Regulators allow more banks to opt for 18-month exam cycle

• Key insight: Banks with between $3 billion to $6 billion that are well capitalized and in good regulatory standing may qualify for 18-month examination cycles rather than the standard annual examination cycle. 
• Supporting data: The Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. estimate that 188 additional institutions — including 19 foreign bank subsidiaries — are expected to qualify.
• Forward look: Regulators said the longer cycle should reduce burden on what they say are relatively stable firms. 

The Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. Thursday issued an interim final rule expanding the number of community banks subject to less frequent exam schedules.

The rule allows insured depository institutions with up to $6 billion of total assets to be eligible for the 18-month exam schedule, as opposed to the standard annual cycle. Previously, only firms with less than $3 billion of assets would have been allowed to choose the longer 18-month cycle. Banks under the threshold must also be well capitalized and receive a good composite CAMELS rating to qualify.

"While extending the examination cycle has the potential to delay an agency's ability to detect deterioration in [a bank's] financial condition," the agencies noted, "the Agencies do not expect that extending the examination cycle by six months for these small, well-rated [banks] with relatively simple risk profiles and no outstanding enforcement action or order would appreciably increase their risk of financial deterioration or failure."

The change comes pursuant to the recently passed 21st Century ROAD to Housing Act, which established the higher threshold. To qualify, an institution must also be well managed and have a composite CAMELS rating of 1 or 2, which correspond to what regulators consider "outstanding" and "good," respective conditions. Firms may not be eligible if they were subject to a formal enforcement proceeding or order, or if the banks changed ownership recently. 

The measure also accompanies community bank deregulation the OCC announced in October last year, scaling back its non-statuatory oversight of small banks, limiting supervision to fundamental banking risks and allowing examiners to determine when and to what extent to intervene with the banks they oversee.

CAMELS — a rating system whose acronym stands for Capital adequacy, Asset quality, Management, Earnings, Liquidity and Sensitivity to market risk — is the rating system regulators use to assess the condition of banks. Regulators recently proposed revising the supervisory ratings framework for the first time in three decades in May, a move bank trade groups requested last year following a proposal from the Federal Reserve System making changes to a similar rating system used for large banks.

The regulators said in their interim final rule that the longer examination cycles would be a boon to smaller banks, allowing staff to address more important needs and deploy their resources more effectively.

"A potential reduction in examination activity is likely to enable those financial institutions' existing staff to allocate resources to other activities that could improve business-related outcomes, such as serving customers," they write in the interim final rule. "These potential beneficial effects will vary from institution to institution depending upon the composition of staff supporting examinations, an institution's business activities, and the decisions of senior management."