Fed considers changes to how it grades big banks

By Pete Schroeder

WASHINGTON, July 10 (Reuters) - The Federal Reserve on Thursday proposed tweaks to how it evaluates large banks by making it easier for them to be considered "well managed," removing a hurdle for potential acquisitions and other restrictions.

The proposal would adjust the U.S. central bank's supervisory framework for large banks, where supervisors grade banks on four separate criteria. Specifically, the proposed changes would make it easier for banks to obtain a "well managed" rating overall, by requiring deficiencies across multiple categories instead of just one, as is currently required.

The move could be a boon for larger banks eyeing potential deals, as one consequence of not being highly rated is a bar on acquisitions.

"That should open the door to more regional bank M&A as about two-thirds of bigger banks could not do deals because of how the holding company rating was calculated," said Jaret Seiberg, an analyst with TD Cowen.

Under the current system, 23 of 36 bank holding companies with over $100 billion in assets are not considered well managed. Eight holding companies would see their rating increase under the proposal.

Under the current system for large banks, established in 2018, firms are graded across three categories: capital, liquidity and governance and controls. In each category, banks can receive four grades: broadly meets expectations, conditionally meets expectations, deficient-1 and deficient-2.

Currently, if a bank receives a "deficient-1" rating in any category, it cannot be considered "well managed" and is subjected to restrictions, including on acquisitions.

Under the proposal, banks would need such a rating across multiple categories, or a single deficient-2 rating, to lose "well managed" status.

Banks have complained for years that the current supervisory system is overly critical and subjective, particularly in how supervisors grade governance and controls. They have pressed regulators to make it more transparent and predictable, and to highlight the overall financial strength shown in bank capital and liquidity.

Fed Vice Chair for Supervision Michelle Bowman noted in a statement that two-thirds of the large banks supervised by the Fed are deemed not well managed under the current system, despite having robust capital and liquidity levels. She argued the proposed changes would better align supervision with "core, material financial risks."

"By addressing this mismatch between ratings and overall firm condition, the proposal adopts a pragmatic approach to determining whether a firm is well managed," she said.

Bowman added that the Fed will consider further tweaks to its bank supervision programs, including potentially adopting an overall composite rating for each bank as opposed to discrete grades across multiple categories.

But Fed Governor Michael Barr, who held the central bank's top regulatory post before Bowman, voted against the proposal. In a statement, he warned it would undermine supervision by allowing banks with management issues to be graded as well managed, and would reduce incentives to fix underlying issues.

"If we permit firms that have significant management weaknesses to acquire other firms, it would increase the likelihood and cost of their failure," he said.