Fed to banks: Improve backup

WASHINGTON, D.C. - The Federal Reserve is spearheading a drive to impose strict new disaster-recovery regulations on financial institutions so that trading and banking operations can more quickly rebound from a Sept. 11-type catastrophic event.

Financial institutions, while also eager to avert a repeat in any future emergency, say they are concerned these regulations will prove too costly and difficult to implement.

"It's going to be expensive to do what the Fed is thinking about," says Paul Hugenberg, IT audit officer at Sky Financial Group, an $11 billion financial services firm.

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WASHINGTON, D.C. - The Federal Reserve is spearheading a drive to impose strict new disaster-recovery regulations on financial institutions so that trading and banking operations can more quickly rebound from a Sept. 11-type catastrophic event.

Financial institutions, while also eager to avert a repeat in any future emergency, say they are concerned these regulations will prove too costly and difficult to implement.

"It's going to be expensive to do what the Fed is thinking about," says Paul Hugenberg, IT audit officer at Sky Financial Group, an $11 billion financial services firm.

The Fed acknowledges its ideas on regulating disaster recovery will add costs - how much remains unclear - and even fundamentally change how financial firms organize their central office and back-up operations.

The Fed has summarized its desire for new regulations in a document titled "The Draft Interagency White Paper on Sound Practices to Strengthen the Resilience of the U.S. Financial System." Comments on it are due today, and banks expect the proposals it contains to become regulations by year-end.

In the wake of the Sept. 11 attacks, Wall Street trading was halted for a week, and the Fed acknowledges that network and data back-up plans proved inadequate, creating a multibillion-dollar payments breakdown among the closely interconnected systems. Federal Reserve Vice Chairman Roger Ferguson is advocating new rules that would require banks, brokerages and other regulated financial firms to be able to resume business within hours in the event of a disaster. Other proposals include requiring financial firms to test back-up systems with their trading partners, and duplicate data center and business operations.

"The events of Sept. 11 graphically demonstrated the interdependence among financial-system participants, wherever located," Ferguson said during a recent meeting of the Institute of International Bankers in Washington, D.C.

Back-up systems not tested

The Fed discovered that many financial firms in the New York area had not tested their data and telecommunications back-up systems before Sept. 11. Few had planned for the magnitude of the destruction, with offices and telecommunications circuits obliterated. In addition, the commercial "hot site" providers with which the financial firms had contracted were turning customers away because of the demand.

This meant that critical financial information couldn't be shared electronically, and the domino effect led a multibillion-dollar "liquidity bottleneck" so severe that the Fed was forced to lend large amounts directly to institutions and provide billions more in payments on uncleared checks. The Federal Reserve staff even stepped in to set priorities for the restoration of key telecommunications circuits.

Ferguson declined to discuss the possible new regulations, but public documents and banking insiders provide a clear picture of the direction under way.

In February, Ferguson summoned two dozen of the largest financial firms, including Citigroup, Bear Stearns, Goldman Sachs, Mellon and Merrill Lynch, to confer with the Federal Reserve banks and other regulatory agencies, including the New York State Banking Department and the Securities and Exchange Commission. The Fed, the SEC, the Treasury's Office of the Comptroller of the Currency and the New York State Banking Department jointly released the draft of the proposed disaster-recovery regulations in late August.