I. Introduction i. Section 39 of the Federal Deposit Insurance Act
1 (FDI Act)
requires each federal banking agency (collectively, the agencies)
to establish certain safety-and-soundness standards by regulation
or by guideline for all insured depository institutions. Under section
39, the agencies must establish three types of standards: (1) operational
and managerial standards; (2) compensation standards; and (3) such
standards relating to asset quality, earnings, and stock valuation
as they determine to be appropriate.
ii. Section 39(a) requires the agencies to establish operational
and managerial standards relating to (1) internal controls, information
systems, and internal audit systems, in accordance with section 36
of the FDI Act (12 USC 1831m); (2) loan documentation; (3) credit
underwriting; (4) interest-rate exposure; (5) asset growth; and (6)
compensation, fees, and benefits, in accordance with subsection (c)
of section 39. Section 39(b) requires the agencies to establish standards
relating to asset quality, earnings, and stock valuation that the
agencies determine to be appropriate.
iii. Section 39(c) requires the agencies to establish
standards prohibiting as an unsafe and unsound practice any compensatory
arrangement that would provide any executive officer, employee, director,
or principal shareholder of the institution with excessive compensation,
fees, or benefits and any compensatory arrangement that could lead
to material financial loss to an institution. Section 39(c) also requires
that the agencies establish standards that specify when compensation
is excessive.
iv. If an agency determines that an institution fails
to meet any standard established by guideline under subsection (a)
or (b) of section 39, the agency may require the institution to submit
to the agency an acceptable plan to achieve compliance with the standard.
In the event that an institution fails to submit an acceptable plan
within the time allowed by the agency or fails in any material respect
to implement an accepted plan, the agency must, by order, require
the institution to correct the deficiency. The agency may, and in
some cases must, take other supervisory actions until the deficiency
has been corrected.
v. The agencies have adopted amendments to their rules
and regulations to establish deadlines for submission and review of
compliance plans.
2vi. The following guidelines set out the safety-and-soundness
standards that the agencies use to identify and address problems at
insured depository institutions before capital becomes impaired. The agencies
believe that the standards adopted in these guidelines serve this
end without dictating how institutions must be managed and operated.
These standards are designed to identify potential safety-and-soundness
concerns and ensure that action is taken to address those concerns
before they pose a risk to the deposit insurance funds.
A. Preservation of existing authority. Neither
section 39 nor these guidelines in any way limits the authority of
the agencies to address unsafe or unsound practices, violations of
law, unsafe or unsound conditions, or other practices. Action under
section 39 and these guidelines may be taken independently of, in
conjunction with, or in addition to any other enforcement action available
to the agencies. Nothing in these guidelines limits the authority
of the FDIC pursuant to section 38(i)(2)(F) of the FDI Act (12 USC
1831(o)) and part 325 of title 12 of the Code of Federal Regulations.
B. Definitions.
1. In general. For purposes of these guidelines,
except as modified in the guidelines or unless the context otherwise
requires, the terms used have the same meanings as set forth in sections
3 and 39 of the FDI Act (12 USC 1813 and 1831p-1).
2. Board of directors, in the case
of a state-licensed insured branch of a foreign bank and in the case
of a federal branch of a foreign bank, means the managing official
in charge of the insured foreign branch.
3. Compensation means all direct
and indirect payments or benefits, both cash and noncash, granted
to or for the benefit of any executive officer, employee, director,
or principal shareholder, including but not limited to payments or
benefits derived from an employment contract, compensation or benefit
agreement, fee arrangement, perquisite, stock option plan, postemployment
benefit, or other compensatory arrangement.
4.
Director shall have the meaning
described in 12 CFR 215.2(c).
35.
Executive officer shall have
the meaning described in 12 CFR 215.2(d).
46.
Principal shareholder shall have the meaning described in 12 CFR 215.2(
l).
5A. Internal controls and information
systems. An institution should have internal controls and information
systems that are appropriate to the size of the institution and the
nature, scope, and risk of its activities and that provide for—
1.
an
organizational structure that establishes clear lines of authority
and responsibility for monitoring adherence to established policies;
2.
effective
risk assessment;
3.
timely
and accurate financial, operational, and regulatory reports;
4.
adequate
procedures to safeguard and manage assets; and
5.
compliance
with applicable laws and regulations.
B.
Internal-audit system.* An institution should have an internal-audit system
that is appropriate to the size of the institution and the nature
and scope of its activities and that provides
for—
1.
adequate
monitoring of the system of internal controls through an internal-audit
function. (For an institution whose size, complexity, or scope of
operations does not warrant a full-scale internal-audit function,
a system of independent reviews of key internal controls may be used.);
2.
independence
and objectivity;
3.
qualified persons;
4.
adequate testing and review of information systems;
5.
adequate documentation of tests and findings and any corrective
actions;
6.
verification
and review of management actions to address material weaknesses; and
7.
review by the institution’s audit committee or
board of directors of the effectiveness of the internal audit systems.
C. Loan documentation. An institution should
establish and maintain loan documentation practices that—
1.
enable the institution to make an informed lending decision and
to assess risk, as necessary, on an ongoing basis;
2.
identify
the purpose of a loan and the source of repayment, and assess the
ability of the borrower to repay the indebtedness in a timely manner;
3.
ensure
that any claim against a borrower is legally enforceable;
4.
demonstrate
appropriate administration and monitoring of a loan; and
5.
take account of the size and complexity of a loan.
D. Credit underwriting. An institution should
establish and maintain prudent credit-underwriting practices that—
1.
are
commensurate with the types of loans the institution will make and
consider the terms and conditions under which they will be made;
2.
consider
the nature of the markets in which loans will be made;
3.
provide
for consideration, prior to credit commitment, of the borrower’s overall
financial condition and resources, the financial responsibility of
any guarantor, the nature and value of any underlying collateral,
and the borrower’s character and willingness to repay as agreed;
4.
establish
a system of independent, ongoing credit review and appropriate communication
to management and to the board of directors;
5.
take
adequate account of concentration of credit risk; and
6.
are appropriate to the size of the institution and the nature and
scope of its activities.
E. Interest-rate exposure. An institution
should—
1.
manage interest-rate risk in a manner that is appropriate to the
size of the institution and the complexity of its assets and liabilities;
and
2.
provide for periodic reporting to management and the board of directors
regarding interest-rate risk with adequate information for management
and the board of directors to assess the level of risk.
F. Asset growth. An institution’s asset growth
should be prudent and consider—
1.
the source, volatility, and use of the funds that support asset
growth;
2.
any
increase in credit risk or interest-rate risk as a result of growth;
and
3.
the
effect of growth on the institution’s capital.
G. Asset quality. An insured depository institution
should establish and maintain a system that is commensurate with the
institution’s size and the nature and scope of its operations to identify
problem assets and prevent deterioration in those assets. The institution
should—
1.
conduct periodic asset-quality reviews to identify problem assets;
2.
estimate the inherent losses in those assets and establish reserves
that are sufficient to absorb estimated losses;
3.
compare
problem-asset totals to capital;
4.
take
appropriate corrective action to resolve problem assets;
5.
consider
the size and potential risks of material asset concentrations; and
6.
provide
periodic asset reports with adequate information for management and
the board of directors to assess the level of asset risk.
H. Earnings. An insured depository institution
should establish and maintain a system that is commensurate with the
institution’s size and the nature and scope of its operations to evaluate
and monitor earnings and ensure that earnings are sufficient to maintain
adequate capital and reserves. The institution should—
1.
compare
recent earnings trends relative to equity, assets, or other commonly
used benchmarks to the institution’s historical results and those
of its peers;
2.
evaluate the adequacy of earnings given the size, complexity, and
risk profile of the institution’s assets and operations;
3.
assess
the source, volatility, and sustainability of earnings, including
the effect of nonrecurring or extraordinary income or expense;
4.
take
steps to ensure that earnings are sufficient to maintain adequate
capital and reserves after considering the institution’s asset quality
and growth rate; and
5.
provide periodic earnings reports with adequate information for
management and the board of directors to assess earnings performance.
I. Compensation, fees, and benefits. An institution
should maintain safeguards to prevent the payment of compensation,
fees, and benefits that are excessive or that could lead to material
financial loss to the institution.
III. Prohibition on Compensation That Constitutes
an Unsafe and Unsound Practice A. Excessive
compensation. Excessive compensation is prohibited as an unsafe
and unsound practice. Compensation shall be considered excessive when
amounts paid are unreasonable or disproportionate to the services
performed by an executive officer, employee, director, or principal
shareholder, considering the following:
1.
the
combined value of all cash and noncash benefits provided to the individual;
2.
the
compensation history of the individual and other individuals with
comparable expertise at the institution;
3.
the
financial condition of the institution;
4.
comparable
compensation practices at comparable institutions, based upon such
factors as asset size, geographic location, and the complexity of
the loan portfolio or other assets;
5.
for
postemployment benefits, the projected total cost and benefit to the
institution;
6.
any
connection between the individual and any fraudulent act or omission,
breach of trust or fiduciary duty, or insider abuse with regard to
the institution; and
7.
any
other factors the agencies determine to be relevant.
B. Compensation leading to material financial loss. Compensation that could lead to material financial loss to an institution
is prohibited as an unsafe and unsound practice. 12 CFR 208, appendix
D-1.
