Fed says banks are well managed even with a deficient rating

• Key Insight: The Fed sais its revised supervisory framework reflects that large banks are well capitalized, have sound liquidity positions and good asset quality
• Supporting Data: Roughly 47% of large financial institutions were considered not “well managed” under the former framework.
• Expert Quote: “Bank ratings should reflect overall safety and soundness, not just isolated deficiencies in a single component,” said Fed Vice Chair for Supervision Michelle Bowman.

The Federal Reserve Board of Governors finalized changes to its supervisory rating framework to allow large bank holding companies to be considered “well managed,” even if they receive one deficient rating in supervisory reviews. 

The final notice published Wednesday applies to both large banks and to the rating system framework for roughly 130 top banks that are significantly engaged in insurance activities. 

The revisions better align with rating systems used for other banking organizations, the board said, and “more accurately reflect the strength of individual banks.”

Importantly, 47% of large banks were deemed not well managed under the previous framework, and the Fed said the revision addresses the mismatch between ratings and banks’ overall condition.  Of the 36 bank holding companies in the third quarter subject to the previous framework, 17 were not considered to be well managed. With the revisions, that number dropped to seven, the board’s staff estimated.  

Fed Vice Chair for Supervision Michelle Bowman said the change was needed because it better reflects the resilience, financial and operational strength of large financial institutions. 

“Bank ratings should reflect overall safety and soundness, not just isolated deficiencies in a single component,” Bowman said in a press release. “These framework changes address this by helping to ensure that overall firm condition is the primary consideration in a bank’s rating.”

The Fed’s action is consistent with a number of similar initiatives to relax capital requirements and other regulatory requirements for the largest bank holding companies. The final framework is substantially similar to the board’s proposal that passed 5-1 in July with one abstention. 

However, Federal Reserve Governor Michael Barr issued a scathing statement objecting to the changes. He said the revised framework reduces incentives for large banks to fix serious management problems and allows banks with significant weaknesses to expand or merge, raising the chance and cost of future failures. 

“This rule would undermine oversight of the largest 36 banks in the country by allowing poorly managed large banks to be treated as well managed—granting them privileges meant only for strong, healthy institutions,” Barr, who was until earlier this year the Fed’s Vice Chair for Supervision, wrote in the sole dissent. 

Barr said the revised framework is inconsistent with the Gramm-Leach-Bliley Act and subsequent requirements that “well managed” firms have a satisfactory rating for management in order to make acquisitions. He also objected to removing the presumption that large firms with significant deficiencies must take corrective action. 

Under the new framework, Barr said a firm could have “significant capital weaknesses as well as serious deficiencies in risk management in a number of important areas, including cybersecurity, internal audit, anti-money laundering, and consumer compliance,” and would still be considered well managed.

The Fed’s supervisory framework has three components: capital, liquidity, and governance and controls. Each component has four potential ratings: broadly meets expectations, conditionally meets expectations, deficient-1, or deficient-2.

Under the new framework, the Fed will consider a firm with one deficient-1 rating to be “well managed,” while a firm with a deficient-2 rating will continue to be considered not well managed, meaning the bank would face limits on certain activities such as mergers and acquisitions.

But the revisions to the framework now mean that a bank that receives one or more “deficient” ratings will not necessarily be subject to an enforcement action, depending on the facts and circumstances, the board said in its 105-page notice. Plus, the final notice removes any reference to “reputational risk” for banks rated under the insurance supervisory framework.

The framework applies to bank holding companies and non-insurance, non-commercial savings and loan holding companies with total assets of $100 billion or more, and to intermediate holding companies of foreign banking organizations with assets of $50 billion or more.