EXAMINATIONS AND INSPECTIONS—Communicating Problems to Management and Boards of Directors; Policy Statement

Previously, Federal Reserve examiners and other designated personnel have held a meeting with a banking organization’s management and board of directors after an examination or inspection if it is a large organization or if the examination/inspection revealed that the organization had significant problems. In addition, a copy of the examination/inspection findings has been provided to every bank examined and bank holding company inspected for review by its management and members of its board. That policy is now being modified for the purpose of formalizing and strengthening these traditional Federal Reserve practices for communicating the findings of examinations and inspections to the management and boards of directors of banking organizations.

The new policy establishes specific criteria for determining which examination/inspection findings require follow-up meetings with boards of directors and presents guidelines for the conduct of these meetings. It also introduces the requirements that a written summary of examination findings —separate from the complete examination or inspection report—be distributed to each director and that senior Reserve Bank officials become more involved in communicating and presenting examination/inspection findings to the boards of directors. It is intended that these initiatives will ensure that each director of a state member bank or a bank holding company considered to be a problem organization or identified as having a significant weakness, will clearly understand the nature and dimension of the organization’s problems and the responsibilities of its board of directors to correct them.

The decision to hold a meeting with the board of directors at the conclusion of a state member bank examination or a bank holding company inspection is to be determined on the basis of the organization’s financial condition, its size, the type of examination/inspection conducted and other factors which, in the judgment of the Reserve Bank, indicate the need for such a meeting. To the extent possible, meetings with the board of directors of state member banks should include representatives of the state banking department. Where appropriate, meetings with the boards of bank holding companies may be held jointly with the meeting of the lead bank subsidiary’s board of directors and the bank’s primary federal or state bank supervisor.

Condition. A meeting with the board of directors is to be held at the conclusion of any full-scope examination or inspection in which a state member bank is rated CAMEL composite 4 or 5 or a bank holding company is rated BOPEC composite 4 or 5. Such meetings are also required if an organization is rated composite 3 and its condition appears to be deteriorating or has shown little improvement since a previous examination/inspection in which it received a composite 3 rating.¹ A meeting should also be held with all these organizations following a limited-scope or targeted examination/inspection, if deemed appropriate and desirable by the Reserve Bank.

Size. A meeting will be required at the conclusion of a full-scope examination/inspection of all multinational organizations and major regional organizations with assets in excess of $5 billion. Reserve Banks also are encouraged to conduct such meetings at the conclusion of a full-scope examination/inspection of regional institutions with assets in excess of $1 billion.

It is understood that meetings with boards of directors will have to be tailored to meet the needs of each specific situation. In general, meetings with the full board are to be preferred, but in certain cases the Reserve Bank may determine that a meeting with a committee of the board of directors, such as executive or audit committees, will serve adequately. In all cases, however, the written summary of examination/inspection findings is to be provided to each member of an organization’s board of directors.

The Reserve Bank’s presentation to the board should ordinarily be chaired by a Reserve Bank official, with the examination staff in attendance.

The larger the organization or more serious its problem, the more senior should be the Federal Reserve official. In general, Reserve Bank presidents are expected to become directly involved in the supervision of multinational organizations and regional institutions with over $5 billion in assets that have been rated composite 3, 4, or 5. The president ordinarily will meet with the board of directors and may become involved in other ways, the precise nature of which to depend on the situation.

A meeting with the board of directors should include a formal, structured presentation containing a clear statement that an institution is considered a “problem” institution² or is about to become a problem institution if existing conditions deteriorate. Use of slides, other visual aids, and hard copy handouts is encouraged. Information should also be presented on financial trends and peer-group comparisons. The presentation should make clear the nature of problems uncovered, such as—

The Federal Reserve Banks will begin providing written reports to the directors summarizing the examination/inspection findings for all organizations rated composite 3, 4, or 5, and for those rated composite 1 or 2 showing signs of a significant deterioration in condition or apparent violations of law. The summary report to the directors is intended to complement the complete report of examination/inspection findings prepared for use by bank management and the directors of an organization. The summary report is to focus on identified problems—rather than on the strength of the organization—and present them in a manner that is succinct and unmistakably clear. In all cases, the types of actions to be taken by the directors and management to address these problems should be specifically noted. Institutions rated 4 or 5 are to be told they are “problem” institutions that warrant “special supervisory attention.” Institutions rated 3 are to be informed that their condition is not satisfactory, that they are subject to more than normal supervision, and that they may become “problems” if their weaknesses are not addressed adequately. A summary report should also be prepared when significant weaknesses are uncovered in the examination/inspection of 2-rated institutions. The organization, style, and content of the director’s summary report is also to be utilized for the summary of the examiner’s comments on page one of the complete examination/inspection report. The summary report should also emphasize the responsibilities of the directors to ensure that corrective actions are taken to address all deficiencies noted as presented in a section entitled “Matters Requiring Board Attention.”

The summary report will be sent directly to the banking organization’s management for their distribution to each director. The transmittal letter to the banking organization is to state that the report is a summary of identified problems and contemplated supervisory actions and to request that management distribute the report to each director. The letter is to state further that each director should read the report, sign the introductory statement attesting to having read the report, and return the report to management. Management is to keep on file copies of the statements signed by the directors but is to destroy all but a file copy of the summaries themselves.

It is essential that the directors’ summary report be completed and distributed before any Reserve Bank meeting with the board of directors in order to provide the directors with prior notice of the deficiencies to be discussed. Reserve Banks should also make every effort to distribute the complete examination/inspection report to management prior to meeting with directors. S-2493, attachment B; Oct. 7, 1985.