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Higher expectations for financial compliance.

With banking deregulation in the 1980s and '90s, the U.S. financial system became much more flexible, dynamic, and geographically far reaching. Financial markets have gained vast new sources of capital, and, as banks have become more competitive, consumers often enjoy a wider selection of products and lower fees for services.

For the bank examiners and regulators responsible for helping to keep our financial system safe and sound, daily work has become more complex. With the spread of securitization, increased reliance on information technologies, and other innovations, bank supervision today involves worrying about not only credit risk in lending activities but also operational, market, and liquidity risk.

Boardrooms under scrutiny

As they confront these challenges, Federal Reserve Supervision and Regulation staff must bring an increasingly broad set of skills and analytical expertise to their jobs. Some follow the traditional routine of traveling to small towns where they spend days examining community banks. More and more, though, they supplement on-site exams with off-site surveillance, especially for large banking organizations. Examiners also travel outside the region, working with teams of specialists from other Reserve Banks, and a growing number of examiners concentrate on niches such as private wealth management, real estate financing, or economic capital.

Whatever their focus, examiners must understand and recognize a wide range of potential problems, such as those brought to light following a wave of accounting and governance scandals that began to erupt beginning in 2001. The Sarbanes-Oxley Act of 2002 was written to address certain regulatory gaps and conflicts of interest, focusing supervisory attention on the top of the corporate hierarchy. Certainly, the ordinary role for commercial bank boards of directors has changed. Under Sarbanes-Oxley, corporate directors are expected to actively support regulatory compliance and are subject to criminal penalties designed to ensure that oversight responsibilities prevail.

All corporate directors have a legal and fiduciary obligation to protect shareholder interests. But banks' crucial role in the U.S. economy, backed by federal deposit insurance, gives bank directors the added responsibility of ensuring that banks operate safely and soundly and with adequate capital and internal controls for the risks they assume.

A growing concern is whether a financial institution is at risk because of a legal or noncompliance issue that could damage its reputation, so Federal Reserve examiners have had to add reputational risk to the array of risks it considers.

Getting the new rules right

In particular, the USA Patriot Act extended banks' regulatory compliance by amending the Bank Secrecy Act of 1970. The Patriot Act, passed in 2001 in the wake of terrorist attacks on U.S. soil, expands money-laundering coverage to overseas and nonbank financial institutions in an effort to shut down terrorist financing and sever the potential link between drug money and terrorism.

Under the Patriot Act, financial institutions are required to know certain information about their customers and to report any suspicious activity. The penalties for noncompliance can be severe, and the ensuing negative publicity could further damage the bank. Given the high stakes involved, it's clear that bank managers and directors, along with Atlanta Fed examiners, face a heightened challenge.

This broader interpretation of risk and increasing expectations for enterprisewide risk management are parts of the Federal Reserve's current approach to corporate governance. The challenge for financial institutions and Fed examiners is to sustain the innovative spirit that has made the financial services sector so successful while ensuring that organizations stay accountable to the public interest.
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Title Annotation:Federal Reserve Bank of Atlanta
Publication:Financial Update
Date:Apr 1, 2005
Words:574
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