Top Regulators Discuss Potential Improvements to Bank Supervision

In remarks at an industry event today, Federal Reserve Vice Chairman for Supervision Randal Quarles discussed possible ways to improve the supervisory ratings system that regulators use to assess banks’ strength in various risk areas to make them “more consistent and more predictable.”

“[B]eing clearer to firms about how we apply these standards would help to promote a more efficient banking system,” Quarles said. “In particular, we could be clearer about how we weight the various factors that generate the rating. Banks could benefit because they would be better positioned to anticipate supervisory feedback and understand what steps they need to take to improve their ratings.”

Quarles encouraged regulators to “rely wherever possible on empirical analysis to direct our policy choices and to be open to change where supported by this analysis.” As regulators conduct this analysis, Quarles said that “we should focus on two main variables: the consequences of the ratings that I’ve described . . . and whether or not these consequences are properly calibrated relative to the circumstances that gave rise to the rating.”

As the Fed undertakes a review of its ratings system, Quarles said that he is asking staff to look into the placement of the qualitative elements of the Fed’s ratings frameworks; ways that the Fed could be clearer to the public about how supervisors weigh qualitative and quantitative elements of their ratings; and any conclusions that can be drawn about the effectiveness of the new large financial institution ratings framework, relative to the risk management, financial condition and impact ratings framework.

“Even if we were to make no changes to our ratings frameworks, going through the process of assessing this calibration will surely provide a valuable learning experience,” Quarles said. “It would also increase our conviction in the legitimacy of our ratings frameworks and our confidence as a prudential supervisor.” Read Quarles’ speech.

FDIC Chairman Jelena McWilliams also spoke at the event, offering her views on her agency’s efforts to modernize the supervision process. To achieve the overarching goals of fostering technological transformation, developing a more dynamic supervision model and reducing regulatory burden, McWilliams said that the agency is working to remove unnecessary regulations and operational uncertainties around adopting new technologies.

In addition, the FDIC is investing in development efforts to help tackle supervision issues or address technological challenges—such as those associated with financial reporting, as it did in its first-ever hackathon. As a result of that event, McWilliams said that 15 firms were selected to advance and will unveil initial prototypes “within 70 days and, if selected to continue, a fully functional prototype in 180 days” that will help banks provide more timely and granular data to the FDIC.

“What I envision . . . is a system that allows banks and regulators—operating from a shared understanding of financial information—to engage more regularly and more informally to discuss operations, understand emerging risks, and resolve questions surrounding new products and services,” McWilliams said. “I call this approach to supervision “continuous engagement.”

Under this approach, banks that opt-in “would have more regular, informal engagements with the FDIC,” which would ultimately reduce the burdens associated with an on-site annual examination. “When we are successful, this system will reduce the reporting burden for institutions and the compliance costs of an annual examination, while simultaneously providing greater visibility for the FDIC into an institution’s financial health and into the health of the entire financial system,” she said. “And, because we are engaging more regularly, the FDIC will be able to help institutions identify and mitigate risks to financial health or consumers before they become bigger, more challenging problems.”