Supervision of Large Complex Banking Organizations
DeFerrari, Lisa M., Palmer, David E., Federal Reserve Bulletin
Over the past decade, the long-term trends of consolidation and innovation in the U.S. banking system have intensified. Today a large proportion of assets held by U.S. banking organizations is concentrated in a small number of companies, and U.S. banking organizations have integrated into their product mix activities that extend well beyond traditional deposit-taking and lending. As a result of these developments, there is a small number of banking organizations that are larger and engage in a wider array of financial activities than at any time in recent history.
Banking supervisors have responded to these changes by adapting their approaches to supervision so that they continue to be aligned with the way financial organizations structure and manage their business activities. These newer approaches--collectively referred to as risk-focused supervision--are designed to focus the greatest amount of supervisory attention on the business areas that represent the greatest risk to a banking organization's overall condition.
The Federal Reserve began to implement a structured, more formal program of risk-focused supervision in the early 1990s, and that program continues to evolve as the banking, system itself continues to change. Since the mid-1990s, the Federal Reserve has devoted particular attention to developing and implementing a program for the supervision of the largest, most complex banking organizations, or LCBOs. Given the speed with which the risk profiles of these institutions can change, the LCBO supervision program incorporates both a more continuous supervision process than in the past and a greater emphasis on the evaluation of banking organizations' internal systems and controls for managing risk.
DEVELOPMENT OF THE PROGRAM FOR LCBOS
Trends in the Banking Industry
Since 1989, the U.S. banking industry has undergone both consolidation in assets and expansion in the range of financial activities conducted, an extension of long-term trends. From 1989 to 1999, the number of independent banking organizations in the United States fell from 9,500 to 6,800.(1) Over the same period, total assets held by these banking organizations rose nearly 50 percent in real terms (chart 1). A related trend is that the banking system's assets have become even more concentrated than before in the largest banking organizations. Specifically, the share of total assets held by the fifty largest U.S. banking organizations rose from 55 percent in 1989 to 74 percent in 1999; the share held by the ten largest grew from 26 percent to 49 percent (chart 2).
Expansion in the range of financial activities of U.S. banking organizations is reflected in an increase both in the notional amount of derivatives contracts and in the size of nonbank subsidiaries. A small number of institutions are responsible for the largest portion of derivatives activity of U.S. banking organizations, with the ten largest institutions accounting for nearly 95 percent of the total notional amount. Growth in the assets of nonbank subsidiaries of U.S. banking organizations over the past decade reflects in large part a significant expansion in the securities activities of the largest organizations. Total assets of nonbank subsidiaries held by the largest fifty banking organizations now represent nearly a quarter of their total consolidated assets, and the largest ten companies account for the greatest proportion of these nonbank assets.(2)
Many factors account for the increase in asset concentration at the largest U.S. banking organizations as well as the broadening of the range of their financial activities during the 1990s. These factors include increased competition in financial markets, improvements in information technology, the lifting of restrictions on interstate branching, some easing of regulatory restrictions on securities activities, the globalization of economic activity, and an effort by banking organizations to diversify revenue sources to mitigate cyclical effects on core banking activities, such as lending and deposit-taking. …