Fed Risks Bank Blowups With Ratings Changes, Critics Warn

The Federal Reserve’s ratings system for large banks would become “toothless” under a plan to ease the requirements for lenders to be considered “well managed,” opponents of the proposal said.

The Fed in its July proposal said it intended to address situations where big bank holding companies—those with $100 billion or more in assets—fail to receive a “well managed” label due to governance and other nonfinancial problems, even when they’re found to have sufficient capital and liquidity.

But the proposed change would undermine the importance of good management at large financial firms, Jeremy Kress, a professor at the University of Michigan’s Ross School of Business and a former Fed attorney, said in a comment letter ahead of a Thursday deadline.

Kress noted that Silicon Valley Bank lost its “well managed” status in May 2022, nearly a year before its failure, after the Fed downgraded its governance controls. Under the proposal, SVB would’ve retained that grade, he said.

“Any ratings framework that would have rated SVBFG as ‘well managed’ on the eve of its collapse lacks credibility and should be rejected,” Kress said.

Fed Changes

The Fed’s bank supervisory framework has four potential ratings for measuring financial and operating strength: broadly meets expectations, conditionally meets expectations, deficient-1, and deficient-2.

The proposal would allow banks with no more than one deficient-1 rating to be categorized as “well managed.” Those with a deficient-2 score for any component would still fail to qualify.

Under current rules, 23 of 36 large banks rated by the Fed in the fourth quarter of 2024 didn’t achieve a “well managed” tag, according to the proposal. Fed Vice Chair for Supervision Michelle Bowman has noted many of those lenders had sufficient capital and liquidity.

Those large financial institutions were deemed to have problematic management even “while regulators have repeatedly said that LFIs, and the banking system as a whole, remain strong and resilient,” the Bank Policy Institute and American Bankers Association said in a comment letter.

Failing to achieve a “well managed” designation can restrict a bank’s growth and have other consequences, the banking trade groups noted.

Weakening the tests to get more large banks to pass would put the entire system at risk, the Independent Community Bankers of America said in its comment letter.

“A finding by the Board that too many large firms are failing to satisfy the criteria to be considered ‘well managed’ should result in an enhanced supervisory and enforcement regime for these firms, rather than the Board lowering its standards to allow too big to fail firms with significant deficiencies to grow with less oversight,” the community bank trade group said.