In a recent opinion article published in the International Banker, Greg Baer, President and CEO of the Bank Policy Institute, criticizes the examination practices of US regulators for focusing on risks that he believes are immaterial to banking sector resilience.
According to a recent leak out of the Office of the Comptroller of the Currency (OCC), 11 out of 22 large banks under the regulator's supervision were rated as having "insufficient" or "weak" operational risk management. These alleged deficiencies contributed to about one-third of those banks receiving low overall management ratings as a part of the broader "CAMELS" rating system. The US Federal Reserve has expressed similar concerns, arguing in its May 2024 Supervision and Regulation Report that two-thirds of large banks had management deficiencies.
Baer argues that these findings contradicted the banks' financial strength and resilience, as seen in their capital, liquidity, and earnings reports. The Federal Reserve has itself acknowledged that the banking system remains sound and resilient, he notes. "So, how could the Fed and the OCC reach examination conclusions so dramatically at odds with reality?" Baer argues. "They did so in two ways: by shifting the focus of their examinations from material financial risk to so-called operational risk, and by changing their roles from examination to management consulting."
These operational risks were not the driving force behind the "banking turmoil" of 2023, Baer emphasizes, which was caused by poor management of interest rate and liquidity risks. "Perhaps more significantly, agency examiners exhibited no prescience on that front as interest rate risks and liquidity risks were rising," he writes, as SVB, Signature Bank, and First Republic Bank all received "satisfactory" CAMELS scores ahead of their collapse. "As the SVB experience suggests, it seems clear that their focus on operational risks is distracting examiners and banks from material financial risks," Baer argues.
Baer questions the rationale for focusing on operational risks, highlighting that banks already internalized these risks without the need for government oversight. And examiners' excessive focus on compliance created inefficiencies and morale issues within banks, he contends, distracting from the management of material financial risks.
Ultimately, Baer argues that the regulators' approach is flawed, resulting in unnecessary costs and restrictions for the banking sector. "The more we learn about the secret examination regimes operated by US banking agencies, the more reason there is for concern," he concludes. "Recent news is no exception."
For more from Greg Baer, read his article, "Rethinking Bank Examination," from the 2024 Compendium.
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