- Key insight: New rules that raise thresholds for supervisors to issue Matters Requiring Attention to bank boards of directors could shift more responsibility for catching emerging risks from examiners to the banks themselves.
- Supporting data: The Office of Comptroller of the Currency and Federal Deposit Insurance Corp. rules would focus supervisory criticism on risks with a "material financial impact" and would define "safety and soundness" in regulation.
- Forward look: Banks may face less formal scrutiny of smaller weaknesses that some fear could grow into larger problems.
The Office of the Comptroller of the Currency and Federal Deposit Insurance Corp.'s move to narrow bank supervisors' ability to flag unsafe or unsound practices would give banks more discretion over how they manage supervisory risks — but with that flexibility comes greater responsibility for addressing small problems before they become big ones.
That distinction could materially change the dynamic between examiners and banks, according to Todd Phillips, director at the Klaros Group and a former banking and administrative law professor at Georgia State University and former FDIC lawyer.
"I think this is going to send a signal to banks and examiners that examiners shouldn't push too hard on things that don't have an immediate material financial hook, and allows banks to kind of push back against examiners when they do highlight things," Phillips said, adding that examiners have traditionally identified both existing risks and weaknesses that could develop into larger problems.
"This rule handcuffs the examiners and prevents them from highlighting again things that don't have an obvious hook to material financial conditions," he continued.
The joint final rule, building on a
FDIC Chairman Travis Hill, who has described the rule as part of a broader effort to fundamentally reform bank supervision, said the change gives banks more discretion over how they manage risks.
"It shifts our attention towards underlying fundamental risks and away from banks' processes for managing those risks, and second, it imposes a materiality threshold for evaluating those potential risks," Hill said. "The final rule does not prevent examiners from proactively identifying issues [and] does not require examiners to wait until a financial harm actually occurs to issue a supervisory criticism."
Rather, Hill said, "the risk that a practice or act would materially harm the financial condition of the institution must be 'more than speculative or merely possible.'"
Banking trade groups like the Bank Policy Institute celebrated the change as welcome regulatory relief, arguing that it will give banks greater flexibility to determine how best to comply with regulatory expectations.
"Today's final rule will improve supervision by focusing banks and regulators on material risks to banks' financial condition," the group wrote. "This rule will enhance the clarity and objectivity of bank supervision and allow banks to innovate and compete more effectively."
Monica Freas, a regulatory partner at Skadden and former enforcement director at the OCC, said the rule nevertheless gives banks a clearer signal about which supervisory criticisms warrant the greatest urgency. She also notes the rule gives examiners flexibility to apply the materiality standard differently depending on a bank's size and complexity.
"Institutions on the receiving end of MRAs and substantive law violations should treat them with a high level of urgency given the agency has essentially put the institution on notice that its practices are reasonably expected to lead to material harm and the violations cited are serious," Freas said. "The rule builds in flexibility for what constitutes 'material' harm to the financial condition of a large bank versus a small community bank."
Freas said she expects the additional clarity would be a welcome aspect of the rule for examiners.
"Notwithstanding this being what may be considered a big shift for examiners, my sense is that they will welcome the additional clarity with the finalized rule and PPMs," Freas said. "Examiners are much more comfortable operating under clear rules of the road."
Under the new framework, process, documentation, governance and control weaknesses that do not rise to the level of material financial risk are more likely to be flagged less formally as supervisory observations rather than MRAs.
Read more:
- OCC and FDIC finalize narrower bank supervision procedures
- As education costs rise, credit unions chip in for employees
- A $111 million scheme to keep bad merchants banked
- How Google and Apple's youth plays are pressuring banks
That does not mean banks can safely ignore them. Tracy Moore, Director of Strategic Thought Leadership & Regulatory Affairs at regtech firm Fenergo, said the change makes it more important for institutions to distinguish between an issue's regulatory classification and its underlying risk.
"That does not make them irrelevant," Moore said. "From a technology and risk perspective, banks should still track these issues closely. Small control or data weaknesses can compound across interconnected systems and processes if they are not addressed."
Phillips cautioned that one risk of taking a more hands-off approach to supervision is that supervisors can look at a bank's business from a different perspective, potentially identifying weaknesses that can become more significant over time.
"There can be smaller things that can metastasize into bigger things, and we want examiners to highlight those things," Phillips said. "I think the banking industry and the administration, the agencies are saying, 'If it's not a big issue now, it's not worth bringing it up.'"
That creates a potential tension for banks: Raising the regulatory threshold may reduce the number of MRAs its board must address, but might also reduce the incentive to be proactive in nipping nascent risks in the bud.
"That is a risk if institutions interpret the higher threshold as a reason to deprioritize issues that do not immediately present material financial harm," Moore said. "BSA/AML illustrates why a proactive approach remains important. Weaknesses in monitoring, data or controls can develop over time before their full impact becomes apparent."
Phillips added that regulators are less likely to serve as the second set of eyes for weaknesses that have not yet crossed the materiality threshold.
"I would not advise banks to make any changes. At the end of the day, whether an examiner highlights an issue or not, if it's an issue, the bank should work to fix it," Phillips said. "This just means that it is more on the bank."
