Accounting principles:Specific accounting principles that are a portion of generally accepted accounting principles and that are used to determine the method and/or basis for reporting specific financial transactions. Some accounting principles are more acceptable than other principles because they produce more accurate or reliable financial data. Organizations are generally expected to use the most accepted accounting principles and are not permitted to alternate between two acceptable methods, because, in a given time period, one method produces a more desirable result than the other method.
Affiliated persons:Broadly, individuals (or corporate entities) related through mutual ownership or positions in more than one business enterprise. It is important to note the many banking laws have very specific definitions for this term. As a result, you will need to refer to the definition included in the law (or your legal counsel) to be confident that affiliated persons are appropriately identified. In this course, the definitions provided are specific to the law being discussed.
Allowance for loan and lease losses:An allowance for loan and lease losses is a contra-asset valuation account utilized to write the loan portfolio down to its current realizable value (expected cash flows). Financial institutions must follow generally accepted accounting principles (Financial Accounting Standard No. 5, Accounting for Contingencies, and Financial Accounting Standard No. 114, Accounting by Creditors for Impairment of a Loan) to determine their methodology for estimating the amount that should be in the Allowance for Loan and Lease Losses Account at the end of each quarter.
Asset Quality:The “A” in the CAMELS rating system that considers the quantity of credit risk in the loan and investment portfolios, other real estate owned, and other assets, as well as off-balance sheet items. Management's ability to: identify, measure, monitor, and control credit risk; the adequacy of the ALLL; and other risks that may affect asset values or marketability are also considered.
Assets Sold with Recourse:A loan for which an assignor is liable for payment if the borrower defaults. An assignor is the seller—an individual who transfers a title, claim, property, interest, or right to another person. (Assignor definition is taken from investorwords.com.)
Audit cycle:The length of time over which audit plans provide the required audit coverage for all auditable units within the audit universe. Audit cycles should not be open-ended. For example, some banks set audit cycles at 12 months or less for high-risk areas, 24 months or less for medium-risk areas, and 36 months or less for low-risk areas. The length of audit cycles will vary depending on an institution’s risks. The projected cycle is generally revised annually to ensure that resources are adequate to complete current and future plan years.
Audit manager:The person with responsibility for the internal audit function or department. This person may be identified by various titles including, chief audit executive, director of internal audit or, in a smaller institution, the internal auditor.
Audit of financial statements:The auditor evaluates the accounts and records maintained by management that are used to prepare the financial statements In doing so, the auditor must achieve a reasonable understanding of management’s system of internal controls, but is not required to rely on management’s internal controls. The objective of a financial statement audit is for the auditor to express an opinion on the fairness of the presentation of the financial statements as a specific date. This does not mean that the auditor has determined unequivocally, as some people believe, that every number on the financial statements is precisely correct.
Audit of internal control over financial reporting:The auditor evaluates the assessment performed by management and obtains and evaluates his own evidence regarding whether the internal controls over the financial reporting process are properly designed, exist and are operating effectively. The auditor’s objective is to express an opinion on management’s assessment of the effectiveness of the company’s internal control over financial reporting. This means that the auditor must have reasonable assurance that no material weakness existed as of the date of management’s assessment.
Audit plan:A risk-based list prepared annually by the chief audit executive that determines the period’s priorities for internal audit engagements consistent with the organization’s objectives. The plan and any subsequent changes to it are approved by the audit committee or the board of directors.
Audit program:A written document that describes the steps needed to complete an audit of a specific auditable unit. An audit program usually includes the following sections: audit objective and scope, audit planning and audit tests.
Audit reports:A formal written summary of an audit engagement that typically includes a rating for the audit, a description of the scope of the audit and procedures utilized in conducting the audit, and the findings (deficiencies) from the audit and their significance. The final audit report should be sent to the audit committee at the same time it is sent to management. However, the findings are normally discussed with management and an action plan from management is included in the final report.
Audit scope:All of the relevant activities, systems, records, personnel, physical assts and attributes of the auditable unit that need to be examined and evaluated to make a determination on the design, existence, and effectiveness of internal controls, the accuracy of reporting and communicating, and the adequacy of monitoring. The scope of an audit, for either internal or external audit, should not be limited by management or circumstances if the audit report is to have credibility and validity.
Audit step:Each action that will be taken in the planning and performance of the audit of an auditable unit.
Audit tests:Audit procedures such as inquiries of appropriate management, inspecting documents, observing application of specific controls (walk throughs), analytical review and tracing transactions. Inquiry and/or analytical review alone are not sufficient.
Audit universe:The aggregation of all of an organization’s auditable units. The audit universe should include all significant business units and processes that could expose the organization to risk that is more than remote and/or more than inconsequential. The audit cycle is complete when all auditable units in the audit universe have been audited at least once.
Auditable unit:The lowest process, account or product with characteristics or attributes that have sufficient risk or susceptibility to loss for which an organization is willing to plan an audit engagement. The audit universe is comprised of all of the auditable units in an organization. The number of auditable units will vary from organization to organization depending upon the size, complexity and relative risks within the organization.
Available-for-Sale Securities (AFS):AFS securities are those a bank purchases with the intent of selling if the need arises. AFS securities are reported on the bank's balance sheet at fair value. In other words, they are marked to market on a regular basis, with any difference between fair value and book value reported as an unrecognized gain or loss, thus affecting the bank's capital position.
Balance sheet:A bank’s balance sheet is the most effective tool to judge its current risk taking. It provides information on bank assets, liabilities and capital at a given point in time. Decisions about the mix and structure of the bank’s assets and liabilities can impact the bank’s financial performance on a daily basis. For more information, review the Balance Sheet lesson.
Bank:An organization, such as a national bank, state bank, and any federal branch and insured branch, which is usually chartered by either a state or the federal government for the purpose of accepting deposits. Banks may also make loans and invest in securities. See 12 U.S.C. 1813(a).
Bank ledger accounts:Banks, in fact most businesses, use a general ledger. The general ledger contains major ledger accounts for asset, liability and owner’s equity items. Examples of these ledger accounts are cash, loans, furniture and fixtures, deposits and common stock (definition taken from Financial Accounting: Basic Concepts, 6th edition, Earl A. Spiller and Phillip T. May Dame Publication, Inc. Houston, Texas, 1997, p. 927).
Bank Run:The process in which a significant number of bank depositors demand their money from the bank, either simultaneously or within a very short time, typically out of fear that the bank is about to fail. The total amount of depositor demands can exceed the bank's ability to pay them, causing the bank to be closed by regulators.
Bank's primary regulator:In the U.S., banks are chartered by the federal and state governments. Banks chartered by the federal government are designated as national banks and are supervised by the Office of the Comptroller of the Currency (OCC). Membership in the Federal Reserve System is required for national banks. For state- chartered banks, or state banks, Federal Reserve membership is optional. Those with membership are referred to as state- member banks and are supervised jointly by the Federal Reserve and their state chartering authority (the state of Missouri, for example). Non-Federal Reserve banks are called state nonmember banks. The Federal Deposit Insurance Corporation (FDIC) and their state chartering authority supervise these banks jointly.
Basis Point:A basis point is equivalent to one hundredth of a percentage point (0.01%). Basis points are often used to measure changes in, or differences between, yields on fixed income securities since these often change by very small amounts (definition taken from investorwords.com).
Basis risk:This is the risk from unequal movements in interest rates on a bank’s assets and liabilities with the same maturity.
Brokered Deposits:Deposits gathered by a broker from several depositors in an effort to place jumbo or near-jumbo CDs with banks, gaining a higher rate of interest than the individual investors could obtain as individual depositors. Any insured depository institution that is in less than well-capitalized condition is restricted in the interest rate it can offer on brokered deposits and/or its ability to accept or renew brokered deposits.
Call report:Also known as the Consolidated Report of Condition and Income, this is a detailed financial report that a bank’s regulator requires. It contains information about a bank’s assets, liabilities, capital, income and expenses, among other data.
Call reports are submitted quarterly, reflecting financial information as of the close of business on the last calendar day of each calendar quarter. Specific reporting requirements depend upon the size of the bank and whether it has any foreign offices. Call reports are public information that may be obtained from the federal banking regulators or online at the FDIC web site.
The name call report harkens back to days when a bank’s chartering authority would make a surprise “call” for the bank’s report. For more information, see the Balance Sheet lesson.
Capital:1.) Cash or goods used to generate income; or 2.) the net worth of a business, i.e. the amount by which its assets exceed its liabilities (definitions taken from investorwords.com). Bank capital serves the same purpose as capital in other businesses. It is the cushion that funds operations and sustains the bank through poor economic times, or through unanticipated adverse events (such as unexpected loss from fraud or natural calamities).
Capital categories:The capital categories defined in the prompt corrective action regulation are:
- well capitalized: total risk-based capital ratio of 10 percent or greater, tier 1 risk-based capital ratio of 6 percent or greater, and a leverage ratio of 5 percent or greater, and the bank is not under a formal action to meet and maintain a specific capital ratio;
- adequately capitalized: total risk-based capital ratio of 8 percent or greater, tier 1 risk-based capital ratio of 4 percent or greater, and either a leverage ratio of 4 percent or greater or 3 percent or greater if the bank is rated CAMELS composite-rated 1 and is not experiencing or anticipating significant growth;
- undercapitalized: total risk-based capital ratio less than 8 percent, or tier 1 risk-based capital ratio less than 4 percent; or a leverage ratio less than 4 percent or less than 3 percent if the bank is rated CAMELS composite-rated 1 and is not experiencing or anticipating significant growth;
- significantly undercapitalized: total risk-based capital ratio less than 6 percent; or tier 1 risk-based capital ratio less than 3 percent; or a leverage ratio less than 3 percent; and
- critically undercapitalized: a ratio of tangible equity to total assets equal to or less than 2 percent.
Case law:Also known as Common Law. The law created by judges when deciding individual disputes or cases. Non-statutory law or law that fills in gaps in statutory law. Legal principles that are developed by appellate courts when deciding appeals are collectively termed case law or common law. Since the 12th century, the common law has been England’s primary system of law. When the United States became independent, states adopted the English common law as their law. Since that time, decisions by U.S. courts have developed a body of U.S. case law that has superseded English common law in most areas.
Charged off loans:Loans whose interest and principle, or portions thereof, have been determined to be uncollectible and whose balances have been written down to their realizable values on the organization’s books. The amounts to be written off could have been determined internally or directed by bank regulators. The board of directors must approve all loan balances to be charged off.
Chief audit executive:The chief audit executive is the manager of the internal audit function. In the case where internal audit activities are outsourced to a vendor, it is the person responsible for overseeing the contract, supervising the quality of these services, and reporting to the board of directors and senior management regarding these activities. Persons holding this position generally have the titles of director of internal audit, general auditor, chief internal auditor, or inspector general. The chief audit executive is generally expected to have a title and experience equivalent to those of other senior officers of the organization.
Civil money penalty laws:The Federal Reserve Board may assess a civil money penalty against a bank or institution-affiliated party under any of the following statutes:
- Section 8(i) of the Federal Deposit Insurance Act:
- Tier 1: up to $6,500 per day for any violation of law, regulation, final or temporary order, written agreement, or condition imposed in writing;
- Tier 2: up to $32,500 per day for any violation described in Tier 1 or reckless engagement in an unsafe or unsound practice that is part of a pattern of misconduct or causes more than a minimal loss to the bank, or results in pecuniary gain or other benefit to the bank or party;
- Tier 3: up to the lesser of $1,250,000 or 1 percent of the total assets of the bank, per day, for any knowing violation described in Tier 1 or engagement in an unsafe or unsound practice that knowingly or recklessly causes substantial loss to the bank or pecuniary gain or other benefit.
- Section 7(j) of the Federal Deposit Insurance Act—Change in Bank Control—the same three tier provisions apply for any violation of the change in bank control statute or accompanying regulations;
- Section 9 of the Federal Reserve Act: Regulatory Reporting Violations:
- Tier 1: up to $2,200 per day for a bank that maintains procedures reasonably adapted to avoid any inadvertent error and unintentionally:
- fails to file or publish a report within the prescribed time period,
- submits a false or misleading report, or
- inadvertently files a minimally late report.
- Tier 2: up to $27,000 per day for bank that:
- fails to file or publish a report within the prescribed time period, or
- submits a false or misleading report in a manner not described in Tier 1.
- Tier 3: up to the lesser of $1,250,000 or 1 percent of the total assets of the bank per day, if the bank knowingly or with reckless disregard for the accuracy of the information, submits a false or misleading report.
Classified Assets:Loans or other assets, identified internally or by bank regulators, that have experienced a current or prior event of impairment leaving the borrower unable to repay some portion of the loan. Once identified, the financial institution writes the loan balances down to the current realizable value (expected cash flows) by a charge to income and a credit to the allowance for loan and lease losses. When the loss is confirmed, the loan balance is credited and the allowance for loan and lease losses is debited.
Classified loans:Loans or portions of loans, identified internally or by bank regulators, that have experienced a current or prior event of impairment leaving the borrower unable to repay some portion of the loan. Once identified, the financial institution writes the loan balances down to the current realizable value (expected cash flows) by a charge to income and a credit to the allowance for loan and lease losses. When the loss is confirmed, the loan balance is credited and the allowance for loan and lease losses is debited.
Compliance:Conformity and adherence to laws, regulations, and contracts. Additionally, compliance can be interpreted as conformity to internal policies, practices plans and procedures.
Confidential supervisory information:Confidential supervisory information includes reports of examination, inspection and visitation; confidential operating and condition reports; and any information derived from, related to or contained in such reports. Confidential supervisory information does not include documents a bank prepares for its own business purposes and that are in its possession. See 12 C.F.R 261.1(c).
Contested actions:When the notice of charges and of hearing is issued, it starts a formal process that includes convening a public administrative hearing conducted before an administrative law judge who is appointed by the Office of Financial Institutions Adjudication. Counsel may represent the bank or individual. After the hearing, the judge makes a recommended decision to the Federal Reserve Board. A hearing must be held within 30 to 60 days of service of the notice of charges, unless the administrative law judge sets a later date. After considering the record of the proceeding, including the administrative law judge’s recommended decision, the Federal Reserve Board determines whether to issue a final order. Banks and individuals who are subject to adverse orders that were issued as a result of contested proceedings may appeal the order to the appropriate federal court of appeals. The Federal Reserve’s rules for contested actions are more fully described in the Federal Reserve’s Rules of Practice for Hearings at 12 C.F.R. Part 263.
Control environment:The attitude and actions of the board of directors and senior management of an organization regarding the significance of controls within the organization, also known as “tone at the top.” This environment provides the discipline and structure for the achievement of the primary objectives of the system of internal control. The control environment includes:
- ethical values and integrity,
- management’s style and operating philosophy,
- the organization’s structure,
- the manner of assigning authority and responsibility,
- the formalization of human resource policies and practices, and
- commitment to the competence of its personnel.
Corporate entity:A bank is a corporate entity governed by a board of directors who are elected by the shareholders to represent and protect their interests. Thus, directors are an important part of a bank`s governance system, possessing ultimate responsibility for the conduct of the bank`s affairs.
Corporate transparency:A term used to describe a culture of openness wherein the organization discloses information, in plain language, including, but not limited to, management policies and decisions, accounting polices, practices, and implications, off-balance activities, management estimates and strategies, corporate governance policies and practices, ethical codes, and executive compensation.
Correspondent Banks:A correspondent bank is a bank that accepts deposits of and/or performs banking services for insured depository institutions.
COSO elements:The five essential components of internal control—control environment, risk assessment, control activities, information and communication, and monitoring—as defined by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), Internal Control – Integrated Framework.
Coverage Ratio:The coverage ratio is the Allowance for Loan and Lease Losses divided by noncurrent loans. This ratio provides an indication of the adequacy of a bank’s loan loss reserve to cover or absorb possible future loan losses. This ratio is referred to as the coverage ratio because it gives an indication of how well the reserve covers potential future loan losses.
Covered Transaction:A covered transaction is one that is covered by the law (for instance, extensions of credit, guarantees and purchases of assets).
Credit Risk:The risk that a borrower will fail to repay a loan as originally agreed.
Delinquent loans:Loans whose balance, after the borrowers’ payments of interest and principal, are not paid current in accordance with contractual terms.
Deposit Insurance:Protects bank depositors' money from loss caused by a bank's inability to pay the depositor upon demand, usually in the event of a bank failure. While states used to allow state-chartered banks to use private deposit insurance, virtually all 50 states now require banks to subscribe to insurance from the FDIC. This is also a requirement of national banks as well.
Derivatives:A derivative is a financial instrument whose characteristics and value depend upon the characteristics of an underlier, typically a commodity, bond, equity or currency. Related definitions:
- Underlier: An underlier is a security or commodity that is subject to delivery upon exercise of an option contract or convertible security. Exceptions include index options and futures which cannot be delivered and are therefore settled in cash.
- Convertible security: A bond, preferred stock or debenture that is exchangeable at the option of the holder for common stock of the issuing corporation.
- Option: The right, but not the obligation, to buy (for a call option) or sell (for a put option) a specific amount of a given stock, commodity, currency, index or debt, at a specified price (the strike price) during a specified period of time.
(Definitions taken from investorwords.com. For more information about securities and financial instruments, see the Basic Investment Concepts for Banks lesson in this course.)
Detective controls:Controls having the objective of detecting errors, noncompliance or fraud that has already occurred.
Discount Window:The discount window is a credit facility of the Federal Reserve System where insured institutions may borrow funds to meet short-term and seasonal liquidity needs.
Discussion of contested actions:The issuance of the notice of charges and of hearing starts a formal process that includes the convening of a public administrative hearing conducted before an administrative law judge, appointed by the Office of Financial Institutions Adjudication. The bank or individual may be represented by counsel. After the hearing, the judge makes a recommended decision to the Federal Reserve Board. A hearing must be held within 30 to 60 days of service of the notice of charges, unless the administrative law judge sets a later date. After considering the record of the proceeding, including the administrative law judge’s recommended decision, the Federal Reserve Board determines whether to issue a final order. Banks and individuals who are subject to adverse orders that were issued as a result of contested proceedings may appeal the order to the appropriate federal court of appeals. The Federal Reserve’s rules for contested actions are more fully described in the Federal Reserve’s Rules of Practice for Hearings at 12 C.F.R. Part 263.
Due from Bank:An amount owed to a bank by another, classified on the balance sheet as the equivalent of cash. (Definition taken from Banking & Finance Terminology, 4th edition, American Bankers Association, 1999, p. 135.)
Duration:Duration is a time measure that can be used to assess a bank’s capital exposure to small changes in interest rates. As an analytical tool, duration analysis can provide valuable insights regarding the effects of interest rate changes on the value of a bank’s assets, liabilities and, hence, its capital position. However, it has a number of weaknesses, which led many institutions to use an economic value of equity simulation model as a tool to judge their capital exposure to interest rate changes.
Early Examination:Banks with total assets of less than $250 million that are in satisfactory condition and meet other tests may be examined every 18 months, larger institutions every 12 months. Banks in less than satisfactory condition may be examined as frequently as every six months.
Earnings:Earnings are revenues minus cost of sales, operating expenses and taxes over a given period of time. Earnings are the reason corporations exist, and are often the single most important determinant of a stock's price. Also called income (definition taken from investorwords.com).
Economic Value of Equity Simulation (EVE):EVE analysis attempts to forecast the effects of interest rate changes on the value of a bank’s capital. This is done by looking at the net effects of interest rate changes on the market value of a bank’s assets and liabilities.
As the designations “short-term” and “long-term” denote, both EAR and EVE models should be used to obtain a complete picture of a bank’s interest rate risk exposure.
Effect of removal:The effect of Removal and Prohibition Order is an industry-wide prohibition. An individual subject to such an order cannot, without the prior approval of appropriate federal banking regulators, among other things:
- participate in the conduct of the affairs of any insured depository institution, bank holding company, the U.S. operations of foreign banking organizations, Edge and Agreement Corporations, federal depository institution regulators, Federal Housing Financing Board, or Federal Home Loan Bank;
- solicit, procure, transfer, or vote any proxy, consent, or other voting rights in the above institutions;
- vote for a director; and
- serve or act as an institution-affiliated party.
Enterprise risk management:A strategic process implemented by an organization’s board of directors and applied across an organization that is designed to identify potential events that may impact the organization (negatively or positively), to consider effective responses that are within the organizations risk appetite, and to provide reasonable assurance that the organizations objectives are being achieved. An essential element of this strategic process is the identification and management of cross-enterprise risks. The objective of enterprise risk management is to address strategic, operations, compliance and reporting issues within the organization using the components: internal environment; objective setting; event identification; risk assessment; risk response; control activities; information and communication; and monitoring.
Evaluation 8 Ratios:Many times the reports you receive will contain basic financial ratios as well as dollar amounts generated from the bank#8217; reports. An example of some ratios you might see are similar to those we are calling the Evaluation 8, in this course. These are eight common ratios derived from balance sheet and income statement information that you can use to judge bank earnings and earnings quality, asset quality, and capital position. For more information on these ratios, review the Basic Ratio Analysis lesson. Often these Evaluation 8 ratios are compared with history, budget and peer bank data in order to provide a context by which to judge current performance.
Executive sessions:Private meetings between a committee and another party, generally without members of senior management present. For example, the audit committee frequently meets in separate executive sessions with financial management, the external auditor, and the chief audit executive. The nominating/governance committee and the compensation/human resource committees meet in executive session without any members of management present. The purpose of executive sessions is to encourage open communication and to provide a venue for the participants to have discussion that might not be possible in the presence of senior management.
External audit firm: Public accounting firm that is, by definition, independent of its client and that performs an audit of the client’s financial statements for the purpose of rendering an opinion on the fairness of the presentation of those statements. The audit firm may also be engaged to provide an attest opinion on the design, existence, and effectiveness of the client’s internal controls over financial reporting and disclosure. With prior approval from the client’s audit committee, the same accounting firm may be engaged to perform specific non-audit accounting services, such as tax services, as long as these services have not been specifically prohibited by the Securities Exchange Commission (SEC) or the Public Company Accounting Oversight Board (PCAOB).
FAS 115:FAS 115 is Statement of Financial Accounting Standards No. 115 from the Financial Accounting Standards Board. FAS 115 addresses the accounting treatment for certain investments in debt and equity securities.
Under FAS 115, banks must carry their investment securities in one of three buckets:
- held-to-maturity (HTM), which are carried at amortized cost;
- trading securities, purchased and held primarily for sale, are carried at fair value with unrealized gains and losses included in current period earnings; and,
- available-for-sale (AFS) , which are neither HTM nor trading securities, are carried at fair value, but their unrealized gains and losses are a separate component of shareholders’ equity.
FDIC:Federal Deposit Insurance Corporation — An independent agency of the federal government that administers the federal deposit insurance fund, manages banks that are placed into receivership, and supervises state-chartered banks that are not members of the Federal Reserve System.
FDICIA Organizations:Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA), which amended section 36 of the Federal Deposit Insurance Corporation Act (FDIC Act) imposed a reporting requirement on all banks that had assets of $500 million or more (whether public or closely held) on January 1 of any given year. These banks and their parent bank holding companies, if any, are required to submit copies of the following reports to the FDIC and their other federal regulators:
- audited financial statements with audit opinion for the bank or parent bank holding company;
- management’s assertions regarding responsibility for preparation of financial statements in accordance with GAAP, establishing a system of internal controls over financial reporting and safeguarding of assets, and compliance with specified laws (dividend payments and Regulation O);
- management’s assertion that it has examined the system of internal controls and has found them to be effective as of the end of the current year;
- management’s assertion that is had examined it compliance with the specified laws and found that the organization was in compliance for the current year;
- the external auditors’ attestation that it has reviewed management’s assertion regarding internal controls and it has tested internal controls and, in its opinion, has found that internal controls were effective at the end of the current year; and
- any significant correspondence, including management letters, between the financial institution and the external auditor, including termination of services that transpired during the current year.
In 2005, for banks with total assets between $500million and $1billion, the FDIC amended FDICIA to drop two of the above requirements: management and the external auditors’ assertion and attestation on the existence and effectiveness of the system of internal controls. All other reporting requirements remain in place for these banks. For banks with total assets that exceed $1 billion, the original reporting requirements remain applicable.
Federal Funds:Reserves held in a bank's account with its Federal Reserve Bank. Also called fed funds for short. Reserve Banks have paid interest on those reserves since November 2008. Banks with reserves in excess of what is required by the Federal Reserve can lend these funds to other depository institutions. For the lending bank, they would be called fed funds sold. For the borrowing bank, they are fed funds purchased. Most fed funds transactions are on an overnight basis, but longer-term arrangements can be made.
Federal Home Loan Bank (FHLB) advances:A longer-term funding source is the FHLB. A bank must be both a member of the FHLB system and meet FHLB lending qualifications to make use of a regional FHLB's lending programs. These programs have a wide range of maturities and interest rate terms and can be used to fund residential loans and, in the case of smaller banks, fund small business, small farm and small agribusiness loans.
Federal Reserve discount window:The Federal Reserve discount window is a credit source that provides borrowing banks time to make orderly adjustments in their assets and/or liabilities to meet liquidity needs.
Fieldwork:Substantive testing of transactions or walk throughs of processes that are conducted in the unit or process under audit and not in the auditor’s office. Fieldwork allows the opportunity for observation and inquiry and provides unit employees the opportunity to share information that may concern them.
Financial expert:A person who has, through education and/or experience as a public accountant, auditor or a principal financial officer, controller, or principal accounting officer of a reporting issuer, or experience in one or more positions involving similar functions, achieved the level of expertise to be able to understand financial statements and accounting principles of the complexity that will be utilized by the issuer organization.
Financial intermediary:A bank is a financial intermediary, taking in deposits and lending or investing a portion of those deposits to borrowers, charging a higher interest rate than what is paid on the deposits. That intermediary role poses many risks to banks, risks that the board of directors need to identify, measure, monitor, and control.
Financial literacy:a person who is able to read and understand financial statements.
FinCen:A federal repository for collecting suspicious activity reports filed by financial institutions related to suspected crimes related to bank fraud, the Bank Secrecy Act, and the Patriot Act.
Forensic audit:A specialized audit, generally conducted by auditors with special training in interviewing, tracing transactions, and gathering documentary evidence, that occurs when an organization has reason to believe a fraud has occurred. Responsibility for overseeing a forensic audit is generally shared by an audit committee and its own legal counsel rather than the counsel usually engaged to represent the organization as a whole.
Fraud:Any of a number of acts characterized by deceit, concealment or violation of trust. These acts are not dependent upon the application of threat of violence or physical force. Frauds are perpetrated by individuals acting alone, individuals acting in collusion, or organizations to obtain money, property, or services, or to avoid payment or loss of services or to secure personal or business advantage.
Full scope audit:An audit of a business unit or process (an auditable unit) that encompasses all of the transactions or activities of that auditable unit. All significant controls are tested for design, existence and effectiveness. A full scope audit should generally include a walk though to document the flow of the units work, hand-offs to other individuals or departments, and documentation of the existence of controls.
Gap Analysis:Gap analysis was one of the first analytical methods developed to assess banks’ interest rate exposure. It remains one of the most frequently used methods.
Gap analysis looks at timing differences between the repricing of interest rates on a bank’s assets and liabilities to determine its interest rate exposure, making it a good tool for judging repricing risk. When these timing differences are large, the bank faces greater net income exposure than when these differences are small.
Gap, unfortunately, is not a very good tool for judging basis, yield curve and options risk in a bank’s assets and liabilities. Accordingly, many banks use income simulation to judge their interest rate risk exposure.
Generally Accepted Accounting Principles:The generally accepted accounting principles are the rules, conventions, practices and procedures that form the foundation of financial accounting. (Definition taken from Banking & Finance Terminology, Fourth Edition, American Banker Association, Washington, D.C., 1999, p. 182).
Governance-related committees:Audit, Nominating/Governance, and Compensation/Human Resources.
Guarantor:One who guarantees an obligation and has a legal duty to fulfill it (definitions are taken from investorwords.com).
Hedge:An investment made in order to reduce the risk of adverse price movements in a security, by taking an offsetting position in a related security, such as an option or a short sale (definition taken from investorwords.com).
Hedges:An investment made in order to reduce the risk of adverse price movements in a security, by taking an offsetting position in a related security, such as an option or a short sale (definition taken from investorwords.com).
Held-to-Maturity Securities (HTM):HTM securities are those a bank purchases with the intent (and it has the ability) to hold until maturity. They are reported on a bank's balance sheet at amortized cost—the bank's cost adjusted for premium paid or discount received. If HTM securities must be sold to meet liquidity needs, then the HTM portfolio becomes “tainted,” requiring the bank to reclassify all of these securities as AFS securities, marking them to market and recognizing any gains or losses.
Holding Company:A bank holding company is a company that owns or controls a bank or banks.
Income Simulation:Income simulations are generally computer-based models that use information on a bank’s current balance sheet position and assumptions about future interest rate movements, management strategies, customer behavior, and new business and reinvestment plans to project future cash flows, income and expenses. These projections, or simulations, can be run for a variety of interest rate scenarios and can be used to perform “what if” analyses on the effects of interest rate changes under alternative business strategies. Often, however, analyses are done for a base case scenario—the bank under no interest rate change—and for rising and falling rate scenarios. In some instances, other scenarios may be presented (for example, a most likely rate change scenario).
Income Statement:An income statement provides information on bank income and expense items over a period of time. Because you can see the net result (income and expense) of your decisions over time, income statements are the most effective tool to judge the effectiveness of risk management. For more information, review the Income Statement lesson.
Indemnification:The Federal Deposit Insurance Corporation’'s regulations provide criteria for making permissible indemnification payments. A bank may make or agree to make a reasonable indemnification payment if all of the following conditions are met:
- The bank’s board of directors determines in writing that the institution-affiliated party acted in good faith and the best interests of the bank.
- The board of directors determines that the payment will not materially affect the bank's safety and soundness.
- The payment is not a prohibited indemnification payment, as defined in the regulations.
- The institution-affiliated party agrees in writing to reimburse the bank, to the extent not covered by permissible insurance, for advance payments made in the event that (among other things) the administrative action results in a final order or settlement in which the institution-affiliated party is assessed a civil money penalty, is removed or prohibited from banking, or is required, under a final order, to cease an action or take any affirmative action (for example, make restitution to the bank).
For further information, please see the Federal Reserve Board’s SR 02-17
Industrial Loan Company:State-chartered financial institutions that are not subject to the Bank Holding Company Act or supervision by the Federal Reserve and, therefore, may be owned by non-financial commercial companies that are, in turn, not subject to oversight by federal or state banking regulators. ILCs generally have the same powers as banks (e.g., lending and deposit taking) and may also have the ability to branch in multiple states. As of June 30, 2008, the states of California, Colorado, Hawaii, Indiana, Minnesota, Nevada and Utah charter such institutions.
Institution-Affiliated Party:Any officer, director, employee, controlling shareholder or agent of a financial institution, and any other person who has filed or is required to file a change-in-control notice. This includes any shareholder, consultant, joint-venture partner, or any other person who participates in the conduct of the affairs of the financial institution, as well as any independent contractors, including attorneys, appraisers, and accountants, who knowingly or recklessly participate in any violation of law or regulation, breach of fiduciary duty, or unsafe or unsound practice that causes (or is likely to cause) more than a minimal financial loss to or a significant adverse effect on a financial institution.
Intangible asset:An intangible asset is something of value that cannot be physically touched, such as a brand, franchise, trademark or patent.
Interest Earning Asset:Assets on which the bank receives interest income. Interest earning assets are assets that provide the bank with revenue, such as loans and investments. Other assets (such as building, furniture and fixtures or office equipment needed to conduct business) may provide the bank with an implied return, but do not explicitly provide it with revenue.
Interest Income:Interest Income is the revenue a bank receives on its loans and investments.
Interest Rate Risk:Interest rate risk is one component of market risk. Market risk refers to the risk that an institution’s earnings and capital may be affected by changes in market rates or prices such as interest rates, securities prices, commodity prices and foreign exchange rates.
Internal audit charter:A formal written document that defines the function’s purpose, authority, and responsibilities. It should establish the function’s position within the organization, authorize access to all records, personnel, and physical properties relevant to the performance of internal audit engagements and define the scope of internal audit activities.
Internal audit function:An objective assurance activity designed to evaluate and improve an organization’s controls and operations by bringing a systematic, disciplined approach to evaluate the design and effectiveness of risk management, control, and governance processes. Included in the responsibilities of internal audit are: ensuring controls exist so that financial and operational records are accurate and complete; evaluating the design, existence and effectiveness of internal controls; coordinating their work with the work of external auditors; performing due diligence for pending purchases; analyzing task performance in functional areas; confirming internal compliance with laws, regulations, policies, and procedures; ensuring that physical assets are compared to financial records; evaluating whether management has complied with contractual terms and conditions; reviewing system development projects; reviewing building or remodeling projects; evaluating computer and software application access and other controls; and investigating alleged fraud situations.
Internal controls:A process designed and implemented by an organization’s board of directors and management to provide reasonable assurance for accomplishing these organizational objectives: 1) safeguard the organization’s assets: 2) ensure accurate and reliable accounting data; 3) promote operational efficiency; and 4) adhere to standards and policies established by the board of directors and senior management. Internal controls over accounting are expected to have the following characteristics: 1) separation of the duties of authorizing, recording, custody, and monitoring; 2) transactions must be conducted by persons acting within the scope of their authority; 3) transactions must be recorded in the periods in which they occurred; 4) access to assets should be limited to those with proper authority; 5) there should be regular comparisons of assets to records; 6) persons with access to assets and records must be competent and have integrity. The components of the internal control process are: the control environment; risk assessment; control activities; information and communication; and monitoring.
Jumbo Certificate of Deposit:A certificate of deposit (CD) of $100,000 or more. Such CDs typically pay a higher rate of interest. They are generally considered volatile or noncore forms of funding, particularly when the CD amount exceeds FDIC insurance limits, as the depositors will quickly move the money out of any bank that is perceived to be in trouble.
Legal Risk:Legal risk is the risk of loss or harm from unenforceable contracts, lawsuits or adverse judgments.
Letter of Credit:A letter of credit is a document issued by a bank on behalf of its customer authorizing a third party to draw drafts on the bank up to a stipulated amount.
Leverage Ratio:Also known as Tier 1 leverage ratio. This is the ratio of Tier 1 capital to average total assets.
Line of Credit:A line of credit is an expression by a bank of the amount of money a bank is willing to lend to a customer over a specific period of time. The unused portion represents the remaining amount the customer can draw on the credit line after previous draws. Some lines of credit include material adverse change (MAC) clauses. These clauses release the bank#8217; obligator to permit further draws on a line in the event the creditworthiness of the borrower to whom the line is extended should change.
Liquidity:The bank's ability to convert assets to cash in a reasonable time frame and at a reasonable cost.
Liquidity Risk:The risk that when a bank needs to raise cash for its day-to-day operating needs it won’t be able to do so at a reasonable cost.
Loan policy:Written policies and procedures approved by the board of directors that provide guidance regarding the lending function. These policies establish the types of lending the board authorizes, the criteria for each type and risk parameters and concentrations for each type. The policies set the lending authorities for each loan officer, combinations of loan officers, and specify which loans must be approved by the board itself. The policies also establish minimum collateral and documentation requirements for the various loan types. In many banks, the loan policy specifies the loan application, loan documentation, loan approval, and loan booking processes. It may also contain the methodology for calculating the loan loss reserve, the bank’s criteria for grading loans, the bank’s procedures for collection of problem loans and charge off of loans with identified losses. It may also require that certain reports be submitted to the board on a periodic basis so that the board can monitor the lending activity. Loan policies are individualized for each financial institution, its lending activities, and its risk appetite and are not, generally, interchangeable between banks.
Loan-To-Value Ratios:The ratio determined by dividing the amount of loans by the value of the collateral securing the loans. There are supervisory loan-to-value limits for real estate loans, as prescribed by Federal Reserve Regulation H, which address interagency guidelines for real estate lending policies. For example, banks should lend no more than 65 percent of the value of raw land, or no more than 75 percent of the value on land development loans. Institutions may exceed these guidelines in circumstances where credit is justified; however, loans made above supervisory limits must be reported to a bank's board of directors quarterly until their loan-to-value ratio falls below these limits.
Management letter:At the end of the audit (financial statement or audit of internal controls), the external auditor provides a letter to the audit committee and/or management. Depending on the audit standards under which the audit was performed and the firm’s policy, this letter will report on various situations the auditors observed while conducting the audit. Some items may be matters which the auditor wants to call to the client’s attention, but, generally, the items will be identified as deficiencies, significant deficiencies or material weaknesses. For public clients, PCAOB AS No. 2 requires that all material weaknesses be reported in the annual report, all significant deficiencies be reported in writing to the audit committee, and all deficiencies be reported in writing (at a minimum) to the client’s management. Currently, the reporting requirements are less specific for audited nonpublic firms and, in a few cases, the auditor makes oral presentations but does not provide control deficiencies in writing to the audit committee. Audit committees have a right to have all findings sent to them in writing and should require their auditors do this. Some firms ask the client to respond in writing to the findings outlined in the management letter and others do not.
Management representation letter:Pursuant to Statement of Auditing Standards No. 85, an external auditor cannot provide an opinion on an organization’s financial statements unless management has provided the auditor with a letter of written representations that, as a minimum, includes:
- management’s acknowledgement of its responsibility for the fair presentation of the financial statements;
- management’s belief that the financial statements are fairly presented and in conformity with GAAP;
- management has made all financial records and data available;
- management has provided all minutes of stockholder, board and board committee meetings;
- management has provided the auditor with all communications from regulators concerning noncompliance or deficiencies in financial reporting practices;
- there are no unrecorded transactions;
- management believes that any uncorrected financial statement misstatements, in aggregate or individually, are immaterial;
- management acknowledges it is responsible for the design and implementation of programs and controls to prevent and detect fraud;
- management has informed the auditor of any known or suspected frauds involving management or employees involved in internal control or positions where fraud could have a material effect;
- any knowledge management has regarding suspected fraud by employees, customers, regulators, or others;
- plans or intentions that could affect the carrying value or classification of assets or liabilities;
- information concerning related third party transactions and amounts receivable from or payable to related parties;
- guarantees, written or oral, under which the entity is contingently liable;
- significant estimates or material concentrations known to management;
- violations or possible violations of laws or regulations which may expose the entity to liability;
- unasserted claims or assessments that the entity’s lawyer has advised management are probable of assertion and must be disclosed;
- other liabilities and gain or loss liabilities contingencies that are required to be disclosed or accrued pursuant to FAS Statement No. 5, Accounting for Contingencies;
- existence of title to assets, liens or encumbrances on assets and assets pledged as collateral; and
- compliance with aspects of contractual agreements that may affect the financial statements.
Market Risk:Market risk broadly refers to the risk that a bank's earnings and capital might be adversely affected by changes in interest rates, exchange rates or securities prices. This course focuses on how the risk posed by changes in interest rates may adversely affect a bank's net income and capital position.
Material weakness:A significant deficiency, or a combination of significant deficiencies, that result in a reasonably likely or probable likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. In determining whether a control deficiency, or a combination of deficiencies, is a significant deficiency or a material weakness, the auditor should evaluate the effect of compensating controls and whether such compensating controls are effective.
Monetary Policy:The process in which a country's central bank or other authority controls the supply, availability, and cost of money, usually with the goals of economic stability and growth.
Net Interest Income:Net interest income is the difference between interest received and interest paid.
Net Losses to Average Total Assets Ratio:The Net Losses to Average Total Assets ratio is equivalent to charge-offs less recoveries, divided by average total assets.
Non-Accrual Loans:Non-accrual loans are those 90 days or more past due, not adequately collateralized and not in the process of collection. Regardless of delinquency period, a loan should be placed on nonaccrual when full payment of principal and interest is not expected.
Non-audit services:Services provided by a public accounting firm that are not directly related to the performance of an audit of the financial statements or an audit of internal controls. Permissible non-audit activities by the firm that performs the audit (for example, tax services or the annual valuation of an ESOP’s shares) must be pre-approved by the audit committee prior to performance of the services. The firm that conducts the organization’s audit is prohibited by SOX from performing specific non-audit services for publicly traded companies. The prohibited services are: 1) Bookkeeping; 2) Financial information systems design and implementation; 3) Appraisal or valuation services, including loan review and impairment tests of goodwill; 4) Actuarial services; 5) Internal audit outsourcing services; 6) Management functions or human resources; 7) Broker, dealer, investment advisor, or banker services; 8) Legal or expert services unrelated to audit; and 9) Any other services that the PCAOB determines to be impermissible. The two determinants for reaching conclusions about the permissibility of non-audit services are that the external auditor cannot act in the capacity of management and the external auditor cannot audit any work that was done by the firm.
Noncumulative Perpetual Preferred Stock:Noncumulative perpetual preferred stock is preferred stock with no fixed final maturity date, where the issuing firm does not have to make up past unpaid dividends. Preferred stock is one of the two major types of equity securities (the other is common stock). Preferred stock receives dividends (and preference to company assets, should the corporation be liquidated) before common stock. The dividend rate for most preferred stock is fixed at the time of issuance. Preferred stock does not usually entail voting rights for the stockholder.
Nonindemnifiable Losses:Losses for which a
corporation, in this case a bank, cannot indemnify its officer or directors. For example, there may be
laws or regulations that prohibit it from doing so, the corporation’s
financial condition may prohibit such payments, the company’s bylaws may prohibit it or the board may not permit it.
Off-Balance Sheet:These items are not listed on the balance sheet because they are potential obligations, not current actual obligations. Some examples include unused lines of credit or lines of credit the bank holds with other sources like correspondent banks or the Federal Home Loan Bank (FHLB).
Off-balance sheet items:Off-balance sheet items are assets that, under accounting rules, are not reflected on a bank's balance sheet, but can, nonetheless, expose the bank to financial losses for which capital must be maintained. Examples of off-balance sheet items include such things as standby letters of credit, unfunded loan commitments, interest rate swaps and commercial letters of credit.
Operational Risk:Operational risk is the risk to the bank that errors made in the course of conducting its business will result in losses.
Options Risk:The risk that arises from implicit and explicit options in a bank’s assets and liabilities, such as prepayment of loans or early withdrawal of funds.
Par Value:An arbitrary amount printed on each stock certificate which represents the amount of shareholder investment that cannot be reduced by voluntary actions of the board of directors, for example paid out as dividends used to repurchase of stock by the corporation. It is sometimes referred to as legal or stated capital. Financial Accounting: Basic Concepts, 6th edition, Earl A. Spiller and Phillip T. May, Dame Publication, Inc. Houston, Texas, 1997), pp. 603-605, 932.
Parent Bank Holding Company:A corporation that owns and controls a bank or banks.
Past-Due Ratio:Loans that are 30 days or more past-due plus nonaccrual loans divided by total loans.
Peer Values:With peer comparisons, your bank’s performance is measured against similar banks. Peer values reflect data for banks in such a peer group.
Pledging Requirements:Many governmental bodies require banks to pledge securities that serve as collateral for their deposits to reduce the possibility of loss in case the bank fails.
Preferred Stock:Preferred stock is one of the two major types of equity securities (the other is common stock). Preferred stock receives dividends (and preference to company assets, should the corporation be liquidated) before common stock. The dividend rate for most preferred stock is fixed at the time of issuance. Preferred stock does not usually entail voting rights for the stockholder.
Premium or Discount:Because of legal restrictions on bank ownership of stock, bank investments consist mainly of corporate and government debt. When the interest rate paid by such a debt instrument (a bond, for example) is above prevailing rates paid on newly issued debt with similar risk characteristics, the higher-paying debt will sell for more than the principal amount paid at maturity — the debt sells for a premium. Similarly, securities sell for less than their face value—or, at a discount—when the rate they pay is less than current market rates.
Preventitive controls:These controls have the objective of preventing errors or fraud that could result in a misstatement of the financial statements from even occurring.
Problem Loan Migration:Movement from a shorter past-due loan category to a longer past-due loan category.
Prompt Corrective Action (PCA):The Federal Deposit Insurance Act places mandatory and discretionary restrictions on any bank that fails to remain at least adequately capitalized.
Prompt corrective action and BSA compliance:The bank’s Federal regulator is required to take a formal action against the bank in the following circumstances:
- Prompt Corrective Action – The Federal Deposit Insurance Act places mandatory and discretionary restrictions on any bank that fails to remain at least adequately capitalized.
- Bank Secrecy Act compliance - Any bank that has not established and maintained a program reasonably designed to assure and monitor compliance with the Bank Secrecy Act or failed to correct any previously identified problem with the procedures will be subject to a formal enforcement action. See the FFIEC Bank Secrecy Act Anti-Money Laundering Manual.
- National Flood Insurance Act – requires the Federal Reserve to adopt regulations that prohibit a state member bank from making or renewing a loan secured by certain types of real estate in a designated flood hazard area unless the property is covered by flood insurance. The Federal Reserve must assess a civil money penalty against a bank that is found to have engaged in a pattern or practice of violating the flood insurance requirement.
Prompt Corrective Action restrictions:The Federal Deposit Insurance Act places mandatory restrictions on any bank that fails to remain at least adequately capitalized and also requires the regulator to take action against a bank that is significantly undercapitalized or critically undercapitalized.
Restrictions, among other things:
- an undercapitalized bank:
- cannot pay dividends;
- must submit an acceptable capitalrestoration plan;
- until the plan is accepted, a bank cannot increase its asset size, make acquisitions, branch, or enter a new line of business;
- regulator may also impose some additional restrictions.
- a significantly undercapitalized bank:
- subject to the same mandatory requirements as undercapitalized;
- cannot pay bonuses to or increase senior officer compensation without prior regulatory approval;
- the federal regulator must take one or more of the following actions, including:
- require recapitalization or sale of the bank,
- restrict transactions with affiliates,
- restrict interest rates paid,
- more stringently restrict asset growth,
- require the election or dismissal of directors,
- require the hiring or dismissal of senior executive officers, and
- impose certain of the mandatory restrictions for critically undercapitalized banks.
- the federal regulator may also require other appropriate action.
- a critically undercapitalized bank:
- subject to same mandatory restrictions as a significantly undercapitalized bank;
- regulator may impose same discretionary restrictions as on a significantly undercapitalized bank;
- cannot, without prior FDIC approval, enter into certain material transactions, engage in covered transactions under section 23A, increase interest rates paid, or take other specified actions;
- generally, cannot pay interest or principal on subordinated debt after 60 days of becoming critically undercapitalized;
- the bank will be placed in receivership within 90 days, unless the regulators determine that other action is appropriate; and
- receiver generally must be appointed if bank is critically undercapitalized for more than
Pronouncements:Pronouncements are the authoritative issuances of accounting and auditing standard setters. Collectively, they are called GAAP (generally accepted accounting principles) and GAAS (generally accepted auditing standards). In the United States, GAAP is currently officially established by the Financial Accounting Standards Board and the Securities Exchange Commission. Previously, the American Institute of Certified Public Accountants, Accounting Principles Board, and the Accounting Research Board also issued accounting standards, some of which are still in place. Auditing standards for public companies have been established by the Public Company Accounting Oversight Board (PCAOB) (subject to approval by the SEC). Auditing standards for nonpublic companies continue to be established by the Auditing Standards Board (ASB). However, the ASB is working on projects to bring the standards for nonpublic companies into alignment with PCAOB standards.
Protected Class:A protected class is basically anyone who is a member of a class which in the past was discriminated against because of their age, race, color, religion, national origin, sex, marital status or source of income. They are protected because the regulation specifically prohibits discrimination based on those factors.
Ratio Analysis:A bank’s balance sheet and income statement are valuable information sources for identifying risk taking and assessing risk management effectiveness. Rather than using the dollar amounts found on these statements in their analyses, financial analysts, bankers and bank supervisors typically pull data from them to develop financial ratios to evaluate bank performance. This is done to provide perspective and facilitate making comparisons.
Receivership:The state of being in the hands of a receiver, a person appointed to hold in trust and administer property under litigation, or a person appointed to settle the affairs of a business involving a public interest or to manage a corporation during reorganization.
Reinvestment Vehicle:The securities, such as commercial paper, in which cash collateral is invested.
Related parties:Persons or entities with a relationship through family or ownership to one or more principal owners or officers of an organization. Transactions between related parties may raise questions regarding a conflict of interest or may be subject to specific banking regulations such as Regulation W or Regulation O.
Removal standards:An individual’s conduct at any financial institution or business institution must meet at least one test from each of the following three elements:
- Action element: institution-affiliated party has directly or indirectly:
- violated a law, rule, regulation, cease and desist order, condition imposed in writing, or any written agreement between the bank and the regulator;
- engaged or participated in any unsafe or unsound practice in connection with the bank or business; or
- breached the individual’s fiduciary duty.
- Result element: as a result of the institution-affiliated party’s action:
- the bank or business institution suffered or will probably suffer financial loss or other damage;
- the individual received financial gain or other benefit; or
- the interests of the bank’s depositors have been or could be prejudiced.
- Culpability element: institution-affiliated party’s action:
- involves the party’s personal dishonesty; or
- demonstrates the party’s willful or continuing disregard for the bank’s or business’s safety and soundness.
Repeat findings:An audit exception that is identified at two or more consecutive audits. Repeat findings are considered more serious than first-time findings because they raise a concern that management has consciously chosen to ignore a control issue. This concern is heightened with an auditor uncovers multiple complete findings. Good governance practices dictate that the audit committee and the board of directors should take forceful action if a pattern of repeat findings is observed by an internal audit department.
Report of Condition and Income:The Report of Condition and Income is a quarterly balance sheet and income statement filed by every insured bank in the country to it primary federal banking supervisor.
Repricing:A financial contract is said to reprice whenever the interest rate that it pays changes. Instruments with fixed interest rates do not reprice, by definition. Instruments with floating interest rates, such as variable-rate loans and CDs, reprice at a specified frequency, often once or twice a year. These contracts typically also specify a benchmark interest rate to be used for the repricing. For example, a variable-rate mortgage might reprice by changing its interest rate every six months to equal the long-term Treasury rate plus some spread (say 100 basis points) to compensate the bank for the credit risk. From an interest-rate-risk standpoint, a repricing instrument is equivalent to a maturing instrument, because the interest rate that the bank pays or receives is updated to the prevailing market rate in both cases.
Repricing Risk: risk that arises from mismatches in maturity and interest rate changes in a bank's assets and liabilities. A financial contract is said to reprice whenever the interest rate it pays changes.
Repurchase Agreement:A repurchase agreement is the sale of securities with a simultaneous agreement to buy those securities back at a specified time and price. It is a bank liability (definition taken from Banking and Finance Terminology, 4th Edition, American Bankers Association, p. 327).
Reputational Risk:Reputational risk is the risk of loss or harm to a bank from negative publicity.
Risk assessments:Evaluations performed at least annually by the internal audit function with the assistance of management that measure the inherent risk in the activities of an auditable unit. This evaluation is typically performed utilizing predetermined consistent criteria and weighted to reflect the importance of certain criteria in achieving the organization’s objectives. The numerical scores for each auditable unit are fit into ranges that have been categorized for levels of risk (usually, high, moderate, and low). The assigned level is used to determine the frequency with which that unit will be audited.
Risk Management Reports:Risk management reports could include information such as risk weighted assets, concentrations of credit, and asset quality information.
Risk-Weighted Assets:Risk-weighted assets are the bank’s assets weighted for the credit risk they pose. (Loans are weighted 1, case weight is 0, U.S. government securities are .20.) Risk-weighted assets also include off-balance sheet items converted to their balance sheet equivalent and weighted appropriately.
Securities:Securities are instruments that signify an ownership position in a corporation (shares of stock), a creditor relationship with a corporation or government body (bonds), or rights to ownership such as those embodied in options or subscription rights. A voting security is one that gives the bearer a right to vote on corporate matters. (Definition taken from the online UBS dictionary of banking.)
Security Agreement:There are many legal documents associated with making a loan. One of these documents is a security agreement. This agreement provides a description of the collateral for a loan and gives the lender certain rights to that collateral in the event of borrower default.
Significant deficiencies:A control deficiency, or a combination of control deficiencies, that adversely affects the organization’s ability to initiate, authorize, record, process, or report external financial data reliably in accordance with generally accepted accounting principles such that it is reasonably probable that a misstatement of the organization’s annual or interim financial statements that is not inconsequential will not be prevented or detected.
Smaller nonpublic organizations:Usually refers to banks with total assets of less than $500 million that are closely held and not listed on any public stock exchange.
Standby Letter of Credit:Standby letter of credit is a letter of credit that typically is drawn upon when the issuing bank’s customer does not perform accordingly to an agreement with another party (definition taken from Banking and Finance Terminology, 4th Edition, American Bankers Association, p. 360).
Subchapter S Status:A domestic corporation or limited liability company that: has one class of stock; has no more than 100 shareholders, all of whom are U.S. citizens or residents; and meets other tests under the Internal Revenue Code (IRC), may elect to be taxed under subchapter S of chapter 1 of the IRC. This means the corporation itself will pay no income taxes. Instead, corporate income or losses are divided among and passed through to the shareholders, who are then taxed via their individual income tax return. Since 1997, banks have been able to elect subchapter S federal income tax filing status.
Sureties:A surety is one who makes a pledge, guarantee or offers a bond to back the performance of an individual or company (definition is taken from investorwords.com).
Suspicious activity report:Financial institutions file these reports relevant to a possible violation of law or regulation. For example, a SAR should be filed when bank personnel detect a transaction for which there is no business or apparent lawful purpose, or is not the sort that the particular customer would normally be expected to engage in based on available information.
Taxable Equivalent:A taxable equivalent basis means that an adjustment is made that makes it possible to compare after-tax returns on taxable securities with the returns on tax-exempt securities.
Tier 1 Capital:For most community banks, Tier 1 Capital is simply common stock, surplus and undivided profits.
Tier 1 Risk-based Capital Ratio:This is the ratio of Tier 1 capital to risk-weighted assets.
Tier 2 Capital:For most community banks, Tier 2 Capital is simply the Allowance for Loan and Lease Losses, limited to 1.25 percent of risk-weighted assets.
Total Classification Ratio:The total classification ratio is the ratio of a bank’s classified assets divided by its Tier 1 Capital plus reserves. Values for this ratio above 40 to 50 percent often represent less than satisfactory asset quality.
Total Risk-based Capital Ratio:This is the sum of Tier 1 and Tier 2 capital divided by risk-weighted assets.
Trading securities:Trading securities, purchased and held primarily for sale, are carried at fair value with unrealized gains and losses included in current period earnings.
Troubled Condition:Section 225.71 of the Federal Reserve Board's Regulation Y defines a “troubled condition” for a state member bank as a bank (i) that has a composite rating of 4 or 5; (ii) is subject to a cease and desist order or written agreement that requires action to improve the bank's financial condition, unless otherwise informed in writing by the Federal Reserve; or (iii) is informed in writing by the Federal Reserve that it is in a troubled condition.
Unfunded Loan Commitments:Unused portions of commitments to make or purchase extensions of credit, i.e., seasonal or living advances to farmers under prearranged lines of credit.
Uniform Bank Performance Report (UBPR):A financial ratio report that allows a detailed analysis of bank performance relative to banks of similar asset size, branch structure and urban/rural location. For more information about the UBPR and how it can be used, review the lesson on Making Financial Comparisons.
Unrecognized Gains or Losses:unrecognized gains and losses are what most people refer to as paper gains and losses and occur when the market value of an asset or liability is above or below what has been recorded on the bank’s balance sheet.
Unsafe/Unsound practices:Although not defined in statute or regulation, an unsafe or unsound practice generally means any action, or lack of action, that is contrary to generally accepted standards of prudent operation the possible consequences of which, if continued, would be abnormal risk of loss or damage to the institution, its shareholders, or the deposit insurance fund (Federal Reserve Commercial Bank Examination Manual, section 5040.1).
Violation:Noncompliance with a law or regulation.
Watch List:Watch list is the list of loans that the bank has identified as presenting more than normal credit risk which require greater monitoring.
Weighted Classification Ratio:The weighted classification ratio is an asset quality measure used only by the Federal Reserve System. The numerator for this ratio is the bank’s classified assets, weighted by the severity of their classification. The weights used are 20 percent for loans classified substandard, 50 percent for loans classified doubtful and 100 percent for loans classified loss. This total is divided by the bank’s Tier 1 Capital plus reserves. Weighted classification ratio values above 15 percent often represent unsatisfactory asset quality.
Whistleblower process:A process established by an organization’s board of directors and senior management designed to allow employees, vendors and customers to report any suspected irregularities observed related, primarily, to accounting, auditing or internal controls. The Sarbanes-Oxley Act of 2002 establishes an expectation that the board and/or senior management of publicly traded organizations will establish such a process.
Wrongful acts:Any actual or alleged breach of duty, neglect, error, misstatement,
misleading statement, omission or act by an individual acting in their capacity as a director.
Yield Curve Risk:The risk of adverse shifts in market interest rates and the effects they may have on asset or liability values, such as different effects on similar instruments with different maturities.