Fed Warns Banks: More Oversight Ahead Unless Risk Is Better Managed

Responding to the Asian financial crisis, the Federal Reserve Board on Monday told banks to improve credit-risk management efforts or face greater oversight.

"Recent events in both emerging and developed financial markets have illustrated that risk management systems broke down in some product, customer, and business lines that experienced significant growth and above normal initial profitability," Richard Spillenkothen, the Fed's director of banking supervision and regulation, wrote in a letter to the industry.

Banks should devote more resources to managing high-growth and high-risk business lines, he said. For all counterparties, lenders should check creditworthiness, measure off-balance-sheet exposures, conduct stress tests, and limit total credit. Banks also should tailor risk-management efforts to the threats posed by specific customers, he wrote.

This is the third piece of risk-management guidance issued to the industry this year. Last week the Office of the Comptroller of the Currency released guidelines for derivatives trading and the Basel Committee for Banking Supervision unveiled a policy on extending credit to hedge funds. Copies of the Fed letter are available at www.federalreserve.gov.