An earlier post discussed how the tone from the top can either mitigate or reinforce concerns around regulatory capture. The 2023 post concluded that regulatory capture was real, if overblown. More recent actions by agency leadership have made the situation decidedly worse by undercutting the examiner’s authority. Three prominent examples include revisions to the supervisory appeals process, encouraging bankers to inform on examiners, and proposals to no longer consider responsiveness to supervision when assessing management.
The notion of regulatory capture contends that regulators act to serve the interests of the industries they regulate rather than the public interest. Federal ethics rules tend to focus on examiners with a particular emphasis on avoiding conflicts of interest and imposing post-employment restrictions. More serious, however, are cases where agency leadership consistently sides with the industry it regulates and undercuts the authority of front-line examiners.
Appeals Process
The FDIC and OCC have recently proposed or enacted changes to the supervisory appeals process. These “reforms” are premised on presumed regulatory overreach and an ineffective appeals process. As I’ve pointed out previously, this is a good example of an a priori fallacy, which assumes something is true without assessing at the evidence. The extent of the evidence rests on two facts: appeals are infrequent and usually unsuccessful. But adverse exam findings are likewise infrequent. From 2020 through 2025, between 92% and 99% of national banks received the two highest CAMELS ratings of 1 or 2. There really wasn’t a lot to appeal. Adverse findings are also thoroughly vetted. No one wants to get a finding overturned on appeal, so such findings are usually well-supported. Bear in mind that the acquittal rate for federal crimes is well under 10%, and that’s with a much higher standard of proof.
Changes to the appeals process vary by agency but include two key elements. The first is to define “independent” review more narrowly. At OCC, the Ombudsman judged appeals. At FDIC, board members or their designees handled appeals. The Ombudsman is arguably more independent, since that office is entirely separate from supervision. New rules will have a further separation. OCC is contemplating use of a three-person board that includes two term employees. FDIC will also use a three-person board, with at least one member having “relevant industry experience.”
The second is a “de novo standard of review.” In other words, the decision will not defer to the supervisor’s judgment in close calls. This approach is quite different to what we see in professional sports. In Major League Baseball, an instant replay review can only overturn a call on the field with “clear and convincing evidence” that the original call was wrong. For the National Football League, the standard is “incontrovertible visual evidence.” And these standards apply to split second decisions. Material supervisory findings, in contrast, usually involve wide-ranging review of the bank’s documentation and MIS, meetings with bank management, and an extensive vetting process. But now banks will get a do-over, inevitably based on a more cursory review.
The cost-benefit analysis OCC provided as part of its appeals proposal is revealing. OCC sees more frequent appeals, more successful appeals (it projects a success rate of 50%), and delayed implementation of corrective actions all as positives. Banks therefore save money by not spending on remediation. If supervisors maintain a high success rate by bringing far fewer supervisory actions, that’s totally cool too. Nowhere does the analysis mention that deterring or delaying supervisory actions could lead to more bank failures. The regulators here definitely seem to be siding with the banking industry rather than the public.
The Snitch Patrol
Using the appeals process to tip the scales toward banks is likely to discourage examiners from taking assertive supervisory action. There have, however, been more consequential changes to supervision over the past two years that may make changes to the appeals process largely moot. There have been zero reported appeals involving OCC since 2024 as regulators have raised the bar for adverse findings. Still, it could have a further chilling effect on supervisory actions. More chilling and much creepier guidance comes from the Federal Reserve’s new Statement of Supervisory Operating Principles.
The Statement includes the following sentence: “A Board-supervised banking organization is encouraged to report a failure to comply with any of the supervisory operating principles contained in this statement by contacting the Head of Supervision of the relevant Reserve Bank or the Board’s Deputy Director for Supervision.” Banks are already expected to report illegal acts, like soliciting a bribe. That can also extend to abusive or unprofessional behavior, as shown in this report from the FDIC’s Inspector General. That’s normal. What’s not normal is to enlist an industry snitch patrol to inform on examiners for perceived deviations from policy. Regulators usually have quality assurance functions and, in more extreme cases, Inspectors General to address those types of issues.
What deviations from policy are we talking about here? The Operating Principles include some reasonable objectives like identifying safety and soundness threats as soon as possible. But much of the document looks like it was written by a bank lobbyist. (Maybe it was.) It includes vague language, like not being “distracted” by “devoting excessive attention to processes, procedures, and documentation.” What is “excessive attention to processes” in this context? Following prudent loan underwriting practices?
These principles represent a substantial change to bank supervision but did not go through the normal rulemaking process or include public comment. The Bank Policy Institute has made a big deal about supposed violations of the Administrative Procedures Act when supervisors sought to tighten regulations. However, they seem perfectly ok with such changes when they ghostwrite the guidance.
Responsiveness to Supervision
Regulators are also proposing a more direct and more consequential undermining of an examiner’s authority. Proposed changes to CAMELS ratings would remove “responsiveness to recommendations from auditors and supervisory authorities” from the rating criteria. CEOs with eight-figure compensation packages may not like to take direction from civil servants, but it’s hard to see what purpose this change serves. This change will make it easier for a bank’s senior management to give examiners the middle finger and, for good measure, do the same to auditors.
History also does not support such a casual approach. SVB had 31 open MRAs or MRIAs at the time of its failure. Signature Bank had 3 open MRBAs and 49 open supervisory recommendations. These cases are not outliers. Anyone what has spent significant time in bank supervision knows that those banks unwilling or unable to correct deficiencies are much more likely to become problems.
There are inevitably subjective aspects of bank supervision. Even quantitative measures of risk are open to interpretation. But evaluations of a bank’s response to supervision can, and usually are, fact-based. When considering a possible downgrade to the quality of risk management, I usually turned to the supervisory record. It’s one thing for examiners, auditors, and others to identify concerns. It’s quite another if the bank’s remediation is behind schedule or past due. Should this no longer be a consideration?
Concluding Thoughts
Missteps by agency leadership that create perceptions of regulatory capture are not new. Placating bad actors like Charles Keating or calling regulated banks “customers” looked bad at the time and even worse in retrospect. But the actions by current agency leaders take regulatory capture to a new level. These actions reflect a willingness to place industry interests above the public interest. More troubling, they reflect, intentionally or not, a contempt for their own staffs.
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