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Bank Regulators Increase Scrutiny of Lenders’ Risk Management Practices 

Federal Reserve building

In an effort to prevent bank failures, U.S. bank supervisors have reportedly increased scrutiny of lenders’ risk management practices and are taking disciplinary action. 

This comes after the collapses of three banks earlier this year, which were partly fueled by deposit runs and concerns over high interest rates impacting their balance sheets, Reuters reported Wednesday (Dec. 6). 

Regulators are now adopting a tougher and more proactive approach, conducting surprise reviews of confidential supervisory bank health ratings and in some cases issuing downgrades to ensure that banks address lapses in risk management, according to the report. 

This proactive approach aims to ensure that banks are held accountable for their risk management practices, the report said. The Federal Reserve and the Federal Deposit Insurance Corp. (FDIC) have pledged to strengthen supervision. 

The confidential nature of the regulatory process has made it challenging to obtain detailed information on the number of banks targeted, per the report. However, sources suggest that regulators are focusing on small, mid-sized and larger banks. 

The concerns stem from the potential impact of high interest rates and a slowing economy on banks’ health, according to the report. Regulators are particularly concerned about exposure to commercial real estate, a sector struggling with high rates and office vacancies. Downgrades have been attributed to factors such as insufficient capital, management issues, and exposure to commercial real estate. 

The downgrading of banks’ CAMELS rating (which measures bank safety and soundness) can have far-reaching implications, the report said. It affects banks’ deposit insurance premiums, audits and their ability to engage in certain activities. Downgraded lenders may be barred from making deals and denied emergency liquidity from the Federal Reserve. 

The off-cycle reviews of CAMELS ratings have raised concerns among banks, as they can result in significant consequences for their operations, per the report. Banks under a 4(m) sanction, which is imposed for weak capital or poor management, must seek regulatory approval for certain business activities and may take years to exit the sanction. 

While bigger banks are subject to continuous monitoring, they are also feeling increased pressure from regulators, according to the report. Top management is being warned that failure to address identified problems could result in confidential sanctions. Regulators are seeking personal accountability from bank executives, requesting briefings with C-suite executives or board members to ensure they are actively addressing the issues. 

The Federal Reserve said in April that it aims to strengthen its bank supervision and regulation after the failure of Silicon Valley Bank. The regulator found that the bank’s board of directors and management failed to manage their risks.