Supervisory Information and the Frequency of Bank Examinations

ank supervisors need timely and reliable information about the financial condition and risk profile of banks in order to conduct effective supervision. Although such information can be obtained in part from regulatory reports and public disclosures, a key source is the on-site bank examination. Bank examinations enable supervisors to confirm the accuracy of information in regulatory reports. More important, perhaps, the examinations allow supervisors to gather confidential information about banks’ financial conditions and to assess qualitative attributes, such as internal controls and risk management procedures, that affect bank risk profiles. Such confidential information may be valuable to supervisors, yet it is costly to obtain: bank examinations absorb considerable resources on the part of supervisors as well as banks. Thus, supervisors face a trade-off between the timeliness of the information gathered from bank examinations and the costs of obtaining it. In particular, the longer the time since a bank’s most recent examination, the higher the likelihood that conditions at the bank will have changed in a way that diminishes the current value of that information. This concern must be balanced against the costs of conducting more frequent examinations. The potential “time decay” of bank examination information has been a concern for both supervisors and policymakers. Supervisors have developed a number of approaches for allocating scarce examination resources, including off-site monitoring systems to help identify banks whose financial conditions may have deteriorated. Concern about the timeliness of examination information also motivated provisions in the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), which mandates annual on-site examinations for most commercial banks. In this case, legislators felt that frequent examinations would be useful in limiting losses to the deposit insurance system. B