USA: Fed issues warnings on bank business.

The current low interest rates have created an enormous volume and the Federal Reserve Board is concerned that competition amongst lenders is leading to poor lending decisions and a risk of increased default.

As a result, it has issued guidance in conjunction by the Federal Financial Institutions Examination Council which includes the Office of the Comptroller of the Currency, the Federal Reserve Board, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision. The guidance applies to all banks and thrifts; however, it is primarily applicable to those institutions that are actively involved in mortgage banking activities.

The Fed says "while the number of institutions with significant exposure to mortgage banking assets is limited, mortgage banking is a significant and growing business line for many institutions."

The guidance sets out the agencies" expectations regarding risk management activities including valuation and modeling processes, hedging activities, management information systems, and internal audit. The guidance also notes that the agencies may require additional capital for institutions that fail to consider the sound practices set forth in this advisory in their risk management programs.

Risk management has become a buzzword at the Fed: Greenspan and Rice have both been pushing caution in uncertain conditions. But the result of bank inspections suggests that there has been little notice in some institutions.

The guidance also considers questions of balance sheet valuations of loans: they are to be assessed on both value and risk management bases. The primary aim of the guidance appears to be general market protection: questions of reserves, capital adequacy and concerns over hedging activities. The guidance also emphasises that there is a need for a separation of duties between accounting, hedging and valuation departments. In the case of many of the USA's many tiny banks, this may be difficult.

The Fed does not want to see a growth in bad debt. That would have an impact on the confidence in the markets that are already in turmoil. It wants to make certain that banks etc. are complying with accounting standards including the often criticised GAAP.

The guidance reminds internal audit departments of their duties of independence and the requirement for them to report direct to the banks' boards and to be appropriately qualified.

The full guidance is at The Fed Website.