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GAO warns FDIC of regulatory capture shortcomings

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Banking
Tuesday, September 29, 2020

A recent report by the Government Accountability Office (GAO) found weaknesses in the examination process of the Federal Deposit Insurance Corp. (FDIC) which could expose the regulator to the risk of regulatory capture.

GAO offered four recommendations to the FDIC in its report, saying management could better address threats to capture by improving adherence to agency policies.

GAO recommended that the division director for Risk Management Supervision (RMS) should require case managers to document how high-risk areas in the scoping plan were considered by the examination team if they were not addressed in the examination report.

The director also should implement policies to require that higher-level managers review case managers’ documentation that describes whether banks have fully addressed matters requiring board attention (MRBAs), GAO stated. It also recommended that the director should revise examination documentation retention policies to increase the retention period beyond one examination cycle for banks with satisfactory or better composite ratings.

Finally, it recommended that FDIC Chairwoman Jelena McWilliams should direct RMS and the Legal Division Ethics Unit to develop a process for systematically requesting and collecting information on where departing examiners, including examiners-in-charge, enter into employment after leaving FDIC.

“FDIC has several policies for documenting bank examination decisions that help promote transparent decision-making and assign responsibility for decisions. Such policies are likely to help reduce benefits to industry of capturing the examination process,” the report stated. “However, GAO found that some examinations were not implemented consistent with FDIC policies and that gaps in FDIC policies limited their effectiveness. For example, GAO found that managers sometimes did not clearly document how they concluded that banks had addressed recommendations.”

The report pointed out that FDIC already has policies in place to address potential conflicts of interest that could help block or reduce avenues of inducement, citing post-employment conflict-of-interest policies designed to prevent former employees from exerting undue influence on FDIC and to reduce industry’s ability to induce current FDIC employees with prospective employment arrangements.

“One such policy requires the agency to review the workpapers of examiners-in-charge who accept employment with banks they examined in the prior 18 months. However, FDIC has not fully implemented a process for identifying when to review the workpapers of departing examiners to assess whether independence has been compromised,” GAO stated. “In particular, FDIC does not have a process for collecting information about departing employees’ future employment. By revising its examiner-departure processes, the agency could better identify when to initiate workpaper reviews.”

In responding to GAO’s recommendations, RMS said the regulator takes the issue of regulatory capture seriously. However, in addressing the recommendations overall, RMS said some recommendations would undermine agency goals.

“Specifically, RMS expressed concern that implementing these recommendations would conflict with agency goals to empower staff, establish accountability for delegated authorities and minimize regulatory burden by providing timely decision-making,” GAO stated.

GAO said RMS detailed pilot programs around two of the recommendations which it said would help the FDIC answer GAO concerns.

The first of those addressed the recommendation to revise document retention policies.

“RMS said it would implement a pilot project to extend the retention of workpapers beyond one examination cycle for these banks,” GAO stated. “RMS said it plans to evaluate the results of the pilot and assess its effectiveness. These actions, if fully implemented, would address our recommendation.”

The other address the post-employment work of FDIC staff.

“RMS said it would implement a process with the Legal Division Ethics Unit to request information from departing examiners about whether and where they will enter into employment upon leaving FDIC,” GAO stated. “RMS said that this action will be implemented as part of a three-year pilot project, and that RMS and the Legal Division Ethics Unit will evaluate the results at the end of the three-year period and assess the pilot program’s effectiveness. If these actions are fully implemented, we believe they would address our recommendation.”

GAO expressed concern over responses to its other two recommendations, though.

The first, around documenting high-risk areas in the scoping plan led RMS to say it would make a policy change to require examiners to obtain written concurrence from their manager for material changes in planned examination procedures before the examination ended.

Managers who review the proposed changes would be required to provide documentation of their concurrence to case managers. Case managers would be expected to ensure that these changes are documented in the confidential section of the examination report.

“Although this policy change likely would improve management’s control over changes to scoping plans, it does not address our finding that small-bank examination reports did not always document whether and how the examination addressed all of the high-risk areas that were in the scoping plan,” GAO stated. “If case managers documented that examination procedures for areas not discussed in the examination report were assessed and that examiners’ conclusions about these areas were well supported, RMS management would have better assurance that case managers were monitoring examination teams’ procedures and conclusions for all planned aspects of the examination.”

GAO said that RMS’ concerns about our recommendations conflicting with agency goals for staff empowerment, staff accountability and timely decision-making conflicted with current FDIC policy.

“We note that FDIC policy already requires case managers to perform the review that we are discussing. We found that case managers’ review of examination reports is an important control established by FDIC,” GAO wrote. “Having layers of review that involve individuals with differing perspectives – such as case managers – can limit the effect any one individual can have on an examination. Requiring that case managers provide a brief statement explaining the results of this analysis would not seem to conflict with agency goals for staff empowerment or accountability or add a meaningful delay in finalizing the examination report.”

Finally, RMS told GAO that it was taking two new actions to address the recommendation of managers’ review of case manager documentation.

“First, RMS said in June 2020 it conducted a training session for all case managers that included the importance of following RMS policy for evaluating and documenting institutions’ responses to MRBAs. Second, RMS said it will expand the size of review samples during the next round of its regional reviews for the purpose of confirming that there is not a systematic problem with case managers’ adherence to RMS policy,” GAO stated. “RMS said its prior reviews had not indicated a systemic problem with case manager adherence to RMS policy related to the evaluation and documentation of MRBA resolution. RMS observed that our analysis was not generalizable to MRBA documentation across FDIC. RMS also said its planned actions were responsive to our findings, particularly in light of its conclusions about the low residual risk of regulatory capture at FDIC.”

GAO said the training and expansion of the size of review samples would help, but it did not believe the steps addressed its recommendation.

“FDIC uses the MRBA tracking process to help identify when banks’ corrective actions are not sufficient to address supervisory concerns. When banks do not address the supervisory concern, they are subject to increased monitoring and could be subject to additional supervisory action,” GAO stated. “Thus, inaccurate or incomplete information about MRBAs’ status may inhibit FDIC in determining when increased monitoring or additional supervisory action could be appropriate. Adding appropriate controls – such as supervisory review – to monitor case manager compliance with this documentation policy could help ensure that FDIC achieves its goal of transparency in determining whether banks have addressed MRBAs.”

The report stated that lawyers of review and documentation could help mitigate capture risk at FDIC.

“Having a review policy would provide better assurance that case managers have not been captured, for example, by prematurely closing MRBAs as completed to avoid conflicts with banks resistant to implementing MRBAs,” GAO stated. “We noted in our report that channels of capture can be nonfinancial and can include actions taken by a capturing party to make adversarial situations difficult for regulatory staff. We do not believe FDIC’s general concerns about our recommendations impairing staff empowerment and timely decision-making outweigh the substantial potential benefits from adding a layer of review. Further, we believe it would enhance staff accountability.”

 We therefore maintain that our recommendation is appropriate and should be addressed. 

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