The Federal Reserve’s Supervisory Posture Update

The Federal Reserve recently communicated updates on its supervisory approach for safety and soundness examinations for institutions less than $100 billion.  An Ask the Fed event was held on August 19 entitled “An Update on The Federal Reserve’s Supervisory Posture for Small Banks as Pandemic Conditions Improve.” You can find a recording of the event here. 

The main theme from this recent event was to remain agile. Our state member banks will recall that we held two webinars for them last year, the first on our pause on examinations, and later, our resumption of examinations. Even when we restarted examinations, the scope was limited to areas of key risk, and we strived to balance our work with the fact that the pandemic was still prevalent, and examinations may not be top of mind for our bankers. Flexibility has been key for the past 18 months and that will remain true going forward. Everyone’s safety is our primary goal, so on-going communications between our office and your institutions will ensure we take the safest approach. Note – this update focuses on how we conduct our examinations and not where. Multiple considerations must be worked through before we return to on-site examinations. 

While examinations are still virtual for now, there are three central focus areas for safety and soundness examinations going forward. Our examination teams will continue to focus on risk, but loan risk ratings, capital preservation, and liquidity resilience are the main areas that will receive some level of attention on each examination. Examiners won’t criticize bankers for working prudently with their borrowers when it comes to credit. Classification definitions have not changed, but we remind you that “well-defined weaknesses” should be risk-graded accordingly. For capital, examiners will not automatically criticize an institution for declining below the community bank leverage ratio thresholds. Instead, examiners will assess the underlying factors (e.g., growth due to PPP lending, deposit growth, etc.) as they determine capital adequacy.  Given the large levels of deposit growth at most banks, examiners will consider the nature and timing of pandemic-related inflows/outflows along with the deployment of excess funds when assessing liquidity.

Finally, we will also be expanding our examination scopes to “back to normal” for the other risk areas. This will allow us to review areas that were scaled back during the pandemic, including higher risk areas such as cybersecurity. Rest assured that we will continue to tailor the scopes of our examinations based on your risk profile for each of these areas coming back into focus.

For specific questions, please reach out to your portfolio team here at the Federal Reserve Bank of Richmond.