BEIJING BRUSSELS CHICAGO DALLAS GENEVA HONG KONG LONDON LOS ANGELES NEW YORK SAN FRANCISCO SHANGHAI SINGAPORE TOKYO WASHINGTON, D.C.
BANK EXAMINATION ISSUES:Some Practical Advice for International Banks
Connie M. FriesenInstitute of International Bankers
U.S. Regulatory/Compliance Orientation ProgramJuly 17, 2007
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Introduction
The bank examination process presents an opportunity for an international bank with U.S. operations to demonstrate its understanding of applicable U.S. laws and regulations. It also permits a bank to share with regulators its successful implementation of risk management and compliance programs that are consistent with applicable safety and soundness concerns.
However, using the examination process to a bank’s advantage is not easy. Preparation for a successful exam requires the consistent attention over time of senior management, the compliance function and business line managers.
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I. Preparation is a Continuous Process
• “Safety and soundness” is always a primary focus of the examination process.
• Demonstrate that your bank is aware of “safety and soundness” issues and manages them well.
• A key element of good preparation is a comprehensive risk management and compliance plan.
• A plan that focuses on risk management and compliance requirements for each line of business will demonstrate that a bank is aware of safety and soundness issues and manages them well.
Comprehensive Risk Management and Compliance Plan
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I. Preparation is a Continuous Process
• Hold monthly meetings of senior management, the compliance function and business line managers to discuss compliance issues and to make certain they are dealt with appropriately.
• Hold quarterly liaison meetings with representatives of Head Office to coordinate handling of issues.
• Be certain to document the meetings and any compliance initiatives that result from them.
• Create a “record” that you can share with bank examiners.
• Such a record will demonstrate that your bank is pro-active and anticipates issues.
Active Involvement of U.S. Senior Management and Head Office
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I. Preparation is a Continuous Process
• U.S. senior management should be certain that Head Office understands the special burden of U.S. compliance requirements and examination process.
– Adopting a uniform “global” set of policies and procedures will not be sufficient.
– Sufficient resources (personnel, time, systems) must be devoted to U.S. operations.
– OFAC compliance, the internal audit function, data protection and BSA/AML compliance are examples of areas where U.S. approach may diverge from expectations and practice in the home country*.
Recognition of Special Burden of U.S. Compliance Requirements
__________* See Exhibit A for a list of useful sources on U.S. bank examination requirements and expectations.
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• Be prepared to share and discuss issues that may have developed during a previous exam and are now resolved; even if this examination is conducted, for example, by Federal Reserve Bank of New York (“FRBNY”), the FRBNY examination team will be interested in how you resolved issues from a previous examination by New York State Banking Department (“NYSBD”).
• Note that regulators share information.
I. Preparation is a Continuous Process
Co-ordination Issues
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• General manager should lead the continuous preparation process and should always be fully informed. General manager “sets the tone” for compliance standards and ethical conduct of business.
• General manager should communicate with head of compliance function on a continuing basis.
• General manager should make certain that U.S. compliance function receives the support, attention and resources that it needs.
II. Management and Compliance Function Should Work Together
Promoting a Compliance Culture
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II. Management and Compliance Function Should Work Together
• Objective should be to maintain a “compliance culture” which sets high standards for everyone in the U.S. office or offices.
• U.S. Head of Compliance should be responsible for continuous monitoring of changes in statutes and regulations.
• Quarterly reports from U.S. Head of Compliance and outside counsel may serve to clarify new issues and steps to be taken.
• Continuous dialogue between U.S. Head of Compliance, U.S. business lines and Head Office compliance function is essential.
Compliance Function Must Assume Leadership Responsibility
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III. Incorporate a Risk-Based Focus in All Lines of Business
• Remember that a primary objective of exam process is to evaluate the condition of the U.S. office.
• Key part of the evaluation is to assess levels of current risk and the possibility that future risks will result from current and planned activities.
• U.S. office needs to demonstrate full control of a robust risk-management process.
Risk-Based Focus and Preparation Efforts
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III. Incorporate a Risk-Based Focus in All Lines of Business
• Make a risk-based assessment part of every line of business, every new product and every new customer relationship.
• “Risk-based” assessment means an assessment of operational risk, legal risk, counterparty risk, market risk, interest rate risk, etc.
• Branch risk assessment and customer risk assessment are now key requirements for BSA/AML compliance program.
Risk Assessment
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IV. Develop “Books and Records” that will Serve as an Examination Resource
• Develop a “Compliance Risk Matrix” that will serve as a checklist and index.
• See Exhibit B for an example of one possible format for a compliance risk matrix.
• The compliance risk matrix will help U.S. office identify necessary policies and procedures.
Compliance Risk Matrix
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IV. Develop “Books and Records” that will Serve as an Examination Resource
• Risk matrix will identify levels of risk as “high,” “medium” or “low.”
• Compliance review of various activities can be scheduled at various intervals depending on level of risk.
• Compliance review will look at policies and procedures to see if they reasonably address the regulatory requirements and are adapted to level of risk.
Compliance Review
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V. Be Prepared to Respond to Examination Questions About Items Highlighted by Internal Audit or Compliance Review
• Bank examiners often look first to issues highlighted by internal audit.
• Therefore, pay particular attention to issues detected during the internal audit process.
• Document carefully and fully all measures taken to address issues highlighted by internal audit.
Response to Internal Audit Issues
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V. Be Prepared to Respond to Examination Questions About Items Highlighted by Internal Audit or Compliance Review
• Any deficiencies in policies or procedures identified in compliance review process should be addressed before the bank examination begins.
• As is the case with deficiencies identified by internal audit, it is important to document fully all steps taken to remedy deficiencies cited in compliance review process.
Response to Compliance Review Issues
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VI. Use “First Day Letter” as a Guide to Exam Preparation
• So-called “First Day Letter” will be sent to bank about one month before scheduled bank examination date.
• Typically, bank is required to provide responses (preferably in electronic format) just before start date of actual examination.
• First Day Letter will be signed by examiner-in-charge and bank will have an opportunity to ask questions.
• Typical areas of focus will be general lines of business, safety and soundness and BSA/AML issues.
Contents of First Day Letter
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VI. Use “First Day Letter” as a Guide to Exam Preparation
• A “Questionnaire for General Manager” may be part of First Day Letter. It might request information about items such as the following:
– List of new products and services introduced since last examination.
– Head office plans for the U.S. office.
– Identification of any changes that might require approval or licensing (additional offices, broker-dealer, IBF, Cayman Branch).
– Description of head office support for branch (liaison committees; attempts to integrate compliance).
– Views of general manager on AML compliance.
General Manager Questionnaire
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• Be certain that U.S. office understands what is required by each item of the First Day Letter
• Contact the regulators if items are not clear.
• Assign responsibility for response to appropriate personnel.
• Compliance officer and senior management should co-ordinate the preparation and gathering of materials; liaison and contact persons for each line of business should be identified.
• Compliance officer should have a general understanding of every item prepared or provided for the response.
VI. Use “First Day Letter” as a Guide to Exam Preparation
Effective Use of First Day Letter
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VII. Be Prepared for Intense Scrutiny of BSA/AML Issues
• BSA/AML items now dominate typical First Day Letter requests.
• Specific areas of BSA/AML focus might include:– Approval and appropriate revisions of AML Program.
– Determination that BSA/AML Program meets all PATRIOT Act requirements.
– Documentation of Training Program.
– Risk assessment of products, services, customers and geographic locations.
– List of high risk accounts.
– List of customers on which bank took adverse action because of its CIP.
Focus on BSA/AML Issues
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• Additional areas of AML focus:
– SARs (including documentation for SARs considered but not filed).
– Procedures used to monitor transactions for suspicious activity.
– Funds transfer records.
– Foreign correspondent accounts.
– OFAC issues
Policies and procedures
Risk assessment and risk management
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VII. Be Prepared for Intense Scrutiny of BSA/AML Issues
Additional BSA/AML Issues
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• Be certain to review the most recent 12-18 months of releases, notices, statements of guidance issued by NYSBD, FRB and OCC.
• If any of these regulatory changes have affected a particular bank, they are likely to receive special focus during the examination.
VIII. Be Prepared for “Hot Issues” and “New Items”
New Developments
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VIII. Be Prepared for “Hot Issues” and “New Items”
Examples:
• Loans to hedge funds; accounts for hedge funds
• Account relationships with money services businesses (“MSBs”)
• Any possibility of transactions that relate to Iran
• Participation in “complex structured finance transactions”
• Correspondent banking relationships
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IX. Be Responsive During the Examination
• Have organized files containing responses to First Day Letter requests ready for examiners when they arrive.
• Have a meeting with examiners when they arrive to introduce contact people and explain the preparation done by U.S. office.
• Develop a process to respond quickly to requests for clarification, additional information, etc.
• If examiners request information U.S. office does not have, either try to obtain it as quickly as possible or explain why it cannot be provided.
Conduct of the Examination
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• To the extent possible, try to deal with any identified issues or weaknesses immediately.
• For larger issues, explain why past practice has been to deal with an issue in a particular way, but express willingness to do things differently if this is what is expected by examiners.
• To the extent possible, try to take recommended actions on identified issues immediately; do not wait for the conclusion of the exam.
IX. Be Responsive During the Examination
Dealing with Problems or Weaknesses
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• If examiners indicate you should really be following approach “x” and your bank has special reasons for following approach “y” to achieve a better result, try to explain this to regulators prior to or at the exit interview and ask if they are willing to accept the bank’s approach.
IX. Be Responsive During the Examination
When to Suggest Alternative Approaches
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• U.S. senior management and compliance officer should keep Head Office informed of the progress of the exam.
• If significant weaknesses or major issues develop, try to involve Head Office in the resolution.
• Try to make certain Head Office understands the perspective of U.S. regulators and examiners.
• Try to work with Head Office so responsible personnel will know what to say to home country regulators.
IX. Be Responsive During the Examination
Keep Head Office Informed
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X. Tips for a Successful Exit Interview
• Follow Common Rules of Business Behavior
– Be polite and respectful.
– Respond diplomatically to questions and criticisms.
– Emphasize your bank’s “culture of compliance” and “pro-active” approach.
• Try to Limit Scope of Criticism
– Resolve any misunderstandings about specific items.
– Explain that each criticized item will be taken care of immediately.
Polite and Diplomatic Responses
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X. Tips for a Successful Exit Interview
• Try to limit number and significance of items that will appear in Written Report of Examination.
– Indicate that you have developed a “plan of action” to respond to items cited in draft report.
– Note that certain items that were the subject of examination attention have now been fully resolved (if that is true).
– If examiners indicate that the final examination report will cite a deficiency, ask to discuss the issue with them while they are still “on-site” and develop and implement a plan to remedy the deficiency as soon as possible.
Limiting Cited Items
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Conclusions
• Preparation for bank examinations is a continuous process.
• “Prevention is the best cure.”
• Make certain that Head Office understands examination issues and the responses provided by U.S. office being examined.
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