UNDERSTANDING THE FED: FIVE THINGS YOU SHOULD KNOW ABOUT SUPERVISION AND REGULATION

The following information was released by the Federal Reserve Bank of Atlanta:

The Federal Reserve is the central bank of the United States. But that doesn't mean it's the kind of bank where you get cash from an ATM, borrow money for a home, or keep a safe deposit box.

As the central bank, the Federal Reserve is tasked with a variety of responsibilities that, as a whole, promote the health, safety, and prosperity of the US economy and financial system. While commercial banks provide financial services directly to the public, the Fed provides services to commercial banks. That's why some people describe the Fed as the bank for banks.

The Federal Reserve System is a nonpolitical institution that includes 12 independent regional Reserve Banks, located around the country, as well as the Federal Reserve Board of Governors in Washington, DC. Each Reserve Bank brings unique data and perspectives from their regions to the Board of Governors, so the economic experiences of all Americans are represented in the formation of monetary policy.

The Fed performs five main functions. They include:

Today, we're highlighting supervision and regulation, and five key things we think everyone should know about this work. Keep an eye out for snapshots of the other functions. We'll link them to the list above as they're available.

1. The Federal Reserve's role in banking supervision and regulation

Before the creation of the Federal Reserve, the US had several banking panics, eight in the financial center of Manhattan alone between 1863 and 1911, as well as other regional panics across the United States. So in 1913, Congress created the Fed and gave it broad regulatory and supervisory powers to address the conditions that create such panics. The Fed doesn't manage banks and financial institutions, but it does supervise and regulate them to promote a safe, sound, stable, and efficient banking system for an economy that benefits all Americans. The Fed's scope includes protecting depositors' funds, protecting the rights of banking customers, and maintaining a stable, efficient, and competitive banking system.

To achieve these goals, the Fed establishes financial industry regulations based on the laws enacted by Congress. To ensure regulatory compliance, financial institutions are supervised by the Fed, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and state banking regulators. Each agency supervises a particular type of financial institution so their supervision does not overlap.

2. The Fed's supervisory approach

Imagine that banking is a sport and that banks are sports teams. The sport has rules and referees who ensure each bank team plays by the rules. Likewise, financial institutions are governed by laws and regulations and it is the job of examiners to make sure the institutions play by the rules. There are penalties for violations, and referees can provide observations based on what they see in examinations.

The Fed's Supervision and Regulation Division monitors certain financial institutions to help ensure they follow the regulations and laws protecting their operational safety and soundness. Small banks may be examined every 12 to 18 months, while large and foreign banks are monitored more frequently, with meetings conducted with executives and management throughout the year.

3. The Fed supervises banks, financial institutions, and systems

The Fed supervises individual institutions, from small community banks to large, complex financial institutions. Examiners read documents, assess processes and activities, and talk to bank executives and management. The Fed reviews compliance with the Community Reinvestment Act, which Congress enacted to ensure banks provide lending in low- and moderate-income communities, among other outcomes. Any violation of laws or regulations may earn a penalty and must be fixed by the institution.

With the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Congress expanded the Fed's scope to include the entire financial system for purposes of identifying threats that could destabilize the US economy. In addition, the Fed communicates with central banks in other countries to monitor for situations that could spread across borders.

4. The Fed examines banks for soundness

Bank examiners review and evaluate a bank's activities, risk management, and financial condition (defined as the amount of financial resources a bank has, the quality of its loans, and the strength of its earnings). The purpose is to ensure the bank is operating in a safe and sound manner so that it can properly serve its customers.

With each exam, examiners notify a bank of the documents they want to see and who they will interview. Any problems with activities, management, or condition are noted in a confidential report to the bank, along with corrective guidance. It's the bank's job to fix the problems and the examiner's job to follow up on that work. Banks that fail to correct issues could have their rating score reduced.

5. The Fed conducts stress tests

The Fed works to ensure healthy financial institutions. The Dodd-Frank Act requires the Fed conduct annual stress tests of the nation's largest banks, defined as having consolidated assets of $100 billion or more. Approximately 20 to 40 banks are tested each year, on a revolving basis. The goal of each test is to see if a bank could survive a severe economic downturn and maintain the credit supply to the economy.

More broadly, stress tests provide insights into the financial capacity of individual firms as well as possible vulnerabilities in the overall banking system. The Fed reports test results to the public, who can use them to make decisions about doing business with a given bank. The Fed's policymakers use test results to evaluate possible weaknesses in the banking system, as well as to create safety-focused policies for the future.

More about the Atlanta Fed's role in promoting supervision and regulation

The Federal Reserve operates three supervision programs (the Community and Regional Bank Group, the Large Bank Group, and the International Group) and two additional outreach programs (Service Providers and Consumers and Communities). The Atlanta Fed provides supervision for these programs throughout the Federal Reserve's Sixth District, comprised of Alabama, Florida, and Georgia, and portions of Louisiana, Mississippi, and Tennessee.

Want to know more about Supervision and Regulation?

If you'd like to take a deeper dive into the world of Supervision and Regulation, check out The Fed Explained: What the Central Bank Does, which details the structure, responsibilities, and work of the US central banking system.