Large Bank Supervision:

Improved Implementation of Federal Reserve Policies Could Help Mitigate Threats to Independence

GAO-18-118: Published: Nov 6, 2017. Publicly Released: Dec 6, 2017.

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What GAO Found

The Board of Governors of the Federal Reserve System (Board) has not finalized and implemented its enterprise risk management (ERM) framework, and as a result, it may have limited ability to manage risks across the Large Institution Supervisory Coordinating Committee (LISCC) program. One such risk is regulatory capture, a condition that exists when a regulator acts in service of private interests, such as the interests of the regulated industry, at the expense of the public interest. GAO has previously found that regulators should be independent of inappropriate influence, including undue influence from the industry they are regulating. LISCC is a supervisory program developed by the Board to enhance the oversight of large, complex financial institutions. LISCC takes a cross-cutting approach to supervision, drawing staff from across the Federal Reserve System including the Board and four Federal Reserve Banks, and risks of regulatory capture span various aspects of the LISCC program. To help the Board manage its diverse risks, the Board has recognized the advantages of implementing an ERM, which the Office of Management and Budget (OMB) encourages all federal agencies to do. The Board began to develop an ERM framework in 2017, but it has not yet developed some of OMB's recommended key elements, such as risk identification and assessment. Completing and implementing the ERM framework should position the Board to better manage regulatory capture risks across the LISCC program.

The LISCC program has other policies to mitigate threats to independence for supervisory staff. For example, under the LISCC program, four Reserve Banks supervise the largest financial institutions with oversight from the Board, which increases the transparency and accountability of supervisory decisions and helps to ensure those decisions are free of inappropriate influence. In addition, the Federal Reserve has mechanisms for Reserve Bank staff to communicate their views directly to Board officials. However, GAO found weaknesses in some internal controls related to guidance and monitoring mechanisms. These limit the Board's assurance that policies are being implemented consistently across the LISCC program. Because of these weaknesses, the four Reserve Banks may not be mitigating regulatory capture risks and threats to supervisory independence as effectively or consistently as possible.

The Board and the four Reserve Banks have also implemented various conflict-of-interest and other ethics policies for LISCC examiners and other types of supervisory employees. While these policies are not explicitly designed to address regulatory capture, Federal Reserve officials said they use them in part for this purpose. However, GAO found weaknesses in the Federal Reserve's implementation of these policies. For example, the Federal Reserve officials said that they have policies to help mitigate threats to independence posed by the revolving door—that is, the movement of employees between the financial industry and the Federal Reserve—but they do not systematically collect employment data needed to implement these policies effectively. Without addressing this and other weaknesses, the Federal Reserve may be limited in its ability to use its ethics policies to mitigate regulatory capture.

Why GAO Did This Study

The Board of Governors created LISCC in 2010, in the wake of the financial crisis of 2007–2009, to strengthen supervision of the largest U.S. financial institutions that pose the greatest risk to the economy. However, questions have been raised about the independence of the supervisory process and the risk of regulatory capture.

GAO was asked to review regulatory capture and threats to independence in large bank supervision. This report discusses the Federal Reserve's policies for (1) managing risks of regulatory capture in the LISCC program using an ERM approach; (2) mitigating threats to supervisory independence for the LISCC program; and (3) mitigating conflicts of interest for LISCC supervisory personnel. GAO reviewed studies and Federal Reserve policies and procedures. GAO also interviewed officials and supervisory staff at the Board and the LISCC Reserve Banks.

What GAO Recommends

GAO is making six recommendations to help improve the Federal Reserve's implementation of ERM and to strengthen internal controls to more effectively mitigate risks of regulatory capture and threats to supervisory independence across the LISCC program. Although the Federal Reserve neither agreed nor disagreed with the recommendations, it identified ongoing and planned efforts to address them.

For more information, contact Lawrance Evans, Jr. at (202) 512-8678 or EvansL@gao.gov.

Recommendations for Executive Action

  1. Status: Open

    Comments: In August 2018, the Board of Governors reported to us that it is developing its ERM framework. The Board added that it is establishing a Board Risk Committee (comprised of senior leaders) to oversee its ERM program and serve as the central forum for addressing Board-wide risk issues. The Board also said that it has begun to implement a number of strategic components of the ERM framework.

    Recommendation: As the Board of Governors implements plans to develop an ERM framework, it should include a component to identify and assess risks of regulatory capture across the LISCC program. (Recommendation 1)

    Agency Affected: Federal Reserve System: Board of Governors

  2. Status: Open

    Comments: In August 2018, the Board of Governors told us that its LISCC supervisory program has continued to finalize and implement program-wide guidance for the LISCC Reserve Banks on implementing LISCC policies. The Board added that it has memorialized all aspects of the LISCC supervisory program within a comprehensive LISCC program manual. According to the Board, the LISCC program manual remains in a near-final form pending completion of a proposal to revise the Board's supervisory ratings system, which the Board anticipates being finalized by year-end 2018. The Board expects that the LISCC program manual will be completed by fall 2019.

    Recommendation: The Board of Governors should finalize and implement program-wide guidance for the LISCC Reserve Banks on implementing LISCC policies. (Recommendation 2)

    Agency Affected: Federal Reserve System: Board of Governors

  3. Status: Open

    Comments: In August 2018, the Board of Governors told us that they currently assess the effectiveness of Reserve Bank supervision functions, including their adherence to System guidance, through a continuous oversight program. They added that the Board has recognized that the recommendation to formalize the monitoring and assessment of the LISCC program would provide greater assurance regarding the implementation of LISCC guidance. In our recommendation, we acknowledged that the Board stated that it was "in the process of augmenting its oversight program through the development of a LISCC-specific oversight framework that is to encompass all Board and Reserve Bank LISCC activities and provide for a comprehensive assessment of program effectiveness for implementation in 2018." We also added that, "Until this framework is put into place, the Board may not have reasonable assurance that policies are being implemented appropriately and effectively." In its response to us, the Board said that it implemented those changes in the first half of 2018. It added that in the second half of 2018, staff identified further targeted review and oversight activities employing and testing the LISCC-specific oversight framework.

    Recommendation: The Board of Governors should finalize and implement a mechanism to monitor and regularly assess Reserve Banks' implementation of LISCC policies and procedures. (Recommendation 3)

    Agency Affected: Federal Reserve System: Board of Governors

  4. Status: Open

    Comments: In August 2018, the Board of Governors told us that they were assessing the feasibility of integrating existing electronic systems. They added that they have drafted guidance that develops a LISCC-specific conflicts of interest and examiner credential program that will seek to ensure consistency in the interpretation and application of conflicts of interest rules for all staff, both at the Board and the Reserve Banks, that participate in the LISCC supervisory program. They said that the Board plans to issue this guidance and begin implementation of a more consistent and centralized disclosure review approach in 2018. In addition, they said that they have begun collecting and storing conflicts of interest disclosure information for all LISCC participants, including Board LISCC staff, in one electronic system. They added that they have provided initial training to Board LISCC staff on the disclosure review process and the electronic system to ensure consistent collection of conflicts of interest data for all LISCC participants.

    Recommendation: The Board of Governors should streamline its conflict-of-interest disclosure review process for participants in the LISCC program, such as by storing disclosure information in compatible electronic systems. (Recommendation 4)

    Agency Affected: Federal Reserve System: Board of Governors

  5. Status: Open

    Comments: In August 2018, the Board of Governors told us that they had implemented policies intended to mitigate the risk that an employee may be influenced by prior employment or the prospect of future employment and place their private interests ahead of the organization's supervisory mission. As an example, they said that recently the Federal Reserve broadened the scope of post-employment restrictions applicable to senior examiners. They added that the Board has begun to develop a more systematic approach to collect and monitor pre- and post-employment data through the use of an electronic system. They said that this updated electronic system is scheduled to be released, for both Board and Reserve Banks use, in 2019.

    Recommendation: The Board of Governors should systematically collect and maintain information on the institutions supervisory employees work for before they are hired by the Federal Reserve and their employment destination when they leave. (Recommendation 5)

    Agency Affected: Federal Reserve System: Board of Governors

  6. Status: Open

    Comments: In August 2018, the Board of Governors told us that their Ethics program staff and Supervision & Regulation staff are jointly assessing the current ethics programs, policies, and procedures applicable to LISCC program participants. The Federal Reserve expects to finalize and implement new conflicts of interest policies and procedures applicable to LISCC participants in 2019.

    Recommendation: The Board of Governors should conduct a periodic self-assessment of ethics programs, policies, and procedures that apply to LISCC program participants. (Recommendation 6)

    Agency Affected: Federal Reserve System: Board of Governors

 

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