BANK EXAMINATION ISSUES: Some Practical Advice for International Banks

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BANK EXAMINATION ISSUESSome Practical Advice
for International Banks

• Connie M. Friesen
• Institute of International BankersU.S.
  Regulatory/Compliance Orientation Program
• July 17, 2007

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Introduction

• The bank examination process presents an
  opportunity for an international bank with U.S.
  operations to demonstrate its understanding of
  applicable U.S. laws and regulations. It also
  permits a bank to share with regulators its
  successful implementation of risk management and
  compliance programs that are consistent with
  applicable safety and soundness concerns.
• However, using the examination process to a
  banks advantage is not easy. Preparation for a
  successful exam requires the consistent attention
  over time of senior management, the compliance
  function and business line managers.

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I. Preparation is a Continuous Process
Comprehensive Risk Management and Compliance Plan

• Safety and soundness is always a primary focus
  of the examination process.
• Demonstrate that your bank is aware of safety
  and soundness issues and manages them well.
• A key element of good preparation is a
  comprehensive risk management and compliance
  plan.
• A plan that focuses on risk management and
  compliance requirements for each line of business
  will demonstrate that a bank is aware of safety
  and soundness issues and manages them well.

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Preparation is a Continuous Process
Active Involvement of U.S. Senior Management and
Head Office

• Hold monthly meetings of senior management, the
  compliance function and business line managers to
  discuss compliance issues and to make certain
  they are dealt with appropriately.
• Hold quarterly liaison meetings with
  representatives of Head Office to coordinate
  handling of issues.
• Be certain to document the meetings and any
  compliance initiatives that result from them.
• Create a record that you can share with bank
  examiners.
• Such a record will demonstrate that your bank is
  pro-active and anticipates issues.

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Preparation is a Continuous Process
Recognition of Special Burden of U.S. Compliance
Requirements

• U.S. senior management should be certain that
  Head Office understands the special burden of
  U.S. compliance requirements and examination
  process.
• Adopting a uniform global set of policies and
  procedures will not be sufficient.
• Sufficient resources (personnel, time, systems)
  must be devoted to U.S. operations.
• OFAC compliance, the internal audit function,
  data protection and BSA/AML compliance are
  examples of areas where U.S. approach may diverge
  from expectations and practice in the home
  country.

__________ See Exhibit A for a list of useful
sources on U.S. bank examination requirements and
expectations.
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Preparation is a Continuous Process
Co-ordination Issues

• Be prepared to share and discuss issues that may
  have developed during a previous exam and are now
  resolved even if this examination is conducted,
  for example, by Federal Reserve Bank of New York
  (FRBNY), the FRBNY examination team will be
  interested in how you resolved issues from a
  previous examination by New York State Banking
  Department (NYSBD).
• Note that regulators share information.

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II. Management and Compliance Function Should
Work Together
Promoting a Compliance Culture

• General manager should lead the continuous
  preparation process and should always be fully
  informed. General manager sets the tone for
  compliance standards and ethical conduct of
  business.
• General manager should communicate with head of
  compliance function on a continuing basis.
• General manager should make certain that U.S.
  compliance function receives the support,
  attention and resources that it needs.

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II. Management and Compliance Function Should
Work Together
Compliance Function Must Assume Leadership
Responsibility

• Objective should be to maintain a compliance
  culture which sets high standards for everyone
  in the U.S. office or offices.
• U.S. Head of Compliance should be responsible for
  continuous monitoring of changes in statutes and
  regulations.
• Quarterly reports from U.S. Head of Compliance
  and outside counsel may serve to clarify new
  issues and steps to be taken.
• Continuous dialogue between U.S. Head of
  Compliance, U.S. business lines and Head Office
  compliance function is essential.

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III. Incorporate a Risk-Based Focus in All Lines
of Business
Risk-Based Focus and Preparation Efforts

• Remember that a primary objective of exam process
  is to evaluate the condition of the U.S. office.
• Key part of the evaluation is to assess levels of
  current risk and the possibility that future
  risks will result from current and planned
  activities.
• U.S. office needs to demonstrate full control of
  a robust risk-management process.

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III. Incorporate a Risk-Based Focus in All Lines
of Business
Risk Assessment

• Make a risk-based assessment part of every line
  of business, every new product and every new
  customer relationship.
• Risk-based assessment means an assessment of
  operational risk, legal risk, counterparty risk,
  market risk, interest rate risk, etc.
• Branch risk assessment and customer risk
  assessment are now key requirements for BSA/AML
  compliance program.

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IV. Develop Books and Records that will Serve
as an Examination Resource
Compliance Risk Matrix

• Develop a Compliance Risk Matrix that will
  serve as a checklist and index.
• See Exhibit B for an example of one possible
  format for a compliance risk matrix.
• The compliance risk matrix will help U.S. office
  identify necessary policies and procedures.

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IV. Develop Books and Records that will Serve
as an Examination Resource
Compliance Review

• Risk matrix will identify levels of risk as
  high, medium or low.
• Compliance review of various activities can be
  scheduled at various intervals depending on level
  of risk.
• Compliance review will look at policies and
  procedures to see if they reasonably address the
  regulatory requirements and are adapted to level
  of risk.

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V. Be Prepared to Respond to Examination
Questions About Items Highlighted by Internal
Audit or Compliance Review
Response to Internal Audit Issues

• Bank examiners often look first to issues
  highlighted by internal audit.
• Therefore, pay particular attention to issues
  detected during the internal audit process.
• Document carefully and fully all measures taken
  to address issues highlighted by internal audit.

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V. Be Prepared to Respond to Examination
Questions About Items Highlighted by Internal
Audit or Compliance Review
Response to Compliance Review Issues

• Any deficiencies in policies or procedures
  identified in compliance review process should be
  addressed before the bank examination begins.
• As is the case with deficiencies identified by
  internal audit, it is important to document fully
  all steps taken to remedy deficiencies cited in
  compliance review process.

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VI. Use First Day Letter as a Guide to Exam
Preparation
Contents of First Day Letter

• So-called First Day Letter will be sent to bank
  about one month before scheduled bank examination
  date.
• Typically, bank is required to provide responses
  (preferably in electronic format) just before
  start date of actual examination.
• First Day Letter will be signed by
  examiner-in-charge and bank will have an
  opportunity to ask questions.
• Typical areas of focus will be general lines of
  business, safety and soundness and BSA/AML issues.

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VI. Use First Day Letter as a Guide to Exam
Preparation
General Manager Questionnaire

• A Questionnaire for General Manager may be part
  of First Day Letter. It might request
  information about items such as the following
• List of new products and services introduced
  since last examination.
• Head office plans for the U.S. office.
• Identification of any changes that might require
  approval or licensing (additional offices,
  broker-dealer, IBF, Cayman Branch).
• Description of head office support for branch
  (liaison committees attempts to integrate
  compliance).
• Views of general manager on AML compliance.

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VI. Use First Day Letter as a Guide to Exam
Preparation
Effective Use of First Day Letter

• Be certain that U.S. office understands what is
  required by each item of the First Day Letter
• Contact the regulators if items are not clear.
• Assign responsibility for response to appropriate
  personnel.
• Compliance officer and senior management should
  co-ordinate the preparation and gathering of
  materials liaison and contact persons for each
  line of business should be identified.
• Compliance officer should have a general
  understanding of every item prepared or provided
  for the response.

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VII. Be Prepared for Intense Scrutiny of BSA/AML
Issues
Focus on BSA/AML Issues

• BSA/AML items now dominate typical First Day
  Letter requests.
• Specific areas of BSA/AML focus might include
• Approval and appropriate revisions of AML
  Program.
• Determination that BSA/AML Program meets all
  PATRIOT Act requirements.
• Documentation of Training Program.
• Risk assessment of products, services, customers
  and geographic locations.
• List of high risk accounts.
• List of customers on which bank took adverse
  action because of its CIP.

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VII. Be Prepared for Intense Scrutiny of BSA/AML
Issues
Additional BSA/AML Issues

• Additional areas of AML focus
• SARs (including documentation for SARs considered
  but not filed).
• Procedures used to monitor transactions for
  suspicious activity.
• Funds transfer records.
• Foreign correspondent accounts.
• OFAC issues
• Policies and procedures
• Risk assessment and risk management
• Iran

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VIII. Be Prepared for Hot Issues and New
Items
New Developments

• Be certain to review the most recent 12-18 months
  of releases, notices, statements of guidance
  issued by NYSBD, FRB and OCC.
• If any of these regulatory changes have affected
  a particular bank, they are likely to receive
  special focus during the examination.

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VIII. Be Prepared for Hot Issues and New
Items

• Examples
• Loans to hedge funds accounts for hedge funds
• Account relationships with money services
  businesses (MSBs)
• Any possibility of transactions that relate to
  Iran
• Participation in complex structured finance
  transactions
• Correspondent banking relationships

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IX. Be Responsive During the Examination
Conduct of the Examination

• Have organized files containing responses to
  First Day Letter requests ready for examiners
  when they arrive.
• Have a meeting with examiners when they arrive to
  introduce contact people and explain the
  preparation done by U.S. office.
• Develop a process to respond quickly to requests
  for clarification, additional information, etc.
• If examiners request information U.S. office does
  not have, either try to obtain it as quickly as
  possible or explain why it cannot be provided.

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IX. Be Responsive During the Examination
Dealing with Problems or Weaknesses

• To the extent possible, try to deal with any
  identified issues or weaknesses immediately.
• For larger issues, explain why past practice has
  been to deal with an issue in a particular way,
  but express willingness to do things differently
  if this is what is expected by examiners.
• To the extent possible, try to take recommended
  actions on identified issues immediately do not
  wait for the conclusion of the exam.

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IX. Be Responsive During the Examination
When to Suggest Alternative Approaches

• If examiners indicate you should really be
  following approach x and your bank has special
  reasons for following approach y to achieve a
  better result, try to explain this to regulators
  prior to or at the exit interview and ask if they
  are willing to accept the banks approach.

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IX. Be Responsive During the Examination
Keep Head Office Informed

• U.S. senior management and compliance officer
  should keep Head Office informed of the progress
  of the exam.
• If significant weaknesses or major issues
  develop, try to involve Head Office in the
  resolution.
• Try to make certain Head Office understands the
  perspective of U.S. regulators and examiners.
• Try to work with Head Office so responsible
  personnel will know what to say to home country
  regulators.

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X. Tips for a Successful Exit Interview
Polite and Diplomatic Responses

• Follow Common Rules of Business Behavior
• Be polite and respectful.
• Respond diplomatically to questions and
  criticisms.
• Emphasize your banks culture of compliance and
  pro-active approach.
• Try to Limit Scope of Criticism
• Resolve any misunderstandings about specific
  items.
• Explain that each criticized item will be taken
  care of immediately.

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X. Tips for a Successful Exit Interview
Limiting Cited Items

• Try to limit number and significance of items
  that will appear in Written Report of
  Examination.
• Indicate that you have developed a plan of
  action to respond to items cited in draft
  report.
• Note that certain items that were the subject of
  examination attention have now been fully
  resolved (if that is true).
• If examiners indicate that the final examination
  report will cite a deficiency, ask to discuss the
  issue with them while they are still on-site
  and develop and implement a plan to remedy the
  deficiency as soon as possible.

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Conclusions

• Preparation for bank examinations is a continuous
  process.
• Prevention is the best cure.
• Make certain that Head Office understands
  examination issues and the responses provided by
  U.S. office being examined.

NY1 6273080
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Contact Information

• Connie M. FriesenPartner, Sidley Austin
  LLP212-839-5507cfriesen_at_sidley.com