Conducting Offsite Bank Examinations
by Kerri Allen, Examiner, Examinations and Inspections, Federal Reserve Bank of Kansas City and William Mark, Lead Examiner, Supervision and Regulation, Federal Reserve Bank of Chicago
Bank examinations may be conducted offsite for various reasons. During unique circumstances such as disasters and pandemics, offsite examinations may be necessary. The current coronavirus (COVID-19) pandemic, for example, emphasizes the urgency of evaluating and, in many cases, temporarily modifying the way business is routinely conducted, especially if mandated shelter-in-place orders and other operational challenges are presented that may interfere with standard operating practices. Although this pandemic and other disasters cause many economic and operational uncertainties, the Federal Reserve has established methodologies and practices to assess the safety and soundness of institutions offsite in an efficient and secure manner. This article discusses the Federal Reserve’s use of offsite examinations as part of its safety and soundness supervision over community banks and the relevance of offsite examinations during unique circumstances, such as the current COVID-19 pandemic.
Benefits of Offsite Examination Work
Not long ago, bank examiners performed all bank examination procedures onsite, from reconciling the general ledger to counting cash in teller drawers. Over the past decade, significant technological advances have radically transformed the supervision process, which includes the proliferation of offsite examination work. Today, a considerable amount of monitoring and examination work is performed offsite. From both a convenience and continuity standpoint, conducting examinations offsite can be particularly useful for both bankers and examiners, especially when extenuating circumstances, such as weather or illness, impede individuals from working onsite at the bank.
Preparing for an offsite examination may require more coordination and preparation than for an entirely onsite review. However, despite some additional effort on the front end, an offsite examination offers several benefits, including procedural efficiencies such as minimizing disruption of bank activities, providing greater flexibility for Reserve Banks to manage resources, and offering greater training or mentoring opportunities for newer examiners.
Consider the loan file review portion of an examination.1 There are benefits and efficiencies to performing this process offsite. An offsite arrangement can reduce the number of examiners needed at the bank to perform loan reviews because a large portion of an examination team is devoted to assessing asset quality. This could minimize onsite disruption for bank staff. Although examiners and loan personnel may miss the traditional face-to-face interaction, discussions can still be conducted via phone and email. Flexibility to better accommodate the time demands of bankers, especially during unusual circumstances, is a positive byproduct of offsite loan reviews. Further, Reserve Bank staff can benefit from offsite work because this work may facilitate more formalized training given the availability of a wider range of resources in the Reserve Bank or branch office.
Supervisory Work During Exigent Circumstances
Pandemics and natural disasters affect the way both bankers and regulators conduct their work. For example, in light of COVID-19, the Federal Reserve adjusted its supervisory approach to focus on monitoring and outreach to help financial institutions of all sizes understand the challenges and risks posed by the current environment.2 This shift allows banks to focus on day-to-day operations while examiners strive to understand key issues and potential issues facing the banking sector. Examiners can assist community banks in leveraging the tools and programs available to them and regulators can implement modified examination and other monitoring operations as appropriate. In many ways, the role of the regulator during a pandemic or other crisis is to serve as a “voice” for the banks it oversees, relaying the collective challenges, patterns, and resource needs the banks are observing and experiencing.
The unique challenges of COVID-19 have highlighted the importance of offsite monitoring and examination support in the short term. In response to the added complexity of shelter-in-place orders in many parts of the country, the Federal Reserve has reinforced the use of various technological tools to facilitate efficient and secure communication in the context of teleworking.
COVID-19 likely will continue to affect different geographic regions to varying degrees for quite some time. Because of this, predicting when supervisory practices will return to business as usual is difficult. Given these uncertainties, examiner judgment plays a greater role in the examination planning and scoping processes, as different approaches to examination activities will likely need to be taken for different banks. Although there are logistical consequences in postponing and significantly modifying the scope of examination activities, the safety of examiners and financial institution staff is paramount. Undoubtedly, the COVID-19 experience will result in many supervisory “lessons learned” vis-à-vis the offsite examination processes.
Communication Remains Key
Regardless of where examination activities are conducted, it is essential that Reserve Bank staff effectively communicate with bank management. Certain supervisory tasks and examination components do not require a great deal of face-to-face discussion with bank management and can be performed offsite. This generally includes the examination of certain financial components because examiners can review electronic documents and follow up with bank management if clarification is needed. While face-to-face interaction is reduced in these cases, examiners are expected to follow communication protocols during all phases of the examination, from scheduling and scoping to requesting additional information and conveying conclusions to bank management.3 When appropriate, it remains an effective practice for examination leadership, as well as central points of contact and Reserve Bank management, to visit with bank management onsite during examinations to foster open dialogue and build positive working relationships and rapport.
Communication between the offsite examination team and bank staff can be challenging because of real and perceived lag time between messages. These communication challenges can be mitigated if both parties promptly address the status of requested items, schedule meetings, or even acknowledge the receipt of messages.
From a monitoring perspective, communication between bank and examination staff is paramount. Together with information gathered in the examination and surveillance processes, periodic touchpoints between examinations help examiners understand changes in the organization’s risk profile. Periodic touchpoints help examiners understand any changes in the bank’s strategic plans, products and services, as well as its assets and liabilities. These conversations also provide insight into local economic conditions, which are invaluable to the risk assessment process. In light of the current pandemic stress scenario, it is important that regulators remain apprised of newly implemented bank programs and efforts to assist or work with customers, including lending relief provisions or operational/branch modifications. Finally, these interactions provide opportunities for supervisory staff to share effective practices and clarify guidance and regulations.
Considerations for Conducting Offsite Examinations
When determining the ability to conduct examination activities offsite, examiners consider various factors such as risk profile, management preferences, and technology capabilities, particularly for loan file review. The quality of submitted data and documentation, logistical hurdles, and the need for onsite observations of control processes are factors examiners consider to determine the extent of offsite work.
Technological and Logistical Considerations
The bank’s technological capability plays a key role in determining whether it is feasible for certain examinations to be effectively completed offsite. To that end, examiners can leverage various tools to support the effective completion of an offsite examination. A Reserve Bank’s first day letter (FDL) that results from the offsite examination scoping process notifies bank management of an upcoming examination and requests documentation needed by examiners in support of the supervisory event. The FDL typically prescribes the items the bank should provide examiners prior to the examination versus items to be made available upon the arrival of the examination team at the bank. Bank management then uploads these requested documents to a secure website, which saves examiners time by allowing them to review the documentation before and during the examination.
The example of the FDL illustrates the importance of a secure document uploading system in completing offsite examination work. Similarly, relevant information and supplemental documentation can be exchanged via secure email. In many cases, examiners and bankers use video conferencing tools to facilitate virtual “face-to-face” discussions when examiners are located offsite, and at the same time, they must ensure that these interactions are conducted in a secure manner.
Examiners have conducted the review of various financial and policy components of bank examinations offsite for quite some time.4 Today, however, one of the primary and relatively recent offsite examination functions is loan file review, a process discussed earlier in this article. Performing a loan review offsite is a decision made in conjunction with bank management, as it is contingent on the bank’s preferences as well as its technological capabilities and resources to provide electronically imaged loan files in a clear and secure way. Based on experiences with the offsite loan review process, the Federal Reserve recognizes that not all banks have the technical capability or desire to facilitate offsite loan file review. It is expected that the offsite loan review process will continue to evolve and be refined over time.
It should be noted that during contingency telework situations, such as pandemics, in which Reserve Bank facilities are unavailable, examination staff have stringent security guidelines in place regarding offsite loan review. In such cases, examiners must follow specific guidelines to ensure that sensitive information is not accessed by unauthorized individuals or listening devices. The Federal Reserve staff must consult with bank management during the examination scoping and planning process to determine whether the bank is amenable to such an arrangement.
Feedback on Offsite Examination Work
The Federal Reserve has conducted various quality assurance reviews to determine whether examination work conducted offsite is compromising the effectiveness of community bank examinations. Overall, these internal reviews have found that offsite examination work does not materially affect the overall outcomes of the supervision program.
As previously discussed, the offsite loan review process provides some efficiencies for banks and examiners and attempts to address bankers’ requests to minimize the number of examiners who are present at the bank during an onsite examination. The Federal Reserve recognizes the time and effort it takes bankers to prepare for an offsite examination. As part of the examination wrap-up process, Federal Reserve examiners often solicit feedback regarding the effectiveness of offsite examination processes from bank management, and feedback from bankers at any time is always encouraged.
As Governor Michelle Bowman indicated in her 2019 speech “A Conversation on Community Banking,” “the Federal Reserve continues to tailor and reduce regulatory burden by conducting portions of community bank examinations offsite.”5 This supervisory approach will bear in mind considerations for safety, risk, and technological capabilities. If some well-managed banks prefer examination activities to be completed onsite, the Federal Reserve plans to honor such requests. In her speech, Governor Bowman reinforces this point, noting that “personal contact and relationship building are important to community banking and, I believe, also to community bank oversight.” Especially in times of operational and economic stress, it is even more crucial that the examination process, offsite or otherwise, be conducted with the backdrop of flexibility, open communication, and a risk-focused mindset.
- 1 See FRB guidance on offsite loan review at Supervision and Regulation (SR) letter 16-8, “Off-Site Review of Loan Files,” available at www.federalreserve.gov/supervisionreg/srletters/sr1608.htm .
- 2 At the time this article was written, the Federal Reserve had placed a moratorium on most examination work for institutions in the community and regional banking organization supervisory portfolios in an effort to help banks to focus on their day-to-day operations. See the Board’s March 24, 2020, press release, available at www.federalreserve.gov/newsevents/pressreleases/bcreg20200324a.htm .
- 3 See FRB guidance on examination communication expectations at SR letter 19-5, “Communication Expectations for Community Bank Examinations and Inspections,” available at www.federalreserve.gov/supervisionreg/srletters/sr1905.htm .
- 4 See SR letter 95-13, “Recommendations to Increase the Portion of Examinations and Inspections Conducted in Reserve Bank Offices,” available at www.federalreserve.gov/boarddocs/srletters/1995/SR9513.htm .
- 5 See Governor Bowman’s February 11, 2019, remarks at the Conference for Community Bankers, sponsored by the American Bankers Association, San Diego, CA, at www.federalreserve.gov/newsevents/speech/bowman20190211a.htm .