Risk Management

In my inaugural article for this newsletter, I focus on supply and demand, a choice befitting the centrality of the economy to the Fed’s responsibilities. Specifically, why is the Supervision, Regulation and Credit (SRC) division of the Minneapolis Fed supplying this newsletter, and why should you read (demand) it?

Let’s start with demand and begin by specifying our audience and our goal.We’ve aimed the newsletter at depository institutions that have or may have contact with SRC through our examination of state member banks and holding companies, our provision of credit and related management of our credit risk and/or our processing of statistical and regulatory reports.We write the material in the newsletter in an effort to inform and improve the operations and decisions of these financial institutions. In particular, we want the newsletter to reduce the cost of and uncertainty associated with complying with our regulations and our operational and supervisory expectations.We want these benefits to come at a low cost, so we are keeping articles short and focused.

Financial institutions, and other readers with an interest in financial institutions, will have an incentive to read the newsletter if we meet these goals.

We certainly need your feedback to ensure that we achieve these goals. Please send comments and suggestions for improvements to our outreach email address: Mpls.src.outreach@mpls.frb.org.

I have already explained some of our supply rationale, but it goes beyond improved compliance. SRC needs to be more transparent and more present in the district.We are a public institution supported by taxpayers.We have a duty of clarity to the public.¹ The newsletter provides one tool for greater communication.We have also increased our outreach efforts throughout the district and have made the information on banking conditions available on our website.

A column in a newsletter offers a unique chance to communicate. I will use my column to explain key features of SRC operations. In that vein, I view an emphasis on risk management by depositories as a defining feature across our activities.We expect depository institutions to manage the risk associated with their Federal Reserve accounts, for example, and we make an evaluation of risk management a key component of our supervision of financial institutions.

The Federal Reserve has long emphasized risk management in its assessments of banks. We provide a distinct risk management rating for our safety and soundness exams, for example. I expect the focus on risk management to continue to grow even more.

Weak risk management poses a risk to financial institutions even when overall conditions and the conditions of a specific firm seem robust. Deficiencies in risk management can manifest themselves in future loss. The financial crisis and related weak recovery only reinforced this message. I think Federal Reserve Governor Sarah Bloom Raskin put it well:²

One thing I would note here is that if done properly, effective examination requires looking behind the numbers. The crisis made clear that a bank that appears to be in sound financial condition may actually have a ticking time bomb on its books. As I said before, it can be difficult for an examiner to tell a profitable bank with strong financial indicators that there are management weaknesses. But that is exactly what we should empower our examiners to do because we know that the seeds of financial crisis are planted during the good times.When conducting an examination, an examiner should be attuned to weaknesses in governance, risk management, and internal controls that may not pose a current problem but that may expose the bank to losses in the future. And ultimately, as you know, it is easier to fix a problem during the good times.

Finally, I want to reiterate my request for feedback and your thoughts. In particular, what type of information should SRC communicate via public means, and how should we communicate it? Please give us the benefit of your thoughts.

Endnotes

1 Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis, elaborated on these points in the June 2010 Region. See “Failure to Communicate?”.

2 See “Community Bankers and Supervisors: Seeking Balance,” a speech at the Federal Reserve Bank of New York Community Bankers Conference, April 7, 2011.