Financial Institution Supervision Section
Background
Safety and soundness examinations are conducted in order to maintain public confidence in the Massachusetts banking industry, as a whole, and in individual banks. Such confidence is clearly essential because the system's customers serve as the source of funding, without which banks would not be able to meet their most fundamental objective of providing financial services.
The Division's safety and soundness examinations make use of Generally Accepted Accounting Principles ("GAAP") and the Federal Financial Institutions Examination Council's "Uniform Financial Institutions Rating System". Accordingly, institutions are rated from 1 to 5 (1 being the strongest). Individual ratings are assigned to six key performance areas identified by the acronym "CAMELS": Capital Adequacy, Asset Quality, Management, Earnings, Liquidity and Sensitivity. From these individual ratings an overall or composite rating is determined.
The Division has adopted the Federal Deposit Insurance Corporation ("FDIC") report of examination format for banks. The Credit Union Section has used the National Association of State Credit Union Supervisors ("NASCUS")/National Credit Union Administration ("NCUA") AIRES Examination Program. Individual pages of the FDIC report of examination are devoted to each of the aforementioned five key financial performance areas. Open section pages contain ratio analysis, summary trends, and narrative sections, including comments on management. Supplemental pages contain supporting data and schedules. A confidential section is used for sensitive narrative, information, and details on the conduct of the examination. Comparable pages exist in the NASCUS/NCUA report. Use of federal examination policies, procedures, and examination report formats provides state and federal bank regulators and regulated institutions with uniform supervision and eliminates redundancy.
In order to complete a safety and soundness examination, specific knowledge is needed in a great number of areas, including, but not limited to, the following:
1. Loans
The Division's examination force has the demonstrated ability to evaluate all types of loans. A number of experienced examiners are particularly strong in evaluating commercial and real estate loans. These skills have been further sharpened as a result of the New England banking crisis. The Division has also targeted its training program to this area. Almost all safety and soundness examiners have completed either Office of Thrift Supervision ("OTS") Real Estate Appraisal School I or the more advanced OTS Real Estate Appraisal School II.
2. Investments
Examiners are highly skilled in evaluating the investment portfolios and investment strategies of banks. They are familiar with sophisticated forms of investments, hedging strategies and concepts, including the use of derivatives.
3. Asset/Liability Management
Asset/Liability Management is an integral component of the Division's examination process. It has been emphasized by examiners since disintermediation occurred in the 1980s. Its renewed importance in the current uncertain interest rate environment is communicated to bank management by examiners. The current regulatory emphasis is on evaluating bank risk systems, including assumptions and their simulations.
4. Liquidity
The evaluation of a bank's liquidity is a key component of the examination process. Examiners possess the requisite skills to make evaluations and recommendations. This skill was extremely important in responding to the liquidity crises that developed in 1991 after the Rhode Island Bank Holiday and the subsequent collapse of the Bank of New England. As a consequence, the Division instituted an off-site daily and weekly liquidity monitoring system for troubled banks and credit unions. A coordinated response plan to deposit runs at banks is in place with the Federal Reserve Bank of Boston.
5. Operations
Examiners are required to examine the day-to-day operations of an institution. Internal routine and controls are thoroughly reviewed. Policies and procedures are reviewed for completeness and compliance. Remedial action is required for any noted deficiencies. Comments on operational problems cited in prior CPA reports are also reviewed to ensure that a bank is earnestly maintaining the highest quality of operations.
6. Management
Examiners are extremely competent in reviewing and evaluating bank management. The Division has long recognized the importance of sound operating management and an involved and active directorate. Bank management is evaluated fairly and objectively. Since 1977, the Division has not had to resort to the formal use of its statutory officer/director removal powers. Weak management is usually independently replaced by directorates on the basis of examination report documentation.
7. Off-Balance Sheet Items
Expertise is also required for the examination of off-balance sheet items. Examiners are required to evaluate a bank's exposure from routinely encountered off-balance sheet items such as standby letters of credit and mortgage banking related risks.