Introduction to Bank Regulation: Supervision

Introduction to Bank Regulation: Supervision

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December 20, 2018
Introduction to Bank Regulation: Supervision
To identity and mitigate risks, bank regulators have the
enforcement powers to reprimand banks that are not
authority to monitor bank activities and, if necessary, direct
complying with the rules.
a bank to change its behavior. Bank supervision creates
certain benefits (e.g., fewer bank failures, more systemic
Supervision refers to certain regulators’ authority to
stability) but imposes certain costs (e.g., bank compliance
monitor and examine banks, impose reporting requirements,
costs, reduced credit availability). Congress often faces
and instruct banks to modify behavior. Supervision enables
policy questions about whether these benefits and costs are
regulators to evaluate and promote the safety and soundness
appropriately balanced. This In Focus provides a brief
of individual banks (known as micro-prudential
overview of bank supervision and related policy issues.
supervision) and the banking system as a whole (macro-
prudential supervision). In addition, regulators evaluate
Who Supervises Banks?
bank compliance with other statutory requirements,
Banks are supervised by a primary regulator, which is
including consumer protection and fair lending laws
determined by a bank’s charter type and whether the bank is
(consumer compliance supervision), anti-money laundering
a member of the Federal Reserve System. The federal
laws, cybersecurity requirements, and compliance with the
primary regulators are the Federal Reserve (the Fed), the
Community Reinvestment Act (P.L. 95-128).
Office of the Comptroller of the Currency (OCC), and the
Federal Deposit Insurance Corporation (FDIC). (The
Regulators have complementary tools to achieve their
National Credit Union Administration [NCUA] supervises
supervisory goals (see Figure 1). They continuously
credit unions.) Banks chartered at the state level also are
monitor banks, often using information banks are required
supervised by state-level bank regulatory agencies.
to report or that was gathered during previous
examinations. Supervision is an iterative process, and
Banks above a certain asset size also are subject to
examiners can use information gathered through monitoring
supervision for compliance with consumer protection laws
to determine the scope and areas of focus for upcoming
and regulations by the Consumer Financial Protection
exams.
Bureau (CFPB). For banks with more than $10 billion in
assets, the CFPB is generally the primary supervisor for
Figure 1. The Bank Examination Cycle
consumer compliance. For banks with $10 billion or less in
assets, the primary regulator generally remains the primary
supervisory authority for consumer compliance. (CFPB
rules may apply to all banks, regardless of which agency is
a bank’s supervisor).
Before the Dodd-Frank Act (P.L. 111-203), the Fed, OCC,
and FDIC supervised banks for both safety and soundness
and consumer compliance. Congress created the CFPB in
response to assertions that this dual mandate restricted bank
regulators’ incentive or ability to monitor and curtail

questionable consumer lending practices leading up to the
Source: Consumer Financial Protection Bureau.
2008 financial crisis. Critics of the CFPB assert that certain
Note: Certain large banks may have examiners continuously on-site.
banks subject to its supervision (e.g., those over but near
the $10 billion threshold) face overly burdensome
Reporting. Banks submit a Report of Condition and
examinations; these critics call for raising the $10 billion
Income—referred to as the call report—to regulators
threshold or returning consumer compliance supervision to
quarterly. The call report is comprised of “schedules”
the primary regulator. Proponents of the CFPB argue that
containing multiple line items related to bank operations for
making such changes could lead to inappropriately lax
which a value must be reported. These data are reported
consumer compliance supervision, similar to what was in
using standard definitions so that regulators and the public
place during the run-up to the financial crisis.
can compare banks. To lower the burden on small banks
relative to big banks, the number of items that a bank must
How Are Banks Supervised?
report depends on its size and other considerations. The
Bank regulators have three main tools to regulate banks:
Economic Growth, Regulatory Relief, and Consumer
they can promulgate rules implementing banking law that
Protection Act of 2018 (P.L. 115-174) mandated further
banks must follow, they can supervise banks to ensure
simplification (expected to be implemented in 2019),
banks are complying with those rules, and they have
requiring banks with under $5 billion in assets to file a
shorter call report every other quarter. In addition, current
statute requires the regulators to review call reports every
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Introduction to Bank Regulation: Supervision
five years to eliminate any information or schedule that “is
Appeals Process. Bank regulators have established
no longer necessary or appropriate.” The most recent
processes for a bank to appeal its examination results.
burden-reducing revisions took effect in June 2018.
Although regulators often resolve disputes informally
through discussion between the bank and the examiner,
Examinations. Regulators are generally to conduct a full-
they are required to maintain a formal independent appeals
scope, on-site examination of banks at least once every 12
process for supervisory findings, appoint an independent
months. However, banks that (1) have less than $3 billion in
ombudsman, and maintain safeguards to prevent retaliation
assets (this threshold was raised by P.L. 115-174), (2) meet
against a bank that disputes the examination findings. Each
the capital requirements necessary to be considered well-
agency ombudsman’s exact role varies, but generally the
capitalized, and (3) were most recently found to be well
ombudsman serves as a facilitator for the resolution of
managed and in “outstanding” condition (banks under $200
complaints. Only the OCC currently allows banks to appeal
million in assets can be in “good” condition), among other
an examination directly to the agency’s ombudsman.
conditions, are to be examined once every 18 months.
Some observers argue that this appeals process is unfairly
Periodic examinations (often on-site at bank offices)
slanted against banks, as the supervisory agency may be
involve an evaluation of bank practices and performance.
unlikely to admit mistakes. They propose changes, such as
Examiners may objectively confirm whether banks meet
establishing a more independent ombudsman and giving
requirements set by quantitative regulations or may
banks the right to appeal exam results to an administrative
subjectively interpret whether a bank satisfies the goals of
law judge. Opponents to these changes view the creation of
qualitative regulations. Problems may lead to more frequent
an additional ombudsman for all banking agencies as
or detailed exams. In addition, regulators are permanently
redundant and express concerns that the proposed changes
placed on-site at offices of certain large banks.
could result in incorrectly overturned supervisory decisions.
Bank examiners rate a bank based on the Uniform Financial
Regulatory Relief Debate
Institutions Ratings System, wherein the banks receive a
Bank supervision creates certain benefits, such as reducing
rating from 1 (best) to 5 (worst) across six “CAMELS”
losses from bank failures and providing systemic stability,
components—capital adequacy, asset quality, management,
which may improve overall economic growth. Subjecting
earnings, liquidity, and sensitivity to market risk—and a
banks to a supervisory program also may promote public
composite rating based on all those components. Examiners
and market confidence in the banking system. However, it
communicate findings and ratings to bank management and
imposes costs on banks, such as resources expended to
require corrective actions for banks with poor ratings.
comply with examination and reporting requirements,
Similar uniform interagency ratings systems are used for
which could reduce the amount of credit available and thus
cybersecurity and consumer compliance.
slow economic growth.
Regulators also examine banks under the Community
Broadly, recent congressional debates related to the bank
Reinvestment Act (P.L. 95-128) to determine how well they
supervisory framework involve questions about whether
are meeting the credit needs of the communities in which
bank supervision is unduly burdensome (i.e., the benefits do
they operate. In these exams, banks are given a composite
not justify the costs) and whether banks should be provided
rating based on up to three component ratings in lending,
with regulatory relief (i.e., supervision should be made
investment, and service. Ratings range from outstanding to
more lenient). The 115th Congress provided regulatory
substantial noncompliance, and poor ratings can be the
relief from bank supervision in P.L. 115-174, and regulators
basis for regulators to deny permission to a bank to expand
provided relief in recent rules. The 116th Congress may
operations into additional areas.
continue the debate about whether current practices strike
the appropriate balance between costs and benefits,
Guidance. After a rule has been finalized, regulators can
particularly for banks below certain asset thresholds.
issue nonbinding guidance or supervisory letters to banks
providing explanations of how to adhere to a regulation.
Small Banks. As the recent changes to call reports and
Although changes in supervision cannot substitute for the
examinations indicate, some aspects of supervision are
rulemaking process, they can subtly influence regulatory
tailored to reduce regulatory burden for small banks (often
burden by changing how rules are complied with or
called community banks). Proponents contend that current
enforced in ways that critics argue amount to rulemaking
tailoring does not go far enough. They argue that there are
outside the rulemaking process. High-profile examples in
economies of scale to compliance (i.e., compliance costs
recent years include a joint agency guidance on leveraged
rise less than proportionately with size). If true, this would
lending and a joint agency statement on commercial real
mean compliance costs on small banks are
estate loans. A CFPB guidance on discrimination applying
disproportionately high compared with larger banks and
to indirect auto lenders (which include banks) was nullified
more likely to be unduly burdensome.
by P.L. 115-172 under the Congressional Review Act
(CRA) in 2018, following a 2017 decision by the
Opponents of this view argue that too many restrictions on
Government Accountability Office that guidance was
the supervision of small banks—hundreds of which failed
subject to the CRA. For more information, see CRS Report
during the financial crisis—could blunt its effectiveness.
R45248, The Congressional Review Act: Determining
They note that the existence of compliance costs does not
Which “Rules” Must Be Submitted to Congress.
necessarily mean supervision is unduly burdensome;
benefits such as greater safety and soundness among banks
or stronger consumer protection could justify those costs.
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Introduction to Bank Regulation: Supervision

David W. Perkins, Analyst in Macroeconomic Policy
IF11055
Marc Labonte, Specialist in Macroeconomic Policy

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