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  • District Circular Letters Index

    July 25, 1997

    GUIDANCE ON SOUND RISK MANAGEMENT PRACTICES FOR PRIVATE BANKING ACTIVITIES

    To State Member Banks, Bank Holding Companies,
    U.S. Branches and Agencies of Foreign Banks
    and Others Concerned
    in the Twelfth Federal Reserve District

    Review of Private Banking Activities

    Private banking activities, which involve, among other things, personalized services such as money management, financial advice, and investment services for high net worth clients, have become an increasingly important aspect of the operations of some large, internationally active banking organizations. The Federal Reserve has traditionally reviewed private banking activities in connection with regular on-site examinations.

    In 1996 and 1997, the Federal Reserve Bank of New York undertook a comprehensive review of private banking activities at approximately 40 domestic and foreign banking organizations in the Second District in order to enhance the Federal Reserve's understanding about private banking operations. Examiners focused principally on assessing each institution's ability to recognize and manage the potential legal risks and dangers to its reputation that may be associated with inadequate knowledge and understanding of its clients' personal and business backgrounds, sources of wealth, and uses of private banking accounts. In carrying out the reviews, examiners considered the parameters of an appropriate control infrastructure that is suited to support the effective management of these risks.

    Guidance on Sound Risk Management Practices for Private Banking Activities

    The reviews indicated that there are certain essential elements associated with sound private banking activities, and these elements are described in a paper, prepared by the Federal Reserve Bank of New York, entitled "Guidance on Sound Risk Management Practices Governing Private Banking Activities.

    The sound practices paper provides guidance regarding the basic controls necessary to minimize legal risk and danger to reputation, and to deter illicit activities, such as money laundering. The essential elements associated with sound private banking activities are, in brief outline, as follows:

  • Management Oversight-- Senior management's active oversight of private banking activities and the creation of an appropriate corporate culture are crucial elements of a sound risk management and control environment. Goals and objectives must be set at high levels, and senior management must be proactive in overseeing compliance with corporate policies and procedures.
  • Policies and Procedures--All private banking operations should have "Know Your Customer" policies and procedures, consistent with guidance provided by the Federal Reserve over the past several years, that require banking organizations to obtain identification and basic background information on their clients, describe the clients' source of wealth and lines of business, request references, handle referrals, and identify red flags and suspicious transactions. Private banking operations should also have adequate written credit policies and procedures that address, among other things, money laundering-related issues, such as lending secured by cash collateral.
  • Risk Management Practices and Monitoring Systems--Sound private banking operations stress the importance of the acquisition and retention of documentation relating to their clients, as well as due diligence regarding obtaining follow-up information where needed to verify or corroborate information provided by a customer or his or her representative. Inherent in sound private banking operations is the retention of beneficial owner information in the United States for accounts opened by financial advisors or through the use of off-shore facilities. Adequate management information systems capable of, among other things, monitoring all aspects of an organization's private banking activities are also stressed. These include systems that provide management with timely information necessary to analyze and effectively manage the private banking business and systems that enable management to monitor accounts for suspicious transactions and to report any such instances to law enforcement authorities and banking regulators as required by the regulators' suspicious activity reporting regulations.
  • Segregation of Duties, Compliance, and Audit--Because private banking activities are generally conducted through relationship managers, banking organizations need to have an effective system of oversight by senior officials and by board committees, as well as guidelines pertaining to the segregation of duties to prevent the unauthorized waiver of documentation requirements, poorly documented referrals, and overlooked suspicious activities. Likewise, strong compliance and internal audit programs are essential to ensure the integrity of the risk management and internal control environment established by senior management and the board of directors.

    • Additionally, the Federal Reserve will distribute an updated Bank Secrecy Act examination manual in the nest few weeks. The updated manual will include examination procedures relating to recent additions and changes to the Bank Secrecy Act, as well as updated sections relating to anti-money laundering initiatives.

    Copies

    Copies of the sound practices paper are available from our Corporate Services Department. To request copies to be sent via mail, please call (415) 974-2748. To request copies to be sent via fax, please call (415) 974-3333, and specify document number 4251.

    Additional Information

    For additional information regarding these matters, please contact Ms. Nancy Bercovici, Senior Vice President, Federal Reserve Bank of New York, at (212) 720-8227, Mr. Richard A. Small, Special Counsel, Division of Banking Supervision and Regulation, Board of Governors of the Federal Reserve System, at (202) 452-5235, or Mr. David W. Walker, Assistant Vice President, Federal Reserve Bank of San Francisco, at (415) 974-2907.

    FEDERAL RESERVE BANK OF SAN FRANCISCO