Several government agencies monitor the balance sheets of banks to make sure they have positive net worth and are not taking too high a level of risk. Within the U.S. Department of the Treasury, the Office of the Comptroller of the Currency has a national staff of bank examiners who conduct on-site reviews of the 1,500 or so of the largest national banks. The bank examiners also review any foreign banks that have branches in the United States. The Office of the Comptroller of the Currency also monitors and regulates about 800 savings and loan institutions.
The National Credit Union Administration (NCUA) supervises credit unions, which are nonprofit banks owned and run by their members. There are over 6,000 credit unions in the U.S. economy, though the typical credit union is small compared to most banks.
The Federal Reserve also has some responsibility for supervising financial institutions. For example, conglomerate firms that own banks and other businesses are called “bank holding companies.” While other regulators like the Office of the Comptroller of the Currency supervises the banks, the Federal Reserve supervises the holding companies.
When the supervision of banks (and bank-like institutions such as savings and loans and credit unions) works well, most banks will remain financially healthy most of the time. If the bank supervisors find that a bank has low or negative net worth, or is making too high a proportion of risky loans, they can require that the bank change its behavior—or, in extreme cases, even force the bank to be closed or sold to a financially healthy bank.
Bank supervision can run into both practical and political questions. The practical question is that measuring the value of a bank’s assets is not always straightforward. As discussed in Money and Banking, a bank’s assets are its loans, and the value of these assets depends on estimates about the risk that these loans will not be repaid. These issues can become even more complex when a bank makes loans to banks or firms in other countries, or arranges financial deals that are much more complex than a basic loan.
The political question arises because the decision by a bank supervisor to require a bank to close or to change its financial investments is often controversial, and the bank supervisor often comes under political pressure from the owners of the bank and the local politicians to keep quiet and back off.
For example, many observers have pointed out that Japan’s banks were in deep financial trouble through most of the 1990s; however, nothing substantial had been done about it by the early 2000s. A similar unwillingness to confront problems with struggling banks is visible across the rest of the world, in East Asia, Latin America, Eastern Europe, Russia, and elsewhere.
In the United States, laws were passed in the 1990s requiring that bank supervisors make their findings open and public, and that they act as soon as a problem is identified. However, as many U.S. banks were staggered by the recession of 2008–2009, critics of the bank regulators asked pointed questions about why the regulators had not foreseen the financial shakiness of the banks earlier, before such large losses had a chance to accumulate.