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Banks want a Camels overhaul, but chiming in is risky

WASHINGTON — After the Federal Reserve and the Federal Deposit Insurance Corp.’s requested input on the rating system used to score banks' overall health, many in the industry cheered what they hope will be a much-needed upgrade to the 1970s-era scorecard. But many others were left scratching their heads.

As part of their exams, banks receive total combined scores and individual scores in five areas: capital adequacy, assets, management capability, earnings, liquidity and sensitivity to market risk, collectively referred to as Camels. A bank is rated on a scale from one to five, and those ratings are not disclosed to the public.

In October, the Fed and FDIC on Friday issued a request for comment "on the consistency of ratings assigned under the CAMELS system," asking specifically whether ratings are consistent with the Camels methodology, how do agencies communicate a Camels score, and whether use of the Camels system varies from one examination cycle to another.

But submitting public comments to the banking regulators on the topic could prove to be a double-edged sword, some say. The agencies asked for specific feedback, but commenters who are open about the process could risk divulging details about a process that is top secret. For one thing, banks aren’t supposed to know the scores of other banks.

“Whenever you get comment letters, the examiners always tell you the most valuable thing to them are specific responses and data to back up what you're saying because then they can actually act on it,” said Greg Lyons, a partner at Debevoise & Plimpton. “Unfortunately, by the nature of the beast here, you can't do that, which makes the issue much more difficult to address.”

The Fed and the FDIC did acknowledge this in their request for input, noting that “given confidentiality requirements applicable to financial institutions’ CAMELS ratings and other report of examination findings and conclusions, the agencies realize there are limitations on responses regarding the consistency of how CAMELS ratings are assigned.”

Regulators appear to have received the message that the Camels system is in need of adjustment.

In a June 2018 speech, FDIC Chairman Jelena McWilliams said assessing the Camels system was one of her top priorities. “It guides so much of what a bank can and cannot do,” McWilliams said. “I actually wonder whether the three agencies apply the Camels rating uniformly. And to the extent that they don’t, why not and what does it mean?”

But financial institutions may be anxious about giving away any indication of what their score might be or what regulatory challenges they face.

Some of the questions the agencies posed would be almost impossible for banks to answer without implicating themselves, according to a source familiar with the situation, who spoke on the condition of anonymity.

One question asked commenters to elaborate on the extent to which each agency assigns ratings “in a manner that is consistent with the CAMELS rating system,” and another asked if the agencies were “generally consistent in their approach to assigning CAMELS ratings to institutions when compared to each other and across supervisory agencies.”

But banks are scored only by their own supervisory agency, and not all three, and theoretically should not know how a different supervisory agency scores an institution because the scores are confidential.

"Unless a bank has been subjected to Camels ratings by all three agencies, it couldn’t really know the consistency across agencies,” said the source. “If I get a Camels rating from the [Office of the Comptroller of the Currency], how do I know whether it’s consistent with what the Fed does for another bank if I’m not allowed to share that information with another bank?”

Even if trade associations submit comments on behalf of the banks they represent, they would still be limited in the comments they could offer, said Kimberly Monty Holzel, a partner in Goodwin's financial industry, consumer financial services and fintech practices.

"A lot of these questions speak to the deliberative process that the agency is using to assign ratings, or to collaborate with other regulators to maintain consistency in the ratings. That's not information that a bank is necessarily privy to," she said. "To the extent that the banks are privy to this information, that would likely be confidential supervisory information, which banks are not permitted to disclose."

One common complaint about the Camels rating system has been that the examination process is too subjective.

Lyons noted that the rating scale provides “significant discretion,” which has become “more meaningful as the ratings have taken on more and more significance.” Banks with comparable conditions may get different ratings, depending on the agency or examiner conducting a review.

However, banks likely won’t be eager to air their grievances with their examiners in a public comment letter.

"There may be some concern that public responses to some of the questions asked by the RFI disparage the examiners or could be interpreted negatively by the exam staff and compromise their ability to work well together in the future, as banks are subject to ongoing oversight," said Holzel.

Greg Baer, the president and CEO of the Bank Policy Institute, said a better Camels process should enable examiners to be more mindful of a bank's need to comply with rules written after the financial crisis. Those compliance responsibilities are the same from bank to bank. He added that banks should not worry about commenting on that aspect of the process.

“It’s not faulting your examiner to say that in evaluating the bank’s liquidity, you should look at whether it’s in compliance with a liquidity coverage ratio, which the current standards don’t consider,” he said.

Meanwhile, the exclusion of the OCC from the request for comment has also raised some eyebrows.

“They ask about consistency across agencies, but one of the major agencies that uses Camels is the OCC, which is not a party to the RFI," said the source. "It’s a little weird to talk about consistency across agencies and not include all the agencies that use the ratings system. It seems to kind of undermine the point.”

In a statement, an OCC spokesperson said the agency was supportive of the Fed and the FDIC’s effort and looked forward to seeing the feedback.

“It was not necessary for the OCC to join a request for information in order for the regulators to gain the valuable feedback from the process,” the spokesperson said.

But some are still confused about what the feedback will be used for, and what the agencies' ultimate goal is.

In their request for information, the Fed and FDIC said they were interested only in information and comments on the consistency of the ratings assigned by the agencies, as well as how Camels ratings are used in bank application and enforcement action processes.

"If I were a bank I’d be scratching my head because it's not clear what this information will be used for, and I’m not sure I would know what to do here,” the source said. “To the extent that I thought it might be something that could be to my benefit, I would go as far as I could to push that goal, but it's unclear."

Often, a request for information precedes an advance notice of proposed rulemaking, but not always.

"I'm curious as to why some of these questions were asked, and the underlying reason for this RFI," said Holzel. "The questions may provide some insight into what types of changes to the Camels rating system the regulators are gearing up for, which would require or be well informed by public input like this."

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