Supervising and Regulating Banks
One of Congress’ paramount concerns in creating the Federal Reserve was to address the nation’s banking panics. This need led to one of the Fed’s three main responsibilities: to foster safe, sound and competitive practices in the nation’s banking system.
To accomplish this, Congress gave the Fed responsibility to regulate the banking system and to supervise certain types of financial institutions. What’s the difference between these two responsibilities? Bank regulation refers to the written rules that define what acceptable behavior is for financial institutions. The Board of Governors carries out this responsibility. Bank supervision refers to the enforcement of these rules. The 12 Reserve banks carry out this responsibility, supervising state-chartered member banks, the companies that own banks and international organizations that do banking business in the United States. The Federal Deposit Insurance Corp. (FDIC), the Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS) also supervise financial institutions.
For the Fed, supervising banks generally means carrying out three duties: establishing safe and sound banking practices, protecting consumers in financial transactions and ensuring the stability of U.S. financial markets by lending funds through its discount window. The goal of these duties is to minimize risk in the banking system.
SAFETY AND SOUNDNESS
The banking system is only as safe and sound as the banks within the system. So the Federal Reserve examines banks regularly to identify and contain bank risk.
In the past, Reserve bank examiners reviewed each bank in much the same way—looking over the bank’s books on site and evaluating the quality of its assets and its ability to cover loan losses. Today, Fed examinations are more customized for each bank; they take into account that each bank differs markedly in its services and products and that a bank’s own management should be held responsible for monitoring the institution’s exposure to risk. By looking at the bank’s risk-management procedures and internal controls, Reserve bank examiners assess whether a bank’s ability to manage risk matches the level of risk it assumes. Examiners also review a bank’s performance in complying with its own internal policies, as well as with Federal and state laws and regulations.
At the end of an on-site review, Fed examiners issue the bank a rating that reflects the institution’s condition. The rating indicates whether the institution is sound enough to withstand fluctuations in the economy or whether it exhibits weaknesses that require corrective action and close monitoring. Between examinations, Reserve banks monitor financial institutions by examining reports filed with the Fed.
Another way the Federal Reserve helps keep the banking system safe and sound is by reviewing major changes in a bank’s structure or service offerings. When a bank wishes to expand, merge with another bank, acquire another bank or introduce new products, it must first get permission from the Federal Reserve. Reserve banks have two objectives when evaluating any application: ensuring that the resulting organization or product will be safe and sound, and maintaining competition in the regional banking market.
CONSUMER PROTECTION
Another Fed goal is to protect consumers in lending and deposit transactions. Congress has given the Fed broad power to make, interpret and enforce laws that protect consumers from lending discrimination and inaccurate disclosure of credit costs or interest rates. Fed examiners specially trained in consumer compliance laws examine banks for their adherence to such regulations. In their Community Affairs departments, Federal Reserve banks also take active roles in helping institutions broaden access to capital and credit by hosting forums and bringing together lenders, government agencies and community development groups.
DISCOUNT WINDOW LENDING
One of the most important ways that the Fed ensures safety and soundness of the banking system is by offering funds for loan through its discount window. The Fed lends money to banks so that a shortage of funds at one institution does not disrupt the flow of money and credit in the entire banking system. Typically, the Fed makes loans to satisfy banks’ unanticipated needs for short-term funds. But the Fed also makes longer-term loans to help banks manage seasonal fluctuations in their customers’ deposit or credit demands. The discount window was once used only to provide emergency funds from the “lender of last resort.” Today, the discount window is often used to provide back-up funding to generally sound institutions.
