WASHINGTON — For decades, the details regulators learned about banks through the examination process have been tantamount to state secrets available to a select few.
But a line will be crossed next week, when federal regulators are expected to release the results of stress tests regulators have conducted at the nation's 19 largest banks. That regulators are saying anything at all about financial institutions that are still open could lead to a push for an even brighter spotlight on the industry and its supervisors.
Some are already beginning to argue that if regulators can divulge details on how a bank's capital position might hold up during severely stressed periods, they should also publicize other sensitive data, such as an institution's Camels rating.
"Transparency of other supervisory details in a clear and understandable way would be good," said Karen Shaw Petrou, the managing director of Federal Financial Analytics Inc. "I've been profoundly unpersuaded that the cone of secrecy as used over the years by bank examiners did anything to stabilize the system, as evidenced by the situation today. In fact, had there been more transparency earlier on, the market would have discovered the problems for itself."
Regulators have an instinctual resistance to revealing much supervisory information out of fear it could rock the markets and lead to bank runs. But policymakers laid the groundwork for more scrutiny of examinations by saying in February that the stress tests results would be made public.
"It could set a precedent," said Robert Clarke, the former comptroller of the currency who is now a senior partner at Bracewell & Giuliani LLP. "The regulators have never permitted banks to release reports except to accountants, lawyers or officers."
In an effort to calm investors, Treasury Secretary Timothy Geithner said in February that regulators would conduct the stress test to prepare the industry for more losses that could be in the offing. He said nothing about publicizing other information, but Cornelius Hurley, a former Fed lawyer who is now the director of the Morin Center for Banking and Financial Law at the Boston University School of Law, said the desire for more information is yet another "unintended consequence" of a government program.
"Geithner announces the stress test in February and ups the ante," Hurley said.
In considering what other aspects of the regulatory process to publicize, the most obvious candidate is the Camels rating examiners apply to institutions.
As the acronym suggests, the rating, which assigns banks a score of 1 to 5 (with 5 being the weakest), reviews institutions' capital, asset quality, management, earnings, liquidity and sensitivity. By releasing stress test results, regulators are already essentially telling the public how they judge the bank's success in many of those categories.
"The stress test results are an extension of the supervisory process," said Bert Ely, an independent consultant in Alexandria, Va. "They're almost like Camels ratings. This is one of the problems some regulators have had with the test, because it leads to exactly this kind of question."
Regulators have in the past argued that publicly releasing a Camels rating would lead to bank panics. If a bank slipped from a Camels 3 to Camels 4, for example, depositors would be aware there were significant supervisory issues and would almost certainly flee the bank.
"There would be a flight to quality," said Kevin Jacques, the chairman of finance at Baldwin-Wallace College in Berea, Ohio. "All of the 1-rated banks would have an advantage over the 2-rated banks."
That may not be a bad thing, many argue.
Petrou said that releasing Camels ratings would encourage a bank to keep a strong grade and, if it slipped, work hard to regain ground.
"If a bank was downgraded from a 1 to a 2, they damn well better try to get back to a 1 again," she said. "I view it like a GPA. Kids disclose their GPA."
The same concept is also true for investors. If a bank's rating declines, Wall Street would surely abandon it for other institutions that are seen as stronger. But, according to Joseph Mason, a finance professor at Louisiana State University, that would help policymakers better understand where public funds should be directed.
"Investors want to know where to place their funds today," he said. "They're retreating from the whole industry. The way through this crisis is to help investors differentiate between the strong and weak banks and have the government help the banks that are left."
Since the financial crisis began, there has been consistent criticism that supervision behind closed doors has resulted in lax oversight. A Government Accountability Office report sent to Congress last month found that federal regulators identified risk management weaknesses at financial institutions but did not demand improvements. Several inspector general reports after bank failures have found similar results.
That, according to Mason, would be less likely to happen if the regulators were held more publicly accountable for their actions.
"The public can rationally question regulatory decision making," he said. "The more sunshine on the regulatory process, the better. … As this crisis shows, it's important to hold regulators up to the public eye."
Even before the economic turmoil began, international regulators were pressing banks to be more transparent. Pillar 3 of the Basel II capital rule was drummed up as a way to require banks to disclose more details about their business. Last year regulators considered expanding the rule to force institutions to reveal more of their securitization and off-balance-sheet activities.
But financial institutions in the United States are nowhere close to completing the implementation of Basel II and, even if they were, Petrou said Pillar 3 just focuses on the banks. Regulatory activity deserves some disclosure as well, she said.
"Pillar 3 is a useful directive, but it's all investor-oriented and not supervisory-oriented," she said. "The proposal is one-sided."
To be sure, there are plenty of skeptics who question the value of throwing open the doors to the public to view examination material.
Richard Spillenkothen, a former head of supervision at the Fed who is now with the Deloitte Center for Banking Solutions, helped develop the Camels system three decades ago. At first, he said, examiners did not even reveal the ratings to the banks. He disputes the notion that somehow the financial crisis could have been prevented if examination details had been more accessible.
"The fact that perhaps regulators may have missed things going into this doesn't lead to the conclusion that if they published ratings, the public would have somehow found all of this," he said. "The process works best when bankers are free to exchange information and provide information about important events."
Still, Petrou rejects the doomsday predictions of those who seek to keep examinations close to the banking agencies' vests.
"There has long been a fear that it would lead to panics," she said. "Look at where we are today."
