WASHINGTON - The Federal Reserve Board on Tuesday sketched the future of supervision for financial holding companies and their affiliates, reserving a large measure of discretionary authority for itself.

While stressing cooperation and respect for other regulators' authority, a 10-page letter to Fed examiners from Richard Spillenkothen, the central bank's director of banking supervision and regulation, asserts the Fed's right to require reports from, and conduct examinations of, nonbank subsidiaries of these holding companies.

When reviewing a bank subsidiary, the Fed's examiners should rely as much as possible on information collected by its primary regulator, Mr. Spillenkothen wrote. However, he said, they have the authority "where necessary and appropriate" to conduct or participate in reviews of banks and thrifts for the purpose of validating risk management and internal controls processes.

"The Fed is flexing its muscles here. It is really laying down the law to the nonbank regulators," said Bert Ely, a financial services industry consultant based in Alexandria, Va. "They dress it up in words of cooperation, but there is some strong language about what the Fed wants to know and how they are going to act on it."

The letter confronts one of the most vexing issues raised by the Gramm-Leach-Bliley Act of 1999, which opened the door to the combination of banking, insurance, securities, and other financial activities.

The law established a system of so-called functional regulation. Bank and thrift regulators supervise depository affiliates. But a broker-dealer unit, for example, would be regulated by the Securities and Exchange Commission, and insurance sales and underwriting by state insurance commissioners.

The law made the Fed THE "umbrella supervisor" of financial holding companies, with responsibility for their stability, systemwide risk management processes, and capital adequacy.

According to the letter, the Fed expects to fulfill that role through regular assessments of a financial holding company's risk management and control systems, and targeted testing to see that they have been effectively implemented.

Fed officials, the letter said, will have "periodic discussions" with senior management and boards of directors as well as individuals in charge of specific lines of business, risk management, internal audit and internal control.

In order to understand the risk profile of the financial holding company as a whole, Mr. Spillenkothen wrote, examiners should meet with primary bank regulators to exchange information and examine their reports on the institution.

In assessing the capital adequacy of a financial holding company, the letter said, the Fed will examine the capital levels of its subsidiaries. However, it notes that because different methods of measuring capital are used by different regulators, the results may be difficult to reconcile into a holding-company-wide capital assessment. Financial holding companies will be required to maintain specific capital ratios, based on those currently applied to bank holding companies.

The central bank has tempered its rhetoric about umbrella regulation since the Gramm-Leach-Bliley Act became law in November. In a speech three days after President Clinton signed the bill, Fed Chairman Alan Greenspan staked his claim as top bank regulator, saying, "If the bank is large and/or a significant part of the organization, both law and good supervisory and stabilization policies require an active umbrella supervisor."

But Mr. Spillenkothen on Tuesday wrote: "Financial holding company supervision is not intended to impose bank-like supervision on financial holding companies, nor is it intended to duplicate or replace supervision by the primary bank, thrift, or functional regulators of financial holding company subsidiaries."


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