American Bankers Association, Bank Policy Institute support Fed’s proposed changes to bank rating system

The American Bankers Association along with the Bank Policy Institute expressed their support for proposed changes by the Federal Reserve to the large financial institution rating system.

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The organizations claim that the current rating system fails to accurately reflect bank performance, while constraining the ability of banks to serve their customers.

“If report cards worked like the current LFI ratings framework, a student’s GPA would equal their lowest grade,” the associations wrote in a letter to the Federal Reserve. “This wouldn’t give a complete picture of a student’s performance, and the current LFI ratings approach doesn’t give a complete picture of bank condition. We’re grateful the Federal Reserve is improving the usefulness of this framework so that it can more reliably spot and address actual risks.”

The LFI rating system is used by the Federal Reserve to assess how well a bank is managed based on three components: capital planning and positions; liquidity risk management and positions; and governance and controls.

Under the current rating system, if any one of the three components is rated unsatisfactory, a bank is deemed less-than-satisfactory and not “well-managed.” Receiving an unsatisfactory score limits banks’ ability to expand their products, services or branch networks, make new investments or acquisitions, or conduct internal reorganizations.

Because of this framework, over two-thirds of large banks were rated as unsatisfactory. To address the disconnect, the associations endorsed the Federal Reserve’s proposal and urged the agency to adopt the proposed changes without delay.

Further, the associations recommended that the Federal Reserve adopt several additional changes to the bank ratings framework. They include:

• Focus on objective, material financial risks. Banks are in the business of managing financial risk, and the rubric used to evaluate their performance should prioritize material risks and apply objective, transparent standards.
• Adopt similar changes to other rating frameworks. The Federal Reserve’s rating systems for smaller banks and foreign banking organizations should undergo similar reforms.
• Implement greater due process and transparency in ratings. Regulators should provide more transparent explanations of findings so banks can better understand and resolve issues, and banks that have been downgraded should be offered a meaningful appeal process.
• Consider economic growth when defining a “large financial institution.” LFI ratings generally apply to bank holding companies and intermediate holding companies with over $100 billion in total consolidated assets. That threshold should be indexed to inflation and economic growth.

The ABA is the voice of the nation’s $24.5 trillion banking industry.