Fed: Supervisory problems on the rise for banks of all sizes

Bloomberg News

The number of outstanding supervisory findings — for large, regional and community banks alike — have continued to climb in recent months, according to the Federal Reserve's latest supervision and regulation report.

The semiannual report was released Thursday and noted that only about half of large financial institutions — those with total assets of $100 billion or more — had satisfactory ratings based on the Fed's three-pronged rating system, which considers capital planning, liquidity management and governance and controls. 

Large banks with satisfactory ratings have hovered between 50% and 60% during the past several years, according to the report, but the share has steadily declined since 2019. 

The report notes that large banks were generally well capitalized, and the 23 institutions examined in this year's stress test had sufficient capital and liquidity to withstand a severe economic downturn. Meanwhile, governance issues plagued the large banks, accounting for two-thirds of the findings by Fed examiners. Liquidity and interest rate risk management issues were also on the rise.

Smaller and medium-size banks — those in the community and regional bank supervisory portfolios — also saw supervisory issues jump from last year. The report attributes this rise to adverse financial conditions. 

Overall, the vast majority of community and regional banks were on sound supervisory footing, the report notes, highlighting the fact that more than 90% received satisfactory ratings in the CAMELs rating system, which examines capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risks. 

Even so, those smaller and regional banks struggled to manage certain risks. Information technology and operational risks were the most cited issues among both regional banks, those with between $10 billion and $100 billion of assets, and community banks, those with less than $10 billion of assets.

For community banks, credit risk was the second-most cited issue followed by the broad category of management, risk management and internal controls. Among regional banks, the broad risk management category was the second-most cited, followed by compliance with the Bank Secrecy Act and anti-money-laundering requirements. 

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The report comes at a time when the Fed's supervisory policy is under a microscope. Banks and banking trade groups have argued that examiners have been overly assertive in recent months after the failures of Silicon Valley Bank, Signature Bank and First Republic heightened concerns about liquidity and interest rate risk. A leak of confidential supervisory information to Bloomberg over the summer revealed that several large banks have received a deluge of supervisory actions this year. Consumer advocates, lawmakers and the agency itself have noted that poor supervisory oversight contributed to the bank's demise. 

Meanwhile, advocates of stronger supervision note that supervisory findings have been on the rise, a shift they attribute to the departure of former Fed Vice Chair for Supervision Randal Quarles. In his report on the failure of SVB, current Vice Chair for Supervision Michael Barr blamed a culture of lax supervision that developed under his predecessor for the Fed's lackluster response to issues at the bank.

This week's report states that the Fed has learned lessons from the SVB episode and is "committed to taking additional steps to strengthen its supervisory efforts."

The report reflects an enhanced focus on the management of interest rate risks as well as liquidity, two issues that were central to the failure of SVB. Interest rate risk, in particular, was noted as a top priority for both large banks as well as community and regional ones. 

The report also singled out commercial real estate loans as an area of enhanced focus for supervisors, given the higher levels of delinquency in such assets. Distress in office loans, in particular, has skyrocketed since last year, the report notes.