Fed Strips Discretion From Bank Exams, Raising Risks Regulators Missed Before

The Fed Is Rewriting How It Rates Bank Management

The Federal Financial Institutions Examination Council, led by Federal Reserve Vice Chair for Supervision Michelle Bowman, has proposed changes to the CAMELS rating system that would strip the management component of its current authority. CAMELS stands for Capital adequacy, Asset quality, Management, Earnings, Liquidity and Sensitivity to market risk.

The reforms would remove "special consideration" language that currently elevates management ratings above other factors. They would also narrow what examiners can evaluate, replacing broad discretion with explicit directives tied to measurable outcomes. Most significantly: a bank could no longer receive an overall "less than satisfactory" rating if its capital, asset quality, earnings, liquidity and market risk scores were all strong, even if management quality was poor.

Bowman framed the shift as a move toward objectivity. "The revisions introduce clearer, more objective metrics for each component and replace subjective management assessments with measurable factors," she told Congress.

Banks and their legal advisers have wanted this for years. "The management component has been inappropriately used, over-indexed, and a catch-all phrase," said Meg Tahyar, a partner at Davis Polk, summarizing the banking industry complaint.

The Failure Record Contradicts the Reform Logic

The confidentiality of CAMELS scores makes it nearly impossible to evaluate whether subjective management oversight actually prevents failures. Only after a bank fails does its examination report become public. Two recent cases tell conflicting stories.

Signature Bank failed in 2023. The FDIC concluded poor management was the root cause, citing "rapid, unrestrained growth" without adequate risk controls. Yet FDIC examiners never downgraded Signature's management score below "satisfactory" from 2017 through 2021. The FDIC later acknowledged it failed to follow its own oversight policies.

Silicon Valley Bank failed in 2022. The Fed had downgraded SVB's management score from 2 to 3 ("less than satisfactory") in 2022, citing poor practices. But the Fed's post-mortem notes that SVB's most critical failures were in interest rate risk management—a category that should have been caught under "sensitivity to market risk," not management.

The Wells Fargo fake accounts scandal (2016) offers a third data point. The bank's sales culture incentivized employees to open accounts without customer permission to inflate numbers. At the time, Wells Fargo's financial metrics were strong; had examiners been bound by the new standard of "material financial risk," the issue might have been missed. Yet Congress also found that the Fed and OCC were slow to act even after the fraud was known, suggesting the problem was not oversight design but enforcement will.

Cliff Rossi, former chief risk officer at Citigroup and credit risk officer at Washington Mutual before its 2008 failure, warns that the new framework could recreate pre-crisis blind spots. "Should the proposed changes go forward, it could undercut all the advances in risk management, organizational stature and effectiveness that have been in place since the '08 crisis," he said. At WaMu, incentive structures drove aggressive mortgage origination while borrower quality declined—a management failure that strong financial data alone would not have flagged.

A Shift Toward Rules-Based Supervision With Hidden Trade-offs

The reforms represent a broader move away from discretionary, forward-looking supervision toward a more mechanical, numbers-driven approach. Regulators say this reduces burden on banks. Critics raise two risks.

First: examiners lose their early warning system. If management quality can only trigger a downgrade when tied to a specific, measurable financial weakness, issues that breed financial risk slowly (perverse incentives, weak controls, siloed risk reporting) may go unnoticed until they show up in balance sheets or, worse, in failure reports.

Second: rigid rules may paradoxically increase regulatory burden later. Phillip Basil, former Federal Reserve supervisory policy specialist now at Better Markets, argues that by stripping discretion, regulators will eventually be forced to define universal thresholds for what constitutes material risk. "It becomes the government telling banks how to manage their risks, which has never been the role of supervision," he said.

David Zaring, professor at Wharton, notes the current frustration with box-checking: examiners police documentation and procedures rather than substance. The proposed fix—moving toward quantitative criteria—may address that complaint but at the cost of losing the ability to question *why* management is making the decisions it makes.

The FFIEC proposal still allows downgrading for "significant noncompliance with law or regulation," so the door is not fully closed. But the bar is higher, and the discretion is narrower.

Sean Vanatta, senior lecturer on financial history at the University of Glasgow, points out the core constraint: "We're so dependent on the experiences that bankers convey. We only get these moments of crisis to provide some kind of external evaluation." The confidentiality of CAMELS means no independent audit of whether the old system worked or whether the new one will. Both regulators and banks are largely guessing.