Will coronavirus hasten arrival of fully remote bank exams?
WASHINGTON — As bank regulators have moved their examination process off-site in the midst of the coronavirus pandemic, a debate is unfolding about whether remote supervision should be the way of the future.
Off-site monitoring and electronic exchange of documents and data were already key components of exams. And before the virus outbreak, regulators were already contemplating how to make the supervisory process more efficient through digital technology.
But now quarantine measures are testing the benefits and limitations of off-site-only exams — as well as highlighting the gaps in regulators' technological apparatus — before officials predicted digital supervision would become a reality.
“The pandemic has given everyone a lesson in exponential change,” said Jo Ann Barefoot, co-founder and CEO of the Alliance for Innovative Regulation. “We’re just not geared towards change of that scale, especially in the government and regulatory sector.”
Social distancing has heightened focus on document exchanges, virtual meetings and off-site monitoring to an extent that many observers say it will be difficult for examiners to resume their normal on-site operations after the public health emergency ends.
“The agencies can’t just pick up where the old schedule left off by the time the pandemic winds down. It’s going to take some time to catch up,” said Karen Solomon, an attorney at Covington and former chief counsel at the Office of the Comptroller of the Currency. "This is uncharted territory."
Senior regulatory officials say despite the challenges presented by the pandemic, examiners have not experienced significant limitations across most of their supervised institutions.
While meeting with management is a staple of on-site bank examinations, executives and supervisory officials have largely transitioned to communicating via teleconference software, phone and email while examiners continue to analyze bank-provided data remotely.
The Federal Deposit Insurance Corp. has ceased on-site bank examination since mid-March. The OCC similarly has gone to virtually 100% remote exams.
In March, the Federal Reserve announced a plan to suspend exams for banks with assets of less thanr $100 billion until at least the end of April. The Fed said it would shift from traditional examination work to “monitoring and outreach to help financial institutions of all sizes,” according to a statement.
Even OCC examiners who typically work full time inside the nation’s largest banks are now “almost 100%” remote, according to Senior Deputy Comptroller Maryann Kennedy, who oversees large-bank supervision at the agency.
“We've had some very good operational resiliency across the agency, particularly with our technological capabilities to be able to do a lot of meetings remotely,” Kennedy said. “Virtually no meetings are going on right now face-to-face with bank management.”
At the Fed, examiners typically performed more than 50% of their oversight work off-site before the pandemic struck, while almost every exam had some remote component. The agency’s examiners have since transitioned to 100% remote examination work.
At the FDIC, officials estimate that before the pandemic, the agency conducted about 40% of its prudential bank examination activity off-site, in addition to about 60% of its consumer protection exam work.
Regulators say the core of bank examination — particularly in the midst of an economic crisis — is the exchange of documents and data, which has largely been unaffected. Using regulator-designed file exchange platforms, such as FDICconnect and BankNet at the OCC, examiners already have the capacity to receive and review the majority of all but the most sensitive supervisory documents.
“We were very well prepared for this because we’ve been doing a lot of work off-site,” said Senior Deputy Comptroller Blake Paulson, who oversees community and midsize bank supervision at the OCC. As the pandemic developed and regulators started “updating the process for exams, that worked pretty seamlessly,” he said.
But others say something is lost when examiners are unable to get a feel for a bank and its management without the ability to be inside its walls.
“Most examiners would say, and many bankers would agree, that there is a benefit from a face-to-face interaction between bankers and regulators,” said Solomon. “So I don’t know that there would be a real interest in totally off-site exams from either side. But examiners can already gather a lot of information and analyze it remotely— so I wouldn't see increased off-site monitoring as a radical shift.”
Independent of the temporary shift in operations during the pandemic, examiners typically start by analyzing data from call reports. From there, examiners determine what to dig into and which follow-up data to request that is not found in the reports — all before ever stepping foot inside the bank.
In cases where banks have lacked the capacity to embrace an increase in electronic document exchanges and remote meetings, some supervisors have delayed or suspended exams.
But officials say the transition has mostly been smooth.
“Both bankers and examiners did an extraordinary job of working through those issues in the early days of the pandemic and figuring out how we allow bankers the space and the time to do what they needed to do,” said Paulson.
Similarly, an FDIC official said the agency “recognizes that institutions may have operational or staffing challenges associated with the pandemic that limit the ability of management to respond to normal supervisory requests.”
“Most institutions have chosen to continue with examination activities, and only a small number of examinations have been temporarily delayed due to operational considerations at the institution or on-site document access limitations,” the official said.
The FDIC official said examiners were still “prepared to go on-site, if necessary, and will consider institutional examination risk factors, operational considerations, and employee health and safety in making these case-by-case determinations.”
With the turmoil from the pandemic, examiners conducting off-site monitoring are more likely to intensify their focus on certain elements such as the level of account withdrawals and other signs of liquidity strength. Traditional exams during steadier times focus on factors such as transaction testing, asset quality and underwriting.
But the agencies' need to shift their exam focus temporarily comes amid a longer-term debate about making the supervision process more efficient through the use of digital technology.
In a speech last year, FDIC Chair Jelena McWilliams said digital "advances will allow the FDIC to use a new regulatory approach to supervision, powered by the same technology that is revolutionizing the banks we supervise."
She added that "we have already begun to make progress."
"In 2019, technology enabled us to conduct an average of 64% of our consumer compliance examinations and 44% of our prudential examinations off-site," McWilliams said. "And, as we train our examiners more on the use of these techniques and incorporate more new technology, we will further cut the costs of our exams on institutions without compromising on quality."
But overall, the process of regulators catching up to tech changes in the industry has been slow. And observers are divided over whether shifting to a remote examination footing makes sense outside of a crisis.
Start with the letter of the law: under the Federal Deposit Insurance Act, bank supervisors are required to conduct a “full-scope, on-site examination of each insured depository institution” every 12 or 18 months, depending on the size of the institution.
Several current and former regulators emphasized the importance of face-to-face interaction during bank exams.
“Demeanor, body language, non-verbal cues — those are all much more clear in person,” said Dan Stipano, a partner at Buckley LLP and former deputy chief counsel at the OCC. “That’s the key thing that’s lost when you need to work remotely.”
But he argued that more remote exams wouldn’t prevent regulators from fulfilling their oversight responsibilities. “Examiners can function remotely and still get their jobs done, and agencies can still take whatever supervisory and enforcement actions they need to," he said. "They’re not limited in that way.”
Broader limitations to remote bank exams persist in the form of technology. While the brunt of bank examination work hinges on the exchange of documents and data — an everyday occurrence for most businesses in the digital age — that supervisory information is “incredibly sensitive,” said Stipano.
“Not only does that information concern the financial position of the institution, but there’s also a lot of sensitive customer data,” he continued.
The problem is particularly acute for smaller banks, many of which have limited back-office capacity and have depended on traditional on-site bank examination for years. “The small banks just may not have the capacity for virtual exams in the same way as the big banks, where much is already digitized,” said Amy Friend, former chief counsel of the OCC and now a senior adviser to FS Vector.
The FDIC's “prior efforts and our existing systems have enabled FDIC to carry out examination activities and complete most scheduled examinations over the past six weeks,” according to the agency official.
But “not every institution maintains loan files in imaged form,” the official said, and that makes it more difficult to share documents digitally. “Some of those institutions have requested short-term examination delays citing a pandemic-related lack of available staff to scan and send the FDIC copies of requested loan files and other materials. In those instances, we have granted requests for short-term delays.”
As the pandemic winds down, delays in examination for banks overwhelmed by the crisis will also introduce a problem regulators have never had to contend with at such scale: how best to play catch-up in the coming year with limited pools of examiners.
“As things improve, whether we get a national all-clear or things reopen more gradually, regulators will need to think hard about how they deploy exam resources,” said Solomon.
Some analysts say that while the work bank regulators have already done to increase their capacity for remote bank examinations has helped in the short term, the crisis has exposed more fundamental shortcomings in how bank exams are conducted.
Barefoot argued that even if some of the more human parts of bank examinations become lost when conducted remotely, “you gain the potential for much more efficiency if you can collect more data.”
“Across the regulatory landscape, we need to have humans doing less data collection and less assembling of information,” Barefoot said. “Machines can point the humans towards high-priority, high-risk situations, and allow the trained examiners to focus on those.”