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Federal Reserve Operations


Banking Supervision and Regulation

The Federal Reserve has supervisory issued a joint notice of proposed rule-
and regulatory authority over a variety making (NPR) describing proposals for
of financial institutions and activities. It implementing the Basel II framework in
works with other federal and state super- the United States. In December, they
visory authorities to ensure the safety issued an NPR proposing revisions to
and soundness of supervised financial capital requirements for trading book
institutions and the stability of U.S. positions subject to the market risk capi-
financial markets as a whole. tal rule. The agencies are also develop-
In 2006, U.S. banking organizations ing Basel II supervisory guidance for
reported record earnings despite tight examiners and the banking industry.
net interest margins resulting from a Under the NPR implementing Basel
persistently flat yield curve and height- II, the new capital framework would be
ened competition for deposits and loans. mandatory for large, internationally ac-
Credit quality indicators remained his- tive banking organizations and optional
torically strong, although nonperform- for all others. Federal banking supervi-
ing assets increased, particularly in resi- sors expect that the vast majority of
dential real estate portfolios. For a banking organizations will remain sub-
second consecutive year, there were no ject to the existing risk-based capital
failures of insured banks. Banking su- framework (Basel I). To update Basel I
pervisors focused on banking activities and mitigate some of the consequences
that could prove vulnerable in the event of the differences between Basel I and
of an economic downturn. In particular, Basel II, the agencies in December
the federal banking agencies during the issued an NPR proposing changes to the
year issued guidance for supervised Basel I framework that would be op-
financial institutions on extensions of tional for banking organizations not sub-
credit for nontraditional residential mort- ject to Basel II.
gages and for commercial real estate.
Delinquencies among loans of these and
most other types remained low. Scope of Responsibilities for
Federal Reserve staff continued to Supervision and Regulation
work throughout the year with the other The Federal Reserve is the federal su-
federal banking agencies to prepare for pervisor and regulator of all U.S. bank
U.S. implementation of the Basel II capi- holding companies, including financial
tal accord.1 In September, the agencies holding companies formed under the
authority of the 1999 Gramm-Leach-
1. The Basel II capital accord, an international Bliley Act, and state-chartered commer-
agreement formally titled “International Conver- cial banks that are members of the Fed-
gence of Capital Measurement and Capital Stan-
dards: A Revised Framework,” was developed by
eral Reserve System. In overseeing these
the Basel Committee on Banking Supervision, organizations, the Federal Reserve seeks
which is made up of representatives of the central
banks or other supervisory authorities of thirteen issued in November 2005 are available on the
countries. The original document was issued in web site of the Bank for International Settlements
2004; the original version and an updated version (
64 93rd Annual Report, 2006

primarily to promote their safe and and inspections and off-site surveillance
sound operation, including their compli- and monitoring. It also takes enforce-
ance with laws and regulations.2 ment and other supervisory actions as
The Federal Reserve also has respon- necessary.
sibility for supervising the operations of
all Edge Act and agreement corpora-
tions, the international operations of
Examinations and Inspections
state member banks and U.S. bank hold- The Federal Reserve conducts examina-
ing companies, and the U.S. operations tions of state member banks, the U.S.
of foreign banking companies. branches and agencies of foreign banks,
The Federal Reserve exercises impor- and Edge Act and agreement corpora-
tant regulatory influence over entry into tions. In a process distinct from exami-
the U.S. banking system, and the struc- nations, it conducts inspections of bank
ture of the system, through its adminis- holding companies and their nonbank
tration of the Bank Holding Company subsidiaries. Whether an examination or
Act, the Bank Merger Act (with regard an inspection is being conducted, the
to state member banks), the Change in review of operations entails (1) an as-
Bank Control Act (with regard to bank sessment of the quality of the processes
holding companies and state member in place to identify, measure, monitor,
banks), and the International Banking and control risks; (2) an assessment of
Act. The Federal Reserve is also respon- the quality of the organization’s assets;
sible for imposing margin requirements (3) an evaluation of management, in-
on securities transactions. In carrying cluding an assessment of internal poli-
out these responsibilities, the Federal cies, procedures, controls, and opera-
Reserve coordinates its supervisory ac- tions; (4) an assessment of the key
tivities with the other federal banking financial factors of capital, earnings, li-
agencies, state agencies, functional quidity, and sensitivity to market risk;
regulators, and the bank regulatory and (5) a review for compliance with
agencies of other nations. applicable laws and regulations. The table
provides information on the examinations
and inspections conducted by the Fed-
Supervision for eral Reserve during the past five years.
Safety and Soundness Inspections of bank holding compa-
nies, including financial holding compa-
To promote the safety and soundness of nies, are built around a rating system
banking organizations, the Federal Re- introduced in 2005 that reflects the re-
serve conducts on-site examinations cent shift in supervisory practices for
these organizations away from the his-
2. The Board’s Division of Consumer and torical analysis of financial condition
Community Affairs coordinates the Federal Re- toward a more dynamic, forward look-
serve’s supervisory activities with regard to com- ing assessment of risk-management
pliance with consumer protection and civil rights
laws. Those activities are described in the chapter practices and financial factors. Under
“Consumer and Community Affairs.” Supervision the system, known as RFI but more
for compliance with other banking laws and regu- fully termed RFI/C(D), holding compa-
lations, which is described in this chapter, is the nies are assigned a composite rating (C)
responsibility of the Board’s Division of Banking
Supervision and Regulation and the Federal Re-
that is based on assessments of three
serve Banks, whose examiners also check for components: risk management (R), fi-
safety and soundness. nancial condition (F), and potential
Banking Supervision and Regulation 65

State Member Banks and Holding Companies, 2002–2006

Entity/Item 2006 2005 2004 2003 2002

State member banks

Total number . . . . . . . . . . . . . . . . . . . . . . . . . . 901 907 919 935 949
Total assets (billions of dollars) . . . . . . . . . 1,405 1,318 1,275 1,912 1,863
Number of examinations . . . . . . . . . . . . . . . 761 783 809 822 814
By Federal Reserve System . . . . . . . . . . 500 563 581 581 550
By state banking agency . . . . . . . . . . . . . 261 220 228 241 264

Top-tier bank holding companies

Large (assets of more than $1 billion)
Total number . . . . . . . . . . . . . . . . . . . . . . . . 448 394 355 365 329
Total assets (billions of dollars) . . . . . . 12,179 10,261 8,429 8,295 7,483
Number of inspections . . . . . . . . . . . . . . . 566 501 500 454 439
By Federal Reserve System 1 . . . . . . . 557 496 491 446 431
On site . . . . . . . . . . . . . . . . . . . . . . . . . 500 457 440 399 385
Off site . . . . . . . . . . . . . . . . . . . . . . . . . 57 39 51 47 46
By state banking agency . . . . . . . . . . . 9 5 9 8 8
Small (assets of $1 billion or less)
Total number . . . . . . . . . . . . . . . . . . . . . . . . 4,654 4,760 4,796 4,787 4,806
Total assets (billions of dollars) . . . . . . 947 890 852 847 821
Number of inspections . . . . . . . . . . . . . . . 3,449 3,420 3,703 3,453 3,726
By Federal Reserve System . . . . . . . . 3,257 3,233 3,526 3,324 3,625
On site . . . . . . . . . . . . . . . . . . . . . . . . . 112 170 186 183 264
Off site . . . . . . . . . . . . . . . . . . . . . . . . . 3,145 3,063 3,340 3,141 3,361
By state banking agency . . . . . . . . . . . 192 187 177 129 101

Financial holding companies

Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 599 591 600 612 602
Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 38 36 32 30

1. For large bank holding companies subject to con-

tinuous, risk-focused supervision, includes multiple tar-
geted reviews.

impact (I) of the parent company and its processes for identifying, measuring,
nondepository subsidiaries on the sub- monitoring, and controlling risks. The
sidiary depository institution.3 The key features of the supervision program
fourth component, depository institution for large complex banking organizations
(D), is intended to mirror the primary (LCBOs) are (1) identifying those
regulator’s rating of the subsidiary de- LCBOs that are judged, on the basis of
pository institution. their shared risk characteristics, to
In managing the supervisory process, present the highest level of supervisory
the Federal Reserve takes a risk-focused risk to the Federal Reserve System;
approach that directs resources to (2) maintaining continual supervision of
(1) those business activities posing the these organizations so that the Federal
greatest risk to banking organizations Reserve’s assessment of each organiza-
and (2) the organizations’ management tion’s condition is current; (3) assigning
to each LCBO a supervisory team com-
posed of Reserve Bank staff members
3. Each of the first two components has four who have skills appropriate for the orga-
subcomponents: Risk Management—Board and nization’s risk profile (the team leader is
Senior Management Oversight; Policies, Proce- the System’s central point of contact for
dures, and Limits; Risk Monitoring and Manage-
ment Information Systems; and Internal Controls.
the organization, has responsibility for
Financial Condition—Capital; Asset Quality; only one LCBO, and is supported by
Earnings; and Liquidity. specialists capable of evaluating the
66 93rd Annual Report, 2006

risks of LCBO business activities and will incorporate this change into exist-
functions); and (4) promoting System- ing regulations are being developed. The
wide and interagency information- Federal Reserve conducted 500 exams
sharing through automated systems. of state member banks in 2006.
For other banking organizations, the
risk-focused supervision program pro- Bank Holding Companies
vides that examination procedures are
At year-end 2006, a total of 5,825 U.S.
tailored to each banking organization’s
bank holding companies were in opera-
size, complexity, and risk profile. As
tion, of which 5,102 were top-tier bank
with the LCBOs, examinations entail holding companies. These organizations
both off-site and on-site work, includ- controlled 6,106 insured commercial
ing planning, pre-examination visits, banks and held approximately 96 per-
detailed documentation, and examina- cent of all insured commercial bank
tion reports tailored to the scope and assets in the United States.
findings of the examination. Federal Reserve guidelines call for
annual inspections of large bank holding
State Member Banks companies as well as complex smaller
At the end of 2006, 901 state-chartered companies. In judging the financial con-
banks (excluding nondepository trust dition of the subsidiary banks owned by
companies and private banks) were holding companies, Federal Reserve ex-
members of the Federal Reserve Sys- aminers consult examination reports
tem. These banks represented approxi- prepared by the federal and state bank-
mately 12 percent of all insured U.S. ing authorities that have primary respon-
commercial banks and held approxi- sibility for the supervision of those
mately 14 percent of all insured com- banks, thereby minimizing duplication
mercial bank assets in the United States. of effort and reducing the supervisory
The guidelines for Federal Reserve burden on banking organizations. Non-
examinations of state member banks are complex bank holding companies with
fully consistent with section 10 of the consolidated assets of $1 billion or less
Federal Deposit Insurance Act, as are subject to a special supervisory pro-
amended by section 111 of the Federal gram that permits a more flexible ap-
Deposit Insurance Corporation Improve- proach.4 In 2006, the Federal Reserve
ment Act of 1991 and by the Riegle conducted 557 inspections of large bank
Community Development and Regula- holding companies and 3,257 inspec-
tory Improvement Act of 1994. A full- tions of small, noncomplex bank hold-
scope, on-site examination of these ing companies.
banks is required at least once a year,
although certain well-capitalized, well- Financial Holding Companies
managed organizations having total Under the Gramm-Leach-Bliley Act,
assets of less than $250 million may be bank holding companies that meet cer-
examined once every eighteen months. tain capital, managerial, and other re-
The Financial Services Regulatory Re-
lief Act of 2006, signed into law in 4. The program was implemented in 1997 and
October, authorized the federal banking modified in 2002. See SR letter 02-01 for a discus-
sion of the factors considered in determining
agencies to raise the total asset threshold whether a bank holding company is complex or
for certain institutions from $250 mil- noncomplex (
lion to $500 million. Interim rules that srletters/).
Banking Supervision and Regulation 67

quirements may elect to become finan- and agreement corporations, and bank
cial holding companies and thereby holding companies, the Federal Reserve
engage in a wider range of financial generally conducts its examinations or
activities, including full-scope securities inspections at the U.S. head offices of
underwriting, merchant banking, and in- these organizations where the ultimate
surance underwriting and sales. The stat- responsibility for the foreign offices lies.
ute streamlines the Federal Reserve’s Examiners also visit the overseas offices
supervision of all bank holding compa- of U.S. banks to obtain financial and
nies, including financial holding compa- operating information and, in some
nies, and sets forth parameters for the instances, to evaluate the organizations’
supervisory relationship between the efforts to implement corrective mea-
Federal Reserve and other regulators. sures or to test their adherence to safe
The statute also differentiates between and sound banking practices. Examina-
the Federal Reserve’s relations with tions abroad are conducted with the co-
regulators of depository institutions and operation of the supervisory authorities
its relations with functional regulators of the countries in which they take
(that is, regulators for insurance, securi- place; for national banks, the examina-
ties, and commodities firms). tions are coordinated with the Office of
As of year-end 2006, 604 domestic the Comptroller of the Currency (OCC).
bank holding companies and 44 foreign At the end of 2006, 53 member banks
banking organizations had financial were operating 675 branches in foreign
holding company status. Of the domes- countries and overseas areas of the
tic financial holding companies, 38 had United States; 34 national banks were
consolidated assets of $15 billion or operating 625 of these branches, and 19
more; 121, between $1 billion and state member banks were operating the
$15 billion; 86, between $500 million remaining 50. In addition, 17 nonmem-
and $1 billion; and 359, less than ber banks were operating 21 branches in
$500 million. foreign countries and overseas areas of
the United States.
International Activities
Edge Act and Agreement Corporations
The Federal Reserve supervises the for-
eign branches and overseas investments Edge Act corporations are international
of member banks, Edge Act and agree- banking organizations chartered by the
ment corporations, and bank holding com- Board to provide all segments of the
panies and also the investments by bank U.S. economy with a means of financing
holding companies in export trading com- international business, especially ex-
panies. In addition, it supervises the ac- ports. Agreement corporations are simi-
tivities that foreign banking organizations lar organizations, state chartered or fed-
conduct through entities in the United erally chartered, that enter into an
States, including branches, agencies, rep- agreement with the Board to refrain
resentative offices, and subsidiaries. from exercising any power that is not
permissible for an Edge Act corporation.
Foreign Operations of Sections 25 and 25A of the Federal
U.S. Banking Organizations Reserve Act grant Edge Act and agree-
ment corporations permission to engage
In supervising the international opera- in international banking and foreign
tions of state member banks, Edge Act financial transactions. These corpora-
68 93rd Annual Report, 2006

tions, most of which are subsidiaries of State-licensed and federally licensed

member banks, may (1) conduct a de- branches and agencies of foreign banks
posit and loan business in states other are examined on-site at least once every
than that of the parent, provided that the eighteen months, either by the Federal
business is strictly related to interna- Reserve or by a state or other federal
tional transactions, and (2) make foreign regulator. In most cases, on-site exami-
investments that are broader than those nations are conducted at least once ev-
permissible for member banks. ery twelve months, but the period may
At year-end 2006, 71 banking organi- be extended to eighteen months if the
zations, operating 9 branches, were branch or agency meets certain criteria.
chartered as Edge Act or agreement cor- In cooperation with the other federal
porations. These corporations are exam- and state banking agencies, the Federal
ined annually. Reserve conducts a joint program for
supervising the U.S. operations of for-
U.S. Activities of Foreign Banks eign banking organizations. The pro-
gram has two main parts. One part in-
The Federal Reserve has broad authority volves examination of those foreign
to supervise and regulate the U.S. activi- banking organizations that have mul-
ties of foreign banks that engage in tiple U.S. operations and is intended to
banking and related activities in the ensure coordination among the various
United States through branches, agen- U.S. supervisory agencies. The other
cies, representative offices, commercial part is a review of the financial and
lending companies, Edge Act corpora- operational profile of each organization
tions, commercial banks, bank holding to assess its general ability to support its
companies, and certain nonbanking U.S. operations and to determine what
companies. Foreign banks continue to risks, if any, the organization poses
be significant participants in the U.S. through its U.S. operations. Together,
banking system. these two processes provide critical in-
As of year-end 2006, 178 foreign formation to U.S. supervisors in a logi-
banks from 54 countries were operating cal, uniform, and timely manner. The
214 state-licensed branches and agen- Federal Reserve conducted or partici-
cies, of which 8 were insured by the pated with state and federal regulatory
Federal Deposit Insurance Corporation authorities in 339 examinations in 2006.
(FDIC), and 45 OCC-licensed branches,
of which 4 were insured by the FDIC.
These foreign banks also owned
12 Edge Act and agreement corpora-
tions and 2 commercial lending compa- The U.S. Department of the Treasury
nies; in addition, they held a controlling regulations (31 CFR 103) implementing
interest in 62 U.S. commercial banks. the Bank Secrecy Act (BSA) generally
Altogether, the U.S. offices of these for- require banks and other types of finan-
eign banks at the end of 2006 controlled cial institutions to file certain reports
approximately 19 percent of U.S. com- and maintain certain records that are
mercial banking assets. These 178 for- useful in criminal or regulatory proceed-
eign banks also operated 85 representa- ings. The BSA and separate Board regu-
tive offices; an additional 59 foreign lations require banking organizations su-
banks operated in the United States pervised by the Board to file reports on
solely through a representative office. suspicious activity related to possible
Banking Supervision and Regulation 69

violations of federal law, including operations in the financial industry, the

money laundering, terrorist financing, Federal Reserve reviews the informa-
and other financial crimes. In addition, tion technology activities of supervised
BSA and Board regulations require that banking organizations as well as certain
banks develop written programs on independent data centers that provide
BSA/anti-money-laundering compliance information technology services to these
and that the programs be formally ap- organizations. All safety and soundness
proved by bank boards of directors. An examinations include a risk-focused re-
institution’s compliance program must view of information technology risk
(1) establish a system of internal con- management activities. During 2006, the
trols to ensure compliance with the Federal Reserve was the lead agency in
BSA, (2) provide for independent com- 1 cooperative, multiagency examination
pliance testing, (3) identify individuals of a large, multiregional data processing
responsible for coordinating and monitor- servicer.
ing day-to-day compliance, and (4) pro-
vide training for personnel as appropriate. Fiduciary Activities
The Federal Reserve is responsible
for examining its supervised institutions The Federal Reserve has supervisory re-
for compliance with various anti- sponsibility for state member commer-
money-laundering laws and regulations. cial banks and depository trust compa-
During examinations of state member nies that together reported, at the end of
banks and U.S. branches and agencies of 2006, $36 trillion of assets in various
foreign banks and, when appropriate, fiduciary or custodial capacities. Addi-
inspections of bank holding companies, tionally, state member nondepository
examiners review the institution’s com- trust companies supervised by the Fed-
pliance with the BSA and determine eral Reserve reported $33 trillion of as-
whether adequate procedures and con- sets held in a fiduciary or custodial
trols to guard against money laundering capacity. During on-site examinations
and terrorism financing are in place. of fiduciary activities, an organization’s
compliance with laws, regulations, and
general fiduciary principles and poten-
Specialized Examinations tial conflicts of interest are reviewed;
The Federal Reserve conducts special- its management and operations, includ-
ized examinations of banking organiza- ing its asset- and account-management,
tions in the areas of information technol- risk-management, and audit and control
ogy, fiduciary activities, transfer agent procedures, are also evaluated. In 2006,
activities, and government and munici- Federal Reserve examiners conducted
pal securities dealing and brokering. The 97 on-site fiduciary examinations.
Federal Reserve also conducts special-
ized examinations of certain entities, Transfer Agents and
other than banks, brokers, or dealers, Securities Clearing Agencies
that extend credit subject to the Board’s
margin regulations. As directed by the Securities Exchange
Act of 1934, the Federal Reserve con-
Information Technology Activities ducts specialized examinations of those
state member banks and bank holding
In recognition of the importance of in- companies that are registered with the
formation technology to safe and sound Board as transfer agents. Among other
70 93rd Annual Report, 2006

things, transfer agents countersign and that dealt in municipal securities during
monitor the issuance of securities, regis- 2006, 9 were examined during the year.
ter the transfer of securities, and ex-
change or convert securities. On-site ex- Securities Credit Lenders
aminations focus on the effectiveness of Under the Securities Exchange Act of
an organization’s operations and its 1934, the Board is responsible for regu-
compliance with relevant securities lating credit in certain transactions
regulations. During 2006, the Federal involving the purchase or carrying of
Reserve conducted on-site examinations securities. As part of its general exami-
at 15 of the 78 state member banks and nation program, the Federal Reserve
bank holding companies that were regis- examines the banks under its jurisdic-
tered as transfer agents and examined tion for compliance with the Board’s
1 state member limited-purpose trust Regulation U (Credit by Banks and
company acting as a national securities Persons other than Brokers or Dealers
depository. for the Purpose of Purchasing or Carry-
ing Margin Stock). In addition, the Fed-
Government and Municipal Securities eral Reserve maintains a registry of per-
Dealers and Brokers sons other than banks, brokers, and
dealers who extend credit subject to
The Federal Reserve is responsible for
Regulation U. The Federal Reserve may
examining state member banks and for-
conduct specialized examinations of
eign banks for compliance with the Gov-
these lenders if they are not already
ernment Securities Act of 1986 and with
subject to supervision by the Farm
Department of the Treasury regulations
Credit Administration, the National
governing dealing and brokering in gov-
Credit Union Administration (NCUA),
ernment securities. Twenty-five state
or the Office of Thrift Supervision
member banks and 8 state branches of
foreign banks have notified the Board
At the end of 2006, 602 lenders other
that they are government securities deal-
than banks, brokers, or dealers were reg-
ers or brokers not exempt from Trea-
istered with the Federal Reserve. Other
sury’s regulations. During 2006, the
federal regulators supervised 210 of
Federal Reserve conducted 6 examina-
these lenders, and the remaining 392
tions of broker-dealer activities in gov-
were subject to limited Federal Reserve
ernment securities at these organiza-
supervision. On the basis of regulatory
tions. These examinations are generally
requirements and annual reports, the
conducted concurrently with the Federal
Federal Reserve exempted 290 lenders
Reserve’s examination of the state mem-
from its on-site inspection program. The
ber bank or branch.
securities credit activities of the remain-
The Federal Reserve is also respon-
ing 102 lenders were subject to either
sible for ensuring that both state mem-
biennial or triennial inspection. Sixty
ber banks and bank holding companies
inspections were conducted during the
that act as municipal securities dealers
comply with the Securities Act Amend-
ments of 1975. Municipal securities
dealers are examined pursuant to Business Continuity
the Municipal Securities Rulemaking
Board’s rule G-16 at least once every In 2006, the Federal Reserve continued
two calendar years. Of the 20 entities its efforts to strengthen the resilience of
Banking Supervision and Regulation 71

the U.S. financial system in the event of actions in 2006. Informal enforcement
unexpected disruptions. Throughout the actions include memoranda of under-
year, the staff continued to work with standing and board of directors resolu-
financial institutions to assess imple- tions. Information about these actions is
mentation of the sound practices identi- not available to the public.
fied in the April 2003 “Interagency Pa-
per on Sound Practices to Strengthen the
Resilience of the U.S. Financial Sys-
Surveillance and
tem,” a joint publication with the OCC
Off-Site Monitoring
and the Securities and Exchange Com- The Federal Reserve uses automated
mission (SEC). During 2006, the agen- screening systems to monitor the finan-
cies provided additional guidance to cial condition and performance of state
help institutions implement testing of member banks and bank holding compa-
their business continuity plans. The nies between on-site examinations. Such
agencies continue to coordinate their monitoring and analysis helps direct ex-
efforts to ensure a consistent supervi- amination resources to institutions that
sory approach for business continuity have higher risk profiles. Screening sys-
practices. tems also assist in the planning of ex-
aminations by identifying companies
that are engaging in new or complex
Enforcement Actions and activities.
Special Examinations In January 2006, the Federal Reserve
The Federal Reserve has enforcement replaced its primary off-site monitoring
authority over the banking organizations tool, SEER (System to Estimate
it supervises and their affiliated parties. Examination Ratings), with the Supervi-
Enforcement actions may be taken to sion and Regulation Statistical Assess-
address unsafe and unsound practices or ment of Bank Risk model (SR-SABR).
violations of any law or regulation. For- Drawing primarily on the financial data
mal enforcement actions include cease- that banks report on their Reports of
and-desist orders, written agreements, Condition and Income (Call Reports),
removal and prohibition orders, and civil SR-SABR uses econometric techniques
money penalties. In 2006, the Federal to identify banks that report financial
Reserve completed 37 formal enforce- characteristics weaker than those of
ment actions. Civil money penalties to- other banks assigned similar supervisory
taling $212,050 were assessed. All civil ratings. To supplement the SR-SABR
money penalties, as directed by statute, screening, the Federal Reserve also
are remitted to either the Department of monitors various market data, including
the Treasury or the Federal Emergency equity prices, debt spreads, agency rat-
Management Agency. Enforcement or- ings, and measures of expected default
ders, which are issued by the Board, and frequency, to gauge market perceptions
written agreements, which are executed of the risk in banking organizations. In
by the Reserve Banks, are made public addition, the Federal Reserve prepares
and are posted on the Board’s web quarterly Bank Holding Company
site( Performance Reports (BHCPRs) for use
enforcement). in monitoring and inspecting supervised
In addition to taking these formal en- banking organizations. The reports,
forcement actions, the Reserve Banks which are compiled from data provided
completed 70 informal enforcement by large bank holding companies in
72 93rd Annual Report, 2006

quarterly regulatory reports (FR Y-9C banks and supervisory authorities. Tech-
and FR Y-9LP), contain, for individual nical assistance involves visits by Fed-
companies, financial statistics and eral Reserve staff members to foreign
comparisons with peer companies. authorities as well as consultations with
BHCPRs are made available to the foreign supervisors who visit the Board
public on the National Information or the Reserve Banks. Technical assis-
Center web site, which can be accessed tance in 2006 was concentrated in Latin
at America, Asia, and former Soviet bloc
During the year, four major upgrades countries. The Federal Reserve, along
to the web-based Performance Report with the OCC, the FDIC, and the
Information and Surveillance Monitor- Department of the Treasury, was also an
ing (PRISM) application were com- active participant in the Middle East and
pleted. PRISM is a querying tool used North Africa Financial Regulators’
by Federal Reserve analysts to access Training Initiative, which is part of the
and display financial, surveillance, and U.S. government’s Middle East Partner-
examination data. In the analytical ship Initiative.
module, users can customize the pre- During the year the Federal Reserve
sentation of institutional financial infor- offered training courses exclusively for
mation drawn from Call Reports, Uni- foreign supervisory authorities in Wash-
form Bank Performance Reports, ington, D.C., and a number of foreign
FR Y-9 statements, BHCPRs, and other jurisdictions. System staff also took part
regulatory reports. In the surveillance
in technical assistance and training mis-
module, users can generate reports
sions led by the International Monetary
summarizing the results of surveillance
Fund, the World Bank, the Inter-
screening for banks and bank holding
American Development Bank, the Asian
companies. The upgrades made more
regulatory data available for querying, Development Bank, the Basel Commit-
added the results of surveillance tee on Banking Supervision, and the
screens (including SR-SABR), added Financial Stability Institute.
new search options, and improved the The Federal Reserve is also an asso-
user interface. ciate member of the Association of Su-
The Federal Reserve works through pervisors of Banks of the Americas
the Federal Financial Institutions Ex- (ASBA), an umbrella group of bank su-
amination Council (FFIEC) Task Force pervisors from countries in the Western
on Surveillance Systems to coordinate Hemisphere. The group, headquartered
surveillance activities with the other fed- in Mexico, promotes communication
eral banking agencies.5 and cooperation among bank supervi-
sors in the region; coordinates training
programs throughout the region, with
Technical Assistance the help of national banking supervisors
In 2006, the Federal Reserve continued and international agencies; and aims to
to provide technical assistance on bank help members develop banking laws,
supervisory matters to foreign central regulations, and supervisory practices
that conform to international best prac-
tices. The Federal Reserve contributes
5. The federal banking agencies that are mem-
significantly to ASBA’s organizational
bers of the FFIEC are the Federal Reserve Board, management and to its training and tech-
the FDIC, the NCUA, the OCC, and the OTS. nical assistance activities.
Banking Supervision and Regulation 73

Supervisory Policy and the advanced measurement ap-

proach for operational risk, would con-
The Federal Reserve’s supervisory tinue to be subject to the tier 1 leverage
policy function is responsible for devel- ratio requirement and the market risk
oping guidance for examiners and bank- capital rule, if applicable, as well as the
ing organizations as well as regulations prompt corrective action rules.
for banking organizations under the Fed-
eral Reserve’s supervision. Staff mem- Revisions to Market Risk Capital Rule
bers participate in supervisory and regu-
latory forums, provide support for the On September 25, 2006, the agencies
work of the FFIEC, and participate in issued for public comment a notice of
international forums such as the Basel proposed rulemaking proposing revi-
Committee on Banking Supervision, the sions to the market risk capital rule used
Joint Forum, and the International Ac- by the OCC, Board, and FDIC since
counting Standards Board. 1997 for banking organizations having
significant exposure to market risk. Un-
der the market risk capital rule, certain
Capital Adequacy Standards banking organizations are required to
calculate a capital requirement for the
Risk-Based Capital Standards for general market risk of their covered
Certain Internationally Active positions and the specific risk of their
Banking Organizations covered debt and equity positions. The
proposed revisions would enhance the
On September 25, 2006, the Federal
rule’s risk sensitivity, require the market
Reserve, OCC, FDIC, and OTS pub-
risk capital charge to reflect any incre-
lished a joint notice of proposed rule-
mental default risk of traded positions,
making (NPR) setting forth their views
and require public disclosure of certain
on Basel II and seeking public comment
qualitative and quantitative market risk
on the U.S. plan for implementing the
information. The comment period will
agreement. Under the proposal, the ba-
end on January 23, 2007.
sic minimum risk-based capital ratio
format—regulatory capital divided by
Risk-Based Capital Standards
risk-weighted assets—would be main-
for Banking Organizations
tained, with the minimum for tier 1 capi-
Not Subject to Basel II
tal set at 4 percent and the minimum for
total qualifying capital set at 8 percent. On December 26, 2006, the banking
The primary differences between the agencies issued for public comment an
current and proposed rules are the NPR proposing modifications to Basel I
internal-ratings-based methodologies that would be optional for banking orga-
used to calculate risk-weighted assets nizations not subject to Basel II. The
and the advanced measurement ap- proposals aim to enhance risk sensitivity
proach for operational risk under Ba- without unduly increasing regulatory
sel II. Banking organizations using the burden. They would expand the number
methods set forth in the NPR would also of risk-weight categories, allow the use
be subject to certain public disclosure of external credit ratings to risk-weight
requirements, to foster transparency and certain exposures, expand the range of
market discipline. All banking organiza- recognized collateral and eligible guar-
tions, including those using the internal- antors, use loan-to-value (LTV) ratios
ratings-based approach for credit risk to risk-weight residential mortgages,
74 93rd Annual Report, 2006

increase the credit conversion factor for fecting the banking industry in the areas
certain commitments having an original of accounting, auditing, internal con-
maturity of one year or less, assess a trols, disclosure, and supervisory finan-
capital charge for early amortizations in cial reporting. Federal Reserve staff
securitizations of revolving credit expo- members interact with key entities in the
sures, and remove the 50 percent limit accounting and auditing professions, in-
on the risk weight for certain over-the- cluding standards-setters and accounting
counter derivatives transactions. The firms, the other banking agencies, and
comment period for the NPR will end the banking industry, and issue su-
on March 26, 2007. pervisory guidance as appropriate.
During 2006, the Federal Reserve, to-
Other Capital Issues gether with the other banking agencies,
Board staff conduct supervisory analy- issued a comment letter to the Financial
ses of innovative capital instruments and Accounting Standards Board (FASB) on
novel transactions to determine whether its then-proposed Statement of Financial
such instruments qualify for inclusion in Accounting Standards titled The Fair
tier 1 capital.6 Much of this work in Value Option for Financial Assets and
2006 involved evaluating enhanced Financial Liabilities.7 The agencies also
forms of trust preferred securities that jointly issued guidance on loan and lease
bank holding companies developed in losses and on limitations on the liability
order to be granted more credit for eq- of external auditors.
uity by the rating agencies under the
Board’s 2005 revisions to the rule on the Policy Statement on the Allowance for
qualifying components of tier 1 capital. Loan and Lease Losses
Staff members also identify and
In December the Federal Reserve,
address supervisory concerns related to
FDIC, NCUA, OCC, and OTS issued
supervised banking organizations’ capi-
tal issuances and work with the Reserve “Interagency Policy Statement on the
Banks to evaluate the overall composi- Allowance for Loan and Lease Losses,”
tion of banking organizations’ capital. which updates and replaces earlier guid-
In this work, the staff often must ance on the methodology for calculating
review the funding strategies proposed the allowance for loan and lease losses
in applications for acquisitions and (ALLL). Revisions were made to ensure
other transactions submitted to the Fed- that policy is consistent with generally
eral Reserve by banking organizations. accepted accounting principles and with
recent supervisory guidance related to
the ALLL. Updated in the guidance are
Accounting Policy the responsibilities of boards of direc-
tors, management, and banking organi-
The supervisory policy function is also zation examiners; factors to be consid-
responsible for monitoring major do- ered in estimating the ALLL; and the
mestic and international proposals, stan- objectives and elements of an effective
dards, and other developments af- loan review system, including a sound
credit-grading system. The guidance
6. Tier 1 capital comprises common stockhold-
ers’ equity and qualifying forms of preferred stock, 7. The FASB issued the final standard, State-
less required deductions such as goodwill and ment of Financial Accounting Standard No. 159,
certain intangible assets. in February 2007.
Banking Supervision and Regulation 75

also reiterates the points of agreement implement a risk-based approach to

between the SEC and the banking agen- complying with the BSA.
cies since 1999. To assist in application In January, the Federal Reserve, the
of the revised guidance, the agencies Department of the Treasury’s Financial
also issued a supplemental document Crimes Enforcement Network, and the
anticipating frequently asked questions. other federal banking agencies issued
guidance on sharing Suspicious Activity
Advisory on Limitations on the Reports (SARs) with head offices or
Liability of External Auditors controlling companies. The guidance
confirmed that a U.S. branch or agency
The Federal Reserve, FDIC, NCUA,
of a foreign bank may disclose a SAR to
OCC, and OTS in May issued “Inter-
its head office outside the United States.
agency Advisory on the Unsafe and Un-
Similarly, a U.S. bank or savings asso-
sound Use of Limitation of Liability
ciation may disclose a SAR to its con-
Provisions in External Audit Engage-
trolling company, whether domestic or
ments.” The guidance addresses safety
and soundness concerns that may arise
In March, the Federal Reserve issued
when financial institutions enter into ex-
a final rule amending Regulation K (In-
ternal audit contracts that limit the audi-
ternational Banking Operations) to con-
tor’s liability for audit services. Specifi-
form the Board’s regulations to BSA
cally, the guidance informs financial
requirements and to clarify that Edge
institutions that the inclusion of certain
and agreement corporations and U.S.
auditor liability limitations in external
branches, agencies, and representative
audit contracts (typically referred to as
offices of foreign banks supervised by
engagement letters) for audits of finan-
the Federal Reserve must establish and
cial statements, audits of internal con-
maintain procedures reasonably de-
trol over financial reporting, or attesta-
signed to ensure and monitor compli-
tions on management’s assessment of
ance with the BSA and its implementing
internal control over financial reporting
is generally unsafe and unsound.
In April, the Federal Reserve and the
other federal banking agencies entered
Bank Secrecy Act and into a memorandum of understanding
Anti–Money Laundering with the Office of Foreign Assets Con-
trol within the Department of the Trea-
In 2006, the FFIEC updated the Bank sury to facilitate information-sharing
Secrecy Act/Anti–Money Laundering and to further enhance interagency coor-
Examination Manual issued in 2005 by dination in implementing U.S. sanctions
adding sections on risk assessment and rules.
automated clearinghouse transactions,
updating the section on trade finance,
and incorporating regulatory changes.
International Guidance on
The manual continues to contain an
Supervisory Policies
overview of Bank Secrecy Act (BSA) As a member of the Basel Committee on
and anti-money-laundering requirements Banking Supervision (Basel Commit-
and supervisory expectations, resource tee), the Federal Reserve participates in
materials, and examination procedures efforts to advance sound supervisory
and to emphasize a banking organiza- policies for internationally active bank-
tion’s responsibility to establish and ing organizations and to improve the
76 93rd Annual Report, 2006

stability of the international banking ance, “Core Principles for Effective Bank-
system. In 2006, the Federal Reserve ing Supervision,” was issued in October.
continued to work cooperatively on
Basel II, the 2004 accord to revise the Joint Forum
international capital regime, and to de- In 2006, the Federal Reserve also con-
velop international supervisory guid- tinued to participate in the Joint
ance. The Federal Reserve also contin- Forum—a group established under the
ued to participate in Basel Committee aegis of the Basel Committee to address
working groups to address issues not issues related to the banking, securities,
fully resolved in the Basel II framework. and insurance sectors, including the
regulation of financial conglomerates. It
Risk Management is made up of representatives of the
The Federal Reserve contributed to su- Basel Committee, the International Or-
pervisory policy papers, reports, and ganization of Securities Commissions,
recommendations issued by the Basel and the International Association of In-
Committee during 2006 that were gen- surance Supervisors. The Federal Re-
erally aimed at improving the super- serve contributed to the following super-
vision of banking organizations’ risk- visory policy papers, reports, and
management practices.8 recommendations issued by the Joint
Forum during 2006.9
• “Enhancing Corporate Governance for
Banking Organizations,” final paper • “Regulatory and Market Differences:
issued in February, updating guidance Issues and Observations,” issued in
published in 1999 May
• “Basel II: International Convergence • “The Management of Liquidity Risk
of Capital Measurement and Capital in Financial Groups,” issued in May
Standards: A Revised Framework— • “High-Level Principles for Business
Comprehensive Version,” published Continuity,” issued in August
in June
International Accounting
Core Principles for
Effective Banking Supervision The Federal Reserve participates in the
Basel Committee’s Accounting Task
The Core Principles, developed by the Force (ATF) and represents the Basel
Basel Committee in 1997, have become Committee at international meetings on
the de facto international standard for accounting, auditing, and disclosure is-
sound prudential regulation and supervi- sues affecting global banking organiza-
sion of banks. In 2006, the Federal Re- tions. During 2006, Federal Reserve
serve participated in a Basel Committee staff were involved in the development
effort to update the Core Principles in of two key Basel Committee documents
light of the significant changes in inter- issued to national supervisors and also
national banking regulation and experi- of various comment letters related to
ence gained since the principles were accounting and auditing that were sub-
last revised in 1999. The revised guid- mitted to the International Accounting

8. Papers issued by the Basel Committee can 9. Papers issued by the Joint Forum can be
be accessed via the Bank for International Settle- accessed via the Bank for International Settle-
ments web site at ments web site at
Banking Supervision and Regulation 77

Standards Board and the International • conducting a public service campaign

Auditing and Assurance Standards encouraging individuals affected by
Board. Hurricane Katrina to contact their
The Basel Committee document “Su- lenders (and also issuing a statement
pervisory Guidance on the Use of the encouraging financial institutions to
Fair Value Option for Financial Instru- work with their borrowers to assist
ments by Banks,” issued in June, pro- them in their financial recovery); and
vides guidance on the prudential super- • releasing “Lessons Learned from Hur-
vision of banks in their implementation ricane Katrina: Preparing Your Institu-
of the fair value option included in the tion for a Catastrophic Event,” a book-
amended International Accounting Stan- let describing financial institutions’
dard (IAS) 39, which became effective experiences with Hurricane Katrina
January 1, 2006. Under IAS 39, the fair and the lessons they learned that other
value option allows an organization to institutions might find helpful in con-
irrevocably elect, at the date of pur- sidering their readiness for a cata-
chase, a fair value measurement for cer- strophic event.
tain financial instruments and to record
in current earnings the gains and losses
resulting from changes in fair value.
Credit Risk Management
The Basel Committee document The Federal Reserve works with the
“Sound Credit Risk Assessment and other federal banking agencies to
Valuation for Loans,” issued in June, develop guidance on the management
provides guidance on assessing credit of credit risk.
risk and accounting for loan impair-
ment. Specifically, the document ad- Real Estate Appraisals
dresses supervisory expectations for, and Under the federal banking agencies’
supervisory evaluations of, a banking regulations on real estate appraisals,
organization’s establishment and sup- regulated institutions must ensure that
port of its loan-loss-allowance accounts. the appraisals they use in connection
with federally related transactions ad-
here to the Uniform Standards of Profes-
Response to Hurricane Katrina sional Appraisal Practice (USPAP). In
Since Hurricane Katrina, the federal June 2006, the Federal Reserve, FDIC,
banking agencies—the Federal Reserve, NCUA, OCC, and OTS issued an inter-
FDIC, NCUA, OCC, and OTS—and the agency statement informing regulated
state banking agencies in Alabama, institutions that the Appraisal Standards
Louisiana, and Mississippi have worked Board of the Appraisal Foundation had
together to monitor and support the made significant revisions to USPAP,
recovery efforts of financial institutions effective July 1, 2006; providing an
and their customers in the U.S. Gulf overview of the revisions; and discuss-
Coast region. In 2006, the interagency ing the ramifications of the revisions for
efforts included the institutions’ compliance with the
• developing examiner guidance on the
Home Equity Lending
agencies’ expectations related to as-
sessments of the financial condition of In September, the Federal Reserve,
institutions affected by the hurricane; FDIC, NCUA, OCC, and OTS issued an
78 93rd Annual Report, 2006

addendum to guidance issued in 2005— lease losses that reflect the collectibil-
“Interagency Credit Risk Management ity of the portfolio; and
Guidance for Home Equity Lending”—
• ensure that consumers have sufficient
that provided additional guidance on
information to understand the loan
managing the risks associated with
terms and the associated risks before
open-end home equity lines of credit they choose a product or a payment
(HELOCs) that have interest-only or arrangement.
negative amortization features. While
such HELOCs may give consumers
Commercial Real Estate
some flexibility, the agencies are con-
cerned that consumers may not fully
understand the product terms and asso- In December, the Federal Reserve,
ciated risks. The addendum addressed FDIC, and OCC issued guidance titled
the timing and content of communica- “Interagency Guidance on Concentra-
tions with consumers that are obtaining tions in Commercial Real Estate Lend-
HELOCs having these features and ing, Sound Risk Management Practices”
clarified the agencies’ expectations for to remind institutions that strong risk-
assessing borrower repayment capacity. management practices and appropriate
levels of capital are important elements
Nontraditional Mortgage Products of a sound lending program, particularly
if the institution has a concentration in
In September, the Federal Reserve, commercial real estate loans. The guid-
FDIC, NCUA, OCC, and OTS issued ance reinforced and enhanced existing
guidance, titled “Interagency Guidance regulations and guidelines for safe and
on Nontraditional Mortgage Product sound real estate lending. (For more in-
Risks,” that addresses risk-management formation, see the box “Guidance on
and consumer disclosure practices that Concentrations in Commercial Real Es-
institutions should employ to effectively tate Lending.”)
assess and manage the risks associated
with residential mortgage loans that
allow borrowers to defer repayment of Complex Structured Finance Activities
principal and, sometimes, interest (re- During the year, the Federal Reserve,
ferred to as nontraditional mortgage FDIC, OCC, OTS, and SEC prepared a
loans). Specifically, the guidance states final statement on sound practices for
that regulated institutions should complex structured finance transactions
• ensure that loan terms and underwrit- (CSFTs). The statement, to be issued in
ing standards are consistent with pru- early 2007, describes the types of inter-
dent lending practices (including, for nal controls and risk-management pro-
example, that they evaluate the bor- cedures that financial institutions should
rower’s repayment capacity); use to identify, manage, and address the
heightened legal and reputational risks
• recognize that many nontraditional that may arise from certain CSFTs.
mortgage loans, particularly those that (Excluded are most structured finance
have risk-layering features, are un- transactions that are familiar to partici-
tested in a stressed environment and pants in the financial markets and have
warrant strong risk-management stan- well-established track records—such as
dards, capital levels commensurate standard public mortgage-backed securi-
with risk, and allowances for loan and ties and hedging-type transactions in-
Banking Supervision and Regulation 79

volving “plain vanilla” derivatives or Board’s Small Bank Holding Company

collateralized debt obligations.) Finan- Policy Statement and (2) an exemption
cial institutions that engage in CSFTs from the Board’s risk-based and lever-
should, as part of their process for ap- age capital adequacy guidelines for
proving transactions and new products, bank holding companies. The final rule
establish and maintain policies, proce- also modifies the qualitative criteria
dures, and systems that are designed to used in determining whether a bank
identify elevated-risk CSFTs and should holding company that is under the
ensure that transactions and new prod- asset-size threshold nevertheless would
ucts so identified are subject to greater not qualify for the policy statement or
review by appropriate levels of manage- the exemption. In addition, the final
ment. An institution should decline to rule clarifies the treatment under
participate in an elevated-risk CSFT if it the policy statement of subordinated
determines that the transaction presents debt associated with trust preferred
unacceptable risks or would result in a securities.
violation of applicable laws, regulations,
or accounting principles.
Economic Growth and Regulatory
Paperwork Reduction Act of 1996
Banks’ Securities Activities The Economic Growth and Regulatory
In December, the Board and the SEC Paperwork Reduction Act of 1996 re-
requested comments on joint proposed quires that the federal banking agencies
rules that would help define the scope of review their regulations every ten years
securities activities that a bank may con- to identify and eliminate any unneces-
duct without registering with the SEC as sary requirements imposed on insured
a securities broker. The Gramm-Leach- depository institutions. (In addition, the
Bliley Act eliminated the blanket “bro- Board periodically reviews each of its
ker” exception for banks that had been regulations.) During 2006, the Federal
contained in section 3(a)(4) of the Secu- Reserve, OCC, FDIC, and OTS con-
rities Exchange Act of 1934, but it ducted the required review. Among
granted exceptions designed to allow other activities, they met with represen-
banks to continue to engage in securities tatives of the banking industry and of
transactions for customers in connection consumer groups around the country to
with their normal trust, fiduciary, custo- hear their concerns and their sugges-
dial, and other banking operations. The tions for reducing regulatory burden.
proposed rules would implement the The agencies expect to issue a final
most important “broker” exceptions. report in 2007.
Comments on the proposal are due by
March 26, 2007.
Bank Holding Company
Regulatory Financial Reports
Small Bank Holding Company The Federal Reserve requires that U.S.
Threshold bank holding companies periodically
In February, the Board issued a final submit reports providing financial and
rule that raises, from $150 million to structure information. This information
$500 million, the asset-size threshold is essential to the supervision of the
used to determine whether a bank hold- companies and the formulation of regu-
ing company qualifies for (1) the lations and supervisory policies. It is
80 93rd Annual Report, 2006

Guidance on Concentrations in Commercial Real Estate Lending

As any banker worth his or her salt knows, lending concentrations must be
carefully identified, monitored, and managed. It is one of the basics of banking to
understand the consequences of placing all your eggs in one basket. Naturally,
supervisors from time to time have concerns about growing credit risk concentra-
tions at banks and bankers’ ability to manage them.
Susan Schmidt Bies, Member, Board of Governors
June 2006

In response to rising concentrations of Risk Management Practices,” the agencies

commercial real estate (CRE) loans at recognize that financial institutions play a
many financial institutions, the Federal vital role in funding real estate develop-
Reserve, the Office of the Comptroller of ment in their communities and can do so in
the Currency, and the Federal Deposit In- a profitable way. However, as an institu-
surance Corporation on December 12, tion’s concentration in CRE lending in-
2006, issued guidance promoting sound creases, management should understand its
risk-management practices in this sector.1 possible exposure to a downturn in the
In the guidance, titled “Concentrations in CRE market or to other adverse market and
Commercial Real Estate Lending, Sound economic events.
Supervisors have observed over the past
decade that CRE concentrations have been
1. As defined by the guidance, CRE loans rising at many institutions, especially at
include land development and construction loans small and medium-size banks. Between
(including one- to four-family residential and 1993 and 2005, CRE loans as a proportion
commercial construction loans) and other land of total equity plus reserves rose from
loans; loans secured by multifamily property; 145 percent to 280 percent for commercial
and loans secured by nonfarm nonresidential banks with assets between $100 million
property for which 50 percent or more of the
source of repayment is third-party, nonaffiliated,
and $1 billion and from 120 percent to
rental income or the proceeds of the sale, refi- 230 percent for commercial banks with
nancing, or permanent financing of the property. assets of $1 billion to $10 billion. Experi-
The guidance also applies to some loans to real ence has shown that credit concentrations
estate investment trusts and unsecured loans to add a dimension of risk that compounds
developers. the simple risk inherent in individual loans.

also used in responding to requests from The reports are used to detect emerging
Congress and the public for information financial problems, to review perfor-
on bank holding companies and their mance and conduct pre-inspection
nonbank subsidiaries. Foreign banking analysis, to monitor and evaluate risk
organizations are also required to peri- profiles and capital adequacy, to evalu-
odically submit reports to the Federal ate proposals for bank holding company
Reserve. mergers and acquisitions, and to analyze
The FR Y-9 series of reports provides the holding company’s overall financial
standardized financial statements for condition. The nonbank subsidiary
bank holding companies on both a con- reports—FRY-11, FR 2314, and
solidated basis and a parent-only basis. FR Y-7N—help the Federal Reserve
Banking Supervision and Regulation 81

Further, supervisors are concerned that The agencies recognize that different
risk-management practices at some institu- types of CRE lending present different lev-
tions may not have kept pace with the els of risk. For example, a well-structured
growth of CRE concentrations. loan for a multifamily housing project
The agencies developed the 2006 CRE would generally have a lower risk profile
guidance to remind financial institutions than a loan for an office building to be built
that strong risk-management practices and on speculation. The guidance acknowl-
appropriate capital levels are important edges that institutions are in the best posi-
elements of a sound CRE lending program, tion to make such assessments about the
particularly when an institution has a con- level and nature of concentration risk in
centration in CRE loans or has experienced their CRE portfolios.
rapid portfolio growth. The guidance pro- Building upon the agencies’ existing
vides the agencies’ examiners with two regulations and guidelines for real estate
supervisory screening criteria designed to lending and loan portfolio management,
identify institutions whose CRE concentra- the guidance describes the key elements
tions may require additional scrutiny: that an institution should address in the
• Total loans for construction, land devel- areas of board and management oversight,
opment, and other land represent 100 portfolio management, management infor-
percent or more of the institution’s total mation systems, market analysis, credit-
capital; or underwriting standards, portfolio stress-
testing and sensitivity analysis, and the
• Total CRE loans represent 300 percent or credit-risk review function.
more of the institution’s total capital, and The Federal Reserve recognizes that
the outstanding balance of the institu- commercial real estate lending is a criti-
tion’s commercial real estate loan portfo- cally important activity that has become
lio has increased 50 percent or more the “bread and butter” business of many
during the previous thirty-six months. small and medium-size banks. Supervisors
These screening criteria serve as a start- emphasize that they did not intend the
ing point for a dialogue between the agen- guidance to limit commercial real estate
cies’ supervisory staff and an institution’s lending; rather, they expect that the guid-
management about the level and nature of ance will encourage institutions to develop
CRE concentration risk. The guidance fo- and maintain appropriate corporate-
cuses on CRE loans for which the risk of governance structures to address the risks
default is sensitive to CRE market demand, posed by their lending strategies.
capitalization rates, vacancy rates, or rents.

determine the condition of bank holding was raised from $150 million to
companies that are engaged in nonbank $500 million, reducing the number of
activities and also aid in monitoring the respondents by approximately 60 per-
volume, nature, and condition of the cent. Other FR Y-9C revisions effective
companies’ nonbank subsidiaries. March 31 included the elimination of a
In March, several revisions to the number of data items; the addition of
FR Y-9C, FR Y-9LP, and FR Y-9SP data items on loans for purchasing and
reports were approved for implementa- carrying securities, regulatory capital,
tion during 2006. Effective March 31, and credit derivatives; and the removal
the asset-size threshold for filing of the FR Y-9C filing requirement for
the FR Y-9C and FR Y-9LP reports lower-tier bank holding companies hav-
82 93rd Annual Report, 2006

ing total assets of $1 billion or more. Holding Companies and Change in

Revisions effective September 30 in- Bank Control).
cluded new officer signature require-
ments and additional data items on mort-
Commercial Bank
gage banking activities and secured Regulatory Financial Reports
Effective June 30, the asset-size cap As the federal supervisor of state mem-
for the FR Y-9SP was raised from ber banks, the Federal Reserve, along
$150 million to $500 million, increasing with the other banking agencies through
the number of respondents by approxi- the FFIEC, requires banks to submit
mately 50 percent. Other FR Y-9SP re- quarterly Consolidated Reports of Con-
visions effective June 30 included the dition and Income (Call Reports). Call
addition of two items identifying the Reports are the primary source of data
total value of off-balance-sheet activi- for the supervision and regulation of
ties conducted directly or through a non- banks and the ongoing assessment of the
bank subsidiary and the total value of overall soundness of the nation’s bank-
debt and equity securities registered ing system. Call Report data, which also
with the SEC. Revised officer signature serve as benchmarks for the financial
requirements for the FR Y-9SP were information required by many other
effective December 31. Federal Reserve regulatory financial re-
ports, are widely used by state and local
In March, the Board also revised the
governments, state banking supervisors,
asset-size threshold for the quarterly
the banking industry, securities analysts,
FR Y-11 and FR 2314 nonbank subsid-
and the academic community.
iary reports, to make it consistent with
For the 2006 reporting period, the
the revised threshold for the FR Y-9C FFIEC implemented various revisions
and to reduce reporting burden. Revis- to the Call Report to streamline the re-
ing the threshold for the FR Y-11 re- porting requirements and to add new
duced the number of quarterly respon- items that focus on areas of increasing
dents by approximately 30 percent; the supervisory concern. The principal revi-
revision had no immediate effect on the sions included the collection of data re-
number of FR 2314 filers. Other lated to the implementation of deposit
FR Y-11 and FR 2314 revisions effec- insurance reform provisions, funding
tive March 31 included the addition of a sources (Federal Home Loan Bank
new equity capital component to the advances and other borrowings), and
balance sheet for reporting partnership mortgage banking activities. The signa-
interest and, for the FR Y-11 only, the ture and attestation requirements were
expansion of the scope of several loan revised to add the chief financial officer,
items reported on the balance sheet or equivalent, to the list of officials re-
memoranda. quired to attest to and sign the Call
Effective December 31, a new report Report.
was implemented: the Annual Report of In October, the FFIEC proposed revi-
Merchant Banking Investments Held for sions for the 2007 reporting period to
an Extended Period (FR Y-12A). The address new safety and soundness con-
report collects data concerning mer- siderations and to facilitate supervision.
chant banking investments that are ap- Among the proposed revisions are
proaching the end of the holding period changes in data collection related to the
permissible under Regulation Y (Bank deposit insurance assessment collection
Banking Supervision and Regulation 83

process; changes in generally accepted compliance with best-practices and

accounting principles (including certain regulatory requirements.
financial instruments measured at fair
value and principles for accounting for
defined benefit pension and other post- National Information Center
retirement plans); and nontraditional
mortgage products. The National Information Center (NIC)
is the Federal Reserve’s comprehensive
repository for supervisory, financial, and
Supervisory Information banking structure data and supervisory
Technology documents. NIC includes comprehen-
sive data on banking structure through-
Information technology supporting Fed- out the United States; the National Ex-
eral Reserve supervisory activities is amination Database (NED), which
managed within the System supervisory enables supervisory personnel and state
information technology (SSIT) function banking authorities to access NIC data;
in the Board’s Division of Banking the Banking Organization National
Supervision and Regulation. SSIT Desktop (BOND), an application that
works through assigned staff at the facilitates secure, real-time electronic
Board and the Reserve Banks, as well information-sharing and collaboration
as through System committees, to among federal and state banking regula-
ensure that key staff members through- tors for the supervision of banking orga-
out the System participate in identify- nizations; and the Central Document and
ing requirements and setting priorities Text Repository (CDTR), which con-
for IT initiatives. tains documents supporting the supervi-
In 2006, the SSIT function worked on sory processes.
the following strategic projects and ini- The structure and supervisory data
tiatives: (1) align technology invest- systems are continually being updated
ments with business needs; (2) improve to extend their useful lives and improve
security of information-sharing tech- business workflow efficiency. During
nologies and provide for seamless 2006, the NED system was modified to
collaboration in interagency efforts; begin collecting Bank Secrecy Act
(3) identify and implement improve- information in an automated format, to
ments in the accessibility of technology support Federal Reserve enforcement
to staff working in the field; (4) identify activities. In 2006, the BOND and
opportunities to converge and stream- CDTR systems were modified to pro-
line IT applications, including key vide further integration with the Federal
administrative systems, to provide con- Reserve’s internal surveillance pro-
sistent and seamless information; gram, to provide additional support for
(5) evaluate and implement technolo- the supervision of large financial insti-
gies (such as portals, search engines, tutions, and to allow integration of
and content management tools) to examinations of technology service
integrate supervisory and management providers. In addition, user authentica-
information systems that support both tion software was upgraded for external
office-based and field staff; and agency users, and use of the BOND
(6) enhance the information security and CDTR systems was extended to
framework for the supervisory function, additional federal and state regulatory
improving both overall security and agencies.
84 93rd Annual Report, 2006

Staff Development ness or consumer affairs. In 2006, 190

examiners passed the first proficiency
The System Staff Development Program examination, and 61 passed the second
trains staff members at the Board, the proficiency examination: 53 the safety
Reserve Banks, state banking depart- and soundness exam, and 8 the con-
ments, and foreign supervisory authori- sumer affairs exam.
ties. Training is offered at the basic,
intermediate, and advanced levels in
several disciplines within bank supervi- Regulation of the
sion: safety and soundness, information
U.S. Banking Structure
technology, international banking, and The Federal Reserve administers several
consumer affairs. Classes are conducted federal statutes that apply to bank hold-
in Washington, D.C., as well as at ing companies, financial holding compa-
Reserve Banks and other locations. The nies, member banks, and foreign bank-
Federal Reserve System also partici- ing organizations—the Bank Holding
pates in training offered by the FFIEC Company Act, the Bank Merger Act, the
and by certain other regulatory agencies. Change in Bank Control Act, the Fed-
The System’s involvement includes de- eral Reserve Act, and the International
veloping and implementing basic and Banking Act. In administering these
advanced training in relation to various statutes, the Federal Reserve acts on a
emerging issues as well as in specialized variety of proposals that directly or indi-
areas such as international banking, in- rectly affect the structure of the U.S.
formation technology, anti–money laun- banking system at the local, regional,
dering, capital markets, payment sys- and national levels; the international op-
tems risk, and real estate appraisal. In erations of domestic banking organiza-
addition, the System co-hosts the World tions; or the U.S. banking operations of
Bank Seminar for supervisors from de- foreign banks. The proposals concern
veloping countries. bank holding company formations and
In 2006, the Federal Reserve trained acquisitions, bank mergers, and other
3,619 students in System schools, 952 in transactions involving bank or nonbank
schools sponsored by the FFIEC, and 24 firms. In 2006, the Federal Reserve
in other schools, for a total of 4,595, acted on 1,378 proposals, which repre-
including 312 representatives of foreign sented 3,171 individual applications
central banks and supervisory agencies filed under the five administered
(see table). The number of training days statutes.
in 2006 totaled 23,321.
The System gave scholarship assis-
tance to the states for training their ex-
Bank Holding Company Act
aminers in Federal Reserve and FFIEC Under the Bank Holding Company Act,
schools. Through this program, 605 state a corporation or similar legal entity
examiners were trained—308 in Federal must obtain the Federal Reserve’s
Reserve courses, 293 in FFIEC pro- approval before forming a bank holding
grams, and 4 in other courses. company through the acquisition of one
A staff member seeking an examin- or more banks in the United States.
er’s commission is required to take a Once formed, a bank holding company
first proficiency examination as well as must receive Federal Reserve approval
a second proficiency examination in one before acquiring or establishing addi-
of two specialty areas: safety and sound- tional banks. The act also identifies the
Banking Supervision and Regulation 85

Training Programs for Banking Supervision and Regulation, 2006

Number of sessions conducted

Total Regional

Schools or seminars conducted by the Federal Reserve

Core schools
Banking and supervision elements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 7
Financial analysis and risk management . . . . . . . . . . . . . . . . . . . . . . . . . . 8 7
Bank management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 1
Report writing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 15
Management skills . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 8
Conducting meetings with management . . . . . . . . . . . . . . . . . . . . . . . . . . 14 14

Other schools
Credit risk analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 4
Examination management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 5
Real estate lending seminar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2
Senior forum for current banking and regulatory issues . . . . . . . . . . . . 2 2
Basel II corporate activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2
Basel II operational risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 0
Basel II retail activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 1

Principles of fiduciary supervision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2

Commercial lending essentials for consumer affairs . . . . . . . . . . . . . . . 1 1
Consumer compliance examinations I . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 0
Consumer compliance examinations II . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2
CRA examination techniques . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2
CA risk-focused examination techniques . . . . . . . . . . . . . . . . . . . . . . . . . 2 2
Fair lending examination techniques . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 3

Foreign banking organizations seminar . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1

Information systems continuing education . . . . . . . . . . . . . . . . . . . . . . . . 7 7
Asset liability management (ALM1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2
Asset liability management (ALM2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1
Fundamentals of interest rate risk management . . . . . . . . . . . . . . . . . . . 8 8
Trading and operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1
Technology risk integration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 3

Leadership dynamics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 4
Fundamentals of fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 15
Information technology seminars1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 11
Seminar for senior supervisors of foreign central banks2
and 13 other international courses . . . . . . . . . . . . . . . . . . . . . . . . . . 34 26

Self-study or online learning 3

Orientation (core and specialty) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ... ...
Self-study modules (26 modules) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ... ...

Other agencies conducting courses 4

Federal Financial Institutions Examination Council . . . . . . . . . . . . . . . . . . 78 2
The Options Institute . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1

1. Held at the IT Lab at the Chicago Reserve Bank. 3. Self-study programs do not involve group sessions.
2. Conducted jointly with the World Bank. 4. Open to Federal Reserve employees.

nonbanking activities permissible for consider the financial and managerial

bank holding companies; depending on resources of the applicant, the future
the circumstances, these activities may prospects of both the applicant and the
or may not require Federal Reserve firm to be acquired, the convenience and
approval in advance of their com- needs of the community to be served,
mencement. the potential public benefits, the com-
When reviewing a bank holding com- petitive effects of the proposal, and the
pany application or notice that requires applicant’s ability to make available to
prior approval, the Federal Reserve may the Federal Reserve information deemed
86 93rd Annual Report, 2006

necessary to ensure compliance with company status must file a written dec-
applicable law. In the case of a foreign laration with the Federal Reserve. In
banking organization seeking to acquire 2006, 48 domestic financial holding
control of a U.S. bank, the Federal company declarations and 7 foreign
Reserve also considers whether the for- bank declarations were approved.
eign bank is subject to comprehensive
supervision or regulation on a consoli-
dated basis by its home-country supervi- Bank Merger Act
sor. In 2006, the Federal Reserve acted
on 638 applications filed by bank hold- The Bank Merger Act requires that all
ing companies to acquire a bank or a proposals involving the merger of
nonbank firm, or to otherwise expand insured depository institutions be acted
their activities. on by the appropriate federal banking
Bank holding companies generally agency. The Federal Reserve has pri-
may engage in only those nonbanking mary jurisdiction if the institution sur-
activities that the Board has previously viving the merger is a state member
determined to be closely related to bank- bank. Before acting on a merger pro-
ing under section 4(c)(8) of the Bank posal, the Federal Reserve considers
Holding Company Act. Since 1996, the the financial and managerial resources
act has provided an expedited prior- of the applicant, the future prospects of
notice procedure for certain permissible the existing and combined organiza-
nonbank activities and for acquisitions tions, the convenience and needs of the
of small banks and nonbank entities. community(ies) to be served, and the
Since that time the act has also permit- competitive effects of the proposed
ted well-run bank holding companies merger. In 2006, the Federal Reserve
that satisfy certain criteria to commence approved 65 merger applications under
certain other nonbank activities on a de the act.
novo basis without first obtaining Fed- As a result of enactment of the Finan-
eral Reserve approval. cial Services Regulatory Relief Act of
A bank holding company may repur- 2006, the Federal Reserve is no longer
chase its own shares from its sharehold- required for each proposed bank merger
ers. When the company borrows money to either request competitive factors re-
to buy the shares, the transaction ports from the other federal banking and
increases the company’s debt and de- thrift regulatory agencies or provide re-
creases its equity. The Federal Reserve ports on competitive factors to those
may object to stock repurchases by hold- other agencies. The Federal Reserve
ing companies that fail to meet certain now must consider only the views of the
standards, including the Board’s capital U.S. Department of Justice regarding the
adequacy guidelines. In 2006, the competitive aspects of a proposed bank
Federal Reserve reviewed 7 stock- merger. In addition, the views of the
repurchase proposals by bank holding Department of Justice need not be solic-
companies. ited for bank mergers involving affili-
The Federal Reserve also reviews ated insured depository institutions.
elections from bank holding companies Before these statutory changes occurred
seeking financial holding company sta- in the third quarter of 2006, the Federal
tus under the authority granted by the Reserve had submitted 451 reports
Gramm-Leach-Bliley Act. Bank holding on competitive factors to the other
companies seeking financial holding agencies.
Banking Supervision and Regulation 87

Change in Bank Control Act tain Federal Reserve approval to estab-

lish domestic branches, and all member
The Change in Bank Control Act re- banks (including national banks) must
quires individuals and certain other par- obtain Federal Reserve approval to es-
ties that seek control of a U.S. bank or tablish foreign branches. When review-
bank holding company to obtain ap- ing proposals to establish domestic
proval from the appropriate federal branches, the Federal Reserve consid-
banking agency before completing the ers, among other things, the scope and
transaction. The Federal Reserve is re- nature of the banking activities to be
sponsible for reviewing changes in the conducted. When reviewing proposals
control of state member banks and bank for foreign branches, the Federal
holding companies. In its review, the Reserve considers, among other things,
Federal Reserve considers the financial the condition of the bank and the bank’s
position, competence, experience, and experience in international banking. In
integrity of the acquiring person; the 2006, the Federal Reserve acted on new
effect of the proposed change on the and merger-related branch proposals for
financial condition of the bank or bank 2,033 domestic branches and granted
holding company being acquired; the prior approval for the establishment of 7
effect of the proposed change on compe- new foreign branches.
tition in any relevant market; the com- State member banks must also obtain
pleteness of the information submitted Federal Reserve approval to establish
by the acquiring person; and whether financial subsidiaries. These subsidiaries
the proposed change would have an ad- may engage in activities that are finan-
verse effect on the federal deposit insur- cial in nature or incidental to financial
ance funds. In addition, with enactment activities, including securities and insur-
of the Financial Services Regulatory Re- ance agency-related activities. In 2006,
lief Act of 2006, the Federal Reserve 1 application for a financial subsidiary
must also consider the future prospects was approved.
of the institution to be acquired: a pro-
posed transaction should not jeopardize
the stability of the institution or the Overseas Investments by
interests of depositors. During its review U.S. Banking Organizations
of a proposed transaction, the Federal U.S. banking organizations may engage
Reserve may contact other regulatory or in a broad range of activities overseas.
law enforcement agencies for informa- Many of the activities are conducted
tion about relevant individuals. indirectly through Edge Act and agree-
In 2006, the Federal Reserve ap- ment corporation subsidiaries. Although
proved 98 changes in control of state most foreign investments are made un-
member banks and bank holding der general consent procedures that in-
companies. volve only after-the-fact notification to
the Federal Reserve, large and other sig-
Federal Reserve Act nificant investments require prior ap-
proval. In 2006, the Federal Reserve
Under the Federal Reserve Act, a mem- approved 29 proposals for significant
ber bank may be required to seek Fed- overseas investments by U.S. banking
eral Reserve approval before expanding organizations. The Federal Reserve also
its operations domestically or interna- approved 16 applications to make addi-
tionally. State member banks must ob- tional investments through an Edge
88 93rd Annual Report, 2006

Act or agreement corporation, 1 applica- with U.S. law. In 2006, the Federal Re-
tion to establish an Edge Act corpora- serve approved 19 applications by for-
tion, and 2 applications to extend the eign banks to establish branches, agen-
corporate existence of an Edge Act cies, or representative offices in the
corporation. United States.

International Banking Act Public Notice of

The International Banking Act, as Federal Reserve Decisions
amended by the Foreign Bank Supervi- Certain decisions by the Federal Re-
sion Enhancement Act of 1991, requires serve that involve an acquisition by a
foreign banks to obtain Federal Reserve bank holding company, a bank merger, a
approval before establishing branches, change in control, or the establishment
agencies, commercial lending company of a new U.S. banking presence by a
subsidiaries, or representative offices in foreign bank are made known to the
the United States. public by an order or an announcement.
In reviewing proposals, the Federal Orders state the decision, the essential
Reserve generally considers whether the facts of the application or notice, and
foreign bank is subject to comprehen- the basis for the decision; announce-
sive supervision or regulation on a con- ments state only the decision. All orders
solidated basis by its home-country su- and announcements are made public im-
pervisor. It also considers whether the mediately; they are subsequently re-
home-country supervisor has consented ported in the Board’s weekly H.2 statis-
to the establishment of the U.S. office; tical release. The H.2 release also
the financial condition and resources of contains announcements of applications
the foreign bank and its existing U.S. and notices received by the Federal Re-
operations; the managerial resources of serve upon which action has not yet
the foreign bank; whether the home- been taken. For each pending applica-
country supervisor shares information tion and notice, the related H.2A con-
regarding the operations of the foreign tains the deadline for comments. The
bank with other supervisory authorities; Board’s web site (www.federalreserve.
whether the foreign bank has provided gov) provides information on orders and
adequate assurances that information announcements as well as a guide for
concerning its operations and activities U.S. and foreign banking organizations
will be made available to the Federal that wish to submit applications or no-
Reserve, if deemed necessary to deter- tices to the Federal Reserve.
mine and enforce compliance with
applicable law; whether the foreign bank
has adopted and implemented proce- Enforcement of
dures to combat money laundering and Other Laws and Regulations
whether the home country of the foreign
bank is developing a legal regime to The Federal Reserve’s enforcement re-
address money laundering or is partici- sponsibilities also extend to the disclo-
pating in multilateral efforts to combat sure of financial information by state
money laundering; and the record of the member banks and the use of credit to
foreign bank with respect to compliance purchase and carry securities.
Banking Supervision and Regulation 89

Financial Disclosures by rities. The Board’s Regulation X applies

State Member Banks these credit limitations, or margin re-
quirements, to certain borrowers and to
State member banks that issue securities
certain credit extensions, such as credit
registered under the Securities Exchange
obtained from foreign lenders by U.S.
Act of 1934 must disclose certain infor-
mation of interest to investors, including citizens.
annual and quarterly financial reports Several regulatory agencies enforce
and proxy statements. By statute, the the Board’s securities credit regula-
Board’s financial disclosure rules must tions. The SEC, the National Associa-
be substantially similar to those of the tion of Securities Dealers, and the
SEC. At the end of 2006, 17 state mem- national securities exchanges examine
ber banks were registered with the brokers and dealers for compliance
Board under the Securities Exchange with Regulation T. With respect to
Act of 1934. compliance with Regulation U, the fed-
eral banking agencies examine banks
under their respective jurisdictions; the
Securities Credit Farm Credit Administration, the
Under the Securities Exchange Act, the NCUA, and the OTS examine lenders
Board is responsible for regulating under their respective jurisdictions; and
credit in certain transactions involving the Federal Reserve examines other
the purchase or carrying of securities. Regulation U lenders.
The Board’s Regulation T limits the
amount of credit that may be provided
by securities brokers and dealers when Federal Reserve Membership
the credit is used to trade debt and
equity securities. The Board’s Regula- At the end of 2006, 2,593 banks were
tion U limits the amount of credit that members of the Federal Reserve System
may be provided by lenders other than and were operating 53,938 branches.
brokers and dealers when the credit is These banks accounted for 35 percent of
used to purchase or carry publicly held all commercial banks in the United
equity securities if the loan is secured by States and for 71 percent of all commer-
those or other publicly held equity secu- cial banking offices. Á

Consumer and Community Affairs

Among the Federal Reserve’s responsi- which implements the Electronic Fund
bilities in the areas of consumer and Transfer Act, and the associated com-
community affairs are mentary to make the regulation applica-
ble to payroll card accounts established
• writing and interpreting regulations to
through an employer to provide a con-
implement federal laws that protect
and inform consumers; sumer with electronic fund transfers of
salary, wages, or other employee com-
• supervising state member banks to en- pensation on a recurring basis. The
sure compliance with the regulations; Board also amended Regulation E to
• investigating complaints from the clarify that a person, such as a merchant,
public about state member banks’ must obtain a consumer’s authorization
compliance with regulations; and to collect returned-item fees electroni-
cally from the consumer’s account. The
• promoting community development in Board engaged in several rulemaking
historically underserved markets. and other activities with the other fed-
These responsibilities are carried out by eral banking agencies and the Federal
the members of the Board of Governors, Trade Commission (FTC). The Board,
the Board’s Division of Consumer and the Federal Deposit Insurance Corpora-
Community Affairs, and the consumer tion (FDIC), and the Office of the
and community affairs staff of the Fed- Comptroller of the Currency (OCC)
eral Reserve Banks. issued final guidance on the most recent
amendments to the agencies’ Commu-
nity Reinvestment Act (CRA) regula-
tions. The Board also issued joint final
Implementation of Statutes
guidance with the OCC, the FDIC, the
Designed to Inform and Protect
Office of Thrift Supervision (OTS), and
the National Credit Union Administra-
The Board of Governors writes regula- tion (NCUA) to address the risks associ-
tions to implement federal laws involv- ated with nontraditional mortgage prod-
ing consumer financial services and fair ucts. In addition, the Board and the FTC
lending. The Board revises and updates jointly issued a report to Congress on
these regulations to address the intro- the consumer dispute provisions of the
duction of new products and technolo- Fair Credit Reporting Act.
gies, to implement legislative changes to Furthermore, the Board raised the
existing laws, and to address problems dollar threshold that triggers additional
consumers may encounter in their finan- requirements under the Home Owner-
cial transactions. To interpret and clarify ship and Equity Protection Act and
the regulations, Board staff issue com- raised the exemption threshold for
mentaries and other guidance. depository institutions required to col-
During 2006, the Board published fi- lect data under the Home Mortgage Dis-
nal amendments to its Regulation E, closure Act.
92 93rd Annual Report, 2006

Amendments to Regulation E amendments clarify the consumer-

(Electronic Fund Transfers) authorization requirements for the elec-
tronic collection of returned-item fees.
Payroll Cards The final rule states that a person seek-
ing to collect a fee for a returned check
In August, the Board published final or any other item must obtain a con-
amendments to Regulation E that ad- sumer’s authorization to initiate an EFT
dress payroll card accounts established to collect this fee. This requirement
through an employer on behalf of a applies to the person initiating the EFT,
consumer and to which recurring elec- not to the consumer’s account-holding
tronic fund transfers of salary, wages, or financial institution. Consumer authori-
other employee compensation are made. zation is obtained when (1) a notice
Under the final rule, payroll card stating the specific amount of the fee
accounts are subject to the same require- (or explaining how the fee is calcu-
ments that apply to traditional transac- lated, if the fee may vary) and a state-
tion accounts under Regulation E; these ment that the fee will be collected via
requirements include a financial institu- an EFT is provided to the consumer
tion’s duty to provide payroll-card and (2) the consumer goes forward with
account holders with initial disclosures, the transaction. For point-of-sale trans-
periodic statements, and error-resolution actions, the notice must be posted in a
and liability provisions. For periodic prominent and conspicuous location,
statements, however, the final rule and a copy of the notice must be given
allows financial institutions to provide to the consumer to retain. The required
the specified account information elec- copy of the notice may be given to the
tronically, and in writing upon the con- consumer at the time of the transaction
sumer’s request, rather than through or mailed to the consumer’s address as
paper statements. soon as reasonably practicable after the
Regulation E applies to financial in- EFT has been initiated.
stitutions that (1) hold an account be-
longing to a consumer or (2) both issue Joint Guidance on the Community
an access device (such as a debit card) Reinvestment Act Regulations
to a consumer and agree with the con-
sumer to provide electronic fund trans- In March, the Board, along with the
fer (EFT) services. The final rule clari- FDIC and the OCC, issued joint final
fies that the depository institution guidance to implement changes to the
holding the consumer’s funds in a pay- agencies’ CRA regulations, which were
roll card account is a financial institu- effective in September 2005. The guid-
tion under the regulation. The final rule ance answers frequently asked questions
does not generally cover employers or about the new CRA rules, including a
third-party service providers. The man- new rule that provides CRA “commu-
datory compliance date for the final rule nity development” consideration for
is July 1, 2007. bank activities that revitalize or stabilize
designated disaster areas. The guidance
states that banks will receive consider-
Returned-Item Fees
ation for activities they conduct within
In December, the Board published a 36 months of an area’s designation as a
final rule amending Regulation E and disaster area when such activities help
its official staff commentary. These to attract new, or to retain existing, busi-
Consumer and Community Affairs 93

nesses or residents to the area and are for nontraditional mortgage products are
related to disaster recovery. consistent with prudent lending prac-
The guidance also implements a new tices, which include considering whether
rule that provides “community develop- a borrower has the capacity to repay a
ment” consideration for bank activities loan. The second section outlines the
that revitalize or stabilize underserved need for financial institutions to have
or distressed middle-income rural areas. strong risk-management standards, capi-
The guidance describes the types of ac- tal levels commensurate with the risk of
tivities that will receive consideration as their products and activities, and an al-
well as how such activities will be lowance for loan and lease losses that
evaluated. In addition, the guidance dis- reflects the collectibility of their loan
cusses the new community development portfolio. The third section describes
test for intermediate small banks (banks recommended practices to ensure that
that have assets of between $250 million financial institutions are providing con-
and $1 billion). sumers with clear and balanced informa-
tion that allows them to understand the
terms and associated risks of a loan
Interagency Guidance before they choose a specific product or
on the Risks of payment option. (See related box “Non-
Nontraditional Mortgage Products traditional Mortgages—Balancing Inno-
In September, the Board, along with the vation, Regulation, and Education.”)
OCC, the FDIC, the OTS, and the
NCUA, issued final guidance to address Report on Compliance with
the risks associated with the growing Consumer Dispute Provisions of
use of so-called nontraditional mortgage the Fair Credit Reporting Act
products, such as interest-only mort-
gages and payment-option adjustable- In August, the Board and the FTC issued
rate mortgages.1 These products, which a joint report to Congress pursuant to
allow borrowers to defer repayment of section 313(b) of the Fair and Accurate
the loan’s principal and sometimes inter- Credit Transactions Act of 2003 (the
est, are being offered to a wide spectrum FACT Act). In addition to other
of borrowers. Among other issues, the changes, the FACT Act amended the
interagency guidance addresses con- Fair Credit Reporting Act (FCRA) to
cerns that some borrowers may not fully enhance the FCRA’s consumer dispute
understand the risks of these products, provisions. The joint report describes
including their potential for negative the extent to which consumer reporting
amortization. agencies (CRAs) and furnishers of infor-
Specifically, the agencies provided mation to CRAs comply with the con-
guidance in three primary areas: loan sumer dispute provisions of the FCRA.
terms and underwriting standards, port- Before writing the report, the Board and
folio and risk-management practices, the FTC conducted a study that exam-
and consumer protection issues. The ined several sources of information:
first section of the guidance advises fi- public comments from consumers,
nancial institutions to ensure that their CRAs, and consumer and industry
loan terms and underwriting standards groups; consumer complaints sent to the
federal financial institution regulatory
1. See agencies; bank examination data on
bcreg/2006/20060929/default.htm. FCRA compliance; and other studies,
94 93rd Annual Report, 2006

Nontraditional Mortgages—
Balancing Innovation, Regulation, and Education

Homeownership has long been viewed as a later in the term of a nontraditional mort-
fundamental step to furthering personal gage in order to recapture repayment of
and financial well-being. A home is often principal. Because nontraditional mort-
the largest and most important asset gages typically allow a borrower to make
individuals and families acquire, and the lower payments early in the loan, these
equity earned on a home can, over time, loans have become increasingly popular in
provide homeowners with financial flex- high-cost housing markets.
ibility and security. Consumers have But nontraditional mortgages can also
benefited from public policies to encour- carry significant risk, including negative
age and facilitate homeownership, as well amortization, which occurs when the
as from innovations in the financial ser- amount of the loan increases over time, and
vices industry that have increased both the “payment shock,” which occurs when
number of lenders and types of home loans interest rate adjustments result in a much
available. While increased competition and higher payment later in the loan term. Fur-
product choice provide consumers with ther, reports of aggressive marketing prac-
new opportunities, they also present many tices for these loans, as well as reported
challenges for both borrowers, who must incidents of consumers receiving inad-
be prepared to evaluate their options, and equate or misleading loan disclosures, have
for regulators, who seek to ensure raised concerns among consumer groups,
consumer protections without hindering financial institution regulatory agencies,
market innovation through overly restric- and some lawmakers that nontraditional
tive regulation. mortgages are inappropriately marketed to
In recent years, so-called nontraditional and used by some borrowers. However, the
mortgages, including interest-only and need to ensure that consumer protections
payment-option adjustable-rate mortgages, are in place for nontraditional mortgages
have become increasingly popular. Origi- must be balanced with the desire to encour-
nally designed as niche products to meet the age innovation and flexibility in the mort-
needs of certain borrowers, such as wealthy gage industry.
customers or customers who have seasonal In 2006, the Federal Reserve Board took
or other fluctuations in their incomes, non- a multifaceted approach to responding to
traditional mortgages are now common- consumer-related issues in today’s mort-
place among more-typical borrowers. In gage market, including the risks presented
2006, nontraditional mortgages accounted by the growing use of nontraditional mort-
for one-third of all mortgage originations, gage products. During the summer, the
compared with only one-tenth of mortgage Board convened a series of public hearings
originations in 2003. Nontraditional mort- to discuss home equity lending markets
gages can provide borrowers with greater and practices. After conducting initial out-
flexibility by allowing them to repay only reach to an array of interested groups, Fed-
interest for a period of time or to choose eral Reserve regulatory and research staff
among other repayment options, in contrast structured the hearings to include discus-
to a fully amortizing loan that requires sion panels on the impact of the 2002
fixed payments throughout the loan term. changes to the Home Ownership and
The interest rate and payments are adjusted Equity Protection Act (HOEPA) regu-
Consumer and Community Affairs 95

lations, as well as panels on key issues in cludes an in-depth discussion of nontradi-

the mortgage market. Topics included tional mortgages and illustrations of how
trends and issues associated with complex loan payments may result in negative am-
products, such as nontraditional mortgages ortization.1 The Board also published a
and reverse mortgages, as well as efforts to consumer information brochure, “Interest-
provide consumers with pre- and post- Only Mortgage Payments and Payment-
purchase counseling and intervention, Option ARMs—Are They for You?,”
lender “best practices” and the role of which includes a glossary of lending terms,
mortgage brokers, and the results of re- a mortgage shopping worksheet, and a list
search on state predatory lending laws. The of additional information sources to help
hearings also explored consumer behavior consumers evaluate whether these types of
in shopping for mortgage loans and dis- loans are right for them.2 This publication
cussed the challenges of designing more stresses the importance of understanding
effective and informative consumer disclo- key mortgage loan terms, warns of the
sures. Both lenders and consumer advo- risks consumers may face, and urges bor-
cates participated in the hearings, which rowers to be realistic about whether they
enabled diverse viewpoints on both the can handle future payment increases. In
benefits and pitfalls of nontraditional mort- addition, interagency guidance on nontradi-
gages to be presented. tional mortgages, issued in September,
Lenders testified that nontraditional highlights the increased risk for lenders
mortgage loans are appropriately under- and borrowers that nontraditional mort-
written and have historically shown strong gages can present.3 The guidance discusses
performance. Consumer advocates and the importance of (1) carefully managing
state officials, on the other hand, testified the potential heightened risk levels, for
that aggressive marketing and the complex- the benefit of both lenders and borrowers;
ity of these products increase the risk that a (2) using prudent loan-structuring and
borrower will obtain a mortgage he or she -underwriting standards; (3) considering a
does not understand and might not be able borrower’s repayment capacity; and (4) en-
to afford. They also questioned whether suring that consumers have sufficient infor-
additional loan disclosures would only mation to understand the terms and risks
overwhelm consumers, because the prod- before making a loan or payment choice.
ucts are so complex. Board staff are consid- The mortgage industry has proven to be
ering the comments from these hearings, as innovative in developing a wide range of
well as insights gained from consumer fo- mortgage credit products. Through its su-
cus groups and other sources of informa- pervisory responsibilities, research, con-
tion, as they evaluate potential revisions to sumer education, and outreach to commu-
the mortgage disclosure requirements in nities and lenders, the Federal Reserve
Regulation Z. will continue to strive to balance such in-
Recognizing the important role of educa- novation in the financial services industry
tion in understanding mortgage transac- with responsive oversight and consumer
tions, the Board partnered with other fed- protection.
eral supervisory agencies to improve the
resources available to both consumers and
lenders on nontraditional mortgages. For 1.
consumers, the Federal Reserve, in partner- english.htm
ship with the Office of Thrift Supervision, interestonly/default.htm
updated the “Consumer Handbook on 3.
Adjustable-Rate Mortgages,” which in- 2006/20060929/default.htm
96 93rd Annual Report, 2006

reports, and data conducted or main- in the consumer price index. As a

tained by the federal financial institution result, depository institutions that
regulatory agencies. The report found have assets of $36 million or less as of
that most CRAs appear to be processing December 31, 2006, are exempt from
consumer disputes within the statutory data collection, effective January 1,
time frame; however, there was dis- 2007.
agreement as to the adequacy of the
dispute investigations conducted by
CRAs and furnishers of information to Supervision for Compliance
CRAs. with Consumer Protection and
To ensure that the FACT Act provi- Community Reinvestment Laws
sions enhancing the consumer dispute
process are given enough time to be
effective, the Board and the FTC did not Activities Related to the
recommend any additional administra- Community Reinvestment Act
tive or legislative actions at this time.
However, as discussed in the report, the The Community Reinvestment Act
FTC and the Board will continue to (CRA) requires that the Federal Reserve
monitor the performance of the dispute and other banking agencies encourage
process, explore possible enhancements, financial institutions to help meet the
and recommend actions, if appropriate. credit needs of the local communities in
which they do business, consistent with
safe and sound operations. To carry out
Other Regulatory Actions this mandate, the Federal Reserve
• examines state member banks to as-
The Board also took the following regu- sess their compliance with the CRA;
latory actions during 2006:
• analyzes applications for mergers and
• In August, the Board amended the acquisitions by state member banks
official staff commentary to Regula- and bank holding companies in rela-
tion Z to raise from $528 to $547 the tion to CRA performance; and
total dollar amount of points and fees
that triggers additional requirements • disseminates information on commu-
for certain mortgage loans under the nity development techniques to bank-
Home Ownership and Equity Protec- ers and the public through community
tion Act. As prescribed by that statute, affairs offices at the Reserve Banks.
the increased threshold (effective
January 1, 2007) reflects changes in Examinations for Compliance
the consumer price index. with the CRA
• In December, the Board amended the The Federal Reserve assesses and rates
official staff commentary to Regula- the CRA performance of state member
tion C to raise from $35 million to banks in the course of examinations con-
$36 million the asset-size exemption ducted by staff at the twelve Reserve
threshold for depository institutions Banks. During the 2006 reporting
required to collect data under the period, the Reserve Banks conducted
Home Mortgage Disclosure Act. As CRA examinations of 276 banks: 27
prescribed by that statute, the were rated Outstanding, 248 were rated
increased threshold reflects changes Satisfactory, none was rated Needs to
Consumer and Community Affairs 97

Improve, and one was rated Substantial cants were being denied mortgage loans
Noncompliance.2 more frequently than nonminority appli-
cants; other concerns described included
Analysis of Applications for potentially predatory lending practices
Mergers and Acquisitions in of subprime and payday lenders; poten-
Relation to the CRA tial adverse effects of branch closings;
During 2006, the Board considered and lenders’ failure to address the con-
applications for several significant bank- venience and needs of low- and
ing mergers. The Board approved the moderate-income communities. Many of
application by Capital One Financial the comments referenced pricing infor-
Corporation, McLean, Virginia, to ac- mation on residential mortgage loans
quire North Fork Bancorporation, Inc., that was required to be reported begin-
Melville, New York, in November; this ning with the 2004 Home Mortgage Dis-
acquisition was a major expansion of closure Act (HMDA) data. Comment-
Capital One Corporation’s relatively ers’ concerns that minority applicants
new retail banking operations. In addi- were more likely than nonminority
tion, three large bank holding compa- applicants to receive higher-priced mort-
nies, National City Corporation, in gages were largely based on observa-
Cleveland, Ohio; BB&T Corporation, in tions of the 2004 and 2005 HMDA pric-
Winston-Salem, North Carolina; and ing data.3
In total, the Board acted on twenty-
Marshall & Ilsley Corporation, in Mil-
four bank and bank holding company
waukee, Wisconsin, each acquired two
applications that involved protests by
large banking organizations in 2006.
members of the public concerning the
Several other significant applications
CRA performance of insured depository
are listed below.
institutions. The Board also reviewed
• An application by Trustmark Corpora- thirty-six applications involving other
tion, Jackson, Mississippi, to acquire issues related to CRA, fair lending, or
Republic Bancshares of Texas, Inc., compliance with consumer credit pro-
Houston, Texas, was approved in tection laws.4
• An application by Wachovia Corpora- Other Consumer Compliance
tion, Charlotte, North Carolina, to Activities
acquire Golden West Financial Cor-
poration, Oakland, California, was ap- The Division of Consumer and Commu-
proved in September. nity Affairs supports and oversees the
supervisory efforts of the Reserve Banks
• An application by Regions Financial to ensure that consumer protection laws
Corporation, Birmingham, Alabama, and regulations are fully and fairly en-
to acquire AmSouth Bancorporation,
also of Birmingham, was approved in 3. HMDA requires lenders to collect price infor-
October. mation on loans they originated in the higher-
priced segment of the home-loan market. “Higher-
The public submitted comments on priced mortgages” refers to mortgage loans whose
each of these applications. Commenters annual percentage rates are 3 percentage points or
expressed concerns that minority appli- more over the yield on comparable Treasury secu-
rities on first-lien loans, and 5 percentage points or
more over that yield on junior-lien loans.
2. The 2006 reporting period for examination 4. In addition, four applications involving con-
data was July 1, 2005, through June 30, 2006. sumer compliance issues were withdrawn.
98 93rd Annual Report, 2006

forced. Division staff provide guidance equately met the needs of their assess-
and expertise to the Reserve Banks on ment areas. (See “Response to the 2005
consumer protection regulations, exami- Hurricanes” later in this chapter.”)
nation and enforcement techniques, ex-
aminer training, and emerging issues. Fair Lending
The staff develop and update examina-
tion policies, procedures, and guide- The Federal Reserve is committed to
lines, as well as review Reserve Bank ensuring that every institution it super-
supervisory reports and work products. vises complies fully with the federal fair
They also participate in interagency ac- lending laws—the Equal Credit Oppor-
tivities that promote uniformity in ex- tunity Act (ECOA) and the Fair Housing
amination principles and standards. Act. Fair lending reviews are conducted
Examinations are the Federal Re- regularly within the supervisory cycle.
serve’s primary means of enforcing Additionally, examiners may conduct
compliance with consumer protection fair lending reviews outside of the usual
laws. During the 2006 reporting period, supervisory cycle, if warranted. To pro-
the Reserve Banks conducted 321 con- mote rigorous and consistent fair lend-
sumer compliance examinations—303 ing enforcement, the Division of Con-
of state member banks and 18 of foreign sumer and Community Affairs staff
banking organizations.5 coordinate investigations of potential
The Board periodically issues guid- fair lending violations with Reserve
ance for Reserve Bank examiners on Bank staff.
consumer protection laws and regula- The Federal Reserve enforces the
tions. In addition to updating examina- ECOA and the provisions of the Fair
tion procedures and guidance in concert Housing Act that apply to lending insti-
with the other federal financial institu- tutions. The ECOA prohibits creditors
tion regulatory agencies, the Board from discriminating against any appli-
issued guidance on state member banks’ cant, in any aspect of a credit transac-
activities in disaster areas affected by tion, on the basis of race, color, reli-
the 2005 hurricanes in the Gulf Coast gion, national origin, sex, marital sta-
region.6 As put forth in the guidance, tus, or age. In addition, creditors may
state member banks located outside of not discriminate against an applicant
the hurricane disaster areas will receive because the applicant receives income
CRA consideration for their activities from a public assistance program or has
that revitalize or stabilize the disaster exercised, in good faith, any right under
areas, if the banks have otherwise ad- the Consumer Credit Protection Act.
The Fair Housing Act prohibits dis-
5. The foreign banking organizations examined crimination in residential real estate–
by the Federal Reserve are organizations operating related transactions, including the mak-
under section 25 or 25A of the Federal Reserve ing and purchasing of mortgage loans,
Act (Edge Act and agreement corporations) and on the basis of race, color, religion,
state-chartered commercial lending companies
owned or controlled by foreign banks. These insti- national origin, handicap, familial sta-
tutions are not subject to the Community Reinvest- tus, or sex.
ment Act and typically engage in relatively few Pursuant to the ECOA, if the Board
activities that are covered by consumer protection has reason to believe that a creditor has
6. The guidance was released in a letter (CA
engaged in a pattern or practice of dis-
06-5) to the Reserve Banks on February 24, 2006 crimination in violation of the ECOA,
( the matter will be referred to the Depart-
Consumer and Community Affairs 99

ment of Justice. If a violation of the • Two state member banks were found
ECOA also constitutes a violation of to have engaged in discrimination on
the Fair Housing Act and a referral is the basis of marital status in their
not made to the Department of Justice, pricing of auto loans, in violation of
the matter will be referred to the the ECOA. The banks used rate sheets
Department of Housing and Urban that expressly provided that non-
Development. spousal co-applicants (applicants who
During 2006, the Board referred the were not married to each other) should
following matters to the Department of be charged higher interest rates.
Justice, on the basis of these findings:
• The Board determined that a state
• The Board determined that a mort- member bank discriminated on the
gage company owned by a state basis of age, in violation of the ECOA,
member bank had engaged in red- by offering customers over 50 years of
lining—that is, discrimination against age a special account with preferential
potential borrowers on the basis of credit features. The “over 50” account
the racial composition of their provided for an interest rate reduction
neighborhoods—in violation of the on consumer loans if payment was
ECOA and the Fair Housing Act. The made through automatic debit. This
mortgage company had adopted a interest rate reduction was not offered
marketing strategy that was based on to borrowers who did not have an
negative racial stereotypes and, as a “over 50” account. The ECOA gener-
result, excluded a cluster of minority ally prohibits creditors from consider-
neighborhoods from its lending ing age when evaluating creditworthi-
activity. ness, except that a creditor may
consider the age of an applicant
• The Board found that a state member 62 years or older in the applicant’s
bank had violated the ECOA and the favor.
Fair Housing Act by discriminating
against several mortgage applicants on Since the addition of pricing informa-
the basis of race and national origin.7 tion to the data reported under HMDA,
The bank rejected several minority the Federal Reserve has used the pricing
applicants on the basis of “insufficient data to facilitate its fair lending enforce-
collateral” without ordering an ap- ment efforts. (See “Reporting on Home
praisal, even though, in contrast, the Mortgage Disclosure Act Data” later in
bank did not deny any white appli- this chapter.) The Federal Reserve does
cants for insufficient collateral with- not rely on HMDA data alone in its
out ordering an appraisal. enforcement efforts, however, because
HMDA data do not include many
potential determinants of loan pricing,
such as the borrower’s credit history
7. The Board referred this case to the Depart- and the loan-to-value ratio. Instead, the
ment of Justice in December 2005. It was not Federal Reserve analyzes the HMDA
included in the 2005 Annual Report because the pricing data in conjunction with other
referral occurred outside the reporting period for fair lending risk factors—such as
the 2005 report (July 1, 2004, through June 30,
2005). It is included in the 2006 Annual Report,
discretionary pricing and incentives for
which otherwise reports referrals occurring during loan officers to charge higher prices—to
the 2006 calendar year. identify lenders that are at risk for pric-
100 93rd Annual Report, 2006

ing discrimination.8 These lenders will Coordination with

receive a targeted pricing review. Dur- Other Federal Banking Agencies
ing a targeted pricing review, exam-
iners collect additional information The member agencies of the Federal
(including factors that are not available Financial Institutions Examination
in the HMDA data) to determine Council (FFIEC) develop uniform ex-
whether a pricing disparity by race or amination principles, standards, proce-
ethnicity is fully attributable to legiti- dures, and report formats.9 In 2006, the
FFIEC revised examination procedures
mate factors, or whether any portion of
for the Fair Credit Reporting Act
the pricing disparity is attributable to
(FCRA). Section 604(g) of the FCRA
generally prohibits creditors from ob-
taining and using medical information
Flood Insurance in connection with any determination of
a consumer’s eligibility, or continued
The National Flood Insurance Act im- eligibility, for credit unless permitted by
poses certain requirements on loans se- regulation. The agencies have issued
cured by buildings or mobile homes lo- regulations creating exceptions to the
cated in, or to be located in, areas statute’s general prohibition; therefore,
determined to have special flood haz- the FCRA examination procedures have
ards. Under the Federal Reserve’s Regu- been revised to reflect these new regula-
lation H, which implements the act, state tions. In addition, the FFIEC revised the
member banks are generally prohibited CRA examination procedures for large
from making, extending, increasing, or banks, small banks, wholesale or
renewing any such loan unless the build- limited-purpose banks, and banks oper-
ing or mobile home and any personal ating under strategic plans. The revi-
property securing the loan are covered sions incorporate the CRA regulatory
by flood insurance for the term of the changes that were approved in 2005.
loan. The act requires the Board and In 2006, the four banking agencies
other federal financial institution regula- (the FDIC; the Federal Reserve, the
tory agencies to impose civil money OCC; and the OTS) convened the first
penalties when it finds a pattern or prac- Interagency Consumer Affairs Confer-
tice of violations of the regulation. The ence. The conference’s objectives were
civil money penalties are payable to to (1) discuss the banking regulatory
the Federal Emergency Management issues that affect consumers, (2) deter-
Agency for deposit into the National mine more-effective ways for the agen-
Flood Mitigation Fund. cies to share information about the com-
During 2006, the Board imposed civil plaints they receive, and (3) identify
money penalties against four state mem- best practices for communicating and
ber banks. The penalties, which were interacting with the public. These agen-
assessed via consent orders, totaled cies plan to hold regular consumer

9. The FFIEC member agencies are the Board

of Governors of the Federal Reserve System, the
Federal Deposit Insurance Corporation (FDIC),
8. See the Interagency Fair Lending Examina- the Office of the Comptroller of the Currency
tion Procedures for a full discussion of fair lending (OCC), the Office of Thrift Supervision (OTS), and
risk factors ( the National Credit Union Administration (NCUA).
Consumer and Community Affairs 101

affairs conferences; the next conference The FFIEC member agencies, along
is scheduled for October 2007. with state financial institution regula-
Finally, the Board, the OCC, and the tors, also conducted a public service
FDIC updated the host-state loan-to- campaign to encourage banks, thrifts,
deposit ratios used to determine compli- and credit unions to continue working
ance with section 109 of the Riegle- with borrowers affected by Hurricane
Neal Interstate Banking and Branching Katrina or Hurricane Rita. Public ser-
Efficiency Act of 1994.10 vice announcements (PSAs) were dis-
tributed to radio stations and print pub-
lications in geographic areas that had
Response to 2005 Hurricanes the highest concentrations of people af-
fected by the hurricanes. The radio
In 2006, the Federal Reserve and the PSAs played more than 1,495 times on
other banking agencies continued initia- thirty-one stations, reaching an esti-
tives to help financial institutions af- mated audience of 4.13 million people
fected by the 2005 hurricanes in the in the targeted regions. The print PSAs
Gulf Coast. The Board, the FDIC, the appeared more than sixteen times in ten
OCC, and the OTS sponsored an inter- newspapers and other local publications,
agency forum, “The Future of Banking reaching approximately 565,000 people.
in the Gulf Coast: Helping Banks and
Thrifts Rebuild Communities,” that fo-
cused on the short-term and long-term Training for Bank Examiners
challenges facing these financial institu- Ensuring that financial institutions com-
tions, including how they can help meet ply with laws that protect consumers
the needs of their local communities. In and encourage community reinvestment
addition to officials from the sponsoring is an important part of the bank exami-
agencies, senior executives from both nation and supervision process. As the
large and small financial institutions and number and complexity of consumer
representatives from community devel- financial transactions grow, training for
opment corporations and a number of examiners of the organizations under
other federal agencies participated in the the Federal Reserve’s supervisory re-
forum. sponsibility becomes even more impor-
The FFIEC member agencies and the tant. The consumer compliance exam-
Conference of State Bank Supervisors iner training curriculum consists of six
released a booklet, “Lessons Learned courses focused on various consumer
from Hurricane Katrina: Preparing Your protection laws, regulations, and exam-
Institution for a Catastrophic Event.”11 ining concepts. In 2006, these courses
Using financial institutions’ experiences were offered in ten sessions to more
and lessons learned during Hurricane than 195 consumer compliance examin-
Katrina and its aftermath, the booklet is ers and System staff members.
intended to help other institutions plan Board and Reserve Bank staff regu-
for an emergency or a catastrophic larly review the core curriculum for ex-
event. aminer training, updating subject matter
and adding new elements as appropriate.
10. See the June 13, 2006, press release During 2006, staff conducted curricu-
lum reviews of the following two
11. The booklet is available on the FFIEC’s courses in order to incorporate technical
web site ( changes in policy and laws, along with
102 93rd Annual Report, 2006

changes in instructional delivery requires most mortgage lenders located

techniques: in metropolitan areas to collect data
about their housing-related lending ac-
• Community Reinvestment Act Exami-
tivity, report the data annually to the
nation Techniques Course. Equips as-
government, and make the data publicly
sistant examiners to participate in all
aspects of a CRA examination, includ- available. In 1989, Congress expanded
ing the evaluation of a bank’s CRA the data required by HMDA to include
program and the determination of its information about loan applications that
CRA rating. did not result in a loan origination, as
well as information about the race, sex,
• Fair Lending Examination Techniques and income of applicants and borrowers.
Course. Provides assistant examiners In response to the growth of the
with the skills and knowledge to plan subprime-loan market, the Federal
and conduct the risk-focused fair lend- Reserve updated Regulation C in 2002.
ing portion of a consumer compliance The revisions, which became effective
examination. in 2004, require lenders to collect price
When appropriate, courses are deliv- information for loans they originated in
ered via alternative methods, such as the the higher-priced segment of the home-
Internet or other distance-learning tech- loan market. When applicable, lenders
nologies. The CRA course discussed report the number of percentage points
above uses a combination of instruc- by which a loan’s annual percentage
tional methods: (1) classroom instruc- rate exceeds the threshold that defines
tion focused on case studies and “higher-priced loans.” The threshold is
(2) specially developed computer-based 3 percentage points or more above the
instruction that includes interactive self- yield on comparable Treasury securities
check exercises. The computer-based for first-lien loans, and 5 percentage
instruction is reinforced through daily points or more above that yield for
conference calls and discussions on junior-lien loans. The HMDA data col-
electronic bulletin boards. The Fair lected in 2004 and released to the pub-
Lending course discussed above also lic in 2005 provided the first publicly
uses computer-based training. available loan-level data about loan
In addition to providing core training, prices. The FFIEC released the 2005
the examiner curriculum emphasizes the HMDA data to the public in September
importance of continuing professional 2006.
development. Opportunities for continu- A September 2006 article published
ing development include special projects by Federal Reserve staff in the Federal
and assignments, self-study programs, Reserve Bulletin uses the 2005 data to
rotational assignments, the opportunity describe the market for higher-priced
to instruct at System schools, mentoring loans and patterns of lending across loan
programs, and an annual senior exam- products, geographic markets, and bor-
iner forum. rowers and neighborhoods of different
races and incomes.12
As in 2004, relatively few lenders
Reporting on Home Mortgage accounted for most of the higher-priced
Disclosure Act Data
12. The complete article is available at
The Home Mortgage Disclosure Act
(HMDA), enacted by Congress in 1975, bull06hmda.pdf.
Consumer and Community Affairs 103

loan originations in 2005. Of the 8,850 on the West Coast also had an elevated
home lenders reporting HMDA data, incidence of higher-priced lending in
1,120 of them made 100 or more higher- 2005. For example, in many metropoli-
priced loans. The 10 home lenders that tan areas in the South, Southwest, and
had the largest volume of higher-priced West, 30 percent to 40 percent of the
loans accounted for about 59 percent of homebuyers who obtained conventional
all such loans. Higher-priced lending is loans in 2005 received higher-priced
also concentrated by price: in 2005, the loans.
vast majority of higher-priced loans had Third, the incidence of higher-priced
annual percentage rates within 3 per- lending varies greatly among borrowers
centage points of the reporting thresh- of different races and ethnicities. In
olds. As in 2004, the majority of all 2005, as in 2004, blacks and Hispanics
loan originations were not higher priced were much more likely than non-
in 2005, however, the incidence of Hispanic whites and Asians to receive
higher-priced lending did increase higher-priced loans. For example, in
substantially—26.2 percent in 2005, 2005, 55 percent of black borrowers,
compared with 15.5 percent in 2004. and 46 percent of Hispanic borrowers,
Some of the increase in the incidence received higher-priced home-purchase
of higher-priced lending is attributed to loans, compared with only 17 percent of
changes in the interest rate environment non-Hispanic white or Asian borrowers.
from 2004 to 2005, as well as to To a large extent, these differences re-
changes in borrower profiles and lender flect a segmentation of the home-loan
practices. market, that is, black and Hispanic bor-
Loan pricing is a complex process rowers were much more likely to obtain
that may reflect a wide variety of fac- mortgage loans from institutions that
tors about the level of risk a particular specialize in higher-priced lending.
loan or borrower presents to the lender. Because HMDA data lack informa-
As a result, the prevalence of higher- tion about credit risk and other legiti-
priced lending varies widely. First, the mate pricing factors, it is not possible to
incidence of higher-priced lending var- determine from HMDA data alone
ies by product type. For example, whether the observed pricing disparities
manufactured-home loans show the and market segmentation reflect dis-
greatest incidence of higher-priced crimination. When analyzed in conjunc-
lending, because these loans are consid- tion with other fair lending risk factors
ered higher risk. In addition, first-lien and supervisory information, however,
mortgages are generally less risky than the HMDA data can facilitate fair lend-
comparable junior-lien loans, and the ing supervision and enforcement. (See
pricing for these loans reflects their risk “Fair Lending” earlier in this chapter.)
profiles: 25.7 percent of first-lien refi-
nance loans were reported as higher-
priced in 2005, compared with 30.2 Agency Reports on Compliance
percent of comparable junior-lien loans. with Consumer Protection Laws
Second, higher-priced lending varies
widely by geography. As in 2004, many The Board reports annually on compli-
of the metropolitan areas that reported ance with consumer protection laws by
the greatest incidence of higher-priced entities supervised by federal agencies.
lending were in the southern region of This section summarizes data collected
the country. Several metropolitan areas from the twelve Federal Reserve Banks,
104 93rd Annual Report, 2006

the FFIEC member agencies, and other Act (ECOA) and Regulation B, as well
federal enforcement agencies.13 as other consumer regulations. The other
FFIEC agencies did not issue any for-
Regulation B mal enforcement actions relating to
(Equal Credit Opportunity) Regulation B during the reporting pe-
The FFIEC agencies reported that riod.
87 percent of the institutions examined The other agencies that enforce the
during the 2006 reporting period were in ECOA—the Farm Credit Administra-
compliance with Regulation B, com- tion (FCA), the Department of Trans-
pared with 85 percent for the 2005 re- portation, the Securities and Exchange
porting period. The most frequently Commission (SEC), the Small Business
cited violations involved the failure to Administration, and the Grain Inspec-
take one or more of the following ac- tion, Packers and Stockyards Adminis-
tions: tration of the Department of Ag-
riculture—reported substantial compli-
• abstain from inquiring about the race, ance among the entities they supervise.
color, religion, national origin, or sex
The FCA’s examination activities
of an applicant in connection with a
revealed that most Regulation B viola-
credit transaction unless permitted by
tions involved either creditors’ provid-
ing inadequate statements of specific
• collect information for monitoring reasons for denial or creditors’ failure
purposes about the race, ethnicity, sex, to request or provide information for
marital status, and age of applicants government monitoring purposes. As
seeking credit primarily for the pur- reported by the SEC, an examination
chase or refinancing of a principal conducted by the National Association
residence of Securities Dealers, Inc., found one
violation of Regulation B at a member
• note on the application form monitor- firm. The firm’s written supervisory
ing information regarding ethnicity, procedures did not contain information
race, and sex when an applicant regarding the denial of credit to cus-
chooses not to provide the informa- tomers. However, none of these other
tion agencies initiated any formal enforce-
• provide a written notice of denial or ment actions relating to Regulation B
other adverse action to a credit appli- during 2006.
cant that contains the specific reason
for the adverse action, along with Regulation E
other required information (Electronic Fund Transfers)
During this reporting period, the OTS The FFIEC agencies reported that ap-
issued one supervisory agreement to a proximately 95 percent of the institu-
savings association for its alleged viola- tions examined during the 2006 report-
tions of the Equal Credit Opportunity ing period were in compliance with
Regulation E, which is comparable to
the level of compliance for the 2005
13. Because the agencies use different methods reporting period. The most frequently
to compile the data, the information presented
here supports only general conclusions. The 2006
cited violations involved the failure to
reporting period was July 1, 2005, through June take one or more of the following ac-
30, 2006. tions:
Consumer and Community Affairs 105

• determine whether an error occurred, were in compliance with Regulation M,

within ten business days of receiving which is comparable to the level of com-
a notice of error from a consumer pliance for the 2005 reporting period.
The FFIEC agencies did not issue any
• give the consumer provisional credit
formal enforcement actions relating to
for the amount of an alleged error
Regulation M during the period.
when an investigation into the alleged
error cannot be completed within ten
Regulation P (Privacy of Consumer
business days
Financial Information)
• provide initial disclosures that contain
required information, including limita- The FFIEC agencies reported that
tions on the types of transfers permit- 98 percent of the institutions examined
ted and error-resolution procedures, at during the 2006 reporting period were in
the time a consumer contracts for an compliance with Regulation P, com-
electronic fund transfer service pared with 97 percent for the 2005 re-
porting period. The most frequently
• when a determination is made that no cited violations involved the failure to
error has occurred, provide a written take one or more of the following
explanation and note the consumer’s actions:
right to request documentation sup-
porting the institution’s findings • provide a clear and conspicuous
annual privacy notice to customers
The Federal Trade Commission (FTC)
filed two complaints in federal district • disclose the institution’s information-
court for alleged violations of Regula- sharing practices in initial, annual, and
tion E and federal statutes. Among other revised privacy notices
allegations, one complaint alleged that • provide customers with a clear and
the defendants charged consumers’ conspicuous initial privacy notice that
credit cards or debited their bank
accurately reflects the institution’s pri-
accounts, both on a recurring basis, to
vacy policies and practices, not later
pay for a discount health plan, without
than when the customer relationship is
obtaining the consumers’ authorization
for preauthorized electronic fund trans-
fers. The other complaint alleged that The FFIEC agencies did not issue any
defendants enrolled consumers in a formal enforcement actions relating to
mail-order program for dietary supple- Regulation P during the reporting
ments and then automatically billed con- period.
sumers on a recurring basis, without
obtaining their authorizations for the re- Regulation Z (Truth in Lending)
curring debits. The FFIEC agencies and
the SEC did not issue any formal en- The FFIEC agencies reported that
forcement actions relating to Regulation 85 percent of the institutions examined
E during the period. during the 2006 reporting period were in
compliance with Regulation Z, com-
Regulation M (Consumer Leasing) pared with 80 percent for the 2005 re-
porting period. The most frequently
The FFIEC agencies reported that more cited violations involved the failure to
than 99 percent of the institutions exam- take one or more of the following
ined during the 2006 reporting period actions:
106 93rd Annual Report, 2006

• in closed-end credit transactions, ac- The FTC continued litigation against

curately disclose the finance charge a mortgage broker and its principals for
and the security interest that the credi- their alleged violations of Regulation Z
tor has or will acquire in the property and federal statutes, in connection with
identified advertisements for extremely low mort-
gage rates. In 2004, the court entered a
• ensure that disclosures reflect the stipulated preliminary injunction against
terms of the legal obligation between the defendants. In 2006, the defendant’s
the parties and, when any information chief executive filed for bankruptcy, fol-
necessary for an accurate disclosure is lowing his 2005 agreement to—among
unknown, ensure that the creditor other terms—pay the FTC $400,000 un-
states that the disclosure is an estimate der a stipulated order releasing him from
• on certain residential mortgage trans- confinement for civil contempt of the
actions, provide a good faith estimate 2004 stipulated preliminary injunction.
of the required disclosures before con- The FTC filed a proof of claim for
summation, or not later than three amounts it is owed in the underlying
business days after receipt of the loan federal district court action and the con-
application tempt action. Litigation is ongoing in
this case.
In addition, 106 banks supervised by In 2006, the FTC settled charges in a
the Federal Reserve and the FDIC were case alleging that a defendant violated
required, under the Interagency En- Regulation Z and federal statutes. The
forcement Policy on Regulation Z, to defendant allegedly engaged in misrep-
reimburse a total of approximately resentation about refunds for tax infor-
$1.5 million to consumers for under- mation products. After accepting prod-
stating the annual percentage rate or the uct returns from consumers, or
finance charge in their consumer loan otherwise acknowledging that the con-
disclosures. sumers were owed refunds, the defen-
The OTS issued three supervisory dant failed to credit the consumers’
agreements for violations of a number credit card accounts in a timely fashion.
of consumer regulations, including
Regulation Z, during the reporting Regulation AA (Unfair or Deceptive
period. The other FFIEC agencies did Acts or Practices)
not issue any formal enforcement
The FFIEC agencies reported that more
actions relating to Regulation Z during
than 99 percent of the institutions exam-
the reporting period.
ined during the 2006 reporting period
The Department of Transportation in-
were in compliance with Regulation
vestigated one air carrier for its im-
AA, which is comparable to the level of
proper handling of credit card and cash
compliance for the 2005 reporting
refunds for unused refundable tickets.
period. No formal enforcement actions
As a result of this investigation, the air
relating to Regulation AA were issued
carrier made the required refunds and
during the reporting period.
entered into a consent order under which
it was directed to cease and desist from
Regulation CC (Availability of Funds
further violations of the credit refund
and Collection of Checks)
requirements of Regulation Z. The air
carrier was assessed a civil penalty of The FFIEC agencies reported that
$50,000. 92 percent of institutions examined dur-
Consumer and Community Affairs 107

ing the 2006 reporting period were in • provide account disclosures clearly
compliance with Regulation CC, com- and conspicuously, in writing, and in a
pared with 93 percent for the 2005 re- form that the consumer may keep
porting period. The most frequently
cited violations involved the failure to The FFIEC agencies did not issue any
take one or more of the following formal enforcement actions related to
actions: Regulation DD during the reporting pe-
• make available on the next business
day the lesser of $100 or the aggregate
amount of checks deposited that are Consumer Complaints
not subject to next-day availability The Federal Reserve investigates com-
• follow procedures when invoking the plaints against state member banks and
exception for large-dollar deposits forwards to the appropriate enforcement
agency any complaints that it receives
• provide required information when that involved other creditors and busi-
placing an exception hold on an nesses. Each Reserve Bank investigates
account complaints against state member banks
• make funds from local and certain in its District. In 2006, the Federal Re-
other checks available for withdrawal serve received 641 consumer complaints
within the times prescribed by regu- about regulated practices by state mem-
lation ber banks—complaints were received by
mail, by telephone, in person, and elec-
The OTS issued one supervisory agree- tronically via the Internet.
ment for violations of a number of con-
sumer regulations, including Regulation
CC. The other FFIEC agencies did not Complaints against
issue any formal enforcement actions State Member Banks
related to Regulation CC during the re- Of the 641 complaints about regulated
porting period. practices, 70 percent involved consumer
Regulation DD (Truth in Savings) loans: 2 percent alleged discrimination
on a basis prohibited by law (race, color,
The FFIEC agencies reported that 91 religion, national origin, sex, marital sta-
percent of institutions examined during tus, handicap, age, the fact that the ap-
the 2006 reporting period were in com- plicant’s income comes from a public
pliance with Regulation DD, which is assistance program, or the fact that the
comparable to the level of compliance applicant has exercised a right under the
for the 2005 reporting period. The most Consumer Credit Protection Act), and
frequently cited violations involved the the remainder concerned other credit-
failure to take one or more of the follow- related practices, such as fair credit re-
ing actions: porting; billing-error resolution; and
credit card rates, terms, and fees.
• use the phrase “annual percentage
Twenty-eight percent of the complaints
yield” in an advertisement disclosing
involved disputes about insufficient-
required additional terms and condi-
funds charges and procedures, amounts
tions for customer accounts
withdrawn from a consumer’s account,
• provide account disclosures contain- funds availability, and other deposit ac-
ing all required information count practices, including electronic
108 93rd Annual Report, 2006

Consumer Complaints against State against state member banks resulted in a

Member Banks, by Classification, 2006 finding that the bank had violated a
consumer protection regulation. The
Classification Number most common violations involved real
estate loans, deposit accounts, and elec-
Regulation B (Equal Credit Opportunity) . . . . . 53
Regulation C (Home Mortgage Disclosure) . . . 0 tronic fund transfers.
Regulation E (Electronic Fund Transfers) . . . . 73
Regulation H (Bank Sales of Insurance) . . . . . . 1
Regulation H (Flood Insurance) . . . . . . . . . . . . . 3 Unregulated Practices
Regulation M (Consumer Leasing) . . . . . . . . . . . 1
Regulation P (Privacy of Consumer As required by section 18(f) of the Fed-
Financial Information) . . . . . . . . . . . . . . . . . . 17
Regulation Q (Payment of Interest) . . . . . . . . . . 0 eral Trade Commission Act, the Board
Regulation Z (Truth in Lending) . . . . . . . . . . . . . 243
Regulation BB (Community Reinvestment) . . . 1 continued to monitor complaints about
Regulation CC (Expedited Funds banking practices that are not subject to
Availability) . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
Regulation DD (Truth in Savings) . . . . . . . . . . . 60 existing regulations and to focus on
Fair Credit Reporting Act . . . . . . . . . . . . . . . . . . . 117 those that concern possible unfair or
Fair Debt Collection Practices Act . . . . . . . . . . . 20
Fair Housing Act . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 deceptive practices. In 2006, the Fed-
Regulations T, U, and X . . . . . . . . . . . . . . . . . . . . 0 eral Reserve received more than 1,300
Real Estate Settlement Procedures Act . . . . . . . 10
complaints against state member banks
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 641
that involved unregulated practices.
The most common complaints involved
fund transfers; the remaining 2 percent checking accounts and credit cards.
concerned disputes about trust services Consumers most frequently complained
or other practices. (See tables.) about problems with either opening or
In 97.5 percent of the 641 complaints closing an account (113 complaints),
against state member banks regarding issues involving fraud (104),
regulated practices that were investi- insufficient-funds charges and proce-
gated in 2006, the banks had correctly dures (77), and concerns over specific
handled the customer’s account. The interest rates, terms, and fees on credit
remaining 2.5 percent of the complaints cards (70). The remainder of the com-

Complaints against State Member Banks That Involve Regulated Practices, 2006

All complaints Complaints involving violations

Subject of complaint
Number Percent Number Percent

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 641 100 16 2.50

Discrimination alleged
Real estate loans . . . . . . . . . . . . . . . 3 0.47 0 0
Credit cards . . . . . . . . . . . . . . . . . . . . 4 0.62 0 0
Other loans . . . . . . . . . . . . . . . . . . . . 3 0.47 0 0

Other types of complaints

Real estate loans . . . . . . . . . . . . . . . 57 8.89 4 7.02
Credit cards . . . . . . . . . . . . . . . . . . . . 342 53.35 3 0.88
Other loans . . . . . . . . . . . . . . . . . . . . 41 6.40 1 2.44

Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108 16.85 3 2.78

Electronic fund transfers . . . . . . . . . . . . . 73 11.39 5 6.85

Trust services . . . . . . . . . . . . . . . . . . . . . . . 1 0.16 0 0

Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 1.40 0 0
Consumer and Community Affairs 109

plaints concerned a wide range of sure and notification requirements of

unregulated practices involving credit financial institutions that provide pay-
cards, including errors or delays in pro- roll card account services to consumers.
cessing consumers’ payments, the Under the interim final rule, financial
amounts banks charged for late pay- institutions are granted relief from the
ments, and overlimit fees and proce- requirement to provide consumers with
dures. paper periodic statements—if they pro-
vide the information in periodic state-
Complaint Referrals to HUD ments to consumers through alternative
In accordance with a memorandum of means (such as electronically or by tele-
understanding between HUD and the phone). Both industry and consumer
federal bank regulatory agencies that re- representatives generally supported the
quires that a complaint alleging a viola- proposed changes and agreed that their
tion of the Fair Housing Act be for- scope and approach effectively ad-
warded to HUD, in 2006 the Federal dressed consumer protection issues.
Reserve referred three complaints to Several industry representatives noted
HUD that alleged state member bank that substituting alternative methods for
violations of the Fair Housing Act. In the delivery of account information ap-
two of the three cases, the Federal Re- propriately balances consumers’ rights
serve’s investigations revealed no evi- and their need to access their accounts,
dence of illegal discrimination. The re- on the one hand, with financial institu-
maining case was pending at year-end. tions’ potential compliance costs, on the
other. Some consumer representatives,
however, suggested that the periodic
Advice from the statements are an important educational
Consumer Advisory Council tool for consumers and, therefore, con-
sumers would benefit from receiving
The Board’s Consumer Advisory paper periodic statements.
Council—whose members represent Council members also discussed pro-
consumer and community organizations, posed changes to Regulation Z, which
the financial services industry, aca- implements the Truth in Lending Act
demic institutions, and state agencies— (TILA), at their March meeting. Mem-
advises the Board of Governors on bers shared their views on whether the
matters concerning laws and regula- Board should establish a standard cutoff
tions that the Board administers and on time for the crediting of payments on
other issues related to consumer finan- open-end credit accounts. The council
cial services. Council meetings are held did not reach a consensus on a specific
three times a year, in March, June, and cutoff time; however, members noted
October, and are open to the public. that such a cutoff would have important
(For a list of members of the council, consequences, including high fees and
see the section “Federal Reserve Sys- increased interest rates, for consumers
tem Organization.”) who make late payments. Several mem-
During their March meeting, council bers suggested that the need to provide
members discussed proposed changes to consumers with more transparency
Regulation E, which implements the about the costs and fees imposed as a
Electronic Fund Transfer Act (EFTA). result of late payments may be greater
The proposed changes addressed payroll than the need to establish cutoff times
card accounts, specifically the disclo- for the crediting of payments. Council
110 93rd Annual Report, 2006

members also discussed a TILA amend- programs, methods for educating con-
ment that requires creditors that offer sumers, and how to measure and evalu-
open-end credit accounts to provide con- ate the effectiveness of financial educa-
sumers with disclosures, on each peri- tion programs. Members identified
odic statement, about the effects of mak- financial education as a fundamental
ing only minimum payments on their tool for helping consumers build and
accounts. Members expressed a wide preserve assets. Because financial lit-
range of views on whether such disclo- eracy not only enhances the well-being
sures would be meaningful and useful to of individuals or households but also
consumers; members also shared con- strengthens neighborhoods and commu-
cerns about ensuring the accuracy of the nities, council members support (1)
disclosures. making financial literacy a national pub-
During its March and June meetings, lic policy priority and (2) creating na-
the council discussed issues related to tional education initiatives and more-
the Board’s public hearings on the home formalized methods to train and educate
equity lending market, as well as the consumers.
adequacy of existing consumer disclo- At the October meeting, members
sures and protections. Members dis- also discussed proposed regulations and
cussed the Board’s 2002 revisions to the guidelines to implement provisions of
Home Ownership and Equity Protection the Fair and Accurate Credit Transac-
Act (HOEPA) rules and their effect on tions Act (FACT Act) that require finan-
consumer protections and the availabil- cial institutions to identify “red flags”
ity of credit in the high-cost and for detecting possible cases of identity
subprime-lending markets. The council theft. Most industry representatives ex-
also discussed several issues related to pressed the need for more-flexible
how consumers shop for credit and how guidelines that would allow financial
that process may affect the loan terms institutions to use a risk-based approach
they ultimately receive. Members dis- to address identity-theft risks, which
cussed the increased role that mortgage change rapidly. Consumer representa-
brokers play in the loan-making tives were concerned that the proposed
process—and whether this role high- guidelines give covered institutions and
lights a need for additional regulation of creditors too much discretion over their
brokers, specifically regulation on the identity-theft prevention and detection
broker practice of directing potential policies. Council members also shared
borrowers to certain mortgage products. their views on the implementation of the
Members addressed the need to proposed regulations, including the staff
strengthen consumer disclosures to en- training requirement and requirements
sure that borrowers understand key for covered institutions to develop and
credit terms and costs, particularly for implement a written identity-theft pre-
mortgage products that feature interest- vention program.
only periods, prepayment penalties, and At their October meeting, members
adjustable or “teaser rates.” Several discussed the importance of creating
members also expressed a need for addi- greater incentives to encourage invest-
tional research on consumer behavior in ment in affordable housing. Homeown-
the home mortgage market. ership is a fundamental part of a con-
In June, the council discussed several sumer’s asset-building strategy; the
issues related to financial literacy, availability of affordable housing in a
including goals for financial education neighborhood can create economic op-
Consumer and Community Affairs 111

portunities that, in turn, support future Members also commented on the pro-
investments in entrepreneurship and posed illustrations of consumer informa-
education. Members noted that financial tion, which were part of the guidance.
institutions play a critical role by provid- The illustrations are designed to help
ing mortgage credit to consumers and borrowers better understand the features
by financing the development of afford- of nontraditional mortgages. The coun-
able housing. They highlighted the need cil was generally supportive of the illus-
for federal bank regulators to play a trations. Members stated that the illus-
larger role by providing institutions with trations highlight important information,
greater incentives for (1) meeting afford- such as the costs, terms, features, and
able housing needs and (2) expanding risks of a loan, for borrowers. However,
their outreach to local community orga- members expressed a need to include
nizations, as part of their community additional loan information, such as in-
reinvestment strategies. formation on the risk of payment shock
During each of their meetings this to the consumer, the costs of reduced-
past year, council members discussed documentation loans, prepayment penal-
interagency guidance on managing the ties, and the potential for negative amor-
potential heightened risk of new and tization of the loan.
emerging residential mortgage products,
often referred to as “nontraditional,” “al-
ternative,” or “exotic” mortgage loans. Consumer Education
Members generally supported the guid- and Research
ance, noting its importance in light of The Consumer Education and Research
the recent proliferation and use of non- section produces the Board’s consumer
traditional mortgage products, especially education materials and supports the
by consumers whose household incomes Board’s consumer outreach initiatives.
are not keeping up with home-price Section staff also conduct research in
appreciation. Members generally agreed support of the division’s policy develop-
that these products do not present prob- ment and community development func-
lems for some borrowers. But the loans tions. For example, research staff ana-
are risky for consumers whose cash lyze the annual HMDA data, which are
flows or income projections may limit then used in the monitoring and enforce-
their ability to repay, who may not have ment of the fair lending laws.
the capacity or discipline to manage the The Federal Reserve maintains a con-
loan, or who are not fully informed sumer information web site (www.
about the terms and conditions such that
loans carry. contains publications and educational
Several members expressed concern materials related to the Board’s con-
that the guidance has given certain mort- sumer regulations. In 2006, staff pro-
gage originators a competitive advan- duced or updated the following publica-
tage, since the key principles of the tions on nontraditional mortgages:
guidance apply only to banking and
thrift organizations and federal credit • “Interest-Only Mortgage Payments
unions. Others reiterated this concern by and Payment-Option ARMs—Are
emphasizing that the agencies are only They for You?” (a new publication,
providing guidance rather than creating issued jointly with the FFIEC agen-
requirements that could be enforced by cies, that includes a glossary of lend-
consumers or law enforcement agencies. ing terms, a mortgage-shopping work-
112 93rd Annual Report, 2006

sheet, and a list of additional Emergency Relief (a private nonprofit

information sources) organization), staff are studying whether
a two-day financial education program
• “Consumer Handbook on Adjustable- had an impact on how the participating
Rate Mortgages” (substantially re- soldiers manage their finances. At this
vised and updated in conjunction with stage, baseline data have been collected,
the OTS to incorporate descriptions and staff will be working to gather
and illustrations of how changes in follow-up data.
interest rates affect a consumer’s loan
payments, including an example of how
an increase in interest rates may actu- Research on Financial Information
ally increase the total loan amount) and Disclosures
In addition, the Board’s brochure “How A financial institution is required to pro-
to File a Consumer Complaint about a vide consumers with disclosures about
Bank,” was updated. (The brochure is its products and services, including dis-
available in both English and Spanish.) closures about its privacy policy or the
Print and web-based versions of these terms of a loan. The Federal Reserve is
publications are available on the web one of seven agencies working to de-
site. velop more “consumer-friendly” disclo-
Throughout the year, Board staff par- sures, that is, disclosures written in clear,
ticipated in a number of financial edu- understandable language that provide in-
cation events, including events for formation a consumer can use to com-
community members, federal employ- pare financial services providers. In the
ees, and congressional staff. The Board spring, the agencies released a report
continued to work with the interagency that summarized their research on devel-
Financial Literacy and Education Com- oping a comprehensible financial pri-
mission (FLEC); last year, staff helped vacy notice for consumers.15 The Finan-
update and expand the FLEC’s cial Services Regulatory Relief Act of web site to incorporate 2006, which was signed in October, sub-
links to Reserve Bank consumer educa- sequently required the federal financial
tion resources. In their speeches and regulatory agencies to develop a model
other appearances, Board members privacy notice. The design, format, and
underscored the importance of financial language of the model notice must be
education to an individual’s economic easily understood and allow consumers
well-being. Former Governor Mark to compare the privacy policies of differ-
Olson spoke at the press conference for ent financial institutions.
the announcement of FLEC’s National As part of its overall effort to improve
Strategy for Financial Education in consumer disclosures, the Board studied
April. Chairman Ben Bernanke testified how consumers use different types of
on the Federal Reserve’s role in finan- information sources—both the quantity
cial education before the U.S. Senate and quality of the sources—and whether
Committee on Banking, Housing, and this information affected their credit and
Urban Affairs in May.14 investment decisions. This study, in
In cooperation with the Department addition to the research on privacy no-
of Defense, the U.S. Army, and Army tices, will be used in the upcoming

14. See 15. See

testimony/2006/20060523/default.htm. press/bcreg/2006/20060331/default.htm.
Consumer and Community Affairs 113

review of the Board’s open-end credit organizations that serve low- and
regulations. The Board has contracted moderate-income communities and
with a market research firm to conduct populations. Similarly, the Board’s CAO
formative and usability testing on credit promotes and coordinates Systemwide
card disclosures, including the disclo- efforts, in addition to engaging in activi-
sures used in solicitation letters, applica- ties and exploring issues that have pub-
tions, periodic statements, and change- lic policy implications. In 2006, the
in-terms notices. Consumer testing will Board and the Reserve Banks collabo-
continue in early 2007; the Board will rated on a number of activities that fo-
consider data collected in these sessions cused on asset-building for individuals
as it develops new proposed rules under and strengthening community develop-
Regulation Z. ment organizations, while continuing
their efforts to expand public under-
standing of the need to enhance access
Promotion of Community to affordable credit in underserved
Economic Development and markets.
Access to Financial Services in
Historically Underserved
Markets Collaborative Efforts
In 2006, the community affairs function The Reserve Banks and the Board con-
within the Federal Reserve System sup- tinued their work on two substantial col-
ported several initiatives to promote laborative efforts over the past year. The
community economic development and System resumed its asset-building and
fair access to credit for low- and wealth-creation partnership with the
moderate-income communities and CFED, a nonprofit organization dedi-
populations. The function continued to cated to expanding access to economic
focus on improving the sustainability opportunity by bringing together com-
and financial capacity of community de- munity development practitioners, pub-
velopment organizations, creating asset- lic policy analysts, and private-sector
building opportunities for low-income representatives. In 2006, the Federal
individuals, and promoting initiatives to Reserve System and the CFED held the
help homeowners preserve this impor- last three in a series of five forums
tant asset and avoid foreclosure. Activi- convening leaders in economic policy,
ties included publishing newsletters and community development, philanthropy,
articles, sponsoring conferences and and the financial industry. Starting with
seminars, conducting research, and sup- the initial forum in June 2005, the fo-
porting the dissemination of information rums were convened to encourage more
to both general and targeted audiences. individuals to engage in asset-building
As a decentralized function, the Com- activities, such as homeownership, en-
munity Affairs Offices (CAOs) at each trepreneurship, savings, and investment.
of the twelve Reserve Banks design ac- One session, held in Kansas City, fo-
tivities in response to the needs of com- cused on the unique challenges to devel-
munities in the Districts they serve in oping asset-building programs in rural
conjunction with staff from the Board. communities; the forum was cospon-
The CAOs focus on providing informa- sored by the Reserve Banks of Kansas
tion and promoting awareness of City, Dallas, Minneapolis, and St. Louis.
investment opportunities to financial A second meeting, hosted by the
institutions, government agencies, and Reserve Bank of Atlanta, explored asset-
114 93rd Annual Report, 2006

building for low- and moderate-income Richmond Reserve Bank chaired the
savers, but from the perspective of planning committee for the South Caro-
financial institutions. The discussions lina Asset Development Collaborative,
focused on developing products to help and staff from the San Francisco
this population begin or expand its sav- Reserve Bank facilitated both the Or-
ing efforts. The final forum, hosted by egon Asset Building Convergence and
the Board of Governors, gathered a the Washington State Asset Building
roundtable of leaders in the asset- Summit. Other Reserve Banks contin-
building field. The leaders reflected on ued to provide advisory services for
the results of the regional forums and more than a dozen other state and re-
identified next steps to help the industry gional asset-building coalitions through-
progress.16 out the country, such as the Houston
A related initiative, led by the San Asset Building Coalition, Minnesota
Francisco Reserve Bank, was a call for Saves, and the Nashville Wealth Build-
papers on asset-building issues and strat- ing Alliance.
egies. Twenty-eight of the more than Another Systemwide collaboration
100 papers received were presented at a was a partnership with the Aspen Insti-
research forum during CFED’s 2006 tute, a national research and leadership
Assets Learning Conference, “A Life- development organization. The goal of
time of Assets: Building Families, Com- this collaboration was to identify sus-
munities and Economies.” More than tainable and scalable business models
1,000 participants attended; staff from that community development organiza-
each Reserve Bank and the Board were tions can use to more effectively
actively involved in planning the confer- advance their goals. In 2006, the Federal
ence, including developing the agenda, Reserve System and the Aspen Institute
presenting research, and serving as mod- cosponsored four conferences around
erators and participants in formal discus- the country that explored a variety of
sion groups. The Board’s Community business models that have led to suc-
Affairs officer delivered a keynote ad- cessful community development finance
dress during the conference. Board staff programs. A forum at the San Francisco
presented research on the asset port- Reserve Bank highlighted funding ef-
folios of low-income households and forts for community development finan-
how these assets have changed over the cial institutions (CDFIs), individual de-
past fifteen years (from 1989 to 2004). velopment account programs, charter
Staff also explored homeownership and schools, and child care facilities. A fo-
foreclosure patterns that affect the asset- rum at the Chicago Reserve Bank fo-
building capabilities of low-income cused on collaborative efforts to pro-
households.17 mote the earned-income tax credit by
Beyond the CFED partnership, helping low- to moderate-income fami-
Reserve Banks have been active in the lies prepare their taxes. Participants at a
promotion and development of regional forum at the New York Reserve Bank
asset-building coalitions. Staff from the examined several collaborative efforts
undertaken by development organiza-
16. Summaries of the forum sessions are avail- tions, including efforts to share infra-
able on the CFED web site ( structure resources (facilities, equip-
17. The research papers presented at this confer-
ment, etc.), collaborate on fundraising,
ence are available at and pool other resources and strategies
research/assets.html. to increase their organizational capacity.
Consumer and Community Affairs 115

Finally, a forum at the Dallas Reserve for community development loans,

Bank focused on the formation of poten- and included remarks by Governor
tial new sources of capital for CDFIs Kroszner, who keynoted the conference.
and community development corpora- The Minneapolis Reserve Bank has
tions. These forums generated ongoing taken the lead in another initiative to
Systemwide research on various aspects expand access to financial services
of public and private subsidies for com- through its work with Native American
munity development. Staff from several communities. On many reservations, ac-
of the Reserve Banks and the Board are cess to affordable credit is often limited
currently involved in a research project by ambiguities and inconsistencies in
to measure the magnitude of the need the various tribal laws that govern se-
for public and private groups to subsi- cured transactions. In response, Minne-
dize community development, measure apolis Reserve Bank staff have worked
how effectively these subsidies are uti- to help investors and lenders better un-
lized, and identify emerging strategies derstand the property rights of Native
for optimizing the leverage of subsidy Americans. For the past few years, the
dollars. Reserve Bank staff have worked to cre-
ate an improved legal structure that
tribes can use to facilitate their efforts to
Access to Financial Services borrow from off-reservation partners or
Staff from around the System have con- other tribes. In 2005, staff were part of a
tinued working on several initiatives to team that completed a draft Model
enhance access to affordable credit in Tribal Secured Transactions Act (MTA)
currently underserved markets. In 2006, for the National Conference of Com-
the San Francisco Reserve Bank and the missioners on Uniform State Laws
Board partnered to study issues related (NCCUSL). Throughout 2006, staff sup-
to the creation of a secondary market for ported education and dissemination ef-
community development loans. The San forts for the MTA by providing techni-
Francisco Reserve Bank devoted an cal assistance and making numerous
issue of its Community Development presentations, including one to tribal
Investment Review to an overview of the judges, on the benefits of tribal adoption
community development finance indus- of the MTA. During the year, the Crow
try, which included advice on best prac- tribe adopted the MTA, three additional
tices from industry practitioners. The tribes in Montana passed resolutions to
Board and the San Francisco Reserve adopt it, and approximately fifteen tribes
Bank followed up by hosting a confer- were in various stages of considering
ence in Washington, D.C., for lenders, adoption of the MTA.
investors, and financial intermediaries,
in addition to policymakers and academ-
ics. The conference sought to (1) assess
Resources, Advisory Services,
the status of the industry and (2) discuss
and Outreach
ways to innovate and collaborate to In 2006, the Board released an update of
increase liquidity for community devel- the Federal Reserve Fiscal Impact Tool
opment lending. The next edition of the (FIT). First released in 2003, the FIT
Review included the conference pro- software helps users analyze the fiscal
ceedings and essays by conference par- impacts of economic development in
ticipants laying out a possible road map small- and mid-sized communities. FIT
for the creation of a secondary market supports economic development plan-
116 93rd Annual Report, 2006

ning by producing a cost-benefit analy- to and endorsement of state-level activi-

sis of proposed development projects; ties, for example, the Minneapolis
FIT estimates a project’s impact on local Reserve Bank’s participation in Minne-
sales and property tax revenues and on sota’s Emerging Market Homeowner-
costs to local government. To supple- ship Initiative and the Cleveland
ment this analysis, FIT integrates a wide Reserve Bank’s promotion (through the
array of data, at the city, county, and Pittsburgh Branch) of the foreclosure-
state levels, on incorporated locations in mitigation efforts of the Pennsylvania
the United States. The 2006 update con- secretary of banking.
tains more and newer data, along with a Over the past year, the Board contin-
module that allows for time discounting ued its outreach activities to provide the
and the calculation of a net present public with information about the
value. The Board distributed more than Board’s responsibilities, to facilitate un-
1,000 copies of the updated software in derstanding of changes in banking regu-
2006. Users include state and local eco- lations and their impact on banks and
nomic development organizations, aca- consumers, to promote community de-
demics, and consultants. A recent sur- velopment and consumer education, and
vey of users identified two com- to foster discussion of policy issues.
munities—El Paso, Texas, and Lincoln, Board staff periodically met with finan-
Nebraska—that have employed FIT to cial institutions, community groups, and
assist in setting limits on incentives for other members of the public in formal
development projects. and informal settings. For example, the
During the past year, the foreclosure Board expanded its prior work with Op-
rate has risen for certain housing mar- eration HOPE, a national nonprofit or-
kets. Low- and moderate-income fami- ganization dedicated to developing and
lies and communities may be especially implementing programs focused on con-
at risk for foreclosure. Consequently, necting minority communities with
the Board and the Reserve Banks have mainstream, private-sector resources
enhanced their efforts to preserve home- and to empowering underserved com-
ownership among these populations. munities. The System has collaborated
The Board continued its involvement with Operation HOPE in prior years,
with NeighborWorkst America (Neigh- and the director of the Board’s Division
borWorks), a national network of more of Consumer and Community Affairs
than 240 community-based organiza- serves on the Operation HOPE Mid-
tions providing financial support, techni- Atlantic Advisory Board. In 2006,
cal assistance, and training for commu- Chairman Bernanke delivered a keynote
nity rehabilitation efforts. A member of address at the “Anacostia Economic
the Board of Governors serves on the Summit,” a conference sponsored by
NeighborWorks board of directors, and Operation HOPE and the District of Co-
members of the Board’s staff serve on lumbia. (Anacostia is an underdeveloped
the organization’s Center for Homeown- neighborhood in southeast Washington,
ership Education and Counseling. Staff D.C.) The summit focused on ways to
from the Reserve Banks have led re- encourage revitalization in this area and
gional collaborative efforts with Neigh- highlighted the importance of obtaining
borWorks through their participation in both targeted public and private invest-
foreclosure-prevention training work- ment to jump-start the development ef-
shops for homeownership counselors. forts in this and other underserved
The Banks have also provided support neighborhoods. In preparation for the
Consumer and Community Affairs 117

conference, Chairman Bernanke toured local property developers to gain first-

the Anacostia community with lenders, hand insight into the community’s
community development leaders, and redevelopment. Á

Federal Reserve Banks

In addition to contributing to the setting years, the Reserve Banks have recov-
of national monetary policy and super- ered 99.0 percent of their priced services
vising and regulating banks and other costs, including the PSAF (table).2 In
financial entities (discussed in preced- 2006, the Board implemented changes
ing chapters), the Federal Reserve Banks to the method for calculating the target
provide payment services to depository return on equity measure in the PSAF.3
and certain other institutions, distribute Overall, the price index for priced
the nation’s currency and coin, and services increased 2.4 percent from 2005
serve as fiscal agents and depositories to 2006. Revenue from priced services
for the United States. amounted to $908.4 million, other in-
come was $122.8 million, and costs
Developments in were $875.5 million, resulting in net
Federal Reserve Priced Services income from priced services of $155.7
million. In 2006, the Reserve Banks re-
The Federal Reserve Banks provide a
covered 108.8 percent of total costs of
range of payment and related services to
$947.5 million, including the PSAF.4
depository institutions, including col-
lecting checks, operating an automated
nors assets and costs that are related to priced
clearinghouse service, transferring funds services are also allocated to priced services; in
and securities, and providing a multilat- the pro forma financial statements at the end of
eral settlement service. The Reserve this chapter, Board assets are part of long-term
Banks charge fees for providing these assets, and Board expenses are included in operat-
“priced services.” ing expenses.
2. Effective December 31, 2006, the Reserve
The Monetary Control Act of 1980 Banks implemented the Financial Accounting
requires that the Federal Reserve estab- Standards Board’s Statement of Financial Ac-
lish fees for priced services provided to counting Standards No. 158, Employers’ Account-
depository institutions so as to recover, ing for Defined Benefit Pension and Other Postre-
tirement Plans (FAS 158), which resulted in the
over the long run, all direct and indirect recognition of a $343.9 million reduction in equity
costs actually incurred as well as the related to the priced services’ benefit plans. In-
imputed costs that would have been in- cluding this reduction in equity, which represents
curred, including financing costs, taxes, a decline in economic value, results in cost recov-
and certain other expenses, and the re- ery of 95.5 percent for the ten-year period. For
details on how implementing FAS 158 affected the
turn on equity (profit) that would have pro forma financial statements, refer to notes 2, 3,
been earned if a private business firm and 5 at the end of this chapter.
had provided the services. The imputed 3. In 2005, the Board approved changing the
costs and imputed profit are collectively method from using the average of the results of
three analytical methods—the comparable ac-
referred to as the private-sector adjust- counting earnings model, the discounted cash-
ment factor (PSAF).1 Over the past ten flow model, and the capital asset pricing model
(CAPM)—to using only the CAPM.
1. In addition to income taxes and the return on 4. Financial data reported throughout this
equity, the PSAF is made up of three imputed chapter—revenue, other income, cost, net rev-
costs: interest on debt, sales taxes, and assess- enue, and income before taxes—can be linked to
ments for deposit insurance by the Federal Deposit the pro forma financial statements at the end of
Insurance Corporation (FDIC). Board of Gover- this chapter. Other income is revenue from invest-
120 93rd Annual Report, 2006

Priced Services Cost Recovery, 1997–2006

Millions of dollars except as noted

Revenue from Targeted return Total Cost recovery
Year expenses and
services 1 on equity costs (percent) 3, 4
imputed costs 2

1997 ...................... 818.8 752.8 54.3 807.1 101.5

1998 ...................... 839.8 743.2 66.8 809.9 103.7
1999 ...................... 867.6 775.7 57.2 832.9 104.2
2000 ...................... 922.8 818.2 98.4 916.6 100.7

2001. . . . . . . . . . . . . . . . . . . . . . . 960.4 901.9 109.2 1,011.1 95.0

2002 . . . . . . . . . . . . . . . . . . . . . . 918.3 891.7 92.5 984.3 93.3
2003 . . . . . . . . . . . . . . . . . . . . . . 881.7 931.3 104.7 1,036.1 85.1
2004 . . . . . . . . . . . . . . . . . . . . . . 914.6 842.6 112.4 955.0 95.8
2005 . . . . . . . . . . . . . . . . . . . . . . 994.7 834.7 103.0 937.7 106.1
2006 . . . . . . . . . . . . . . . . . . . . . . 1,031.2 875.5 72.0 947.5 108.8

1997–2006 . . . . . . . . . . . . . . . . 9,149.9 8,367.5 870.5 9,238.1 99.0

Note: Here and elsewhere in this chapter, totals and of $7,722.6 million, imputed costs of $296.4 million, and
percentages may not reflect components shown because imputed income taxes of $348.5 million.
of rounding. 3. Revenue from services divided by total costs.
1. For the ten-year period, includes revenue from ser- 4. For the ten-year period, cost recovery is 95.5 per-
vices of $8,727.4 million and other income and expense cent, including the reduction in equity related to FAS 158
(net) of $422.5 million. reported by the priced services in 2006.
2. For the ten-year period, includes operating expenses

Commercial Check Collection adoption of check-processing services

Service associated with the Check Clearing for
the 21st Century Act (Check 21).5
In 2006, operating expenses and im- The Reserve Banks handled 11.0 bil-
puted costs for the Reserve Banks’ com- lion checks in 2006, a decrease of 9.9
mercial check collection service totaled percent from 2005 (table). The decline
$716.9 million, of which $35.4 million in Reserve Bank check volume is con-
was attributable to the transportation of sistent with nationwide trends away
commercial checks between Reserve from the use of checks and toward
Bank check-processing centers. Rev- greater use of electronic payment meth-
enue amounted to $745.0 million, of ods.6 Of all the checks presented by the
which $34.2 million was attributable Reserve Banks to paying banks in 2006,
to estimated revenues derived from 14.0 percent of the checks were depos-
the transportation of commercial ited and 4.3 percent were presented us-
checks between Reserve Bank check- ing Check 21 products, compared with
processing centers, and other income 1.8 percent and 0.0 percent, respec-
was $100.7 million. The resulting net
income was $128.7 million. Check ser- 5. The Reserve Banks’ Check 21 product suite
vice revenue in 2006 increased $4.7 mil- includes electronic alternatives to paper-check col-
lection, return, and presentment.
lion from 2005, largely because of price 6. The Federal Reserve System’s retail pay-
increases and faster-than-anticipated ments research suggests that the number of checks
written in the United States has been declining
ment of clearing balances net of earnings credits, since the mid-1990s. For details, see Federal
an amount termed net income on clearing bal- Reserve System, “The 2004 Federal Reserve
ances. Total cost is the sum of operating expenses, Payments Study: Analysis of Noncash Payments
imputed costs (interest on debt, interest on float, Trends in the United States, 2000–2003”
sales taxes, and the FDIC assessment), imputed (December 2004). (
income taxes, and the targeted return on equity. pdf/2004PaymentResearchReport.pdf)
Federal Reserve Banks 121

Activity in Federal Reserve Priced Services, 2004–2006

Thousands of items

Percent change
Service 2006 2005 2004
2005 to 2006 2004 to 2005

Commercial check . . . . . . . . . . . . . . . . . 10,982,367 12,195,301 13,904,382 –9.9 –12.3

Commercial ACH . . . . . . . . . . . . . . . . . . 8,230,782 7,338,950 6,486,091 12.2 13.1
Funds transfer . . . . . . . . . . . . . . . . . . . . . 136,399 135,227 128,270 0.9 5.4
Multilateral settlement . . . . . . . . . . . . . 470 440 435 6.8 1.3
Securities transfer . . . . . . . . . . . . . . . . . . 9,053 9,235 9,208 –2.0 0.3

Note: Activity in commercial check is the total num- securities transfer, the number of transactions originated
ber of commercial checks collected, including processed online and offline; and in multilateral settlement, the
and fine-sort items; in commercial ACH, the total number number of settlement entries processed.
of commercial items processed; in funds transfer and

tively, in 2005.7 Overall, the price index trillion), an increase of 12.2 percent
for check services increased 3.6 percent from 2005. Overall, the price index for
from 2005. ACH services decreased 9.1 percent
In response to the continuing decline from 2005.
in check volume, the Reserve Banks in In 2006, the Reserve Banks began
2006 continued to reduce check service offering ACH risk-management services
operating costs through a combination to all depository institutions. These ser-
of measures, including consolidating vices help originating institutions man-
some check-processing sites. Check pro- age the operational and credit risk asso-
cessing at New Orleans has now been ciated with originating ACH payments.
consolidated to Atlanta; New York’s By the end of 2006, 76 financial institu-
East Rutherford Operations Center to tions subscribed to these services.
Philadelphia; Columbus to Cleveland;
and Boston to Windsor Locks, Con-
necticut. Additional consolidations are Fedwire Funds and
planned for 2007 and beyond. National Settlement Services
Reserve Bank operating expenses and
Commercial Automated imputed costs for the Fedwire Funds
Clearinghouse Services and National Settlement Services to-
taled $59.3 million in 2006. Revenue
Reserve Bank operating expenses and from these operations totaled $63.6 mil-
imputed costs for commercial automated lion and other income amounted to $8.6
clearinghouse (ACH) services totaled million, resulting in net income of $13.0
$80.1 million in 2006. Revenue from million.
ACH operations totaled $80.5 million
and other income totaled $10.9 million, Fedwire Funds Service
resulting in net income of $11.3 million. The Fedwire Funds Service allows par-
The Banks processed 8.2 billion com- ticipants to draw on their reserve or
mercial ACH transactions (worth $13.1 clearing balances at the Reserve Banks
and transfer funds to other institutions
7. The Reserve Banks also offer non-Check 21
electronic presentment products. In 2006, 25.2
that maintain accounts at the Banks. In
percent of the Reserve Banks’ deposit volume was 2006, the number of Fedwire funds
presented to paying banks using these products. transfers originated by depository insti-
122 93rd Annual Report, 2006

tutions increased 0.9 percent from 2005, ticipants in the service.8 Reserve Bank
to approximately 136.4 million. The operating expenses and imputed costs
average daily value of Fedwire funds for providing this service totaled $19.1
transfers in 2006 was $2.3 trillion. Over- million in 2006. Revenue from the ser-
all, the price index for the Fedwire vice totaled $19.2 million, and other
Funds and National Settlement Services income totaled $2.6 million, resulting in
increased 3.4 percent from 2005. net income of $2.7 million. Overall, the
Last year, the Reserve Banks collabo- price index for the service increased
rated with The Clearing House Pay- 2.8 percent from 2005.
ments Company to study the use of In 2006, approximately 9.1 million
funds transfers for business-to-business non-Treasury securities transfers were
payments. The study examined why processed by the service, slightly lower
businesses select one payment type over than in 2005. Last year, the Reserve
another and what changes are needed to Banks also implemented technical
make funds transfers a more attractive changes to the Fedwire Securities Ser-
payment alternative. Key findings from vice applications to support changes to
the study suggested that businesses the Federal Reserve Policy on Payments
wanted a more streamlined process for System Risk (PSR). The PSR policy
making funds transfers and favored the changes require that government-
inclusion of remittance information in sponsored enterprises and certain inter-
funds transfer orders. national organizations fund principal
and interest payments before the
Reserve Banks distribute those pay-
National Settlement Service ments in order to limit the credit expo-
The National Settlement Service is a sure of the Reserve Banks.
multilateral settlement system that
allows participants in private-sector
clearing arrangements to exchange and Float
settle transactions on a net basis using
reserve or clearing balances. In 2006, The Federal Reserve had daily average
the service processed settlement files for credit float of $85.9 million in 2006,
approximately fifty-four local and na- compared with debit float of $133.4 mil-
tional private arrangements, primarily lion in 2005.9
check clearinghouse associations. The
Reserve Banks processed slightly more
than 17,300 files that contained more 8. The expenses, revenues, volumes, and fees
than 470,000 settlement entries for these reported here are for transfers of securities issued
arrangements in 2006. by federal government agencies, government-
sponsored enterprises, and certain international
organizations. The Reserve Banks provide Trea-
sury securities services in their role as the U.S.
Fedwire Securities Service Treasury’s fiscal agent. These services are not
considered priced services. For details, see the
The Fedwire Securities Service allows section “Debt Services” later in this chapter.
participants to transfer electronically se- 9. Credit float occurs when the Reserve Banks
curities issued by the U.S. Treasury, fed- present items for collection to the paying bank
prior to providing credit to the depositing bank,
eral government agencies, government- and debit float occurs when the Reserve Banks
sponsored enterprises, and certain credit the depositing bank prior to presenting items
international organizations to other par- for collection to the paying bank.
Federal Reserve Banks 123

Developments in curity features and subtle background

Currency and Coin colors.
The Presidential $1 Coin Act re-
The Federal Reserve Banks distribute quires, among other things, that the Fed-
the nation’s currency (in the form of eral Reserve and the Mint take steps to
Federal Reserve notes) and coin through ensure that an adequate supply of $1
depository institutions and also receive coins is available for commerce. To that
currency and coin from circulation end, the Federal Reserve worked with
through these institutions. As currency the United States Mint to develop an
flows into the Reserve Banks, the Banks effective distribution strategy for Presi-
inspect the notes and destroy those that dential $1 coins, the first of which was
are unfit for recirculation. issued by the Mint in February 2007.
The Reserve Banks received 38.5 bil- Consistent with the requirements of the
lion Federal Reserve notes from circula- Presidential $1 Coin Act, the Federal
tion in 2006, a 3.5 percent increase from Reserve and the Mint conducted out-
2005, and made payments of 39.1 bil- reach to depository institutions and coin
lion notes into circulation in 2006, a users in an effort to gauge demand for
1.5 percent increase from 2005. They the coins and to anticipate and eliminate
received 59.7 billion coins from circula- obstacles to the efficient circulation of
tion in 2006, a 6.5 percent increase from $1 coins.
2005, and made payments of 73.9 bil- The Reserve Banks conducted exten-
lion coins into circulation, a 2.7 percent sive testing of a prototype upgrade to
increase from 2005. the high-speed currency-processing ma-
In March, the Board approved a pol- chines. The Reserve Banks will begin
icy that provides incentives to encour- implementing the upgrades on their ma-
age depository institutions to recirculate chines in 2007; the upgrades are sched-
fit currency to their customers rather uled to be completed in 2009.
than return it to the Federal Reserve for The Federal Reserve developed the
processing. Under the policy, the Fed- requirements for an automation system
eral Reserve implemented a custodial to replace the current platform used to
inventory program that allows deposi- support and facilitate the System’s pro-
tory institutions to transfer a portion of vision of cash services. The Reserve
the currency holdings in their vaults to Banks issued a preview request for pro-
the books of a Reserve Bank. As of posal for development of the new auto-
December 31, the Reserve Banks had mation system and held an orientation
established twenty-nine custodial in- with potential vendors in December.
ventory sites with depository institu- The Reserve Banks completed a com-
tions. Beginning in July 2007, the prehensive study of cost-effective alter-
Reserve Banks will charge fees to insti- natives to the existing infrastructure for
tutions that, within a one-week period, providing cash services. The study
deposit fit $10 or $20 notes and reorder resulted in the elimination of cash pro-
currency of the same denomination, cessing at the Oklahoma City and Bir-
above a de minimis amount, within the mingham offices in March and May,
same Reserve Bank office’s service respectively, and the replacement of
area. these offices with outsourced cash de-
In March, the Reserve Banks began pots. In these cash depot arrangements,
issuing the redesigned $10 Federal armored carrier facilities serve as collec-
Reserve note that includes enhanced se- tion and distribution points for deposi-
124 93rd Annual Report, 2006

Expenses of the Federal Reserve Banks for Fiscal Agency and Depository Services,
Thousands of dollars

Agency and service 2006 2005 2004

Department of the Treasury

Bureau of the Public Debt

Treasury retail securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73,931.4 86,503.2 103,257.7
Treasury securities safekeeping and transfer . . . . . . . . . . . . . 7,535.2 6,055.8 6,267.0
Treasury auction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,594.9 17,553.5 17,159.5
Computer infrastructure development and support . . . . . . . 3,853.1 2,575.5 5,935.1
Other services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,578.7 1,806.5 1,709.8
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110,493.2 114,494.5 134,329.1

Financial Management Service

Payment services
Government check processing . . . . . . . . . . . . . . . . . . . . . . . . 20,918.6 20,988.0 24,245.4
Automated clearinghouse . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,823.1 5,709.5 5,352.9
Fedwire funds transfers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123.1 109.4 111.6
Other payment programs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69,696.8 49,366.0 33,646.9
Collection services
Tax and other revenue collections . . . . . . . . . . . . . . . . . . . . 37,095.5 39,736.0 34,248.4
Other collection programs . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,122.6 14,354.2 12,922.8
Cash-management services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48,320.2 40,496.7 21,835.8
Computer infrastructure development and support . . . . . . . 67,046.4 67,703.3 52,673.3
Other services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,414.8 2,332.2 6,931.6
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 270,561.2 240,795.4 191,968.6

Other Treasury
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,786.3 15,726.7 15,106.1
Total, Treasury . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 397,840.7 371,016.6 341,403.7

Other Federal Agencies

Department of Agriculture
Food coupons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,929.8 2,642.4 4,519.0
United States Postal Service
Postal money orders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,334.4 7,647.8 7,774.6
Other agencies
Other services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,977.1 14,870.2 16,104.0
Total, other agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,241.4 25,160.4 28,397.5

Total reimbursable expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 426,082.1 396,177.0 369,801.2

tory institutions’ currency deposits and process electronic and check payments
orders. The deposits and orders are for the Treasury, maintain the Trea-
transported to and from the nearest sury’s bank account, and invest excess
Reserve Bank by armored carrier for Treasury balances. The Reserve Banks
processing. also provide limited fiscal agency and
depository services to other entities.
Developments in The total cost of providing fiscal
Fiscal Agency and agency and depository services to the
Government Depository Services Treasury and other entities in 2006
amounted to $426.1 million, compared
As fiscal agents and depositories for the with $396.2 million in 2005 (table).
federal government, the Federal Reserve Treasury-related costs were $397.8 mil-
Banks provide services related to the lion in 2006, compared with $371.0 mil-
federal debt, help the Treasury collect lion in 2005, an increase of 7.2 percent.
funds owed to the federal government, The cost of providing services to other
Federal Reserve Banks 125

entities was $28.2 million, compared Sell Direct in 2006, compared with
with $25.2 million in 2005. In 2006, as 14,000 securities worth $874.8 million
in 2005, the Treasury and other entities in 2005. The Banks printed and mailed
reimbursed the Reserve Banks for the more than 28.9 million savings bonds in
costs of providing these services. 2006, a 10 percent decrease from 2005.
They issued more than 5.3 million Se-
ries I (inflation-indexed) bonds and 23.1
Debt Services million Series EE bonds.
The Reserve Banks auction, provide
safekeeping for, and transfer Treasury
securities. Reserve Bank operating ex-
Payments Services
penses for these activities totaled The Reserve Banks process both elec-
$31.1 million in 2006, compared with tronic and check payments for the Trea-
$23.6 million in 2005. The Banks pro- sury. Reserve Bank operating expenses
cessed 148,000 commercial tenders for for processing government payments
Treasury securities, compared with and for payments-related programs to-
169,000 in 2005. They originated taled $96.6 million in 2006, compared
12.9 million transfers of Treasury secu- with $76.2 million in 2005. The Banks
rities in 2006, a 1.8 percent increase processed 991.6 million ACH payments
from 2005. The Reserve Banks are de- for the Treasury, an increase of 2.8 per-
veloping a new Treasury auction appli- cent from 2005, and more than 855,000
cation and infrastructure that will pro- Fedwire funds transfers. They also pro-
vide increased functionality and cessed 192 million paper government
security. The application will be opera- checks, a decline of 11 percent from
tional in late 2007. 2005. In addition, the Banks issued more
The Reserve Banks also operate com- than 170,000 fiscal agency checks, a
puter applications and provide customer decrease of 17.4 percent from 2005.
service and back-office support for the
Treasury’s retail securities programs.
Reserve Bank operating expenses for
Collection Services
these activities were $73.9 million in The Reserve Banks support several
2006, compared with $86.5 million in Treasury programs to collect funds
2005. The Reserve Banks operate owed the federal government. Reserve
Legacy Treasury Direct, a program that Bank operating expenses related to these
allows investors to purchase and hold programs totaled $51.2 million in 2006,
Treasury securities directly with the compared with $54.1 million in 2005.
Treasury through the Reserve Banks in- The Banks operate the Federal Reserve
stead of through a broker. The program Electronic Tax Application (FR-ETA) as
held $72 billion (par value) of Treasury an adjunct to the Treasury’s Electronic
securities as of December 31. Because Federal Tax Payment System (EFTPS).
the program was designed for investors EFTPS allows businesses and individual
who plan to hold their securities to ma- taxpayers to pay their taxes electroni-
turity, it does not provide transfer ser- cally. It uses the automated clearing-
vices. Investors may, however, sell their house (ACH) to collect funds, so tax
securities for a fee through Sell Direct, a payments must be scheduled at least one
program operated by one of the Reserve day in advance. Some business taxpay-
Banks. Approximately 13,000 securities ers, however, do not know their tax
worth $678.9 million were sold through liability until the tax due date. FR-ETA
126 93rd Annual Report, 2006

allows these taxpayers to use EFTPS by was $1.04 billion. In March, Treasury
providing a same-day electronic federal launched the Repurchase Agreement
tax payment alternative. FR-ETA col- Program, a pilot program that allows
lected $456.3 billion for the Treasury in Treasury to place a portion of its excess
2006, compared with $409.2 billion in operating funds directly with TT&L de-
2005. positaries through a repurchase transac-
In addition, the Reserve Banks oper- tion for a set period at an agreed-on
ate, a Treasury program that interest rate. In 2006, the Reserve Banks
allows members of the public to pay for placed a total of $478.9 billion of invest-
goods and services offered by the fed- ments through repurchase agreements.
eral government over the Internet. They
also operate the Treasury’s Paper Check
Conversion and Electronic Check Pro-
Services Provided to Other Entities
cessing programs, whereby checks writ- The Reserve Banks provide fiscal
ten to government agencies are con- agency and depository services to other
verted into ACH transactions at the point domestic and international entities when
of sale or at lockbox locations. In 2006, required to do so by the Secretary of the
the Reserve Banks originated more than Treasury or when required or permitted
2.6 million ACH transactions through to do so by federal statute. The majority
these programs, roughly the same num- of the work is securities-related.
ber of transactions as in 2005.
Electronic Access to
Cash-Management Services Reserve Bank Services
The Treasury maintains its bank account In 2006, the Federal Reserve Banks
at the Reserve Banks and invests the completed the migration of their Fed-
funds it does not need for current pay- Line DOS customers to FedLine Advan-
ments with qualified depository institu- tage. About 6,200 customers were con-
tions through the Treasury Tax and Loan verted to FedLine Advantage, a web-
(TT&L) program, which the Reserve based access delivery channel typically
Banks operate. Reserve Bank operating used by small and medium-sized deposi-
expenses related to this program and tory institutions to access critical pay-
other cash-management initiatives to- ment services, such as the Fedwire
taled $48.3 million in 2006, compared Funds, Fedwire Securities, National
with $40.5 million in 2005. The invest- Settlement, and FedACH Services. In
ments either are callable on demand or addition, the Reserve Banks began mi-
are for a set term. In 2006, the Reserve grating their high-volume computer-
Banks placed a total of $309.2 billion in interface customers, which are typically
immediately callable investments, which large depository institutions, to FedLine
includes funds invested through retained Direct, an internet-protocol-based
tax deposits and direct, special direct, computer-to-computer access delivery
and dynamic investments, and $508 bil- channel for critical payment services.
lion in term investments. The rate for Also in 2006, the Reserve Banks an-
term investments is set by auction; the nounced a new option, FedLine
Reserve Banks held 104 such auctions Command, a lower-cost computer-to-
in 2006, roughly the same number of computer access delivery channel for
auctions as in 2005. In 2006, the Trea- FedACH customers. The Reserve Banks
sury’s income from the TT&L program will continue to migrate customers to
Federal Reserve Banks 127

FedLine Direct and FedLine Command nology projects and to fully transition to
in 2007. the TPS by January 1, 2008.
Also in 2006, the Federal Reserve
Bank of New York migrated its primary
Information Technology dealers (banks and securities broker-
In early 2006, the Federal Reserve dealers) to the FedTrade application,
Banks initiated the first phase of the which provides increased functionality
Information Security Architecture and security. The FedTrade application
Framework (ISAF), a program that will is used to execute various forms of open
cost $30.5 million by the end of 2008, market operations using electronic auc-
when this phase of the program will be tions with the primary dealers as
completed. The ISAF program is in- bidders.
tended to respond to the continuing and Throughout 2006, the Reserve Banks
increasingly sophisticated threats facing continued to focus on initiatives to re-
information technology systems and to duce IT costs over the long term by
improve information security at all standardizing processes, increasing pro-
points in the Federal Reserve System’s ductivity, and strengthening the Federal
networks. ISAF is a portfolio of initia- Reserve’s ability to respond to cyber
tives to improve (1) targeted security security threats.
services by ensuring that overall risks
are reduced and the residual risks of
these services are acceptable and (2) the
Examinations of the
overall efficiency and coherence of the
Federal Reserve Banks
provisioning of these services. Section 21 of the Federal Reserve Act
The System established a National requires the Board of Governors to order
Information Security Assurance (NISA) an examination of each Federal Reserve
function in 2006 to enhance information Bank at least once a year. The Board
security governance. By managing and performs its own reviews and engages a
coordinating information security at the public accounting firm. The public
enterprise level, NISA will have an inte- accounting firm performs an annual au-
grated view of information security dit of the combined financial statements
compliance across the Reserve Banks. of the Reserve Banks (see the section
NISA will implement a business- “Federal Reserve Banks Combined
oriented model of information security Financial Statements”) and audits the
responsibility and accountability and annual financial statements of each of
will establish comprehensive informa- the twelve Banks. The Reserve Banks
tion security standards and processes for use the framework established by the
all the Reserve Banks. Committee of Sponsoring Organizations
In mid-2006, the Federal Reserve of the Treadway Commission (COSO)
System adopted the Technology Project in assessing their internal controls over
Standards (TPS), a set of standards for financial reporting, including the safe-
managing information technology guarding of assets. The Reserve Banks
projects. The standards are based on the have further enhanced their assessments
Project Management Book of Knowl- under the COSO framework to
edge (PMBOK), a recognized industry strengthen the key control assertion pro-
best practice. All Reserve Banks are cess and in 2006 met the requirements
expected to train their staff members of the Sarbanes-Oxley Act of 2002.
who are involved in information tech- Within this framework, management of
128 93rd Annual Report, 2006

each Reserve Bank provides an asser- schedule of participated income ac-

tion letter to its board of directors annu- counts at year-end. The FOMC receives
ally confirming adherence to COSO the external audit reports and the report
standards, and a public accounting firm on the division’s examination.
confirms management’s assertion and
issues an attestation report to the Bank’s
board of directors and to the Board of
Income and Expenses
Governors. The accompanying table summarizes the
The firm engaged for the audits of the income, expenses, and distributions of
individual and combined financial state- net earnings of the Federal Reserve
ments of the Reserve Banks for 2006 Banks for 2005 and 2006.
was PricewaterhouseCoopers LLP Income in 2006 was $38,410 million,
(PwC). Fees for these services totaled compared with $30,729 million in 2005.
$4.2 million. To ensure auditor indepen- Expenses totaled $4,056 million ($2,987
dence, the Board requires that PwC be million in operating expenses, $276 mil-
independent in all matters relating to the lion in earnings credits granted to de-
audit. Specifically, PwC may not per- pository institutions, $301 million in as-
form services for the Reserve Banks or sessments for expenditures by the Board
others that would place it in a position of Governors, and $492 million for the
of auditing its own work, making man- cost of new currency). Revenue from
agement decisions on behalf of the priced services was $908 million. Net
Reserve Banks, or in any other way additions to and deductions from current
impairing its audit independence. In net income showed a net loss of
2006, the Reserve Banks did not engage $159 million. The loss was due prima-
PwC for nonaudit services. rily to interest expense on securities sold
The Board’s annual examination of under agreements to repurchase offset,
the Reserve Banks includes a wide range in part, by unrealized gains on assets
of off-site and on-site oversight activi- denominated in foreign currencies reval-
ties conducted by the Division of ued to reflect current market exchange
Reserve Bank Operations and Payment rates. Statutory dividends paid to mem-
Systems. Division personnel monitor the ber banks totaled $871 million, $90 mil-
activities of each Reserve Bank on an lion more than in 2005; the increase
ongoing basis and conduct on-site reflects an increase in the capital and
reviews based on the division’s risk- surplus of member banks and a conse-
assessment methodology. The examina- quent increase in the paid-in capital
tions also include assessing the effi- stock of the Reserve Banks.
ciency and effectiveness of the internal Payments to the U.S. Treasury in the
audit function. To assess compliance form of interest on Federal Reserve
with the policies established by the Fed- notes totaled $29,052 million in 2006,
eral Reserve’s Federal Open Market up from $21,468 million in 2005; the
Committee (FOMC), the division also payments equal net income after the
reviews the accounts and holdings of the deduction of dividends paid and of the
System Open Market Account at the amount necessary to equate the Reserve
Federal Reserve Bank of New York and Banks’ surplus to paid-in capital. The
the foreign currency operations con- implementation of FAS 158 required a
ducted by that Bank. In addition, PwC reduction to surplus of $1,849 million
audits the schedule of participated asset and increased the amount necessary to
and liability accounts and the related equate surplus to paid-in capital in 2006.
Federal Reserve Banks 129

Income, Expenses, and Distribution of Net Earnings

of the Federal Reserve Banks, 2006 and 2005
Millions of dollars

Item 2006 2005

Current income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,410 30,729

Current expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,264 2,890
Operating expenses 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,987 2,677
Earnings credits granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 276 213

Current net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,147 27,840

Net additions to (deductions from, − ) current net income . . . . . . . . . . . . . . . –159 −3,577
Assessments by the Board of Governors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 793 743
For expenditures of Board . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 301 266
For cost of currency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 492 477

Net income before payments to Treasury . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34,195 23,520

Dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 871 781
Transferred to surplus 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,272 1,272

Payments to Treasury 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29,052 21,468

1. Includes a net periodic pension expense of $53 mil- surplus by $1,849 million and increased the amount of the
lion in 2006 and a net periodic pension credit of $11 mil- transfer required to equate capital and surplus.
lion in 2005. 3. Interest on Federal Reserve notes.
2. The implementation of FAS 158 in 2006 reduced

In the “Statistical Tables” section of 4.59 percent, from 3.80 percent in 2005,
this report, table 10 details the income and the average rate of interest earned
and expenses of each Reserve Bank for on loans increased to 5.44 percent, from
2006 and table 11 shows a condensed 3.49 percent.
statement for each Bank for the years
1914 through 2006; table 9 is a state-
ment of condition for each Bank, and Volume of Operations
table 13 gives the number and annual Table 12 in the ’’Statistical Tables’’ sec-
salaries of officers and employees for tion shows the volume of operations in
each Bank. A detailed account of the the principal departments of the Federal
assessments and expenditures of the Reserve Banks for the years 2003
Board of Governors appears in the sec- through 2006.
tion “Board of Governors Financial
Federal Reserve Bank Premises
In 2006, construction continued on the
Holdings of Securities and Loans
Kansas City Bank’s new headquarters
The Federal Reserve Banks’ average building and construction began on the
daily holdings of securities and loans San Francisco Bank’s new Seattle
during 2006 amounted to $794,395 mil- Branch building after the Board ap-
lion, an increase of $32,886 million proved the project’s final design. The
from 2005 (table). Holdings of U.S. gov- multiyear renovation program at the
ernment securities increased $32,879 New York Bank’s headquarters building
million, and holdings of loans increased continued, as did facility renovation
$7 million. The average rate of interest projects at several Reserve Bank offices
earned on the Reserve Banks’ holdings to accommodate the consolidation of
of government securities increased to check activities. A long-term facility re-
130 93rd Annual Report, 2006

Securities and Loans of the Federal Reserve Banks, 2004–2006

Millions of dollars except as noted

Item and year Total government Loans 2
securities 1

Average daily holdings 3

2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 719,647 719,494 153
2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 761,509 761,295 214
2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 794,395 794,174 221

Earnings 4
2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22,347 22,344 3
2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,966 28,959 7
2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36,464 36,452 12
Average interest rate (percent)
2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.11 3.11 1.74
2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.80 3.80 3.49
2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.59 4.59 5.44

1. Includes federal agency obligations. 4. Earnings have not been netted with the inter-
2. Does not include indebtedness assumed by the Fed- est expense on securities sold under agreements to
eral Deposit Insurance Corporation. repurchase.
3. Based on holdings at opening of business.

development program at the St. Louis ing garage. The sales of the Chicago
Bank continued. Construction of a new Bank’s former Detroit Branch building,
pedestrian-screening vestibule was com- the Kansas City Bank’s Oklahoma City
pleted, and construction of an addition Branch building, and the San Francisco
to the Board’s headquarters building be- Bank’s Portland Branch building were
gan. finalized. Efforts to sell the St. Louis
Security enhancement programs con- Bank’s Little Rock Branch building con-
tinue at several facilities. One such tinued, as did efforts by the Dallas Bank
project is the recently completed exter- to sell excess land at its Houston
nal perimeter security improvement Branch.
project at the Boston Bank. In addition, Activities for the Portland Branch
the Richmond Bank continued construc- were moved to leased facilities. The
tion of additional security improvements Kansas City Bank sold its Oklahoma
to its headquarters building. The Dallas City Branch building and is leasing
Bank completed the purchase of prop- space in the building for the Branch’s
erty behind its headquarters building for administrative activity. The Birming-
the construction of a remote vehicle- ham Branch check and cash operations
screening and shipping/receiving facil- were relocated to the head office in At-
ity. Planning continues for a similar lanta. The Birmingham building will
screening facility at the Philadelphia house the remaining Branch activities,
Bank. and available space will be leased.
Also during 2006, the Board ap- Table 14 in the “Statistical Tables”
proved the Richmond Bank’s purchase section of this report details the acquisi-
of property adjacent to its headquarters tion costs and net book value of the
building for construction of a new park- Federal Reserve Banks and Branches. Á
Federal Reserve Banks 131

Pro Forma Financial Statements for Federal Reserve Priced Services

Pro Forma Balance Sheet for Priced Services, December 31, 2006 and 2005
Millions of dollars

Item 2006 2005

Short-term assets (Note 1)

Imputed reserve requirements
on clearing balances . . . . . . . . . . . . 821.7 993.2
Imputed investments . . . . . . . . . . . . . . . . . 7,245.7 8,626.4
Receivables . . . . . . . . . . . . . . . . . . . . . . . . . 73.6 77.0
Materials and supplies . . . . . . . . . . . . . . . 0.9 1.3
Prepaid expenses . . . . . . . . . . . . . . . . . . . . 24.2 25.6
Items in process of collection . . . . . . . . 3,391.0 5,934.4
Total short-term assets . . . . . . . . 11,557.1 15,657.7

Long-term assets (Note 2)

Premises . . . . . . . . . . . . . . . . . . . . . . . . . . . . 424.9 424.5
Furniture and equipment . . . . . . . . . . . . . 127.9 156.1
Leases, leasehold improvements, and
long-term prepayments . . . . . . . . . . 83.3 88.5
Prepaid pension costs . . . . . . . . . . . . . . . . 399.0 796.8
Deferred tax asset . . . . . . . . . . . . . . . . . . . . 146.0 0.0
Total long-term assets . . . . . . . . . 1,181.0 1,465.9

Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . 12,738.1 17,123.6

Short-term liabilities
Clearing balances and balances
arising from early credit
of uncollected items . . . . . . . . . . . . . 8,015.6 10,703.2
Deferred-availability items . . . . . . . . . . . 3,592.5 5,163.0
Short-term debt . . . . . . . . . . . . . . . . . . . . . . 0.0 0.0
Short-term payables . . . . . . . . . . . . . . . . . . 100.4 126.2
Total short-term liabilities . . . . . 11,708.4 15,992.4

Long-term liabilities
Long-term debt . . . . . . . . . . . . . . . . . . . . . . 0.0 0.0
benefits obligation . . . . . . . . . . . . . . 392.8 275.0
Total long-term liabilities . . . . . 392.8 275.0

Total liabilities . . . . . . . . . . . . . . . . . . . . . . 12,101.2 16,267.4

Equity (including accumulated other
comprehensive loss of
$343.9 million at
December 31, 2006) . . . . . . . . . . . . 636.9 856.2
Total liabilities and equity (Note 3) . . . 12,738.1 17,123.6

Note: Components may not sum to totals because of The accompanying notes are an integral part of these
rounding. pro forma priced services financial statements.
132 93rd Annual Report, 2006

Pro Forma Income Statement for Federal Reserve Priced Services, 2006 and 2005
Millions of dollars

Item 2006 2005

Revenue from services provided

to depository institutions (Note 4) . . . . . . 908.4 901.0
Operating expenses (Note 5) . . . . . . . . . . . . . . . . 803.5 750.0
Income from operations . . . . . . . . . . . . . . . . . . . . 104.8 150.9
Imputed costs (Note 6)
Interest on float . . . . . . . . . . . . . . . . . . . . . . . . . –4.9 6.1
Interest on debt . . . . . . . . . . . . . . . . . . . . . . . . . . 0.0 0.0
Sales taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.8 11.3
FDIC insurance . . . . . . . . . . . . . . . . . . . . . . . . . 0.0 5.9 0.0 17.4
Income from operations after
imputed costs . . . . . . . . . . . . . . . . . . . . . . . . . 98.9 133.5
Other income and expenses (Note 7)
Investment income . . . . . . . . . . . . . . . . . . . . . . 383.6 292.7
Earnings credits . . . . . . . . . . . . . . . . . . . . . . . . . –260.8 122.8 −199.0 93.7
Income before income taxes . . . . . . . . . . . . . . . . 221.8 227.2
Imputed income taxes (Note 6) . . . . . . . . . . . . . 66.1 67.3
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155.7 160.0
Memo: Targeted return on equity (Note 6) . . 72.0 103.0

Note: Components may not sum to totals because of The accompanying notes are an integral part of these
rounding. pro forma priced services financial statements.

Pro Forma Income Statement for Federal Reserve Priced Services, by Service, 2006
Millions of dollars

Commercial Commercial Fedwire Fedwire

Item Total check ACH funds securities

Revenue from services

(Note 4) . . . . . . . . . . . . . . . . . . . . . . . . . . 908.4 745.0 80.5 63.6 19.2

Operating expenses
(Note 5) . . . . . . . . . . . . . . . . . . . . . . . . . . 803.5 658.2 74.7 52.9 17.7
Income from operations . . . . . . . . . . . . . . . . 104.8 86.8 5.8 10.7 1.5

Imputed costs (Note 6) . . . . . . . . . . . . . . . . . 5.9 4.1 0.6 0.8 0.3

Income from operations
after imputed costs . . . . . . . . . . . . . . . . 98.9 82.7 5.2 9.9 1.3
Other income and expenses,
net (Note 7) . . . . . . . . . . . . . . . . . . . . . . 122.8 100.7 10.9 8.6 2.6
Income before income taxes . . . . . . . . . . . . 221.8 183.3 16.1 18.5 3.9

Imputed income taxes

(Note 6) . . . . . . . . . . . . . . . . . . . . . . . . . . 66.1 54.6 4.8 5.5 1.2
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155.7 128.7 11.3 13.0 2.7

Memo: Targeted return on

equity (Note 6) . . . . . . . . . . . . . . . . . . . 72.0 57.1 7.5 5.6 1.8

Note: Components may not sum to totals because of The accompanying notes are an integral part of these
rounding. pro forma priced services financial statements.
Federal Reserve Banks 133


Notes to Pro Forma Financial Statements for Priced Services

(1) Short-Term Assets liabilities include clearing balances maintained at Reserve
Banks and deposit balances arising from float. Other
The imputed reserve requirement on clearing balances
held at Reserve Banks by depository institutions reflects a long-term liabilities consist of accrued postemployment,
treatment comparable to that of compensating balances postretirement, and nonqualified pension benefits costs
held at correspondent banks by respondent institutions. and obligations on capital leases.
The reserve requirement imposed on respondent balances In order to reflect the funded status of its benefit plans
must be held as vault cash or as non-earning balances as required by FAS 158, the Reserve Banks recognized
maintained at a Reserve Bank; thus, a portion of priced the deferred items related to these plans, which include
services clearing balances held with the Federal Reserve prior service costs and actuarial gains or losses, on the
is shown as required reserves on the asset side of the balance sheet. This resulted in an increase to the benefits
balance sheet. Another portion of the clearing balances is obligation related to the priced services and an offsetting
used to finance short-term and long-term assets. The adjustment, net of tax, to AOCI, which is included in
remainder of clearing balances is assumed to be invested equity.
in a portfolio of investments, shown as imputed Equity is imputed at 5 percent of total assets.
Receivables are (1) amounts due the Reserve Banks for (4) Revenue
priced services and (2) the share of suspense-account and
difference-account balances related to priced services. Revenue represents charges to depository institutions for
Materials and supplies are the inventory value of short- priced services and is realized from each institution
term assets. through one of two methods: direct charges to an institu-
Prepaid expenses include salary advances and travel tion’s account or charges against its accumulated earn-
advances for priced-service personnel. ings credits.
Items in process of collection is gross Federal Reserve
cash items in process of collection (CIPC) stated on a (5) Operating Expenses
basis comparable to that of a commercial bank. It reflects
adjustments for intra-System items that would otherwise Operating expenses consist of the direct, indirect, and
be double-counted on a consolidated Federal Reserve other general administrative expenses of the Reserve
balance sheet; adjustments for items associated with non- Banks for priced services plus the expenses for staff
priced items, such as those collected for government members of the Board of Governors working directly on
agencies; and adjustments for items associated with pro- the development of priced services. The expenses for
viding fixed availability or credit before items are re- Board staff members were $7.5 million in 2006 and $6.6
ceived and processed. Among the costs to be recovered million in 2005.
under the Monetary Control Act is the cost of float, or net Effective January 1, 1987, the Reserve Banks imple-
CIPC during the period (the difference between gross mented the Financial Accounting Standards Board’s
CIPC and deferred-availability items, which is the portion Statement of Financial Accounting Standards No. 87,
of gross CIPC that involves a financing cost), valued at Employers’ Accounting for Pensions (FAS 87). Accord-
the federal funds rate. ingly, the Reserve Banks recognized operating expenses
for the qualified pension plan of $11.5 million in 2006
(2) Long-Term Assets and a credit to expenses of $1.3 million in 2005. Operat-
ing expenses also include the nonqualified pension ex-
Consists of long-term assets used solely in priced ser- pense of $3.2 million in 2006 and $1.0 million in 2005.
vices, the priced-service portion of long-term assets The implementation of FAS 158 does not change the
shared with nonpriced services, and an estimate of the systematic approach required by generally accepted
assets of the Board of Governors used in the development accounting principles to recognize the expenses associ-
of priced services. ated with the Reserve Banks’ benefit plans in the income
Effective December 31, 2006, the Reserve Banks statement.
implemented FAS 158, which requires an employer to The income statement by service reflects revenue, op-
record the funded status of its benefit plans on its balance erating expenses, and imputed costs. Certain corporate
sheet, resulting in a reduction to the prepaid pension asset overhead costs not closely related to any particular priced
related to priced services and the recognition of an asso- service are allocated to priced services based on an
ciated deferred tax asset with an offsetting adjustment, net expense-ratio method. Corporate overhead was allocated
of tax, to accumulated other comprehensive income among the priced services during 2006 and 2005 as
(AOCI) (see note 3). follows (in millions):
2006 2005
(3) Liabilities and Equity
Under the matched-book capital structure for assets, Check . . . . . . . . . . . . . . . . . . . . . 30.6 29.4
ACH . . . . . . . . . . . . . . . . . . . . . . 4.1 3.7
short-term assets are financed with short-term payables Fedwire funds . . . . . . . . . . . . . . 2.8 2.6
and clearing balances. Long-term assets are financed with Fedwire securities . . . . . . . . . . 1.5 1.3
long-term liabilities and clearing balances. As a result, no
short- or long-term debt is imputed. Other short-term Total . . . . . . . . . . . . . . . . . . . . . . 39.0 37.0
134 93rd Annual Report, 2006

(6) Imputed Costs Unrecovered float includes float generated by services

Imputed costs consist of income taxes, return on equity, to government agencies and by other central bank ser-
interest on debt, sales taxes, the FDIC assessment, and vices. Float recovered through income on clearing bal-
interest on float. Many imputed costs are derived from the ances is the result of the increase in investable clearing
private-sector adjustment factor (PSAF) model. The cost balances; the increase is produced by a deduction for float
of debt and the effective tax rate, which reflect bank for cash items in process of collection, which reduces
holding company data as the proxy for a private-sector imputed reserve requirements. The income on clearing
firm, are used to impute debt and income taxes in the balances reduces the float to be recovered through other
PSAF model. The after-tax rate of return on equity is means. As-of adjustments and direct charges refer to float
based on the returns of the equity market as a whole and that is created by interterritory check transportation and
is used to impute the profit that would have been earned the observance of non-standard holidays by some deposi-
had the services been provided by a private-sector firm. tory institutions. Such float may be recovered from the
Interest is imputed on the debt assumed necessary to depository institutions through adjustments to institution
finance priced-service assets; however, no debt was im- reserve or clearing balances or by billing institutions
puted in 2006 or 2005. The sales taxes and FDIC assess- directly. Float recovered through direct charges and per-
ment that the Federal Reserve would have paid had it item fees is valued at the federal funds rate; credit float
been a private-sector firm are also among the components recovered through per-item fees has been subtracted from
of the PSAF. the cost base subject to recovery in 2006.
Interest on float is derived from the value of float to be
recovered, either explicitly or through per-item fees, dur- (7) Other Income and Expenses
ing the period. Float costs include costs for checks,
book-entry securities, ACH, and funds transfers. Consists of investment income on clearing balances and
Float cost or income is based on the actual float the cost of earnings credits. Investment income on clear-
incurred for each priced service. Other imputed costs are ing balances for 2006 and 2005 represents the average
allocated among priced services according to the ratio of coupon-equivalent yield on three-month Treasury bills
operating expenses less shipping expenses for each ser- plus a constant spread, based on the return on a portfolio
vice to the total expenses for all services less the total of investments. In both years, the return is applied to the
shipping expenses for all services. total clearing balance maintained, adjusted for the effect
The following list shows the daily average recovery of of reserve requirements on clearing balances. Expenses
actual float by the Reserve Banks for 2006 in millions of for earnings credits granted to depository institutions on
dollars: their clearing balances are derived by applying a dis-
counted average coupon-equivalent yield on three-month
Total float –84.7 Treasury bills to the required portion of the clearing
Unrecovered float 15.6 balances, adjusted for the net effect of reserve require-
Float subject to recovery –100.3 ments on clearing balances.

Sources of recovery of float

Income on clearing balances –10.0
As-of adjustments –1.2
Direct charges 497.6
Per-item fees –589.1

The Board of Governors and the

Government Performance and Results Act
The Government Performance and port indicates that the Board generally
Results Act (GPRA) of 1993 requires met its goals for 2004–05.
that federal agencies, in consultation All of the aforementioned documents
with Congress and outside stakeholders, are available on the Board’s web site,
prepare a strategic plan covering a mul- at
tiyear period and submit an annual per- rptcongress. The Board’s mission state-
formance plan and performance report. ment and a summary of the Federal
Although the Federal Reserve is not Reserve’s goals and objectives, as set
covered by the GPRA, the Board of forth in the most recently released stra-
Governors voluntarily complies with the tegic and performance plans, are listed
spirit of the act. below.

Strategic Plan, Performance The mission of the Board is to foster the
Plan, and Performance Report stability, integrity, and efficiency of the
The Board’s strategic plan articulates nation’s monetary, financial, and pay-
the Board’s mission, sets forth major ment systems so as to promote optimal
goals, outlines strategies for achieving macroeconomic performance.
those goals, and discusses the environ-
ment and other factors that could affect Goals and Objectives
their achievement. It also addresses
issues that cross agency jurisdictional The Federal Reserve has six primary
lines, identifies key quantitative perfor- goals with interrelated and mutually re-
mance measures, and discusses perfor- inforcing elements.
mance evaluation. The most recent stra-
tegic plan covers the period 2006–09. Goal
Both the performance plan and the
performance report are prepared bienni- To conduct monetary policy that pro-
ally. The performance plan sets forth motes the achievement of maximum
specific targets for some of the perfor- sustainable long-term growth and the
mance measures identified in the strate- price stability that fosters that goal
gic plan and describes the operational Objectives
processes and resources needed to meet
those targets. It also discusses data vali- v Stay abreast of recent developments
dation and results verification. The most and prospects in the U.S. economy
recent performance plan covers the and financial markets, and in those
period 2006–07. abroad, so that monetary policy deci-
The performance report discusses the sions will be well informed.
Board’s performance in relation to its v Enhance our knowledge of the struc-
goals. The most recent performance re- tural and behavioral relationships in
136 93rd Annual Report, 2006

the macroeconomic and financial mar- v Promote compliance by domestic and

kets, and improve the quality of the foreign banking organizations super-
data used to gauge economic perfor- vised by the Federal Reserve with
mance, through developmental re- applicable laws, rules, regulations,
search activities. policies, and guidelines through a
v Implement monetary policy effec- comprehensive and effective supervi-
tively in rapidly changing economic sion program.
circumstances and in an evolving
financial market structure.
v Contribute to the development of U.S. Goal
international policies and procedures,
To effectively implement federal laws
in cooperation with the U.S. Depart-
designed to inform and protect the con-
ment of the Treasury and other
sumer, to encourage community devel-
opment, and to promote access to bank-
v Promote understanding of Federal
ing services in historically underserved
Reserve policy among other govern-
ment policy officials and the general
public. Objectives
v Take a leadership role in shaping the
Goal national dialogue on consumer protec-
tion in financial services, addressing
To promote a safe, sound, competitive,
the rapidly emerging issues that affect
and accessible banking system and
today’s consumers, strengthening con-
stable financial markets
sumer compliance supervision pro-
Objectives grams when required, and remaining
sensitive to the burden on supervised
v Promote overall financial stability, institutions.
manage and contain systemic risk, and v Promote, develop, and strengthen ef-
identify emerging financial problems fective communications and collabo-
early so that crises can be averted. rations within the Board, the Federal
v Provide a safe, sound, competitive, Reserve Banks, and other agencies
and accessible banking system and organizations.
through comprehensive and effective v Increase public understanding of con-
supervision of U.S. banks, bank and sumer protection and community de-
financial holding companies, foreign velopment and the Board’s role in
banking organizations, and related these areas through increased outreach
entities. At the same time, remain and by developing programs that ad-
sensitive to the burden on supervised dress the information needs of con-
institutions. sumers and the financial services
v Provide a dynamic work environment industry.
that is challenging and rewarding. En- v Develop a staff that is highly skilled,
hance efficiency and effectiveness, professional, innovative, and diverse,
while remaining sensitive to the bur- providing career development op-
den on supervised institutions, by ad- portunities to ensure the retention
dressing the supervision function’s of highly productive staff and recruit-
procedures, technology, resource allo- ing highly qualified and skilled
cation, and staffing issues. employees.
Government Performance and Results Act 137

v Promote an efficient and effective effective performance, and sound

work environment by aligning busi- project management and should assist
ness functions with appropriate work the Board in the effective discharge of
processes and implementing solutions its oversight responsibilities.
for work products and processes that
can be handled more efficiently
through automation. Goal
To foster the integrity, efficiency, and
Goal effectiveness of Board programs
To foster the integrity, efficiency, and Objectives
accessibility of U.S. payment and settle-
ment systems v Oversee a planning and budget pro-
cess that clearly identifies the Board’s
Objectives mission, results in concise plans for
v Develop sound, effective policies and the effective accomplishment of op-
regulations that foster payment sys- erations, transmits to the staff the in-
tem integrity, efficiency, and accessi- formation needed to attain objectives
bility. Support and assist the Board in efficiently, and allows the public to
overseeing U.S. dollar payment and measure our accomplishments.
securities settlement systems by as- v Develop appropriate policies, over-
sessing their risks and risk manage- sight mechanisms, and measurement
ment approaches against relevant pol- criteria to ensure that the recruiting,
icy objectives and standards. training, and retention of staff meet
v Conduct research and analysis that Board needs.
contributes to policy development and v Establish, encourage, and enforce a
increases the Board’s and others’ un- climate of fair and equitable treatment
derstanding of payment system dy- for all employees regardless of race,
namics and risk. creed, color, national origin, age, or
Goal v Provide financial management sup-
port needed for sound business
To provide high-quality professional decisions.
oversight of Reserve Banks v Provide cost-effective and secure
Objective information resource management
services to Board divisions, support
v Produce high-quality assessments and divisional distributed-processing re-
oversight of Federal Reserve System quirements, and provide analysis on
strategies, projects, and operations, information technology issues to the
including adoption of technology to Board, Reserve Banks, other financial
the business and operational needs of regulatory institutions, and central
the Federal Reserve. The oversight banks.
process and outputs should help Fed- v Efficiently provide safe, modern, and
eral Reserve management foster and secure facilities and necessary support
strengthen sound internal control sys- for activities conducive to efficient
tems, efficient and reliable operations, and effective Board operations. Á

Federal Legislative Developments

The following federal laws enacted dur- serve requirements on certain deposits
ing 2006 affect the Federal Reserve Sys- held at depository institutions and
tem and the institutions it regulates: the mandates that the Board set the ratio
Financial Services Regulatory Relief of required reserves on transaction
Act of 2006; the Unlawful Internet accounts above a certain percentage
Gambling Enforcement Act of 2006; the (8 percent for amounts above the so-
Military Personnel Financial Services called low reserve tranche, and 3 per-
Protection Act; and the Financial Net- cent for amounts within the low reserve
ting Improvements Act of 2006. tranche). Because the Federal Reserve
does not pay interest on balances held at
Reserve Banks to meet reserve require-
Financial Services
Regulatory Relief Act of 2006 ments, depositories have an incentive to
reduce their reserve balances to a mini-
On October 13, 2006, President Bush mum. To do so, they engage in a variety
signed into law the Financial Services of reserve-avoidance activities, includ-
Regulatory Relief Act of 2006 (Regula- ing using “sweep” arrangements that
tory Relief Act), culminating more than move funds from accounts that are sub-
four years of work by Congress, the ject to reserve requirements to accounts
Board, and other interested parties. The and money market investments that are
act incorporates a number of significant not. These sweep programs and similar
monetary policy, supervisory, and regu- activities absorb resources and therefore
latory provisions that were proposed or diminish banking system efficiency.
supported by the Board. These provi- Depository institutions also may volun-
sions should reduce unnecessary burden tarily hold contractual clearing balances
on banking organizations and improve and excess reserve balances at a Reserve
operation of the financial system. The Bank. These balances also do not explic-
most important provisions of the Regu- itly earn interest, although contractual
latory Relief Act affecting the Federal clearing balances implicitly earn interest
Reserve System and banking organiza- in the form of credits that may be used
tions supervised by the Federal Reserve to pay for Federal Reserve services,
are discussed below. Except as noted
such as check clearing.
below, the act became effective on Octo-
The Regulatory Relief Act gives the
ber 13, 2006.
Federal Reserve the authority, effective
as of October 1, 2011, to pay explicit
Monetary Policy Provisions interest on all types of balances (includ-
ing required reserves, excess reserves,
Authority to Pay Interest
and contractual clearing balances) held
on Balances Held at Reserve Banks
by or for depository institutions at a
and Greater Flexibility in Setting
Reserve Bank. Paying interest on re-
Reserve Requirements
quired reserve balances, once autho-
For monetary policy purposes, federal rized, will remove a substantial portion
law obliges the Board to establish re- of the incentive for depositories to
140 93rd Annual Report, 2006

engage in reserve-avoidance measures, to the Federal Reserve as required re-

and the resulting improvements in effi- serve balances. These amendments,
ciency should eventually be passed once implemented, will enable national
through to bank borrowers and depositors. and state member banks to take advan-
Moreover, if the Board were to deter- tage of the same type of pass-through
mine to pay explicit interest on contrac- reserve arrangements previously avail-
tual clearing balances, once authorized able only to state nonmember banks.
to do so, the action could provide a
stable enough supply of voluntary bal-
ances to allow the Federal Reserve to Supervisory and
effectively implement monetary policy Regulatory Provisions
using existing procedures without the Rules Implementing the “Broker”
need for required reserves. Exceptions for Banks Adopted as
Importantly, the Regulatory Relief Part of the Gramm-Leach-Bliley Act
Act gives the Board the discretion, ef-
fective as of October 1, 2011, to lower Before the Gramm-Leach-Bliley Act
the ratio of reserves that a depository (GLB Act) of 1999, banks had a blanket
institution must maintain against its exception from the definition of “bro-
transaction accounts below the ranges ker” in the Securities Exchange Act of
currently established by law, including 1934. This meant that banks could
potentially establishing a zero reserve engage in any type of securities activity
ratio. Thus, once these authorities permissible under federal and state
become effective, the Board could reduce banking laws without registering with
or even eliminate reserve requirements if the Securities and Exchange Commis-
it determined that such action was consis- sion (SEC) as a broker and without com-
tent with the effective implementation of plying with the SEC’s rules applicable
monetary policy. Such action, if taken, to registered brokers. In the GLB Act,
would reduce a significant regulatory Congress eliminated this blanket excep-
burden for all depository institutions. tion for banks from the definition of
Having the authority to pay interest “broker” and replaced it with eleven
on excess reserves also will enhance the exceptions for broad types of securities
Federal Reserve’s monetary policy tool- activities conducted by banks. These
kit. If the Board were to determine to pay new activity-focused exceptions were
interest on such balances at some point in designed and intended to allow banks to
the future, the rate paid would act as a continue to provide their customers with
minimum for overnight interest rates securities services as part of their usual
and, thus, could help mitigate potential trust, fiduciary, custodial, and other
volatility in overnight interest rates. banking functions. The SEC requested
comment on rules that would implement
Authority for Member Banks these “broker” exceptions for banks in
to Use Pass-Through Reserves 2001 and 2004.
The Regulatory Relief Act requires
The Regulatory Relief Act also elimi- that the SEC and the Board, within 180
nated the statutory provisions that pro- days of enactment, jointly request com-
hibited banks that are members of the ment on a new “single set” of rules to
Federal Reserve from counting as implement the “broker” exceptions for
reserves their deposits in other banks banks that were adopted as part of the
that are “passed through” by those banks GLB Act. The Regulatory Relief Act
Federal Legislative Developments 141

also requires that the SEC and the Board thereby allowing additional small, well-
jointly adopt a “single set” of final rules run institutions to potentially qualify for
to implement these exceptions after con- an extended examination schedule. On
sulting with, and seeking the concur- January 11, 2007, President Bush also
rence of, the Office of the Comptroller signed into law a complementary bill,
of the Currency (OCC), the Federal De- Pub. L. 109-473, that allows an insured
posit Insurance Corporation (FDIC), and depository institution that meets the
the Office of Thrift Supervision (OTS). new $500 million total assets threshold
In addition, the act provides that the to potentially qualify for an eighteen-
single set of final rules adopted jointly month on-site exam cycle if the institu-
by the Board and the SEC shall super- tion received a composite rating of
sede the rules previously issued by the either a 1 or a 2 at its most recent safety
SEC to implement these exceptions. and soundness examination.
On December 18, 2006—well before
the end of the 180-day period estab- Nonwaiver of Privileges
lished by the Regulatory Relief Act— The Regulatory Relief Act includes an
the Board and the SEC issued and re- important provision that should facili-
quested comment on joint proposed tate the sharing of information between
rules to implement the “broker” excep- banking organizations and federal, state,
tions for banks. See 71 FR 77,522 and foreign banking authorities. Specifi-
(Dec. 26, 2006). These joint proposed cally, the act provides that any privilege
rules—designated Regulation R—are (for example, attorney-client or work-
designed to accommodate the securities product privilege) a person may have
activities that banks conduct as part of with respect to information is not
their normal banking functions, consis- waived or destroyed if the person pro-
tent with the purposes of the GLB Act. vides that information to “any federal
banking agency, state bank supervisor,
Expanded Eligibility for Eighteen- or foreign banking authority for any pur-
Month Examination Schedule pose in the course of the supervisory or
for Small Banks regulatory process of such agency, su-
pervisor, or authority.”
The Regulatory Relief Act expands the
number of well-capitalized and well-
Voting State Representative Added to
managed small insured depository insti-
the Federal Financial Institutions
tutions that may qualify for an eighteen-
Examination Council
month (rather than a twelve-month) on-
site safety and soundness examination Another provision of the Regulatory
schedule. Before the act, an insured Relief Act adds a state representative as
depository institution could qualify for a voting member of the Federal Finan-
an extended eighteen-month safety and cial Institutions Examination Council
soundness examination schedule only if (FFIEC). Specifically, the act provides
the institution had less than $250 mil- for the current State Liaison Committee
lion in total assets, was well capitalized of the FFIEC (which is composed of
and well managed, and met certain other five representatives of state supervisory
supervisory criteria. See 12 USC agencies for depository institutions) to
1820(d)(4). The act raised this $250 mil- elect a chairperson, and adds this
lion asset threshold for an eighteen- chairperson as a full voting member of
month exam cycle to $500 million, the FFIEC.
142 93rd Annual Report, 2006

Elimination of Certain Reporting 215) that implement the elimination of

Requirements Relating to these reporting requirements. See 71 FR
Insider Lending 71,472 (December 11, 2006).
The Regulatory Relief Act eliminated Streamlining the Supervisory Process
certain reporting requirements previ- for Bank Merger Transactions
ously imposed on banks and their execu-
tive officers and principal shareholders The Regulatory Relief Act streamlines
that the federal banking agencies did not the supervisory process for Bank Merger
find particularly useful in monitoring Act (12 USC 1828(c)) transactions in
insider lending or preventing insider two respects. First, it eliminates the need
abuse. Specifically, the act eliminated for the responsible agency in a Bank
the statutory provisions that previously Merger Act transaction to request a re-
required port on the competitive effects of the
transaction from each of the other fed-
• an executive officer of a bank to file a eral banking agencies, as well as the
report with the bank’s board of direc- Attorney General. Instead, the act re-
tors whenever the executive officer quires that the responsible agency re-
obtained a loan from another bank in quest a competitive factors report only
an amount that exceeded the amount from the Attorney General and provide
the executive officer could obtain a copy of the request to the FDIC (if it is
from his or her own bank (12 USC not the responsible agency). Second, the
375a(g)(6)), Regulatory Relief Act allows the
reviewing agency for a Bank Merger
• a bank to file a separate report with its Act transaction to avoid requesting a
quarterly Call Report concerning any competitive factors report from the other
loans the bank made to its executive federal banking agencies and the Attor-
officers since its previous Call Report ney General if the transaction involves
(12 USC 375a(g)(9)), and affiliated institutions. The act also elimi-
• an executive officer or principal share- nates the post-approval waiting period
holder of a bank to file an annual for bank mergers involving affiliated in-
report with the bank’s board of direc- stitutions, as these transactions typically
do not present any competitive issues.
tors if the officer or shareholder had a
The act does not, however, alter in any
loan outstanding from a correspon-
way the reviewing agency’s obligation
dent bank of the bank (12 USC
to conduct a competitive analysis of a
proposed Merger Act transaction.
Although the act eliminated these re-
Amendment Allowing the Board to
porting requirements, it did not alter the
Grant Exceptions from the Attribution
statutory and regulatory limits and re-
Rule in Section 2(g)(2) of the Bank
strictions on lending to insiders or the
Holding Company Act
ability of the federal banking agencies
to examine for potential insider lending Section 2(g)(2) of the Bank Holding
abuses as part of the supervisory pro- Company Act (BHC Act) (12 USC
cess. On December 6, 2006, the Board 1841(g)(2)) provides that in all circum-
adopted, on an interim basis, and re- stances, a company is deemed to control
quested public comment on amendments any shares that are held by a trust for the
to the Board’s Regulation O (12 CFR benefit of the company or its sharehold-
Federal Legislative Developments 143

ers, members, or employees. This attri- serving as a management official of any

bution rule was intended to prevent a other nonaffiliated depository organiza-
bank holding company from using a tion if the organizations have offices
trust established for the benefit of its located in the same metropolitan statis-
management, shareholders, or employ- tical area. The act provides an exception
ees to evade the BHC Act’s restrictions from this restriction if each of the
on the acquisition of shares of banks and depository organizations involved has
nonbanking companies. However, the less than a specified amount of total
rule can create inappropriate results in assets. The Regulatory Relief Act raised
situations in which the bank holding this specified amount from $20 million
company does not have the ability to to $50 million, thus allowing a greater
control, directly or indirectly, the shares number of small depository organiza-
acquired by the trust. Accordingly, the tions to qualify for the exception.
Regulatory Relief Act allows the Board
to waive application of this attribution Protection of Confidential Information
rule if the Board determines that the Received by Federal Banking Agencies
exception is appropriate in light of the from Foreign Banking Supervisors
facts and circumstances of the case and
The Regulatory Relief Act clarifies the
the purposes of the BHC Act. Such an
authority of the Board and the other
exception might be appropriate, for
federal banking agencies to maintain the
example, if the shares are held by the
confidentiality of information obtained
trust as part of a participant-directed and
from a foreign regulatory or supervisory
widely held 401(k) plan and the plan’s
authority. Specifically, the act provides
investment options are selected by an
that a federal banking agency may not
independent fiduciary (and not by the
be compelled to disclose information
bank holding company or its officers,
received from a foreign regulatory or
directors, or employees).
supervisory authority if public disclo-
Streamlining Reports of Condition sure of the information would violate
the law of the foreign country and the
The Regulatory Relief Act requires the federal banking agency obtained the in-
Board and the other federal banking formation in connection with the admin-
agencies to conduct a review of the istration and enforcement of the federal
Call Report forms within one year of banking laws or under a memorandum
enactment, and at least once every five of understanding between the foreign
years thereafter, and to eliminate any authority and the agency. The act, how-
information or schedule that the agen- ever, would not authorize the agencies
cies determine is no longer necessary or to withhold such information from Con-
appropriate. gress or if the information was sought
under a court order in an action initiated
Increase in Asset Threshold for the by the United States or the agency.
Small Depository Institution Exception
under the Depository Institution Modification to Cross-Marketing
Management Interlocks Act Restrictions Applicable to
Merchant Banking Investments
The Depository Institution Management
Interlocks Act, among other things, gen- Another provision of the Regulatory Re-
erally prohibits a management official lief Act allows the depository institution
of one depository organization from subsidiaries of a financial holding com-
144 93rd Annual Report, 2006

pany, with prior Board approval, to Amendments to Allow D.C.-Chartered

engage in cross-marketing activities Banks to Become State Member Banks
through “statement stuffers” and Inter-
The Regulatory Relief Act makes sev-
net web sites with nonfinancial portfolio
companies held by the financial holding eral technical changes to the Federal
Reserve Act to allow banks chartered in
company under the GLB Act’s mer-
chant banking authority. Previously, the the District of Columbia to become state
member banks.
depository institution subsidiaries of a
financial holding company were permit-
ted to engage, with Board approval, in Enforcement-Related Provisions
these limited types of cross-marketing
activities only with portfolio companies Amendments Expanding the Agencies’
held by the financial holding company Suspension Authority
under the GLB Act’s insurance com-
pany investment authority. The Federal Deposit Insurance Act (FDI
Act) currently allows the appropriate
Change in Bank Control Act federal banking agency to suspend,
Amendments remove, or prohibit an institution-
The Regulatory Relief Act expands the affiliated party (IAP) from participating
factors that the Board and the other fed- in the affairs of the depository institu-
eral banking agencies may consider in tion with which he or she is affiliated if
determining whether to disapprove, or the IAP is charged with or convicted of
extend the time period for processing, a certain crimes involving dishonesty,
notice filed under the Change in Bank breach of trust, or money laundering.
Control Act (CIBC Act). In particular, See 12 USC 1818(g)(1). The Regulatory
the act allows the appropriate federal Relief Act expands this authority by
banking agency to disapprove a CIBC allowing the appropriate federal bank-
Act notice if the agency determines that ing agency to suspend an IAP that has
the future prospects of the institution to been charged with such a crime from
be acquired might jeopardize the stabil- participating in the affairs of any deposi-
ity of the institution or the interests of tory institution (not just the institution at
depositors. (Currently, the financial and which the IAP then serves). In addition,
managerial factors in the CIBC Act fo- the act clarifies that the appropriate
cus on the resources of the acquiring agency may suspend, remove, or pro-
person, not the institution to be ac- hibit an IAP even if the IAP is no longer
quired.) In addition, the act allows an associated with any depository institu-
agency to extend the time for processing tion at the time the action is taken.
a CIBC Act notice for up to an addi-
Restricting the Ability of Convicted
tional two 45-day periods (beyond the
Individuals to Participate in the Affairs
initial 60-day review period and discre-
of a Bank Holding Company or
tionary 30-day extension) if the agency
Edge Act or Agreement Corporation
determines that additional time is needed
to analyze (1) the future prospects of the Section 19 of the Federal Deposit Insur-
institution to be acquired or (2) the safety ance Act (12 USC 1829) automatically
and soundness of any plans by the ac- prohibits a person that has been con-
quiring person to make major changes in victed of a crime involving dishonesty, a
the business, corporate structure, or man- breach of trust, or money laundering
agement of the institution. from participating in the affairs of an
Federal Legislative Developments 145

insured depository institution without ten condition imposed on the institution

the consent of the FDIC. The Regula- or an IAP, or a written agreement en-
tory Relief Act extends this prohibition tered into by the agency with the institu-
so that persons convicted of such crimes tion or IAP, without demonstrating that
also may not participate in the affairs of the institution or IAP was unjustly en-
a bank holding company (other than a riched or acted in reckless disregard of
foreign bank), an Edge or agreement the law or a prior agency order. Simi-
corporation, or a savings and loan hold- larly, the act allows the appropriate fed-
ing company unless the individual re- eral banking agency for an undercapital-
ceives the prior consent of the Board or ized institution to enforce a written
the OTS, as appropriate. The Regulatory condition imposed on, or a written
Relief Act also gives the Board and the agreement entered into with, the institu-
OTS additional discretionary authority tion or an IAP without regard to the
to remove a person convicted of such a limit in the FDI Act (12 USC
crime from, respectively, a nonbank sub- 1831o(e)(2)(E)) that normally caps the
sidiary of a bank holding company or a liability of a controlling shareholder un-
savings and loan holding company. der a capital restoration plan.

Authority to Enforce Clarifying the Ability of the Banking

Deposit Insurance Conditions Agencies to Enforce Conditions
Imposed in Connection with
Section 8 of the Federal Deposit Insur-
CIBC Act Notices
ance Act currently permits the appropri-
ate federal banking agency for an in- The Regulatory Relief Act amends sec-
sured depository institution to enforce a tion 8(b) of the Federal Deposit Insur-
written condition imposed by that ance Act to provide that the appropriate
agency on the institution or an IAP of federal banking agency for an insured
the institution. The Regulatory Relief depository institution may enforce writ-
Act amended section 8 of the FDI Act to ten conditions imposed in connection
allow the appropriate federal banking with “any action on any application,
agency for an institution to enforce a notice, or other request” by the deposi-
condition imposed on an insured deposi- tory institution or an IAP. These changes
tory institution by another federal bank- are designed to clarify and confirm the
ing agency. This will allow, for exam- agencies’ ability to enforce conditions
ple, the Board (as the appropriate imposed in connection with a notice filed
agency for a state member bank) to en- under the Change in Bank Control Act.
force a condition imposed on a state
member bank by the FDIC in connec- Board Approval of
tion with the bank’s application for de- OCC Removal Actions
posit insurance
The Regulatory Relief Act strikes the
provision in the FDI Act (see 12 USC
Standards for Enforcing Written
1818(e)(4)) that required the Board to
Conditions and Written Agreements
issue a final decision in any contested
The Regulatory Relief Act also amended administrative action by the OCC to
section 8 of the Federal Deposit Insur- remove or prohibit an IAP of a national
ance Act to allow the appropriate fed- bank. Thus, the OCC now has the same
eral banking agency for an insured authority as the Board, the FDIC, and
depository institution to enforce a writ- the OTS to independently remove or
146 93rd Annual Report, 2006

prohibit an IAP of an institution under may be used by financial institutions, at

the agency’s jurisdiction. their option, to fulfill the initial and
annual privacy policy disclosure re-
quirements imposed by section 503 of
Consumer-Related Provisions the Gramm-Leach-Bliley Act (12 USC
Public Welfare Investments by 6803). The model form must be issued
National and State Banks in proposed form for public comment
within 180 days of enactment. The
The Regulatory Relief Act makes sev- Board has been working extensively
eral important modifications to the stat- with the other relevant agencies and
utes that authorize national and state conducting consumer testing to develop
member banks to make “public welfare” potential model privacy forms that may
investments. See 12 USC 24 (eleventh) be used by financial institutions.
and 338a. First, it raises, from 10 per-
cent of capital and surplus to 15 percent
of capital and surplus, the aggregate Studies and Reports
amount of “public welfare” investments GAO Study of
that a national or state member bank Currency Transaction Reports
may make under these authorities.1 In
addition, the act refocuses these invest- The Regulatory Relief Act directs the
ments on low- and moderate-income Government Accountability Office
(LMI) families and communities by pro- (GAO) to conduct a study of the volume
viding that to be considered a “public of currency transaction reports (CTRs)
welfare” investment, an investment must filed with the Secretary of the Treasury
primarily benefit LMI families or com- under the Bank Secrecy Act. The study
munities (such as by providing housing, must evaluate, among other things,
services, or jobs). The act also clarifies (1) the extent to which depository insti-
that each “public welfare” investment tutions avail themselves of the current
made by a national or state member exemption system for CTRs, (2) ways to
bank, either directly or through a subsid- improve the current exemption system
iary, must benefit primarily LMI com- for CTRs, and (3) the usefulness of
munities or families. CTRs to law enforcement agencies. The
Regulatory Relief Act also provides that
Development of Model the study should include recommenda-
Privacy Disclosure Forms tions for changes to the CTR exemption
The Regulatory Relief Act requires the system that would reduce burden with-
Board, the other federal banking agen- out adversely affecting the reporting sys-
cies, the National Credit Union Admin- tem’s effectiveness. The GAO must sub-
istration, the Secretary of the Treasury, mit a report on its findings to Congress
the Securities and Exchange Commis- by January 13, 2007.
sion, and the Federal Trade Commission
to jointly develop a model form that Unlawful Internet Gambling
1. As under current law, a national or state
Enforcement Act of 2006
member bank would have to obtain the approval The Unlawful Internet Gambling En-
of the OCC or the Board, respectively, to make
"public welfare" investments that, in the aggre-
forcement Act of 2006, Pub. L. 109-
gate, exceed 5 percent of the bank’s capital and 347, (codified at 31 USC 5361 et seq.)
surplus. prohibits a person engaged in the busi-
Federal Legislative Developments 147

ness of betting or wagering from know- jointly find that it is not reasonably prac-
ingly accepting credit, electronic fund tical to identify and block, or otherwise
transfers, checks, drafts, or similar in- prevent or prohibit, such restricted trans-
struments drawn on or payable through actions. The regulations must be pub-
any financial institution in connection lished by July 10, 2007.
with the participation of another person
in unlawful Internet gambling (“re-
stricted transactions”). The act generally
Military Personnel Financial
defines “unlawful Internet gambling” as
Services Protection Act
transmitting a bet by any means that The National Defense Authorization Act
involves the use, at least in part, of the for Fiscal Year 2007, Pub. L. No. 109-
Internet and where such bet or wager is 364, enacted on September 30, 2006,
unlawful under any applicable federal or imposes restrictions on and disclosure
state law in the state or tribal lands in requirements for consumer credit pro-
which the bet or wager is initiated, re- vided to members of the military and
ceived, or otherwise made. their families. The act charges the De-
The act charges the Secretary of the partment of Defense (DOD) with defin-
Treasury and the Board, in consultation ing “consumer credit” in its regulations
with the Attorney General, with devel- and permits the DOD to include all con-
oping regulations to require each pay- sumer credit apart from residential mort-
ment system that the agencies determine gages, loans to fund the purchase of a
could be used to process restricted pay- motor vehicle, and other personal prop-
ments (as well as financial transaction erty loans when the property purchased
providers participating in such payment from the proceeds of the loan serves as
systems) to establish “policies and pro- collateral for the loan. Requirements for
cedures reasonably designed to identify creditors include a 36 percent annual
and block or otherwise prevent or pro- percentage rate (APR) cap, which
hibit the acceptance of restricted trans- includes all fees, along with APR calcu-
actions.” In prescribing the regulations, lations and disclosures that differ from
the Secretary and the Board must iden- the APR used in disclosures under the
tify the types of policies and procedures, Truth in Lending Act (TILA). The act
including nonexclusive examples, mandates that all credit disclosures,
deemed by the agencies to be reason- including TILA disclosures, be provided
ably designed to identify and block re- both orally and in writing prior to the
stricted transactions. To the extent prac- extension of credit.
tical, any participant in a designated Moreover, the act imposes limitations
payment system must be permitted to on lending to members of the military
choose among alternative means of and their dependents, such as prohibit-
complying, including by relying on and ing rollovers and refinancings of con-
complying with the policies and proce- sumer credit by the same creditor, and
dures of the designated payment system, prohibiting loans with prepayment pen-
so long as these policies and procedures alties and mandatory arbitration clauses.
comply with the regulation. The act also The act imposes criminal and monetary
requires the Secretary and the Board to penalties for knowing violations and
grant exemptions from any requirement voids contracts that are prohibited under
imposed under the regulations to par- the statute. The legislation was intended,
ticular types of transactions or desig- at least in part, to address concerns
nated payment systems if the agencies about payday loans, installment loans
148 93rd Annual Report, 2006

that are secured by a motor vehicle changes to the netting and financial con-
(other than loans for the purchase of a tract provisions that were added or re-
motor vehicle), and other forms of short- vised by title IX of the 2005 act. The
term credit to military members and 2006 act updates the descriptions of
their dependents. In prescribing regula- various financial contracts (“securities
tions for this legislation, the DOD must contract,” “forward contract,” and
consult with the Board, among other “swap agreement”) in the Federal De-
federal agencies. The effective date of posit Insurance Act, the Federal Credit
the act is October 1, 2007, regardless of Union Act (FCUA), and the Bankruptcy
whether the DOD adopts regulations. Code to reflect current market and regu-
This statute would become effective ear- latory practice. The 2006 act also re-
lier if interim regulations are issued by vises provisions in the Bankruptcy Code
the DOD. to clarify the rights of certain counter-
parties to exercise self-help foreclosure-
on-collateral rights, setoff rights, and
Financial Netting Improvements netting rights with respect to financial
Act of 2006 contracts with a debtor. These provi-
In 2005, Congress passed comprehen- sions conform the Bankruptcy Code
sive legislation to revise the federal with parallel provisions in the FDI Act
bankruptcy laws (Bankruptcy Abuse and the FCUA. In addition, the 2006 act
Prevention and Consumer Protection amends the FDI Act and the FCUA to
Act of 2005, Pub. L. 109-8). Title IX of clarify the conditions under which a re-
that act contained amendments to bank- ceiver of an insolvent depository institu-
ing laws and the Bankruptcy Code to tion can enforce a financial contract that
provide increased certainty that netting contains a “walkaway” clause (a clause
and close-out of financial market con- that would otherwise allow a contract
tracts would be enforceable, even in the participant to suspend, condition, or ex-
event of a counterparty insolvency. Title tinguish a payment obligation when the
IX also clarified certain duties and other party becomes insolvent). The
obligations of the FDIC as receiver or 2006 act also makes other technical and
conservator of an insured depository conforming revisions to the FDI Act,
institution. FCUA, Bankruptcy Code, Federal De-
The Financial Netting Improvements posit Insurance Corporation Improve-
Act of 2006 (Pub. L. 109-390), enacted ment Act of 1991, and Securities Inves-
on December 12, 2006, makes technical tor Protection Act of 1970. Á