The bank rating system used by federal financial institution regulators should be “rethought entirely” to emphasize benefits of objective standards over subjective ones, the head of an influential bank lobbying organization will tell a Senate committee Tuesday.
In prepared testimony, Greg Baer, president and CEO of the Bank Policy Institute (a group formed last year by the merger of two older banking lobbying groups, the Financial Services Roundtable and the Clearing House Association) advised the Senate Banking Committee that four key reforms should be made to banking regulation – including a “rethought” of CAMELS.
CAMELS – which stands for Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity to market risk – was developed in the late 1970s without the “S” component, which was added in 1997. The federal credit union regulator – the National Credit Union Administration (NCUA) – has not yet adopted the S but is considering it; the agency does employ the CAMEL portions of the rating system.
In all cases, the ratings reached by the regulators are typically not shared publicly, but only with the financial institution under examination.
Baer told the Senate panel that a review of the system should “emphasize the benefits of objective, transparent, consistent standards over subjective, opaque, and ad hoc standards.” He suggested that a management component, if retained, “should not be a highly subjective wild card that can be used to deem a bank with solid capital, liquidity, and earnings to be unsafe and unsound, and thereby subject to an expansion ban.” He recommended that assessment of management should focus on financial management, and that a “meaningful appeals process should be instituted.”
Baer outlined three other reforms of the bank supervision system:
- The Federal Reserve and Office of the Comptroller of the Currency (OCC) should return to applying statutory standards for branching, merger, and investment applications, rather than forcing banks to rely on guidance issued by the agencies. He called the approach a “a zero-based review of the application process.” Any resulting application process should emphasize transparency and accountability,” he said, adding that leaders of the Fed, FDIC ,and OCC “personally should receive regular reports on applications that have been pending for more than a given period – say, 75 days – along with the reason for the delay. The pendency of an investigation should not constitute grounds for delay absent extraordinary circumstances.”
- Federal banking regulators should seek public comment on what a regulator means when it issues a “Matters Requiring Attention” (MRA) to a bank following an exam. “If an MRA is an unenforceable suggestion, with no consequences for a company’s ability to grow or invest, then they should make that clear. If it is a de facto order, then it should be issued only when there is a legal basis for it – a violation of law or an unsafe or unsound banking practice – and the bank should receive Administrative Procedures Act (APA)-prescribed process.”
- Banking regulators should confirm that guidance they may issue about regulatory compliance is not binding and will not form the basis for an MRA. He added that “only violations of law (including an unsafe and unsound practice) will form the basis for an MRA. This step is necessary because by numerous accounts their earlier statement is being disregarded in practice.”
However, on that last point, another witness before the committee – Boston College Law School Professor Patricia A. McCoy – argued that guidance by regulators provides needed transparency in regulation. She noted that banks and other regulated entities have “ample recourse if guidances are given binding effect.”
“Criticisms of guidance often assert that examination reports downgrade companies for failure to follow guidance or that enforcement actions are based on guidance violations,” she told the committee. “This might raise concerns that guidances were being given binding effect against third parties without prior public input into their substance through the notice-and-comment process. In the more likely case, federal banking regulators base negative exam ratings, exam citations, and enforcement actions on violations of statutes or rules, on unsafe or unsound practices (in the case of the prudential banking regulators), or on unfair, deceptive or abusive practices (in the case of the Consumer Financial Protection Bureau), and not on any guidances that happen to overlap.”
The hearing – titled “Guidance, Supervisory Expectations, and the Rule of Law: How do the Banking Agencies Regulate and Supervise Institutions?” – featured no federal financial institution regulators. Banking and credit union agency heads are, however, scheduled to testify before the Banking Committee May 15.
Guidance, Supervisory Expectations, and the Rule of Law: How do the Banking Agencies Regulate and Supervise Institutions?