Banks Support Changes to Federal Reserve’s Supervisory Ratings System

The American Bankers Association and the Bank Policy Institute expressed support for proposed changes to the Large Financial Institution rating system in a letter today to the Federal Reserve. The current rating system fails to accurately reflect bank performance, the associations argued, and unnecessarily constrains banks’ ability to serve their customers.

“If report cards worked like the current LFI ratings framework, a student’s GPA would equal their lowest grade,” the associations stated after filing the letter. “This wouldn’t give a complete picture of a student’s performance, and the current LFI ratings approach doesn’t give a complete picture of bank condition. We’re grateful the Federal Reserve is improving the usefulness of this framework so that it can more reliably spot and address actual risks.”

The LFI rating system is a rubric used by the Federal Reserve to assess how well a bank is managed based on three components: (1) capital planning and positions; (2) liquidity risk management and positions; and (3) governance and controls.

Under the current rating system, a bank is deemed less-than-satisfactory and not “well-managed” if any one of the three components is rated unsatisfactory, even if the other two ratings and the bank’s overall financial health are strong. Receiving an unsatisfactory score limits banks’ ability to serve their customers by expanding their products, services or branch networks, engaging in new investments or acquisitions or conducting internal reorganizations.

Over two-thirds of large banks were rated as unsatisfactory because of this framework, despite repeated statements from regulators that large financial institutions, and the banking system as a whole, remain strong and resilient.

To address the disconnect, the associations endorsed the Federal Reserve’s proposal and urged the agency to adopt the proposed changes without delay.

In addition, the associations recommended that the Federal Reserve, along with the FDIC and OCC, adopt several additional changes to the bank ratings framework:

Focus on objective, material financial risks. Banks are in the business of managing financial risk, and the rubric used to evaluate their performance should prioritize material risks and apply objective, transparent standards.

Adopt similar changes to other rating frameworks. The banking agencies’ CAMELS rating system for banks should also be revised to focus on financial risk and eliminate the outsized effect of the “Management” rating. The Federal Reserve’s rating systems for smaller banks and foreign banking organizations should undergo similar reforms.

Implement greater due process and transparency in ratings. Regulators should provide more transparent explanations of findings so banks can better understand and resolve issues, and banks that have been downgraded should be offered a meaningful appeal process.

Consider economic growth when defining a “large financial institution.” LFI ratings generally apply to bank holding companies and intermediate holding companies with over $100 billion in total consolidated assets. That threshold should be indexed to inflation and economic growth.

To access a copy of the letter, please click here.