There are few events in the life of a bank that are more important than a safety and soundness examination by the institution’s primary regulator. A passing grade means the bank will be able to execute its growth strategy, including acquisitions, product development and business expansion, with little interruption or objection from their regulator. Not only does a failing grade mean that bank’s major growth initiatives will probably be put on hold, but its management team will have to spend both time and money fixing the deficiencies—resources that otherwise would be spent on more productive pursuits. Gary Bronstein, a Washington, DC-based partner at Kilpatrick, Townsend & Stockton LLP, offers advice to bank management teams and boards for how to prepare for an exam in an edited conversation with Bank Director Editor in Chief Jack Milligan.
Preparing for a Safety and Soundness Examination
The first thing, which is probably the most important thing, is for management and the board to review any deficiencies or matters requiring attention from the prior exam and make sure those have been addressed. The regulators will verify and review the effectiveness of any corrective action taken after a prior exam. A few other things that are perhaps a little less pressing but still important to consider include any changes in the bank’s business activities since the last exam. You might want to take a look at your policies and procedures to make sure that those have been updated to reflect the new activities. For example, if the bank is engaging in a new lending activity or a new subsidiary activity, do the policies and procedures reflect what they’re doing? Also, if you’re expanding to new markets, that also may require a look at the policies and procedures.
It’s also important that you prepare your employees for the examination process. You ought to make sure that they’re aware of the exam, that it’s coming, what the schedule is, when the examiners will be there and where they’ll be located. Remind employees of simple things about office protocol that you might take for granted, such as not having business discussions in public areas where they may be overheard by an examiner, and not to leave documents laying around in conference rooms and photo copiers that examiners might have access to and that might contain sensitive information that you’re not ready to provide. Employees should be knowledgeable about the policies and procedures for which they’re responsible, because they may be asked to talk about it.
Approximately 30 to 90 days before the exam, the bank will receive what’s called a first day letter, which talks about the scope of the exam. That is to be taken seriously. It’s important to do your homework, relative to that letter and what’s in it. The other thing that’s worth looking at is each of the federal banking agencies have an examination manual that’s posted online. It sets forth the supervisory and examination objectives. That’s absolutely worth reviewing. It’s a good idea to appoint a point person at the bank who is responsible for handling all inquiries that arise during the exam. And when you gather information for examiners, keep a record of what you’ve gathered so that in case anything gets lost, you have a record of it.
The Importance of the Initial Meeting With the Examiners
It’s important to think in advance of an exam about the opening meeting that will take place with the examiners. It’s important to make a good first impression because that can set the tone for the exam. You should probably have your full executive team present for that. I don’t think it’s necessary to have board member at that initial meeting because most banks generally think of an exam, certainly at the initial stage, to be more of a management function, rather than a board function. It might be a good idea to have your compliance officer present, as well as key officers in charge of particular business units. You might start off the meeting by talking about issues that were raised during the prior exam and address those up front. Address some changes that have taken place at the bank since the last exam so that the examiners are well-informed of what has taken place. Set the ground rules for how this is going to unfold in terms of how long they’re going to be there, what days of the week and the person to contact.
Other Pre-Examination Considerations
Take care of logistics, such as where the examiners are going to sit. Make sure they have access to things that they need because that sets a nice tone. It’s a good idea to be proactive. Sometimes you have new examiners who are not familiar with your bank, so it’s a good idea to start off with a summary of your business, where you’re headed and what your control environment looks like. Also, you might consider self-identifying issues or problems, but don’t do that without being prepared to provide a remediation plan of how you’re going to deal with those issues.
And make sure your files are organized because it sets a bad tone if you’re having difficulty finding things and it takes a long time, so organize your files related to things you expect the examiners are going to look for.
Conducting a Mock Examination
Some banks conduct a mock regulatory examination, which may help you prepare for the process and identify areas to focus on. It could be performed by someone at the bank who is experienced in having gone through a number of exams, so they’re familiar with how the examination process takes place. Or you could use an outside consultant who walks you through an initial meeting, gets you prepared for issues that would typically arise during the exam. What happens if the examiner approaches you about X, Y or Z? How are you going to respond? What happens if you disagree with an examiner? Who’s going to be the spokesperson and how can you effectively address the disagreement?
Handling Difficulties as They Come Up During the Exam
Issues regularly come up during an exam. They could be tactical in nature. It might be the examiner taking a position that there’s been a regulatory violation. Is that based upon a law or regulation? It might not, in fact, be a violation, but there may be a disagreement. It might be a reasonable and understandable disagreement. It may not be. It may be a misunderstanding about something that the bank is doing that they’re actually not doing. It can be a mistake. Some of the examiners are inexperienced and like any person, an examiner can make a mistake. The question becomes, how do you proceed?
My first piece of advice for disagreeing with an examiner is this: Proceed with caution. The last thing you should do in communicating with the examiner is to dress that person down, or berate the person. I’ve seen that happen and things deteriorate quickly. That’s a bad idea in almost any scenario but it’s certainly a bad idea when you’re dealing with an examiner or regulator. You should never be condescending or disparaging. I think it’s important to be non-defensive, factual, unemotional and just set forth why you disagree. If it’s done in a constructive manner, it should go pretty well.
The importance of dealing with problems as they come up
Whether it’s a regulatory violation or some other significant issue that arises during the exam, the bank should make every effort to try to get it resolved, hopefully while the examiners are still there, but certainly before the examination report is issued. If it’s a regulatory violation, it’s a good idea to get the lawyers involved, whether it’s in-house or outside counsel, to get an opinion about whether or not the situation does rise to a regulatory violation and then address it head-on, but again in a constructive way. Hopefully, it can be solved by resolution as opposed to a heated argument.
The board’s role in preparing for a safety and soundness examination
The one thing the board can be doing all year long is to make sure that any discussions about board oversight of management is properly recorded in the minutes, because the examiners are going to look at the board minutes and I’ve heard it said on many occasions that from an examiner’s perspective, if it’s not in the minutes, it didn’t happen. That’s not to suggest that you should have a stenographer on hand to record every word, but it ought to be a fair summary of what discussions have taken place, particularly with respect to the prior exam. It’s important to have a record that these issues were discussed, that the exam was discussed, the response was discussed and questions were asked.
It is important that there be a tone at the top communicating that the examination process is important, and that begins with the board and the senior management team. As far as board involvement is concerned, certainly if it’s a troubled bank, the board is going to be more involved in the examination process and there’s the expectation that the board will be. With a healthy bank, you might have the chair of the audit committee be available as needed. Issues that may be discussed include the internal audit process and the internal controls environment. The audit committee chair is the most credible person to discuss those issues.
Managing the post-examination process
As always, management is on the front lines and the board is performing an oversight function. I think it’s important after the exam to have open lines of communication with the examiners, particularly with an issue that might be unresolved, because I think it’s important to vet those issues, provide additional information, and hopefully correct those issues before a final report is released, so that kind of back-and-forth communication between management and examiners is important. If there are any issues of significance, those ought to be brought to the board’s attention as soon as possible so that the board is aware of it. If they’re significant enough, the examiners are going to want to meet with the board, so the board needs to be well informed before any meeting takes place with the examiners.
The final report ought to be reviewed carefully and a well thought out plan for correcting any problems ought to be developed. The written response ought to be delivered in a non-defensive and factual way, without getting combative. I think it’s important not to over-commit to remediation and corrections because the last thing you want is to commit to doing something and you’re unable to deliver. It’s important at the board level that there be a written record of discussions about the exam process, the report, the response and it’s important that management fully report to the board about the issues that arose during the exam. The board ought to be engaged and ought to challenge management about the areas of concern that were raised during the process, because ultimately, the board is going to be held responsible if there are any repeat violations of issues raised during the exam.