A failure to progress on a program meant to manage risk among large banks and financial institutions may be leading to a threat to the independence at the Federal Reserve from the industry it regulates, a congressional investigative agency concluded in a report released Wednesday.
The Government Accountability Office (GAO) in its report stated that the failure of the Fed to finalize and implement its enterprise risk management (ERM) framework to balance risks across its Large Institution Supervisory Coordinating Committee (LISCC) program may be risking the condition in which a regulator acts in service of private interests, such as the interests of the regulated industry, at the expense of the public interest. Known as “regulatory capture,” GAO said it has warned about the condition in the past.
“GAO has previously found that regulators should be independent of inappropriate influence, including undue influence from the industry they are regulating,” the oversight agency, which is answerable to Congress, wrote in its “Improved Implementation of Federal Reserve Policies Could Help Mitigate Threats to Independence.”
In its summary of a 97-page report, GAO noted that the LISCC is a supervisory program developed by the Fed to enhance the oversight of large, complex financial institutions. The report states that the LISCC “takes a cross-cutting approach to supervision, drawing staff from across the Federal Reserve System including the Board and four Federal Reserve Banks, and risks of regulatory capture span various aspects of the LISCC program.”
The GAO report points out that, in recognition of the advantages an ERM holds in managing the risk presented, the Fed began developing an ERM framework this year. However, the report states, the agency has not yet developed some of the key elements of the risk management plan recommended by the White House Office of Management and Budget (OMB). Those include risk identification and assessment. “ompleting and implementing the ERM framework should position the Board to better manage regulatory capture risks across the LISCC program,” GAO wrote.
In addition, GAO said it found weaknesses in some internal controls related to guidance and monitoring mechanisms under the LISCC. “These limit the Board’s assurance that policies are being implemented consistently across the LISCC program,” GAO wrote.
Because of these weaknesses, GAO stated, the four Federal Reserve Banks which supervise the largest financial institutions with oversight from the Fed Board, “may not be mitigating regulatory capture risks and threats to supervisory independence as effectively or consistently as possible.”
In addition, the oversight agency said that – although the Fed Board and the four banks have installed various conflict-of-interest and other ethics policies for LISCC examiners and other types of supervisory employees – it has found weaknesses in the application of the policies. “For example, the Federal Reserve officials said that they have policies to help mitigate threats to independence posed by the revolving door—that is, the movement of employees between the financial industry and the Federal Reserve—but they do not systematically collect employment data needed to implement these policies effectively. Without addressing this and other weaknesses, the Federal Reserve may be limited in its ability to use its ethics policies to mitigate regulatory capture,” GAO wrote.
Six recommendations were made in the report to improve the Fed’s implementation of ERM and “to strengthen internal controls to more effectively mitigate risks of regulatory capture and threats to supervisory independence across the LISCC program.” The recommendations include:
- identify and assess risks of regulatory capture across the LISCC program.
- finalize and implement program-wide guidance for the LISCC Reserve Banks on implementing LISCC policies.
- finalize and implement a mechanism to monitor and regularly assess Reserve Banks’ implementation of LISCC policies and procedures.
- streamline its conflict-of-interest disclosure review process for participants in the LISCC program, such as by storing disclosure information in compatible electronic systems.
- systematically collect and maintain information on the institutions supervisory employees work for before they are hired by the Federal Reserve and their employment destination when they leave.
- conduct a periodic self-assessment of ethics programs, policies, and procedures that apply to LISCC program participants.