This morning, the House Subcommittee on Financial Institutions held a hearing to examine regulatory overreach, especially around regulatory tailoring and bank supervision. Sarah Flowers, BPI senior vice president and senior associate general counsel of regulatory affairs, testified before the committee. Her testimony cautioned against one-size-fits-all regulations that treat all banks as equally risky, regardless of the size and complexity of their business models. Flowers also examined failures in bank supervision that impede banks’ ability to support their communities, without meaningfully improving safety or soundness.
Here are some takeaways from the hearing:
1. Congress passed S. 2155 in 2018, requiring regulators to tailor bank regulations to an institution’s size.
Subcommittee Chair Andy Barr (R-KY): “In 2018 Congress acknowledged the need to adjust regulations on financial institutions that reflect their associated risk profile and lending strategies. This led to the passage of the bipartisan Economic Growth Regulatory Relief and Consumer Protection Act, or S.2155. This was a monumental step in recalibrating our federal bank regulation framework toward a more dynamic, risk-based approach that does not impose excessive compliance burdens on small or less complex financial institutions. Unfortunately, Democrat-appointed regulatory officials under the Biden administration abandoned the bipartisan policy approach of tailoring in favor of a uniform, subjective based approach.”
2. The rule was intended to better calibrate bank regulations to reduce regulatory burdens on small and mid-size institutions.
Michael Radcliffe, Community Financial Services Bank: “[W]e operate with unmatched efficiency and local focus. However, the increasing regulatory burden is jeopardizing our ability to serve these communities. At CFSB, we spend over $632,000 annually on compliance costs alone. This includes expenses for personnel training, reporting and technology, all resources that can instead support local families, farmers and small businesses. CFPB 1071 rule exemplifies the challenge. While it aims to promote fair lending, the data collection requirements impose significant administrative costs and raise privacy concerns amongst our borrowers, eroding the trust that defines community banking.”
3. While regulatory tailoring is the law, it is inconsistently applied due to subjective and opaque bank supervisory practices.
Chairman French Hill (R-AR): “Would you agree that tailoring regulations for well managed institutions already exists in law, and it’s just not being implemented by our supervisors?”
Meg Tahyar (Davis Polk): “Yes, I agree it does exist in the law from the previous act, but we don’t know how it is being implemented by supervisors in practice because of the culture of secrecy, but based on the anecdotal evidence, I think it is being inconsistently implemented.”
4. Bank supervisors engage in so-called “horizontal reviews” that exacerbate this problem and can result in unfair penalties.
Sarah Flowers, BPI: “Regional banks routinely report that the agencies use horizontal reviews to hold them to the same standards as global systemically important banks, or GSIBs, through the exam process. These banks are technically exempt from those standards, but nothing stops an examiner from imposing them by issuing a Matter Requiring Attention or MRA in a non-public exam. A key reform should be the adoption of regulations that define an unsafe or unsound practice using a financial materiality standard. This would help ensure that enforcement actions are grounded in practices that genuinely threaten a bank’s financial integrity.”
5. Rather than prioritizing material financial risks, bank examiners remain focused on process, immaterial risks and subjective factors, as witnessed with Silicon Valley Bank.
Rep. Bill Huizenga (R-MI) “[W]hat would be a better way for examiners to ensure that, to ensure that this type of mismanagement isn’t missed or, frankly, even worse, ignored in the future?”
Sarah Flowers, BPI: “I think that what would be really important, as I mentioned in my testimony, is to refocus the exam framework on material financial risks. That could include a standard for what constitutes safety and soundness that’s moored in financial risk. I think with SVB, we saw that there, they didn’t lack examiners, they didn’t lack examiners with energy and authority and tools, but what they did lack was that focus. So, refocusing them so that they’re not distracted by process related governance and management minutia.”
6. The “Management” rating in the CAMELS rating system is untethered to any financial risk and exemplifies this problem.
Rep. Scott Fitzgerald (R-WI): “Ms. Flowers. How does this over-reliance on a subjective assessment of management lead to misaligned supervisory actions?”
Sarah Flowers, BPI: “Thank you for that question. I think it’s really important. If you’re overly focusing your exam framework on the minutia of governance and management issues, which can really run the gamut from IT, vendor management and a lot of sort of immaterial risks that are very unlikely to impact the safety and soundness of a financial institution, then you’re focusing supervisory attention away from the true risk that they should be focused on, like credit risk, liquidity risk, interest rate risk, those types of things. So, by focusing a lot of attention on the most subjective and uniquely subjective aspect and component of the CAMELS framework, you redirect supervisory attention away from material financial risk.”
Rep. Scott Fitzgerald (R-WI): “So, if you would shift towards a more objective, kind of transparent criteria, could that improve both the accuracy of the ratings and I guess the overall safety of the banking system?”
Sarah Flowers, BPI: “It would certainly improve the accuracy of the ratings. The CAMELS framework should be a framework that assesses financial condition and integrity of an institution, focusing it away on subjective measures of risk, including the minutia that allow examiners to be at best in sort of a management consulting practice and at worst in politicizing risks, takes away from their focus on core issues of safety and soundness.”
7. Bank supervision is secretive, and banks are effectively unable to challenge examiner findings.
Meg Tahyar (Davis Polk): “There are many unknown unknowns in supervision. Is it effective? Does it work? In business as usual or in troubled times? We actually don’t know. That is because it’s not transparent. Why isn’t it more transparent? I’m not suggesting body cams on examiners, but there are some things that could be done that are relatively easy. One is to release very old exam reports, 35 years or more, where nobody was at the bank or at the agencies is still working. Another is to release more consistent anonymized aggregate data that will allow an examination into whether exams are consistent and fair across banks or models and whether tailoring works.
Another is to reform the appeals process, which is broken. As Secretary Bessent recently said, it’s more theoretical than real. In a 13-year period at the FDIC, there were 50 appeals to over 100,000 exams, and I don’t think anybody’s that perfect. There were very few wins last year. Banks were one to 17.”
8. Opaque and subjective expectations can also lead to unintended consequences — as demonstrated with examiners’ use of “reputational risk.”
Rep. Blake Moore (R-UT): “Do you think there’s a credible, objective way to measure reputational risk, or is [it] inherently just too subjective to remain part of the supervisory framework?”
Meg Tahyar (Davis Polk): “It’s inherently too subjective. It’s new. Let’s remember how new it is. It didn’t exist 20 years ago. Doesn’t add anything to existing risks. For example, Bank Secrecy Act, anti-money laundering, terrorist financing, they’re all already covered. And I just think experience has shown that it cannot be objectively supervised or managed.”
9. Transparency into how U.S. banking agencies participate in international bodies can lead to a safer and fairer financial system.
Rep. Roger Williams (R-TX): “Ms. Flowers, could you elaborate on the lack of transparency into the prudential regulators engagements with international organizations? How do these agreements put our financial system at risk?”
Sarah Flowers, BPI: “Thank you for the question. I think it’s really important. We have very little insight into our federal banking agency’s participation in committees like the Basel Committee and other of the international bodies you mentioned. The Basel committee, for example, doesn’t release minutes. We don’t know what positions are taken by our agencies unless they voluntarily disclose them, and we don’t get official reports on U.S. views and whether they are advancing positions that are promoting our unique domestic banking system and its structure in those international bodies. Our own efforts at BPI, via FOIA requests to obtain materials about the Federal Reserve and the Federal Reserve Bank of New York’s deliberations at the Basel Committee, specifically concerning the Basel Three Endgame, were summarily and categorically denied, even though the Federal Reserve identified hundreds of pages of documents, their own documents related to those deliberations, they claimed exemptions and refused to share them. And you know, in spite of the fact that they identified this, they didn’t provide an explanation of why sharing those documents with the public wouldn’t increase transparency around that process.”
10. Aligning regulatory thresholds with economic growth could also improve regulatory tailoring.
Sarah Flowers, BPI: “[R]egulations need to reflect economic reality rather than being frozen in time. There is an urgent need to index regulatory tailoring thresholds for all banks for economic growth and inflation. Regulation that fails to evolve with the macroeconomic environment constrains growth without offering an offsetting benefit. Economic growth and inflation do not increase systemic risk in the financial system; as the economy expands, various sectors of the economy grow proportionally. Annually and automatically adjusting the tailoring category thresholds would prevent banks from facing more stringent regulations solely due to natural economic expansion.
Once properly indexed, as new rules are developed, care must be taken to prescribe less stringent requirements for firms whose activities and structure present less risk. Rules designed to address the complex activities of internationally active banks should not be indiscriminately applied to smaller banks with less complex structures and business models.”
