Bank Examination Quality:

OCC Examinations Do Not Fully Assess Bank Safety and Soundness

AFMD-93-14: Published: Feb 16, 1993. Publicly Released: Feb 16, 1993.

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GAO reviewed bank examinations performed by the Office of the Comptroller of the Currency (OCC).

GAO found that: (1) although the OCC handbook provides guidance for performing internal control assessments, OCC allows examiners discretion in determining the scope of an examination; (2) OCC did not comprehensively review internal controls in recent examinations of an estimated 72 percent of large banks and 59 percent of small banks supervised by OCC as of September 30, 1990; (3) internal control weaknesses that were evident to examiners were not recognized as early warning signs of financial deterioration and were not specifically considered in assessing bank safety and soundness; (4) OCC insufficiently tested loans for an estimated 50 percent of large and 59 percent of small banks supervised by OCC; (5) examiners assess loan quality based on loan samples that exclude major segments of the banks' loan portfolios; (6) OCC has no minimum loan sampling criteria and believes that the level of loans reviewed during examinations is limited by examiner resource constraints; (7) examiners did not have a sufficient basis to conclude that they had identified the full extent of problem loans and related losses; (8) OCC guidance on risk factors that should be considered in establishing loan loss reserves does not provide a means for quantifying these risk factors; and (9) the OCC handbook included specific guidance regarding working paper documentation and review, but compliance was inconsistent because handbook procedures were not mandatory.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: In April 1994, OCC issued OCC Bulletin 94-22, which provides guidance to examiners on the audit, reporting, and audit committee requirements of FDICIA. Bulletin 94-22 also transmits a new section to be added to the examiners handbook with specific procedures for review of these FDICIA requirements. The procedures include review of records of management supporting its assertions concerning the effectiveness of internal controls and determination of the adequacy of management's standards for such assertions. The procedures also instruct examiners to consider adjusting the scope of the examination on the basis of the review of management's records. However, OCC did not establish comprehensive internal control procedures as recommended in the report and, therefore, does not have a sufficient basis to judge the adequacy of management's standards and procedures for reliance in the examination.

    Recommendation: The Comptroller of the Currency should require examiners to rely on the assessments required by the Federal Deposit Insurance Corporation (FDIC) Improvement Act of 1991 to the extent possible, and supplement these assessments as necessary to ensure a comprehensive assessment of internal controls. As a basis for reliance, the Comptroller should direct the examiners to use the internal control review procedures as guidance in reviewing the quality of management's and the external auditor's internal control assessments required by the act.

    Agency Affected: Department of the Treasury: Office of the Comptroller of the Currency

  2. Status: Closed - Not Implemented

    Comments: OCC indicated in its internal recommendation follow-up documentation that it did not intend to mandate comprehensive internal control assessments of all banks.

    Recommendation: The Comptroller of the Currency should require examiners to conduct independent comprehensive reviews of internal controls of banks with assets of less than $150 million.

    Agency Affected: Department of the Treasury: Office of the Comptroller of the Currency

  3. Status: Closed - Not Implemented

    Comments: In commenting on the report, OCC stated that it did not believe that it was necessary to add a separate CAMEL component for internal controls in light of action it had already taken to strengthen examinations in this area.

    Recommendation: The Comptroller of the Currency should require that the condition of a bank's system of internal controls be added to the capital adequacy, asset quality, management, earnings and liquidity (CAMEL) rating as a separate critical area for rating to highlight the significance of internal controls to a bank's viability.

    Agency Affected: Department of the Treasury: Office of the Comptroller of the Currency

  4. Status: Closed - Not Implemented

    Comments: According to a GAO review of agency responses and actions on the internal control recommendations, the regulators apparently did not make a coordinated effort to implement these recommendations.

    Recommendation: The Comptroller of the Currency should coordinate the implementation of the internal control recommendations with the other federal depository institution regulatory agencies to achieve uniform requirements.

    Agency Affected: Department of the Treasury: Office of the Comptroller of the Currency

  5. Status: Closed - Implemented

    Comments: OCC issued its revised examiner handbook (dated August 1998), which includes a revised and updated section on statistical sampling. The revised sampling methodology provides a representative view of the loan portfolio as a basis to determine loan quality and the adequacy of the reserve for loan losses.

    Recommendation: The Comptroller of the Currency should require examiners to use and appropriately document sampling methodologies which provide a representative view of the loan portfolio as a basis to determine loan quality and the adequacy of the reserve for loan losses.

    Agency Affected: Department of the Treasury: Office of the Comptroller of the Currency

  6. Status: Closed - Implemented

    Comments: The OCC comment letter and recommendation follow-up indicated that OCC already required examiners to expand the examination scope when risk rating discrepancies were identified. OCC stated in its recommendation follow-up documentation that it intended to reemphasize this requirement in its training sessions and the updated Comptroller's Handbook.

    Recommendation: The Comptroller of the Currency should require examiners to expand their testing of individual loans to ensure proper identification of problem loans and related specific reserves where the loan risk rating or other loan administration systems are found to be unreliable.

    Agency Affected: Department of the Treasury: Office of the Comptroller of the Currency

  7. Status: Closed - Not Implemented

    Comments: The OCC comment letter indicated OCC's intent to provide more specific guidance to examiners on assessing loan loss reserves in its updated Comptroller's Handbook. However, OCC's internal recommendation followup indicated that no formal corrective action was planned.

    Recommendation: The Comptroller of the Currency should require examiners to develop a quantitative risk-based approach to evaluate the adequacy of a bank's overall loan loss reserve which considers loss exposure from individual problem credits as well as inherent loss exposures in the remainder of the portfolio, which are outlined in Banking Circular 201.

    Agency Affected: Department of the Treasury: Office of the Comptroller of the Currency

  8. Status: Closed - Not Implemented

    Comments: The OCC comment letter noted that OCC was continually working to improve working paper documentation and review. However, no planned corrective action was noted in the letter or the follow-up documentation on the recommendation.

    Recommendation: The Comptroller of the Currency should require examiners to fully document all examination working papers and indicate supervisory review and concurrence by initialing or signing each working paper.

    Agency Affected: Department of the Treasury: Office of the Comptroller of the Currency

  9. Status: Closed - Not Implemented

    Comments: OCC indicated in its internal recommendation follow-up form that no corrective action was to be taken, as OCC had comprehensive procedures in its examination handbook. OCC also noted that use of all such procedures at every examination would not be mandated.

    Recommendation: The Comptroller of the Currency should develop comprehensive internal control review procedures for all major aspects of bank operations to be used during OCC annual on-site examinations. The procedures should identify any major risk areas in each bank's operations, identify the related significant internal controls, and require testing to assess the effective operation of the internal controls.

    Agency Affected: Department of the Treasury: Office of the Comptroller of the Currency

  10. Status: Closed - Not Implemented

    Comments: OCC stated in its recommendation follow-up that it did not intend to coordinate with the other agencies because they each have different loan quality and examination quality requirements.

    Recommendation: The Comptroller of the Currency should coordinate implementation of the examination loan quality and examination quality control recommendations with the other federal depository institution regulatory agencies to achieve uniform requirements.

    Agency Affected: Department of the Treasury: Office of the Comptroller of the Currency

 

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