Federal Reserve Operations

Federal Reserve Operations

Banking Supervision and Regulation

The Federal Reserve has supervisoryand regulatory authority over a varietyof financial institutions and activities. Itplays an important role as umbrellasupervisor of bank holding companies,including financial holding companies.And it is the primary federal supervisorof state banks that are members of theFederal Reserve System.

U.S. bank holding companies andstate member banks continued to facesubstantial challenges in 2008, exac-erbated by problems in funding andcapital markets as well as the ongoingeconomic slowdown. Bank holdingcompany asset quality and earningscontinued their deterioration over thecourse of the year, in part due to ongo-ing problems linked to the residentialhousing market. The effects of the sub-stantial challenges facing the bankingindustry were revealed in bank hold-ing companies’ reported net losses of$27 billion for the full year. Nonper-forming assets increased notably as thequality of various types of assets de-clined, and overall loan delinquencies in-creased. As in 2007, several institutionsrecognized significant valuation write-downs on assets affected by marketconditions. Liquidity and capital contin-ued to be strained. Some institutionsreceived federal government assistancein the form of capital injections via theTreasury’s Troubled Asset Relief Pro-gram, and many others drew on FederalReserve liquidity facilities to a consid-erable degree. While regulatory capitalratios suffered some erosion over 2008,bank holding companies in general con-tinued to maintain ratios in excess ofminimum regulatory requirements.

State member banks faced challengessimilar to those faced by bank holdingcompanies in 2008. As a group, theysuffered net losses of $3.2 billion,reflecting asset write-downs and higherloan-loss provisions. Credit qualityindicators worsened further during theyear, with additional increases in non-performing loans and delinquencies.Charge-off ratios reached their highestlevel in over a decade. Risk-based capi-tal ratios increased somewhat over theyear; at year-end more than 98 percentof all state member banks continued toreport capital ratios consistent with a“well capitalized” designation underprompt corrective action standards. Onestate member bank, with assets of$237.5 million, failed.

During 2008, the Federal Reserveundertook a range of activities to iden-tify and correct some of the risk-management weaknesses revealed bythe financial crisis that began in mid-2007. These supervisory activities cov-ered a number of areas, including firm-wide risk identification and seniormanagement oversight. Liquidity riskmanagement and capital adequacy weregiven special attention. Where institu-tions did not make appropriate progress,supervisors downgraded supervisoryratings and used enforcement tools tobring about corrective action. In addi-tion, the Federal Reserve undertook aSystemwide effort to identify lessonslearned for supervisors and to begindeveloping recommendations for poten-tial improvements to supervisory prac-tices. The objective of the lessons-learned process is to improve all aspectsof the supervisory process, including

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oversight of individual institutions andpromotion of overall financial stability.The lessons-learned process, which willcontinue into 2009, has drawn on stafffrom around the Federal Reserve System,including presidents and members of theboards of directors of the Reserve Banks.

In 2008, banking supervisors contin-ued to focus on the adequacy of banks’credit-risk management practices andthe important role banks play in creditintermediation. The Federal Reserveissued two statements emphasizing thecritical role that banking organizationshave in U.S. credit markets and encour-aging those organizations to pursueresponsible lending activities as theymeet the credit needs of households andbusinesses. Also, the Federal Reserve,Federal Deposit Insurance Corporation(FDIC), and Office of the Comptrollerof the Currency (OCC) jointly issuedrevisions to the Guide to the Inter-agency Country Exposure ReviewCommittee Process to reflect improve-ments in regulated institutions’ analysesof cross-border-exposure and country-risk management programs and the in-creased availability of information oncountry and transfer risk. In addition,the Federal Reserve, FDIC, OCC, Of-fice of Thrift Supervision (OTS), andNational Credit Union Administration(NCUA) jointly issued for comment pro-posed Interagency Appraisal and Evalu-ation Guidelines to reaffirm supervisoryexpectations for sound practices inappraising and evaluating real estate.

Federal Reserve staff continued towork with the other federal bankingagencies to implement the advanced ap-proaches of the Basel II Capital Accordin the United States, with the final ruletaking effect on April 1, 2008.1 Institu-

tions may begin transitioning to the newrules after they adopt an implementa-tion plan and have in place systems thatcomply with the final rule’s qualifica-tion requirements. In January 2008, theagencies published final reportingrequirements and reporting templatesfor institutions that will be adopting theBasel II advanced approaches. In lightof identified supervisory lessonslearned, the Federal Reserve plans toaugment its processes for conductingexaminations and inspections asneeded, as well as its processes forensuring that there is appropriatefollow-up with institutions about issuesidentified during examinations andinspections.

Scope of Responsibilities forSupervision and Regulation

The Federal Reserve is the federalsupervisor and regulator of all U.S.bank holding companies, includingfinancial holding companies formedunder the authority of the 1999 Gramm-Leach-Bliley Act, and state-charteredcommercial banks that are members ofthe Federal Reserve System. In oversee-ing these organizations, the FederalReserve seeks primarily to promotetheir safe and sound operation, includ-ing their compliance with laws andregulations.

The Federal Reserve also has respon-sibility for supervising the operations ofall Edge Act and agreement corpora-tions, the international operations of

1. The Basel II Capital Accord, an interna-tional agreement formally titled “InternationalConvergence of Capital Measurement and Capital

Standards: A Revised Framework,” was devel-oped by the Basel Committee on Banking Super-vision, which is made up of representatives of thecentral banks or other supervisory authorities of19 countries. The original document was issued in2004; the original version and an updated versionissued in November 2005 are available on thewebsite of the Bank for International Settlements(www.bis.org).

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state member banks and U.S. bank hold-ing companies, and the U.S. operationsof foreign banking organizations.

The Federal Reserve exercises im-portant regulatory influence over entryinto the U.S. banking system, and thestructure of the system, through itsadministration of the Bank HoldingCompany Act, the Bank Merger Act(with regard to state member banks),the Change in Bank Control Act (withregard to bank holding companies andstate member banks), and the Interna-tional Banking Act. The Federal Re-serve is also responsible for imposingmargin requirements on securities trans-actions. In carrying out these responsi-bilities, the Federal Reserve coordinatesits supervisory activities with the otherfederal banking agencies, state agen-cies, functional regulators (that is, regu-lators for insurance, securities, andcommodities firms), and the bank regu-latory agencies of other nations.

Supervision forSafety and Soundness

To promote the safety and soundness ofbanking organizations, the Federal Re-serve conducts on-site examinationsand inspections and off-site surveillanceand monitoring. It also takes enforce-ment and other supervisory actions asnecessary.

Examinations and Inspections

The Federal Reserve conducts examina-tions of state member banks, the U.S.branches and agencies of foreign banks,and Edge Act and agreement corpora-tions. In a process distinct from exami-nations, it conducts inspections of bankholding companies and their nonbanksubsidiaries. Whether an examination oran inspection is being conducted, thereview of operations entails (1) an eval-uation of the adequacy of governance

provided by the board and senior man-agement, including an assessment ofinternal policies, procedures, controls,and operations; (2) an assessment of thequality of the risk-management andinternal control processes in place toidentify, measure, monitor, and controlrisks; (3) an assessment of the keyfinancial factors of capital, asset quality,earnings, and liquidity; and (4) a reviewfor compliance with applicable lawsand regulations. The table providesinformation on examinations and in-spections conducted by the FederalReserve during the past five years.

Inspections of bank holding compa-nies, including financial holding com-panies, are built around a rating systemintroduced in 2005 that reflects the shiftin supervisory practices away from ahistorical analysis of financial conditiontoward a more dynamic, forward look-ing assessment of risk-managementpractices and financial factors. Underthe system, known as RFI but morefully termed RFI/C(D), holding compa-nies are assigned a composite rating (C)that is based on assessments of threecomponents: Risk Management (R),Financial Condition (F), and the poten-tial Impact (I) of the parent companyand its nondepository subsidiaries onthe subsidiary depository institution.2

The fourth component, Depository In-stitution (D), is intended to mirror theprimary supervisor’s rating of the sub-sidiary depository institution.

The Federal Reserve uses a risk-focused approach to supervision, withactivities focused on identifying theareas of greatest risk to banking organi-

2. Each of the first two components has foursubcomponents: Risk Management—Board andSenior Management Oversight; Policies, Proce-dures, and Limits; Risk Monitoring and Manage-ment Information Systems; and Internal Controls.Financial Condition—Capital; Asset Quality;Earnings; and Liquidity.

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zations and assessing the ability of theorganizations’ management processesfor identifying, measuring, monitoring,and controlling those risks. Key aspectsof the risk-focused approach to consoli-dated supervision of large complexbanking organizations (LCBOs) include(1) developing an understanding of eachLCBO’s legal and operating structure,and its primary strategies, businesslines, and risk-management and internalcontrol functions; (2) developing andexecuting a tailored supervisory planoutlining the work required to maintaina comprehensive understanding andassessment of each LCBO, incorporat-ing reliance to the fullest extent pos-sible on assessments and informationdeveloped by other relevant domesticand foreign supervisors and functionalregulators; (3) maintaining continualsupervision of these organizations—

including through meetings with bank-ing organization management andanalysis of internal and external in-formation—so that the Federal Re-serve’s understanding and assessmentof each organization’s condition re-mains current; (4) assigning to eachLCBO a supervisory team composed ofReserve Bank staff members who haveskills appropriate for the organization’srisk profile (the team leader is the Fed-eral Reserve System’s central point ofcontact for the organization, has respon-sibility for only one LCBO, and issupported by specialists capable ofevaluating the risks of LCBO businessactivities and functions and assessingthe LCBO’s consolidated financial con-dition); and (5) promoting Systemwideand interagency information-sharingthrough automated systems and othermechanisms (see box ‘‘Enhanced Guid-

State Member Banks and Bank Holding Companies, 2004–2008

Entity/Item 2008 2007 2006 2005 2004

State member banksTotal number . . . . . . . . . . . . . . . . . . . . . . . . . .. 862 878 901 907 919Total assets (billions of dollars) . . . . . . . .. 1,854 1,519 1,405 1,318 1,275Number of examinations . . . . . . . . . . . . . . .. 717 694 761 783 809

By Federal Reserve System . . . . . . . . . . 486 479 500 563 581By state banking agency . . . . . . . . . . . . . 231 215 261 220 228

Top-tier bank holding companiesLarge (assets of more than $1 billion)

Total number . . . . . . . . . . . . . . . . . . . . . . . . 485 459 448 394 355Total assets (billions of dollars) . . . . . . . 14,138 13,281 12,179 10,261 8,429Number of inspections . . . . . . . . . . . . . . . 519 492 566 501 500

By Federal Reserve System1 . . . . . . . 500 476 557 496 491On site . . . . . . . . . . . . . . . . . . . . . . . . . 445 438 500 457 440Off site . . . . . . . . . . . . . . . . . . . . . . . . . 55 38 57 39 51

By state banking agency 19 16 9 5 9Small (assets of $1 billion or less)

Total number . . . . . . . . . . . . . . . . . . . . . . . . 4,545 4,611 4,654 4,760 4,796Total assets (billions of dollars) . . . . . . . 1,008 974 947 890 852Number of inspections . . . . . . . . . . . . . . . 3,192 3,186 3,449 3,420 3,703

By Federal Reserve System . . . . . . . . 3,048 3,007 3,257 3,233 3,526On site . . . . . . . . . . . . . . . . . . . . . . . . . 107 120 112 170 186Off site . . . . . . . . . . . . . . . . . . . . . . . . . 2,941 2,887 3,145 3,063 3,340

By state banking agency . . . . . . . . . . . 144 179 192 187 177

Financial holding companiesDomestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 557 597 599 591 600Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 43 44 38 36

1. For large bank holding companies subject to con-tinuous risk-focused supervision, includes multiple tar-geted reviews.


ance for the Consolidated Supervisionof Bank Holding Companies and theCombined U.S. Operations of ForeignBanking Organizations).

For other banking organizations, therisk-focused consolidated supervisionprogram provides that examination andinspection procedures are tailored toeach banking organization’s size, com-plexity, risk profile, and condition. Aswith the LCBOs, these supervisory pro-grams entail both off-site and on-site work, including planning, pre-examination visits, detailed documenta-tion, and examination reports tailored tothe scope and findings of the examina-tion.

State Member Banks

At the end of 2008, 862 state-charteredbanks (excluding nondepository trustcompanies and private banks) weremembers of the Federal Reserve Sys-tem. These banks represented approxi-mately 12 percent of all insured U.S.commercial banks and held approx-imately 15 percent of all insured com-mercial bank assets in the United States.

The guidelines for Federal Reserveexaminations of state member banks arefully consistent with section 10 of theFederal Deposit Insurance Act, asamended by section 111 of the FederalDeposit Insurance Corporation Im-provement Act of 1991 and by theRiegle Community Development andRegulatory Improvement Act of 1994.A full-scope, on-site examination ofthese banks is required at least once ayear, although certain well-capitalized,well-managed organizations havingtotal assets of less than $500 mil-lion may be examined once every18 months.3 The Federal Reserve con-

ducted 486 exams of state memberbanks in 2008.

Bank Holding Companies

At year-end 2008, a total of 5,757 U.S.bank holding companies were in opera-tion, of which 5,030 were top-tier bankholding companies. These organizationscontrolled 5,893 insured commercialbanks and held approximately 97 per-cent of all insured commercial bankassets in the United States.

Federal Reserve guidelines call forannual inspections of large bank hold-ing companies and complex smallercompanies. In judging the financialcondition of the subsidiary banksowned by holding companies, FederalReserve examiners consult examinationreports prepared by the federal and statebanking authorities that have primaryresponsibility for the supervision ofthose banks, thereby minimizing dupli-cation of effort and reducing the super-visory burden on banking organizations.Noncomplex bank holding companieswith consolidated assets of $1 billion orless are subject to a special supervisoryprogram that permits a more flexibleapproach.4 In 2008, the Federal Reserveconducted 500 inspections of large bankholding companies and 3,048 inspec-tions of small, noncomplex bank hold-ing companies.

3. The Financial Services Regulatory ReliefAct of 2006, which became effective in October

2006, authorized the federal banking agencies toraise the threshold from $250 million to $500 mil-lion, and final rules incorporating the change intoexisting regulations were issued on September 21,2007.

4. The special supervisory program was imple-mented in 1997 and modified in 2002. SeeSR letter 02-01 for a discussion of the factorsconsidered in determining whether a bank hold-ing company is complex or noncomplex(www.federalreserve.gov/boarddocs/srletters/).


Enhanced Guidance for the Consolidated Supervision ofBank Holding Companies and the Combined U.S. Operationsof Foreign Banking Organizations

This guidance should not only provide greater clarity regarding our long-

standing responsibilities as a consolidated supervisor, but is also responsive toongoing developments in the financial sector. The objectives of fostering finan-cial stability and deterring or managing financial crises will be furthered by theFederal Reserve having a more complete view of firmwide risks and controls.

Randall S. Kroszner, Member, Board of GovernorsOctober 2008

The continuing growth and increased com-plexity of many banking organizationsexposes these firms to a wide array ofpotential risks, and financial trouble in onepart of an organization can spread rapidlyto other parts of the organization. More-over, because large banking organizationsincreasingly operate with multiple domes-tic and foreign banking and nonbankingentities, but operate and manage their busi-nesses on an integrated basis, a singlesupervisor of a particular legal entity isunlikely to have a complete view of firm-wide risks and controls.

In response to these trends, and to betterfulfill both its supervisory responsibilitiesand its other central bank objectives suchas fostering financial stability and deter-ring or managing financial crises, the Fed-eral Reserve on October 16, 2008, issuedguidance refining and clarifying its pro-grams for the consolidated supervision ofbank holding companies (including finan-cial holding companies) and the combinedU.S. operations of foreign banking organi-zations.1

The Federal Reserve has a long-standing responsibility for the consolidatedsupervision of U.S. bank holding compa-nies (including financial holding compa-nies). Consolidated supervision, whichencompasses the parent holding companyand its subsidiaries, enables the FederalReserve to understand the organization’s

1. See SR letter 08-9/CA letter 08-12, “Con-solidated Supervision of Bank Holding Compa-nies and the Combined U.S. Operations of For-eign Banking Organizations.”

structure, activities, resources, and risksand to address any deficiencies beforethey pose a danger to the holding compa-ny’s subsidiary depository institutions. Inaddition to its role as consolidated super-visor, the Federal Reserve is responsiblefor the overall supervision of the U.S.operations of foreign banking organiza-tions. Fundamental to the effectiveness ofthe Federal Reserve as consolidatedsupervisor is coordination with, and reli-ance on, the work of other relevantdomestic and foreign bank supervisorsand functional regulators (that is, a fed-eral or state regulator of a functionallyregulated nondepository subsidiary of abank holding company or foreign bankingorganization, such as the Securities andExchange Commission).

While the effort to enhance and clarifythe Federal Reserve’s approach to con-solidated supervision began well beforethe recent period of considerable strain infinancial markets, the enhanced approachset forth in the guidance emphasizes sev-eral elements that should support a moreresilient financial system. These include,among other things, greater focus on cor-porate governance, capital adequacy,funding and liquidity management, andthe supervision of nonbank subsidiaries.

The guidance specifies principal areasof focus for consolidated supervisionactivit ies and provides for more-consistent Federal Reserve supervisorypractices and assessments across institu-tions having similar activities and risks. Itsets forth specific expectations for super-visors to use when assessing primary


governance functions, risk controls, andbusiness lines; nonbank operations; andother key activities and risks, with added em-phasis on risk-management systems andinternal controls used by bank holdingcompanies and foreign banking organiza-tions that provide core clearing and settle-ment services or have a significant pres-ence in critical financial markets. Inaddition, the guidance discusses uniqueaspects of supervising the combined U.S.operations of foreign banking organiza-tions.

For each bank holding company andforeign banking organization, the FederalReserve (1) maintains an understanding ofkey elements of the organization’s strat-egy, structure, business lines, frameworkfor governance and internal control, pres-ence in the financial markets, and primarysources of revenue and risk, and (2)assesses the effectiveness of the organiza-tion’s risk-management systems and con-trols in accounting for the main risksinherent in the organization’s activities, itsfinancial condition, and the potential nega-tive impact of nonbank operations onaffiliated depository institutions. The Fed-eral Reserve takes a systematic approachto developing these assessments, asreflected in the RFI (Risk management,Financial condition, and Impact) ratingassigned to bank holding companies andthe combined U.S. operations ratingassigned to foreign banking organizationshaving multiple U.S. operations.

While the Federal Reserve’s supervisoryobjectives are the same for all bank hold-ing companies and foreign banking organi-zations, the amount and nature of thesupervisory and examination work neces-sary to understand, supervise, and developan assessment of an individual organiza-tion varies. Supervisory activities are tai-lored for each organization on the basis ofa variety of factors, including the natureand degree of involvement by other super-visors and regulators; the risks posed bythe organization’s specific activities andsystems; and the potential effect of weak-nesses in control functions on the organi-

zation, its subsidiary depository institu-tions, or key financial markets. For exam-ple, additional supervisory activities maybe conducted if there are gaps in informa-tion relating to significant risks or activi-ties, indications of weaknesses in risk-management systems or internal controls,or indications of violations of consumerprotection or other laws, or if a consoli-dated organization or subsidiary deposi-tory institution is in less-than-satisfactorycondition.

An important aspect of the FederalReserve’s consolidated supervision pro-grams for bank holding companies andforeign banking organizations is the as-sessment and evaluation of practicesacross groups of organizations havingsimilar characteristics and risk profiles.This “portfolio approach” facilitates con-sistency of supervisory practices and as-sessments across comparable organiza-tions and improves the Federal Reserve’sability to identify outlier organizationsamong established peer groups. Becausethe Federal Reserve’s supervisory activi-ties are tailored to specific institutions andportfolios, separate guidance documentswere issued for different supervisory port-folios to promote appropriate and consis-tent supervision of organizations.

The nature and scope of the indepen-dent Federal Reserve supervisory workrequired to develop and maintain thisunderstanding and assessment dependslargely on the extent to which the FederalReserve can draw on information orassessments from other bank supervisorsor functional regulators. Understandingand assessing some areas—such as therisk management and financial conditionof significant nonbank subsidiaries thatare not functionally regulated—will, bytheir nature, typically require more in-dependent Federal Reserve supervi-sory work. Understanding and assessingother areas—such as firmwide risk-management and control functions—typically will require a greater degree ofcoordination with other bank supervisorsor functional regulators.


Financial Holding Companies

Under the Gramm-Leach-Bliley Act,bank holding companies that meet cer-tain capital, managerial, and other re-quirements may elect to become finan-cial holding companies and therebyengage in a wider range of financialactivities, including full-scope securitiesunderwriting, merchant banking, andinsurance underwriting and sales. Thestatute streamlines the Federal Re-serve’s supervision of all bank holdingcompanies, including financial holdingcompanies, and sets forth parametersfor the supervisory relationship betweenthe Federal Reserve and other regula-tors. The statute also differentiatesbetween the Federal Reserve’s relationswith regulators of depository institu-tions and its relations with functionalregulators.

As of year-end 2008, 557 domesticbank holding companies and 45 foreignbanking organizations had financialholding company status. Of the domes-tic financial holding companies, 33 hadconsolidated assets of $15 billion ormore; 128, between $1 billion and$15 billion; 87, between $500 millionand $1 billion; and 309, less than$500 million.

International Activities

The Federal Reserve supervises the for-eign branches and overseas investmentsof member banks, Edge Act and agree-ment corporations, and bank holdingcompanies and also the investments bybank holding companies in export trad-ing companies. In addition, it supervisesthe activities that foreign banking orga-nizations conduct through entities inthe United States, including branches,agencies, representative offices, andsubsidiaries.

Foreign Operations ofU.S. Banking Organizations

In supervising the international opera-tions of state member banks, Edge Actand agreement corporations, and bankholding companies, the Federal Reservegenerally conducts its examinations orinspections at the U.S. head offices ofthese organizations, where the ultimateresponsibility for the foreign officeslies. Examiners also visit the overseasoffices of U.S. banks to obtain financialand operating information and, in someinstances, to evaluate the organizations’efforts to implement corrective mea-sures or to test their adherence to safeand sound banking practices. Examina-tions abroad are conducted with thecooperation of the supervisory authori-ties of the countries in which they takeplace; for national banks, the examina-tions are coordinated with the OCC.

At the end of 2008, 53 member bankswere operating 545 branches in foreigncountries and overseas areas of theUnited States; 32 national banks wereoperating 495 of these branches, and 21state member banks were operating theremaining 50. In addition, 20 nonmem-ber banks were operating 26 branchesin foreign countries and overseas areasof the United States.

Edge Act and Agreement Corporations

Edge Act corporations are internationalbanking organizations chartered by theBoard to provide all segments of theU.S. economy with a means of financ-ing international business, especiallyexports. Agreement corporations aresimilar organizations, state chartered orfederally chartered, that enter into anagreement with the Board to refrainfrom exercising any power that is notpermissible for an Edge Act corpora-tion.


Sections 25 and 25A of the FederalReserve Act grant Edge Act and agree-ment corporations permission to engagein international banking and foreignfinancial transactions. These corpora-tions, most of which are subsidiaries ofmember banks, may (1) conduct a de-posit and loan business in states otherthan that of the parent, provided that thebusiness is strictly related to interna-tional transactions, and (2) make for-eign investments that are broader thanthose permissible for member banks.

At year-end 2008, 60 banking organi-zations, operating 11 branches, werechartered as Edge Act or agreementcorporations. These corporations areexamined annually.

U.S. Activities of Foreign Banks

The Federal Reserve has broad author-ity to supervise and regulate the U.S.activities of foreign banks that engagein banking and related activities in theUnited States through branches, agen-cies, representative offices, commerciallending companies, Edge Act corpora-tions, commercial banks, bank holdingcompanies, and certain nonbankingcompanies. Foreign banks continue tobe significant participants in the U.S.banking system.

As of year-end 2008, 175 foreignbanks from 53 countries were operating208 state-licensed branches and agen-cies, of which 6 were insured by theFDIC, and 45 OCC-licensed branchesand agencies, of which 4 were insuredby the FDIC. These foreign banks alsoowned 12 Edge Act and agreement cor-porations and 2 commercial lendingcompanies; in addition, they held a con-trolling interest in 61 U.S. commercialbanks. Altogether, the U.S. offices ofthese foreign banks at the end of 2008controlled approximately 18 percent ofU.S. commercial banking assets. These

175 foreign banks also operated 95 rep-resentative offices; an additional 54 for-eign banks operated in the United Statesthrough a representative office.

State-licensed and federally licensedbranches and agencies of foreign banksare examined on-site at least once every18 months, either by the Federal Re-serve or by a state or other federal regu-lator. In most cases, on-site examina-tions are conducted at least once every12 months, but the period may beextended to 18 months if the branch oragency meets certain criteria.

In cooperation with the other federaland state banking agencies, the FederalReserve conducts a joint program forsupervising the U.S. operations of for-eign banking organizations. The pro-gram has two main parts. One partinvolves examination of those foreignbanking organizations that have mul-tiple U.S. operations and is intended toensure coordination among the variousU.S. supervisory agencies. The otherpart is a review of the financial andoperational profile of each organizationto assess its general ability to supportits U.S. operations and to determinewhat risks, if any, the organizationposes through its U.S. operations. To-gether, these two processes providecritical information to U.S. supervisorsin a logical, uniform, and timely man-ner. The Federal Reserve conducted orparticipated with state and federal regu-latory authorities in 487 examinationsin 2008.

Compliance withRegulatory Requirements

The Federal Reserve examines super-vised institutions for compliance with abroad range of legal requirements, in-cluding anti-money-laundering and con-sumer protection laws and regulations,and other laws pertaining to certain


banking and financial activities. Mostcompliance supervision is conductedunder the oversight of the Board’s Divi-sion of Banking Supervision and Regu-lation, but consumer compliance super-vision is conducted under the oversightof the Division of Community and Con-sumer Affairs. The two divisions coor-dinate their efforts with each other andalso with the Board’s Legal Division toensure consistent and comprehensiveFederal Reserve supervision for compli-ance with legal requirements.

Anti-Money-Laundering Examinations

U.S. Department of the Treasury regula-tions implementing the Bank SecrecyAct (BSA) generally require banks andother types of financial institutions tofile certain reports and maintain certainrecords that are useful in criminal orregulatory proceedings. The BSA andseparate Board regulations requirebanking organizations supervised by theBoard to file reports on suspiciousactivity related to possible violations offederal law, including money launder-ing, terrorism financing, and otherfinancial crimes. In addition, BSA andBoard regulations require that banksdevelop written BSA compliance pro-grams and that the programs be for-mally approved by bank boards ofdirectors. The Federal Reserve is re-sponsible for examining its supervisedinstitutions for compliance with appli-cable anti-money-laundering laws andregulations and conducts such examina-tions in accordance with the FederalFinancial Institutions ExaminationCouncil (FFIEC) Bank Secrecy Act/Anti–Money Laundering ExaminationManual.5

Specialized Examinations

The Federal Reserve conducts special-ized examinations of banking organiza-tions in the areas of information tech-nology, fiduciary activities, transferagent activities, and government andmunicipal securities dealing and broker-ing. The Federal Reserve also conductsspecialized examinations of certainentities, other than banks, brokers, ordealers, that extend credit subject to theBoard’s margin regulations.

Information Technology Activities

In recognition of the importance ofinformation technology to safe andsound operations in the financial indus-try, the Federal Reserve reviews theinformation technology activities ofsupervised banking organizations aswell as certain independent data centersthat provide information technologyservices to these organizations. Allsafety and soundness examinationsinclude a risk-focused review of infor-mation technology risk-managementactivities. During 2008, the FederalReserve continued as the lead agency intwo interagency examinations of large,multiregional data processing servicersand assumed leadership in two addi-tional such examinations.

Fiduciary Activities

The Federal Reserve has supervisoryresponsibility for state member com-mercial banks and depository trust com-panies that together reported, at the end

5. The FFIEC is an interagency body of finan-cial regulatory agencies established to prescribeuniform principles, standards, and report formsand to promote uniformity in the supervision of

financial institutions. The Council has six votingmembers: the Board of Governors of the FederalReserve System, the Federal Deposit InsuranceCorporation, the National Credit Union Adminis-tration, the Office of the Comptroller of the Cur-rency, the Office of Thrift Supervision, and thechair of the State Liaison Committee.


of 2008, $39 trillion of assets in variousfiduciary or custodial capacities. Addi-tionally, state member nondepositorytrust companies supervised by the Fed-eral Reserve reported $28 trillion ofassets held in a fiduciary or custodialcapacity. During on-site examinationsof fiduciary activities, an organization’scompliance with laws, regulations, andgeneral fiduciary principles and itspotential conflicts of interest are re-viewed; its management and opera-tions, including its asset- and account-management, risk-management, andaudit and control procedures, are alsoevaluated. In 2008, Federal Reserveexaminers conducted 116 on-site fidu-ciary examinations.

Transfer Agents

As directed by the Securities ExchangeAct of 1934, the Federal Reserve con-ducts specialized examinations of thosestate member banks and bank holdingcompanies that are registered with theBoard as transfer agents. Among otherthings, transfer agents countersign andmonitor the issuance of securities, reg-ister the transfer of securities, andexchange or convert securities. On-siteexaminations focus on the effectivenessof an organization’s operations and itscompliance with relevant securitiesregulations. During 2008, the FederalReserve conducted on-site examinationsat 14 of the 62 state member banks andbank holding companies that were reg-istered as transfer agents.

Government and Municipal SecuritiesDealers and Brokers

The Federal Reserve is responsible forexamining state member banks and for-eign banks for compliance with theGovernment Securities Act of 1986 andwith Treasury regulations governingdealing and brokering in government

securities. Twelve state member banksand 5 state branches of foreign bankshave notified the Board that they aregovernment securities dealers or bro-kers not exempt from Treasury’s regu-lations. During 2008, the Federal Re-serve conducted 2 examinations ofbroker-dealer activities in governmentsecurities at these organizations. Theseexaminations are generally conductedconcurrently with the Federal Reserve’sexamination of the state member bankor branch.

The Federal Reserve is also respon-sible for ensuring that state memberbanks and bank holding companies thatact as municipal securities dealers com-ply with the Securities Act Amend-ments of 1975. Municipal securitiesdealers are examined pursuant tothe Municipal Securities RulemakingBoard’s rule G-16 at least once everytwo calendar years. Of the 12 entitiesthat dealt in municipal securities during2008, 5 were examined during the year.

Securities Credit Lenders

Under the Securities Exchange Act of1934, the Board is responsible for regu-lating credit in certain transactionsinvolving the purchase or carrying ofsecurities. As part of its general exami-nation program, the Federal Reserveexamines the banks under its jurisdic-tion for compliance with the Board’sRegulation U (Credit by Banks and Per-sons other than Brokers or Dealers forthe Purpose of Purchasing or CarryingMargin Stock). In addition, the FederalReserve maintains a registry of personsother than banks, brokers, and dealerswho extend credit subject to RegulationU. The Federal Reserve may conductspecialized examinations of these lend-ers if they are not already subject tosupervision by the Farm Credit Admin-istration (FCA) or the NCUA.


At the end of 2008, 580 lenders otherthan banks, brokers, or dealers wereregistered with the Federal Reserve.Other federal regulators supervised 191of these lenders, and the remaining 389were subject to limited Federal Reservesupervision. The Federal Reserve ex-empted 180 lenders from its on-siteinspection program on the basis of theirregulatory status and annual reports.Nonexempt lenders are subject to eitherbiennial or triennial inspection. Sixty-four inspections were conducted duringthe year.

Business Continuity

In 2008, the Federal Reserve continuedits efforts to strengthen the resilience ofthe U.S. financial system in the event ofunexpected disruptions. The FederalReserve, together with other federal andstate financial regulators, are membersof the Financial Banking Information In-frastructure Committee (FBIIC), whichwas formed to improve coordinationand communication among financialregulators, enhance the resilience of theU.S. financial sector, and promote thepublic/private partnership. The FBIIChas established emergency communica-tion protocols to maintain effectivecommunication among members in theevent of an emergency. The FBIIC pro-tocols were activated in 2008 at thetime of the flooding in the Midwest,each time a significant hurricane madelandfall in the United States, and at thetime of the white powder HazMatincident.6

The Federal Reserve and the otherFFIEC agencies continued in 2008 tocoordinate their efforts to ensure a con-sistent supervisory approach in the areaof business continuity practices. InMarch, the agencies published anupdate to the FFIEC Business Continu-ity Planning Booklet, which providesguidance to both examiners and theindustry. The revised booklet expandsdiscussions of business impact analysisand testing; discusses lessons learned inrecent years, for example, lessons fromHurricanes Katrina and Rita; and pro-vides a framework for financial institu-tions to develop or update their pan-demic plans to address the uniquebusiness continuity challenges associ-ated with a pandemic influenza out-break. The booklet also stresses theresponsibilities of each institution’sboard and management to address bus-iness continuity planning with anenterprise-wide perspective by consid-ering technology, business operations,communications, and testing strategiesfor the entire institution.

Enforcement Actions

The Federal Reserve has enforcementauthority over the banking organiza-tions it supervises and their affiliatedparties. Enforcement actions may betaken to address unsafe and unsoundpractices or violations of any law orregulation. Formal enforcement actionsinclude cease-and-desist orders, writtenagreements, removal and prohibitionorders, and civil money penalties. In2008, the Federal Reserve completed54 formal enforcement actions. Civilmoney penalties totaling $32,790 wereassessed, and an order of restitutiontotaling $203,923 was issued. As di-rected by statute, all civil money penal-ties are remitted to either the Treasuryor the Federal Emergency Management

6. In October 2008, the FBI, U.S. PostalInspectors, and state and local authorities beganinvestigating more than 30 threatening letters thatwere received at financial institutions in NewYork, New Jersey, Washington, D.C., Ohio, Illi-nois, Colorado, Oklahoma, Georgia, California,and Texas. Most of the letters contained a powdersubstance with a threatening communication.


Agency. Enforcement orders, which areissued by the Board, and written agree-ments, which are executed by theReserve Banks, are made public andare posted on the Board’s website(www.federalreserve.gov/boarddocs/enforcement/).

In addition to taking these formalenforcement actions, the Reserve Bankscompleted 216 informal enforcementactions in 2008. Informal enforcementactions include memoranda of under-standing and board of directors resolu-tions. Information about these actions isnot available to the public.

Surveillance andOff-Site Monitoring

The Federal Reserve uses automatedscreening systems to monitor the finan-cial condition and performance of statemember banks and bank holding com-panies between on-site examinations.Such monitoring and analysis helpsdirect examination resources to institu-tions that have higher risk profiles.Screening systems also assist in theplanning of examinations by identifyingcompanies that are engaging in new orcomplex activities.

The primary off-site monitoring toolused by the Federal Reserve is theSupervision and Regulation StatisticalAssessment of Bank Risk model (SR-SABR). Drawing mainly on the finan-cial data that banks report on theirReports of Condition and Income (CallReports), SR-SABR uses econometrictechniques to identify banks that reportfinancial characteristics weaker thanthose of other banks assigned similarsupervisory ratings. To supplement theSR-SABR screening, the Federal Re-serve also monitors various marketdata, including equity prices, debtspreads, agency ratings, and measures

of expected default frequency, to gaugemarket perceptions of the risk in bank-ing organizations. In addition, the Fed-eral Reserve prepares quarterly BankHolding Company Performance Reports(BHCPRs) for use in monitoring andinspecting supervised banking organiza-tions. The BHCPRs, which are com-piled from data provided by large bankholding companies in quarterly regula-tory reports (FR Y-9C and FR Y-9LP),contain, for individual companies, fi-nancial statistics and comparisons withpeer companies. BHCPRs are madeavailable to the public on the NationalInformation Center (NIC) website,which can be accessed at www.ffiec.gov.

During 2008, four major upgrades tothe web-based Performance ReportInformation and Surveillance Monitor-ing (PRISM) application were com-pleted. PRISM is a querying tool usedby Federal Reserve analysts to accessand display financial, surveillance, andexamination data. In the analyticalmodule, users can customize the pre-sentation of institutional financial infor-mation drawn from Call Reports, Uni-form Bank Performance Reports,FR Y-9 statements, BHCPRs, and otherregulatory reports. In the surveillancemodule, users can generate reports sum-marizing the results of surveillancescreening for banks and bank holdingcompanies. The upgrades made moreregulatory data available for querying,gave users the ability to display moredata on commercial real estate con-centration ratios, and provided a wayto access SEC Focus Report (Part II)data.

The Federal Reserve works throughthe FFIEC Task Force on SurveillanceSystems to coordinate surveillanceactivities with the other federal bankingagencies.


International Training andTechnical Assistance

In 2008, the Federal Reserve continuedto provide technical assistance on banksupervisory matters to foreign centralbanks and supervisory authorities. Tech-nical assistance involves visits by Fed-eral Reserve staff members to foreignauthorities as well as consultations withforeign supervisors who visit the Boardor the Reserve Banks. Technical assis-tance in 2008 was concentrated in LatinAmerica, Asia, and former Soviet bloccountries. The Federal Reserve, alongwith the OCC, the FDIC, and the Trea-sury, was also an active participant inthe Middle East and North Africa(MENA) Financial Regulators’ TrainingInitiative, which is part of the U.S. gov-ernment’s Middle East PartnershipInitiative. The Federal Reserve alsocontributes to the regional training pro-vision under the Asia Pacific EconomicCooperation (APEC) Financial Regula-tors’ Training Initiative.

During the year, the Federal Reserveoffered a number of training coursesexclusively for foreign supervisory au-thorities, both in the United States andin a number of foreign jurisdictions.System staff also took part in technicalassistance and training missions led bythe International Monetary Fund, theWorld Bank, the Asian DevelopmentBank, the Basel Committee on BankingSupervision (Basel Committee), and theFinancial Stability Institute.

The Federal Reserve is also an asso-ciate member of the Association ofSupervisors of Banks of the Americas(ASBA), an umbrella group of banksupervisors from countries in the West-ern Hemisphere. The group, headquar-tered in Mexico, promotes communica-tion and cooperation among banksupervisors in the region; coordinatestraining programs throughout the re-

gion, with the help of national bankingsupervisors and international agencies;and aims to help members developbanking laws, regulations, and supervi-sory practices that conform to in-ternational best practices. The Fed-eral Reserve contributes significantly toASBA’s organizational managementand to its training and technical assis-tance activities.

Initiatives for Minority-Owned andDe Novo Depository Institutions

The Federal Reserve is committed tofostering the strength and vitality of thenation’s minority and de novo de-pository institutions. In furtherance ofthis objective, during 2008 the Fed-eral Reserve launched Partnership forProgress, a training and technical assis-tance program designed specifically forthese institutions. The program seeks tohelp these institutions compete effec-tively in today’s marketplace by offer-ing them a combination of one-on-oneguidance and targeted workshops ontopics of particular relevance to startingand growing a bank in a safe and soundmanner. In addition, training and infor-mation on resources are provided via anextensive web-based program center(www.fedpartnership.gov). DesignatedPartnership for Progress contacts ineach of the twelve Reserve Bank Dis-tricts and at the Board answer questionsand coordinate assistance for institu-tions requesting guidance. These con-tacts also host regional conferences andconduct other outreach activities withintheir Districts in support of minorityand de novo institutions. The ReserveBanks hosted 14 such regional trainingsessions and conferences during theyear.

The Federal Reserve has coordinatedits efforts with those of the other agen-cies through participation in an annual


interagency conference for minoritydepository institutions. For the federalbank regulatory agencies, the confer-ence provides an opportunity to meetwith senior managers from minority-owned institutions and gain a bet-ter understanding of the institutions’unique challenges and opportunities. Inaddition, the agencies offer trainingclasses and breakout sessions on emerg-ing banking issues.

Supervisory Policy

Capital Adequacy Standards

Risk-Based Capital Standards forCertain Internationally ActiveBanking Organizations

During the year, the Federal Reserve,OCC, FDIC, and OTS issued a finalrule, effective April 1, 2008, imple-menting the advanced approaches ofBasel II. The advanced approachesframework is broadly consistent withthe advanced approaches of the Basel IICapital Accord. It also includes a num-ber of prudential safeguards—such asthe requirement that banking organiza-tions satisfactorily complete a four-quarter parallel run before operatingunder the advanced approaches frame-work—and transitional capital floorsthat limit maximum cumulative reduc-tions of a banking organization’s risk-based capital requirements over threetransitional periods. It retains the long-standing minimum risk-based capitalrequirement of 4 percent tier 1 capitaland 8 percent total qualifying capitalrelative to risk-weighted assets.7 Bank-ing organizations subject to the frame-

work are required to meet certain pub-lic disclosure requirements designed tofoster transparency and market disci-pline.

Institutions may begin transitioningto the new advanced approaches afterthey adopt an implementation plan andhave in place systems that comply withthe rule’s qualification requirements.Final reporting requirements and report-ing templates for institutions that willbe adopting the Basel II advancedapproaches were also published in2008. In June, the agencies issued anotice of proposed rulemaking to adoptthe standardized approaches of theBasel II Capital Accord. The agenciesare currently reviewing and consideringthe comments received. In addition, inJuly the U.S. banking agencies issuedsupervisory guidance relating to anaspect of the Basel II framework,known as Pillar 2, that requires banks tohave a robust internal capital adequacyassessment process (ICAAP) that pre-scribes capital levels commensuratewith their full risk profiles—levelsabove those prescribed by minimumregulatory measures.

The recent market turmoil has high-lighted areas in which the Basel IICapital Accord must be strengthened,and efforts are under way to addressthose areas. Among the changes underconsideration are higher capital require-ments for re-securitizations, such ascollateralized debt obligations backedby asset-backed securities. The capitaltreatment of liquidity facilities that sup-port asset-backed commercial paperconduits is also under review. In addi-tion, the current market risk capitalframework for trading activities is beingreexamined to better reflect potentialexposures arising from the complex,less-liquid credit products that institu-tions hold in their trading portfolios.These changes, which are being devel-

7. Tier 1 capital comprises common stockhold-ers’ equity and qualifying forms of preferredstock, less required deductions such as goodwilland certain intangible assets.


oped by the Basel Committee, will beconsidered for implementation in theUnited States through the agencies’notice and comment process.

Also during the year, the federalbanking and thrift regulatory agenciesissued a final rule that permits a bank-ing organization to reduce the amountof goodwill it must deduct from tier 1capital by any associated deferred taxliability. Under the rule, the regulatorycapital deduction for goodwill is equalto the maximum capital reduction thatcould occur as a result of a completewrite-off of the goodwill under gener-ally accepted accounting principles(GAAP).

In response to the recent market tur-moil, the Federal Reserve, in someinstances together with the other bank-ing agencies, issued several rulemak-ings and guidance.

• The agencies issued an interagencystatement allowing banking organiza-tions to recognize the effect of the taxchange enacted in the EconomicEmergency Stabilization Act of 2008in their third quarter 2008 regulatorycapital calculations. The change pro-vided relief to banking organizationsin recognizing their losses on certainholdings of Federal National Mort-gage Association (Fannie Mae) andFederal Home Loan Mortgage Cor-poration (Freddie Mac) preferredstock by changing the character ofthe losses from capital to ordinary forfederal income tax purposes.

• The agencies published a Notice ofProposed Rulemaking that proposedamending the agencies’ risk-basedcapital rules to change the risk weighton Fannie Mae and Freddie Mac debtand guaranteed securities from 20percent to 10 percent.

• The Board approved an interim finalrule to provide state member banksand bank holding companies partici-pating in the Board’s newly estab-lished Asset-Backed CommercialPaper Money Market Mutual FundLiquidity Facility with an exemptionfrom the Board’s leverage and risk-based capital guidelines for asset-backed commercial paper held as aresult of participation in the facility.The exemption is subject to safetyand soundness conditions.

• The Board approved an interim finalrule to allow bank holding companiesto include in their tier 1 capital, with-out restriction, the senior perpetualpreferred stock issued to the Depart-ment of the Treasury under its newlyestablished Capital Purchase Pro-gram.

Other Capital Issues

In 2008, Board staff conducted supervi-sory analyses of innovative capitalinstruments and novel transactions todetermine whether the instrumentsqualify for inclusion in regulatory capi-tal. Much of the work involved evaluat-ing enhanced forms of trust preferredsecurities, mandatory convertible secu-rities, perpetual preferred stock, andconvertible perpetual preferred stock(mandatory and optionally convertible).Also, later in 2008 significant staff ef-fort was devoted to working with Trea-sury staff to develop the Capital Pur-chase Program as part of the TroubledAsset Restructuring Program.

Staff members also identified andaddressed supervisory concerns relatedto banking organizations’ capital issu-ances and worked with the ReserveBanks to evaluate the overall composi-tion of banking organizations’ capital.As part of this process, the staff oftenmust review the funding strategies pro-


posed in applications for acquisitionsand other transactions submitted to theFederal Reserve by banking organ-izations.

Other Policy Issues

Equity Investments in Banks andBank Holding Companies

Also in 2008, the Board approved a pol-icy statement that explains some of themost significant factors and principlesconsidered when determining whetherminority equity investments in a bank-ing organization are “controlling” forpurposes of the BHC Act. In assessingwhether a minority equity investor has acontrolling influence over the manage-ment or policies of the banking organi-zation, all the facts and circumstancessurrounding the investor’s investmentin, and relationship with, the bankingorganization will be considered, as wellas the percentage of total equity owned.

Accounting Policy

The Federal Reserve strongly endorsessound corporate governance and effec-tive accounting and auditing practicesfor all regulated financial institutions.Accordingly, the supervisory policyfunction is responsible for monitoringmajor domestic and international pro-posals, standards, and other develop-ments affecting the banking industry inthe areas of accounting, auditing, inter-nal controls over financial reporting,financial disclosure, and supervisoryfinancial reporting.

Federal Reserve staff members inter-act with key constituents in the account-ing and auditing professions, includingstandard-setters, accounting firms, otherfinancial sector regulators, accountingand banking industry trade groups, andthe banking industry. These efforts helpin understanding current practice and

proposed standards and in formulatingappropriate policy responses based onthe potential impact of changes in stan-dards or guidance, or other events, onfinancial institutions. As a consequence,Federal Reserve staff routinely provideinformal input to standard-setters, aswell as formal input through publiccomment letters on proposals, to ensureappropriate and transparent financialstatement reporting. Supervisory guid-ance is also issued to financial institu-tions and supervisory staff by the Fed-eral Reserve as appropriate. In addition,Federal Reserve policy staff support theefforts of the System and ReserveBanks in financial institution super-visory activities related to financialaccounting, auditing, reporting, anddisclosure.

Domestic Accounting

During 2008, economic conditions re-sulted in accounting and reporting chal-lenges for financial institutions. Ad-dressing these challenges was a priorityfor Federal Reserve staff members. Sig-nificant issues arising from stressedmarket conditions included accountingfor financial instruments at fair value,accounting for impairment in securitiesand other financial instruments, andanalyzing proposals for modifying ac-counting for off-balance-sheet struc-tures. Staff members participated in anumber of discussions with accountingand auditing standard-setters and pro-vided commentary on a number of pro-posals relevant to the banking industry.For example, they provided commentletters to the Financial AccountingStandards Board (FASB) on proposalsrelated to accounting for transfers offinancial assets, reducing complexityin reporting financial instruments, ac-counting for hedging activities, and im-pairment of certain beneficial interests.


Federal Reserve staff also partici-pated in FASB and Securities andExchange Commission (SEC) efforts toimprove financial reporting and to con-sider accounting issues that have arisenduring the global crisis, such as publicroundtable discussions. A senior Fed-eral Reserve representative was an offi-cial observer on the SEC AdvisoryCommittee on Improvements to Finan-cial Reporting, which was establishedto examine the U.S. financial reportingsystem with the goals of reducingunnecessary complexity and makinginformation more useful and under-standable for investors. In this role,senior staff participated in efforts thatled to the issuance of the Final Reportof the Advisory Committee on Improve-ments to Financial Reporting providedto the SEC in August 2008. In addition,the SEC consulted with Federal Reservestaff, as required under section 133 ofthe Emergency Economic StabilizationAct, when preparing its Report onMark-to-Market Accounting.

Compliance Risk Management

Bank Secrecy Act andAnti-Money-Laundering Compliance

In 2008, the Federal Reserve providedtraining for staff on risk-focusing andthe use of the FFIEC minimum BankSecrecy Act/Anti–Money Laundering(BSA/AML) examination procedures inconjunction with broader efforts toincrease consistency and address indus-try concerns about regulatory burden.The Federal Reserve participates in theFFIEC BSA/AML working group,which is a forum for the discussion ofall pending BSA policy and regulatorymatters, as well as the Treasury-ledBank Secrecy Act Advisory Group,which includes representatives of regu-

latory agencies, law enforcement, andthe financial services industry and cov-ers all aspects of the BSA.

The Federal Reserve and other fed-eral banking agencies continued during2008 to regularly share examinationfindings and enforcement proceedingswith the Financial Crimes EnforcementNetwork (FinCEN) under the inter-agency memorandum of understanding(MOU) that was finalized in 2004, andwith the Treasury’s Office of ForeignAssets Control (OFAC) under the inter-agency MOU that was finalized in2006.

International Coordination onSanctions, Anti–Money Laundering,and Counter-Terrorism Financing

The Federal Reserve participates in anumber of international coordinationinitiatives related to sanctions, moneylaundering, and terrorism financing. Forexample, the Federal Reserve has along-standing role in the U.S. delega-tion to the intergovernmental FinancialAction Task Force and its workinggroups, contributing a banking supervi-sory perspective to formulation of inter-national standards on these matters.

The Federal Reserve also continuesto contribute to international efforts topromote transparency and address risksfaced by financial institutions involvedin international funds transfers. TheFederal Reserve participates in a sub-committee of the Basel Committee thatfocuses on AML/counter-terrorism fi-nancing issues. In 2008, the Basel Com-mittee released for public comment aconsultative document titled Due Dili-gence and Transparency regardingCover Payment Messages Related toCross-Border Wire Transfers andassisted in the review of comments inpreparation for finalizing the paper.


Corporate Compliance

In October 2008, the Federal Reserveissued guidance clarifying supervisoryexpectations with respect to compliancerisk management. The guidance en-dorses principles applicable to all bank-ing organizations set forth by the BaselCommittee in its April 2005 paper titledCompliance and the ComplianceFunction in Banks. It also clarifies theFederal Reserve’s supervisory viewsrelating to firmwide compliance-riskmanagement programs and oversight atlarge banking organizations havingcomplex compliance profiles.

International Guidance onSupervisory Policies

As a member of the Basel Committee,the Federal Reserve participates inefforts to advance sound supervisorypolicies for internationally active bank-ing organizations and to improve thestability of the international bankingsystem. In 2008, the Federal Reserveparticipated in ongoing cooperativework on strategic responses to thefinancial markets crisis, initiatives toenhance Basel II, implementation ofBasel II, and development of interna-tional supervisory risk-managementguidance, particularly in the areas offunding liquidity risk management,counterparty credit risk, and stress-testing practices.

Risk Management

The Federal Reserve contributed tosupervisory policy papers, reports, andrecommendations issued by the BaselCommittee during 2008 that were gen-erally aimed at improving the supervi-sion of banking organizations’ risk-

management practices.8 Three of thesewere

• Principles for Sound Liquidity RiskManagement and Supervision, pub-lished in September

• Proposed Revisions to the Basel IIMarket Risk Framework and Guide-lines for Computing Capital forIncremental Risk in the TradingBook, published in July

• Liquidity Risk: Management andSupervisory Challenges, published inFebruary

Joint Forum

In 2008, the Federal Reserve continuedto participate in the Joint Forum—agroup established under the aegis of theBasel Committee to address issuesrelated to the banking, securities, andinsurance sectors, including the regula-tion of financial conglomerates. TheJoint Forum is made up of representa-tives of the Basel Committee, the Inter-national Organization of SecuritiesCommissions, and the InternationalAssociation of Insurance Supervisors.The Federal Reserve contributed to thedevelopment of supervisory policypapers, reports, and recommendationsissued by the Joint Forum during 2008.9

The Federal Reserve also participated inJoint Forum–sponsored information-sharing on pandemic planning and otherbusiness continuity initiatives. In 2008,work of the Joint Forum published bythe Basel Committee included

8. Papers issued by the Basel Committee canbe accessed via the Bank for International Settle-ments website (www.bis.org).

9. Papers issued by the Joint Forum can beaccessed via the Bank for International Settle-ments website (www.bis.org).


• Credit Risk Transfer Developmentsfrom 2005 to 2007, published inJuly

• Cross-Sectoral Review of Group-wide Identification and Managementof Risk Concentrations, published inApril

• Customer Suitability in the RetailSale of Financial Products and Ser-vices, published in April

International Accounting

The Federal Reserve participates in theBasel Committee’s Accounting TaskForce (ATF), which represents theBasel Committee at international meet-ings on accounting, auditing, and dis-closure issues affecting global bankingorganizations. During 2008, FederalReserve staff participated in activitiesarising from global market conditionsand in support of efforts related tofinancial stability. In particular, staffmembers contributed to the develop-ment of numerous Basel Committeecomment letters related to accountingand auditing matters that were submit-ted to the International AccountingStandards Board and the InternationalAuditing and Assurance StandardsBoard (IAASB).

The Basel Committee in November2008 issued for public comment aconsultative paper titled SupervisoryGuidance for Assessing Banks’ Finan-cial Instrument Fair Value Practices.The paper describes supervisory expec-tations regarding bank practices and thesupervisory assessment of valuationpractices. It evolved from work relatedto the development of the paper FairValue Measurement and Modeling: AnAssessment of Challenges and LessonsLearned from the Market Stress,which was issued in June 2008. Thetwo papers were prepared as a result of

initial findings and lessons learned fromthe current financial crisis and wereincorporated in Report of the Finan-cial Stability Forum on Enhancing Mar-ket and Institutional Resilience, issuedin April.

Credit Risk Management

The Federal Reserve works with theother federal banking agencies todevelop guidance on the managementof credit risk, to coordinate the assess-ment of regulated institutions’ creditrisk, and to ensure that institutionsproperly identify, measure, and managecredit risk.

Working with Mortgage Borrowers

The ongoing financial and economicstress has highlighted the crucial rolethat prudent bank lending practices playin promoting the nation’s economicwelfare. In 2008, the Federal Reserveissued two statements to emphasize theimportant role of banking organizationsin U.S. credit markets and to encouragethese organizations to pursue respon-sible lending activities as they meet thecredit needs of American householdsand businesses. In March, the FederalReserve issued a statement emphasizingthe need for regulated institutions to betransparent in their residential mortgagemodification activities and to supportindustry efforts to improve the collec-tion of data on the type and volume ofmortgage modifications. In November,the Federal Reserve, FDIC, OCC, andOTS issued a statement emphasizingthe need for banking organizations andtheir regulators to work together inmeeting the credit needs of consumersand businesses. In this statement, theagencies encouraged banking organiza-tions to pursue economically viable andappropriate lending opportunities and


stressed the importance of prudent lend-ing practices, a strong capital position,prudent dividend policies, and appropri-ate employee compensation practices.

Shared National CreditProgram

In October, the Federal Reserve, FDIC,OCC, and OTS released summaryresults of the 2008 annual review of theShared National Credit Program. Theagencies established the program in1977 to promote an efficient and consis-tent review and classification of sharednational credits. A shared nationalcredit (SNC) is any loan or formal loancommitment—and any asset, such asother real estate, stocks, notes, bonds,and debentures taken as debts previ-ously contracted—extended to borrow-ers by a supervised institution, its sub-sidiaries and affiliates. A SNC musthave an original loan amount that ag-gregates to $20 million or more andeither (1) is shared by three or moreunaffiliated supervised institutions un-der a formal lending agreement or (2) aportion of which is sold to two or moreunaffiliated supervised institutions, withthe purchasing institutions assumingtheir pro rata share of the credit risk.

The 2008 SNC review was based onanalyses of credit data as of December31, 2007, provided by federally super-vised institutions. The 2008 reviewfound that the volume of shared na-tional credits rose 22.6 percent over the2007 review, to $2.8 trillion. The recordgrowth in credit volume was concen-trated in large syndicated loans under-written in late 2006 and the first half of2007, led by the media and telecom,utilities, finance and insurance, and oiland gas sectors. “Criticized” creditsrose $259.3 billion, to $373.4 billion,accounting for 13.4 percent of the SNCportfolio compared with 5.0 percent in

the 2007 review. Within the “criticized”category, “special mention” (potentiallyweak) credits increased $167.9 billion,accounting for 7.5 percent of the SNCportfolio compared with 1.9 percent inthe 2007 review, and “classified” cred-its (credits having well-defined weak-nesses) increased $91.5 billion, ac-counting for 5.8 percent of the SNCportfolio compared with 3.1 percent inthe 2007 review. The criticized creditsand related ratios do not include theeffects of hedging or other techniquesthat organizations often use to mitigaterisk.

The 2008 SNC review also includeda supervisory assessment of underwrit-ing standards. Examiners found an in-ordinate volume of syndicated loanshaving structurally weak underwritingcharacteristics, particularly in non-investment-grade or leveraged transac-tions. The most commonly cited weak-nesses were liberal repayment terms,repayment dependent on refinancingor recapitalization, and nonexistent orweak loan covenants. Examiners alsofound that an excessive number of loanagreements did not provide adequatewarnings or allow for proactive controlover the credit.

Revisions to the Guide to theInteragency Country Exposure ReviewCommittee Process

In November, the Federal Reserve,FDIC, and OCC jointly issued revisionsto the Guide to the Interagency CountryExposure Review Committee (ICERC)Process to reflect improvements inregulated institutions’ cross-border ex-posure analyses and country risk man-agement programs, as well as increasedavailability of information on countryand transfer risk (see SR letter 08-12).The agencies will now assign anICERC rating to only those countries in


default and, accordingly, have elimi-nated the rating categories Other Trans-fer Risk Problems (OTRP), Weak,Moderately Strong, and Strong. Theywill continue to closely monitor regu-lated institutions’ cross-border expo-sures. The revised guide sets forthsupervisory expectations for an institu-tion’s country risk assessment processand rating systems. It also emphasizesthat an institution is expected to haveappropriate limits on exposure to eachsovereign entity, to perform financialanalyses of its exposures, and to applyrobust risk management to all countryexposures, not just to the countriesrated by the agencies.

Proposed Interagency Appraisal andEvaluation Guidelines

In November, the Federal Reserve,FDIC, NCUA, OCC, and OTS jointlyissued for comment proposed In-teragency Appraisal and EvaluationGuidelines to reaffirm supervisory ex-pectations for sound real estate ap-praisal and evaluation practices. Theproposed guidance would replace the1994 Interagency Appraisal and Evalu-ation Guidelines to reflect changes inindustry practice, uniform appraisalstandards, and technology. It incorpo-rates supervisory guidance issued by theagencies since 1994 and clarifies theirexpectations for a regulated institution’srisk-management principles and internalcontrols for its real estate collateralvaluation function. The proposed guid-ance also includes a discussion of theuse of automated valuation models inthe development of an evaluation ofreal estate collateral for real estatetransactions below the appraisal thresh-old set forth in the agencies’ appraisalregulation. The comment period for theproposal closed on January 20, 2009.

Pandemic Planning

In January, the FBIIC and the FinancialServices Sector Coordinating Council(FSSCC), an organization made up offinancial services trade associations andindividual firms, published an after-action report on a pandemic flu exerciseheld in September and October 2007 forthe financial services sector in theUnited States. A total of 2,775 organi-zations participated in the exercise, ofwhich approximately 62 percent werebanks, thrifts, and credit unions. Theexercise revealed several key themesthat are important to pandemicplanning: communications plans,infrastructure-dependency plans, cross-trained employees, telecommuting,human resources issues, and plans for asecond wave of the pandemic.

Throughout 2008, the Federal Re-serve and the other FFIEC agencieswere engaged in several projects de-signed to help the agencies prepare fora pandemic event. The agencies spon-sored a Roundtable on Pandemic Plan-ning attended by approximately 170 in-dustry representatives, including someinternational participants. The FFIEC’sBusiness Continuity Planning Bookletwas updated in March to include guid-ance on identifying the continuity plan-ning that should be in place to minimizeadverse effects of a pandemic event.The agencies also discussed with indus-try representatives the potential industryneed for regulatory relief in the event ofa pandemic. A meeting of FFIEC mem-bers and industry trade group represen-tatives focusing on emergency pre-paredness, response, and recovery washeld in March, and a second meetingwas held in September.

In January, the Federal Reserve Bankof New York began a series of reviewsto assess the progress made by the top15 banking organizations in the country


with respect to pandemic preparedness.A white paper was published that high-lights the practices of firms as well asconclusions and themes as they relate tothe current state of pandemic prepared-ness planning at systemic banking orga-nizations.10

Banks’ Securities Activities

In August, the Federal Reserve releasedthe Small Entity Compliance Guide forRegulation R. Regulation R, adoptedjointly by the Board and the Securitiesand Exchange Commission in Septem-ber 2007, implemented certain keyexceptions for banks from the definitionof the term “broker” under section3(a)(4) of the Securities Exchange Actof 1934, as amended by the Gramm-Leach-Bliley Act. The guide provides ageneral description of the regulationand contact information for small enti-ties having questions regarding compli-ance.

Regulatory Reports

The Federal Reserve’s supervisory pol-icy function is responsible for develop-ing, coordinating, and implementingregulatory reporting requirements forvarious financial reporting forms filedby domestic and foreign financial insti-tutions subject to Federal Reservesupervision. Federal Reserve staff mem-bers interact with relevant federal andstate supervisors, including foreignbank supervisors as needed, to recom-mend and implement appropriate andtimely revisions to the reporting formsand the attendant instructions.

Bank Holding CompanyRegulatory Reports

The Federal Reserve requires that U.S.bank holding companies periodicallysubmit reports providing financial andstructure information. The informationis essential in supervising the compa-nies and in formulating regulations andsupervisory policies. It is also used inresponding to requests from Congressand the public for information aboutbank holding companies and their non-bank subsidiaries. Foreign bankingorganizations also are required to peri-odically submit reports to the FederalReserve.

Reports in the FR Y-9 series—FR Y-9C, FR Y-9LP, and FR Y-9SP—provide standardized financial state-ments for bank holding companies onboth a consolidated and a parent-onlybasis. The reports are used to detectemerging financial problems, to reviewperformance and conduct pre-inspectionanalysis, to monitor and evaluate riskprofiles and capital adequacy, to evalu-ate proposals for bank holding companymergers and acquisitions, and to ana-lyze a holding company’s overall finan-cial condition. Nonbank subsidiaryreports—FR Y-11, FR 2314, and FR Y-7N—help the Federal Reserve deter-mine the condition of bank holdingcompanies that are engaged in nonbankactivities and also aid in monitoring thenumber, nature, and condition of thecompanies’ nonbank subsidiaries. TheFR Y-8 report provides information ontransactions between an insured deposi-tory institution and its affiliates that aresubject to section 23A of the FederalReserve Act; it is used to monitor bankexposures to affiliates and to ensurebanks’ compliance with section 23A ofthe Federal Reserve Act. The FR Y-10report provides data on changes in orga-nization structure at domestic and for-

10. The population under review included coreclearing and settlement organizations and firmsthat play a critical role in financial markets andare subject to resiliency guidelines issued in April2003, also called the “Sound Practices Paper.”


eign banking organizations (FBOs). TheFR Y-6 and FR Y-7 reports gather ad-ditional information on organizationstructure and shareholders from domes-tic banking organizations and FBOs,respectively; the information is used tomonitor structure so as to determinecompliance with provisions of the BankHolding Company Act and RegulationY and to assess the ability of an FBO tocontinue as a source of strength to itsU.S. operations.

In February, a number of revisions tothe FR Y-9C report were approved forimplementation during 2008: (1) report-ing of interest and fee income on one-to four-family residential mortgagesand all other real estate loans separ-ately from income on all other loans;(2) reporting of the quarterly averagefor one- to four-family residential mort-gages and all other real estate loansseparately from the quarterly averagefor all other loans; (3) addition of dataitems for restructured troubled mort-gages and mortgage loans in the processof foreclosure; (4) expansion of theschedule for closed-end one- to four-family residential mortgage bankingactivity to include originations, pur-chases, and sales of open-end mort-gages as well as closed-end and open-end mortgage loan repurchases andindemnifications during the quarter;(5) modification of the definition of“trading account” and collection ofadditional information about instru-ments accounted for under the fairvalue option on the loan schedule andthe fair value measurements schedule;(6) revision of the schedule on tradingassets and liabilities; (7) clarification ofthe instructions for reporting creditderivative data in the risk-based capitalschedule, and corresponding change tothe report; (8) modification of thethreshold for reporting sub-categoriesof other non-interest income and ex-

pense in the income statement; and(9) revision of the instructions for re-porting fully insured brokered depositsin the deposit liabilities schedule toconform to the instructions for reportingtime deposits in the schedule.

Effective March 2008, the require-ment that subsidiaries created for thepurpose of issuing trust preferred secu-rities (trust preferred securities subsidi-aries) file the FR Y-11, FR 2314, andFR Y-7N was dropped. In addition, newitems were added to the reports to col-lect (1) certain data from all institutionsthat choose, under generally acceptedaccounting principles, to apply a fairvalue option to one or more financialinstruments and one or more classesof servicing assets and liabilities and(2) data on income from annuity sales.Also added on the FR Y-7N were a newitem for reporting the amount of part-nership interests and a new section,Notes to the Financial Statements. Ef-fective December, a question was addedto the FR Y-11S, FR 2314S, and FR Y-7NS to determine whether the subsidi-ary has adopted a fair value option.

Also effective December 2008, theFR Y-10 report was updated to includecollection of the tax ID number for allreportable banking and nonbankingentities located in the United States. Inaddition, cover pages and instructionsfor the FR Y-6 and FR Y-7 were modi-fied to highlight, for reporting entities,issues surrounding the submission ofinformation on individuals.

In November, the Federal Reserveproposed a number of revisions to theFR Y-9C for implementation in 2009comparable to those proposed for thebank Call Report, as described in thenext section. In addition, the Fed-eral Reserve proposed to revise theFR Y-9C to (1) add new data items andrevise existing data items on tradingassets and liabilities; (2) collect infor-


mation associated with the Treasury’sCapital Purchase Program; and (3) addnew data items and revise existing dataitems on regulatory capital require-ments. Also in November, the FederalReserve proposed to revise the FR Y-11, FR 2314, and FR Y-7N in March2009 to collect new information onassets held in trading accounts and torequire that respondents submit all FRY-8 reports electronically, effectivewith the June 30, 2009, report date.

Commercial BankRegulatory Financial Reports

As the federal supervisor of state mem-ber banks, the Federal Reserve, alongwith the other banking agencies throughthe FFIEC, requires banks to submitquarterly Call Reports. Call Reports arethe primary source of data for the su-pervision and regulation of banks andthe ongoing assessment of the overallsoundness of the nation’s banking sys-tem. Call Report data, which also serveas benchmarks for the financial infor-mation required by many other FederalReserve regulatory financial reports, arewidely used by state and local govern-ments, state banking supervisors, thebanking industry, securities analysts,and the academic community.

During 2008, the FFIEC imple-mented revisions to the Call Report toaddress new safety and soundness con-siderations and to facilitate supervision.Among these revisions were collectionof additional information related to one-to four-family residential mortgageloans; modification of the definition of“trading account” in response to thecreation of a fair value option undergenerally accepted accounting prin-ciples; revision of certain schedules tocollect additional information aboutinstruments accounted for under the fairvalue option; revision of the instruc-

tions for reporting daily average depositdata by newly insured institutions toconform with the FDIC’s assessmentregulations; clarification of the instruc-tions for reporting credit derivativesdata on the risk-based capital schedule;and collection of information necessaryto calculate assessments for participantsin the FDIC’s Transaction AccountGuarantee Program.

In September, the FFIEC proposed anumber of revisions to the Call Reportfor implementation in 2009. The pro-posed revisions include new items on(1) held-for-investment loans and leasesacquired in business combinations;(2) the date on which the bank’s fiscalyear ends; (3) real estate constructionand development loans on which inter-est is capitalized; (4) holdings of com-mercial mortgage–backed securities andstructured financial products, such ascollateralized debt obligations; (5) fairvalue measurements for assets andliabilities reported at fair value on arecurring basis; (6) pledged loans andpledged trading assets; (7) collateraland counterparties associated with over-the-counter derivatives exposures; (8)credit derivatives; (9) remaining maturi-ties of unsecured other borrowings andsubordinated notes and debentures;(10) unused short-term commitments toasset-backed commercial paper con-duits; (11) past due and nonaccrualtrading assets; (12) investments in realestate ventures; and (13) held-to-maturity and available-for-sale securi-ties in domestic offices. In addition,revisions were proposed to (1) modifyseveral data items relating to noncon-trolling (minority) interests in consoli-dated subsidiaries; (2) provide forexemptions from reporting certain ex-isting items by banks having less than$1 billion in total assets; (3) clarify thedefinition of the term “loan secured byreal estate”; (4) provide guidance in the


reporting instructions on quantifyingmisstatements in the Call Report;(5) eliminate the confidential treatmentof data collected from trust institutionson fiduciary income, expenses, andlosses; and (6) expand information col-lected on trust department activities.

Supervisory InformationTechnology

Information technology supporting Fed-eral Reserve supervisory activities ismanaged within the System supervisoryinformation technology (SSIT) functionin the Board’s Division of Banking Su-pervision and Regulation. SSIT worksthrough assigned staff at the Board andthe Reserve Banks, as well as throughSystem committees, to ensure that keystaff members throughout the Systemparticipate in identifying requirementsand setting priorities for informationtechnology initiatives.

In 2008, the SSIT function workedon several strategic projects and in-itiatives: (1) alignment of technol-ogy investments with business needs;(2) identification and implementation ofimprovements to make technology anddata more accessible to staff working inthe field; (3) strengthening of compli-ance with data-privacy regulations;(4) implementation of new software toimprove the processing of bank applica-tions; and (5) implementation of col-laboration and analysis technologies(such as communities of practice andbusiness intelligence tools) to integratesupervisory and management informa-tion systems that support both office-based and field staff. With the otherfederal regulatory agencies, the SSITalso implemented the first phase of themodernization of the Shared NationalCredit system. And it began a project todevelop a comprehensive tool for track-ing exam findings Systemwide.

National Information Center

The National Information Center (NIC)is the Federal Reserve’s comprehensiverepository for supervisory, financial,and banking-structure data. It is also themain repository for many supervisorydocuments. NIC includes (1) data onbanking structure throughout the UnitedStates as well as foreign banking con-cerns; (2) the National ExaminationDatabase (NED), which enables super-visory personnel as well as federal andstate banking authorities to access NICdata; (3) the Banking OrganizationNational Desktop (BOND), an applica-tion that facilitates secure, real-timeelectronic information-sharing and col-laboration among federal and statebanking regulators for the supervisionof banking organizations; and (4) theCentral Document and Text Repository,which contains documents supportingthe supervisory processes.

Within the NIC, the supporting sys-tems have been modified over time toextend their useful lives and improvebusiness workflow efficiency. During2008, work continued on upgrading theentire NIC infrastructure to provideeasier access to information, a consis-tent Federal Reserve enterprise infor-mation data repository, a comprehen-sive metadata repository, and uniformsecurity across the Federal ReserveSystem. An initial model was providedto a representative group of FederalReserve users and stakeholders. Signifi-cant design changes resulted from thefeedback of that group. Implementationis expected to be phased in beginningmid-year 2009 and to be completed byyear-end 2010. Also during the year,several programming changes weremade to NIC applications in support ofbusiness needs, primarily for the creditrisk and discount window functions tomonitor new Federal Reserve programs


created to assist the financial and bank-ing markets.

The Federal Reserve continued in2008 to work with other federal regula-tory agencies to modernize the collec-tion of SNC information by creating acommon collection facility. Implemen-tation of the initial phase was effectiveyear-end 2008, for fourth-quarter data.SNC data will begin being reported ona quarterly basis.

Finally, the Federal Reserve partici-pated in a number of technology-relatedinitiatives supporting the supervisionfunction as part of FFIEC task forcesand subgroups.

Staff Development

Training and staff development focuseson recruiting, deploying, developing,and retaining staff having the skills nec-essary to meet supervisory responsibili-ties today and in the future. The staffdevelopment program is responsible forthe ongoing development of nearly2,300 professional supervisory staff.Training for banking supervision andregulation in 2008 is summarized in thetable.

Examiner Commissioning Program

The Examiner Commissioning Pro-gram (ECP) involves approximately

22 weeks of instruction. Individualsmove through a combination of class-room offerings, self-paced assignments,and on-the-job training over a period oftwo to five years. Achievement is mea-sured by two professionally validatedproficiency examinations: the first pro-ficiency exam is required of all ECPparticipants; the second proficiencyexam is offered in two specialty areas—safety and soundness, and consumeraffairs. A third specialty, in informationtechnology, requires that individualsearn the Certified Information SystemsAuditor certification offered by theInformation Systems Audit ControlAssociation. In 2008, 147 examinerspassed the first proficiency exam and93 passed the second proficiency exam(63 in safety and soundness, and 30 inconsumer affairs).

Continuing ProfessionalDevelopment

Other formal and informal learningopportunities are available to examin-ers, including other schools and pro-grams offered within the System andFFIEC-sponsored schools. System pro-grams are also available to state agen-cies. In 2008, “rapid response” sessionswere instituted in response to emergingor urgent training needs associated with

Training for Banking Supervision and Regulation, 2008

Course sponsoror type

Number of participantsInstructional time

(training days unlessotherwise noted)

Number ofcourse offeringsFederal Reserve

personnelState

personnel

Federal Reserve System . . . . 3,217 359 11,998 128FFIEC . . . . . . . . . . . . . . . . . . . . 508 275 2,006 55The Options Institute1 . . . . . . 6 4 18 1Rapid response . . . . . . . . . . . . 1,745 0 10 one-hour

conference calls10

1. The Options Institute, an educational arm of theChicago Board Options Exchange, provides a three-dayseminar on the use of options in risk management.


implementation or issuance of newlaws, regulations, or guidance.

Regulation of theU.S. Banking Structure

The Federal Reserve administers fivefederal statutes that apply to bank hold-ing companies, financial holding com-panies, member banks, and foreignbanking organizations—the Bank Hold-ing Company Act, the Bank MergerAct, the Change in Bank Control Act,the Federal Reserve Act, and the Inter-national Banking Act. In administeringthese statutes, the Federal Reserve actson a variety of proposals that directly orindirectly affect the structure of the U.S.banking system at the local, regional,and national levels; the internationaloperations of domestic banking organi-zations; or the U.S. banking operationsof foreign banks. The proposals concernbank holding company formations andacquisitions, bank mergers, and othertransactions involving bank or nonbankfirms. In 2008, the Federal Reserveacted on 1,057 proposals representing1,910 individual applications filedunder the five statutes.

Bank Holding Company Act

Under the Bank Holding Company Act,a corporation or similar legal entitymust obtain the Federal Reserve’sapproval before forming a bank holdingcompany through the acquisition of oneor more banks in the United States.Once formed, a bank holding companymust receive Federal Reserve approvalbefore acquiring or establishing addi-tional banks. Also, bank holding com-panies generally may engage in onlythose nonbanking activities that theBoard has previously determined to beclosely related to banking under section4(c)(8) of the Bank Holding Company

Act. Depending on the circumstances,these activities may or may not requireFederal Reserve approval in advance oftheir commencement.11

When reviewing a bank holding com-pany application or notice that requiresprior approval, the Federal Reserve mayconsider the financial and managerialresources of the applicant, the futureprospects of both the applicant and thefirm to be acquired, the convenienceand needs of the community to beserved, the potential public benefits, thecompetitive effects of the proposal, andthe applicant’s ability to make availableto the Federal Reserve informationdeemed necessary to ensure compliancewith applicable law. In the case of aforeign banking organization seeking toacquire control of a U.S. bank, the Fed-eral Reserve also considers whether theforeign bank is subject to comprehen-sive supervision or regulation on a con-solidated basis by its home-countrysupervisor. In 2008, the Federal Reserveacted on 495 applications and noticesfiled by bank holding companies toacquire a bank or a nonbank firm, or tootherwise expand their activities.

A bank holding company may repur-chase its own shares from its sharehold-ers. When the company borrows moneyto buy the shares, the transaction in-creases the company’s debt and de-creases its equity. The Federal Reservemay object to stock repurchases byholding companies that fail to meet cer-tain standards, including the Board’scapital adequacy guidelines. In 2008,

11. Since 1996, the act has provided an expe-dited prior notice procedure for certain permis-sible nonbank activities and for acquisitions ofsmall banks and nonbank entities. Since that timethe act has also permitted well-run bank holdingcompanies that satisfy certain criteria to com-mence certain other nonbank activities on a denovo basis without first obtaining Federal Reserveapproval.


the Federal Reserve reviewed 7 stock re-purchase proposals by bank holdingcompanies.

The Federal Reserve also reviewselections submitted by bank holdingcompanies seeking financial holdingcompany status under the authoritygranted by the Gramm-Leach-BlileyAct. Bank holding companies seekingfinancial holding company status mustfile a written declaration with the Fed-eral Reserve. In 2008, 29 domesticfinancial holding company declarationsand 5 foreign bank declarations wereapproved.

Bank Merger Act

The Bank Merger Act requires that allproposals involving the merger ofinsured depository institutions be actedon by the relevant federal bankingagency. The Federal Reserve has pri-mary jurisdiction if the institution sur-viving the merger is a state memberbank. Before acting on a merger pro-posal, the Federal Reserve considers thefinancial and managerial resources ofthe applicant, the future prospects of theexisting and combined organizations,the convenience and needs of the com-munity(ies) to be served, and the com-petitive effects of the proposed merger.The Federal Reserve also must considerthe views of the U.S. Department ofJustice regarding the competitive as-pects of any proposed bank mergerinvolving unaffiliated insured deposi-tory institutions. In 2008, the FederalReserve approved 71 merger applica-tions under the act.

Change in Bank Control Act

The Change in Bank Control Actrequires individuals and certain otherparties that seek control of a U.S. bankor bank holding company to obtain

approval from the relevant federalbanking agency before completing thetransaction. The Federal Reserve isresponsible for reviewing changes inthe control of state member banks andbank holding companies. In its review,the Federal Reserve considers the finan-cial position, competence, experience,and integrity of the acquiring person;the effect of the proposed change on thefinancial condition of the bank or bankholding company being acquired; thefuture prospects of the institution to beacquired; the effect of the proposedchange on competition in any relevantmarket; the completeness of the infor-mation submitted by the acquiring per-son; and whether the proposed changewould have an adverse effect on theDeposit Insurance Fund. A proposedtransaction should not jeopardize thestability of the institution or the inter-ests of depositors. During its review ofa proposed transaction, the FederalReserve may contact other regulatory orlaw enforcement agencies for infor-mation about relevant individuals. In2008, the Federal Reserve approved124 changes in control of state memberbanks and bank holding companies.

Federal Reserve Act

Under the Federal Reserve Act, a mem-ber bank may be required to seek Fed-eral Reserve approval before expandingits operations domestically or interna-tionally. State member banks mustobtain Federal Reserve approval toestablish domestic branches, and allmember banks (including nationalbanks) must obtain Federal Reserveapproval to establish foreign branches.When reviewing proposals to establishdomestic branches, the Federal Reserveconsiders, among other things, thescope and nature of the banking activi-ties to be conducted. When reviewing


proposals for foreign branches, the Fed-eral Reserve considers, among otherthings, the condition of the bank and thebank’s experience in international bank-ing. In 2008, the Federal Reserve actedon new and merger-related branch pro-posals for 890 domestic branches andgranted prior approval for the establish-ment of 6 new foreign branches.

State member banks must also obtainFederal Reserve approval to establishfinancial subsidiaries. These subsidi-aries may engage in activities that arefinancial in nature or incidental tofinancial activities, including securities-related and insurance agency–relatedactivities. In 2008, 4 financial subsidi-ary applications were approved.

Overseas Investments byU.S. Banking Organizations

U.S. banking organizations may engagein a broad range of activities overseas.Many of the activities are conductedindirectly through Edge Act and agree-ment corporation subsidiaries. Althoughmost foreign investments are madeunder general consent procedures thatinvolve only after-the-fact notificationto the Federal Reserve, large and othersignificant investments require priorapproval. In 2008, the Federal Reserveapproved 67 proposals for overseasinvestments by U.S. banking organiza-tions, many of which represented in-vestments through an Edge Act oragreement corporation.

International Banking Act

The International Banking Act, asamended by the Foreign Bank Supervi-sion Enhancement Act of 1991, requiresforeign banks to obtain Federal Reserveapproval before establishing branches,agencies, commercial lending company

subsidiaries, or representative offices inthe United States.

In reviewing proposals, the FederalReserve generally considers whetherthe foreign bank is subject to compre-hensive supervision or regulation on aconsolidated basis by its home-countrysupervisor. It also considers whether thehome-country supervisor has consentedto the establishment of the U.S. office;the financial condition and resources ofthe foreign bank and its existing U.S.operations; the managerial resources ofthe foreign bank; whether the home-country supervisor shares informationregarding the operations of the foreignbank with other supervisory authorities;whether the foreign bank has providedadequate assurances that informationconcerning its operations and activitieswill be made available to the FederalReserve, if deemed necessary to deter-mine and enforce compliance with ap-plicable law; whether the foreign bankhas adopted and implemented proce-dures to combat money laundering andwhether the home country of the for-eign bank is developing a legal regimeto address money laundering or is par-ticipating in multilateral efforts to com-bat money laundering; and the record ofthe foreign bank with respect to compli-ance with U.S. law. In 2008, the FederalReserve approved 19 applications byforeign banks to establish branches,agencies, or representative offices in theUnited States.

Public Notice ofFederal Reserve Decisions

Certain decisions by the Federal Re-serve that involve an acquisition by abank holding company, a bank merger,a change in control, or the establish-ment of a new U.S. banking presence bya foreign bank are made known to thepublic by an order or an announcement.


Orders state the decision, the essentialfacts of the application or notice, andthe basis for the decision; announce-ments state only the decision. All ordersand announcements are made publicimmediately; they are subsequentlyreported in the Board’s weekly H.2 sta-tistical release. The H.2 release alsocontains announcements of applicationsand notices received by the FederalReserve upon which action has not yetbeen taken. For each pending applica-tion and notice, the related H.2 givesthe deadline for comments. The Board’swebsite (www.federalreserve.gov) pro-vides information on orders andannouncements as well as a guide forU.S. and foreign banking organizationsthat wish to submit applications ornotices to the Federal Reserve.

Enforcement of Other Lawsand Regulations

The Federal Reserve’s enforcementresponsibilities also extend to the dis-closure of financial information by statemember banks and the use of credit topurchase and carry securities.

Financial Disclosures byState Member Banks

State member banks that issue securitiesregistered under the Securities Ex-change Act of 1934 must disclose cer-tain information of interest to investors,including annual and quarterly financialreports and proxy statements. By stat-ute, the Board’s financial disclosurerules must be substantially similar tothose of the Securities and ExchangeCommission. At the end of 2008, 12state member banks were registeredwith the Board under the SecuritiesExchange Act.

Securities Credit

Under the Securities Exchange Act, theBoard is responsible for regulatingcredit in certain transactions involvingthe purchase or carrying of securities.The Board’s Regulation T limits theamount of credit that may be providedby securities brokers and dealers whenthe credit is used to purchase debt andequity securities. The Board’s Regula-tion U limits the amount of credit thatmay be provided by lenders other thanbrokers and dealers when the credit isused to purchase or carry publicly heldequity securities if the loan is securedby those or other publicly held equitysecurities. The Board’s Regulation Xapplies these credit limitations, or mar-gin requirements, to certain borrowersand to certain credit extensions, such ascredit obtained from foreign lenders byU.S. citizens.

Several regulatory agencies enforcethe Board’s securities credit regulations.The SEC, the Financial Industry Regu-latory Authority (formed through thecombination of the National Associa-tion of Securities Dealers and the regu-lation, enforcement, and arbitrationfunctions of the New York Stock Ex-change), and the Chicago Board Op-tions Exchange examine brokers anddealers for compliance with RegulationT. With respect to compliance withRegulation U, the federal banking agen-cies examine banks under their respec-tive jurisdictions; the Farm CreditAdministration and the National CreditUnion Administration examine lendersunder their respective jurisdictions; andthe Federal Reserve examines otherRegulation U lenders.

Federal Reserve Membership

At the end of 2008, 2,378 banks weremembers of the Federal Reserve System


and were operating 55,892 branches.These banks accounted for 34 percentof all commercial banks in the United

States and for 70 percent of all com-mercial banking offices. Á


Consumer and Community Affairs

Among the Federal Reserve’s responsi-bilities in the areas of consumer andcommunity affairs are

• writing and interpreting regulationsto implement federal laws that pro-tect and inform consumers,

• supervising state member banks toensure compliance with the regula-tions,

• investigating complaints from thepublic about state member banks’compliance with regulations,

• promoting community developmentin historically underserved markets,and

• conducting research and promotingconsumer education.

These responsibilities are carried out bythe members of the Board of Gover-nors, the Board’s Division of Consumerand Community Affairs (DCCA), andthe consumer and community affairsstaffs at Federal Reserve Banks.

The Federal Reserve System’s vari-ous consumer protection and commu-nity development roles continued to beareas of interest in 2008. Amid the con-sequences of a deteriorating financialmarketplace, consumer protection wasamong the issues of concern, particu-larly in the mortgage and credit cardmarkets. Throughout the year, lawmak-ers, regulators, the media, and consum-ers scrutinized various practices used inthe financial services marketplace, ex-pressing concern at the complexity ofproducts and characterizing some prac-tices as unfair or deceptive. In 2008, the

Federal Reserve Board advanced con-sumer protection in financial servicesby finalizing regulations that set newrules for fairness and transparency inthe high-cost mortgage and credit cardmarkets. In addition, the Board contin-ued to commit significant resources inthe areas of supervision, research, com-munity development, and consumereducation to increase understanding ofthe issues and impacts of the creditcrisis on consumers and communities.

Mortgage Credit

Throughout 2008, concerns over con-sumer protection and access to credit inthe mortgage market continued to esca-late, prompting the Federal Reserve tocontinue to pursue a range of efforts tosupport both consumers and industrythrough its regulatory and supervisoryactivities.

Regulatory Actions

Expansion of Consumer Protectionsunder Regulation Z

Concerns about the mortgage creditmarkets continued into 2008 as manylenders and borrowers suffered signifi-cant losses and as property valuesdeclined in much of the country. Analy-ses of these developments revealed arange of lender practices that contrib-uted to the crises, including lax under-writing standards and inadequate an-alyses of borrowers’ ability to repaytheir mortgages. Many of these prac-tices were common among nonbank,subprime mortgage creditors offeringhigher-priced mortgage loans. These

127

lenders were not subject to the samelevel of supervision as insured deposi-tory institutions.

The Board had taken action toaddress some of these concerns in late2007, when it issued proposed amend-ments to Regulation Z to strengthenconsumer protection and underwritingstandards. The proposed rules ad-dressed, in particular, certain creditorpractices as they relate to higher-pricedmortgage loans, under authority grantedby the Home Ownership and EquityProtection Act (HOEPA). The proposalreceived more than 4,500 comment let-ters from the mortgage industry, con-sumer and community organizations,individual consumers, and policy-makers.

In July 2008, the Board approved andpublished the final rules for mortgageloans under Regulation Z to improveconsumer protections and facilitateresponsible lending. The new rulesapply to all mortgage lenders, not justinsured depository institutions, to pro-vide broader protection to consumersand a uniform set of rules for the mort-gage industry. The regulation prohibitsunfair, abusive, or deceptive homemortgage lending practices, and re-stricts certain other mortgage practices.The final rules also establish advertis-ing standards, and require lenders toprovide certain mortgage disclosuresto consumers earlier in the lendingprocess.1

The regulation was approved at apublic meeting held by the Board,where Federal Reserve Chairman BenS. Bernanke stated, “The proposed finalrules are intended to protect consumersfrom unfair or deceptive acts and

practices in mortgage lending, whilekeeping credit available to qualifiedborrowers and supporting sustainablehomeownership.” The new rules applyto “higher-priced mortgage loans”—defined to capture virtually all loansoriginated in the subprime market—butgenerally exclude loans in the primemarket. In addition, the rules also estab-lish new consumer protections thatapply to all mortgage loans secured bya borrower’s principal dwelling.

For higher-priced mortgage loanssecured by a consumer’s principaldwelling, the final regulation adds fourkey protections:

• It prohibits a lender from making aloan without regard to a borrower’sability to repay the loan from incomeand assets other than the home’svalue.

• It requires creditors to verify theincome and assets they rely upon todetermine a borrower’s ability torepay a loan.

• It bans any prepayment penalty if thepayment can change in the initial fouryears. For other higher-priced loans,a prepayment penalty period cannotlast for more than two years. Thisrestriction on prepayment penaltiesis substantially more limiting thanoriginally proposed.

• It requires creditors to establish es-crow accounts for property taxes andhomeowner’s insurance for all first-lien mortgage loans.

For all mortgage loans secured by aborrower’s principal dwelling, the finalrules establish several requirements:

• Creditors and mortgage brokers areprohibited from coercing a real estateappraiser to misstate a home’s value.

• Companies that service mortgageloans are prohibited from engaging in

1. See press release, “Board Issues Final RuleAmending Home Mortgage Provisions of Regula-tion Z” (July 14, 2008), www.federalreserve.gov/newsevents/press/bcreg/20080714a.htm.


certain practices, such as pyramidinglate fees. In addition, servicers arerequired to credit consumers’ loanpayments as of the date of receiptand to provide a payoff statementwithin a reasonable time following arequest.

• Creditors must provide a good-faithestimate of a loan’s costs, including aschedule of payments, within threedays after a consumer applies for anymortgage loan secured by the con-sumer’s principal dwelling, such as ahome improvement or a straight refi-nance loan.

The final rules also set additionalstandards that apply to all mortgageadvertising, requiring additional infor-mation about rates, monthly payments,and other loan features. In addition, thefinal rules ban seven deceptive or mis-leading advertising practices, includingrepresenting that a rate or payment is“fixed” when it can change. The newrules take effect on October 1, 2009,except for the escrow requirement,which will be phased in during 2010 toallow lenders to establish new systemsas needed.

After extensive consumer testing, theBoard withdrew one element of theoriginal proposal relating to “yield-spread premiums”—a common com-pensation method used by lenders origi-nating loans through mortgage brokers.The testing, conducted to ascertain theeffectiveness of a variety of strategies todisclose this practice and its impact onthe cost of the loan to borrowers,revealed that the proposed disclosureswere inadequate in conveying thisinformation to consumers.2 As a result,

the Board committed to consideringalternative approaches as part of itsongoing review of mortgage rules underRegulation Z.

Illustrations to Improve Consumers’Understanding of Adjustable-RateMortgage Products

With the expansion of mortgage creditmarkets over the last several years, therange and complexity of loan types alsoincreased, particularly in the subprimemarket. Here, various adjustable-ratemortgage (ARM) loan products becamemore prevalent as a means to makehomeownership more affordablethrough lower rates and payments in theearly years of a loan.

While beneficial to some borrowers,ARMs also can be very complex andcan present repayment challenges toborrowers whose circumstances proveunsuitable for loans with significantpayment increases. Because of concernsthat consumers were not fully aware ofthe implications presented by theseproducts, the Federal Reserve andother federal financial regulatory agen-cies in May 2008 issued guidancecontaining illustrations that mortgagelenders can use to help consumers un-derstand certain hybrid ARMs.3 Theseillustrations are designed to assist insti-tutions in complying with recommenda-tions set forth in the agencies’ 2007“Statement on Subprime MortgageLending,” which called on institutionsto provide clear, balanced, and timelyinformation to consumers about therelative benefits, costs, and risks of

2. See Summary of Findings, Consumer Test-ing of Mortgage Broker Disclosures (July 10,2008), www.federalreserve.gov/newsevents/press/bcreg/20080714regzconstest.pdf.

3. See press release, “Federal Financial Regu-lators Issue Final Illustrations of Consumer Infor-mation for Hybrid Adjustable-Rate MortgageProducts” (May 22, 2008), www.federalreserve.gov/newsevents/press/bcreg/20080522a.htm.

Consumer and Community Affairs 129

hybrid ARM products.4 The illustra-tions were developed in response torequests by some industry groups, incommenting on the proposed SubprimeStatement, that the agencies either pro-vide uniform disclosures for these prod-

ucts or publish illustrations of the con-sumer information.

Although the illustrations are notmandatory, institutions may use them,provide information based on them, orprovide consumers with informationdescribed in the guidance in an alter-nate format. The illustrations provide

• an explanation of some of the keyfeatures of certain ARM loans thatare identified in the Subprime State-

4. See press release, “Federal Financial Regu-latory Agencies Issue Final Statement onSubprime Mortgage Lending” (June 29, 2007),www.federalreserve.gov/newsevents/press/bcreg/20070629a.htm.

Foreclosures: Responding to Consumers and Communities inCrisis through the Federal Reserve’s Home Mortgage Initiative

With continued deterioration of the sub-prime mortgage market and the overalleconomy, 2008 was marked by an increasein the rate of foreclosure throughout thecountry. As foreclosures mounted and pro-jections worsened throughout the year,nonprofit organizations, governments,lenders, and servicers mobilized to re-spond to the needs of borrowers and com-munities confronting defaulting mortgagesand foreclosures. The Federal ReserveSystem actively engaged in national andregional partnerships to help inform policyand practices around foreclosure preven-tion and neighborhood stabilization incommunities hard hit by foreclosures.

The Federal Reserve System has a sig-nificant presence throughout the countrythrough its 12 regional banks and theirbranch offices and the Board of Governorsin Washington, D.C. Each of these loca-tions offers important research, supervi-sion, and community development exper-tise and insights that help inform local andregional responses to economic conditions.As the mortgage market continued to dete-riorate in 2008, the System worked tocoordinate its resources through the Home-ownership and Mortgage Initiative (HMI),a comprehensive strategy to provide infor-mation and outreach to stem unnecessaryforeclosures, to stabilize communities, and

to prevent negative spillovers at the neigh-borhood level. The HMI coordinated theactivities of the various functional areas ofthe System, including research, publicaffairs, and community affairs, to improveaccess to data and information and todevelop policies relating to foreclosure.This strategy capitalized on the followingareas of expertise:

• outreach to strengthen existing collabo-rations with other regulators, commu-nity groups, policy organizations, finan-cial institutions, and public officials toidentify solutions to prevent unneces-sary foreclosures and their negativeeffects

• regulation to foster an environment thatsupports the homeownership goals ofcreditworthy borrowers with appropriateconsumer protection and responsiblelending practices

• research and analysis to provide com-munity groups, counseling agencies,regulators, financial institutions, andothers with detailed analysis to supportefforts to help troubled borrowers andcommunities

• financial education to help consumersmake informed personal financial deci-sions, including those about homeownership


ment, including payment shock, re-sponsibility for taxes and insurance,prepayment penalties, balloon pay-ments, and increased costs associatedwith stated-income or reduced-docu-mentation loans, and

• a chart, with numerical examples,that depicts in a concrete, readilyunderstandable manner the potentialpayment shock for a loan structuredwith a discounted interest rate good

for the first two years and then sub-ject to increase.

Supervisory Actions

The Board applied its supervisoryauthority in an effort to address theaggressive credit tightening that gavecause for concern in 2008 and to urgemortgage lenders to work with troubledmortgage borrowers. Joining with otherfinancial regulatory agencies, the Board

With respect to outreach, the FederalReserve provided community coalitions,counseling agencies, fellow regulators,financial institutions, and others with de-tailed analyses identifying neighborhoodsat high risk of foreclosures. By understand-ing those areas with high concentrations ofsubprime mortgages, delinquencies, andforeclosures, community leaders can bettertarget their scarce resources to borrowersin need of counseling and other interven-tions that may help forestall foreclosure.

To explore the impact of the foreclosurecrisis on different real estate markets, theFederal Reserve hosted a series of confer-ences entitled, “Recovery, Renewal, Re-building: A Federal Reserve ForeclosureSeries,” in five cities.1 These conferences,held in Atlanta, Los Angeles, Columbus(Ohio), St. Louis, and Washington, D.C.,looked at strategies to address the negativeimpact of foreclosures in high-cost mar-kets, as well as the difficulty of dealingwith foreclosures in neighborhoods inweak-market communities. The series alsohighlighted research on foreclosure andthe resulting problems of vacancy andabandonment. Through this series, confer-ence attendees worked to clarify the issuesand identify the strategies and best prac-tices for moving toward solutions by

1. See additional information on the conferences atstlouisfed.org/RRRseries/ and www.clevelandfed.org/Our_Region/Community_Development/Events/Seminars/2008/20080827/Overview_4Forums.pdf.

examining best practices, creative solu-tions, and innovative ways to prepare forthe future.

The Federal Reserve also forged a part-nership with NeighborWorks America, anational nonprofit organization, to addressissues related to neighborhood stabiliza-tion and, in particular, the disposition ofreal estate owned (REO) properties. Aspart of the collaboration, a website, www.stablecommunities.org, was developed toprovide a one-stop source of informationfor homeowners, community developmentorganizations, and local governments deal-ing with foreclosure-related vacant andabandoned properties.

In addition, the Community Affairsoffices at each of the 12 Reserve Bankslaunched online Foreclosure ResourceCenters that provide information forhomeowners, prospective homebuyers,and community groups to prevent foreclo-sures and lessen their negative influenceon neighborhoods. A Community Foreclo-sure Mitigation Toolkit was also devel-oped.2 The Board also developed infor-mation for consumers on how to protecttheir homes from foreclosure and up-dated other mortgage publications, includ-ing A Consumer’s Guide to MortgageSettlement Costs and What You ShouldKnow about Home Equity Lines of Credit.

2. See Foreclosure Resources at www.federalreserve.gov/consumerinfo/foreclosure.htm.


issued an interagency statement on bothtopics in November 2008.5

With respect to the credit tightening,the supervisory statement noted theagencies’ expectation that all bankingorganizations should fulfill their funda-mental role in the economy as interme-

diaries that provide credit to businesses,consumers, and other creditworthy bor-rowers. The statement emphasizes theessential nature of providing credit in amanner consistent with prudent lendingpractices and continuing to ensure thepursuit of new lending opportunities onthe basis of realistic asset valuationsand balanced assessments of borrowers’repayment capacities.

In light of the escalating rate of mort-gage foreclosures in 2008, the supervi-sory statement also articulated the agen-

5. See press release, “Interagency Statement onMeeting the Needs of Creditworthy Borrowers”(November 12, 2008), www.federalreserve.gov/newsevents/press/bcreg/20081112a.htm.

Staff also revised A Consumer’s Guide toMortgage Refinancings, providing a linkto a mortgage refinancing calculator.3 Forconsumers with questions about bankingprocedures and rules, or who feel theymay have been treated unfairly by theirbanks, the Federal Reserve ConsumerHelp Center feeds queries directly to thevarious regulatory agencies so that con-sumers have only one stop to make to askquestions or file complaints.4

In the regulatory realm, the FederalReserve issued new rules to improve con-sumer protections and disclosures relatingto loans secured by a borrower’s home(see the “Mortgage Credit” discussion ear-lier in this chapter).

To support needed research and analy-sis, the Federal Reserve System launchedseveral initiatives to provide studies, data,and other foreclosure-related resources tocommunities grappling with foreclosures.The System provided, on the website ofthe Federal Reserve Bank of New York,data concerning subprime lending patternsand performance.5 These dynamic mapsand data illustrate subprime and alt-Amortgage loan conditions that may assist

3. See “5 Tips for Protecting your Home from Fore-closure, www.federalreserve.gov/pubs/foreclosuretips/default.htm and www.federalreserve.gov/consumerinfo/mortgages.htm.”

4. See www.federalreserveconsumerhelp.gov.5. See “Dynamic Maps of Nonprime Mortgage

Conditions in the United States,” www.newyorkfed.org/mortgagemaps/.

community groups, policymakers, andlocal governments as they prioritize theuse of their resources for theseforeclosure-related efforts. In addition, aSystem workgroup, consisting of some ofthe Federal Reserve System’s top econo-mists and community development ex-perts, prepared overviews that summarizethe current state of knowledge about hous-ing and mortgage markets, as well asabout foreclosures. The System continuesto conduct research on a wide range oftopics to fill analytical gaps and betterunderstand the effects of foreclosure onneighborhoods, the economy, and thehousing and mortgage markets.

In the interest of supporting borrowers ex-periencing difficulty in meeting their mort-gage obligations, the Board has providedoutlets for mortgage-related consumerfinancial education materials. In addition,through the HMI, the Federal Reserve hasposted internal and external resources oneach of the System’s 13 websites to helpimprove staff and consumers’ access toinformation that can assist them as theywork to address challenges in the mortgagemarket.6 As the mortgage and foreclosureissues and their implications evolve, theFederal Reserve will continue to coordinateits resources and expertise to assist con-sumers and communities during the crisis.

6. See Resources for Consumers, www.federalreserve.gov/consumerinfo/foreclosure_consumers.htm.


cies’ expectation that financial insti-tutions work with existing borrowersto avoid preventable foreclosures, whichcan prove costly to both the institu-tions and to the communities they serve,and to help mitigate other potentialmortgage-related losses. The agencies’statement urges all lenders and servicersto adopt systematic, proactive, andstreamlined mortgage loan modificationprotocols and to review troubled loansusing these protocols. The goal of suchefforts is to help achieve modificationsthat result in mortgages that borrowerscan better manage.

Credit Cards

Credit cards are the most common con-sumer financial services credit product,and represent an important tool forfacilitating transactions for both con-sumers and businesses. Advances intechnology (such as credit scoring) andthe expansion of the financial servicesmarketplace have contributed to a sig-nificant increase in competition in thecredit card market over the last decade.During this time, lenders have em-ployed aggressive marketing and prod-uct development strategies and haveapplied billing practices to generatemore fee-based income. (Previously,lenders had relied almost solely oninterest from their customers’ accountbalances for revenue.) These industrydevelopments have elevated concernsabout consumer protection, the trans-parency of credit card pricing, and theadequacy of consumer disclosures incredit card marketing materials, con-tracts, and periodic statements.

With the significant presence andincreased consumer use of credit cardsin the marketplace, concerns about cer-tain practices have been the topic ofpublic discussion and debate. Inresponse, the Board issued proposed

amendments to Regulation Z (Truth inLending) in May 2007 that wereintended to increase consumer protec-tions and improve disclosures for creditcards.6 Throughout 2008, Board staffconducted consumer testing and col-lected input from consumer advocates,lenders, and policymakers to gain in-sight into the effect the proposed ruleswould have on consumers’ access tocredit and their understanding of infor-mation they need to make informeddecisions about the myriad credit cardoptions in the market (see the “Advicefrom the Consumer Advisory Council”discussion later in this chapter). Basedon this information, the Board issuedadditional proposed amendments toRegulation Z as well as proposedamendments to Regulation AA (Unfairor Deceptive Acts or Practices) in May2008.7 The public response to theseproposals was unprecedented, withBoard staff carefully considering infor-mation obtained through extensive con-sumer testing and review of more than60,000 comment letters received duringthe comment period.8

Final rules regarding credit cardswere issued in December 2008, with an

6. See press release (May 23, 2007),www.federalreserve.gov/newsevents/press/bcreg/20070523a.htm.

7. See press release (May 2, 2008),www.federalreserve.gov/newsevents/press/bcreg/20080502a.htm.

8. See Design and Testing of Effective Truth inLending Disclosures: Findings from QualitativeConsumer Testing Research, submitted to theFederal Reserve Board of Governors by MacroInternational, Inc. (December 15, 2008),www.federalreserve.gov/newsevents/press/bcreg/bcreg20081218a7.pdf, and Design and Testing ofEffective Truth in Lending Disclosures: Findingsfrom Experimental Study, submitted to the Fed-eral Reserve Board by Macro International, Inc.(December 15, 2008), www.federalreserve.gov/newsevents/press/bcreg/bcreg20081218a8.pdf.


effective date of July 1, 2010.9 Theserules were designed to address areas ofconcern by prohibiting certain unfairacts or practices and by improving thedisclosures consumers receive in con-nection with credit card accounts andother revolving credit plans.

The final rules prohibit certain creditcard practices that the Board foundmost concerning. At the Board meetingwhere the rules were approved, Chair-man Bernanke remarked, “The revisedrules represent the most comprehensiveand sweeping reforms ever adopted bythe Board for credit card accounts.These protections will allow consumersto access credit on terms that are fairand more easily understood.”10 Therules seek to promote the responsibleuse of credit cards through greatertransparency in credit card pricing,including the abolition of unfair prac-tices. Greater transparency will enhancecompetition in the marketplace andimprove consumers’ ability to findproducts that meet their needs. In addi-tion, reduced reliance on penalty rateincreases should spur industry efforts toimprove upfront underwriting.

The final rule amending RegulationAA prohibits specific unfair acts orpractices by banks in connection withcredit card accounts. Specifically, thefinal rule will

• protect consumers from unexpectedinterest charges, including increasesin the interest rate during the firstyear after account opening and in-creases in the rate charged on pre-existing credit card balances;

• forbid banks from imposing interestcharges using the “two-cycle” billingmethod;

• require that consumers receive a rea-sonable amount of time to make theircredit card payments;

• prohibit the use of payment alloca-tion methods that unfairly maximizeinterest charges; and

• address subprime credit cards by lim-iting the fees that reduce the amountof available credit.

The final rule amending Regulation Zimproves the effectiveness of the dis-closures consumers receive in connec-tion with credit card accounts and cer-tain other revolving credit plans. Theserevisions are designed to ensure thatinformation is provided to consumers ina timely manner and in a readily under-standable form. Specifically, the finalrule will

• increase the amount of advance no-tice consumers receive from 15 to45 days before an increased rate or anew contract term can be imposed (inorder to better allow consumers toobtain alternative financing or changetheir account usage);

• apply the advance notice requirementwhen the lender increases a rate dueto the consumer’s delinquency ordefault;

• prohibit advertisements that refer to arate as “fixed” unless the rate (1) willnot increase for any reason while theplan is open or a period is specifiedand (2) will not increase for any rea-son during that period; and

• require changes to the format, timing,and content requirements for credit

9. See press release (December 18, 2008),www.federalreserve.gov/newsevents/press/bcreg/20081218a.htm.

10. See statement by Chairman Ben S. Ber-nanke (December 18, 2008), www.federalreserve.gov/ newsevents/ press/ bcreg/bernanke20081218a.htm.


card applications and solicitationsand for the disclosures that consum-ers receive throughout the life of anopen-end account.

As Governor Randall Kroszner notedwhen the rules were approved, “Ourintent is to increase transparency andfairness in how credit card and depositaccounts operate, thereby enhancingcompetition and empowering consum-ers to better manage their accounts andavoid unnecessary costs. The rules rep-resent a significant step forward in con-sumer protection.”11

Overdraft Services

Overdraft services are sometimes of-fered by depository institutions as analternative to traditional ways of cover-ing transactions that overdraw a depositaccount (for example, overdraft lines ofcredit or linked accounts). Coverage isgenerally provided “automatically” toconsumers who meet a depository insti-tution’s criteria (for example, the ac-count has been open a certain numberof days or deposits are made regularly).If an overdraft is paid, the consumer ischarged a flat fee for each item. A dailyfee also may apply for each day theaccount remains overdrawn.

In the past, institutions generally pro-vided overdraft coverage only for checktransactions. In recent years, however,the service has been extended to coveroverdrafts resulting from other types oftransactions, including automated tellermachine (ATM) withdrawals and debitcard transactions at the point of sale.For debit card transactions in particular,the fee may far exceed the amount of

the transaction. Thus, concerns havebeen raised regarding the potentiallysubstantial costs associated with a ser-vice that consumers may not be awareof or did not request.

In December 2008, the Boardaddressed concerns regarding overdraftservices by adopting a final rule amend-ing Regulation DD (Truth in Savings)and a proposed rule amending Regula-tion E (Electronic Fund Transfers).12

The final rule amending Regulation DD(effective January 1, 2010) addressesdepository institutions’ disclosure prac-tices related to overdrafts. This rule isintended to ensure that consumers re-ceive accurate information regardingthe available funds in their depositaccounts so that they can make in-formed decisions about the costs ofengaging in transactions that overdrawthose accounts. Specifically, the finalrule will

• require all institutions to disclose onperiodic statements the aggregatedollar amounts charged for overdraftfees and for returned-item fees (forthe statement period and the year-to-date); and

• require institutions that provide ac-count balance information through anautomated system to provide a bal-ance that does not include additionalfunds that may be made available tocover overdrafts.

In addition, the proposed rule amend-ing Regulation E would, if adopted,provide consumers with certain protec-tions relating to the assessment of over-draft fees. The proposed rule would

• generally prohibit institutions fromimposing an overdraft fee when the

11. See statement by Governor RandallS. Kroszner (December 18, 2008),www.federalreserve.gov/newsevents/press/bcreg/kroszner20081218a.htm.

12. See press release (December 18, 2008),www.federalreserve.gov/newsevents/press/bcreg/20081218a.htm.


account is overdrawn because of ahold placed on funds in the consum-er’s account that exceeds the actualtransaction amount; and

• provide consumers with a choiceregarding their institutions’ overdraftcoverage for ATM and one-time debitcard transactions, but solicits com-ment on two different approaches:

— under one approach, an institutionwould be prohibited from impos-ing an overdraft fee unless (1) theconsumer is given an initial no-tice and a reasonable opportunityto opt out of the institution’soverdraft service and (2) the con-sumer does not opt out; or

— under an alternative approach, aninstitution would be prohibitedfrom imposing an overdraft feefor paying such overdrafts unlessthe consumer affirmatively con-sents (or opts in) to the institu-tion’s overdraft service.

Other Regulatory Actions:Proposed Rules on Risk-BasedPricing Notices

Consumer reports are a primary toolused by creditors to evaluate consumercreditworthiness and establish appropri-ate credit terms, including pricing,based on the risk level a loan applicantrepresents. Risk-based pricing refers tothe practice of using consumer reports(which reflect a consumer’s risk of non-payment) in setting or adjusting theprice and other terms of credit offeredor extended to an individual. Manycreditors offer more favorable terms toconsumers with better credit histories.In recent years, concerns have beenraised that consumers may not be pro-vided with adequate information re-garding risk-based pricing and the role

that negative information in consumerreports can play in determining the costof credit.

To help address this issue, Congressenacted the Fair and Accurate CreditTransactions Act (FACT Act), whichdirected the Federal Reserve Board andthe Federal Trade Commission (FTC) toissue joint regulations requiring credi-tors to provide consumers with risk-based pricing notices when, based inwhole or in part on information in con-sumer reports, a creditor offers or pro-vides credit to a consumer on terms lessfavorable than it offers or provides toother consumers.13

The Board and the FTC issued pro-posed regulations in May 2008.14 Theproposed regulations would apply, withcertain exceptions, to all creditors thatengage in risk-based pricing. Underthese regulations, a risk-based pricingnotice would generally be provided tothe consumer after the terms of credithave been set, but before the consumerbecomes contractually obligated withregard to the credit transaction. Theproposed regulations reflect the agen-cies’ judgments as to the best ap-proaches identified through extensiveoutreach efforts to consumer groups,financial institutions, mortgage bankers,and consumer reporting agencies. Basedon this outreach, the proposal providescreditors with a number of acceptableapproaches to use in identifying con-sumers to whom they must providerisk-based pricing notices. The notices

13. In general, the FACT Act amended the FairCredit Reporting Act (FCRA) to enhance the abil-ity of consumers to combat identity theft, increasethe accuracy of consumer reports, and allow con-sumers to exercise greater control regarding thetype and amount of solicitations they receive.

14. See press release, “Agencies Issue Pro-posed Rules on Risk-Based Pricing Notices”(May 8, 2008), www.federalreserve.gov/newsevents/press/bcreg/20080508a.htm.


serve to alert consumers to the exist-ence of negative information on theirconsumer reports so that they maycheck their reports for accuracy andcorrect any inaccurate information.

In addition, the proposed regulationsinclude certain exceptions to the noticerequirement. The most significant of theexceptions permits creditors, in lieu ofproviding a risk-based pricing notice tothose consumers who receive less fav-orable terms, to provide all of their con-sumers with their credit scores and ex-planatory information about their scores.The proposed regulations include modelnotices to facilitate compliance.

Other Supervisory ActivitiesRelated to Compliance withConsumer Protection andCommunity Reinvestment Laws

DCCA supports and oversees the super-visory efforts of the Federal ReserveBanks to ensure that consumer protec-tion laws and regulations are fully andfairly enforced. Division staff membersprovide guidance and expertise to theReserve Banks on consumer protectionregulations, examination and enforce-ment techniques, examiner training, andemerging issues. Routinely, staff mem-bers develop and update examinationpolicies, procedures, and guidelines;review Reserve Bank supervisory re-ports and work products; and participatein interagency activities that promoteuniformity in examination principlesand standards.

Examinations are the Federal Re-serve System’s primary means for en-forcing compliance with consumerprotection laws. During the 2008 re-porting period,15 Reserve Banks con-ducted 268 consumer compliance ex-

aminations: 263 of state member banksand five of foreign banking organ-izations.16

Fair Lending

The Federal Reserve is committed toensuring that the institutions it super-vises comply fully with the federal fairlending laws—the Equal Credit Oppor-tunity Act (ECOA) and the Fair Hous-ing Act. The Federal Reserve enforcesECOA and the provisions of the FairHousing Act that apply to its supervisedlending institutions. The Federal Re-serve conducts fair lending reviewsregularly within the supervisory cycle.Additionally, examiners may conductfair lending reviews outside of the usualsupervisory cycle, if warranted by fairlending risk. When examiners find evi-dence of potential discrimination, theywork closely with the division’s FairLending Enforcement Section, whichbrings additional legal and statisticalexpertise to the examination and en-sures that fair lending laws are enforcedrigorously and consistently throughoutthe Federal Reserve System.

ECOA prohibits creditors from dis-criminating against any applicant, inany aspect of a credit transaction, on thebasis of race, color, religion, nationalorigin, sex, marital status, or age. Inaddition, creditors may not discriminateagainst an applicant because the appli-cant receives income from a publicassistance program or has exercised, in

15. The 2008 reporting period for examinationdata was July 1, 2007, through June 30, 2008.

16. The foreign banking organizations exam-ined by the Federal Reserve are organizations thatoperate under section 25 or 25A of the FederalReserve Act (Edge Act and agreement corpora-tions) and state-chartered commercial lendingcompanies owned or controlled by foreign banks.These institutions are not subject to the Commu-nity Reinvestment Act and typically engage inrelatively few activities covered by consumerprotection laws.


good faith, any right under the Con-sumer Credit Protection Act. The FairHousing Act prohibits discrimination inresidential real estate-related transac-tions, including the making and pur-chasing of mortgage loans, on the basisof race, color, religion, national origin,handicap, familial status, or sex.

Pursuant to ECOA, if the Board hasreason to believe that a creditor hasengaged in a pattern or practice of dis-crimination in violation of ECOA, thematter will be referred to the Depart-ment of Justice (DOJ). The DOJ re-views the referral and decides if furtherinvestigation is warranted. A DOJ in-vestigation may result in a public civilenforcement action or settlement. TheDOJ may decide instead to returnthe matter to the Federal Reserve foradministrative enforcement. When amatter is returned to the Federal Re-serve, staff ensures that the institu-tion takes all appropriate correctiveaction.

During 2008, the Board referred thefollowing three matters to the DOJ:

• One referral involved an institution’spolicy of automatically discountingchild support income, in violation ofRegulation B, ECOA’s implementingregulation. As this policy primarilyaffected female applicants, the policyalso constituted discrimination on thebasis of gender in violation of Regu-lation B and ECOA.

• Two referrals involved improperspousal guarantees. One referral in-volved a bank’s policy and practiceof obtaining spousal signatures on allautomobile loans secured by jointlyheld collateral, in violation of Regu-lation B. In another matter, an institu-tion obtained spousal guarantees forall of its agricultural and commercialloans, in violation of Regulation B.

If a fair lending violation does notconstitute a pattern or practice, the Fed-eral Reserve takes action to ensure thatit is remedied by the bank. Most lendersreadily agree to correct fair lending vio-lations. In fact, lenders often take cor-rective steps as soon as they becomeaware of a problem. Thus, the FederalReserve generally uses informal super-visory tools (such as memoranda ofunderstanding between the bank’sboard of directors and the ReserveBank) or board resolutions to ensurethat violations are corrected. If neces-sary to protect consumers, however, theBoard can and does bring publicenforcement actions.

Evaluating Pricing Discrimination Riskwith HMDA Data and OtherInformation

When Home Mortgage Disclosure Act(HMDA) pricing data first becameavailable in 2005, Board staff de-veloped—and presently continues torefine—HMDA screens that identifyinstitutions warranting further reviewbased on an analysis of HMDA pricingdata. Because HMDA data lack manyfactors that lenders routinely use tomake credit decisions and set loanprices, such as information about a bor-rower’s creditworthiness and loan-to-value ratios, HMDA data alone cannotbe used to determine whether a lenderdiscriminates. Thus, the Federal Re-serve staff analyzes HMDA data in con-junction with other available supervi-sory information to evaluate a lender’srisk for engaging in discrimination.

For the 2007 HMDA pricing data—the most recent year for which the dataare publicly available—Federal Reserveexaminers performed a pricing dis-crimination risk assessment for eachinstitution that was identified throughthe HMDA screening process. These


risk assessments considered not just theinstitution’s HMDA data, but also thestrength of the institution’s fair lendingcompliance program; past supervisoryexperience with the institution; con-sumer complaints against the institu-tion; and the presence of fair lendingrisk factors, such as discretionary pric-ing. On the basis of these comprehen-sive assessments, Federal Reserve staffdetermined which institutions wouldreceive a targeted pricing review. De-pending on the examination schedule,the targeted pricing review could occuras part of the institution’s next exami-nation or outside the usual supervisorycycle.

Even if an institution is not identifiedthrough HMDA screening, examinersmay still conclude that it is at risk forengaging in pricing discrimination andmay elect to perform a pricing review.The Federal Reserve supervises manyinstitutions that are not required toreport data under HMDA. Also, manyof the HMDA-reporting institutionssupervised by the Federal Reserveoriginate few higher-priced loans and,therefore, report very little pricing data.For these institutions, examiners ana-lyze other available information toassess pricing-discrimination risk and,when appropriate, perform a pricingreview.

During a targeted pricing review,staff analyze additional information,including potential pricing factors notavailable in the HMDA data, to deter-mine whether any pricing disparity byrace or ethnicity is fully attributable tolegitimate factors, or whether any por-tion of the pricing disparity may beattributable to illegal discrimination. Toperform these reviews, staff use analyti-cal techniques that account for theincreasing complexity of the mortgagemarket. Two industry changes inparticular—the proliferation of product

offerings and the increased use of risk-based pricing—have increased the com-plexity of fair lending reviews. Toeffectively detect discrimination bylenders offering an expanding range ofproducts and credit-risk categories, theFederal Reserve increasingly uses sta-tistical techniques. When performing apricing review, staff typically obtainextensive proprietary loan-level data onall mortgage loans originated by thelender, including prime loans (that is,not just the higher-priced loans reportedunder HMDA). To determine how toanalyze these data, the Federal Reservestudies the lender’s specific businessmodel, its pricing policies, and its prod-uct offerings. On the basis of the reviewof the lender’s policies, staff determinewhich factors from the lender’s datashould be considered. A statisticalmodel is then developed that takesthose factors into account and is thentailored to that specific lender. Typi-cally, a test for discrimination in par-ticular geographic markets, such asmetropolitan statistical areas (MSAs), isperformed. Analyzing specific marketsis important, as relatively small un-explained pricing disparities at thenational level can mask much largerdisparities in individual markets.

Monitoring EmergingFair Lending Issues

During this period of financial turbu-lence in credit markets, many institu-tions have been reevaluating and tight-ening credit standards. Some consumeradvocates have voiced concern that cer-tain policies implemented by lenders totighten credit standards may fall dispro-portionately on minorities. For exam-ple, some lenders have implementedtighter credit standards in specific geo-graphic markets.


The Federal Reserve evaluates lend-ers’ policies to ensure that lenders com-ply with the federal fair lending laws asthey adjust their lending practices. Itconducts reviews to evaluate whetherlender policies may violate the fairlending laws by having an illegal dispar-ate impact on minorities, and to identifysteering, redlining, reverse redlining,and other fair lending violations.

Reporting on HMDA Data

HMDA, enacted by Congress in 1975,requires most mortgage lenders locatedin metropolitan areas to collect dataabout their housing-related lendingactivity, report the data annually to thefederal government, and make the datapublicly available. In 1989, Congressexpanded the data required by HMDAto include information about loan appli-cations that did not result in a loanorigination, as well as informationabout the race, sex, and income ofapplicants and borrowers.

In response to the growth ofthe subprime loan market, the Fed-eral Reserve updated Regulation C(HMDA’s implementing regulation) in2002. The revisions, which becameeffective in 2004, require lenders to col-lect price information for loans theyoriginated in the higher-priced loan seg-ment of the home mortgage market.When applicable, lenders report thenumber of percentage points by which aloan’s annual percentage rate exceedsthe threshold that defines “higher-priced loans.” The threshold is 3 per-centage points or more above the yieldon comparable Treasury securities forfirst-lien loans, and 5 percentage pointsor more above that yield for junior-lienloans. The HMDA data, collected in2004 and released to the public in 2005,provided the first publicly availableloan-level data about loan prices. The

Federal Financial Institutions Examina-tion Council (FFIEC) released the 2007HMDA data to the public in September2008.

Analysis of the HMDA data for 2004through 2007 found that the approachused to identify higher-priced loanscould be improved in a way that couldmake the identification of higher-pricedloans less sensitive to changes in theterm-structure of interest rates and moreconsistent with the way mortgage pricesare established. Consequently, Regula-tion C was modified in 2008 (effectivefor loan applications taken as of Octo-ber 1, 2009) to define higher-pricedloans as closed-end mortgages wherethe spread between the loan’s APR anda survey-based estimate of rates cur-rently offered on prime mortgage loansof a comparable type meets or exceeds1.5 percentage points for a first-lienloan (or 3.5 percentage points for asubordinate-lien loan). The revised defi-nition of higher-priced loans underRegulation C is the same as the defini-tion of “higher-priced mortgage loan”adopted by the Federal Reserve Boardunder Regulation Z (Truth in Lending)in July 2008, when it modified thisregulation to address unfair and decep-tive practices in the closed-end segmentof the mortgage market.

An article published in December2008 by Federal Reserve staff in theFederal Reserve Bulletin uses the 2007HMDA data to describe the market forhigher-priced loans and patterns oflending across loan products, geo-graphic markets, and borrowers andneighborhoods of different races andincomes.17 The article focuses attention

17. Robert B. Avery, Kenneth P. Brevoort, andGlenn B. Canner, “The 2007 HMDA Data,” Fed-eral Reserve Bulletin vol. 94 (December 2008)www.federalreserve.gov/pubs/bulletin/2008/pdf/hmda07final.pdf.


on the effects of the mortgage marketturmoil on the 2007 HMDA data,including a detailed assessment of theeffects on the data of the unusuallylarge number of institutions that discon-tinued operations in 2008.

As with the 2004−2006 HMDA data,the 2007 HMDA data show that mostreporting institutions originated few ifany higher-priced loans in 2007: 56 per-cent of the lenders originated less than10 higher-priced loans that year, and 33percent originated no higher-pricedloans. The data also indicate that rela-tively few lenders accounted for mostof the higher-priced loan originations in2007. Of the 8,610 mortgage lendersreporting HMDA data, 987 made 100 ormore higher-priced loans. The 10 mort-gage lenders with the largest volume ofhigher-priced loans accounted for about31 percent of all such loans in 2007.

As in earlier years, the HMDA datashow that the majority of all loan origi-nations were not higher priced; in fact,owing in large part to the mortgagemarket turmoil in 2007, the incidenceof higher-priced lending fell from 28.7percent in 2006 to 18.3 percent in 2007.Some of the decrease reflects the factthat (1) 169 lenders reporting HMDAdata for 2006 data closed operations in2007 and (2) although these lendersextended higher-priced loans in 2007,they did not report this lending activity.The effect of these 169 institutions onthe 2007 data is explored in-depth inthe Federal Reserve Bulletin article.The analysis shows that these lenderswere heavily involved in the higher-priced segment of the mortgage market,but they did not account for most of thedecline in the share of loans that werehigher-priced. The 169 lenders thatclosed operations also tended to extendlarger loans than did other lenders, andthese lenders were more likely to lendin the western region of the United

States and in U.S. metropolitan areasthat experienced greater recent declinesin home values and greater increases inmortgage delinquencies.

Loan pricing is a complex processthat may reflect a wide variety of fac-tors about the level of risk a particularloan or borrower presents to the lender.As a result, the prevalence of higher-priced lending varies widely.

First, the incidence of higher-pricedlending varies by product type. Forexample, manufactured-home loansshow the greatest incidence of higher-priced lending (more than half of theseloans are higher priced), because theseloans are considered higher risk. Inaddition, first-lien mortgages are gener-ally less risky than comparable junior-lien loans: 14.0 percent of first-lienconventional home purchase loans werereported as higher-priced in 2007, com-pared with 21.6 percent of comparablejunior-lien loans.

Second, higher-priced lending varieswidely by U.S. geographic region, re-flecting among other things differencesin regional housing and economic con-ditions and differences in the credit-riskprofiles of borrowers by region. As in2004, 2005, and 2006, many of the met-ropolitan areas reporting the greatestincidence of higher-priced lending in2007 were in the southern region of thecountry, including a number of areas inTexas. Several West Coast metropolitanareas also reported elevated incidencesof higher-priced lending in 2007. Over-all, in many metropolitan areas in theSouth, Southwest, and West, 25 percentto 40 percent of the homebuyers whoobtained conventional loans in 2007received higher-priced loans.

Third, the incidence of higher-pricedlending varies greatly among borrowersof different races and ethnicities. In2007—as in 2004, 2005, and 2006—


African-Americans and Hispanics weremuch more likely than non-Hispanicwhites and Asians to receive higher-priced loans. For example, in the sec-ond half of 2007, 29.5 percent ofAfrican-American borrowers and 24.3percent of Hispanic borrowers receivedhigher-priced, first-lien conventionalhome purchase loans, compared with9.2 percent of non-Hispanic white and5.6 percent of Asian borrowers.18

Because HMDA data lack informationabout credit risk and other legitimatepricing factors, it is not possible todetermine from HMDA data alonewhether the observed pricing disparitiesand market segmentation reflect dis-crimination. When analyzed in conjunc-tion with other fair lending risk factorsand supervisory information, however,the HMDA data can facilitate fair lend-ing supervision and enforcement (seethe “Fair Lending” discussion earlier inthis chapter).

Examinations and ActivitiesRelated to the CommunityReinvestment Act

The Community Reinvestment Act(CRA) requires that the Federal Reserveand other banking agencies encouragefinancial institutions to help meet thecredit needs of the local communities inwhich they do business, consistent withsafe and sound operations. To carry outthis mandate, the Federal Reserve

• examines state member banks toassess their compliance with CRA,19

• analyzes applications for mergers andacquisitions by state member banksand bank holding companies in rela-tion to performance under CRA, and

• disseminates information on commu-nity development techniques to bank-ers and the public through commu-nity affairs offices at the ReserveBanks.

The Federal Reserve assesses andrates the performance of state memberbanks under CRA in the course ofexaminations conducted by staff at the12 Reserve Banks. During the 2008reporting period, the Reserve Banksconducted 243 CRA examinations: 35of the banks were rated Outstanding,204 were rated Satisfactory, 4 wererated Needs to Improve, and none wasrated Substantial Noncompliance.20

Annual Release of CRA Distressed orUnderserved List

In May 2008, the Federal Reserve andother federal bank and thrift regulatoryagencies21 released the 2008 list of“distressed” or “underserved” nonmet-ropolitan, middle-income geographieswhere bank revitalization or stabiliza-tion activities will receive considerationas “community development” underCRA. “Distressed” or “underserved”geographies are designated by the agen-cies in accordance with their CRA regu-lations. In accordance with 2005 CRAregulatory changes, the agencies annu-ally designate “distressed” and “under-served” geographies, and post the list

18. Because the 169 lenders that discontinuedoperations in 2008 extended an unknown quantityof loans in the first part of 2007 but were all outof business by the second half of 2007, focusingon data for the second half of 2007 provides themost reliable assessment of lending patterns.

19. See testimony by Sandra F. Braunstein,director, Division of Consumer and CommunityAffairs (February 13, 2008), www.federalreserve.

gov/newsevents/testimony/braunstein20080213a.htm.

20. The 2008 reporting period for examinationdata was July 1, 2007, through June 30, 2008.

21. Board of Governors of the Federal ReserveSystem, Federal Deposit Insurance Corporation,Office of the Comptroller of the Currency, andOffice of Thrift Supervision.


of these geographies on the FFIECwebsite.

Supervisory Practices regardingBanking Organizations Affected byHurricanes

In September 2008, the Federal Reservereleased a joint supervision and regula-tion (SR) and consumer affairs (CA)letter reaffirming a longstanding policyto use available regulatory flexibility tofacilitate the recovery efforts of bankingorganizations affected by hurricanes.Banking organizations supervised bythe Federal Reserve were encouraged towork with Reserve Bank supervisoryand operations staff to resolve anyoperational issues resulting from Hurri-cane Gustav or any subsequent storms.The letter encouraged banking organi-zations to work with borrowers andother customers in affected areas, andrecognized that banking organizationsmay have to take prudent steps tomodify, extend, or restructure existingloans in areas affected by 2008 hurri-canes.

A separate CA letter, issued in Octo-ber 2008, extended for an additional 36months the period for examiners to rec-ognize community development activi-ties related to revitalization or stabiliza-tion activities in the Gulf Coast areasaffected by Hurricanes Rita and Kat-rina. The extension was based on thecontinued need for long-term recoveryefforts in those communities affected bythese hurricanes.

Analysis of Applications for Mergersand Acquisitions in relation to CRA

Throughout 2008, the Board consideredapplications for several significantbanking mergers. In June, the Boardapproved the application by Bank ofAmerica Corporation, Charlotte, NorthCarolina, one of the nation’s largest

depository institutions, to acquire Coun-trywide Financial Corporation, Calaba-sas, California. Public meetings wereheld in Chicago, Illinois, and Los Ange-les, California, to allow interested per-sons the opportunity to present oral tes-timony on the factors the Board mustreview under the Bank Holding Com-pany Act.

Several other significant applicationswere

• an application by PNC Financial Ser-vices Group, Inc., Pittsburgh, Penn-sylvania, to acquire Sterling Fi-nancial Corporation, Lancaster,Pennsylvania, which was approved inJanuary;

• an application by Toronto-DominionBank, Toronto, Canada, to acquireCommerce Bancorp, Inc., CherryHill, New Jersey, which was ap-proved in March;

• an application by Fifth Third Ban-corp, Cincinnati, Ohio, to acquireFirst Charter Corporation, Charlotte,North Carolina, which was approvedin April;

• an application by Wells Fargo &Company, San Francisco, California,to acquire Wachovia Corporation,Charlotte, North Carolina, which wasapproved in October;

• an application by Bank of AmericaCorporation to acquire Merrill Lynch& Co., New York, New York, and itssubsidiaries, Merrill Lynch Bank &Trust Co., FSB, New York, NewYork, and Merrill Lynch Bank USA,Salt Lake City, Utah, and MerrillLynch Yatirim Bank A.S., Istanbul,Turkey, which was approved inNovember; and

• an application by PNC Financial Ser-vices Group, Inc., Pittsburgh, Penn-


sylvania, to acquire National CityCorporation, Cincinnati, Ohio, whichwas approved in December.

The public submitted comments re-lated to concerns about consumer com-pliance or CRA issues on nine ap-plications. Many of the commentersreferenced pricing information on resi-dential mortgage loans and concernsthat minority applicants were morelikely than nonminority applicants toreceive higher-priced mortgages. Theseconcerns were largely based on obser-vations of lenders’ 2006 and 2007HMDA pricing data. Other issues raisedby commenters included incidentswhere minority applicants were alleg-edly denied mortgage loans more fre-quently than nonminority applicants,where potentially predatory lending waspracticed by subprime and payday lend-ers, where branch closings createdpotentially adverse effects, and wherelenders allegedly failed to effect-ively address the needs of low- and mod-erate-income communities. In addition,the Board also received commentsabout the adverse effects of increasedforeclosures, especially in low- andmoderate-income communities.

The Board considered an additional59 expansionary applications by bankholding companies or state memberbanks with outstanding issues involvingcompliance with consumer protectionstatutes and regulations, including sev-eral related to CRA or fair lending laws.Of those applications, 55 were ap-proved, three were withdrawn (includ-ing one with an adverse CRA rating),and one was returned due to an adverseconsumer compliance rating.

The Board also considered several-nontraditional bank holding companyapplications from commercial entitieswith banking affiliates, including GMAC,LLC, in Detroit, Michigan, and CIT

Group, Inc., in New York, New York.These entities were required to becomebank holding companies in order to par-ticipate in the TARP program adminis-tered by the Department of the Trea-sury. CRA and consumer complianceperformance records of those bankingaffiliates were factors considered by theBoard in approving the applications.

Bank Examiner Trainingand Guidance

Ensuring that financial institutions com-ply with the laws that protect consum-ers and encourage community reinvest-ment is an important part of the FederalReserve’s bank examination and super-vision process. As the number andcomplexity of consumer financial trans-actions have grown, training for ex-aminers of the organizations under theFederal Reserve’s supervisory responsi-bility has become even more crucial.The Board’s consumer complianceexaminer training curriculum consistsof six courses, focused on various con-sumer protection laws, regulations, andexamination concepts. In 2008, thesecourses were offered in 12 sessionswhere nearly 200 consumer complianceexaminers and System staff membersparticipated.

Board and Reserve Bank staff regu-larly review the core curriculum forexaminer training, updating subjectmatter and adding new elements asappropriate. During 2008, staff con-ducted a curriculum review of the Con-sumer Compliance Examinations II(CA II) course in order to incorporaterecent technical changes in policy andlaws, along with changes in instruc-tional delivery techniques. This course,renamed Real Estate Lending Exam-ination Techniques, enables assistantexaminers to focus on the fundamentalskills necessary to determine a


bank’s compliance with consumer lawsand regulations as they apply to realestate products. Examiners also learnabout the Federal Reserve System poli-cies and regulatory requirements associ-ated with the residential real estatelending examination, including annualpercentage rate calculations. In addi-tion, Board and Reserve Bank staff con-ducted an interim curriculum review ofthe Consumer Affairs Risk-focusedExamination Techniques course toupdate and realign technical contentwith the risk-focused examinationprocedures.

The consumer compliance examinertraining curriculum was included in theSystem’s content mapping initiative.These content maps provide stake-holders—staff development expertsthroughout the Federal Reserve—a“bird’s eye view” of individual instruc-tional learning objectives and topics forall of the courses included in the Fed-eral Reserve’s examiner commissioningprogram. The goal of the mapping ini-tiative is to facilitate modularization ofcourse content for “just-in-time train-ing” and periodic sourcing of coursecontent for core proficiency exam-inations.

When appropriate, courses are deliv-ered by methods alternative to class-room training, such as via the Internetor other distance-learning technologies.Several courses use a combination ofinstructional methods: (1) classroominstruction focused on case studies, and(2) specially developed computer-basedinstruction that includes interactive self-check exercises.

In addition to providing core training,the examiner curriculum emphasizesthe importance of continuing profes-sional development. In 2008, the Sys-tem initiated a powerful training deliv-ery method, entitled Rapid Response, tobetter meet this need. In contrast to a

much longer and more traditional train-ing development and delivery model,technical and instructional content ontime-sensitive or emerging topics arebeing designed, developed, and pre-sented to System staff within days orweeks of any perceived need.

Statement to Financial InstitutionsServicing Residential Mortgages onReporting Loss Mitigation ofSubprime Mortgages

In March 2008, DCCA and the Divisionof Banking Supervision and Regulationjointly released a statement that encour-ages financial institutions that servicesubprime mortgage loans to report theirloss-mitigation activities consistent withuniform standards.22 The statementencourages financial institutions to con-sider utilizing loan modification report-ing standards provided by the HOPENOW alliance, and emphasizes thatstandard reporting will help investors insecuritized mortgages, including finan-cial institutions, monitor foreclosureprevention efforts.23 It also notes thatconsistent loan modification reportingwill foster transparency in the securiti-zation market and provide standardizeddata across the mortgage industry. Thelatest statement follows previous state-ments, issued by the Federal Reserveand the other federal banking agencies,that encourage financial institutions to

22. For purposes of this statement, the term“financial institutions” refers to state-charteredbanks and their subsidiaries and bank holdingcompanies and their nonbank subsidiaries.

23. HOPE NOW is an alliance between mort-gage counselors, market participants, and servic-ers to create a unified, coordinated plan to reachand help as many homeowners in distress as pos-sible. The Department of the Treasury and theDepartment of Housing and Urban Developmentencouraged the formation of this alliance. Formore information, visit www.hopenow.com.


work constructively with residentialborrowers who are financially unable tomake contractual payment obligationson their home loans.24

Interagency Examination Proceduresfor the Department of Defense’s FinalRule on Limitations on ConsumerCredit Extended to Service Membersand Dependents (Talent Amendment)

In July 2008, DCCA issued interagencyexamination procedures associated withestablishing compliance with a Depart-ment of Defense (DoD) rule limitingthe extension of consumer credit to ser-vice members and their dependents(the Talent Amendment). The examina-tion procedures are intended to helpdetermine a service provider’s compli-ance with regulations issued by theDoD regarding limitations on theamount of consumer credit that may beextended to service members and de-pendents for payday loans, motor vehi-cle title loans, and tax refund anticipa-tion loans. The rule applies to allpersons engaged in the business ofextending such credit and their assign-ees, and limits the amount that a credi-tor can charge service members andtheir dependents in connection withthese transactions. Total charges mustbe expressed as a total dollar amountand as an annualized rate referred to asthe “Military Annual Percentage Rate”or “MAPR,” and which may not exceed36 percent.

Interagency Examinations ConcerningAffiliate Marketing Standards

In August 2008, DCCA issued inter-agency examination procedures associ-ated with establishing compliance witha regulation implementing Section 624of the Fair Credit Reporting Act(FCRA), as amended by the FACT Act.This “affiliate marketing regulation”generally prohibits a financial institu-tion from using certain informationreceived from an affiliate to make asolicitation to a consumer unless theconsumer is given notice and a reason-able opportunity to opt out of suchsolicitations, and the consumer does notopt out. The final rule applies to infor-mation obtained from the consumer’stransactions or account relationshipswith an institution’s affiliate, from anyapplication the consumer submittedto an affiliate, and from third-partysources, such as credit reports, if theinformation will be used to send mar-keting solicitations.

Interagency Examinations concerningIdentity-Theft Red Flags and OtherRegulations under the Fair CreditReporting Act

In October 2008, DCCA and theBoard’s Division of Banking Supervi-sion and Regulation jointly releasedinteragency25 examination proceduresassociated with establishing compliancewith regulations implementing severalsections of the FCRA, as amended bythe FACT Act. The procedures estab-

24. See SR 07-16/CA 07-4, Statement on LossMitigation Strategies for Servicers of ResidentialMortgages (September 4, 2007), www.federalreserve.gov/newsevents/press/bcreg/20070904a.htm, and SR 07-6/CA 07-1, Workingwith Mortgage Borrowers (April 17, 2007),www.federalreserve.gov/boarddocs/srletters/2007/SR0706.htm.

25. The Board of Governors of the FederalReserve System, the Conference of State BankSupervisors, the Federal Deposit Insurance Cor-poration, the National Credit Union Administra-tion, the Office of the Comptroller of the Cur-rency, and the Office of Thrift Supervision.


lished the agencies’ expectations forfinancial institutions and examinationstaff with respect to the final rules andguidelines regarding identity-theft redflags as well as for other regulationsunder FCRA. The regulatory provisionsfocused on the duties of users of con-sumer reports regarding address dis-crepancies; the duties of financial in-stitutions and creditors in detecting,preventing, and mitigating identitytheft; the duties of card issuers regard-ing changes of address; and the dutiesof financial institutions regarding affili-ate marketing practices.

A new identity-theft red-flags rulerequires a financial institution to peri-odically determine whether it offers ormaintains consumer accounts suscep-tible to identity theft. For accounts cov-ered under the new rule, an institutionmust develop and implement a writtenidentity-theft prevention program thatdetects, prevents, and mitigates identitytheft involving new or existing coveredaccounts. The program must be appro-priate to the size and complexity of thefinancial institution and the nature andscope of its activities. A new card-issuer rule requires credit and debit cardissuers to develop reasonable policiesand procedures to assess the validity ofrequests for changes of address fol-lowed closely by requests for additionalor replacement cards. In such situations,the card issuer must not issue an addi-tional or replacement card until itassesses the validity of the change ofaddress in accordance with its policiesand procedures.

Examinations ConcerningTruth in Savings Disclosures

In July 2008, DCCA issued updatedinteragency examination proceduresassociated with establishing compliancewith Regulation DD (Truth in Savings).

The updated procedures incorporaterecommendations made by the Govern-ment Accountability Office (GAO) in areport issued in March 2008 entitledBank Fees: Federal Banking Regula-tors Could Better Ensure That Consum-ers Have Required Disclosure Docu-ments Prior to Opening Checking orSavings Accounts (GAO-08-281). Thestudy suggests that, despite regulatorydisclosure requirements, consumersmay find it difficult to obtain informa-tion about checking and savings ac-count fees. As a result of the study, theGAO recommended that federal bank-ing regulators assess the extent to whichcustomers receive disclosures on fees,terms, and conditions prior to openingan account. It also recommended thatthe agencies incorporate appropriatesteps into their oversight programs toensure that disclosures continue to bemade available.

The Board’s updated Regulation DDexamination procedures emphasize theexisting requirement to provide fullaccount disclosure (e.g., fees, terms,and conditions) to a consumer, uponrequest, whether or not the consumer isan existing or a prospective customer.The revisions also highlight that the dis-closures should be provided at the timeof the request if the consumer makesthe request in person, or within 10 daysif the consumer is not present whenmaking the request. The revisions to theprocedures also remind examiners thatinstitutions must maintain evidence ofcompliance with Regulation DD, in-cluding the requirement to provide con-sumer disclosures upon request.

Interagency Examinations ConcerningElectronic Fund Transfers

In August 2008, DCCA issued ap-proved interagency examination pro-cedures associated with establishing


compliance with Regulation E (Elec-tronic Fund Transfers). The updatedprocedures incorporate all amendmentsto Regulation E (and the FederalReserve’s Official Staff Commentary)since a prior version was released in1998. Among other changes, the proce-dures clarify the responsibilities ofparties involved in electronic checkconversion transactions, include a re-quirement that consumers receive writ-ten notification in advance of thesetransactions, and revise the OfficialStaff Commentary to provide guidanceon preauthorized transfers from con-sumers’ accounts, error resolution,and disclosures at automated tellermachines.

Interagency Statement on Lending toCreditworthy Borrowers

In November 2008, the agencies issuedan Interagency Statement on Meetingthe Needs of Creditworthy Borrowers.In implementing this statement, institu-tions were encouraged to lend prudentlyand responsibly to creditworthy bor-rowers, work with borrowers to pre-serve homeownership and avoid pre-ventable foreclosures, adjust dividendpolicies to preserve capital and lendingcapacity, and employ compensationstructures that encourage prudent lend-ing. The statement emphasized that theagencies expect banking organizationsto work with existing borrowers toavoid preventable foreclosures, whichcan be costly to both the organizationsand to the communities they serve, andto mitigate other potential mortgage-related losses. The agencies urged thatall lenders and servicers seek modifica-tions that result in mortgages that bor-rowers will be able to sustain over theremaining maturity of their loans. Thestatement also emphasized that the

agencies will fully support bankingorganizations as they work to imple-ment effective and sound loan modifi-cation programs.

Flood Insurance

The National Flood Insurance Actimposes certain requirements on loanssecured by buildings or mobile homeslocated in, or to be located in, areasdetermined to have special flood haz-ards. Under Regulation H, which imple-ments the act, state member banks aregenerally prohibited from making,extending, increasing, or renewing anysuch loan unless the building or mobilehome—and any personal propertysecuring the loan—are covered by floodinsurance for the term of the loan.Moreover, the act requires the Boardand other federal financial institutionregulatory agencies to impose civilmoney penalties when it finds a patternor practice of violations of the regula-tion. The civil money penalties are pay-able to the Federal Emergency Manage-ment Agency for deposit into theNational Flood Mitigation Fund.

In March 2008, the agencies, alongwith the National Credit Union Admin-istration (NCUA) and Farm Credit Sys-tem, requested public comment on newand revised interagency questions andanswers regarding flood insurance. Theagencies proposed substantive as wellas technical revisions to existing guid-ance to help financial institutions meettheir responsibilities under federal floodinsurance legislation and increase pub-lic understanding of the flood insuranceregulations. Final action on these pro-posed revisions is expected in 2009.

During 2008, the Board imposedcivil money penalties against four statemember banks that violated the act. The


penalties, which were assessed via con-sent orders, totaled $17,790.

Agency Reports on Compliancewith Consumer Protection Laws

The Board reports annually on compli-ance with consumer protection laws byentities supervised by federal agencies.This discussion summarizes data col-lected from the 12 Federal ReserveBanks and the FFIEC member agencies(collectively, the FFIEC agencies), aswell as other federal enforcement agen-cies.26

Regulation B(Equal Credit Opportunity)

The FFIEC agencies reported that 85percent of institutions examined duringthe 2008 reporting period were in com-pliance with Regulation B, whichequals the level of compliance for the2007 reporting period. The most fre-quently cited violations involved

• the failure to properly collect infor-mation for government monitoringpurposes, including data on race, eth-nicity, sex, marital status, and age ofapplicants seeking credit primarilyfor the purchase or refinancing of aprincipal residence;

• the improper collection of informa-tion on applicant race, color, religion,national origin, or sex when not per-mitted by regulation;

• the improper requirement of the sig-nature of an applicant’s spouse orother person, other than a joint appli-cant, when the applicant qualifiedunder the creditor’s standards of

creditworthiness for the amount andterms of the credit requested; and

• the failure to provide a credit appli-cant with a written notice of denial orother adverse action that contains thespecific reason for the adverse action,along with other required informa-tion.

The FFIEC agencies did not issueany public enforcement actions specificto Regulation B during the reportingperiod.

The Farm Credit Administration, theDepartment of Transportation, theSecurities and Exchange Commission,the Small Business Administration, andthe Grain Inspection, Packers andStockyards Administration of theUnited States Department of Agricul-ture reported substantial complianceamong the entities they supervise.

Regulation E(Electronic Fund Transfers)

The FFIEC agencies reported thatapproximately 94 percent of the institu-tions examined during the 2008 report-ing period complied with Regulation E,which equals the level of compliancefor the 2007 reporting period. The mostfrequently cited violations involved thefailure to take one or more of the fol-lowing actions:

• determining whether an error oc-curred within 10 business days ofreceiving a notice of error from aconsumer;

• giving a consumer provisional creditfor the amount of an alleged errorwhen an investigation into the al-leged error could not be completedwithin 10 business days;

• providing initial disclosures that con-tain required information, includinglimitations on the types of transfers

26. Because the agencies use different methodsto compile the data, the information presentedhere supports only general conclusions. The 2008reporting period was July 1, 2007, through June30, 2008.


permitted and error-resolution proce-dures, at the time a consumer con-tracted for an electronic fund transferservice; and

• providing a written explanation not-ing the consumer’s right to requestdocumentation that supports the insti-tution’s findings when a determin-ation is made that no error hasoccurred.

The FFIEC agencies did not issueany formal enforcement actions specificto Regulation E during the period.

Regulation M (Consumer Leasing)

The FFIEC agencies reported that morethan 99 percent of institutions examinedduring the 2008 reporting period com-plied with Regulation M, which equalsthe level of compliance for the 2007reporting period. The FFIEC agenciesdid not issue any formal enforcementactions relating to Regulation M duringthe period.

Regulation P (Privacy of ConsumerFinancial Information)

The FFIEC agencies reported that 97percent of the institutions examinedduring the 2008 reporting period com-plied with Regulation P, which equalsthe level of compliance for the 2007reporting period. The most frequentlycited violations involved the failure totake one or more of the followingactions:

• providing a clear and conspicuousannual privacy notice to customers;

• disclosing the institution’s infor-mation-sharing practices in initial,annual, and revised privacy notices;and

• providing customers with a clear andconspicuous initial privacy notice

that accurately reflects the institu-tion’s privacy policies and practices,not later than when the customer rela-tionship is established.

The FFIEC agencies did not issueany formal enforcement actions relatingto Regulation P during the reportingperiod.

Regulation Z (Truth in Lending)

The FFIEC agencies reported that81 percent of the institutions examinedduring the 2008 reporting period werein compliance with Regulation Z, com-pared with 82 percent in 2007. Themost frequently cited violations in-volved the failure to accurately discloseone or more of the following:

• the finance charge in closed-endcredit transactions;

• the amount financed by subtractingany prepaid finance charges;

• the payment schedule, including thenumber, amounts, and timing of pay-ments scheduled to repay the obliga-tions; and

• the annual percentage rate in closed-end credit transactions.

In addition, 146 banks supervised bythe Federal Reserve, FDIC, OCC, andOTS were required, under the Inter-agency Enforcement Policy in Regula-tion Z, to reimburse a total of approxi-mately $2.77 million to consumers forunderstating annual percentage rates orfinance charges in their consumer loandisclosures.

The FFIEC agencies did not issueany public enforcement actions specificto Regulation Z during the reportingperiod. The Department of Transporta-tion continued to prosecute one air car-rier for its improper handling of credit


card refund requests and other FederalAviation Act violations.

Regulation AA (Unfair or DeceptiveActs or Practices)

The FFIEC agencies reported that morethan 99 percent of the institutionsexamined during the 2008 reportingperiod were in compliance with Regula-tion AA, which equals the level of com-pliance for the 2007 reporting period.No formal enforcement actions relatingto Regulation AA were issued duringthe reporting period.

Regulation CC (Availability of Fundsand Collection of Checks)

The FFIEC agencies reported that 89percent of institutions examined duringthe 2008 reporting period were in com-pliance with Regulation CC, comparedwith 90 percent for the 2007 reportingperiod. The most frequently cited viola-tions involved the failure to take one ormore of the following actions:

• making available on the next busi-ness day the lesser of $100 or theaggregate amount of checks depos-ited that are not subject to next-dayavailability;

• following procedures when invokingthe exception for large-dollar depos-its;

• providing required information whenplacing exception holds on accounts;and

• making funds from local and certainother checks available for withdraw-als within the times prescribed byregulation.

The FFIEC agencies did not issueany public enforcement actions specificto Regulation CC during the reportingperiod.

Regulation DD (Truth in Savings)

The FFIEC agencies reported that 86percent of institutions examined duringthe 2008 reporting period were in com-pliance with Regulation DD, comparedwith 88 percent for the 2007 reportingperiod. The most frequently cited viola-tions involved the failure to take one ormore of the following actions:

• providing additional required lan-guage in advertisements that containthe term “annual percentage yield”;

• using the term “annual percentageyield” if advertisements state rates ofreturn;

• providing initial account disclosurescontaining all required information;and

• providing account disclosures in writ-ing and in a form consumers maykeep.

The FFIEC agencies did not issueany public enforcement actions specificto Regulation DD during the reportingperiod.

Consumer Complaints and Inquiries

The Federal Reserve investigates com-plaints against state member banks,and forwards complaints against othercreditors and businesses to the appropri-ate enforcement agency. Each ReserveBank investigates complaints againststate member banks in its District. TheFederal Reserve also responds to con-sumer inquiries on a broad range ofbanking topics, including consumerprotection questions.

The Federal Reserve centralized pro-cessing of consumer complaints andinquiries in late 2007, with the estab-lishment of Federal Reserve ConsumerHelp (FRCH). In 2008, its first full yearof operation, FRCH processed 36,996


cases. Of these cases, 19,515 (53 per-cent) were inquiries and 17,481 (47 per-cent) were complaints, with most casesreceived directly from consumers. Ap-proximately six percent were referredfrom other agencies.

While consumers can contact FRCHby phone, fax, mail, e-mail, or online(www.federalreserveconsumerhelp.gov/),most FRCH consumer contacts oc-curred by telephone. Nevertheless,online complaints submissions totaled5,147 (29 percent) of all complaintsreceived in 2008, and the online formreceived over 300,000 visits during theyear.

Consumer Complaints

Complaints against state member bankstotaled 5,520 in 2008. Most of thesecomplaints, 2,411 (44 percent) wereclosed without investigation pendingthe receipt of additional informationfrom consumers. Of the remaining3,109 complaints, 2,173 (70 percent)involved unregulated practices and936 (30 percent) involved regulatedpractices.

The Federal Reserve forwarded11,966 complaints against other banksand creditors to the appropriate regula-tory agencies for investigation. To mini-mize the time required to re-route com-plaints to these agencies, referrals weretransmitted electronically.

Complaints against State MemberBanks about Regulated Practices

The majority of regulated-practice com-plaints concerned checking account(28 percent) and credit card (26 per-cent) activity. The most common check-ing account complaints related to insuf-ficient funds or overdraft charges andprocedures (33 percent), funds avail-ability (13 percent), and disputed with-drawals of funds (15 percent). The most

common credit card complaints con-cerned billing error resolutions (14 per-cent), “other rates, terms and fees”(12 percent) and debt-collection prac-tices (9 percent).

Real estate-related complaints27

made up 18 percent of total complaints.Of those, 48 percent related to home-purchase loans, 32 percent to homeequity credit lines, and only one percent(or two complaints) concerned adjust-able rate mortgages. The most commoncomplaints related to real estate-relatedpayment errors and delays (14 percent),“other rates, terms, and fees” (10 per-cent), and escrow account problems(9 percent).

27. Includes adjustable-rate mortgages; resi-dential construction loans; open-end home equitylines of credit; home improvement loans; homepurchase loans; home refinance/closed-end loans;and reverse mortgages.

Complaints against State Member BanksThat Involve Regulated Practices, byClassification, 2008

Classification Number

Regulation AA (Unfair or DeceptiveActs or Practices) . . . . . . . . . . . . . . . . . . . . . . 117

Regulation B (Equal Credit Opportunity) . . . . . 30Regulation C (Home Mortgage

Disclosure Act) . . . . . . . . . . . . . . . . . . . . . . . . 8Regulation E (Electronic Funds Transfers) . . . 116Regulation M (Consumer Leasing) . . . . . . . . . . . 3Regulation P (Privacy of Consumer

Financial Information) . . . . . . . . . . . . . . . . . . 41Regulation Q (Payment of Interest) . . . . . . . . . . 0Regulation Z (Truth in Lending) . . . . . . . . . . . . . 247Regulation BB (Community Reinvestment) . . . 0Regulation CC (Expedited Funds

Availability) . . . . . . . . . . . . . . . . . . . . . . . . . . . 122Regulation DD (Truth in Savings) . . . . . . . . . . . 71Regulation V (Fair and Accurate Credit

Transactions) . . . . . . . . . . . . . . . . . . . . . . . . . . 9Fair Credit Reporting Act . . . . . . . . . . . . . . . . . . . 72Fair Debt Collection Practices Act . . . . . . . . . . . 62Fair Housing Act . . . . . . . . . . . . . . . . . . . . . . . . . . . 3National Flood Insurance Act/

Insurance Sales . . . . . . . . . . . . . . . . . . . . . . . . 6Home Ownership Counseling . . . . . . . . . . . . . . . . 1HOPA (Homeowners Protection Act) . . . . . . . . 0Real Estate Settlement Procedures Act . . . . . . . 18Right to Financial Privacy Act . . . . . . . . . . . . . . 10

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 936


Seventeen complaints (2 percent)alleged discrimination on the basis ofprohibited borrower traits or rights(race, color, religion, national origin,sex, marital status, handicap, age, appli-cant income deriving from public assis-tance programs, or applicant reliance onConsumer Credit Protection Act provi-sions). Sixty-five percent of discrimina-tion complaints were related to the raceor national origin of the applicant orborrower.

In the substantial majority (80 per-cent) of investigated complaints againststate member banks, gathered evidencerevealed that banks correctly handledthe situation. Of the remaining 20 per-cent, 5 percent were deemed law vio-lations, 3 percent were general er-rors, and the remainder mainly involvedfactual disputes or litigated matters. Themost common violations involvedchecking accounts and credit cards.

Unregulated Practices

As required by section 18(f) of the Fed-eral Trade Commission Act, the Boardcontinued to monitor complaints aboutbanking practices not subject to existingregulations, with a focus on instances ofpotential unfair or deceptive practices.In 2008, the Board received 2,119 com-

plaints against state member banks thatinvolved these unregulated practices.Most complaints concerned credit cardand checking account activity. Morespecifically, consumers most frequentlycomplained about issues involving in-sufficient funds or overdraft chargesand procedures (386), deposit forgery,fraud, embezzlement or theft (91), con-cerns about credit card interest rates,terms, and fees (87), and concernsabout opening and closing depositaccounts (80).

Complaint Referrals to HUD

In 2008, the Federal Reserve forwardedthree complaints to the Department ofHousing and Urban Development thatalleged violations of the Fair HousingAct.28 The Federal Reserve’s investiga-tion of these complaints revealed no evi-dence of illegal credit discrimination.

Consumer Inquiries

In 2008, the Federal Reserve received19,515 inquiries from consumers re-

28. In accordance with a memorandum ofunderstanding between HUD and the federal bankregulatory agencies requiring that complaintsalleging a violation of the Fair Housing Act beforwarded to HUD.

Complaints against State Member Banks That Involve Regulated Practices, 2008

Subject of complaint

All complaints Complaints involving violations

Number Percent Number Percent

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 936 100 44 5

Discrimination allegedReal estate loans . . . . . . . . . . . . . . . . . . . . . . . . 10 1 1 0.1Credit cards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 0.1 0 0Other loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 1 0 0

Nondiscrimination complaints1

Credit cards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 245 26 6 1Checking accounts . . . . . . . . . . . . . . . . . . . . . . . 264 28 16 2Real estate loans . . . . . . . . . . . . . . . . . . . . . . . . 156 18 7 1

1. Only the top three product categories of nondiscrimination complaints are listed here.


lated to a wide range of topics. Ofthese, 4,488 (23 percent) fell into the“other” category, with several inquiriesrelated to personal and national eco-nomic conditions and several inquiriesrelated to regulatory changes or propos-als under consideration. The top threeconsumer protection issues documentedwith specific codes were the following:adverse action notices received pursu-ant to the Equal Credit Opportunity Act(13 percent), consumer protectionregulations (7 percent), and pre-approved credit solicitations (7 per-cent). Consumers were typically di-rected to other resources, includingother federal agencies or written mate-rials, to address their inquiries.

Outreach and Response toCommunity Development Needsin Historically UnderservedCommunities and Markets

The mission of the community affairsfunction within the Federal ReserveSystem is to promote community eco-nomic development and fair access tocredit for low- and moderate-incomecommunities and populations. A decen-tralized function, the CommunityAffairs Offices (CAOs) are maintainedat each of the 12 Reserve Banks, whereCAO staffs design activities in responseto the needs of communities in the Dis-tricts they serve, with oversight ofoperations provided by Board staff. TheCAOs focus on providing informationand promoting awareness of investmentopportunities to financial institutions,government agencies, and organizationsthat serve low- and moderate-incomepeople and communities. Similarly, theBoard’s CAO promotes and coordinatesSystemwide community developmentefforts; in particular, Board communityaffairs staff focus on issues that havepublic policy implications.

In 2008, the Board’s regulatory andsupervisory actions were augmented bythe System’s Community Affairs staffactivities to address the negative impactof foreclosures on individuals and com-munities. Community Affairs staffdeveloped online Foreclosure ResourceCenters on the websites of each ReserveBank and the Board. These centers pro-vide up-to-date information regardingresources available to distressed bor-rowers, local governments, and lenders.Community Affairs analysts and out-reach specialists continued to use theirlongstanding networks of industry andcommunity relationships to convenemeetings and provide information tolocal community and business leaders,government officials, consumer andcommunity groups, and others engagedin addressing the foreclosure issuelocally. To complement these efforts,System research staff collected and ana-lyzed data on real estate and subprimemortgage conditions, and providedregional foreclosure projections andin-depth analysis of the incidence ofdefaults within particular areas to sup-port state and local government effortsto develop action plans under theNeighborhood Stabilization Program(NSP). In addition, visiting scholarAlan Mallach, of the Federal ReserveBank of Philadelphia, published a dis-cussion paper, How to Spend $3.92 Bil-lion: Stabilizing Neighborhoods byAddressing Foreclosed and AbandonedProperties. The paper serves to assiststates, counties, and cities in determin-ing the best use of funds distributedunder the Housing and EconomicRecovery Act of 2008 (HERA).

Federal Reserve Community Affairsstaff also hosted a number of events,conferences, and meetings on the topicof foreclosure in 2008. The Systemdeveloped a conference series, Re-newal, Recovery, Rebuilding: A Federal


Reserve System Foreclosure Series, tohighlight issues and best practices inweak as well as strong housing markets(see Foreclosures: Responding to Con-sumers and Communities in Crisisthrough the Federal Reserve’s HomeMortgage Initiative in the “MortgageCredit” discussion earlier in this chap-ter). The culmination of the series, heldat the Board’s offices in Washington,D.C., were presentations on the chal-lenges of valuing foreclosed properties,on the NSP program, and on the issu-ance of best practices for dealing withlarge numbers of foreclosures devel-oped in communities such as Flint,Michigan and Youngstown, Ohio.

The System also continued to workwith the HOPE NOW alliance, a col-laboration of counselors, servicers,investors, and other mortgage marketparticipants. Many Reserve Banksco-sponsored “foreclosure mitigation”events, bringing distressed borrowerstogether with counselors and mortgageservicers to discuss and, where pos-sible, to implement loan compromisesbetween borrowers and lenders. Thelargest such event drew more than2,000 borrowers to Gillette Stadium inFoxboro, Massachusetts. The FederalReserve Bank of Boston is working totrack the success of the loan modifica-tions that were arranged at that eventand to better understand any limitationsof the current modification structure.Similar events have either been held orare planned in other Reserve Bankdistricts.

The Board and System worked withNeighborWorks America on a uniquepartnership to (1) address the impact offoreclosures on neighborhoods byjointly developing the tools and train-ing necessary to help local govern-ments and nonprofit organizations,and (2) evaluate approaches and tailorresponses to address the increase in

foreclosures and real-estate-owned(REO) properties. The partnership,begun in May 2008, not only builds onan existing relationship with Neighbor-Works (Federal Reserve staff serve onits Board of Directors), but also lever-ages the System’s ability to conductdata analysis, research, and outreach toaddress issues related to neighborhoodstabilization. As part of the partnership,the Board supported the development ofa new website,29 and new courses forthe NeighborWorks Training Institute,which helps ensure effective manage-ment of REO properties. In addition tobeing offered as part of the TrainingInstitute, these courses are designed tobe portable so that they can be broughtdirectly to communities in 2009.

Finally, the Community Affairs pro-grams at all 12 Reserve Banks and theBoard of Governors collaborated topublish The Enduring Challenge ofConcentrated Poverty: Case Studiesfrom Communities Across the U.S., aproject undertaken by CommunityAffairs in partnership with the Brook-ings Institution. The report was under-taken to develop a deeper understandingof the relationship between “poverty,people, and place.” The Board hosted apolicy forum to highlight issues raisedin the case studies and to discuss place-based and people-based policy solu-tions, such as workforce developmentand education, to address problemsprevalent in communities experiencingconcentrated poverty.

Advice from theConsumer Advisory Council

The Board’s Consumer AdvisoryCouncil—whose members representconsumer and community organiza-

29. See www.stablecommunities.org.


tions, the financial services indus-try, academic institutions, and stateagencies—advises the Board of Gover-nors on matters of Board-administeredlaws and regulations as well as otherconsumer-related financial servicesissues. Council meetings, open to thepublic, were held in March, June, andOctober. For a list of members of theCouncil, see the “Federal Reserve Sys-tem Organization” section in this report;also, visit the Board’s website for tran-scripts of Council meetings.30

Three significant topics of discussionfor the Council in 2008 were

• the Board’s proposal to establish newprotections for consumers in the resi-dential mortgage market throughamendments to Regulation Z, whichimplements the Truth in Lending Act(TILA) and the Home Ownership andEquity Protection Act;

• the Board’s proposal, under the Fed-eral Trade Commission Act (FTCAct), to prohibit unfair or deceptiveacts or practices by banks in connec-tion with credit card accounts andoverdraft services for deposit ac-counts; and

• issues related to home foreclosures,including loss-mitigation strategies,counseling initiatives, and commu-nity stabilization efforts.

Proposed Rules forHome Mortgage Loans

In its March meeting, the Counciladdressed various issues related to con-sumer protections proposed underRegulation Z (see the “MortgageCredit” discussion earlier in thischapter).

Some industry representatives en-dorsed the Board’s approach to definesubprime loans based on the annual per-centage rate (APR) charged rather thanon other loan features, but they ex-pressed the view that the proposed defi-nition would be too broad and wouldcover many prime loans. One memberrecommended using a mortgage-rate(instead of Treasury-securities) index toset the threshold and apply a differentspread for first-lien loans. Anothermember commented that any APRthreshold or other definitional triggerfor higher-priced loans would be,at times, under-inclusive or over-in-clusive, and expressed a preference forerring on the side of over-inclusion.

Several consumer representativesexpressed support for the Board’s pro-posal under which a creditor would beprohibited from engaging in a “patternor practice” of lending based on the col-lateral without regard to the consumer’sability to make scheduled payments.They emphasized the importance ofestablishing rules for prudent under-writing. Offering the perspective ofcommunity banks, an industry represen-tative commented that such institutionsgenerally follow rigorous underwritingstandards, but noted that they some-times need flexibility to adjust theirpractices to meet the needs of particularcustomers. Regarding the proposal’s“pattern or practice” provision, mem-bers expressed concern about the diffi-culty of establishing proof of a patternor practice in litigation, and urged theBoard to clarify what constitutes a pat-tern or practice. Some members notedthat the “pattern or practice” provisionsets up significant hurdles for individualconsumers to bring cases against lend-ers. Members presented a variety ofviews about the idea of designating abright-line presumption of a violation,or a safe harbor, for repayment ability at

30. See the Federal Reserve Board’s ConsumerAdvisory Council webpage, www.federalreserve.gov/aboutthefed/cac.htm.


a 50 percent debt-to-income (DTI)ratio. Several members cautionedagainst using the 50 percent DTI ratioor another specific number in the regu-lation.

Several members endorsed the use ofthird-party documentation to verifyincome and assets, noting that suchflexibility would help address the needsof different borrowers. A consumer rep-resentative urged the Board to clarifywhether nontraditional forms of doc-umentation from small- or micro-business owners would be acceptableunder the regulation.

Various members endorsed a com-plete ban on prepayment penalties forhigher-priced loans. They expressedconcern that prepayment penalties arenot balanced by lower interest rates forsubprime borrowers, who are often theleast financially sophisticated consum-ers and for whom there is no well-known interest-rate benchmark fornegotiating better loan terms. Severalindustry representatives expressed theview that, although there have beenproblems with prepayment penalties inthe subprime market, they can be usefultools and yield lower interest rates forconsumers. Industry representativessuggested that prepayment penalties canbe effectively regulated, such asthrough better disclosure and limits onduration or amount. Both consumer andindustry representatives agreed that thefive-year duration permitted in the pro-posal for penalties would be too long,and considered it not reflective of cur-rent best practices in the industry.

There was general support amongCouncil members for proposed manda-tory escrow accounts as a way to helpensure the successful performance ofhigher-priced loans. In considering theoption to cancel escrow accounts 12months after consummation, one mem-ber expressed the view that 12 months

would be too short, especially for morefinancially vulnerable borrowers orfirst-time homeowners. Several industryrepresentatives noted the potentialimpacts of mandatory escrow accountson financial institutions’ businessprocesses.

In the discussion of yield-spread pre-miums, some members expressed sup-port for requiring the same compensa-tion disclosures for all loan originatorsin order to facilitate better comparisonsamong products and services as well asto better ensure fair lending. Othermembers supported applying the pro-posed disclosure rules only to brokers.Some members spoke against the ideaof establishing an agreement character-ized by a specific compensation figurebefore the loan application is received.In the absence of key information aboutthe borrower or the loan product, thebroker would have to disclose the high-est possible fee, which would not beuseful to the particular borrower. Onemember noted that, in the subprimemarket, loan applications and fees areoften taken at closing, and recom-mended that the Board consider anothertrigger for the written agreement thatwould more likely occur earlier.

Consumer representatives generallysupported the proposal’s advertisingrestrictions. They specifically endorseda “bright-line” rule for use of the word“fixed” in advertisements, permitting itonly if the rate or payment would notchange for the entire length of the loan.

Members expressed support for theproposed rules regarding servicingpractices. An industry member notedthat most of the rules, such as creditingpayments as of the date of receipt andnot pyramiding late fees, are consistentwith current best practices in the indus-try. Other members expressed concernabout the difficulty of accurately dis-closing third-party fees, which may


change without notice, and potentialcompliance challenges if a re-disclosureis required whenever a third-party feechanges.

There was general consensus regard-ing the provisions prohibiting coercionof appraisers, with one member notingthat the rule should highlight the moresubtle ways of unduly influencing theappraisal process.

Under the proposal, creditors wouldbe required to provide transaction-specific cost disclosures earlier. Somemembers cautioned that providing dis-closures earlier would not clarify loanterms for consumers, who could end upwith several sets of disclosures as vari-ous details changed during the loan pro-cess. One member expressed concernabout the proposed rule regarding whatfees can be collected before early dis-closures are provided. Another memberstated that providing the cost disclo-sures early in the application processwould not address a key issue, which isthat estimates generally change by thetime loans close.

Proposed Rules for Credit Cardsand Overdraft Services

In its June and October meetings, theCouncil’s discussions focused on vari-ous aspects of the Board’s proposedrules to prohibit unfair or deceptive actsor practices in connection with creditcard accounts and overdraft services fordeposit accounts (see the “Credit Cards”discussion earlier in this chapter).

Credit Card Accounts

Some industry representatives ex-pressed concern about labeling certainpractices that are used widely amongfinancial institutions as unfair or decep-tive, and urged the Board to considerissuing many of the credit card rulesunder TILA. Other members supported

issuing the rules under the FTC Actrather than TILA. They expressed theview that institutions would face littlenew litigation risk from the proposal,especially if the regulations have clearsafe harbors.

In the discussion of payment alloca-tion, consumer representatives encour-aged the Board to require that paymentsbe allocated first to balances with thehighest APR. Several members com-mented that a single allocation methodwould make credit pricing more trans-parent to consumers and would providea level playing field for creditors. Someconsumer representatives emphasizedthe benefit to less sophisticated con-sumers of allocating payments first tothe highest APR balance.

Industry representatives supportedthe current industry practice of allocat-ing payments to the lowest APR bal-ance first, expressing the view that theproposed pro rata and equal portionallocation methods would be confusingto consumers. They also cautioned thatswitching to the proposed allocationmethods likely would lead to highercredit costs and reduced access tocredit as institutions seek to offsetlosses in revenue. Some members urgedthe Board, in applying the approvedpayment-allocation methods, to treatpromotional rate balances and deferredinterest balances in the same way asother balances.

Several members supported the pro-posal to restrict creditors’ ability toincrease rates on existing balances,emphasizing that it would provide safe-guards for both consumers and lenders.They noted that consumers may not beable to prevent risk-based repricingsolely through their behavior becauseoften they lack information about howcredit scores are determined and canchange. Industry representatives op-posed the proposal, saying it would


eliminate a key risk-management toolfor creditors. They stated that, due tolost revenues, overall pricing for creditmay increase and credit availabilitymay decline if creditors cannot applyrisk-based pricing to their riskiest cus-tomers. Industry representatives alsourged the Board to consider expandingthe circumstances where existing bal-ances can be repriced to include otherconsumer behavior that raises concernsabout a borrower’s risk.

There was general support among theCouncil members for restricting thepractice of financing security depositsand initial fees that use up most of aborrower’s credit limit. Several mem-bers expressed concern that the percent-ages in the proposed rule would be toohigh, and they cautioned that thosethresholds could become the standard.One member recommended that thefinancing of security deposits and feesshould be spread out beyond the pro-posed 12 months.

Members disagreed about the appro-priateness of the proposed safe harborfor mailing periodic statements 21 daysbefore a payment’s due date, particu-larly given the trend toward electronicpayments. There was general agreementamong the members about the proposedprovisions regarding cut-off times anddue dates for mailed payments. Severalmembers recommended that the ruleapply to all types of payments. Con-sumer representatives endorsed the banon two-cycle billing, and expressedsupport for the proposed provisionregarding firm offers of credit.

Overdraft Services

The Board’s overdraft services proposalwould prohibit banks from imposing afee for paying an overdraft unless thebank provides the consumer with anopportunity to opt out of the overdraft

payment and the consumer has not doneso. Industry representatives recom-mended issuing the rules under Regula-tion E (Electronic Fund Transfer Act)rather than the FTC Act, expressing theview that overdraft services do not con-stitute an unfair or deceptive practicebecause they provide important benefitsto consumers. Industry representativessupported the proposed right to opt outof the payment of overdrafts anddescribed potential operational difficul-ties with an opt-in. They also suggestedadditional exceptions under which over-drafts should be paid and a fee chargedeven if the consumer has opted out.

Several other members urged theBoard to require institutions to gainconsumers’ affirmative consent foroverdraft payments with an opt-in,commenting that banks would be morelikely to provide clear informationabout overdraft services to their cus-tomers. They expressed concern thatconsumers are currently enrolled in over-draft programs automatically, whichthey described as an expensive form ofcredit that often poses more harm thanbenefits for low- and moderate-incomeconsumers, especially college-age stu-dents and the elderly. Some memberssupported the proposed rule requiringinstitutions to allow consumers to optout of overdrafts for ATM and point-of-sale transactions without opting out ofoverdraft services for checks. Industryrepresentatives opposed the partial opt-out, and urged the Board to treat alltransactions in the same way. There wasgeneral support for requiring notice ofthe opt-out at least once for each peri-odic statement cycle in which an over-draft fee or charge occurs.

Industry representatives commentedon the operational challenges and thepotential impact on consumers of a pro-vision that would prohibit banks from


imposing a fee when an account isoverdrawn solely because a hold wasplaced on funds in the consumer’sdeposit account. Consumer representa-tives supported the provision, express-ing the view that institutions should beable to readily address any operationalissues. There was general consensus onthe importance of faster settlement ofauthorized transactions so that debitholds can be released more quickly.Several members also expressed theview that consumers should receive bet-ter notice of debit holds from merchantsat the point of sale so they can choosewhether and how to proceed with thetransaction.

In a discussion of disclosures relatedto overdraft services, several membersemphasized the importance of disclos-ing, on the opt-out notice, any alterna-tives for the payment of overdrafts thatthe institution offers. Consumer repre-sentatives expressed support for dis-closing on periodic statements theaggregate dollar amounts charged foroverdraft fees and returned-item fees.Some members also stated that institu-tions, when they provide account-balance information, should not be per-mitted to include funds that would beavailable through overdrafts.

Foreclosure Issues

In its March and October meetings, theCouncil also addressed various issuesrelated to the surge in foreclosures,including loss-mitigation strategies,counseling initiatives, and communitystabilization efforts. The October dis-cussion focused on two initiatives inHERA: the HOPE for HomeownersProgram and the NSP.

In March, consumer representativesexpressed concern about the capacity ofservicers to engage in loss mitigation ona large scale. They stated that, despite

some recent improvements, servicersgenerally are overwhelmed. Memberspointed to other areas of concernregarding servicers, such as the lack ofcoordination between servicers’ fore-closure and loss-mitigation departmentsas well as pressure for repayment work-outs rather than modifications of loanrates or principal amounts. The ef-forts of the HOPE NOW alliance—coordinating servicer and lender workwith borrowers and collecting and shar-ing data—were also highlighted.

In October, there was general agree-ment that the results of loss-mitigationefforts by servicers have been mixed,with some improvement in responsive-ness but also continued backlogs andcapacity issues. Several members alsoexpressed concern about the voluntarynature of the HOPE for HomeownersProgram for lenders, though industryrepresentatives noted that the programis only one tool among various loss-mitigation strategies.

Several members expressed supportfor a more comprehensive plan to stemthe increasing wave of foreclosures,including a moratorium on foreclosuresand more systematic loan modifica-tions. They urged the Board to use itsinfluence with lenders and servicers toencourage them to pursue sustainableloan modifications. One member ex-pressed support for court-ordered modi-fications of mortgages for principalresidences. Several consumer represen-tatives suggested that institutions par-ticipating in the Troubled Assets ReliefProgram (TARP) should be required tomodify loans.

Industry representatives expressedthe view that servicers and lendersincreasingly recognize the importanceof doing loan modifications that aresustainable for the long term, but a con-sumer advocate stated that many modi-fications still have too short-term a time


frame. Several consumer representa-tives endorsed a focus on principalwrite-downs as a key way to achievesustainable modifications. Industry rep-resentatives pointed to the difficulties indoing principal write-downs, and notedthat focusing on affordability in lossmitigation can preserve homeowner-ship even if the loss of equity is notaddressed.

There was a consensus that timely,accurate, comprehensive, and accessibleinformation about the scope of delin-quencies and defaults and the outcomesof loss-mitigation efforts are critical toan effective analysis of foreclosureissues and proposed policies or solu-tions. Noting that some key data onthese issues are privately held, severalmembers supported the idea of a surveyconducted by the Federal Reserve toensure the credibility and comprehen-siveness of the data collected.

Several members expressed concernsabout the proliferation of firms thatoffer loan-modification or foreclosure-rescue services at high upfront fees, andconsumer representatives described theneed for greater support for counselingagencies.

Various members described the nega-tive impact of the rising number offoreclosures in their communities, andexpressed concern about the effects offoreclosure concentrations in low- andmoderate-income neighborhoods. Theyalso described various local effortsto respond to foreclosures, such asprograms to provide counseling tostruggling borrowers and initiatives toreclaim and rehabilitate foreclosedproperties. Some consumer representa-tives recommended giving favorableCommunity Reinvestment Act (CRA)credit to institutions to address fore-closure-related issues, which couldprompt banks to go beyond their usualwork in low-income areas and take

on initiatives related to foreclosures.Another member suggested that bankscould get favorable CRA credit forforeclosure efforts that fall outside theirassessment area, similar to what waspermitted after Hurricane Katrina.

There was general support for thewide array of activities permitted underthe NSP, which will give communitiesvarious strategies to address theirspecific challenges. One member em-phasized the need to pay attention tofair-housing issues amid the NSP im-plementation. Another member com-mended the intent of the NSP but cau-tioned that its goals cannot be met iffinancial institutions do not resumelending for community developmentprojects. He expressed the view thatsuch lending could be tied to the receiptof TARP funds or could be accom-plished through the network of theCommunity Development FinancialInstitutions Fund. The members gener-ally agreed on the need for comprehen-sive and accurate data on real-estate-owned properties, so that communitiescan more effectively develop and evalu-ate their stabilization strategies.

Other Discussion Topics

At the Council’s June meeting, mem-bers provided feedback on proposedregulations from the Board and the Fed-eral Trade Commission to implement aprovision of the Fair and AccurateCredit Transactions Act of 2003 (whichamends the Fair Credit Reporting Act)that addresses risk-based pricing. Anindustry representative commended theBoard for its attention to the goal ofoperational feasibility in implementingthe proposal. Some members expressedsupport for defining “material terms”primarily with reference to the annualpercentage rate because the bright-linetest would make it easier for creditors


to identify consumers who must receiverisk-based pricing notices. In consider-ing the proposed tests for identifyingwhich consumers should receive no-tices, one member urged the Board toset forth a test to identify those consum-ers receiving less-favorable terms acrossthe spectrum of creditors. Severalmembers expressed concern about thevagueness of the proposed definition of“materially less favorable.”

One member commented that whilethe risk-based pricing notices would aidconsumers by encouraging them tocheck their consumer reports, theywould benefit further if the noticesadvised that other factors also can affectthe credit terms and if the notices gaveexamples of those factors. Membersexpressed divergent views about theBoard’s interpretation that the statutegives a consumer the right to request afree consumer report upon receipt of arisk-based pricing notice. An industryrepresentative commended the Boardfor providing alternative approaches bywhich creditors could determine whichconsumers must receive risk-based pric-ing notices. Several members expressedsupport for the proposal’s exceptionsfor prescreened credit solicitations andcredit-score disclosures. One memberurged the Board to require a notice forconsumers who lack credit files, so thatthey might become aware of their lackof credit records and receive informa-tion on how to establish traditionalcredit files.

At the Council’s October meeting,members discussed recent financialdevelopments, including the challengesfaced by banks and nonbank financialinstitutions, disruptions in credit mar-

kets, and the recently launched TARP.In the discussion of the challenges andopportunities presented by the currentfinancial crisis, several members citedthe need to encourage the flow of creditto communities, especially to low-income communities. They also high-lighted the opportunity for CommunityDevelopment Fund Institutions, com-munity development banks, minoritybanks, and credit unions to continuetheir responsible lending activities,particularly in distressed communities.Members also commented on the im-portance of maintaining access tocredit for small businesses. Both con-sumer and industry representatives em-phasized the need for greater account-ability from institutions that receiveTARP funds to ensure that there arebenefits for low- and moderate-incomeareas.

Another October discussion topicwas the Board’s analysis of the2007 Home Mortgage Disclosure Act(HMDA) data (see the “EvaluatingPricing Discrimination Risk withHMDA Data and Other Information”discussion earlier in this chapter). Sev-eral consumer representatives pointedto the HMDA statistics (about higher-priced loan originations by independentmortgage companies and the percentageof higher-priced loans made to CRA-eligible customers) as evidence thatCRA did not cause the subprime mort-gage crisis. Various members urged theBoard to use its data and analysis torebut misperceptions about CRA, espe-cially in connection with the subprimecrisis, and to highlight the positive out-comes of CRA for low- and moderate-income individuals and communities. Á


Federal Reserve Banks

The Federal Reserve Banks providepayment services to depository and cer-tain other institutions, distribute thenation’s currency and coin, and serve asfiscal agents and depositories for theUnited States. The Reserve Banks alsocontribute to setting national monetarypolicy and supervision and regulation ofbanks and other financial entities (dis-cussed in the preceding chapters of thisreport).

Developments inFederal Reserve Priced Services

Federal Reserve Banks provide a rangeof payment and related services todepository institutions, including col-lecting checks, operating an automatedclearinghouse (ACH) service, transfer-ring funds and securities, and providinga multilateral settlement service. TheReserve Banks charge fees for provid-ing these “priced services.”

The Monetary Control Act of 1980requires that the Federal Reserve estab-lish fees for priced services provided todepository institutions so as to recover,over the long run, all direct and indirectcosts actually incurred as well as theimputed costs that would have beenincurred, including financing costs,taxes, and certain other expenses, andthe return on equity (profit) that wouldhave been earned if a private businessfirm had provided the services.1 Theimputed costs and imputed profit arecollectively referred to as the private-

sector adjustment factor (PSAF).2 Overthe past 10 years, Reserve Banks haverecovered 98.7 percent of their pricedservices costs, including the PSAF (seetable, next page).3

In 2008, Reserve Banks recovered98.5 percent of total priced servicescosts of $886.9 million, including thePSAF.4 Revenue from priced servicesamounted to $773.4 million, otherincome was $100.4 million, and costswere $820.4 million, resulting innet income from priced services of$53.4 million.5

1. Financial data reported throughout thischapter—including revenue, other income, costs,income before taxes, and net income—can belinked to the pro forma financial statements at theend of this chapter.

2. In addition to income taxes and the returnon equity, the PSAF includes three other imputedcosts: interest on debt, sales taxes, and an assess-ment for deposit insurance by the Federal DepositInsurance Corporation (FDIC). Board of Gover-nors assets and costs that are related to pricedservices are also allocated to priced services; inthe pro forma financial statements at the end ofthis chapter, Board assets are part of long-termassets, and Board expenses are included in oper-ating expenses.

3. Effective December 31, 2006, the ReserveBanks implemented the Financial AccountingStandards Board’s Statement of FinancialAccounting Standards (SFAS) No. 158, Employ-ers’ Accounting for Defined Benefit Pension andOther Postretirement Plans, which has resulted inthe recognition of a $690.6 million reduction inequity related to the priced services’ benefit plansthrough 2008. Including this reduction in equity,which represents a decline in economic value,results in cost recovery of 92.0 percent for the10-year period. For details on how implementingSFAS No. 158 affected the pro forma financialstatements, refer to notes 3 and 5 at the end of thischapter.

4. Total cost is the sum of operating expenses,imputed costs (interest on debt, interest on float,sales taxes, and the FDIC assessment), imputedincome taxes, and the targeted return on equity.

5. Other income is revenue from investment ofclearing balances net of earnings credits, anamount termed net income on clearing balances.

163

Commercial Check-CollectionService

In 2008, Reserve Banks recovered97.8 percent of the total costs of theircommercial check-collection service,including the PSAF. Reserve Banks’operating expenses and imputed coststotaled $647.1 million, of which$14.1 million was attributable to thetransportation of commercial checksbetween Reserve Bank check-pro-cessing offices. Revenue amounted to$605.2 million, of which $11.0 millionwas attributable to estimated revenuesderived from the transportation of com-mercial checks between Reserve Bankcheck-processing offices, and otherincome was $78.4 million. The result-ing net income was $36.5 million.Check-service fee revenue in 2008 de-creased $99.8 million from 2007.

Reserve Banks handled 9.5 billionchecks in 2008, a decrease of 4.6 per-cent from 2007 (see table, oppositepage). The decline in Reserve Bankcheck volume is consistent with nation-

wide trends away from the use ofchecks and toward greater use of elec-tronic payment methods.6 Of all thechecks presented by Reserve Banks topaying banks in 2008, 75.9 percentwere deposited and 53.9 percent werepresented using Check 21 products,compared with 42.2 percent and24.6 percent, respectively, in 2007.7 Byyear-end 2008, this growth resulted in91.1 percent of Reserve Bank checkdeposits and 70.5 percent of Reserve

6. The Federal Reserve System’s retail pay-ments research suggests that the number ofchecks written in the United States has beendeclining since the mid-1990s. For details, seeFederal Reserve System, “The 2007 FederalReserve Payments Study: Noncash PaymentTrends in the United States, 2003-2006”(December 2007), www.frbservices.org/files/communications/pdf/research/2007_payments_study.pdf.

7. The Reserve Banks also offer non-Check 21electronic-presentment products. In 2008, 8.4 per-cent of Reserve Banks’ deposit volume was pre-sented to paying banks using these products.

Priced Services Cost Recovery, 1999–2008

Millions of dollars except as noted

YearRevenue from

services1

Operatingexpenses and

imputed costs2

Targeted returnon equity

Totalcosts

Cost recovery(percent) 3, 4

1999 . . . . . . . . . . . . . . . . . . . . . . 867.6 775.7 57.2 832.9 104.22000 . . . . . . . . . . . . . . . . . . . . . . 922.8 818.2 98.4 916.6 100.72001 . . . . . . . . . . . . . . . . . . . . . . 960.4 901.9 109.2 1,011.1 95.02002 . . . . . . . . . . . . . . . . . . . . . . 918.3 891.7 92.5 984.3 93.32003 . . . . . . . . . . . . . . . . . . . . . . 881.7 931.3 104.7 1,036.1 85.12004 . . . . . . . . . . . . . . . . . . . . . . 914.6 842.6 112.4 955.0 95.82005 . . . . . . . . . . . . . . . . . . . . . . 994.7 834.7 103.0 937.7 106.12006 . . . . . . . . . . . . . . . . . . . . . . 1,031.2 875.5 72.0 947.5 108.82007 . . . . . . . . . . . . . . . . . . . . . . 1,012.3 913.3 80.4 993.7 101.92008 . . . . . . . . . . . . . . . . . . . . . . 873.8 820.4 66.5 886.9 98.5

1999−2008 . . . . . . . . . . . . . . . . 9,377.4 8,605.3 896.3 9,501.7 98.7

Note: Here and elsewhere in this chapter, compo-nents may not sum to totals or yield percentages shownbecause of rounding.

1. For the 10-year period, includes revenue from ser-vices of $8,774.1 million and other income and expense(net) of $603.3 million.

2. For the 10-year period, includes operating expensesof $8,092.7 million, imputed costs of $171.3 million, andimputed income taxes of $341.3 million.

3. Revenue from services divided by total costs.4. For the 10-year period, cost recovery is 92.0 per-

cent, including the net reduction in equity related to FAS158 reported by the priced services in 2008.


Bank check presentments being madethrough Check 21 products.

In November 2008, the FederalReserve Banks announced that the Sys-tem would consolidate to a sole site forpaper-check-processing and check-adjustments operations. These an-nouncements are part of the ReserveBanks’ multiyear initiative, begun in2003, to reduce the number of offices atwhich Banks process checks and inorder to meet their long-run cost-recovery requirement under the Mone-tary Control Act of 1980. Because ofthe rapid adoption of electronic checkprocessing, the Reserve Banks wereable to reduce their check-processinginfrastructure more quickly than origi-nally expected. The consolidationsmade it possible for Reserve Banks, inDecember 2008, to discontinue theirdedicated check-transportation routesbetween Reserve Bank offices. Remain-ing paper checks that must be shippedbetween Reserve Banks are transportedby the U.S. Postal Service or air freightservices.

Commercial AutomatedClearinghouse Services

In 2008, the Reserve Banks recovered101.5 percent of the total costs of their

commercial ACH services, includingthe PSAF. Reserve Bank operatingexpenses and imputed costs totaled$88.8 million. Revenue from ACHoperations totaled $86.6 million andother income totaled $11.3 million,resulting in net income of $9.0 million.The Banks processed 10.0 billion com-mercial ACH transactions, an increaseof 7.2 percent from 2007.

In 2008, nationwide ACH volumescontinued to grow, but at a slower rate,as volume increases associated withelectronic check-conversion appli-cations—including checks converted atlockbox locations or at the point ofpurchase—decelerated.

Fedwire Funds andNational Settlement Services

In 2008, Reserve Banks recovered100.4 percent of the costs of their Fed-wire Funds and National SettlementServices, including the PSAF. ReserveBank operating expenses and imputedcosts totaled $62.3 million in 2008.Revenue from these operations totaled$59.9 million, and other incomeamounted to $7.9 million, resulting innet income of $5.5 million.

Activity in Federal Reserve Priced Services, 2006–2008

Thousands of items

Service 2008 2007 2006

Percent change

2007 to 2008 2006 to 2007

Commercial check . . . . . . . . . . . . . . . . . 9,545,424 10,001,289 11,083,122 −4.6 –9.8Commercial ACH . . . . . . . . . . . . . . . . . . 10,040,388 9,363,429 8,230,782 7.2 13.8Fedwire funds transfer . . . . . . . . . . . . . 134,220 137,555 135,227 –2.4 0.9National settlement . . . . . . . . . . . . . . . . 469 505 470 7.2 7.4Fedwire securities transfer . . . . . . . . . . 11,717 10,110 9,053 15.9 11.7

Note: Activity in commercial check is the total num-ber of commercial checks collected, including processedand fine-sort items; in commercial ACH, the total num-ber of commercial items processed; in Fedwire funds

transfer and securities transfer, the number of transac-tions originated online and offline; and in national settle-ment, the number of settlement entries processed.

Federal Reserve Banks 165

Fedwire Funds Service

The Fedwire Funds Service allows par-ticipants to use their balances at Re-serve Banks to transfer funds to otherparticipants. In 2008, the number ofFedwire funds transfers originatedby depository institutions decreased2.4 percent from 2007, to approxi-mately 134.2 million. The average dailyvalue of Fedwire funds transfers in2008 was $3.0 trillion.

In 2008, the Reserve Banks an-nounced plans to implement enhancedFedwire Funds Service message for-mats for cover payments and for pay-ments containing remittance informa-tion by November 2009 and late 2010,respectively. These changes are in-tended to improve payment transpar-ency and efficiency, and provide addi-tional value-added services to FedwireFunds Service participants.

National Settlement Service

The National Settlement Service is amultilateral settlement system thatallows participants in private-sectorclearing arrangements to settle transac-tions using Federal Reserve balances. In2008, the service processed settlementfiles for 47 local and national private-sector arrangements, primarily checkclearinghouse associations. The ReserveBanks processed slightly more than15,000 files that contained almost469,000 settlement entries for thesearrangements in 2008.

Fedwire Securities Service

In 2008, the Reserve Banks recovered102.5 percent of the total costs of theirFedwire Securities Service, includingthe PSAF. The Reserve Banks’ operat-ing expenses and imputed costs for pro-viding this service totaled $22.2 millionin 2008. Revenue from the service

totaled $21.6 million, and other incometotaled $2.9 million, resulting in netincome of $2.3 million.

The Fedwire Securities Serviceallows participants to transfer electroni-cally to other participants in the servicecertain securities issued by the U.S.Treasury, federal government agencies,government-sponsored enterprises, andcertain international organizations.8 In2008, the number of non-Treasury secu-rities transfers processed via the serviceincreased 15.9 percent from 2007, toapproximately 11.7 million.

Float

The Federal Reserve had daily averagecredit float of $1,193.4 million in 2008,compared with credit float of $604.9million in 2007.9

Developments inCurrency and Coin

The Federal Reserve Banks issue thenation’s currency (in the form of Fed-eral Reserve notes) and distribute cointhrough depository institutions. TheReserve Banks also receive currencyand coin from circulation throughthese institutions. The Reserve Banksreceived 36.7 billion Federal Reservenotes from circulation in 2008, a

8. The expenses, revenues, volumes, and feesreported here are for transfers of securities issuedby federal government agencies, government-sponsored enterprises, and certain internationalorganizations. Reserve Banks provide Treasurysecurities services in their role as the U.S. Trea-sury’s fiscal agent. These services are not consid-ered priced services. For details, see the section“Debt Services” later in this chapter.

9. Credit float occurs when the Reserve Bankspresent items for collection to the paying bankprior to providing credit to the depositing bank,and debit float occurs when the Reserve Bankscredit the depositing bank prior to presentingitems for collection to the paying bank.


3.4 percent decrease from 2007, andmade payments of 37.7 billion notesinto circulation in 2008, a 2.1 percentdecrease from 2007. They received64.4 billion coins from circulation in2008, a 1.9 percent increase from 2007,and made payments of 72.3 billioncoins into circulation, a 4.5 percentdecrease from 2007.

Since mid-September, the crisis infinancial markets has heighteneddemand for $100 notes among bothinternational and domestic users.10 In2008, payments exceeded receipts by1.0 billion notes, most of which were ofthe $100 denomination. For this reason,the value of currency in circulation, asof December 31, increased 7.8 percentfrom December 31, 2007, to $853.2 bil-lion.11

Board staff worked with the TreasuryDepartment, the U.S. Secret Service,and the Reserve Banks’ Currency Tech-nology Office to develop more-securedesigns for the $5 and $100 FederalReserve notes. Reserve Banks issuedthe redesigned $5 note in March 2008.The Treasury is continuing to develop anew design for the $100 note.

Consistent with the requirements ofthe Presidential $1 Coin Act, the Fed-eral Reserve and the Mint conductedadditional outreach to depository insti-tutions and coin users to gauge demandfor the coins and to anticipate andeliminate obstacles to the efficient cir-culation of $1 coins. Board staff workedwith the Reserve Banks’ Cash Product

Office to address other coin distributionand management issues, includingincreased coin inventories, resultingpartially from the United States Mint’scommemorative circulating coin pro-grams.

Reserve Banks continued implement-ing a program to extend the useful lifeof the System’s BPS 3000 high-speedcurrency-processing machines. The pro-gram will replace the operating systemsof the current equipment, which willhelp improve processing efficiency.Reserve Banks are in the early stages ofadopting a new cash automation plat-form, known as the currency and coinhandling environment, or CACHE. Thenew system will facilitate control andimprove efficiency in cash operations,provide an expansive and responsivemanagement information reporting sys-tem with superior and flexible reporttools, facilitate business continuity andcontingency planning, and enhance thesupport provided to customers and busi-ness partners.

Developments inFiscal Agency andGovernment Depository Services

As fiscal agents and depositories for thefederal government, the Federal Re-serve Banks provide services related tothe federal debt, help the Treasury col-lect funds owed to the federal govern-ment, process electronic and check pay-ments for the Treasury, maintain theTreasury’s bank account, and investTreasury balances. Reserve Banks alsoprovide certain fiscal agency and de-pository services to other entities.

The total cost of providing fiscalagency and depository services to theTreasury and other entities in 2008amounted to $461.1 million, comparedwith $458.2 million in 2007 (seetable, next page). Treasury-related costs

10. The Federal Reserve measures demand forU.S. currency in terms of growth in net payments(payments to circulation minus receipts from cir-culation). International demand for U.S. currencyis influenced primarily by political and economicuncertainties associated with certain foreign cur-rencies, which contrast with the U.S. dollar’s rela-tively high degree of stability.

11. This increase is double the 3.9 percentaverage annual increase over the last five years.


were $429.9 million in 2008, com-pared with $427.2 million in 2007, anincrease of 0.6 percent. The cost ofproviding services to other entitieswas $31.3 million, compared with$31.0 million in 2007. In 2008, as in2007, the Treasury and other entitiesreimbursed Reserve Banks for the costsof providing these services.

Debt Services

The Reserve Banks support Treasury’swholesale securities services by auc-tioning, providing book-entry safekeep-ing for, and transferring Treasury secu-

rities. Reserve Bank operating expensesfor these activities totaled $46.4 mil-lion in 2008, compared with $50.1 mil-lion in 2007. To improve support ofTreasury-securities auction activities,the Reserve Banks implemented a newTreasury-securities auction applicationand infrastructure in April 2008. TheBanks conducted 263 Treasury securi-ties auctions in 2008, compared with220 in 2007. In addition, the Banks pro-cessed 12.8 million transfers of Trea-sury securities in 2008 through the Fed-wire Securities Service, compared with13.7 million transfers in 2007.

Expenses of the Federal Reserve Banks for Fiscal Agency and Depository Services,2006–2008

Thousands of dollars

Agency and service 2008 2007 2006

Department of the Treasury

Bureau of the Public DebtTreasury retail securities 72,373.7 74,149.2 73,931.4Treasury securities safekeeping and transfer 9,304.7 8,687.7 7,535.2Treasury auction 37,071.6 41,372.0 23,594.9Computer infrastructure development and support 4,463.7 3,558.7 3,853.1Other services 909.9 724.5 1,578.7

Total 124,123.7 128,492.1 110,493.2

Financial Management ServicePayment services

Government check processing 16,366.9 17,522.7 20,918.6Automated clearinghouse 6,530.5 6,050.3 5,823.1Fedwire funds transfers 108.3 116.8 123.1Other payment programs 85,212.8 81,636.9 69,696.8

Collection servicesTax and other revenue collections 37,412.1 38,254.5 37,095.5Other collection programs 11,767.6 12,483.6 14,122.6

Cash-management services 51,620.6 46,093.6 48,320.2Computer infrastructure development and support 65,058.6 70,999.9 67,046.4Other services 7,577.4 7,245.7 7,414.8

Total 281,654.8 280,404.2 270,561.2

Other TreasuryTotal 24,073.1 18,258.6 16,786.3

Total, Treasury 429,851.5 427,154.9 397,840.7

Other Federal Agencies

Department of AgricultureFood coupons 2,676.3 2,706.0 2,929.8

United States Postal ServicePostal money orders 8,257.7 8,913.2 9,334.4

Other agenciesOther services 20,358.4 19,412.0 15,977.1

Total, other agencies 31,292.3 31,031.1 28,241.4

Total reimbursable expenses 461,143.9 458,186.0 426,082.1

Note: Numbers in bold reflect restatements due to recategorization.


Reserve Banks also support the Trea-sury’s retail securities program that pri-marily serves individual investors.Reserve Bank operating expenses forthese activities were $72.4 million in2008, compared with $74.1 million in2007. Reserve Banks operate theLegacy Treasury Direct system, whichallows investors to purchase and holdmarketable Treasury securities directlywith the Treasury instead of through afinancial institution. The Legacy Trea-sury Direct system held $63.4 billion(par value) of Treasury securities as ofDecember 31. The Banks also issue,service, and redeem nonmarketable sav-ings bonds. The Banks printed andmailed more than 22.6 million savingsbonds in 2008, a 9.7 percent decreasefrom 2007. Overall, the volume of retailsecurities transactions processed by theReserve Banks has declined for severalyears and, consequently, the Bankshave reduced expenses and staffinglevels.

Payments Services

Reserve Banks process both electronicand check payments for the Treasury.Reserve Bank operating expenses forprocessing government payments andfor payments-related programs totaled$108.2 million in 2008, compared with$105.3 million in 2007. In 2008, theBanks processed 1,132 million ACHpayments for the Treasury, an increaseof 10.2 percent from 2007. They alsoprocessed 269.4 million governmentchecks, an increase of 26.1 percentfrom 2007. The increase in ACH andcheck payments is largely attributableto economic stimulus payments issuedin 2008.

The proportion of government checksprocessed in paper form continues todecline, as an increasing number ofdepository institutions present checks in

image form. Of all the governmentchecks processed by the Reserve Banksin 2008, 23 percent were presented inpaper form and 77 percent in imageform, compared with 54 percent and46 percent, respectively, in 2007.

Reserve Banks also support the Trea-sury’s initiative to convert check bene-fit payments to direct deposit. In 2008,more than 577,000 check paymentswere converted to direct deposit.

Collection Services

Reserve Banks support several Treasuryprograms that serve to collect fundsowed the federal government. ReserveBank operating expenses related tothese programs totaled $49.2 million in2008, compared with $50.7 million in2007. For example, the Banks operatethe Federal Reserve Electronic TaxApplication (FR-ETA), which providestaxpayers a same-day electronic federaltax payment alternative. FR-ETA col-lected $505.0 billion for the Treasury in2008, compared with $519.8 billion in2007.

In addition, the Reserve Banks oper-ate Pay.gov, a Treasury program thatallows the public to use the Internet toinitiate and authorize payment for fed-eral government goods and services.They also operated the Treasury’s PaperCheck Conversion and ElectronicCheck Processing programs, wherebychecks written to government agenciesare converted into ACH transactions atthe point of sale or at lockbox locations.In 2008, Reserve Banks originated35.6 million ACH transactions throughthese three programs, compared with15.3 million in 2007. At the Treasury’sdirection, Reserve Banks worked toensure a smooth transition of the PaperCheck Conversion and ElectronicCheck Processing programs to a com-mercial bank effective in early 2009.


Treasury Cash-ManagementServices

The Treasury maintains an operatingcash account at the Reserve Banks, andinvests the funds it does not need for agiven day’s payments with qualifieddepository institutions through severalinvestment programs supported by theReserve Banks. Reserve Bank operatingexpenses related to these programs andother cash management initiativestotaled $51.6 million in 2008, comparedwith $46.1 million in 2007. In the Trea-sury Tax and Loan (TT&L) program,qualified depository institutions collecttax payments and may retain thesefunds as investments for the Treasury.The Treasury also invests funds at cer-tain TT&L depositories through directdeposits. These fully collateralizedinvestments are either callable ondemand or set for a term. In 2008,Reserve Banks placed a total of$783.1 billion in immediately callableinvestments—including funds investedthrough retained tax deposits and directinvestments—and $1,217.8 billion interm investments. In addition, the Trea-sury may invest a portion of its op-erating funds directly with TT&Ldepositories through its repurchaseagreements program. In 2008, theReserve Banks placed a total of$225.8 billion of investments throughthis program.

In 2008, the Reserve Banks andTreasury continued work on the Collec-tions and Cash Management Modern-ization (CCMM) initiative, which is amultiyear effort to streamline, modern-ize, and improve the services, systems,and processes supporting the Treasury’scollections and cash management pro-grams. Several Reserve Banks havebeen selected to work on aspects of theCCMM initiative.

Services Provided to Other Entities

When permitted by federal statute orwhen required by the Secretary of theTreasury, Reserve Banks provide fiscalagency and depository services to otherdomestic and international entities. Themajority of the work performed forthese entities is securities-related.

Electronic Access toReserve Bank Services

In 2008, the Federal Reserve Bankssubstantially completed the migrationof computer interface customers to Fed-Line Direct and FedLine Command.12

This migration, typically for high-volume depository institutions, and theFedLine Advantage migration, typicallyfor low- to moderate-volume depositoryinstitutions, complete the ReserveBanks’ initiative to migrate electronicaccess to Reserve Bank services to inter-net-protocol-based electronic access.13

Information Technology

In 2008, the Federal Reserve continuedto develop and implement the ReserveBanks’ IT strategy, further strengthenedIT governance, managed informationsecurity risk, and analyzed and coordi-nated the System’s IT investments.

In 2008, Federal Reserve InformationTechnology (FRIT) continued to leadReserve Bank efforts to transition to

12. FedLine Direct is a computer-to-computerelectronic access channel used to access criticalpayment services, such as Fedwire Funds, Fed-wire Securities, National Settlement, andFedACH Services. FedLine Command is a lower-cost internet-protocol-based computer-to-computer electronic access channel for file deliv-ery services, including the FedACH Service.

13. FedLine Advantage is a web-based elec-tronic access channel used to access critical pay-ment services. The Reserve Banks completed theFedLine Advantage migration in 2006.


a more-robust information securitymodel. The Information Security Archi-tecture Framework (ISAF), a three-yearprogram, was successfully completed.ISAF was developed to respond to thecontinuing and increasingly sophisti-cated security threats facing informa-tion technology systems and to improveinformation security at all points in theFederal Reserve. Through ISAF, theSystem was able to implement projectsthat enhanced user authentication, sepa-rated sensitive applications and infra-structure from low- and moderate-risksystems, and strengthened complianceand patch management. FRIT will con-tinue working to address residual infor-mation security risks.

To enable certain functionalities and,secondly, to help address the businessimplications of reduced demand formainframe services, Reserve Banks areengaged in a multiyear effort to movemajor business applications off themainframe and to a distributed environ-ment. In 2008, the new Treasury auto-mated auction processing system be-came one of the first major businessapplications to be migrated.

Examinations of theFederal Reserve Banks

Section 21 of the Federal Reserve Actrequires the Board of Governors toorder an examination of each FederalReserve Bank at least once a year. TheBoard performs its own reviews andengages a public accounting firm. Thepublic accounting firm performs anannual audit of the combined financialstatements of the Reserve Banks (seethe “Federal Reserve Banks CombinedFinancial Statements” section of thisreport) as well as the annual financialstatements of each of the 12 Banks andthe consolidated limited liability com-pany (LLC) entities. The Reserve Banks

use the framework established by theCommittee of Sponsoring Organiza-tions of the Treadway Commission(COSO) to assess their internal controlsover financial reporting, including thesafeguarding of assets. The ReserveBanks have further enhanced their as-sessments under the COSO frameworkto strengthen the key control assertionprocess and, in 2008, again met therequirements of the Sarbanes-Oxley Actof 2002. Within this framework, themanagement of each Reserve Bank pro-vides an assertion letter to its board ofdirectors annually that confirms adher-ence to COSO standards, and a publicaccounting firm issues an attestationreport to each Bank’s board of directorsand to the Board of Governors.

In 2008, the Board engaged Deloitte& Touche LLP (D&T) for the audits ofthe individual and combined financialstatements of the Reserve Banks andthose of the consolidated LLC enti-ties. Fees for D&T’s services totaled$9.5 million. Of the total fees, $2.3 mil-lion were for the audits of the consoli-dated LLC entities that are associatedwith recent Federal Reserve actions toaddress the financial crisis, and are con-solidated in the financial statements ofthe Federal Reserve Bank of New York(the New York Reserve Bank).14 Toensure auditor independence, the Boardrequires that D&T be independent in allmatters relating to the audit. Specifi-cally, D&T may not perform servicesfor the Reserve Banks or others thatwould place it in a position of auditingits own work, making managementdecisions on behalf of the ReserveBanks, or in any other way impairing

14. Each LLC will reimburse the Board ofGovernors for the fees related to the audit of itsfinancial statements from the entity’s availablenet assets.


its audit independence. In 2008, oneReserve Bank engaged D&T fornonaudit consulting services for whichthe fees were immaterial.

The Board’s annual examination ofthe Reserve Banks and the consoli-dated LLC entities includes a widerange of off-site and on-site oversightactivities, conducted primarily by theDivision of Reserve Bank Operationsand Payment Systems. Division person-nel monitor the activities of eachReserve Bank on an ongoing basis andconduct a comprehensive on-site reviewof each Reserve Bank at least onceevery three years. The reviews alsoinclude an assessment of the internalaudit function’s conformance to Inter-national Standards for the ProfessionalPractice of Internal Auditing, conform-ance to applicable policies and proce-dures, and the audit department’sefficiency.

To assess compliance with thepolicies established by the FederalReserve’s Federal Open Market Com-mittee (FOMC), the division alsoreviews the accounts and holdings ofthe System Open Market Account(SOMA) at the New York ReserveBank and the foreign currency opera-tions conducted by that Bank. In addi-tion, D&T audits the schedule of par-ticipated asset and liability accounts andthe related schedule of participatedincome accounts at year-end. TheFOMC receives the external audit re-ports and the report on the division’sexamination.

Income and Expenses

The table opposite summarizes theincome, expenses, and distributions ofnet earnings of the Federal ReserveBanks for 2008 and 2007. Income in2008 was $41,046 million, comparedwith $42,576 million in 2007.

Expenses totaled $5,723 million($3,232 million in operating expenses,$901 million in interest paid to deposi-tory institutions on reserve balances andearnings credits granted to depositoryinstitutions, $737 million in interestexpense on securities sold under agree-ments to repurchase, $352 million inassessments for Board of Governorsexpenditures, and $500 million for cur-rency costs).15 Net additions to anddeductions from current net incomeshowed a net profit of $3,341 million,which consists of $3,769 million inrealized gains on sales of U.S. govern-ment securities and $1,266 million inunrealized gains on investments de-nominated in foreign currencies reval-ued to reflect current market exchangerates, reduced by $1,693 million in netlosses associated with consolidatedvariable interest entities (VIEs). Divi-dends paid to member banks, set at6 percent of paid-in capital by section7(1) of the Federal Reserve Act, totaled$1,190 million, $198 million more thanin 2007; the increase reflects an in-crease in the capital and surplus ofmember banks and a consequent in-crease in the paid-in capital stock of theReserve Banks.

Payments to the U.S. Treasury in theform of interest on Federal Reservenotes totaled $31,689 million in 2008,down from $34,598 million in 2007; thepayments equal net income after thededuction of dividends paid and of theamount necessary to equate the ReserveBanks’ surplus to paid-in capital.

In the “Statistical Tables” section ofthis report, table 10 details the incomeand expenses of each Reserve Bank for

15. Effective October 9, 2008, the ReserveBanks began paying explicit interest on reservebalances held by depository institutions at theReserve Banks as authorized by the EmergencyEconomic Stabilization Act of 2008.


2008, and table 11 shows a condensedstatement for each Bank for the years1914 through 2008; table 9 is a state-ment of condition for each Bank, andtable 13 gives the number and annualsalaries of officers and employees foreach Bank. A detailed account of theassessments and expenditures of theBoard of Governors appears in the sec-tion “Board of Governors FinancialStatements.”

SOMA Holdings and Loans

The Federal Reserve Banks’ aver-age net daily holdings of securitiesand loans during 2008 amounted to$1,035,700 million, an increase of$233,072 million from 2007 (see table,next page).

SOMA Securities Holdings

The average daily holdings of U.S. gov-ernment, federal agency, and govern-ment-sponsored enterprise (GSE) secu-rities decreased by $235,014 million, toan average daily level of $547,165 mil-lion. The decrease is due to the sale ofsecurities during 2008 and maturingsecurities that were not replaced, offsetby the purchase of federal agency andGSE securities beginning in 2008.Average daily holdings of securitiespurchased under agreements to resell in2008 were $86,130 million, an increaseof $54,447 million from 2007, while theaverage daily balance of securities soldunder agreements to repurchase was$55,034 million, an increase of $20,486million from 2007. Average daily hold-ings of investments denominated in for-

Income, Expenses, and Distribution of Net Earningsof the Federal Reserve Banks, 2008 and 2007

Millions of dollars

Item 2008 2007

Current income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41,046 42,576Current expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,870 5,198

Operating expenses1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,232 3,270Interest paid to depository institutions and earnings credits granted2 . . . . . . . . 901 240Interest expense on securities sold under agreements to repurchase . . . . . . . . . 737 1,688

Current net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36,175 37,378Net additions to (deductions from, −) current net income . . . . . . . . . . . . . . . . . . . . 3,341 1,886

Profits on sales of U.S. government securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,769 . . .Profits on foreign exchange transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,266 1,886Net loss from consolidated VIEs3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . −1,693 . . .

Assessments by the Board of Governors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 853 872For Board expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 352 296For currency costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 576

Change in funded status of benefit plans4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . –3,159 324

Comprehensive income before payments to Treasury . . . . . . . . . . . . . . . . . . . . . . . . 35,504 38,716Dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,190 992Transferred to surplus and change in accumulated other

comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,626 3,126

Payments to U.S. Treasury5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31,689 34,598

Note: Numbers in bold reflect reclassification ofamounts to maintain comparability for the years presented.

1. Includes a net periodic pension expense of $160million in 2008 and $110 million in 2007.

2. In October 2008, the Reserve Banks began to payinterest to depository institutions on qualifying balances.

3. Includes $961 million of interest earnings on loansextended by the New York Reserve Bank in 2008.

4. Subsequent to the adoption of SFAS 158 in 2006,the Reserve Banks began to recognize the change infunded status of benefit plans as an element of othercomprehensive income in their Statements of Income andComprehensive Income.

5. Interest on Federal Reserve notes.. . . Not applicable.


eign securities in 2008 were $24,212million, compared with $21,325 millionin 2007. During 2008, the FederalReserve authorized increases in theamount of central bank liquidity swapsand in the number of eligible foreigncentral banks. The average daily bal-ance of central bank liquidity swapdrawings was $160,331 million in 2008and $532 million in 2007.

The average rate of interest earnedon the Reserve Banks’ holdings ofgovernment securities decreased to4.68 percent, from 4.95 percent in 2007.The average interest rates for securitiespurchased under agreements to reselland securities sold under agreementsto repurchase were 2.20 percent and1.34 percent, respectively, in 2008.Investments denominated in foreigncurrencies and central bank liquidityswaps earned interest at average rates of

2.57 percent and 2.25 percent, respec-tively, in 2008.

Lending

In 2008, average daily primary, second-ary, and seasonal credit extended in-creased $31,386 million to $32,022 mil-lion and term auction credit extendedunder the Term Auction Facility in-creased $172,083 million to $172,905million. The average rate of interestearned on primary, secondary, and sea-sonal credit decreased to 1.60 percent in2008, from 5.20 percent in 2007, whilethe average interest rate on term auctioncredit decreased to 1.91 percent in2008, from 4.66 percent in 2007.

During 2008, the Federal Reserveestablished several lending facilitiesunder authority of section 13(3) of theFederal Reserve Act. These includedthe Primary Dealer Credit Facility

SOMA Holdings and Loans of the Federal Reserve Banks, 2008 and 20071

Millions of dollars except as noted

Item

Average dailyassets (+)/

liabilities(−)2

Currentincome (+)/expense (−)

Average interestrate (percent)

2008 2007 2008 2007 2008 2007

U.S. government securities3 . . . . . . . . . . . . . . . . . . . . . . 547,165 782,179 25,631 38,707 4.68 4.95Securities purchased under agreements to resell . . . 86,130 31,683 1,891 1,591 2.20 5.02Securities sold under agreeements to repurchase . . . −55,034 −34,548 −737 −1,688 1.34 4.89Investments denominated in foreign currencies4 . . . 24,212 21,325 623 546 2.57 2.56Central bank liquidity swaps5 . . . . . . . . . . . . . . . . . . . . 160,331 532 3,606 28 2.25 5.34Primary, secondary, and seasonal credit6 . . . . . . . . . . 32,022 636 512 33 1.60 5.20Term auction credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172,905 822 3,305 38 1.91 4.66Other loans

Primary dealer and other broker-dealer credit7 . . 28,298 . . . 511 . . . 1.81 . . .AMLF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,036 . . . 470 . . . 2.24 . . .Credit extended to AIG8 . . . . . . . . . . . . . . . . . . . . . . . 18,636 . . . 2,367 . . . 12.70 . . .

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,035,700 802,628 38,179 39,256 3.69 4.89

Note: Amounts in bold reflect restatements due tochanges in previously reported data and recategorization.

1. Does not include loans to consolidated VIEs.2. Based on holdings at opening of business.3. Includes federal agency and GSE obligations

beginning in 2008.4. Excludes accrued interest. Investments denomi-

nated in foreign currencies are revalued daily at marketexchange rates.

5. Dollar value of foreign currency held under theseagreements valued at the exchange rate to be used when

the foreign currency is returned to the foreign centralbank. This exchange rate equals the market exchangerate used when the foreign currency was acquired fromthe foreign central bank.

6. Excludes indebtedness assumed by the FederalDeposit Insurance Corporation.

7. Includes credit extended through the PDCF andcredit extended to certain other broker-dealers.

8. Excludes credit extended to consolidated LLCs andundrawn amounts.

. . . Not applicable.


(PDCF), the Asset-Backed CommercialPaper Money Market Mutual FundLiquidity Facility (AMLF), and theAmerican International Group, Inc.(AIG) credit line. Amounts funded bythe Reserve Banks under these pro-grams are recorded as loans by theReserve Banks. During 2008, the aver-age daily holdings under the PDCFand AMLF were $28,298 million and$21,036 million, respectively, withaverage rates of interest earned of1.81 percent and 2.24 percent, respec-tively. The average daily balance ofcredit extended to AIG in 2008 was$18,636 million, which earned interestat an average rate of 12.70 percent.

Investments of ConsolidatedVariable Interest Entities

Additional lending facilities establishedduring 2008 under authority of section13(3) of the Federal Reserve Act in-volved creating and lending to specialpurpose vehicles (SPVs).16 The SPVswere funded by the New York ReserveBank and acquired financial assets andfinancial liabilities pursuant to the pol-icy objectives. The SPVs were deter-mined to be VIEs, and the New YorkReserve Bank is considered to be theprimary beneficiary of each.17 Consis-

tent with generally accepted accountingprinciples, the assets and liabilities ofthese VIEs have been consolidated withthe assets and liabilities of the NewYork Reserve Bank in the preparationof the statements of condition includedin this report.18 The proceeds at thematurity or the liquidation of the VIEs’assets will be used to repay the loansextended by the New York ReserveBank. Information regarding the Re-serve Banks’ lending to the VIEs andthe asset portfolios of each VIE is asdescribed in the table, next page.

Reserve Bank Branch Closure

The Board approved the discontinuationof the New York Reserve Bank’s BuffaloBranch effective October 31.19 At thetime of the discontinuation, the Branchconsisted of a small research and com-munity outreach staff and the Branchboard of directors, which provided eco-nomic and financial intelligence to theBank. The Branch had not performedfinancial services since 2004. TheBranch board of directors was replacedby an upstate New York regional advi-sory board, which provides economicand financial intelligence.

Federal Reserve Bank Premises

A number of Reserve Banks took actionin 2008 to upgrade and refurbish their

16. For further information on the establish-ment and policy objectives of these SPVs, see the“Monetary Policy Report” section of this report.

17. A VIE is an entity for which the value ofthe beneficiaries’ financial interests in the entitychanges with changes in the fair value of its netassets. A VIE is consolidated by the financialinterest holder that is determined to be the pri-mary beneficiary of the VIE because the primarybeneficiary will absorb a majority of the VIE’sexpected losses, receive a majority of the VIE’sexpected residual gains, or both. To determinewhether it is the primary beneficiary of a VIE, theReserve Bank evaluates the VIE’s design, capitalstructure, and the relationships among the vari-able interest holders.

18. As a consequence of the consolidation, theextensions of credit from the New York ReserveBank to the VIEs are eliminated, the net assets ofthe VIEs appear as assets in table 9 in the “Statis-tical Tables” section of this report, and the liabili-ties of the VIEs to entities other than the NewYork Reserve Bank, including those with recourseonly to the portfolio holdings of the VIEs, areincluded in other liabilities in statistical table 9.

19. Before the Buffalo Branch closure, theonly discontinued Branch in the history of theSystem was the Federal Reserve Bank of SanFrancisco’s Spokane Branch, which was discon-tinued in 1938.


facilities and streamline operations. TheKansas City Bank moved into its newbuilding, and the Seattle Branch of theSan Francisco Bank dedicated its newbuilding. The multiyear renovation pro-gram at the New York Bank’s head-quarters building also continued, whilethe St. Louis Bank continued a long-term facility redevelopment programthat includes the construction of anaddition to the Bank’s headquartersbuilding. The New York Bank madeprogress on a program to enhance thebusiness resiliency of its informationtechnology systems and to upgradefacility support for the Bank’s openmarket operations, central bank ser-vices, and data center operations.

Security-enhancement programs con-tinued at several facilities, includingconstruction of security improvementsto the Richmond Bank’s headquartersbuilding and the development of remotevehicle-screening facility designs forthe Philadelphia and Dallas Banks.

Additionally, the St. Louis Bank soldits Little Rock Branch building, and theSan Francisco Bank continued itsefforts to sell the former Seattle Branchbuilding.

For more information, see Table 14in the “Statistical Tables” section of thisreport, which details the acquisitioncosts and net book value of the FederalReserve Banks and Branches.

Key Financial Data for Consolidated Variable Interest Entities as of December 31, 2008

Millions of dollars

Item

Commer-cial PaperFundingFacility

LLC(CPFF)

MaidenLaneLLC1

MaidenLane IILLC1

MaidenLane III

LLC1Total

Net portfolio assets2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 334,910 30,635 19,195 27,256 411,996Liabilities of consolidated VIEs . . . . . . . . . . . . . . . . . . . . . . −812 −4,951 −2 −48 −5,813Net portfolio assets available3 . . . . . . . . . . . . . . . . . . . . . . . . 334,098 25,684 19,193 27,208 406,183

Loans extended by the New York Reserve Bank4 . . . . . . 333,020 29,087 19,522 24,384 406,013Other beneficial interests4,5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,188 1,003 5,022 7,213Total loans and other beneficial interests . . . . . . . . . . . . . . 333,020 30,275 20,525 29,406 413,226

Allocation of excess/(deficiency) of net portfolioassets available over loans and otherbeneficial interests6

Loans extended by the New York Reserve Bank . . . . 1,078 −3,403 −329 0 −2,654Other beneficial interests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . −1,188 −1,003 −2,198 −4,389Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,078 −4,591 −1,332 −2,198 −7,043

1. Maiden Lane LLC was formed to acquire certainassets of Bear Stearns; Maiden Lane II LLC and MaidenLane III LLC were formed to acquire certain assets ofAIG and its subsidiaries.

2. Maiden Lane, Maiden Lane II, and Maiden Lane IIIholdings are recorded at fair value. Fair value reflects anestimate of the price that would be received upon sellingan asset if the transaction were to be conducted in anorderly market on the measurement date. CPFF holdingsare recorded at book value, which includes amortizedcost and related fees.

3. Represents the net assets available for repayment ofloans extended by the New York Reserve Bank and otherbeneficiaries of the consolidated VIEs as of December31, 2008.

4. Book value. Includes accrued interest.5. The “other beneficiary” for Maiden Lane is JPMor-

gan Chase & Co., and AIG is the “other beneficiary” forMaiden Lane II and Maiden Lane III.

6. Represents the allocation of the change in net assetsand liabilities of the consolidated VIEs available forrepayment of the loans extended by the New YorkReserve Bank and other beneficiaries of the consolidatedVIEs. The differences between the fair value of the netassets available and the face value of the loans (includ-ing accrued interest) are indicative of gains or losses thatwould be incurred by the beneficiaries if the assets hadbeen fully liquidated at prices equal to the fair value asof December 31, 2008.

. . . Not applicable.


Pro Forma Financial Statements for Federal Reserve Priced Services

Pro Forma Balance Sheet for Federal Reserve Priced Services, December 31, 2008 and 2007

Millions of dollars

Item 2008 2007

Short-term assets (Note 1)Imputed reserve requirements on

clearing balances . . . . . . . . . . . . . . . . 418.8 755.7Imputed investments . . . . . . . . . . . . . . . . . 4,292.7 6,465.7Receivables . . . . . . . . . . . . . . . . . . . . . . . . . 60.0 66.7Materials and supplies . . . . . . . . . . . . . . . 2.1 1.8Prepaid expenses . . . . . . . . . . . . . . . . . . . . 29.2 28.5Items in process of collection . . . . . . . . . 983.1 1,769.6

Total short-term assets . . . . . . . . 5,786.0 9,088.0

Long-term assets (Note 2)Premises . . . . . . . . . . . . . . . . . . . . . . . . . . . . 441.1 453.5Furniture and equipment . . . . . . . . . . . . . 113.0 130.2Leases, leasehold improvements, and

long-term prepayments . . . . . . . . . . 76.7 64.2Prepaid pension costs . . . . . . . . . . . . . . . . 0.0 484.6Deferred tax asset . . . . . . . . . . . . . . . . . . . . 313.2 109.4

Total long-term assets . . . . . . . . . 944.0 1,242.0

Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . 6,729.9 10,330.0

Short-term liabilitiesClearing balances and balances

arising from early creditof uncollected items . . . . . . . . . . . . . 2,391.8 7,641.1

Deferred-availability items . . . . . . . . . . . 2,779.8 1,685.1Short-term debt . . . . . . . . . . . . . . . . . . . . . . 0.0 0.0Short-term payables . . . . . . . . . . . . . . . . . . 573.5 102.4

Total short-term liabilities . . . . . 5,745.1 9,428.5

Long-term liabilitiesLong-term debt . . . . . . . . . . . . . . . . . . . . . . 0.0 0.0Accrued benefit costs . . . . . . . . . . . . . . . . 605.6 385.0

Total long-term liabilities . . . . . . 605.6 385.0

Total liabilities . . . . . . . . . . . . . . . . . . . . . . 6,350.7 9,813.5

Equity (including accumulated othercomprehensive loss of$690.6 million and$237.9 million atDecember 31, 2008 and 2007,respectively) . . . . . . . . . . . . . . . . . . . . 379.2 516.5

Total liabilities and equity (Note 3) . . . 6,729.9 10,330.0

Note: Components may not sum to totals because ofrounding.

The accompanying notes are an integral part of thesepro forma priced services financial statements.


Pro Forma Income Statement for Federal Reserve Priced Services, 2008 and 2007

Millions of dollars

Item 2008 2007

Revenue from services provided todepository institutions (Note 4) . . . . . . . . 773.4 878.4

Operating expenses (Note 5) . . . . . . . . . . . . . . . 808.7 888.2

Income from operations . . . . . . . . . . . . . . . . . . . . –35.3 –9.8

Imputed costs (Note 6)Interest on float . . . . . . . . . . . . . . . . . . . . . . . . . –22.4 –32.0Interest on debt . . . . . . . . . . . . . . . . . . . . . . . . . . 0.0 0.0Sales taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.4 11.6FDIC Insurance . . . . . . . . . . . . . . . . . . . . . . . . . 0.5 –12.5 0.0 –20.4

Income from operations afterimputed costs . . . . . . . . . . . . . . . . . . . . . . . . . –22.8 10.6

Other income and expenses (Note 7)Investment income . . . . . . . . . . . . . . . . . . . . . . 181.2 362.3Earnings credits . . . . . . . . . . . . . . . . . . . . . . . . . –80.7 100.4 –228.5 133.8

Income before income taxes . . . . . . . . . . . . . . . . 77.6 144.5

Imputed income taxes (Note 6) . . . . . . . . . . . . . 24.2 45.5

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53.4 98.9

Memo: Targeted return on equity (Note 6) . . 66.5 80.4



Pro Forma Income Statement for Federal Reserve Priced Services, by Service, 2008

Millions of dollars

Item TotalCommercial

checkcollection

CommercialACH

Fedwirefunds

Fedwiresecurities

Revenue from services (Note 4) . . . . . . . . 773.4 605.2 86.6 59.9 21.6

Operating expenses (Note 5) . . . . . . . . . . . 808.7 644.4 84.4 59.0 20.9

Income from operations . . . . . . . . . . . . . . . . −35.3 −39.2 2.2 0.9 0.7

Imputed costs (Note 6) . . . . . . . . . . . . . . . . . −12.5 −13.8 0.3 0.8 0.3

Income from operations afterimputed costs . . . . . . . . . . . . . . . . . . . . . −22.8 −25.3 1.9 0.2 0.5

Other income and expenses,net (Note 7) . . . . . . . . . . . . . . . . . . . . . . 100.4 78.4 11.3 7.9 2.9

Income before income taxes . . . . . . . . . . . . 77.6 53.0 13.1 8.1 3.3

Imputed income taxes (Note 6) . . . . . . . . . 24.2 16.5 4.1 2.5 1.0

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53.4 36.5 9.0 5.5 2.3

Memo: Targeted return onequity (Note 6) . . . . . . . . . . . . . . . . . . . 66.5 51.9 7.6 5.3 1.7

Memo: Cost recovery (percent)(Note 8) . . . . . . . . . . . . . . . . . . . . . . . . . . 98.5 97.8 101.5 100.4 102.5




FEDERAL RESERVE BANKS

Notes to Pro Forma Financial Statements for Priced Services

(1) Short-Term Assets

The imputed reserve requirement on clearing balancesheld at Reserve Banks by depository institutions reflectsa treatment comparable to that of compensating balancesheld at correspondent banks by respondent institutions.The reserve requirement imposed on respondent balancesmust be held as vault cash or as balances maintained ata Reserve Bank; thus, a portion of priced services clear-ing balances held with the Federal Reserve is shown asrequired reserves on the asset side of the balance sheet.Another portion of the clearing balances is used tofinance short-term and long-term assets. The remainderof clearing balances is assumed to be invested in a port-folio of investments, shown as imputed investments.

Receivables are comprised of fees due the ReserveBanks for providing priced services and the share ofsuspense-account and difference-account balances relatedto priced services.

Materials and supplies are the inventory value ofshort-term assets.

Prepaid expenses include salary advances and traveladvances for priced-service personnel.

Items in process of collection are gross FederalReserve cash items in process of collection (CIPC),stated on a basis comparable to that of a commercialbank. They reflect adjustments for intra-System itemsthat would otherwise be double-counted on a consoli-dated Federal Reserve balance sheet; adjustments foritems associated with nonpriced items (such as those col-lected for government agencies); and adjustments foritems associated with providing fixed availability orcredit before items are received and processed. Amongthe costs to be recovered under the Monetary Control Actis the cost of float, or net CIPC during the period (thedifference between gross CIPC and deferred-availabilityitems, which is the portion of gross CIPC that involves afinancing cost), valued at the federal funds rate.

(2) Long-Term Assets

Long-term assets consist of long-term assets usedsolely in priced services, the priced-service portion oflong-term assets shared with nonpriced services, an esti-mate of the assets of the Board of Governors used in thedevelopment of priced services, and a deferred tax assetrelated to the priced services pension and postretirementbenefits obligation (see Note 3).

(3) Liabilities and Equity

Under the matched-book capital structure for assets,short-term assets are financed with short-term payablesand clearing balances. Long-term assets are financedwith long-term liabilities and core clearing balances. Asa result, no short- or long-term debt is imputed. Othershort-term liabilities include clearing balances main-tained at Reserve Banks and deposit balances arisingfrom float. Other long-term liabilities consist of accruedpostemployment, postretirement, and qualified and non-qualified pension benefits costs and obligations on capi-tal leases.

Effective December 31, 2006, the Reserve Banksimplemented the Financial Accounting Standard Board’s

Statement of Financial Accounting Standards (SFAS)No. 158, Employers’ Accounting for Defined Benefit

Pension and Other Postretirement Plans, which requiresan employer to record the funded status of its benefitplans on its balance sheet. In order to reflect the fundedstatus of its benefit plans, the Reserve Banks recognizedthe deferred items related to these plans, which includeprior service costs and actuarial gains or losses, on thebalance sheet. This resulted in an adjustment to the pen-sion and benefit plans related to priced services and therecognition of an associated deferred tax asset with anoffsetting adjustment, net of tax, to accumulated othercomprehensive income (AOCI), which is included inequity. The Reserve Bank priced services recognized anet pension liability in 2008 and a net pension asset in2007. The reduction in the System Retirement Plan’sfunded status in 2008 was due to reduced asset valuesand an increase in the projected benefit obligation. Thisreduction in the funded status resulted in a correspondingchange in AOCI of $452.7 million in 2008.

To satisfy the FDIC requirements for a well-capitalized institution, equity is imputed at 10 percent oftotal risk-weighted assets.

(4) Revenue

Revenue represents fees charged to depository institu-tions for priced services, and is realized from each insti-tution through one of two methods: direct charges to aninstitution’s account or charges against its accumulatedearnings credits (see Note 7).

(5) Operating Expenses

Operating expenses consist of the direct, indirect, andother general administrative expenses of the ReserveBanks for priced services plus the expenses of the Boardof Governors related to the development of priced ser-vices. Board expenses were $7.2 million in 2008 and$6.7 million in 2007.

Effective January 1, 1987, the Reserve Banks imple-mented SFAS No. 87, Employers’ Accounting for Pen-sions. Accordingly, the Reserve Bank priced servicesrecognized qualified pension-plan operating expenses of$28.8 million in 2008 and $21.3 million in 2007. Oper-ating expenses also include the nonqualified pensionexpense of $5.4 million in 2008 and $3.1 million in2007. The implementation of SFAS No. 158 does notchange the systematic approach required by generallyaccepted accounting principles to recognize the expensesassociated with the Reserve Banks’ benefit plans in theincome statement. As a result, these expenses do notinclude amounts related to changes in the funded statusof the Reserve Banks’ benefit plans, which are reflectedin AOCI (see Note 3).

The income statement by service reflects revenue,operating expenses, imputed costs, other income andexpenses, and cost recovery. Certain corporate overheadcosts not closely related to any particular priced serviceare allocated to priced services based on an expense-ratiomethod. Corporate overhead was allocated among thepriced services during 2008 and 2007 as follows(in millions of dollars):


2008 2007

Check . . . . . . . . . . . . . . . . . . . . . 31.0 34.7ACH . . . . . . . . . . . . . . . . . . . . . . 4.6 4.3Fedwire Funds . . . . . . . . . . . . . 3.5 3.0Fedwire Securities . . . . . . . . . . 1.9 1.7

Total . . . . . . . . . . . . . . . . . . . . . . 41.2 43.7

(6) Imputed Costs

Imputed costs consist of income taxes, return onequity, interest on debt, sales taxes, an FDIC assessment,and interest on float. Many imputed costs are derivedfrom the private-sector adjustment factor (PSAF) model.The cost of debt and the effective tax rate are derivedfrom bank holding company data, which serves as theproxy for the financial data of a representative private-sector firm, and are used to impute debt and incometaxes in the PSAF model. The after-tax rate of return onequity is based on the returns of the equity market as awhole, and is used to impute the profit that would havebeen earned had the services been provided by a private-sector firm.

Interest is imputed on the debt assumed necessary tofinance priced-service assets; however, no debt wasimputed in 2008 or 2007.

Effective in 2007, the Reserve Bank priced servicesimputed a one-time FDIC assessment credit. In 2008, thecredit offset $4.6 million of the imputed $5.1 millionassessment, resulting in a remaining credit of $8.0 mil-lion. The remaining credit can be used to offset up to90 percent of the assessment in the future.

Interest on float is derived from the value of float tobe recovered, either explicitly or through per-item fees,during the period. Float costs include costs for theCheck, Fedwire Funds, National Settlement Service,ACH, and Fedwire Securities services.

Float cost or income is based on the actual floatincurred for each priced service. Other imputed costs areallocated among priced services according to the ratio ofoperating expenses, less shipping expenses, for each ser-vice to the total expenses, less the total shippingexpenses, for all services.

The following shows the daily average recovery ofactual float by the Reserve Banks for 2008 in millions ofdollars:

Total float –1,191.8Unrecovered float −42.1

Float subject to recovery –1,149.7

Sources of recovery of floatIncome on clearing balances –89.3As-of adjustments 1.6Direct charges 111.8Per-item fees –1,173.8

Unrecovered float includes float generated by servicesto government agencies and by other central bank ser-vices. Float recovered through income on clearing bal-ances is the result of the increase in investable clearingbalances; the increase is produced by a deduction forfloat for CIPC, which reduces imputed reserve require-ments. The income on clearing balances reduces the floatto be recovered through other means. As-of adjustmentsand direct charges refer to float that is created by intert-erritory check transportation and the observance of non-standard holidays by some depository institutions. Suchfloat may be recovered from the depository institutionsthrough adjustments to institution reserve or clearing bal-ances or by billing institutions directly. Float recoveredthrough direct charges and per-item fees is valued at thefederal funds rate; credit float recovered through per-item fees has been subtracted from the cost base subjectto recovery in 2008.

(7) Other Income and Expenses

Other income and expenses consist of investment andinterest income on clearing balances and the cost of earn-ings credits. Investment income on clearing balances for2008 and 2007 represents the average coupon-equivalentyield on three-month Treasury bills plus a constantspread, based on the return on a portfolio of investments.Before October 9, 2008, the return was applied to thetotal clearing balance maintained, adjusted for the effectof reserve requirements on clearing balances. On October9, 2008, the Federal Reserve began paying interest onrequired reserve and excess balances held by depositoryinstitutions at Reserve Banks as authorized by the Emer-gency Economic Stabilization Act of 2008. As a result ofthis change, the investment return is applied only to therequired portion of the clearing balance. Other incomealso includes imputed interest on the portion of clearingbalances set aside as required reserves. Expenses forearnings credits granted to depository institutions ontheir clearing balances are based on a discounted averagecoupon-equivalent yield on three-month Treasury bills.

(8) Cost Recovery

Annual cost recovery is the ratio of revenue, includingother income, to the sum of operating expenses, imputedcosts, imputed income taxes, and targeted return onequity.


The Board of Governors and theGovernment Performance and Results Act

The Government Performance andResults Act (GPRA) of 1993 requiresthat federal agencies, in consultationwith Congress and outside stakeholders,prepare a strategic plan covering a multi-year period and submit an annual per-formance plan and performance report.Although the Federal Reserve is notcovered by the GPRA, the Board ofGovernors voluntarily complies withthe spirit of the act.

Strategic Plan, PerformancePlan, and Performance Report

The Board’s strategic plan articulatesthe Board’s mission, sets forth majorgoals, outlines strategies for achievingthose goals, and discusses the environ-ment and other factors that could affecttheir achievement. It also addressesissues that cross agency jurisdictionallines, identifies key quantitative mea-sures of performance, and discusses theevaluation of performance. The mostrecent strategic plan covers the period2008–2011.

Both the performance plan and theperformance report are prepared everytwo years. The performance plan in-cludes specific targets for some of theperformance measures identified in thestrategic plan and describes the opera-tional processes and resources neededto meet those targets. It also discussesvalidation of data and verification ofresults. The most recent performanceplan covers the period 2008–09.

The performance report discusses theBoard’s performance in relation to its

goals. The most recent performancereport covers the period 2006–07.

The strategic plan, performance plan,and performance report are avail-able on the Board’s website, atwww.federalreserve.gov/boarddocs/rptcongress. The Board’s mission state-ment and a summary of the FederalReserve’s goals and objectives, as setforth in the most recently released stra-tegic and performance plans, are listedbelow. Updated documents will beposted on the website as they arecompleted.

Mission

The mission of the Board is to fosterthe stability, integrity, and efficiency ofthe nation’s monetary, financial, andpayment systems to promote optimalmacroeconomic performance.

Goals and Objectives

The Federal Reserve has six primarygoals with interrelated and mutuallyreinforcing elements.

Goal

Conduct monetary policy that promotesthe achievement of the statutory objec-tives of maximum employment andstable prices

Objectives

v Stay abreast of recent developmentsin and prospects for the U.S. economyand financial markets, and in those

181

abroad, so that monetary policy deci-sions will be well informed.

v Enhance our knowledge of the struc-tural and behavioral relationships inthe macroeconomic and financialmarkets, and improve the quality ofthe data used to gauge economic per-formance, through developmental re-search activities.

v Implement monetary policy effec-tively in rapidly changing economiccircumstances and in an evolving fi-nancial market structure.

v Contribute to the development of U.S.international policies and procedures,in cooperation with the U.S. Depart-ment of the Treasury and other agen-cies, with respect to global financialmarkets and international institutions.

v Promote understanding of FederalReserve policy among other govern-ment policy officials and the generalpublic.

Goal

Promote a safe, sound, competitive, andaccessible banking system and stablefinancial markets

Objectives

v Promote overall financial stability,manage and contain systemic risk,and identify emerging financial prob-lems early so that crises can beaverted.

v Provide a safe, sound, competitive,and accessible banking systemthrough comprehensive and effectivesupervision of U.S. banks, bank andfinancial holding companies, foreignbanking organizations, and relatedentities. At the same time, remainsensitive to the burden on supervisedinstitutions.

v Enhance efficiency and effectiveness,while remaining sensitive to the bur-den on supervised institutions, byaddressing the supervision function’s

procedures, technology, resource allo-cation, and staffing issues.

v Promote compliance by domestic andforeign banking organizations super-vised by the Federal Reserve withapplicable laws, rules, regulations,policies, and guidelines through acomprehensive and effective supervi-sion program.

Goal

Develop regulations, policies, and pro-grams designed to inform and protectconsumers, to enforce federal consumerprotection laws, to strengthen marketcompetition, and to promote access tobanking services in historically under-served markets

Objectives

v Be a leader in, and help shape thenational dialogue on, consumer pro-tection in financial services.

v Promote, develop, and strengtheneffective communications and col-laborations within the Board, the Fed-eral Reserve Banks, and other agen-cies and organizations.

Goal

Provide high-quality professional over-sight of Reserve Banks

Objective

v Produce high-quality assessments andoversight of Federal Reserve Systemstrategies, projects, and operations,including adoption of technology tomeet the business and operationalneeds of the Federal Reserve. Theoversight process and outputs shouldhelp Federal Reserve managementfoster and strengthen sound internalcontrol systems, efficient and reliableoperations, effective performance,and sound project management andshould assist the Board in the effec-


tive discharge of its oversight respon-sibilities.

Goal

Foster the integrity, efficiency, andaccessibility of U.S. payment and settle-ment systems

Objectives

v Develop sound, effective policies andregulations that foster payment sys-tem integrity, efficiency, and accessi-bility. Support and assist the Board inoverseeing U.S. dollar payment andsecurities settlement systems by as-sessing their risks and risk manage-ment approaches against relevant pol-icy objectives and standards.

v Conduct research and analysis thatcontributes to policy developmentand increases the Board’s and others’understanding of payment systemdynamics and risk.

Goal

Foster the integrity, efficiency, andeffectiveness of Board programs

Objectives

v Develop appropriate policies, over-sight mechanisms, and measurementcriteria to ensure that the recruiting,training, and retention of staff meetBoard needs.

v Establish, encourage, and enforce aclimate of fair and equitable treatmentfor all employees regardless of race,creed, color, national origin, age, orsex.

v Provide strategic planning and finan-cial management support needed forsound business decisions.

v Provide cost-effective and secureinformation resource managementservices to Board divisions, supportdivisional distributed-processing re-quirements, and provide analysis oninformation technology issues to theBoard, Reserve Banks, other financialregulatory institutions, and centralbanks.

v Efficiently provide safe, modern, se-cure facilities and necessary supportfor activities conducive to efficientand effective Board operations. Á

Government Performance and Results Act 183

Federal Legislative Developments

The Federal Reserve played an impor-tant role in the public debates leadingup to enactment of the Housing andEconomic Recovery Act of 2008(HERA) and the Emergency EconomicStabilization Act of 2008 (EESA). Eachof these laws provided the U.S. govern-ment with important new tools—utilized during 2008—to help addressthe causes and consequences of therecent and ongoing turmoil in the finan-cial markets.

Although the following summariesare not comprehensive reviews of theselaws, they highlight some of the keyprovisions, including those that affectFederal Reserve System functions.

This report also describes the HigherEducation Opportunity Act of 2008(HEOA), legislation that modified thedisclosure requirements for private edu-cational loans under the Truth in Lend-ing Act, which is administered by theBoard.

Housing and Economic RecoveryAct of 2008

On July 30, 2008, President Bushsigned into law the Housing and Eco-nomic Recovery Act of 2008 (HERA)(Pub. L. No. 110-289), which substan-tially revises the supervisory and regu-latory framework for housing-relatedgovernment-sponsored enterprises(GSEs), specifically, the FederalNational Mortgage Association (FannieMae), the Federal Home Loan Mort-gage Corporation (Freddie Mac), andthe Federal Home Loan Banks(FHLBs). Among other things, HERAestablishes a new, independent agency,

the Federal Housing Finance Agency(FHFA) to succeed to (i) the supervi-sory and regulatory responsibilities ofthe Office of Federal Housing Enter-prise Oversight (OFHEO) with respectto Fannie Mae and Freddie Mac (collec-tively, the enterprises) and of the Fed-eral Housing Finance Board with re-spect to the FHLBs, and (ii) theauthority of the Secretary of the Depart-ment of Housing and Urban Develop-ment (HUD) with respect to housinggoals and new program approvalrequirements for the enterprises.

To help stabilize and maintain confi-dence in the enterprises, the Act alsoprovides the Department of Treasurywith temporary authority to acquireobligations of the GSEs, as well asother securities of the enterprises. Inaddition, HERA includes provisions to

• modernize the mortgage insuranceprograms of the Federal HousingAdministration (FHA);

• create a new HOPE for Homeownersprogram within FHA to assist dis-tressed homeowners attempting torefinance into more sustainablemortgages;

• establish a nationwide mortgageoriginator licensing and registrationsystem; and

• improve the disclosures providedconsumers in connection with mort-gage transactions.

Treasury Authorization to ProvideFinancial Support to GSEs

As strains in financial markets intensi-fied in 2008, investors became increas-ingly worried that the capital of Fannie

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Mae and Freddie Mac would be insuffi-cient to absorb current and expectedlosses on their mortgage portfolios. Inlight of the important role that the GSEsplay in the housing finance markets andthe financial system, Treasury requestedand Congress passed changes as part ofHERA that granted temporary authorityto Treasury to purchase obligations ofthe GSEs and other securities (includingequity capital) issued by Fannie Maeand Freddie Mac, on such terms and insuch amounts as the Treasury deter-mines. The statute requires that theTreasury secretary determine that anysuch purchases are necessary to providestability to the financial markets, pre-vent disruptions in the availability ofmortgage finance, and protect the tax-payer. The Treasury’s authority to pur-chase such obligations or securitiesexpires on December 31, 2009; how-ever, the statute expressly permits theTreasury, after December 31, 2009, toretain (and exercise any rights associ-ated with) any obligations or securitiesacquired by such date.

On September 7, 2008, FHFA, afterconsulting with Treasury SecretaryHenry M. Paulson and Federal ReserveBoard Chairman Ben S. Bernanke,appointed itself conservator for FannieMae and Freddie Mac in accordancewith the conservatorship and consulta-tion provisions of HERA (described in‘‘Prompt Corrective Action and Conser-vatorship and Receivership’’ and‘‘Required Consultations’’ later in thissection). In conjunction with this action,the Treasury, utilizing the new purchaseauthority granted under HERA, enteredinto stock purchase agreements withFannie Mae and Freddie Mac pursuantto which Treasury acquired preferredshares of each enterprise. Pursuant tothese stock purchase agreements, Trea-sury agreed to provide up to $100 bil-lion to each enterprise to ensure that the

enterprise maintains a positive networth. In connection with these actions,Treasury also established a temporarysecured lending credit facility for Fan-nie Mae, Freddie Mac, and the FHLBs,and initiated a temporary program topurchase mortgage-backed securitiesguaranteed as to principal and interestby Fannie Mae and Freddie Mac. Theactions taken by FHFA and Treasuryhelped to stabilize the GSEs, as inves-tors became more confident of the gov-ernment’s support for the GSEs.

GSE Regulation and Supervision

Title I of HERA significantly reformsthe supervisory and regulatory frame-work for the GSEs, representing theculmination of almost a decade of workby Congress and other relevant parties.For several years prior to the enactmentof HERA, the Board had supported leg-islative changes to improve the supervi-sory and regulatory framework of theGSEs and to address the systemic risksposed by the retained mortgage port-folios of Fannie Mae and Freddie Mac.For example, the Board had urged theCongress to

• provide the supervisor of Fannie Maeand Freddie Mac with the authority toset and adjust the capital require-ments for the enterprises in a mannercomparable to the capital authorityavailable to the federal banking agen-cies with respect to insured banks;

• establish a clear and credible receiv-ership process for the enterprises; and

• limit the size of the retained port-folios of the enterprises by anchoringthem to a well-understood publicpurpose.

The supervisory and regulatorychanges enacted under HERA includeprovisions that address each of theseelements. As a general matter, HERA


allows the FHFA director to oversee theprudential operations of the GSEs andto ensure that each GSE operates in asafe and sound manner by, among othermeans, maintaining adequate capitaland establishing adequate internalcontrols.

Capital

Importantly, HERA grants the FHFAdirector broad new authority to set andadjust the capital requirements for theGSEs. For example, HERA providesthe director a free hand to establish, byregulation, risk-based capital require-ments for the enterprises to ensure thatthe enterprises operate in a safe andsound manner and maintain sufficientcapital and reserves to support the risksthat arise in the operations and manage-ment of the enterprises. Previously, fed-eral law specified, in many respects, thetype of risk-based capital standards thathad to be applied to the enterprises, thusgreatly constraining the ability of thesupervisor of the enterprises to alter ormodify these standards to improve theirrisk sensitivity or take account of finan-cial developments or improvements inmethodologies for assessing regulatorycapital adequacy.

HERA also authorizes the FHFAdirector to raise, by regulation, theminimum capital level for Fannie Maeand Freddie Mac under statute (gener-ally, core capital equal to at least2.5 percent of on-balance-sheet assetsplus 0.45 percent of mortgage-backedsecurities guaranteed by the enterpriseand other off-balance-sheet obligations)or by the FHLBs (generally, total capi-tal equal to at least 5 percent of totalassets). Specifically, the director is per-mitted to raise a GSE’s minimum capi-tal level to the extent needed to ensureits safe and sound operation. The direc-tor also must periodically review GSE

capital levels, and may increase, byorder, the minimum capital levels forthe enterprises or FHLBs on a tempo-rary basis, if necessary, and consistentwith the prudential regulation and thesafe and sound operation of the GSE.

Portfolio Limits

HERA requires that the FHFA directorestablish, by regulation, criteria govern-ing the portfolio holdings of FannieMae and Freddie Mac to ensure that theholdings are backed by sufficient capi-tal and consistent with the mission andthe safe and sound operations of theenterprises. In establishing such criteria,the director must consider (i) the abilityof the enterprises to provide a liquidsecondary market through securitizationactivities, (ii) the portfolio holdings ofthe enterprises in relation to the overallmortgage market, and (iii) the enter-prise’s adherence to the prudential man-agement and operation standards estab-lished by the director under HERA anddescribed below (see ‘‘Prudential Man-agement and Operation Standards’’).Additionally, the director is authorized,by order, to make temporary adjust-ments to these portfolio criteria, such asduring times of economic distress ormarket disruption, and to make anenterprise dispose of or acquire anyasset if the director determines that suchaction is consistent with the purposes ofthe Federal Housing Enterprises Finan-cial Safety and Soundness Act of 1992,as amended, or consistent with theauthorizing statutes for the enterprises.

Prompt Corrective Action andConservatorship and Receivership

HERA significantly alters the statutoryprovisions governing the supervisoryactions that may or must be takenagainst a GSE as its regulatory capitallevels decline, and addresses the man-

Federal Legislative Developments 187

ner in which a troubled or failing GSE’scondition may be resolved. As a generalmatter, HERA modifies the prompt cor-rective action framework applicable to atroubled GSE in a manner more closelytracking a similar regime used with atroubled insured depository institutionunder the Federal Deposit InsuranceAct (FDIA). In addition, HERA estab-lishes a process for placing a troubledGSE into conservatorship or receiver-ship and for managing such a conserva-torship or receivership broadly similarin nature to those used with insureddepository institutions under the FDIA.However, because GSEs, unlike insureddepository institutions, do not offer fed-erally insured deposits, the provisionsunder FDIA related to insured deposits(e.g., depositor preferences) and theFDIC’s deposit insurance fund (e.g.,least-cost resolution and related require-ments) do not apply in the case of theresolution of a GSE.

For example, HERA modifies theexisting prompt corrective actionregime for Fannie Mae and FreddieMac to

• require the FHFA director to closelymonitor the condition of an under-capitalized enterprise and its compli-ance with the mandatory capital res-toration plan and other restrictionsapplicable to an undercapitalizedentity;

• restrict the ability of an undercapital-ized enterprise to grow in asset size,acquire additional companies, or en-gage in new activities;

• allow the FHFA director to order anew election for the board of direc-tors of a significantly undercapital-ized enterprise, require a significantlyundercapitalized enterprise to employqualified executive officers, or re-quire the dismissal of any director orofficer who held office for more

than 180 days before the enterprisebecame significantly undercapital-ized; and

• allow the FHFA director to appointthe FHFA as receiver for a criticallyundercapitalized enterprise.

HERA also applied the prompt cor-rective action regime governing theenterprises (as modified) to FHLBs.

HERA also allows, or requires, theFHFA director to place a GSE into con-servatorship or receivership for reasonsother than critical undercapitalization.Specifically, HERA authorizes thedirector to establish a conservatorshipor a receivership for a GSE if the direc-tor finds that any of 11 other separateconditions are met. These conditionsinclude, among others, that

• the GSE’s obligations exceed itsassets;

• the GSE is in an unsafe or unsoundcondition to transact business;

• the GSE is likely to be unable to payits obligations or meet the demandsof its creditors in the normal courseof business;

• the GSE has incurred or is likely toincur losses that will deplete all orsubstantially all of its capital andthere is no reasonable prospect thatthe firm will become adequately capi-talized; and

• the board of directors, shareholders,or members of the GSE have con-sented to the appointment.

HERA also requires that the FHFAdirector place a GSE (even one thenoperating in a conservatorship) into areceivership if the director determinesin writing that

• the assets of the GSE are, and duringthe preceding 60 calendar days havebeen, less than the obligations of theGSE to its creditors or others; or


• the GSE is not, and during the pre-ceding 60 calendar days has not been,generally paying its debts as theybecome due (other than debts subjectto a bona fide dispute).

If a GSE is placed into either conser-vatorship or receivership, HERA autho-rizes the FHFA to take over the busi-ness and operations of the troubled GSEand change management of the GSE. Inthe case of a conservatorship, the FHFAis directed to seek to rehabilitate thetroubled entity for the benefit of itsshareholders and creditors by preserv-ing the entity’s assets and improving itsbusiness operations in order to restorethe entity to a sound and solvent condi-tion. In contrast, in the case of a receiv-ership, the FHFA must place the GSEinto liquidation, and it has the ability todetermine claims of creditors againstthe GSE.

HERA allows FHFA, as receiver, toestablish a ‘‘bridge’’ entity to assumethe assets and liabilities of an FHLB inreceivership. HERA also requires theFHFA director to organize a bridgeentity (referred to in HERA as alimited-life regulated entity) if FannieMae or Freddie Mac are placed into areceivership. HERA provides that abridge entity established for FannieMae or Freddie Mac would immedi-ately, and by operation of law, succeedto the charter of Fannie Mae or FreddieMac, as relevant. Moreover, HERA spe-cifically provides that the amount ofassets transferred from a failed enter-prise to the bridge entity must exceedthe amount of liabilities transferred tothe bridge entity. Together, these provi-sions help ensure that, if an enterprisewere to be placed into a receivership, anew, solvent entity would be estab-lished that could continue to fulfill theenterprises’ important mission in accor-

dance with the enterprises’ governingcharter.

Required Consultations

Title I of HERA requires the FHFAdirector to consult with, and considerthe views of, the Chairman of the Boardof Governors of the Federal ReserveSystem with respect to the risks posedby the GSEs to the financial systemprior to issuing any proposed or finalregulations, orders, or guidelines re-garding prudential management andoperations standards, safe and soundoperations of, and capital requirementsand portfolio standards applicable to,the GSEs. The Act also requires thedirector to consult with the chairmanregarding any decision to place a GSEinto conservatorship or receivership.These consultation requirements expireon December 31, 2009. As noted above,FHFA Director James Lockhart con-sulted with Federal Reserve BoardChairman Bernanke prior to placingFannie Mae and Freddie Mac into sepa-rate conservatorships on September 7,2008.

Prudential Management andOperation Standards

HERA also requires that the FHFAdirector establish standards for theGSEs related to, among other things,the management of interest rate riskexposure; management of market risk;adequacy and maintenance of liquidityand reserves; management of asset andinvestment portfolio growth; invest-ments and acquisitions of assets; over-all risk-management processes; andsuch other operational and manage-ment standards as the director deemsappropriate.


Increase in Conforming-Loan Limits

HERA also permanently increases theFannie Mae and Freddie Mac con-forming-loan limits, which are themaximum dollar size of a mortgage thatmay be purchased by the enterprises.Earlier in 2008, the Economic StimulusAct of 2008 increased, until December31, 2008, the conforming-loan limit formortgages on single-family residencesto the greater of $417,000, or 125 per-cent of the relevant area median homeprice (not to exceed $729,500). Effec-tive January 1, 2009, HERA allowsFannie Mae and Freddie Mac to pur-chase single-family mortgages with amaximum origination balance of up tothe greater of $417,000, or the lesser of115 percent of the area median price or$625,500. Adjustments also were madeto the conforming-loan limits for two-to-four-family residences.

New Products and Activities

Under HERA, Fannie Mae and FreddieMac must obtain the FHFA director’sprior approval before offering any newproduct. In considering a request, thedirector must determine that the productis consistent with the enterprise’s statu-tory authority, is consistent with thesafety and soundness of the enterpriseor the mortgage finance system, and isin the public interest. The director alsomust request public comment on anynew product approval request for30 days. The statute includes certainexclusions from the definition of a newproduct to avoid unduly interfering withthe development of loan underwritingsystems and mortgage products offeredby the enterprises.

FHA Modernization

HERA also includes the FHA Modern-ization Act of 2008, which makes sev-

eral modifications to the National Hous-ing Act to improve the mortgageinsurance programs of the FHA. Similarto the conforming-loan limits of FannieMae and Freddie Mac, FHA con-forming-loan limits were increased bythe Economic Stimulus Act of 2008 andHERA. Effective January 1, 2009, themaximum size of a single-family mort-gage eligible for FHA insurance is thegreater of $417,000, or the lesser of115 percent of the area median price or$625,500. In addition, HERA

• increases from 3 percent to 3.5 per-cent the down payment that a bor-rower must make in cash or cashequivalents on a home in order for themortgage to be eligible for FHAinsurance;

• prohibits borrowers from receivingany part of the required down pay-ment from the seller of the property,any other person who financiallybenefits from the transaction, or anythird party or entity that is reimbursedby such a person or entity for provid-ing the down payment assistance tothe borrower;

• increases, from 2.25 percent to3.0 percent, the maximum annualmortgage insurance premium that theFHA may collect; and

• prohibits the secretary of HUD fromtaking any action, prior to October 1,2009, to implement the risk-basedpremium pricing program that thesecretary had published in the FederalRegister on May 13, 2008, or anyother risk-based premium pricing pro-gram based on the borrower’s ‘‘deci-sion credit score’’ described in suchFederal Register notice.

HOPE for Homeowners

As noted above, HERA also establishesthe HOPE for Homeowners Program


(H4H Program), which is a voluntaryprogram designed to allow qualified,at-risk mortgage borrowers to refinancetheir existing mortgages into new mort-gage loans guaranteed by the FHA,subject to certain conditions and restric-tions. FHA may insure eligible mort-gages under the H4H Program com-mencing no earlier than October 1,2008, and the authority to insure newmortgages expires on September 30,2011. The Emergency Economic Stabi-lization Act of 2008, enacted on Octo-ber 3, 2008, modified the H4H Programin several respects. The following out-lines the key elements of the H4H Pro-gram as amended.

Borrower Eligibility Requirements

To be eligible for the H4H Program, aborrower must have a debt-to-incomeratio of at least 31 percent before apply-ing for a H4H Program mortgage. Theborrower must occupy the property ashis or her primary residence, and theborrower may not have an ownershipinterest in another residential property.Accordingly, investors and investorproperties are not eligible for the pro-gram. Additionally, to be eligible forthe H4H Program, a borrower must cer-tify that he or she did not intentionallydefault on the existing mortgage or anyother debt, and has not knowingly orwillfully furnished material informationknown to be false for the purpose ofobtaining the existing mortgage. Mort-gagors that have been convicted underfederal or state law for fraud in the past10 years also are not eligible for thisprogram.

H4H Mortgage Requirements

Loan-to-value and maximum loanamount. The new FHA-insured mort-gage refinances an eligible borrower’s

existing mortgage at a potentially sig-nificant write-down from its currentprincipal balance and, thus, may signifi-cantly benefit borrowers who are “un-derwater”—that is, owe more on theircurrent mortgage than the value of theirhome. HERA prohibits the new FHA-insured mortgage loan from exceeding90 percent (or such higher percentageas the oversight board for the programdetermines to be appropriate) of theappraised value of the property servingas security for the mortgage. The newFHA-insured refinancing loan also maynot exceed 132 percent of the con-forming-loan limit for Fannie Mae thatwas in effect for 2007 for a property ofapplicable size.

Premiums. HERA requires that HUDcollect an amount equal to 3 percent ofthe principal balance of the new H4Hmortgage as an upfront insurance pre-mium. This amount is paid by the exist-ing lender through a reduction in theamount paid to the lender upon refi-nancing. The Act also requires borrow-ers that refinance into an H4H Programmortgage to pay to HUD an annual pre-mium equal to 1.5 percent of theamount of the outstanding mortgagebalance.

Release of previous mortgage liens.Participation in the H4H Program byborrowers, mortgagees, servicers, andinvestors is voluntary. However, allholders of outstanding mortgage lienson a property to be refinanced under theH4H Program must agree to accept theproceeds of the new FHA-insured refi-nancing loan as payment in full for theirexisting mortgages on the property andrelease all liens on the property. In addi-tion, all prepayment penalties and feesassociated with default or delinquencymust be waived in order for an existingmortgage to be refinanced into a new


H4H Program mortgage. HERA alsolimits the ability of a person with aH4H Program mortgage to take a sec-ond lien on the mortgaged property dur-ing the first five years of the new H4Hmortgage term.

Loan term. HERA mandates that anH4H Program mortgage may have aterm of not less than 30 years and mustbear a single rate of interest that is fixedfor the entire term of the mortgage,thereby eliminating the potential forfuture payment shocks on the mortgage.

First payment default. HERA prohibitsHUD from paying insurance benefits onany mortgage where the borrower failsto make the first payment on the newH4H Program mortgage.

Requirement to Share Equityand Appreciation

HERA also requires borrowers that refi-nance into an H4H Program mortgageto share any newly created equity andfuture appreciation in the property withHUD. Specifically, under HERA, bor-rowers are required to share with HUDa portion of any new equity in the homecreated as a result of the H4H Program.Mortgagors also are required to sharewith HUD 50 percent of any futureproperty appreciation upon sale or dis-position of the property. HUD is autho-rized to offer subordinate mortgage lienholders on the property, in exchange forreleasing their lien, either (1) a share ofHUD’s 50 percent interest in futureappreciation of the mortgaged propertyor (2) an upfront payment in lieu of theright to receive a portion of HUD’sinterest in the property’s future appreci-ation, if any.

Oversight Board

HERA also establishes a Board ofDirectors (Oversight Board) to oversee

the H4H Program. The Oversight Boardis composed of the secretary of Housingand Urban Development, the Treasurysecretary, the Federal Reserve Boardchairman, and the chairperson of theBoard of Directors of the FederalDeposit Insurance Corporation, or therespective designee of each such per-son. HERA further requires the Boardto, among other things, establishrequirements and standards for the H4HProgram and prescribe regulations andguidelines as may be necessary orappropriate to implement such require-ments and standards. The OversightBoard published rules to implement theH4H Program in the Federal Registeron October 6, 2008, and January 7,2009.

Study of Auction orBulk-Refinance Program

HERA also requires the OversightBoard to conduct a study of the needfor, and efficacy of, an auction or bulk-refinancing mechanism to facilitate therefinancing of existing residential mort-gages that are at risk for foreclosureinto mortgages insured under the H4HProgram. The study must identify andexamine various options for mecha-nisms under which lenders and servic-ers of such mortgages may make bidsfor forward commitments for suchinsurance in an expedited manner. Asrequired by HERA, the OversightBoard submitted the study of auction orbulk-refinancing mechanisms to Con-gress on September 29, 2008.

S.A.F.E. Mortgage Licensing Act

Another part of HERA—the Secure andFair Enforcement for Mortgage Licens-ing Act of 2008 (S.A.F.E. Act)—pro-vides for the establishment of a nation-wide mortgage licensing system andregistry for the residential mortgage


industry. The registry is intended toimprove the flow of information be-tween regulators, increase industry ac-countability, enhance consumer protec-tions and information, and establish ameans by which residential mortgageloan originators would be required, tothe extent possible, to act in the bestinterests of consumers.

The statute requires all states todevelop and maintain a system forlicensing and registering individualsengaged in mortgage loan originations.Pursuant to the S.A.F.E. Act, these statelicensing and registering systems mustinteract with the Nationwide Mort-gage Licensing System and Registry(NMLSR), which is to be developedand maintained by the Conference ofState Bank Supervisors and the Ameri-can Association of Residential Mort-gage Regulators. In addition, theS.A.F.E. Act requires the federal bank-ing agencies, along with the FederalFinancial Institutions ExaminationCouncil and the Farm Credit Adminis-tration, to jointly develop and maintaina system for registering employees ofdepository institutions, or regulatedsubsidiaries of depository institutions,as loan originators with the NMLSR.Such a system must be implementedwithin one year after the date of enact-ment of the S.A.F.E. Act, and is to takeinto consideration, as may be appropri-ate, the same exceptions and require-ments set forth below for state-licensedloan originators. If by the end of a one-year period (or in limited cases a two-year period) the secretary of HUDdetermines a state does not have anadequate system of licensing and regis-tration, the S.A.F.E. Act requires thesecretary to establish and maintain asystem for that state.

The S.A.F.E. Act also requires thatindividuals obtain a license from astate, and that they register with either

the state or federal registration system,before they may engage in loan origina-tions. In connection with an applicationfor licensing and registration, an indi-vidual must, at a minimum, provideinformation concerning the applicant’sidentity, including fingerprints and per-sonal history and experience. An indi-vidual may not receive a license or reg-istration if the individual fails to satisfycertain criteria outlined in the statute.The S.A.F.E. Act also outlines the mini-mum competence requirements for thepre-licensing education and testingrequirements for loan originators, aswell as for renewal of state-licensedloan originators, which includes a con-tinuing education requirement.

In addition to provisions relating toregistration and licensing, the S.A.F.E.Act requires the HUD secretary to rec-ommend reforms to the Real EstateSettlement Procedures Act of 1974, andsubmit a preliminary report on the rootcauses of defaults and foreclosures ofhome loans to Congress not later thansix months after the date of statuteenactment.

Mortgage DisclosureImprovement Act

Title X of HERA enacts the MortgageDisclosure Improvement Act (MDIA),which amends, in turn, portions of theTruth in Lending Act (TILA) to helpensure that a consumer is provided withtimely and meaningful disclosures inconnection with certain extensions ofcredit secured by the consumer’s dwell-ing. EESA, enacted on October 3, 2008,also includes several amendments to theMDIA.

The MDIA, as amended, includesmortgage refinancings among the typesof extensions of credit subject to earlydisclosures under TILA. The amend-ments to MDIA also modify the early


disclosure requirement of TILA so thatcreditors must provide certain disclo-sures to borrowers no later than threedays after receiving an application andat least seven days prior to closing.Additional disclosures are required incases of extensions of credit secured bythe dwellings of consumers where theannual rates of interest or schedules ofpayments are variable. Moreover theMDIA requires that any disclosurestatement that no longer accuratelyreflects the annual percentage rate ofinterest should be replaced by an accu-rate statement within three businessdays before the date of transaction. Thestatute also provides that consumersmust receive the disclosures before pay-ing any fee related to the extension ofcredit. However, the statute allows aconsumer to waive the timing require-ment, in case of a bona fide personalfinancial emergency, by providing alender with a signed written requestoutlining such emergency and specifi-cally requesting waiver of the timingrequirement.

Some of the disclosure modificationscodified in the MDIA were previouslyrequired by regulations issued by theBoard in July 2008. The Board issued anotice of proposed rulemaking onDecember 10, 2008, to implement theadditional requirements included in theMDIA.

Emergency EconomicStabilization Act of 2008

On October 3, 2008, President Bushsigned into law the Emergency Eco-nomic Stabilization Act of 2008(EESA) (Pub. L. No. 110-343), whichprovides the Treasury secretary withimportant new tools to help restoreliquidity and stability to the financialsystem, and establishes several mecha-nisms to oversee the implementation

of this authority. The central featureof EESA is the establishment ofthe Troubled Assets Relief Program(TARP), through which the secretary isauthorized to purchase troubled assetsfrom qualifying financial institutionsto help maintain and promote fi-nancial stability.

The EESA also includes severalimportant limitations and conditionsdesigned to protect the interests of tax-payers. For example, EESA generallyrequires that the secretary obtain war-rants or comparable debt instrumentsfrom any financial institution fromwhich the TARP acquires troubledassets. In addition, and as describedbelow, section 111 of EESA requiresthat the secretary develop and imposecertain executive compensation restric-tions on financial institutions fromwhich the TARP purchases troubledassets. Related provisions of EESAlimit the ability of certain financialinstitutions that participate in TARP todeduct executive compensation ex-penses for federal tax purposes.

EESA also includes several otherprovisions affecting financial institu-tions or the Federal Reserve, includinga temporary increase in federal depositinsurance coverage and an accelerationof the effective date of a previouslyadopted legislative amendment that per-mits the Federal Reserve to pay intereston balances held at Federal ReserveBanks by depository institutions.

Troubled Assets Relief Program

In light of the extraordinary eventsoccurring in the financial markets andthe substantial risks such events posedto financial stability and the U.S. econ-omy, Congress passed EESA to imme-diately provide the Treasury secretarywith the authority and facilities torestore liquidity and stability to the U.S.


financial system. EESA also providesthat the secretary should seek to usesuch authorities and facilities to

• protect home values, college funds,ret i rement and other savingsaccounts;

• preserve homeownership;• promote jobs and economic growth;• maximize overall returns to tax-

payers; and• provide public accountability for the

exercise of such authority.

In exercising this authority underEESA, the Treasury secretary must con-sult with the Federal Reserve Board, theFDIC, the Comptroller of the Currency,the Director of the Office of ThriftSupervision, the Chairman of theNational Credit Union AdministrationBoard, and the HUD secretary.

To assist in accomplishing thesegoals, EESA authorizes the Treasurysecretary to establish the TARP andpurchase troubled assets from financialinstitutions on such terms and subject tosuch conditions as the secretary mayestablish in accordance with EESA. Asa general matter, the term ‘‘troubledassets’’ is defined to include residentialand commercial mortgages, and anysecurities, obligations, or other instru-ments based on or related to such mort-gages, so long as they were issued ororiginated on or before March 14, 2008.However, EESA also provides that theterm ‘‘troubled assets’’ shall also applyto any other financial instrument(including, for example, equity instru-ments) that the secretary, after consulta-tion with the Federal Reserve BoardChairman and notification to Congress,determines the purchase of which isnecessary to promote financial marketstability. EESA also generally defines a‘‘financial institution’’ to mean any

institution having significant operationsin the United States—including but notlimited to banks and other depositoryinstitutions—which is established andregulated under U.S. laws, or those ofany of its states, territories, or posses-sions. EESA also provides that, if Trea-sury purchases troubled assets under theTARP, the secretary must establish aprogram to guarantee troubled assetsoriginated or issued prior to March 14,2008. The secretary must collect premi-ums for any guarantee issued under theprogram in an amount that the secretarydeems necessary to meet the purposesoutlined in EESA and provide sufficientreserves, based on an actuarial analysis,to ensure taxpayers are fully protected.

The purchase authority granted to thesecretary by EESA terminates onDecember 31, 2009, although the secre-tary may extend this date until October3, 2010 upon submission of a writtencertification to Congress. However, theauthority of the secretary to hold anytroubled assets purchased prior to thetermination of authority, or to purchaseor fund the purchase of troubled assetsunder a commitment already enteredinto before the termination date, is notsubject to such termination.

EESA authorizes the secretary to pur-chase or insure up to a maximum of$700 billion in troubled assets. Of thisamount, $250 billion was made imme-diately available for use when EESAwas enacted, and the remaining amountwas made available in two separatetranches of $100 bil l ion and$350 billion.

Executive Compensation andCompensation-Related Tax Provisions

As noted above, EESA establishes cer-tain executive compensation restrictionson financial institutions that selltroubled assets to the Treasury under


the TARP. Specifically, EESA requiresthat the secretary impose executivecompensation restrictions on a financialinstitution if the secretary directly (andnot through an auction process) pur-chases troubled assets from the institu-tion, if market prices for the assets arenot available, and if the secretaryreceives a meaningful equity or debtposition in the institution as a result ofthe transaction. These restrictions must

• be designed to ensure that the com-pensation paid to senior executiveofficers of the institution does notprovide incentives to take unneces-sary and excessive risks;

• require the financial institution torecover any bonus or incentive com-pensation paid to a senior executiveofficer based on criteria that are laterproven to be materially inaccurate;and

• prohibit any ‘‘golden parachute’’ pay-ment to a senior executive officerduring the period that the secretaryholds an equity or debt position in thefinancial institution.

For these purposes, the term ‘‘seniorexecutive officer’’ refers, in the case ofa publicly held financial institution, toan individual who is one of the fivehighest paid executives of the institu-tion as disclosed under regulationsissued under the Securities ExchangeAct of 1934 and, in the case of a non-public company, the counterparts ofsuch individuals.

If assets are purchased through anauction and the total amount of assetsacquired from the institution exceedscertain quantitative levels, the secretarymust prohibit any new employmentcontract with a senior executive officerfrom providing for a golden parachutein the event of the individual’s involun-

tary termination or the institution’sbankruptcy filing, insolvency, orreceivership.

Title III of EESA modifies the Inter-nal Revenue Code to provide specialrules for the tax treatment of compensa-tion (including so-called ‘‘golden para-chute’’ payments) paid by TARP recipi-ents to covered executives (as definedin the EESA). Among other things,financial institutions participating in theTARP and selling troubled assets to theTARP (on an aggregate basis) in excessof $300 million are prohibited, for alimited period, from deducting for fed-eral tax purposes any remuneration inexcess of $500,000 to any coveredexecutive. In addition, such financialinstitutions will be subject to a 20 per-cent tax on certain ‘‘golden parachute’’payments provided to coveredexecutives.

Foreclosure Mitigation Efforts andAssistance to Homeowners

EESA provides that, if Treasury ac-quires mortgages, mortgage-backedsecurities, and other assets backed byresidential real estate under the TARP,the Treasury secretary must implementa plan that seeks to maximize assistanceto homeowners and, considering netpresent value to the taxpayers, encour-age the servicers of underlying mort-gages to take advantage of the HOPEfor Homeowners Program as well asother programs available to minimizeforeclosures. In dealing with loan modi-fication requests under existing invest-ment contracts, the secretary, whereappropriate and after consideration ofnet present value to the taxpayer, isdirected to consent to reasonable loss-mitigation measures, including ratereductions or principal write-downs.Furthermore, the secretary must coordi-nate with the FDIC, Board, FHFA,


HUD, and other agencies that holdtroubled assets to identify opportunitiesfor acquiring different classes oftroubled assets, such as mortgage-backed securities, in order to improvethe loan modification and restructuringprocesses and provide protections tobona fide tenants who are current ontheir rent.

Additionally, EESA requires that des-ignated ‘‘federal property managers’’develop foreclosure prevention plansfor residential mortgages and residentialmortgage-backed securities that themanagers hold, own, or control. Suchplans must seek to maximize assistancefor homeowners and, considering netpresent value to the taxpayers, encour-age the servicers of the underlyingmortgages to take advantage of theHOPE for Homeowners Program. Gen-erally speaking, a ‘‘federal propertymanager’’ is defined to include theFHFA, the FDIC, and the Board,assuming that certain specific circum-stances are present. The FHFA isdeemed to be a federal property man-ager only in its capacity as conservatorfor Fannie Mae and Freddie Mac, andthe FDIC is considered a federal prop-erty manager in cases where residentialmortgage loans and mortgage-backedsecurities are held by a bridge deposi-tory institution established by the FDICin connection with the resolution of afailed insured depository institution.The Board is considered a federal prop-erty manager only with respect to anymortgage or mortgage-backed securitiesheld, owned, or controlled by or onbehalf of a Reserve Bank, other thanwhen such assets are held, owned, orcontrolled in connection with open-market operations under section 14 ofthe Federal Reserve Act or as collateralfor an advance or discount that is not indefault.

Oversight and TransparencyProvisions

Continuing Oversight, Auditing, andReporting Requirements

The EESA imposes several continuingreporting obligations on the TreasuryDepartment with respect to its invest-ments under the TARP. Section 114 ofthe EESA requires Treasury, within twobusiness days after an investment, tomake available to the public, in elec-tronic form, pricing and other informa-tion about the investment. In addition,section 105(a) of EESA requires Trea-sury to issue a tranche report approxi-mately every 30 days, which must pro-vide information on, among otherthings, its actions taken during the cov-ered period under the TARP and theadministrative expenses of the TARP.Finally, for each additional aggregateTreasury investment of $50 billionunder the TARP, section 105(b) of theEESA requires the Department to issuea report that describes, among otherthings, the transactions related to itsadditional incremental exposure, thepricing mechanism for each relevanttransaction, a description of the chal-lenges that remain in the financial sys-tem, and an estimate of the additionalactions that may be necessary toaddress such challenges.

EESA also requires that the secretaryprovide to Congress no later than April30, 2009, a report that analyzes both thecurrent state of the regulatory systemand its effectiveness in overseeingfinancial market participants. Thisreport must include recommendationsfor improving the regulatory system.

Special Inspector Generalfor the TARP

As an additional measure to increasetransparency of TARP-related actions,


EESA provides for the establishment ofan Office of the Special Inspector Gen-eral (Special IG) for the TARP, whichmust, among other things, conduct,supervise, and coordinate audits andinvestigations of the purchase, guaran-tee, management, and sale of troubledassets under the TARP. The Special IGmust provide certain designated com-mittees of Congress with periodicreports summarizing the activities of theSpecial IG during the reporting period.The Special IG, appointed by the Presi-dent by and with the advice and consentof the Senate, also assumes inspectorgeneral duties and responsibilities asoutlined under the Inspector GeneralAct of 1978.

Government Accountability Office

EESA provides authority to the Comp-troller General of the United States tocommence ongoing oversight of TARPactivities and performance, includingexamining TARP’s efficacy in meetingthe purposes of EESA. The comptrol-ler must furnish Congress, as well asthe Special IG, with reports at leastevery 60 days. These reports arerequired to analyze, among otherthings

• the performance of the TARP inmeeting the purposes of the EESA,

• the financial condition of the TARP,• characteristics of transactions and

commitments entered into by theTARP,

• the efficiency of the TARP, and• the compliance of TARP, its agents,

and representatives with applicablelaws and regulations.

The comptroller must also undertakea study to determine the extent towhich leverage and sudden deleverag-ing of financial institutions served as afactor in the current financial crisis.

This study must be provided to Con-gress no later than June 1, 2009.

Financial Stability Oversight Board

EESA also establishes the FinancialStability Oversight Board (FINSOB), abody comprising the Federal ReserveBoard chairman; the Treasury secretary;the FHFA director; the Securities andExchange Commission chairman; andthe HUD secretary. The FINSOB isauthorized to review the policies imple-mented by Treasury under TARP andmake recommendations, as appropriate,to the Treasury secretary regarding useof EESA authority. Additionally, theFINSOB must report suspected TARP-related fraud, misrepresentations, ormalfeasance to the Special IG or theU.S. attorney general.

Furthermore, the FINSOB is autho-rized to ensure, through appropriatemeans, that the policies implemented bythe Treasury secretary are in accordancewith the purposes of EESA, are in theeconomic interests of the United States,and are consistent with protecting tax-payers. The FINSOB must meet at leastmonthly and file a quarterly report withcertain designated Congressionalcommittees.

Congressional Oversight Panel

EESA also establishes a CongressionalOversight Panel to monitor the TARPand review the current state of thefinancial markets and the regulatorysystem. The Oversight Panel consists offive members appointed by members ofCongress in the manner specified insection 125 of EESA. The OversightPanel must submit reports to Congressevery 30 days that discuss, among otherthings, the use by the Treasury secre-tary of EESA authority, the impact ofpurchases made by the TARP on thefinancial markets and financial institu-


tions, the extent to which the informa-tion made available on transactionsunder the program has contributed tomarket transparency, the effectivenessof foreclosure mitigation efforts, andthe effectiveness of the program inminimizing long-term costs and maxi-mizing the benefits to taxpayers. Addi-tionally, EESA requires the OversightPanel to submit a separate report ana-lyzing the current state of the regulatorysystem and its effectiveness in provid-ing oversight of financial market par-ticipants, including analysis of existinggaps in consumer protections and rec-ommendations for improvement. Thisseparate report was submitted to Con-gress on January 20, 2009.

Other Provisions of Interest

Interest on Reserves

Section 128 of EESA accelerated toOctober 1, 2008, the effective date of anamendment, previously adopted as partof the Financial Services RegulatoryRelief Act of 2006, that authorizes theReserve Banks, in accordance withBoard regulations, to pay interest onbalances held by or on behalf of deposi-tory institutions at a Reserve Bank.EESA also authorized the Board tolower the level of reserve requirementson transaction accounts below theranges established by the MonetaryControl Act of 1980. On October 9,2008, the Board issued an interim finalrule implementing this new authority.

Section 13(3) Reporting Requirement

Section 129 of EESA requires that theBoard submit a report to designatedCongressional committees within sevendays of authorizing any loan to an indi-vidual, partnership, or corporationunder the emergency lending authorityof section 13(3) of the Federal Reserve

Act. This section of the Federal ReserveAct permits the Federal Reserve tomake secured loans to such persons inunusual and exigent circumstances andsubject to certain additional conditions.The newly required reports must in-clude the justification for exercisingsuch authority, and discuss the specificterms of the action, as well as anyexpected cost to taxpayers. In addition,while a loan under section 13(3) is out-standing, the Board must submit peri-odic updates to designated congres-sional committees not less than every60 days. These periodic reports mustaddress the status of the loan, the valueof collateral held by the Reserve Bankwhich initiated the loan, and the pro-jected cost to taxpayers.

Margin Study Requirement

Not later than June 1, 2009, the comp-troller must complete and submit todesignated congressional committees astudy regarding the extent to whichleverage and sudden deleveraging offinancial institutions was a factorbehind the financial crisis. The studymust include an analysis of the rolesand responsibilities of the Board, theSEC, the Treasury secretary, and otherfederal banking agencies with respectto monitoring these issues, analysis ofthe authority of the Board to regulateleverage, including to what extent suchauthority has been used, and ananalysis of usage of margin authorityby the Board, and any relatedrecommendations.

Temporary Increase in DepositInsurance and FDIC BorrowingAuthority

As noted above, EESA provides for atemporary increase from $100,000 to$250,000 in FDIC deposit insurancecoverage for insured depository institu-


tions and NCUA share insurance cover-age for insured credit unions. This tem-porary increase ends on December 31,2009.

Additionally, EESA allows the FDICto borrow from the Treasury amounts inexcess of that authorized under sections14(a) and 15(c) of the Federal DepositInsurance Act and as necessary to carryout this increase in deposit insurancecoverage.

Mark-To-Market Accounting

EESA authorizes the SEC to suspendapplication of the mark-to-market pro-visions embodied in Statement Number157 of the Financial Accounting Stan-dards Board, if it determines that doingso is necessary or appropriate in thepublic interest and consistent with theprotection of investors. Additionally,the SEC, in consultation with the Fed-eral Reserve Board and the Treasurysecretary, must conduct a study to con-sider (1) the effects of these mark-to-market standards on the balance sheetsof a financial institution, (2) the impactof such accounting on bank failures in2008, (3) the extent to which such stan-dards affect the quality of informationavailable to investors, (4) the processused by FASB in developing such stan-dards, and (5) whether alternative ac-counting standards would better suit theindustry. This study, including legisla-tive and administrative recommenda-tions, was submitted to Congress onDecember 30, 2008.

Higher Education OpportunityAct of 2008

On August 14, 2008, President Bushsigned the Higher Education Opportu-nity Act of 2008 (HEOA) (Pub. L. No.11-315), which includes amendments tothe disclosure requirements for private

educational loans under TILA. TheFederal Reserve Board must adoptregulations implementing HEOA’s dis-closure provisions, which require credi-tors to provide a number of new disclo-sures about the terms and features ofprivate educational loans. Creditors willalso have to disclose information aboutfederal student loan programs, whichmay offer less costly alternatives.

The new disclosures required by theHEOA would be incorporated into thesegregated cost disclosures that credi-tors must provide under TILA. Cur-rently, creditors integrate much of thisinformation in credit agreements, alongwith other contract terms. HEOA seeksto highlight key information by includ-ing it on the TILA disclosure andrequiring that the information be dis-closed multiple times during the lend-ing process. As a result, the TILA dis-closures for private educational loanswill become longer and more detailed.HEOA also requires the Board todevelop and test model disclosureforms, which the Board would publishto encourage lenders to standardize dis-closure format.

HEOA defines ‘‘private educationalloans’’ as loans made expressly forpostsecondary educational expenses,excluding loans made, insured, or guar-anteed by the federal government. Gen-erally, creditors must furnish TILA costdisclosures before credit is extended.Under HEOA, however, creditors willbe required to furnish three sets of dis-closures for private educational loans.First, creditors must disclose the avail-able loan rates and terms in an applica-tion or solicitation for a private educa-tional loan. Creditors must also furnisha second set of disclosures after the bor-rower has been approved for a loan, andafford the applicant at least 30 days inwhich to accept the loan. During thisperiod, the creditor may not change the


rate or terms (except for changes to avariable interest rate based on anindex). If the consumer accepts theloan, the creditor must then furnish athird set of disclosures, after which theconsumer has three days in which tocancel the loan. The creditor may notdisburse the loan funds until the three-day cancellation period expires.

HEOA also contains restrictions forthe marketing of private student loans.It prohibits private creditors from using

the name, emblem, or mascot of an edu-cational institution in a way that impliesthat the institution endorses the credi-tor’s loans. Some schools, however,enter into ‘‘preferred lender’’ arrange-ments and explicitly agree to endorsethat creditor’s student loan product.HOEA restricts but does not prohibitthis practice.

The Board issued a notice of pro-posed rulemaking to implement theseprovisions on March 11, 2009. Á


Documents

Federal Reserve Operations