Fed officially nixes reputation risk from exam practices

Bloomberg News

The Federal Reserve has officially started scrubbing "reputational risk" from its supervisory policies and practices. 

The central bank announced Monday that it is removing all mentions of reputation and reputational risk from its exam manuals and supervisory materials. In some cases, the agency is replacing those references with discussions of specific financial risks.

To ensure these changes go into effect evenly across the bank holding companies and state member banks they supervise, the Federal Reserve Board will retrain examiners on how to operate under the revised standards. 

The Fed's move follows similar moves by the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency, both of which began removing reputational risk considerations in March. In its statement, the Fed said it would work with other agencies to promote consistent practices. 

The central bank also noted that its revisions would not change its expectation that banks maintain "strong risk management to ensure safety and soundness and compliance with law and regulation." It adds that banks are not prohibited from incorporating reputational considerations into their own risk management processes.

Reputational risk was conceived as a means for monitoring whether banks were engaged in or associated with activities that would diminish their standing in the eyes of depositors. But critics have argued in recent months the practice became discriminatory and resulted in banks feeling pressured to deny services to customers in certain unfavored but legal sectors, such as the cryptocurrency industry — a phenomenon known as "debanking."

Evaluating reputational risks generally fall under the broad umbrella of "management" considerations under the ratings system known as CAMELS — standing for capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk. 

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As part of its policy update, the Fed amended two supervision and regulation letters issued in 2021. In one of those updated letters, the Fed noted that management considerations should be incorporated into all other categories of risk within a bank, including credit risk, market risk, liquidity risk, operational risk and legal risk.

The management component of supervision has come under increasing scrutiny in recent months because of the amount of undefined discretion it provides examiners. Some lawmakers have even considered banning it from the CAMELS calculation.

As a candidate for president last fall and as president, Donald Trump has elevated supervisory discretion and debanking as a political issue. He made addressing it a top goal for his new administration earlier this year. The Senate Banking Committee held a hearing about the topic in February, in which Sen. Cynthia Lummis presented a reserve bank guidebook that directed officials to incorporate reputational factors when considering whether to grant master accounts. 

Shortly after that hearing Fed Chair Jerome Powell sat before the banking committee for his first congressional oversight hearing of the year. During his testimony, he promised to swiftly remove the "concept" of reputation risk from its master account policies and take a "fresh look" at reputational consideration more broadly. 

The changes come one day before Powell is set to return to Capitol Hill for his second set of oversight hearings.