Alert May 04, 2010

Federal Banking Agencies Issue Final Guidance on Correspondent Concentration Risks

The FDIC, FRB, OCC and OTS (the “Agencies”) jointly issued final guidance (the “Guidance”) concerning correspondent concentration risks.  A proposed version of the Guidance (the “Proposed Guidance”) was discussed in the September 29, 2009 Alert.  The Agencies state that concentration risks can occur in correspondent relationships when a financial institution (“FI”) engages in a significant volume of activities with another FI.  The Guidance focuses on the need for FIs to identify, monitor and manage correspondent concentration risk on a stand-alone and enterprise-wide basis.  Appropriate due diligence should be performed, say the Agencies, “on all credit exposures to, and funding transactions with, other [FIs] as part of their risk management policies and procedures.”  Correspondent relationships can result in credit (asset) concentration risks and funding (liability) concentration risks.  The Agencies note that correspondent risks represent a lack of risk diversification, and the Guidance states that the Agencies generally consider credit exposures equal to or more than 25% of total capital as concentrations and funding exposures as low as 5% of an FI’s liabilities as concentrations.  In the Proposed Guidance, 25% or more of Tier 1 capital (rather than total capital) was regarded as a concentration. The Guidance provides that management of FIs should (1) identify an FI’s aggregate credit and funding exposures to other FIs and their respective affiliates; (2) specify what information, ratios or trends will be monitored for each correspondent; (3) set prudent correspondent concentration limits and tolerances for factors being monitored and plan for managing concentrations in excess of those limits; and (4) conduct an independent analysis before entering into any credit or funding transactions with another FI.  FIs should be in a position to react quickly to changing circumstances in the level of risk posed by a correspondent relationship.  The Guidance supplements rather than supersedes prior regulatory guidance.  The Guidance is effective May 4, 2010.