Summary
On July 10, 2025, the Board of Governors of the Federal Reserve System (the “FRB”) issued a proposal to modify the supervisory ratings system applicable to the holding companies of large financial institutions (“LFIs”) (the “LFI Framework”).[1] The proposal would eliminate what former Federal Reserve Vice Chair for Supervision Randal Quarles termed the “ascetic principle”[2] of the existing LFI Framework—the feature under which an institution is deemed not to be “well managed” if it is assigned a “Deficient-1” component rating for any of the three rating components.[3] One impact of this feature has been to disqualify an LFI holding company as well managed, and thereby largely preclude expansionary activity, if the holding company has a Deficient-1 rating for the Governance and Controls component, even if it maintains the highest-available ratings with respect to the Capital Planning and Positions and Liquidity Risk Management and Positions components.[4]
In addition, the proposal would remove the presumption under the existing LFI Framework that the FRB will bring an informal or formal enforcement action against a holding company that receives one or more Deficient-1 ratings.[5]
The Federal Reserve approved the proposal by a vote of 5-to-1, with Governor Michael Barr dissenting, Governor Adriana Kugler abstaining and each of those Governors, Governor Lisa Cook and Vice Chair for Supervision Michelle Bowman issuing separate statements. Vice Chair Bowman observed in her statement that “[t]his proposal is the first step in pursuing a broader goal, which is to ensure that supervisory activities, and the accompanying ratings, are aligned with a renewed supervisory focus on core, material financial risks.”[6]
Comments on the proposal are due by August 14, 2025.
Background
In the years following the 2007–2009 financial crisis, the FRB developed a supervisory program specifically designed to address the risks to U.S. financial stability posed by LFIs. Since the adoption of the LFI Framework in 2018, LFIs have been defined to include: (i) bank holding companies with total consolidated assets of $100 billion or more; (ii) all non-insurance, non-commercial savings and loan holding companies with total consolidated assets of $100 billion or more; and (iii) all U.S. intermediate holding companies of foreign banking organizations with total consolidated assets of $50 billion or more.[7] The LFI Framework includes three component ratings and a four-level rating scale to evaluate “whether [an LFI] possesses sufficient financial and operational strength and resilience to maintain safe-and-sound operations and comply with laws and regulations, including those related to consumer protection, through a range of conditions.”[8] The three rating components are: (i) Capital Planning and Positions; (ii) Liquidity Risk Management and Positions; and (iii) Governance and Controls. The four rating levels are: (i) Broadly Meets Expectations; (ii) Conditionally Meets Expectations; (iii) Deficient-1; and (iv) Deficient-2. Unlike other bank supervisory ratings frameworks (such as the CAMELS framework applicable to depository institutions and the RFI/C(D) rating system applicable to smaller bank holding companies), the current LFI Framework does not include a stand-alone management or a composite rating. Nonetheless, under the current LFI Framework, a holding company that receives a rating of Deficient-1 or Deficient-2 in any component rating is not considered well managed, is largely precluded from expansionary activity, and is subject to a presumption that the FRB will take formal or informal enforcement action against it.[9]
The Federal Reserve publishes a semi-annual Supervision and Regulation Report. In each of the last two reports, approximately two-thirds of domestic LFIs were reported as having at least one Deficient-1 or Deficient-2 rating.[10] They were therefore deemed not well managed and thus presumptively ineligible to make acquisitions. Based on the statement in the November 2024 Supervision and Regulation Report that “[m]ost large financial institutions met supervisory expectations with respect to capital planning and liquidity risk management,”[11] it had been assumed that a majority of these Deficient-1 or Deficient-2 ratings related to Governance and Controls.
Almost every LFI has opted to be treated as a “financial holding company” (“FHC”) under the Bank Holding Company Act, as amended by the Gramm-Leach-Bliley Act (the “BHCA”).[12] An FHC can engage in a broader range of financial services activities, such as underwriting, dealing and certain insurance operations.[13] FHCs can also make nonbanking acquisitions without an application under Section 4(c)(8) of the BHCA.[14] An LFI that is no longer deemed well managed, however, can no longer rely on its FHC status to engage in new activities or make acquisitions and investments.[15] This loss of eligibility is typically formalized in a so-called 4(m) agreement, which is non-public. Further, an FHC that is no longer well managed is at risk of losing its FHC status altogether, although this draconian remedy has rarely been invoked.
Proposal
Under the proposal, a holding company that receives at least two Broadly Meets Expectations or Conditionally Meets Expectations component ratings and no Deficient-2 component rating would be considered well managed.[16] Relatedly, the “strong presumption” under the current LFI Framework that a holding company that receives one or more Deficient-1 component ratings will be subject to an informal or formal enforcement action would be removed—the decision whether to bring an enforcement action in that circumstance would be made on the basis of the particular facts and circumstances.[17] The proposal would maintain the current approach that a Deficient-2 rating in any component results in a holding company not being well managed and triggers a strong presumption that the FRB will impose a formal enforcement action.[18]
The revisions contemplated by the proposal are intended to reflect that “a firm with an idiosyncratic deficiency that results in a single component rating of Deficient-1 would generally have sufficient financial and operational strength and resilience to operate in a safe and sound manner through a range of conditions, if the other two components have a rating of Broadly Meets Expectations or Conditionally Meets Expectations.”[19] The proposal notes that a Deficient-1 rating can reflect limited concerns surrounding a specific risk that may require “significant management attention to address” but “could be discrete, and the firm could have strong positions and practices overall.”[20]
At a broader level, the proposal is designed to address a misalignment between the fact that the “vast majority of large financial institutions are well capitalized, have sound liquidity positions, and good asset quality,”[21] and the concurrent reality that, as of the end of 2024, approximately 64% of LFIs were treated as not well managed under the current LFI Framework (i.e., 23 of 36 LFIs in total).[22] In terms of immediate impact, the FRB estimates, based on fourth quarter 2024 data, that the proposed changes would reduce the number of holding companies considered not well managed under the LFI Framework by eight.[23] By decreasing the number of holding companies considered not well managed, the contemplated changes are intended to “better reflect the current condition of the banking system.”[24]
In a dissenting statement, Governor Barr asserted that “[t]reating as well managed a firm that has a deficient rating on any of the three major areas of supervision review (capital, liquidity, and governance and controls) is bad policy and risky,” stressing the view that “a firm’s management should be required to correct deficiencies before the firm can expand without increasing risks to its safety and soundness.”[25] Governor Kugler, who abstained, stated that “the proposal risks going too far.”[26]
In addition to comments on the proposed revisions described above, the proposal requests comment on a number of further items, including: (i) whether the FRB should consider adding a composite rating to the LFI Framework to determine whether a firm is well managed, (ii) potential changes to other supervisory rating systems (including the CAMELS framework that is applicable to depository institutions) and (iii) other changes to supervisory ratings systems to “ensure that a firm’s ‘well managed’ status is appropriately calibrated.”[27] The proposal also notes that the FRB “plans to consider more comprehensive changes to supervisory ratings systems” and “will coordinate future proposals with other banking agencies, as appropriate.”[28]
Implications
The proposed revisions to the LFI Framework will have immediate implications with respect to the ability of several LFIs to engage in expansionary activities. A bank holding company that has elected to be an FHC must continue to meet all eligibility criteria, including being well managed, or it will become subject to restrictions on its ability to rely on FHC authority to engage in new activities or make acquisitions and investments without an application.[29] Holding companies that are not well managed are prohibited from engaging in interstate bank acquisitions[30] and typically have been considered by the Federal Reserve to be presumptively ineligible to engage in expansionary activity, including mergers, acquisitions, asset purchases, and new activities, even if such expansionary activity would not rely on FHC authority.[31]
The recalibration of how the Federal Reserve determines a holding company’s well-managed status under the LFI Framework will have a liberalizing effect on the ability of an LFI to engage in expansionary activities while it is assigned a single Deficient-1 component rating. As the proposal notes, however, in some cases this liberalizing effect will be constrained if a holding company in this circumstance has a subsidiary depository institution that continues to be assigned supervisory ratings under the CAMELS framework that cause the depository institution to be treated as not well managed for BHCA purposes. The practical effect of this dynamic is specifically highlighted by the economic analysis section of the proposal, which estimates that, although eight LFI holding companies would move into well-managed status as a result of the proposal, only three of these organizations would be in a position to fully regain FHC eligibility because of a not well managed rating under the CAMELS framework at the subsidiary depository institution level.[32] This analysis underscores that the ultimate impact of the proposed changes to the LFI Framework will depend to a significant degree on the adoption and implementation of complementary reforms to the bank supervisory process, including taking a “fresh look” at the manner in which CAMELS ratings themselves are assigned, as referenced both by the proposal and by Vice Chair Bowman in recent remarks.[33]
[5] Proposal at 31643. The proposal would also make parallel changes to the ratings system for depository institution holding companies that are significantly engaged in insurance activities (the “Insurance Supervisory Framework”), which is modeled on the LFI Framework. Id. at 31645. Under the Insurance Supervisory Framework, a supervised insurance organization must receive a rating of Conditionally Meets Expectations or better in each of the three rating components to be considered well managed. Id. at 31643. As with LFIs subject to the LFI Framework, supervised insurance organizations that are considered to be not well managed under the Insurance Supervisory Framework face restrictions against pursuing growth and investment activities without prior FRB approval and are subject to a presumption that the FRB will take formal or informal enforcement action against such firms. See id. at 31651.
[11] November 2024 Supervision and Regulation Report at 16.
[14] 12 U.S.C. § 1843(c)(8); see also 12 C.F.R. § 225.86.
[15] 12 U.S.C. § 1843(m); see also 12 C.F.R. § 225.83.
[21] Board Memo at 1; see also November 2024 Supervision and Regulation Report at 1 (noting that “[t]he banking system remains sound and resilient overall”).
[22] Id. at 5; see also Proposal at 31648.
[27] Proposal at 31645-46.
[29] 12 U.S.C. § 1843(m); see also 12 C.F.R. § 225.83.
[30] See 12 U.S.C. § 1842(d)(1)(A).
[31] See FRB, Supervisory Letter SR 14-2 / CA 14-1, Enhancing Transparency in the Federal Reserve’s Applications Process (Feb. 24, 2014), available at https://www.federalreserve.gov/supervisionreg/srletters/sr1402.htm. For example, bank holding companies that are considered not well managed would be subject to limitations on the general consent authority for investments in foreign organizations pursuant to the FRB’s Regulation K. See 12 C.F.R. § 211.9(a).