Board of Governors of the Federal Reserve System

When the Board receives a petition for rulemaking, the first step in our analysis should be to ask whether the Board has statutory authority to make the rule in question. Where the Board lacks legal authority, the decision to deny a petition for rulemaking is the only option. Even where the Board has legal authority, the decision to pursue a rulemaking must take into account other regulatory priorities. Following that analysis, the Board may reasonably conclude that other priorities should take precedence over the subject matter of a requested rulemaking.

Today's denial of the Bank Policy Institute's petition to revisit the Uniform Financial Institutions Rating System for depository institutions (commonly referred to as the "CAMELS" rating system) goes beyond these points in ways that are difficult to correlate with the request received, or with the shifting uses and purposes of the CAMELS framework since it was first introduced. It would not be appropriate for the Federal Reserve Board to prejudge any future efforts to revisit regulations in the future if and when priorities change.

The agency's response suggests that "certain" of the proposed changes could reduce the effectiveness of the CAMELS framework and that making changes to the framework could "impede the utility of bank supervision." Of course, CAMELS ratings have consequences that go beyond supervision. As was helpfully recited in the correspondence received by the Board, supervisory ratings originally carried no automatically binding consequences; rather, the agency was required to take a further enforcement action to demand remediation of an issue identified during an examination. Over time, this has changed, with the result that a poor supervisory rating carries with it a series of legally binding, adverse consequences. The letter received by the Board recommends revisiting whether the automatic consequences associated with ratings are appropriate in each circumstance. As the purpose and function of a supervisory tool evolves over time, it is worth revisiting whether that tool remains fit for purpose. In my view, the correspondence received by the Board raises an important issue that we should not dismiss without a critical review and analysis.

In addition, the Board's draft response notes that "supervisory ratings using the current UFIRS [CAMELS] framework can have significant predictive power for a bank's future performance." We should acknowledge, however, that the execution of supervision may evolve in a way that alters the information content of supervisory ratings. A wide range of stakeholders (including state banking agencies and supervised institutions) have suggested that supervision has undergone a significant shift in the past year, particularly when it comes to determining management ratings and assessing non-financial risks in bank examinations. We do not yet know the impact of these shifts in supervision, but I think it is worth revisiting the effectiveness of the CAMELS framework in light of these changes.

While the Board's response notes that "[t]he Board regularly engages in efforts to consider the effectiveness of its supervisory approach, including the UFIRS framework, consistent with its statutory mandates", my hope is that there is a more thorough analysis of the issues raised in the request as it relates to the effectiveness and use of the CAMELS ratings framework.