The Federal Reserve Board is warning the industry to pay more attention to its private banking operations.

In a letter to the chief executives of all state-chartered member banks, holding companies, and foreign bank branches, the Fed said senior managers should review know-your-customer policies, institute risk management procedures, do annual audits, and increase oversight of private banking units.

The Fed also is distributing a 16-page report this month that lists the best practices used by 40 banks in New York to manage private banking risks.

"Private banking is an area that is growing for larger institutions," said Richard Spillenkothen, the Fed's director of supervision and regulation. "We thought there were important lessons we have learned that would provide basic guidance on what are sound practices."

Private banking has become an increasingly popular and profitable niche for banks, which offer high-net-worth customers sophisticated financial products such as options and swaps in addition to more traditional services such as checking accounts and loans.

Industry officials said they should have no problem complying with the Fed's suggestions.

"We welcome the guidance," said Mary D. Green, senior vice president of Fleet Financial's private clients group. "The Fed is now supporting initiatives which are very compatible with Fleet's current practices and I'm sure the practices of our competitors."

"Most banks are doing these things already," agreed John J. Byrne, senior counsel at the American Bankers Association. "Large institutions have known this was coming down the pike and have put in writing solid policies."

Mr. Byrne said the private banking guidelines also preview the Fed's long-awaited know-your-customer rules, which are expected late this summer.

In its guidelines, the Fed said private bankers should have know-your- customer policies that require consumers to provide basic background data, describe the source of their wealth, and offer references. Reports from bankers who visit foreign clients also should be included in the files, the Fed said.

Bankers also should assign specific employees to look for suspect transactions, and management should include detailed explanations any time it makes a policy exception for a customer, the Fed said. Also, bankers must learn the names of all beneficiaries of trust accounts.

Management also should install a risk management system to ferret out trouble. For example, bankers should verify consumers' financial data by looking at credit reports and should establish a system for filing suspicious activity reports to avoid compliance problems.

Private banks also need computer systems that can identify suspect transactions and must establish separate accounts for each customer.

Managers should limit who can waive requirements for becoming a private banking customer, the Fed said, and follow up on issues raised by regular internal audits.

Finally, the Fed said that senior managers should draft a statement explaining which customers they target for private banking and what products and services they offer.

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