The Office of Thrift Supervision must improve its oversight of institutions operating over the Internet, according to a report by the Treasury Department's Office of Inspector General.

"Examinations of on-line and Internet banking were inconsistent and overly reliant on relatively few specialists," the report stated. "The OTS will need to better manage its work load, broaden its institutional expertise, focus its examination on the operational risks (e.g., liquidity and credit risks), and monitor the thrifts' Internet activities."

The report was the first governmental criticism of the regulation of Internet banking, and such scrutiny is sure to increase as electronic banking spreads.

According to the report, the thrift agency's safety-and-soundness examiners are unfamiliar with the special risks Internet institutions face. "Interest rate margin pressures resulting from higher cost, more volatile deposits coupled with out-of-territory lending could result in increased credit risk and impact the thrift's earnings, liquidity, and capital position," it stated.

The report, dated Sept. 30, was released this week to American Banker under the Freedom of Information Act. The OTS is a unit of the Treasury Department and invited the Inspector General's office to do its review, which covered August 1997 to May 1998.

Currently 26 thrifts conduct transactions over the Internet. More than 230 have Web sites.

Noting the fast rise of Internet banking, the report stated: "The OTS will need to quickly prepare for this cultural change."

In an interview Thursday, Timothy R. Burniston, OTS director of compliance policy, did not dispute the report's conclusions.

"We knew we needed to train staff, we knew our regulations were outdated, we knew there were a number of thrifts out there struggling with their Web sites," he said.

He acknowledged that banking over the Internet and on-line networks has outpaced the agency's ability to keep watch. "We got a good jump on this, and we made a lot of progress, but you have to keep up with it," Mr. Burniston said.

The Inspector General's office, however, did not give enough weight to steps the OTS has already taken to deal with the problems, Mr. Burniston said.

The OTS approved the first charter for an institution operating exclusively over the Internet in 1995 and began addressing these issues by forming an internal task force.

The agency has since begun requiring thrifts to list their Web site addresses on quarterly "thrift financial reports." It has also proposed rules that would require thrifts to get the agency's permission before taking deposits on-line.

The OTS has trained 400 of its 700 safety-and-soundness officers on Internet banking, according to a spokesman. The rest of the examiners will be trained in the next two years.

But Internet banking may be growing faster than the regulators' ability to keep up with it. The report projects that the number of households banking over the Internet will grow to more than 16 million in 2000 from 1.1 million in 1997.

As D.R. Grimes, chief executive officer of the two-year-old thrift Net.B nk outside Atlanta, put it: "There wasn't any cookbook for running an Internet bank. ... There's also no cookbook for regulating one."

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