Bank Supervision and Examination: A Broken System and How to Fix It
Banks are unique among U.S. companies because they are not only subject to intense regulation but also directly overseen by an army of well over 5,000 government examiners. The banking agencies refer to this function as “supervision,” and that term itself illustrates the problem: by statute, the agencies are only authorized to examine banks for legal compliance and unsafe and unsound practices, but over time they have expanded their function to now “supervise” and micromanage banks’ operations and governance, and increasingly dictate their business choices based on how the government thinks they should operate.
Furthermore, this power is subject to no checks and balances: “supervision” operates in secret, and the agencies have created their own enforcement regime, not based in rule or law, to impose significant penalties on any bank that does not follow their mandates. These penalties can be severe and greatly impede the ability of banks to run their businesses; they range from limits on business growth, orders to divest from certain business lines and customers, denials of mergers and acquisitions and increases in deposit insurance fees, among other things.
Fixing this part of the federal oversight regime would allow banks to serve their customers and communities more efficiently and focus on how to unlock economic growth.
The Solution
The solution is simple: restoring the due process required by statute and eliminating the secret enforcement regime.
- The “M” component of the current CAMELS rating system should be eliminated. Management is already part of each of the other component ratings: for example, management is a key component of assessing the bank’s Liquidity component, as stress testing and backup planning are part of that exercise.
- An MRA should be defined by regulation as a material risk to the safety and soundness of the bank, and that regulation should specifically provide reputational risk, climate risk, vendor management, IT, compensation, committee staffing and operational risk cannot form the basis of an MRA unless they meet that standard.
- All agency guidance establishing non-statutory penalties for examination criticisms should be rescinded, and the agencies should return to using the numerous sanctions that Congress has enacted: cease and desist orders, capital directives, safety and soundness directives and the like.
- Examination reports and ratings should be properly limited to objective matters of financial condition, with all exam findings and ratings appealable to a neutral fact-finder and judge.
- The banking agencies should prohibit their examiners from announcing or applying any requirement or mandate that is not already established in public regulations. And examiners’ compliance with those rules should be subject to routine oversight by so-called second and third “lines of defense” – that is, independent compliance and audit controls – that are currently lacking but should be established inside each agency.
- The banking agencies should cease consumer compliance examinations for the banks for which Congress explicitly divested them of that power (those over $10 billion in assets, for which that power was transferred to the CFPB).
- The agencies’ approach to AML compliance, sanctions (where they also have no examination authority) and cyber should be completely rethought.
The Bank Examination Problem, and How to Fix It
What They Are Saying About Bank Supervision
Did You Know:
- Between 2016 and 2023, the number of employee hours dedicated to complying with financial regulations and examiner mandates increased by 61%, even though aggregate employee hours increased only 20% in the same period.
- 42% of C-suite time and 43% of board time is now devoted to regulatory compliance, up 75% and 63% since 2016.
- The portion of bank IT budgets devoted to compliance grew by 40%. In 2016, banks spent 9.6% of their IT budget on compliance duties; in 2023, they spent 13.4%.
