FDIC Tells Staff to Narrow Bank Examinations Ahead of Final Rule

The Federal Deposit Insurance Corp. is instructing its bank examiners to focus their supervision on “material financial risks,” even before the agency finishes defining those risks.

In a December memo to examiners first obtained by Bloomberg Law, the US banking regulator said the changes were “directionally consistent” with a proposal it put forward in October alongside the Office of the Comptroller of the Currency outlining what constitutes an unsafe or unsound banking practice. That proposal is meant to focus supervisory attention on core financial risks affecting banks, the FDIC said.

The comment period on the proposed rule closed Dec. 29, and the FDIC in the memo said it would provide additional prescriptive guidance and training once the rule is finalized.

The memo also instructed FDIC examiners to either restructure or close out “matters requiring board attention” and supervisory recommendations—formal findings that banks are engaging in risky practices or potentially violating the law—to ensure they match the new focus on material financial risks.

MRBAs and supervisory recommendations are meant to highlight risks lurking in a bank’s balance sheet, but the Trump administration’s bank regulators say the examination tools have become too focused on minor process fouls. Newly confirmed FDIC Chairman Travis Hill has questioned, for instance, how examiners missed core financial risks at Silicon Valley Bank before it collapsed.

The FDIC’s memo is part of the administration’s broader push to overhaul banking rules, bringing the agency closer in step with the OCC and the Federal Reserve.

But to some advocates calling for tougher banking rules, the push to ease up on bank exams is opening the door to another financial crisis.

“This essentially dismantles bank supervision as we know it,” said Phillip Basil, the director of economic growth and financial stability at Better Markets and a former Fed official.

Room to Maneuver

Bank regulators can reshape examination priorities without any sort of notice and comment, giving them freedom to respond to new risks as they emerge. Changes can be announced publicly by leadership, in internal memoranda, and through updates to public exam manuals.

The OCC and the Fed have already made their internal examination changes public.

The pending rule from the FDIC and OCC is meant to codify some of those changes, making it harder for future regulators with a stricter view of bank supervision to adjust the dials.

Fed Vice Chair for Supervision Michelle Bowman said Jan. 7 that her agency would soon issue a proposal that largely mirrors the FDIC and OCC plan.

The FDIC’s internal move to bring its supervision priorities closer to those at its sister banking regulators before weighing public comments raises questions about the process, Basil said.

“It’s entirely irresponsible for them to be doing so without waiting for the public comment process to be complete,” he said.

Even banks that are generally supportive of the FDIC’s approach say the agency’s proposed definition of “unsafe or unsound” practices is overly vague.

The FDIC’s memo noted that the proposal is still out for comment and could be substantially revised. Bank supervision would adjust to any of those changes, the memo said.

“It’s not as a problematic as it would be if they were imposing new requirements on banks,” Margaret Tahyar, the head of Davis Polk & Wardwell LLP’s financial institutions practice, said in an email. “Here, the agencies are using their discretion to interpret an ambiguous and broad concept. And, critically, they are using it to instruct their own employees about supervisory priorities.”

In addition to backstopping deposits up to $250,000 and winding down failed financial institutions, the FDIC directly supervises thousands of banks around the country, including many community lenders.

‘Too Little, Too Late’

Critics of the administration’s plans say the exam changes will lead to less oversight, particularly after staffing reductions at all three federal banking regulators. But the memo says examiners will still be able to raise concerns about issues in banks’ loan books that don’t yet pose a significant risk.

The memo requires a review of existing MRBAs and supervisory recommendations, although examiners were given leeway to keep them in place. Examiners will have to show how a flagged issue risks a bank’s stability rather than relying on procedural violations.

The memo also says examiners should still monitor nonfinancial risks, such as cybersecurity.

Banks shouldn’t expect regulatory flags to be lifted immediately, according to Duane Morris LLP partner Joseph Silvia, who represents financial institutions.

“Examination teams, application teams are all about making sure they have a complete record,” he said. “And I don’t see that they’re going to start closing these things out without completing the record.”

Even with that delay and the leeway provided examiners, the new focus on material financial risks and tougher standards for raising issues with a bank will leave some risks unguarded, Basil said.

“If you’re limiting it to material financial risks that are likely to happen, it’s too little, too late at that point,” he said.