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Strengthening Financial Risk Management at the FDIC
Improving Financial Reporting – Horizon 1
The antecedent of the FRC was the FDIC’s Failure Projection Working Group, an informal, interdivisional forum for discussing various failure-projection models and their implications for the FDIC. This working group developed initial contacts and working relationships between divisions at a time when the FDIC had what one participant described as a “stove-pipe culture.”17 The FDIC culture of the time and the evolving composition and objectives of the working group warranted an informal, open, and flexible process.
In 1998, the FDIC converted the working group into the Financial Risk Committee. Most of the FRC’s organizational processes and practices were inherited from the informal working group rather than being deliberately chosen, so the FRC’s processes are generally informal. These processes are described and assessed below.
The FRC is tasked with determining reserves the FDIC should set aside for depository institutions that may fail. The FRC obtains the most accurate, current, and complete information by bringing together a wide group of constituencies, from within and outside the FDIC (Exhibit 1-9). The primary participants of the FRC are four divisions – DIR, DSC, DRR, and DOF – each of which is represented by one to three “FRC principals,” numbering eight in total. The FRC also formally receives input from the Office of the Comptroller of the Currency (OCC), the Federal Reserve Board (FRB), and the Office of Thrift Supervision (OTS).
The FRC operates on a quarterly cycle for two reasons. First, much of the analysis is based on data in Call Reports and Thrift Financial Reports that depository institutions file quarterly. Second, the FRC is tasked with computing the CLR, which is included in the FDIC’s quarterly financial results.
Each quarter, the FRC process begins when DIR finishes entering the Call Report data into its databases and cleaning the data to remove errors. This clean data is generally available 2 months after the start of each quarter. In the next 3 weeks, DIR and DSC calculate the input estimates (e.g., the Pro Forma Model) and compile background materials that the FRC will consider. In the last week of the quarter, the FRC holds a preliminary meeting with other federal bank regulators and a final meeting to decide on the CLR and 2-year Projection.
Calculating estimates and compiling materials. In the last month of each quarter, DIR continuously updates the reserve list,18 which is the basis for the CLR calculations. As described above, DIR runs the Pro Forma Model to project which of these institutions will have capital above and below two percent of assets after one year. DIR then gathers these results into a spreadsheet to compute the CLR estimate according to the established CLR methodology. At the same time, DIR personnel run the three models that provide inputs into the 2-year Projection of failed-bank assets, and DSC compiles its 8-Quarter list based on its supervisory assessments.
All these results are disseminated to FRC participants along with various other reports that speak to the health of insured institutions. These reports typically consist of: DSC’s Quarterly Lending Alert, DSC’s report on the Real Estate Stress Test (REST) Model, DSC’s report on the Statistical CAMELS Offsite Rating (SCOR) Model, DIR’s Market Trends Report, a report from DIR comparing the CLR for the quarter using the Research Model to the CLR as calculated under the prevailing methodology, DIR’s CAMELS Migration report, DSC’s report on Large Insured Depository Institutions (LIDI), and DIR’s Risk Case. Altogether these materials comprise 60 to 100 pages, with a 2- to 4-page summary up front.
Preliminary FRC meeting. At the beginning of the last week of each quarter, the FRC principals meet with representatives from the OCC, FRB, and OTS. The purpose of this “preliminary FRC meeting” is to gather supervisory perspective on insured institutions for which failure is reasonably possible. The other federal bank agencies provide information on the majority of insured institutions that FDIC does not supervise. During this meeting, the FRC principals are briefed on the most important at-risk institutions, and the FDIC’s reserve list is updated to reflect any recent status changes (e.g., changes in CAMELS ratings).
Final FRC meeting. In the final 1 to 3 days of each quarter, the FRC principals and some of their supporting staff meet for the “FRC decision meeting” at which the group decides on the CLR and 2-year Projection of failed-bank assets. Typical attendance at these meetings is 25 to 30 people. Discussion is informal and open to all. At the end of the meeting, the group comes to a consensus about the CLR and 2-year Projection, and these decisions are reported formally to DOF within 1 day.
The remainder of this section assesses the FRC’s organization and processes on nine dimensions. It scores well for using the most current information and for fostering constructive interdivisional debate. On the remaining seven dimensions, the FRC lacks formal processes and procedures that could make it more efficient.
The FRC will become more efficient if it adds some formal procedures and processes. At the next FRC meeting, the FRC principals should adopt the recommendations listed below. None of the proposals requires substantial effort to implement, so they can be implemented immediately.
1.3.a. The FRC should adopt a clear mission statement. The example in Exhibit 1-10 will help to clarify the activities and objectives of the FRC participants and steer their efforts toward a common goal, particularly regarding any mandate for the FRC beyond computing the CLR and 2-year Projection.
1.3.b. The FRC should create a standardized meeting agenda and distribute it well in advance. Discussions at FRC meetings would be more focused if the group worked from a detailed agenda that listed discussion topics (e.g., names of particular institutions), along with a designated discussion leader for each item. To ensure that all FRC principals can adequately prepare for these discussions, this agenda should be distributed one week in advance.
1.3.c. The FRC should create standardized, synthesized briefing materials and distribute them well in advance. The first page of the briefing materials should be a “FRC dashboard” depicting the most essential facts and statistics for FRC principals to consider (Exhibit 1-11). Immediately thereafter, DIR should include a synthesized memorandum interpreting what the FRC dashboard and any other relevant information imply for the FRC’s decisions at the coming meeting. The remaining briefing materials should include only those items that are relevant to specific decisions that the FRC will make. For example, if the FRC will discuss whether to reserve less for a particular institution, then the specifics of that institution should be included. If the FRC will discuss whether to deviate from historical failure rates, then materials on leading indicators of failure rates would be appropriate. All these materials should be distributed at least 2 business days in advance.
SAMPLE FRC DASHBOARD AT HORIZON 1
* Exceptions and over limit conditions indicated in bold
** Standard deviation
1.3.d. The FRC should limit attendance at its meetings. Attendance at the FRC decision meetings should be restricted to the eight FRC principals and one to two supporting participants per division. The presence of five FRC principals (or their designees) will constitute a quorum. To streamline discussions, FRC principals should discourage other participants from speaking unless recognized by the chair.
1.3.e. A chairperson should be formally designated to manage FRC meetings. A formal chairperson would increase efficiency of FRC meetings by keeping discussions on point and managing the group’s decision-making. DIR’s Deputy Director of Financial Risk Management and Research should formally chair each FRC meeting.
1.3.f. The FRC should come to each decision by a vote of the FRC principals. A formal process for reaching decisions would help the committee to restrict its Confidential attention to areas of genuine uncertainty and disagreement. As such, for each needed decision, the FRC chairperson should call for a quick voice vote by the FRC principals in attendance, with the chairperson casting the deciding vote if necessary.
1.3.g. The FRC should set thresholds for when it will discuss whether to override the CLR reserve for a given institution. One way to focus deliberations would be to decide on override criteria in advance. For example, the FRC should set thresholds that will automatically put an institution on an “override list.” The FRC would discuss each institution and vote on whether to deviate from the failure rate or loss rate applied to that institution under the CLR formula. The FRC should set such thresholds based on institution size (e.g., any institution with over $750 million in assets) and the amount of reserves under the CLR formula (e.g., the 10 institutions with the largest reserve amounts). The FRC may elect to discuss additional institutions that are nominated by FRC members because of unique characteristics (e.g., an institution whose franchise value is so large that its loss rate will likely be zero). In discussing overrides for failure rates, DSC has the most relevant information, so it should lead the discussion and take primary responsibility for informing the group. DRR should do the same for loss rates.
1.3.h. The FRC should institute formal and systematic feedback loops to assess and improve its performance. On a regular basis (e.g., March and September) DIR should provide the FRC with a brief assessment of the performance and development of the FDIC’s reserve models (e.g., the CLR methodology, the Credit Risk Model, etc.). Based on these briefings, the FRC should convey to DIR what additional improvements would most benefit the FRC. In addition, the FRC should regularly (e.g., June and December) look back on any of its departures from the CLR methodology (e.g., altering failure probabilities within the 90 percent confidence interval) to determine whether, in retrospect, those departures improved the accuracy of the FRC’s reserving decisions.
1.3.i. The FRC should decide systematically on next steps. At the end of each FRC meeting, the group should discuss and approve a set of next steps, focusing on unresolved issues that warrant further investigation and action before the next FRC meeting. The FRC Chair should take the lead role to ensure the required execution prior to the next meeting.
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