Last April, the Inspectors General of the FDIC and Treasury Department released a joint post-mortem on the failure of Washington Mutual [pdf], looking particularly at the way in which the Office of Thrift Supervision (the primary federal regulator [PFR] for WaMu) and the FDIC carried out their oversight responsibilities.  Today, based largely on that report, a new memorandum of understanding [pdf] was agreed to by the four PFRs: the FDIC, OTS, Office of the Comptroller of the Currency, and the Federal Reserve. That new MOU gives the FDIC direct access to the large financial institutions, regardless of who their PFR is and whether the PFR wants the FDIC poking around.

The April joint IG report on the failure of WaMu offered several conclusions about the FDIC. First among those conclusions was this (pdf pp. 58-59, with emphasis added):

First, the terms of the interagency agreement governing information sharing and back-up examinations require that FDIC prove a requisite level of risk at an institution – heightened risk, material deteriorating conditions, or adverse developments – in order for the primary regulator to grant FDIC access to the institution’s information. The level of risk is largely based on an institution’s CAMELS composite ratings and regulatory capital level.

For large institutions such as WaMu that by their sheer size pose a high risk to the DIF, we believe FDIC should not have to prove a particular level of risk to the primary regulator to obtain access to the institution’s information, as the institution’s risk of failure and the resulting potential impact on the DIF should be enough to allow FDIC access to information it needs to assess risk of loss. As shown in this report and our report on IndyMac, OTS’s consistent assignment of a CAMELS composite 2 ratings for those institutions until their near failure shows the unreliability of CAMELS ratings as predictors of risk to the DIF.

The interagency agreement was intended to balance the needs of FDIC against the regulatory burden on an institution of having two regulators duplicating examinations. One key principle of the interagency agreement is that FDIC must rely, to the fullest extent possible, on the work of the primary regulator. In practical terms, the interagency agreement appeared to drive a wedge between OTS and FDIC as attempts by FDIC to review information at WaMu were seen as an affront to the capabilities of OTS examiners. We believe FDIC must have sufficient and timely access to information at all large insured depository institutions (defined by FDIC as having assets of $10 billion or more) in order to properly assess risk and appropriately price deposit insurance. We also believe that it may not be in the best interest of FDIC to place too much reliance on the ability of the primary regulator to assess risk to the DIF. Ultimately, the DIF, which is backed by the full faith and credit of the United States, and thus the American taxpayer, is responsible for absorbing an institution’s failure, not the primary regulator.

The IGs recommended (p. 60) that the FDIC “revisit the interagency agreement governing information access and back-up examination authority for large insured depository institutions to ensure it provides FDIC with sufficient access to information necessary to assess risk to the DIF.”

Today, the FDIC got what the IGs proposed.  . . .

This new Memorandum of Understanding [pdf] doesn’t take away the ability of the other primary federal regulators to carry out their oversight responsibilities of big banks, but it gives the FDIC the right to sit in on any of the examinations and meetings between the PFRs and the banks, or to separately hold their own investigative sessions, independent of the PFR.

Significantly, it lets the FDIC look not only at the parts of the large institutions that are directly related to banking, but to assess the overall health of all parts of that large institution. The portion of a large institution related to banking may be in fine shape, but if problems in the rest of the institution put the whole thing at risk, the FDIC needs to know about them in order to properly assess charges for the DIF and to safeguard its bottom line.

There are procedures and processes for lots of information sharing, but the bottom line seems to be that if the FDIC has to deal with the fallout of a bank failure via the Deposit Insurance Fund, then the FDIC has the right to be as involved as they see fit (not as the PFR sees fit) when it comes to watching over the health of banks, rather than simply trusting the works of the other PFRs.

This ought to make the whole notion of “regulator shopping” by the large financial institutions somewhat less attractive. If the FDIC thinks your overall business is jeopardizing the bank deposits that they ultimately bear responsibility for, it doesn’t matter who your PFR is. Sheila Bair and her crew can come knocking, with or without permission from the Fed, OTS, or OCC.

Said the FDIC’s press release,

“The agreement reached today strikes that reasonable balance between preserving the role of the primary federal regulator and providing the FDIC with the information that is critical to meeting our statutory responsibilities,” [FDIC Chair Sheila Bair] said. “The FDIC supports the role of the primary federal regulator and has no interest in infringing upon their authorities. However, the FDIC has needs that are separate and distinct from the primary federal regulator that must be met in order to satisfy our statutory responsibilities.”

Poor Ben Bernanke. While he dreams of being the uber-regulator and chief monitor of systemic risk, this new agreement forces the Fed to allow the FDIC independent access directly to the big banks instead of making the FDIC to rely on his tame stable of regulators at the Fed.

I’d love to see a photo of Ben Bernanke signing off on this. He’d be the one with the gritted teeth.