Supervisory Developments
This section provides an overview of recent supervisory efforts to assess institutions' safety and soundness and compliance with laws and regulations. There are separate subsections for large financial institutions with assets of $100 billion or more and community and regional banking organizations. Supervisory approaches and priorities differ by financial institution size and complexity.
The Federal Reserve is responsible for overseeing the implementation of certain laws and regulations relating to consumer protection and community reinvestment. The scope of the Federal Reserve's supervisory jurisdiction varies based on the consumer law or regulation and on the asset size of the state member bank. Consumer-focused supervisory work is designed to promote a fair and transparent marketplace for financial services and to ensure supervised institutions comply with applicable federal consumer protection laws and regulations.
More information about the Federal Reserve's consumer-focused supervisory program can be found in the Federal Reserve's 108th Annual Report 2021. The 2022 Annual Report is expected to be published by the end of the second quarter of 2023.11
Box 3 describes the results of the Silicon Valley Bank Review.
Box 3. Silicon Valley Bank Review
On March 13, the Federal Reserve Board announced that Vice Chair for Supervision Michael S. Barr would lead a review of the supervision and regulation of Silicon Valley Bank (SVB). On April 28, the review was issued.1 The review highlighted four key takeaways on the causes of the bank's failure:
- Silicon Valley Bank's board of directors and management failed to manage their risks;
- Federal Reserve supervisors did not fully appreciate the extent of the vulnerabilities as Silicon Valley Bank grew in size and complexity;
- When supervisors did identify vulnerabilities, they did not take sufficient steps to ensure that Silicon Valley Bank fixed those problems quickly enough; and
- The Board's tailoring approach in response to the Economic Growth, Regulatory Relief, and Consumer Protection Act and a shift in the stance of supervisory policy impeded effective supervision by reducing standards, increasing complexity, and promoting a less assertive supervisory approach.
The report is a self-assessment and its lessons will be used to guide efforts to strengthen the Federal Reserve's supervision and regulation. The Federal Reserve also welcomes external reviews of SVB's failure, as well as congressional oversight, and intends to take other perspectives into account as it considers changes to its framework of bank supervision and regulation to ensure that the banking system remains strong and resilient.
1. Board of Governors of the Federal Reserve System, "Review of the Federal Reserve's Supervision and Regulation of Silicon Valley Bank," news release, April 28, 2023, https://www.federalreserve.gov/newsevents/pressreleases/bcreg20230428a.htm. Return to text
Current Supervisory Priorities
Anticipating a more challenging banking environment, the Federal Reserve focused examination work during 2022 on assessing the adequacy of bank risk management in addressing the impact of higher interest rates on liquidity, asset values, and credit quality. Bank risk-management practices could include taking actions to build capital and liquidity as needed, and being ready to use available sources of funding, including the discount window and the new Bank Term Funding Program.
Work to date has included horizontal assessments of contingency funding plans at firms supervised by the Large Institution Supervision Coordinating Committee as well as of liquidity risk management at large and foreign banking organizations. In addition, the Federal Reserve has increased supervisory activities at community banking organizations (CBOs) and regional banking organizations (RBOs) with elevated interest rate risk exposures. For those CBOs and RBOs with significant securities depreciation or otherwise exhibiting elevated interest rate risk, the Federal Reserve is conducting targeted examinations to assess the adequacy of their liquidity and interest rate risk management. Box 4 describes the Board's supervisory approach to assessing interest rate risk.
More recently, examiners have increased the frequency and depth of their monitoring of the funding positions of potentially vulnerable banks. Examination activities have also been directed toward assessing the current valuation of investment securities, deposit trends, the diversity of funding sources, and the adequacy of contingency funding plans.
Given the structural changes in the commercial real estate markets, particularly lower demand for office space, supervisors have also been conducting more in-depth examinations at state member banks with relatively high concentrations of commercial real estate lending. These supervisory reviews include more testing of commercial real estate loans and detailed evaluations of banks' risk-management practices for this activity.
The Federal Reserve has also been carefully monitoring supervised institutions that are engaging in or interested in engaging in crypto-asset-related activities, complex third-party relationships with fintech companies to deliver banking products, or other novel activities. On August 16, 2022, the Federal Reserve issued SR letter 22-6, which explains that a supervised banking organization should notify its lead supervisory point of contact at the Federal Reserve prior to engaging in any crypto-asset-related activity, or regarding any crypto-asset-related activities it is currently engaged in.12 The Federal Reserve is also creating a specialized team of experts to monitor and analyze novel activities-related developments, and help coordinate oversight of such activities at banks (see box 2).
Box 4. Supervisory Approach to Assessing Interest Rate Risk
The Federal Reserve and other banking agencies have longstanding policies and supervisory guidelines that establish safety and soundness principles for a bank's interest rate risk (IRR) management. The Federal Reserve evaluates IRR as part of its assessment of capital adequacy for all supervised firms. Examiners evaluate firms' IRR exposures and management practices as part of regularly scheduled full-scope or targeted examinations for CBOs and RBOs. For the larger banks, including those supervised by the Large Institution Supervision Coordinating Committee and the Large and Foreign Banking Organizations program, the Federal Reserve looks at IRR through continuous monitoring activities and targeted exams. Supervisory conclusions on the level and management of interest rate risk are summarized in the Sensitivity to Market Risk component of the interagency CAMELS rating system.1 These findings also commonly affect assessments of a bank's management, capital adequacy, and liquidity within the rating system.
Interest rate risk is a fundamental risk in banking. The Federal Reserve and the other federal banking agencies set forth their supervisory expectations for a bank's IRR management in a joint Policy Statement in 1996.2 More recently, the agencies updated this guidance in 2010, as SR letter 10-1 "Interagency Advisory on Interest Rate Risk Management," and further clarified the guidance with the issuance of FAQs in 2012.3
The guidance emphasizes the need for internal stress testing to identify and quantify an institution's IRR exposure and potential weaknesses. Stress testing, which includes both scenario and sensitivity analysis, should be an integral component of an institution's IRR management. In evaluating IRR, examiners evaluate a bank's ability to fully identify its current IRR exposure and yield curve risks, risks arising from alternative future interest rate scenarios, and whether the bank has effective IRR measurement models, metrics, and limits. This includes evaluating the risks associated with declines in the fair value of investment securities that can result from changing interest rates. Firms are also expected to continuously monitor and update key assumptions used in IRR models, such as those estimating deposit flows. Changes in depositor behavior can substantially affect IRR. This is particularly relevant during periods of rising interest rates. Firms should also maintain multiple sources of standby funding to address unexpected liquidity needs. The agencies have emphasized that simulated parallel shifts in the yield curve of plus and minus 200 basis points may not be sufficient to adequately assess a firm's IRR exposure during periods in which rate changes are more significant. A firm's risk management is expected to consider changes in rates of varying or greater magnitude (e.g., up and down by 300 and 400 basis points) across different tenors to reflect potential changing slopes and twists of the yield curve.
Firms should have policies to address interest rate risk and, in particular, established risk limits. When risk limits are breached, a bank should have procedures for taking corrective actions. Where IRR levels are excessive or risk-management practices are insufficient, examiners can cite concerns in a formal written communication requiring a bank to address the deficiencies and take further actions to reduce risk.
1. Refer to the CAMELS definition in appendix A for an explanation of the supervisory ratings framework for state member banks. Return to text
2. See "Joint Agency Policy Statement: Interest Rate Risk" at https://www.federalregister.gov/documents/1996/06/26/96-16300/joint-agency-policy-statement-interest-rate-risk. Return to text
3. See Board of Governors of the Federal Reserve System, "Interagency Advisory on Interest Rate Risk," SR letter 10-1 (January 11, 2010), https://www.federalreserve.gov/boarddocs/srletters/2010/sr1001.htm and "Questions and Answers on Interagency Advisory on Interest Rate Risk Management," SR letter 12-02 (January 13, 2012), https://www.federalreserve.gov/supervisionreg/srletters/sr1202.htm. Return to text
Supervised Institutions
The Federal Reserve supervises bank holding companies, savings and loan holding companies, and state member banks of varying size and complexity. The Federal Reserve follows a risk-focused approach by scaling supervisory work to the size and complexity of an institution.
- The Large Institution Supervision Coordinating Committee (LISCC) program supervises firms that pose elevated risk to U.S. financial stability.
- The Large and Foreign Banking Organization (LFBO) program supervises U.S. firms with total assets of $100 billion or more and all foreign banking organizations operating in the U.S. regardless of size.
- The Regional Banking Organization (RBO) program supervises U.S. firms with total assets between $10 billion and $100 billion.
- The Community Banking Organization (CBO) program supervises U.S. firms with less than $10 billion in total assets.
Table 2 provides an overview of the organizations supervised by the Federal Reserve, by portfolio, including the number of institutions and total assets in each portfolio.
Table 2. Summary of organizations supervised by the Federal Reserve, as of 2022:Q4
| Portfolio | Definition | Number of institutions | Total assets ($ trillions) |
|---|---|---|---|
| Large Institution Supervision Coordinating Committee (LISCC) | Eight U.S. global systematically important banks (G-SIBs) | 8 | 14.3 |
| State member banks (SMBs) | SMBs within LISCC organizations | 4 | 1.1 |
| Large and foreign banking organizations (LFBOs) | Non-LISCC U.S. firms with total assets $100 billion and greater and FBOs | 170 | 10.2 |
| Large banking organizations (LBOs) | Non-LISCC U.S. firms with total assets $100 billion and greater | 18 | 5.1 |
| Large FBOs (with IHC) | FBOs with combined U.S. assets $100 billion and greater | 11 | 3.1 |
| Large FBOs (without IHC) | FBOs with combined U.S. assets $100 billion and greater | 7 | 1.0 |
| Small FBOs (excluding rep offices) | FBOs with combined assets less than $100 billion | 102 | 1.0 |
| Small FBOs (rep offices) | FBO U.S. representative offices | 32 | 0.0 |
| State member banks | SMBs within LFBO organizations | 10 | 1.3 |
| Regional banking organizations (RBOs) | Total assets between $10 billion and $100 billion | 102* | 2.8 |
| State member banks | SMBs within RBO organizations | 32 | 1.0 |
| Community banking organizations (CBOs) | Total assets less than $10 billion | 3,504** | 2.9 |
| State member banks | SMBs within CBO organizations | 655 | 0.6 |
| Insurance and commercial savings and loan holding companies (SLHCs) |
SLHCs primarily engaged in insurance or commercial activities | 6 insurance 4 commercial |
0.9 |
* Includes 101 holding companies and 1 state member bank that does not have a holding company.
** Includes 3,451 holding companies and 53 state member banks that do not have holding companies.
Large Financial Institutions
This section of the report discusses the supervisory approach for large financial institutions, U.S. firms with total assets of $100 billion or more, and foreign banking organizations with combined U.S. assets of $100 billion or more. These firms are either within the LISCC portfolio or the LFBO portfolio. Large financial institutions are subject to regulatory requirements that are tiered to the risk profiles of these firms. Appendix A provides an overview of key regulatory requirements.
Supervisory efforts for large financial institutions focus on four components:
- Capital planning and positions,
- Liquidity risk management and positions,
- Governance and controls, and
- Recovery and resolution planning.13
In February 2023, the Federal Reserve updated the LISCC program manual, which describes the structure, governance, supervisory process, and communication methods used when supervising large, systemically important firms.14
See box 5 for large financial institution supervisory priorities.
Box 5. Large Financial Institution Supervisory Priorities
Capital
-
Financial risks impacted by economic changes, including
- Interest rate risk
- Market and counterparty credit risk
- Consumer and commercial credit risk
- Risk-management practices in credit, market, and interest rate risk
- Implementation of regulatory phase-ins (e.g., counterparty rules)
- LIBOR transition
Liquidity
- Contingency funding plans and intraday liquidity risk management
- Changes in deposits and the effect on funding mix
- Asset/liability management and stress testing
- Liquidity risk management at foreign banking organization branches
Governance and controls
- Operational resilience, including cybersecurity, novel banking, and information technology risks
- Third-party vendor risk management
- Compliance, internal loan review, and audit
- Firm remediation efforts on previous supervisory findings
Recovery and resolution planning
- Recovery and resolution planning, including critical operations review
- Remediation of and follow-up on resolution plan deficiencies and shortcomings, as necessary
- International coordination among global supervisors
The Financial Condition of Large Financial Institutions
Large financial institutions remain sound and report capital ratios well above regulatory minimums. Their aggregate CET1 capital ratio as of December 31, 2022, was 12.6 percent. Significant declines in the fair value of investment securities, however, are affecting capital levels for some firms. During 2022, most large institutions' net interest margins increased substantially, with asset yields increasing more than funding costs. Going forward, Federal Reserve supervisors expect deposit and borrowing costs to rise at a faster pace, which will likely moderately compress net interest margins.
Generally, liquidity positions remain adequate, and large financial institutions maintain sufficient liquid assets to meet liquidity needs under supervisory stress scenarios. However, the recent failures of Silicon Valley Bank (see box 3) and Signature Bank led to volatility in banking markets and increased funding pressures for some firms. These included First Republic Bank, which failed on May 1. Additionally, stress experienced by Credit Suisse before its announced acquisition by UBS (March 19) contributed to market uncertainty.
LFBO Liquidity Horizontal Review
While all large financial institutions continue to exceed regulatory and firm-specific internal liquidity stress metrics, changes in the economic environment have affected firms' liquidity profiles. To assess these developments, as part of the annual horizontal review of liquidity positions and risk management at LFBO firms, supervisors focused on changes to firms' liquidity stress testing assumptions, foundational aspects of liquidity risk management, such as cash flow forecasting and intraday liquidity management, and contingency funding plans, including firms' ability to use liquidity buffers when needed. Findings from these reviews are being compiled and communicated to firm management, along with recommendations for improvements.
The review noted a decline in fair value of securities held in the liquidity buffers as well as a loss of deposits as investors moved to higher yielding alternatives. The impact of changing rates has also led to multiple strategy shifts across firms. Firms that have experienced more pronounced deposit decreases in recent quarters have replaced some outflows with borrowings. Others have recently started to pay higher rates on deposits to customers. Supervisors expect that increased funding costs will result in somewhat tighter net interest margins going forward.
LISCC Contingency Funding Plan Review
As part of sound liquidity risk management, firms are required to create contingency funding plans to identify potential funding sources during times of stress. Examiners regularly evaluate a firms' contingency funding plans. In 2022, as a follow-up to prior examination work, the LISCC program performed additional examination work to confirm whether firms are able to implement their contingency funding plans on short notice.
Potential contingent actions cannot always be tested during normal times. However, the Federal Reserve expects firms to test less disruptive actions and to perform simulation exercises or draft playbooks for other actions. This enables the Federal Reserve to understand the preparedness of bank staff to take contingent actions during turbulent times. For example, the Federal Reserve expects firms to periodically test their ability to borrow from the discount window, which includes having collateral available and positioned in advance of the need to borrow.
While areas requiring improvement were identified during the review, the Federal Reserve concluded that the LISCC firms have taken significant and credible steps to prepare to execute upon their plans if needed. The Federal Reserve expects supervised institutions to regularly update and test their contingent actions in a manner that reflects evolving market conditions and idiosyncratic changes to firms' risk profiles.
Resolution Planning Reviews
In the fourth quarter of 2022, the Federal Reserve and FDIC completed evaluations of current resolution plans and provided feedback on resolution planning to large financial institutions.15 The agencies notified LISCC firms that they need to continue the development of their resolution strategies and capabilities. The Federal Reserve and FDIC also clarified their plans for testing the LISCC firms' capabilities. LISCC firms are required to submit their next resolution plans in July 2023.16
Additionally, in December 2022, the Federal Reserve and FDIC provided specific feedback to two large foreign-based institutions. The agencies identified areas of improvement related to cash- flow forecasting, governance, and continuity of activities of the U.S. operations in the resolution plans.17
Community and Regional Banking Organizations
This section of the report discusses the financial condition and supervisory approach for banking organizations with assets less than $100 billion, including CBOs, which have less than $10 billion in total assets, and RBOs, which have total assets between $10 billion and $100 billion.
The Financial Condition of CBOs and RBOs
During 2022, regulatory capital ratios for community and regional banking organizations improved or remained steady, with the vast majority of CBOs and all RBOs reporting regulatory capital ratios above well-capitalized minimums as of year-end 2022. However, a number of banks hold investment securities with significant declines in the fair value that have reduced their tangible equity levels.
Liquidity levels at most CBOs and RBOs remained high and adequate to support ongoing funding needs. For example, at year-end 2022, core deposits as a share of total assets remained high and above pre-pandemic levels. In March and April 2023, as publicly reported, some RBOs experienced significant deposit outflows, reflecting contagion from recent bank failures. Outflows were concentrated at banking organizations with unusually high levels of uninsured deposits, significant declines in the fair value of securities, and exposures to crypto and novel banking activities and the technology sector. Declines in the fair value of securities can affect banks' willingness to sell securities to fund their liquidity needs. As a result, some firms are turning to contingent sources of funding, such as the discount window and other borrowings.
Current problem loan rates remain very low, but delinquencies have increased for some loan segments from the very low levels over the past several years (see the "Banking System Conditions" section). The Federal Reserve also expects increased interest rates on loans to contribute to higher loan delinquencies in 2023.
Most small banking organizations reported sound earnings and substantial improvements in their net interest margins during 2022. However, deposit and borrowing costs are increasing and will moderate net interest margins and likely reduce earnings in 2023.
Examinations of Interest Rate Risk and Funding
Based on emerging interest rate and liquidity risks, in 2022, the Federal Reserve initiated heightened monitoring of, and targeted examinations at, CBOs and RBOs reporting significant declines in the fair value of securities. These efforts have been directed at fully assessing an institution's sensitivity to market risk and evaluating the effects of this exposure on liquidity and capital. Examiners also have been evaluating liquidity and interest rate risk management practices and contingency funding plans at these institutions (box 6). When weaknesses or excessive exposures are identified, examiners require institutions to take corrective action. They may also downgrade supervisory ratings or implement enforcement actions as appropriate.
In conjunction with these efforts and in the wake of recent bank runs, examiners have elevated the frequency and depth of monitoring of liquidity and interest rate risks at RBOs and CBOs that may be vulnerable to deposit outflows. Furthermore, supervisors have been working with these institutions to ensure they have access to multiple sources of contingent funding, including the Federal Reserve's discount window and recently introduced Bank Term Funding Program. Supervisors are also ensuring banks can operationalize their contingency funding plans as needed during times of stress.
Box 6. CBO and RBO Supervisory Priorities for 2023
Credit risk
- High-risk loan portfolios and debt service coverage capacity in a changing interest rate environment
- Credit concentrations, particularly in commercial real estate
- Implementation of Current Expected Credit Losses (CECL) for CBOs in 2023
Liquidity risk
- Contingent funding plans
- Liquidity coverage of uninsured deposits
Other financial risks
- Interest rate risk
- Securities risk
- Capital adequacy
Operational risk
- Information technology and cybersecurity preparedness
- Fintech and banking-as-a-service activities
- Adequacy of third-party risk management
Evaluation of Commercial Real Estate and Other Credit Exposures
The shift toward telework has reduced demand for office space in a number of markets, which could lead to a decline in the value of office properties. In addition, higher interest rates have increased the risk that some commercial real estate mortgage borrowers may have difficulty refinancing maturing loans. CBOs and RBOs often hold higher concentrations in CRE loans and, therefore, can be exposed to a higher level of risk in the event of a downturn in the CRE market. Accordingly, since mid-2021, the Federal Reserve has increased monitoring of the performance of CRE loans. Further, in June 2022, the Federal Reserve expanded examination procedures for CBOs and RBOs with significant CRE concentration risk, focusing on an institution's financial condition, capital planning, and risk management. These added procedures require more transaction testing of loan quality as well as more in-depth assessments of risk-management processes related to commercial real estate lending. Attention is also being aimed at evaluating construction and land development lending activities. Construction lending has historically accounted for a significant share of losses during CRE market downturns.
Some of these CRE loan reviews have resulted in rating downgrades and the issuance of matters requiring attention at these institutions. In view of concerns about the future performance of some CRE loan segments, particularly the office segment, the Federal Reserve will maintain this heightened focus on evaluating CRE lending at CBOs and RBOs through 2023.
The Federal Reserve is also augmenting examination procedures to assess the impact of increasing interest rates on the performance of commercial and industrial loans. This includes additional testing of loan quality and assessments of underwriting quality as part of regularly scheduled examinations.
Cybersecurity and Crypto-Related Risks
Cybersecurity risk remains a notable issue for CBOs and RBOs. While these institutions have been taking steps to strengthen their systems, examiners continue to identify vulnerabilities. Reliance on third-party service providers and other technology solutions also presents operational risks to smaller banking organizations. As a result, examiners are continuing a high level of testing of these institutions' preparedness for ransomware attacks and system breaches that may put personally identifiable information at risk of disclosure.
The turmoil in crypto markets in late 2022 and early 2023 resulted in extreme deposit runoff at banks that specialized in servicing the crypto industry. It also led to the voluntary liquidation of Silvergate Bank. The Federal Reserve is increasing examination work at institutions engaged in crypto-related activities, including heightening scrutiny of the stability of their crypto-related deposits, as well as other novel fintech activities. Examiners have also increased their attention on assessing third-party risk management for those banking organizations that rely on partnerships to offer these novel services.
References
11. Board of Governors of the Federal Reserve System, 108th Annual Report of the Board of Governors of the Federal Reserve System (Washington: Board of Governors, 2021), https://www.federalreserve.gov/publications/files/2021-annual-report.pdf. Return to text
12. Board of Governors of the Federal Reserve System, "Engagement in Crypto-Asset-Related Activities by Federal Reserve-Supervised Banking Organizations," SR letter 22-6/CA letter 22-6 (August 16, 2022), https://www.federalreserve.gov/supervisionreg/srletters/SR2206.htm. Return to text
13. For more information regarding the framework for supervision of large financial institutions, see "Consolidated Supervision Framework for Large Financial Institutions," SR letter 12-17/CA letter 12-14 (December 17, 2012), https://www.federalreserve.gov/supervisionreg/srletters/sr1217.htm and box 4 in the 2018 Supervision and Regulation Report, https://www.federalreserve.gov/publications/files/201811-supervision-and-regulation-report.pdf. Return to text
14. See Board of Governors of the Federal Reserve System, Large Institution Supervision Coordinating Committee Program Manual (Washington: Board of Governors, February 2023), https://www.federalreserve.gov/publications/files/liscc-program-manual-202302.pdf. Return to text
15. The agencies identified a shortcoming in Citigroup Inc.'s resolution plan and did not identify any shortcomings or deficiencies in the plans from other LISCC banking organizations. See the Board's press release at https://www.federalreserve.gov/newsevents/pressreleases/bcreg20221123a.htm. Return to text
16. The reviews of resolution plans are mandated under section 165(d) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (12 U.S.C. § 5365(d)). Return to text
17. The agencies identified deficiencies in the 2021 plan submission of Credit Suisse AG, and a shortcoming in BNP Paribas' 2021 plan submission. The agencies did not identify shortcomings or deficiencies in the plans from the other LFBOs. See the Board's press release at https://www.federalreserve.gov/newsevents/pressreleases/bcreg20221216b.htm. Return to text