Bank supervision has come under scrutiny following recent turmoil in the US banking industry, specifically the runs on several banks in March 2023. These events raised questions about why supervisors did not intervene more forcefully to address issues such as poor risk management and vulnerabilities from interconnected depositor bases. Regulatory agencies like the Federal Reserve and Federal Deposit Insurance Corporation (FDIC) have since reviewed their actions, acknowledging the vital role supervisors play in fostering a stable banking system.
The impact of supervision on financial institutions is a complex area, but empirical studies generally show that more intensive supervision leads to reduced risk-taking by banks. This reduction in risk does not appear to negatively affect profitability or growth; many studies indicate a neutral to positive effect on these metrics. For instance, more intensively supervised banks do not show lower asset or loan growth rates compared to their less-supervised counterparts, suggesting that supervision can lower the risk of bank failure with minimal cost to profitability.
However, challenges exist in maintaining supervisory independence. The Government Accountability Office (GAO) recently recommended that the FDIC rotate bank examiners to prevent "regulatory capture." A November 2024 report highlighted that while examiners for large institutions rotate, and small institution examiners are limited to two consecutive examinations, case managing supervisors for large banks could remain assigned to the same firm for years. This contrasts with practices at the Office of the Comptroller of the Currency (OCC) and the Federal Reserve, which rotate case managers every five years. The GAO emphasized that prolonged assignments could lead to close relationships with bank management, compromising independence and supervision outcomes.
In a related development, Wall Street banks are actively lobbying the Federal Reserve to solidify its new supervisory regime before 2028, aiming to prevent reversals by future administrations. This overhaul, initiated by Republican regulators, has significantly curtailed the use of "matters requiring attention" (MRAs), which are critical tools for forcing banks to fix risk management issues. Replaced by less binding "observations," banks are seeking legal clarity on how these observations will be escalated, worrying that future Democratic administrations might re-escalate them to MRAs. The Fed plans to amend its 2013 documentation to provide more explicit guidance, ensuring that any escalation to an MRA would only occur if the facts of an issue change.
