliatedparty receiving such a payment has committedany fraud, breach of fiduciary duty, or insiderabuse or has materially violated any applicablebanking law or regulation that had or is likely tohave a material adverse effect on the bank orcompany; (2) that the individual is substantiallyresponsible for the institution’s insolvency ortroubled condition; (3) and that the individual

has violated specified banking or criminal laws.Requests regarding golden parachute pay-

ments or agreements should be forwarded by theReserve Bank to the appropriate Board staff fora final determination on the permissibility of thepayment. Golden parachute payments or agree-ments must be approved by the Board’s Directorof the Division of Banking Supervision andRegulation and the General Counsel. Denialsare not delegated by the Board of Governors toBoard or Reserve Bank staffs.

If a state member bank or bank holdingcompany makes or enters into an agreement tomake a golden parachute payment without priorregulatory approval when such an approval isrequired, appropriate follow-up supervisoryaction should be taken. This follow-up couldinclude an enforcement action requiring theoffending institution-affiliated party to reim-burse the institution for the amount of theprohibited payment. When state member banksor bank holding companies are identified ashaving golden parachute-related issues in thesupervisory process, those issues should becarefully reviewed for compliance with the lawand the FDIC’s regulations. The appropriateReserve Bank supervisory staff and the appro-priate staff of the Board’s Division of BankingSupervision and Regulation and Legal Divisionshould be notified and consulted on the goldenparachute-related issues.



Documents

Duties and Responsibilities of Directors Effective date April 2020 … · 2020-05-19 · Duties and Responsibilities of Directors Effective date April 2020 Section 5000.1 Directors