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Authors Beverly Hirtle and Jose Lopez evaluate changes over time in the quality of information available to supervisors from bank examinations. Periodic exams are a key source of timely and reliable private information about the financial condition and risk profile of banks, explain the authors. Yet such private information is costly to obtain since it can only be gathered during on-site exams that are resource-intensive for both banks and supervisors.
The time it takes for private supervisory information to lose its value--or "decay"--has important implications for supervisors and banks. The faster this information decays, the auhtors note, the more frequently exams need to occur in order for supervisory agencies to have accurate information about the current condition of banks.
Hirtle and Lopez conclude that:
The private supervisory information obtained during bank exams ceases to provide a useful picture of a banks current condition after six to twelve quarters.
The decay rate of private supervisory information appears to be faster in years when the banking industry experiences financial difficulties, and the rate is significantly faster for troubled banks than for healthy ones.
The annual bank examination frequency currently mandated by law is reasonable, particularly for banks whose initial financial condition is troubled or during times of financial stress for the banking industry.
Beverly Hirtle is a vice president at the New York Fed. Jose Lopez, formerly an economist at the New York Fed, is now an economist at the Federal Reserve Bank of San Francisco.