Notice2025-13223
Revisions to the Large Financial Institution Rating System and Framework for the Supervision of Insurance Organizations
Primary source
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Published
July 15, 2025
Issuing agencies
Federal Reserve System
Abstract
The Board is seeking comment on proposed revisions to its Large Financial Institution ("LFI") rating system ("LFI Framework") and the ratings system for depository institution holding companies significantly engaged in insurance activities, referred to as supervised insurance organizations ("Insurance Supervisory Framework," collectively with the LFI Framework, "Frameworks"), which is modeled on the LFI Framework. The proposal would revise the component ratings that a firm must receive to be considered "well managed" under the Frameworks. The proposed revisions reflect experience with the LFI Framework since its introduction in 2018. Specifically, the proposed changes aim to ensure that a firm's "well managed" status reflects that the firm has sufficient financial and operational strength and resilience to maintain safe-and-sound operations through a range of conditions, including stressful ones. The proposed revisions also seek to further align the application of the Frameworks with the operation of other existing supervisory ratings systems. The proposed revisions would not change the scope of firms to which the Frameworks apply. Other changes to the Frameworks and existing supervisory ratings systems will be considered in the future.
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[Federal Register Volume 90, Number 133 (Tuesday, July 15, 2025)]
[Notices]
[Pages 31641-31666]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2025-13223]
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FEDERAL RESERVE SYSTEM
[Docket No. OP-1868]
Revisions to the Large Financial Institution Rating System and
Framework for the Supervision of Insurance Organizations
AGENCY: Board of Governors of the Federal Reserve System (Board).
ACTION: Notice and request for comment.
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SUMMARY: The Board is seeking comment on proposed revisions to its
Large Financial Institution (``LFI'') rating system (``LFI Framework'')
and the ratings system for depository institution holding companies
significantly engaged in insurance activities, referred to as
supervised insurance organizations (``Insurance Supervisory
Framework,'' collectively with the LFI Framework, ``Frameworks''),
which is modeled on the LFI Framework. The proposal would revise the
component ratings that a firm must receive to be considered ``well
managed'' under the Frameworks. The proposed revisions reflect
experience with the LFI Framework since its introduction in 2018.
Specifically, the proposed changes aim to ensure that a firm's ``well
managed'' status reflects that the firm has sufficient financial and
operational strength and resilience to maintain safe-and-sound
operations through a range of conditions, including stressful ones. The
proposed revisions also seek to further align the application of the
Frameworks with the operation of other existing supervisory ratings
systems. The proposed revisions would not change the scope of firms to
which the Frameworks apply. Other changes to the Frameworks and
existing supervisory ratings systems will be considered in the future.
DATES: Comments must be received by August 14, 2025.
ADDRESSES: You may submit comments, identified by Docket No. OP-1868,
by any of the following methods:
<bullet> Agency Website: <a href="https://www.federalreserve.gov/apps/proposals/">https://www.federalreserve.gov/apps/proposals/</a>. Follow the instructions for submitting comments, including
attachments. Preferred Method.
<bullet> Mail: Ann E. Misback, Secretary, Board of Governors of the
Federal Reserve System, 20th Street and Constitution Avenue NW,
Washington, DC 20551.
<bullet> Hand Delivery/Courier: Same as mailing address.
<bullet> Other Means: <a href="/cdn-cgi/l/email-protection#bacacfd8d6d3d9d9d5d7d7dfd4cec9fadcc8d894ddd5cc"><span class="__cf_email__" data-cfemail="671712050b0e0404080a0a020913142701150549000811">[email protected]</span></a>. You must include the
docket number in the subject line of the message.
Comments received are subject to public disclosure. In general,
comments received will be made available on the Board's website at
<a href="https://www.federalreserve.gov/apps/proposals/">https://www.federalreserve.gov/apps/proposals/</a> without change and will
not be modified to remove personal or business information including
confidential, contact, or other identifying information. Comments
should not include any information such as confidential information
that would be not appropriate for public disclosure. Public comments
may also be viewed electronically or in person in Room M-4365A, 2001 C
St. NW, Washington, DC 20551, between 9 a.m. and 5 p.m. during Federal
business weekdays.
FOR FURTHER INFORMATION CONTACT: Marta Chaffee, Senior Associate
Director, (202) 263-4814, Mary Aiken, Senior Associate Director, (202)
721-4534, Juan Climent, Deputy Associate Director, (202) 872-7526,
Catherine Tilford, Deputy Associate Director, (202) 452-5240, April
Snyder, Assistant Director, (202) 452-3099, Missaka Nuwan
Warusawitharana, Manager, (202) 452-3461, Devyn Jeffereis, Senior
Financial Institution Policy Analyst II, (202) 452-2729, and Ricardo
Duque Gabriel, Economist, (202) 313-1663, Division of Supervision and
Regulation; or Reena Sahni, Deputy General Counsel, (202) 527-2911, Jay
Schwarz, Deputy Associate General Counsel, (202) 452-2970, Julie
Anthony, Senior Special Counsel, (202) 475-6682, David Cohen, Counsel,
(202) 452-5259, and Vivien Lee, Attorney, (202) 452-2029, Legal
Division. For users of TTY-TRS, please call 711 from any telephone,
anywhere in the United States or (202) 263-4869.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Current LFI Framework
B. Current Insurance Supervisory Framework
II. Proposed Changes
A. LFI Framework Definition of ``Well Managed''
B. Insurance Supervisory Framework Definition of ``Well
Managed''
III. Economic Analysis
A. Baseline
B. Proposal Relative to Baseline
C. Analysis of Benefits and Costs
1. Benefits
a. Supervisory Efficiency and Efficacy
b. Reduction of Compliance Costs and Other Impediments to Growth
2. Costs
D. Impact on Supervised Insurance Organizations
E. Conclusion
IV. Administrative Law Matters
A. Solicitation of Comments and Use of Plain Language
B. Regulatory Flexibility Act
C. Riegle Community Development and Regulatory Improvement Act
of 1994
D. Providing Accountability Through Transparency Act of 2023
Appendix A--Text of Proposed Large Financial Institution Rating
System
Appendix B--Text of Proposed Insurance Supervisory Framework
I. Background
The Board supervises and regulates companies that control one or
more banks (``bank holding companies'') and companies that are not bank
holding companies that control one or more savings associations
(``savings and loan holding companies,'' and together with bank holding
companies, ``depository institution holding companies''). Congress gave
the Board regulatory and supervisory authority for bank holding
companies through the enactment of the Bank Holding Company Act of 1956
(``BHC Act'').\1\ The Board's regulation and supervision of savings and
loan holding companies began in 2011 when provisions of the Dodd-Frank
Wall Street Reform and Consumer Protection Act (``Dodd-Frank Act'') \2\
transferring supervision and regulation of savings and loan holding
companies from the Office of Thrift Supervision to the Board took
effect.\3\ Upon this transfer, the Board became the federal supervisory
agency for all depository institution holding companies, including a
portfolio of depository institution holding companies significantly
engaged in insurance activities (``supervised insurance
organizations'').\4\ The Board has developed supervisory ratings
frameworks for its supervised entities, based on their size and
complexity, to assess their financial and operational strength.
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\1\ Ch. 240, 70 Stat. 133.
\2\ Public Law 111-203, 124 Stat. 1376 (2010).
\3\ Dodd-Frank Act tit. III, 124 Stat. at 1520-70.
\4\ Specifically, a supervised insurance organization is a
depository institution holding company that is an insurance
underwriting company, or that has over 25 percent of its
consolidated assets held by insurance underwriting subsidiaries, or
has been otherwise designated as a supervised insurance organization
by the Federal Reserve.
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A. Current LFI Framework
The Board adopted the Large Financial Institution (``LFI'') rating
system (``LFI Framework'') in 2018 and issued related guidance in
2019.\5\ The
[[Page 31642]]
Board designed the LFI Framework to align with the Federal Reserve's
supervisory programs and practices, enhance the clarity and consistency
of supervisory assessments and communications of supervisory findings
and implications, and provide transparency related to the supervisory
consequences of a given rating. The LFI Framework applies to bank
holding companies and non-insurance, non-commercial savings and loan
holding companies with total consolidated assets of $100 billion or
more, and U.S. intermediate holding companies of foreign banking
organizations established under Regulation YY with total consolidated
assets of $50 billion or more.
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\5\ 83 FR 58724 (Nov. 21, 2018); SR Letter 19-3/CA Letter 19-2,
Large Financial Institution (LFI) Rating System (Feb. 26, 2019),
<a href="https://www.federalreserve.gov/supervisionreg/srletters/sr1903.htm">https://www.federalreserve.gov/supervisionreg/srletters/sr1903.htm</a>.
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The LFI Framework evaluates whether a firm 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. It
includes three components: (1) capital planning and positions; (2)
liquidity risk management and positions; and (3) governance and
controls.\6\ Each component is rated based on a four-point non-numeric
scale: Broadly Meets Expectations,\7\ Conditionally Meets
Expectations,\8\ Deficient-1,\9\ and Deficient-2.\10\
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\6\ See SR Letter 19-3/CA Letter 19-2.
\7\ Indicates that a firm's practices and capabilities broadly
meet supervisory expectations, and the firm possesses sufficient
financial and operational strength and resilience to maintain safe-
and-sound operations through a range of conditions.
\8\ Indicates that there are certain material financial or
operational weaknesses in a firm's practices or capabilities that
may place the firm's prospects for remaining safe and sound through
a range of conditions at risk if not resolved in a timely manner
during the normal course of business.
\9\ Indicates that there are financial or operational
deficiencies in a firm's practices or capabilities, which put the
firm's prospects for remaining safe and sound through a range of
conditions at significant risk.
\10\ Indicates that there are financial or operational
deficiencies in a firm's practices or capabilities which present a
threat to the firm's safety and soundness, or have already put the
firm in an unsafe and unsound condition.
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The term ``well managed'' is defined in the BHC Act,\11\ as are
certain benefits to a firm from meeting this criteria.\12\ In addition
to being ``well managed'' under the LFI Framework, a large financial
institution must be ``well managed'' at each of its depository
institution subsidiaries to elect to be treated as a financial holding
company, which is a designation created by statute and that permits a
firm making such an election to engage in a broader range of nonbanking
activities, such as securities underwriting and dealing.\13\ The BHC
Act permits a firm that is ``well managed'' to engage in certain
expansionary activities and to pursue investments in and acquisitions
of certain nonbank financial companies without obtaining prior Board
approval. The loss of ``well managed'' status can constrain a banking
organization that is a financial holding company; can limit the banking
organization from benefiting from certain expedited processing
available to ``well managed'' firms; and can limit the scope of certain
new activities permissible for the firm.\14\ This can include
limitations on acquisitions of, and investments in, companies engaged
in certain financial activities without prior approval by the
Board.\15\
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\11\ 12 U.S.C. 1841(o)(9). Under the BHC Act, ``well managed''
means a company or depository institution that has achieved (i) ``a
CAMEL composite rating of 1 or 2 (or an equivalent rating under an
equivalent rating system),'' and (ii) ``at least a satisfactory
rating for management, if such a rating is given.''
\12\ See, e.g., 12 U.S.C. 1843(j)(4)(B).
\13\ For a bank holding company to qualify as a financial
holding company and engage in certain financial activities, the bank
holding company and each of its depository institution subsidiaries
must be ``well capitalized'' and ``well managed.'' See 12 U.S.C.
1843(l)(1).
\14\ See, e.g., 12 U.S.C. 1842(d) and 1843(l); 12 CFR
225.4(b)(6), 225.14, 225.22(a), 225.23;12 CFR 211.9(b),
211.10(a)(14), 211.34; and 12 CFR 223.41.
\15\ See, e.g., 12 CFR 225.83(d)(2).
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The LFI Framework states that a ``well managed'' firm has
sufficient financial and operational strength and resilience to
maintain safe-and-sound operations through a range of conditions,
including stressful ones.\16\ Under the LFI Framework, a firm that
receives a rating of Deficient-1 or Deficient-2 in any component rating
is not considered ``well managed'' for purposes of the BHC Act and for
certain other purposes.\17\ When issuing the LFI Framework, the Board
explained that a banking organization is not in satisfactory condition
overall unless it is considered sound in each of the key areas of
capital, liquidity, and governance and controls. A Deficient-1
component rating is issued when financial or operational deficiencies
at a firm put the firm's prospects for remaining safe and sound through
a range of conditions at risk, but the firm's current condition is not
considered to be materially threatened. Moreover, the LFI Framework
establishes a presumption that the Board will impose an informal or
formal enforcement action on any firm that is not ``well managed.''
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\16\ See SR Letter 19-3/CA Letter 19-2, Large Financial
Institution (``LFI'') Rating System (Feb. 26, 2019), <a href="https://www.federalreserve.gov/supervisionreg/srletters/sr1903.htm">https://www.federalreserve.gov/supervisionreg/srletters/sr1903.htm</a>.
\17\ For purposes of determining whether a firm is considered
``well managed'' under section 2(o)(9) of the BHC Act, the Federal
Reserve considers the three component ratings, taken together, to be
equivalent to assigning a standalone composite rating. 83 FR 58724,
58730 (Nov. 21, 2018). The LFI Framework does not designate any of
the three component ratings as a management rating, because each
component evaluates different aspects of a firm's management.
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The Board has observed based on its implementation of the LFI
Framework since 2018 that a firm that receives two component ratings of
Conditionally Meets Expectations or better and a single Deficient-1
component rating can maintain safe-and-sound operations through a range
of conditions. Therefore, the Board is proposing to change the rating
system such that firms with only one Deficient-1 component rating and
two component ratings of Conditionally Meets Expectations or better are
considered ``well managed.'' The proposal would not change the criteria
for determining if a firm's component rating is Broadly Meets
Expectations, Conditionally Meets Expectations, Deficient-1, or
Deficient-2 under the LFI Framework. Under this proposal, the LFI
Framework would calibrate a firm's ``well managed'' status based on the
totality of the component ratings. These revisions would also result in
the LFI Framework better reflecting the broad strength of the banking
system and would align the application of the LFI Framework more
closely with the operation of other existing supervisory ratings
systems.
B. Current Insurance Supervisory Framework
The Board's current supervisory approach for noninsurance
depository institution holding companies assesses holding companies
whose primary risks are related to the business of banking. The risks
arising from insurance activities, however, are materially different
from traditional banking risks. The top-tier holding company for some
supervised insurance organizations is an insurance underwriting
company, which is subject to supervision and regulation by the relevant
state insurance regulator as well as consolidated supervision from the
Board; for all supervised insurance organizations, the insurance
regulators supervise and regulate the business of insurance
underwriting companies. Additionally, the state insurance regulators
have established Statutory Accounting Principles through the National
Association of Insurance Commissioners to help assess the risks of
insurance companies, some of which do not produce consolidated
financial statements based on generally accepted accounting principles.
[[Page 31643]]
Because of these differences, the Board has tailored its
supervision and regulation of supervised insurance organizations. In
2022, the Board adopted the Insurance Supervisory Framework.\18\ In
addition, in 2023, the Board established a risk-based capital framework
designed specifically for supervised insurance organizations.\19\
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\18\ 87 FR 60160 (Oct. 4, 2022); SR Letter 22-8, Framework for
the Supervision of Insurance Organizations (Sept. 28, 2022), <a href="https://www.federalreserve.gov/supervisionreg/srletters/SR2208.htm">https://www.federalreserve.gov/supervisionreg/srletters/SR2208.htm</a>.
\19\ 88 FR 82950 (Nov. 27, 2023); 12 CFR part 217, subpart J.
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The Insurance Supervisory Framework is modeled after the LFI
Framework. The Board designed the Insurance Supervisory Framework to
reflect supervisory requirements and expectations applicable to
supervised insurance organizations. Further, within the Insurance
Supervisory Framework, the application of supervisory guidance and the
assignment of supervisory resources is based explicitly on a supervised
insurance organization's complexity and individual risk profile.
In addition to other tailoring of the supervision of insurance
organizations,\20\ the Insurance Supervisory Framework establishes a
supervisory rating system for these firms modeled after the LFI
Framework. Similarly to the LFI Framework, the Insurance Supervisory
Framework includes three components (Capital Management, Liquidity
Management, and Governance and Controls), with each component rated
based on a four-point non-numeric scale (Broadly Meets
Expectations,\21\ Conditionally Meets Expectations,\22\ Deficient-
1,\23\ and Deficient-2 \24\).
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\20\ For example, the Insurance Supervisory Framework classifies
supervised insurance organizations as either complex or noncomplex
based on their risk profile. Supervisory activities vary based on
this determination and also based on each firm's individual risk
profile.
\21\ Indicates a supervised insurance organization's practices
and capabilities broadly meet supervisory expectations and can
effectively serves as a source of managerial and financial strength
for its depository institution(s) and possesses sufficient financial
and operational strength and resilience to maintain safe-and-sound
operations through a range of stressful yet plausible conditions.
\22\ Indicates a supervised insurance organization's practices
and capabilities are generally considered sound, but certain
supervisory issues are sufficiently material that if not resolved in
a timely manner during the normal course of business, they may put
the firm's prospects for remaining safe and sound, and/or the
holding company's ability to serve as a source of managerial and
financial strength for its depository institution(s), at risk.
\23\ Indicates that financial or operational deficiencies in a
supervised insurance organization's practices or capabilities put
its prospects for remaining safe and sound, and/or the holding
company's ability to serve as a source of managerial and financial
strength for its depository institution(s), at significant risk.
\24\ Indicates that financial or operational deficiencies in a
supervised insurance organization's practices or capabilities
present a threat to its safety and soundness, have already put it in
an unsafe and unsound condition, and/or make it unlikely that the
holding company will be able to serve as a source of financial and
managerial strength to its depository institution(s).
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Like firms subject to the LFI Framework, certain insurance
organizations that lose their ``well managed'' status may be restricted
from engaging in certain expansionary activities and pursuing
investments in and acquisitions of certain nonbank financial companies
without obtaining prior Board approval.\25\ 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 in order to be considered ``well managed.'' The
Board previously explained that each rating is defined specifically for
supervised insurance organizations with particular emphasis on the
obligation that firms serve as a source of financial and managerial
strength for their depository institution(s).\26\ A Deficient-1
component rating is issued when financial or operational deficiencies
at a firm put its prospects for remaining safe and sound, and/or the
holding company's ability to serve as a source of managerial and
financial strength for its depository institution(s), at significant
risk. Moreover, the Insurance Supervisory Framework establishes a
presumption that the Board will impose an enforcement action on any
firm that is not ``well managed.''
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\25\ See 12 CFR 225.83 and 238.66(b).
\26\ 87 FR 60160 (Oct. 4, 2022).
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The Board has explained that the Insurance Supervisory Framework
was modeled after the LFI Framework.\27\ Therefore, to promote
consistency with the LFI Framework, the Board is proposing to amend the
Insurance Supervisory Framework such that firms with a single
Deficient-1 component rating and two component ratings of Conditionally
Meets Expectations or better would be considered ``well managed.'' The
proposal would not change the criteria for determining if a firm's
component rating is Broadly Meets Expectations, Conditionally Meets
Expectations, Deficient-1, or Deficient-2 under the Insurance
Supervisory Framework. Under this proposal, similar to changes proposed
for the LFI Framework, the Insurance Supervisory Framework would
calibrate a firm's ``well managed'' status based on the totality of the
component ratings. These revisions would also result in the Insurance
Supervisory Framework better reflecting the contribution of other
components of the Board's regulation of supervised insurance
organizations intended to ensure continued financial strength and would
align the application of the LFI Framework more closely with the
operation of other existing supervisory ratings systems.
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\27\ 87 FR 6537 (Feb. 4, 2024).
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In addition to this proposal, the Board plans to consider more
comprehensive changes to supervisory ratings systems, including the
Frameworks, that apply to Federal Reserve-supervised institutions. The
Board will coordinate future proposals with other banking agencies, as
appropriate.
II. Proposed Changes
A. LFI Framework Definition of ``Well Managed''
The Board proposes to revise its LFI Framework so that a firm with
at least two Broadly Meets Expectations or Conditionally Meets
Expectations component ratings and no more than one Deficient-1
component rating would be considered ``well managed'' under the LFI
Framework. A firm would not be considered ``well managed'' under the
LFI Framework if it receives a Deficient-1 for two or more component
ratings. A firm would also not be considered ``well managed'' under the
LFI Framework if it receives a Deficient-2 for any of the component
ratings.
In addition, the Board proposes to remove the presumption in the
LFI Framework that firms with one or more Deficient-1 component ratings
will be subject to an informal or formal enforcement action. Instead,
under the proposal, the LFI Framework would state that firms with one
or more Deficient-1 component ratings may be subject to a formal or
informal enforcement action, depending on particular facts and
circumstances. This change would better align the LFI Framework with
other supervisory
[[Page 31644]]
rating systems.\28\ The proposal maintains a presumption that the Board
will impose a formal enforcement action on a firm with one or more
Deficient-2 component ratings. All other aspects of the LFI Framework
would remain unchanged under the proposal.
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\28\ For example, the Board has previously explained that firms
with a composite 3 rating under the CAMELS framework, ``require more
than normal supervision, which may include formal or informal
enforcement actions.'' See SR Letter 96-38, Uniform Financial
Institutions Rating System (Dec. 27, 1996), <a href="https://www.federalreserve.gov/boarddocs/srletters/1996/sr9638.htm">https://www.federalreserve.gov/boarddocs/srletters/1996/sr9638.htm</a>.
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Since its implementation, the Board has gained experience applying
the LFI Framework and has evaluated whether the standard for
identifying a ``well managed'' firm under the LFI Framework is properly
calibrated. The LFI Framework states that a ``well managed'' firm has
sufficient financial and operational strength and resilience to
maintain safe-and-sound operations through a range of conditions,
including stressful ones. In using the rating system, the Board has
observed that a single Deficient-1 component rating can be indicative
of a discrete deficiency that does not necessarily reflect the overall
condition of a firm. For example, firms may be rated Deficient-1 on
governance and controls due to concerns surrounding a specific
operational risk management issue, including weaknesses in areas such
as operational resilience, cybersecurity, or Bank Secrecy Act and anti-
money laundering compliance. Similarly, firms may be rated Deficient-1
for capital or liquidity due to risk-management deficiencies in a
particular business line. While such deficiencies may require
significant management attention to address, such a deficiency could be
discrete, and the firm could have strong positions and practices
overall.
A component rating of Broadly Meets Expectations signifies that a
firm's practices and capabilities broadly meet supervisory
expectations, and the firm possesses sufficient financial and
operational strength and resilience to maintain safe-and-sound
operations through a range of conditions. A component rating of
Conditionally Meets Expectations means that there is a material
financial or operational weakness in a firm's practices or capabilities
that may place the firm's prospects for remaining safe and sound
through a range of conditions at risk if not resolved in a timely
manner during the normal course of business. These weaknesses can be
resolved through measures that do not require a material change to the
firm's business model or financial profile, or its governance, risk-
management, or internal control structures or practices. Therefore, a
firm that has an idiosyncratic deficiency that results in a rating of
Deficient-1 in an individual component while maintaining a rating of
Broadly Meets Expectations or Conditionally Meets Expectations in its
other two components would generally have sufficient financial and
operational strength and resilience to maintain safe-and-sound
operations through a range of conditions due to its overall robustness.
Conversely, firms with more than one Deficient-1 component rating,
or one or more Deficient-2 component ratings, would not be considered
``well managed,'' as the Board has observed that such firms may not
have sufficient financial and operational strength and resilience to
maintain safe-and-sound operations through a range of conditions due to
a broader range of issues. The LFI Framework's presumptions regarding
enforcement actions would also be revised to reflect this adjustment.
The proposed change to the definition of ``well managed'' firms
under the LFI Framework would also better reflect the current condition
of the banking system. As discussed in the Board's November 2024
Supervision and Regulation Report, the banking system remains sound and
resilient overall: Most banks are well capitalized; liquidity and
funding conditions are stable compared to 2023; and asset quality
generally remains sound.\29\ Further, large banking organizations are
required to meet capital and liquidity regulatory requirements, which
are calibrated to be sufficient to absorb impacts of a severe
stress.\30\ Under the current LFI Framework, however, over half of
large financial institutions are considered not ``well managed,''
despite their resilience under current and stressed conditions.
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\29\ Board of Governors of the Federal Reserve System,
Supervision and Regulation Report (Nov. 2024), <a href="https://www.federalreserve.gov/publications/files/202411-supervision-and-regulation-report.pdf">https://www.federalreserve.gov/publications/files/202411-supervision-and-regulation-report.pdf</a>.
\30\ Many of these firms are subject to enhanced prudential
standards, which establish general risk management, liquidity risk
and capital management, and stress testing requirements for certain
banking organizations. See 12 CFR parts 252 and 238.
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In light of the experience discussed above, the current LFI
Framework's approach of determining a firm's ``well managed'' status
based solely on its lowest component rating has resulted in
overweighting a single component for purposes of ``well managed''
determinations and has not appropriately balanced all of the
components. Revising the LFI Framework to avoid such an outcome would
ensure that ``well managed'' determinations take a more comprehensive
approach and reflect the overall strength of the firm across the three
components.
The proposed revision would better align the application of the LFI
Framework with the operation of the Board's other existing ratings
frameworks, none of which determine a firm's composite rating, which is
relevant to its ``well managed'' status, based solely on any one of its
component ratings. For example, the Uniform Financial Institutions
Rating System (``CAMELS'') incorporates a composite score, which is
relevant to a firm's ``well managed'' status.\31\ The CAMELS composite
score is an evaluation of a firm's managerial, operational, financial,
and compliance performance and therefore takes into account a firm's
performance in multiple component areas.\32\ Similarly, the RFI/C(D)
rating system includes a composite rating based on an evaluation of
several component ratings, including the firm's managerial and
financial condition and an assessment of future potential risk to its
subsidiary depository institutions.\33\ This composite score is
relevant to determining a firm's ``well managed'' status. As such, the
proposed revisions to the LFI Framework would better align the LFI
Framework with the supervisory rating systems used for other banking
organizations.\34\
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\31\ SR Letter 96-38; SR Letter 00-14, Enhancements to the
Interagency Program for Supervising the U.S. Operations of Foreign
Banking Organizations (revised Oct. 23, 2020), <a href="https://www.federalreserve.gov/boarddocs/srletters/2000/sr0014.htm">https://www.federalreserve.gov/boarddocs/srletters/2000/sr0014.htm</a>.
\32\ See id. ``The composite rating generally bears a close
relationship to the component ratings assigned. However, the
composite rating is not derived by computing an arithmetic average
of the component ratings.'' Moreover, for a financial institution to
receive a composite rating of 2, for example, ``generally no
component rating should be more severe than 3.'' SR Letter 96-38.
\33\ SR Letter 19-4/CA Letter 19-3, Supervisory Rating System
for Holding Companies with Total Consolidated Assets Less than $100
Billion (Feb. 26, 2019), <a href="https://www.federalreserve.gov/supervisionreg/srletters/sr1904.htm">https://www.federalreserve.gov/supervisionreg/srletters/sr1904.htm</a>.
\34\ See, e.g., 61 FR 67021 (Dec. 12, 1996); 70 FR 44256 (Aug.
2, 2005); and SR Letter 96-36, Guidance on Evaluating Activities
Under the Responsibility of U.S. Branches, Agencies and Nonbank
Subsidiaries of Foreign Banking Organizations (Dec. 19, 1996),
<a href="https://www.federalreserve.gov/boarddocs/srletters/1996/sr9636.htm">https://www.federalreserve.gov/boarddocs/srletters/1996/sr9636.htm</a>.
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This proposal does not include other changes to the LFI Framework,
including the Board's standard for evaluating the individual component
ratings in the LFI Framework. The proposal does not seek to change the
Board's expectation that a firm with a Deficient-1 component rating
would
[[Page 31645]]
take timely action to correct any financial or operational
deficiencies, restore or maintain its safety and soundness, and comply
with laws and regulations. Further, the Federal Reserve would consider
specific concerns underlying a Deficient-1 component rating in
evaluating any required application from a firm to engage in new or
expansionary activities to the extent those concerns are relevant to
the evaluation of a particular statutory factor.
B. Insurance Supervisory Framework Definition of ``Well Managed''
The Board also proposes to make parallel changes to the ``well
managed'' determination under the Insurance Supervisory Framework.
Under the proposed amended framework, a firm with at least two Broadly
Meets Expectations or Conditionally Meets Expectations component
ratings and no more than one Deficient-1 component rating would be
considered ``well managed'' under the Insurance Supervisory Framework,
whereas a firm would not be considered ``well managed'' under the
Insurance Supervisory Framework if it receives a Deficient-1 rating for
two or more component ratings. A firm would also not be considered
``well managed'' under the Insurance Supervisory Framework if it
receives a Deficient-2 rating for any of the component ratings.
Additionally, the Board proposes to make parallel changes to the
Insurance Supervisory Framework to remove the presumption that firms
with one or more Deficient-1 component ratings will be subject to an
enforcement action. Instead, under the proposal, the Insurance
Supervisory Framework would state that firms with one or more
Deficient-1 component ratings may be subject to a formal or informal
enforcement action, depending on particular facts and circumstances.
The proposal maintains a presumption that a firm with one or more
Deficient-2 component ratings would be subject to a formal enforcement
action by the Board. All other aspects of the Insurance Supervisory
Framework would remain unchanged under the proposal.
While the Insurance Supervisory Framework differs from the LFI
Framework, in that its structure and application support use for
supervised insurance organizations of all sizes and risk profiles, the
Insurance Supervisory Framework is ultimately modeled after the LFI
Framework. Under the Insurance Supervisory Framework, a component
rating of Broadly Meets Expectations means that a firm's practices and
capabilities broadly meet supervisory expectations. The firm
effectively serves as a source of managerial and financial strength for
its depository institution(s) and possesses sufficient financial and
operational strength and resilience to maintain safe-and-sound
operations through a range of stressful yet plausible conditions. A
component rating of Conditionally Meets Expectations signifies that the
firm's practices and capabilities are generally considered sound, but
there are certain supervisory issues that are sufficiently material
that, if not resolved in a timely manner during the normal course of
business, may put the firm's prospects for remaining safe and sound,
and/or the firm's ability to serve as a source of managerial and
financial strength for its depository institution(s), at risk.
Therefore, a firm that has an idiosyncratic deficiency that results in
a rating of Deficient-1 in an individual component while maintaining a
rating of Broadly Meets Expectations or Conditionally Meets
Expectations in its other two components would generally be able to
operate in a safe and sound manner and have sufficient financial and
operational strength to serve as a source of strength for their
depository institution(s) through a range of stressful yet plausible
conditions due to its overall robustness.
Conversely, firms with more than one Deficient-1 component rating,
or one or more Deficient-2 component ratings, would not be considered
``well managed,'' as such firms generally may not be able to operate in
a safe and sound manner and serve as a source of strength for their
depository institution(s) through a range of stressful yet plausible
conditions due to a broader range of issues.
Furthermore, following the adoption of the Insurance Supervisory
Framework, the Board took steps to help ensure the financial strength
of supervised insurance organizations by adopting risk-based capital
requirements for these firms.\35\ This risk-based capital framework,
termed the Building Block Approach, adjusts and aggregates existing
legal entity capital requirements to determine enterprise-wide capital
requirements. These requirements help to ensure that supervised
insurance organizations are appropriately capitalized and, therefore,
help to prevent the economic and consumer impacts resulting from the
failure of organizations engaged in banking and insurance. Currently,
firms subject to the Building Block Approach have capital levels in
excess of minimum requirements.\36\
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\35\ 88 FR 82950 (Nov. 27, 2023).
\36\ Reports submitted by supervised insurance organizations
under the ``Building Block Approach'' are available at <a href="https://www.ffiec.gov/NPW">https://www.ffiec.gov/NPW</a>.
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As discussed previously, none of the Board's other existing ratings
frameworks determine a firm's composite rating, which is relevant to
its ``well managed'' status, based solely on any one of its component
ratings. Therefore, similar to the proposed changes to the LFI
Framework, the proposed changes to the Insurance Supervisory Framework
would better align the Insurance Supervisory Framework with the
supervisory rating systems used for other banking organizations.\37\
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\37\ See, e.g., 61 FR 67021; 70 FR 44256; and SR Letter 96-36.
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This proposal does not include other changes to the Insurance
Supervisory Framework, including the Board's standard for evaluating
the individual component ratings in the Insurance Supervisory
Framework. The proposal does not seek to change the Board's expectation
that a firm with a Deficient-1 component rating would take timely
action to correct financial or operational deficiencies and to restore
and maintain its safety and soundness and compliance with laws and
regulations. Further, while certain firms with a single Deficient-1
component rating would no longer be statutorily limited from engaging
in new activities permissible only for ``well managed'' firms without
Board approval, the Federal Reserve would consider specific concerns
underlying a Deficient-1 component rating in evaluating any application
from a firm to engage in new or expansionary activities to the extent
those concerns are relevant to the evaluation of a particular statutory
factor.
Question 1: What are the advantages and disadvantages of revising
the current Frameworks such that firms that receive a Broadly Meets
Expectations or Conditionally Meets Expectations rating in the capital
and liquidity components and a Deficient-2 rating only in the
governance and controls component would be considered ``well managed''?
Question 2: What are the advantages and disadvantages of revising
the Frameworks to implement a timing requirement where a firm with a
single Deficient-1 component rating would be considered not ``well
managed'' if it has not remediated the deficiency within a certain time
period?
Question 3: What are the advantages and disadvantages of revising
the Frameworks such that a firm with a
[[Page 31646]]
single Deficient-2 component rating would be considered ``well
managed''?
Question 4: What other changes to the Frameworks should be
considered by the Board, and why?
Question 5: Should the Board consider adding a composite rating to
the Frameworks to determine whether a firm is ``well managed''? If so,
what definitions should be used for the composite rating? For example,
should the definitions be aligned with the existing generalized
definitions of Broadly Meets Expectations, Conditionally Meets
Expectations, Deficient-1, or Deficient-2 for each component, footnotes
7-10 and 21-24? What standard should guide the determination of a
composite rating? For example, should the composite rating be based on
a comprehensive assessment, or should it involve a presumption based on
an average or weighted average of the different component ratings?
Question 6: What other changes to supervisory ratings systems (such
as CAMELS, the RFI/C(D) rating system, ROCA ratings for U.S. branches
of foreign banking organizations, and ratings for combined U.S.
operations of foreign banking organizations) should be considered by
the Board to reflect recent experiences in the banking system, and why?
What changes to other supervisory ratings systems should be considered
by the Board to align it with the proposed revisions to the Frameworks,
and why?
Question 7: What other changes to supervisory ratings systems
should be considered by the Board to ensure that a firm's ``well
managed'' status is appropriately calibrated, and why?
III. Economic Analysis
As outlined in previous sections, the changes included in this
proposal would reflect experience with the LFI Framework since its
introduction in 2018, better align the application of the LFI Framework
with the operation of the Board's other existing ratings frameworks,
and better reflect the current condition of the banking system. The
Board assessed the economic impact of the proposal on firms, on
supervisory efficiency and efficacy, and on the broader economy.
Specifically, the Board evaluated the potential impact on firms that
would become ``well managed'' and the broader implications of adopting
this change. It also evaluated the potential effects of the proposal's
elimination of the presumption of enforcement actions in certain cases.
As a result of this proposal, there would be an increase in the number
of firms that are ``well managed'' under the LFI Framework and a
potential reduction in the number of enforcement actions for these
firms that have sufficient financial and operational strength and
resilience to maintain safe-and-sound operations through a range of
stressful conditions. Overall, firms that would become ``well managed''
may face reduced enforcement-related compliance costs and fewer
regulatory impediments to pursue certain activities, including
investments in, and acquisitions of, certain non-bank financial
companies.
The economic analysis is structured in four parts. Section III.A
provides an overview of the baseline (i.e., the current LFI Framework),
describes the current state of the assignment of LFI ratings, and
discusses how these ratings can affect a firm's ``well managed'' status
under the BHC Act. Section III.B discusses the proposal, outlines the
specific changes being considered and estimates the change in the
number of ``well managed'' firms under the proposal. Section III.C
analyzes the potential benefits and costs associated with the proposed
changes relative to the baseline. Section III.D analyzes the impact on
supervised insurance organizations.
A. Baseline
The current LFI Framework (discussed in detail in Section I)
establishes the baseline for the economic analysis. The Board has
assessed the costs and benefits of the proposal (discussed in detail in
Section III.C) relative to this baseline.
Under the current LFI Framework, a firm whose holding company
receives a Deficient-1 or Deficient-2 in any LFI component rating is
not considered ``well managed.'' Furthermore, there is a presumption
that firms with one or more Deficient-1 ratings will be subject to an
informal or formal enforcement action.
The ``well managed'' status of a banking organization under certain
provisions of the BHC Act depends on the ratings of the holding company
and the holding company's depository institution subsidiaries, which
are assigned by the relevant federal banking agency. For instance, for
a bank holding company to qualify as a financial holding company and
engage in certain financial activities, a bank holding company and all
its depository institution subsidiaries must be ``well capitalized''
and ``well managed.'' Thus, regardless of the LFI ratings of its
holding company, a U.S. banking organization may not be able to engage
in certain expansionary activities if any of its subsidiary depository
institutions' management or composite CAMELS rating is 3 or worse. For
a foreign banking organization (``FBO''), the combined ROCA (Risk
Management, Operational Controls, Compliance, Asset Quality) rating
must be 3 or worse for its U.S. branches and agencies to negatively
affect its ``well managed'' status. Additionally, an FBO that has a
combined U.S. operations (``CUSO'') rating of 3 or worse is not treated
as ``well managed'' for BHC Act purposes. Under the BHC Act, and as
discussed in this section, a ``well managed'' firm refers to a banking
organization where the holding company and all relevant subsidiaries
are ``well managed'' and for FBOs, where their ROCA ratings and CUSO
ratings are also at least satisfactory.
For the firms whose holding companies had LFI ratings in Q4 2024,
Figure 1 displays their ratings between Q1 2020 to Q4 2024 and
categorizes them into three categories. The first category, ``Not
Satisfactory DI/FBO Ratings Only,'' shown in black, represents the
number of firms whose depository institutions' composite or management
ratings or their composite ROCA or CUSO ratings were 3 or worse and
whose holding company had all three components of LFI ratings either
Broadly Meets Expectations or Conditionally Meets Expectations. The
second category, ``Not Satisfactory LFI Ratings Only,'' shown in dark
grey, represents the number of firms where the holding company had one
or more Deficient-1 or Deficient-2 LFI component ratings, but the
subsidiary depository institutions' composite and management ratings
and their composite ROCA and CUSO ratings, if applicable, were 1 or 2.
The third category, ``Not Satisfactory LFI and DI/FBO Ratings,'' in
light grey color, represents the number of firms whose subsidiary
depository institutions' composite or management ratings or their
composite ROCA or CUSO ratings, if applicable, were 3 or worse and
whose holding company had one or more Deficient-1 or Deficient-2 LFI
component ratings. As of Q4 2024, 23 out of 36 firms subject to the LFI
Framework were classified as not ``well managed'' under the BHC Act,
based on both the LFI ratings and depository institution composite and
management ratings and composite ROCA and CUSO ratings, if applicable.
Figure 1 reveals an overall upward trend in the number of not
``well managed'' firms throughout the observed period. Ratings at the
holding company and at the depository institution and FBO level usually
coincide, and both contribute to a firm being not ``well managed,'' as
[[Page 31647]]
demonstrated by the large area of light grey bars. Nevertheless, LFI
ratings alone can result in a non-trivial number of firms being not
``well managed,'' as demonstrated by the dark grey bars. As of Q4 2024,
five firms were not ``well managed'' solely due to their LFI ratings.
Moreover, there were very few instances when a not ``well managed''
firm did not have at least one Deficient-1 LFI rating--only five
instances in the whole period according to Figure 1--as demonstrated by
the black bars.
Notably, the upward trend in the number of firms being considered
not ``well managed'' has occurred over a period when the regulatory
capital ratio of large financial institutions as a group remained
generally stable around 13 percent.\38\ Moreover, in Q4 2024 the
average regulatory capital ratio was 2 percentage points higher for not
``well managed'' LFI firms compared to their ``well managed'' LFI
peers. This indicates a misalignment between the results of the current
LFI Framework and the financial condition of these firms. This
misalignment and the associated presumption of an enforcement action in
these cases may have caused the Board to allocate examination,
remediation, and enforcement resources to firms that otherwise have
financial strength and resilience.
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\38\ The average CET1 capital over standardized approach risk
weighted assets between Q1 2020 and Q4 2024 across large financial
institutions was approximately 13 percent.
\39\ Note that, for comparison purposes, we are only including
in this sample firms that were subject to the LFI Framework in Q4
2024.
[GRAPHIC] [TIFF OMITTED] TN15JY25.014
B. Proposal Relative to Baseline
As discussed in detail in Section II, under the proposal, all
elements of the current LFI Framework would be maintained except for
two key changes. The criteria for a firm to be ``well managed'' under
the LFI Framework would be adjusted and the threshold for presumptive
enforcement action would be modified.
First, under the proposed changes, a firm would only be considered
not ``well managed'' under the LFI Framework if it receives a
Deficient-1 rating for two or more components, or if it receives a
Deficient-2 rating for any component. Nevertheless, the firm's ``well
managed'' status under certain provisions of the BHC Act would also
still be conditional on the firm's subsidiary depository institution
ratings (CAMELS) and the foreign bank organization's ratings (CUSO and
ROCA), if applicable.
Second, the proposal would amend the LFI Framework such that firms
with one or more Deficient-1 ratings would no longer be presumed to be
subject to a formal or informal enforcement action. Instead, a firm
with one or more Deficient-1 component ratings may be subject to a
formal or informal enforcement action, depending on particular facts
and circumstances. The proposal maintains the presumption that the
Board will impose a formal enforcement action on a firm with one or
more Deficient-2 component ratings.
The impact of the proposal hinges on the number of firms that would
become ``well managed'' if its holding company has a Deficient-1 rating
for one component and a Broadly Meets Expectations or Conditionally
Meets Expectations for the remaining two components. In addition to
their direct effect on ``well managed'' status, LFI ratings are an
input to the CUSO rating and there might be other interrelations
between ratings that are hard to quantify.\40\ Consequently, assessing
the impact of the LFI Framework change alone and assuming that all
other ratings would not be affected might underestimate the true
effect, and thus provide a lower bound. Conversely, the upper bound of
the proposal's effects would be obtained by computing the number of not
``well managed'' firms as determined by LFI ratings alone, which
assumes that the depository institution or FBO ratings are not more
limiting on the firm than the LFI ratings. Therefore, the Board
calculated the number of not ``well managed'' firms for both the
baseline and the proposal under the following two metrics:
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\40\ See 83 FR 58724, 58727 (Nov. 21, 2018) (``[T]he LFI rating
assigned to the U.S. IHC would be an input into the rating of the
combined U.S. operations of a foreign bank.'').
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[[Page 31648]]
Metric 1: Not ``well managed'' firms under the BHC Act (LFI rating,
or bank CAMELS rating, or equivalent for FBOs).
Metric 2: Not ``well managed'' holding companies under the LFI
Framework.
Metric 1 is equivalent to the sum of all 3 categories presented in
Figure 1. Metric 2 corresponds to the sum of two categories ``Not
Satisfactory LFI Ratings Only'' and ``Not Satisfactory LFI and DI/FBO
Ratings'' in Figure 1. The results are presented in Table 1. The
analysis in Table 1 uses a sample of all 36 firms subject to the LFI
Framework in Q4 2024.
Table 1--Estimated Number of Not ``Well Managed'' Firms in Q4 2024
----------------------------------------------------------------------------------------------------------------
Baseline Proposal
---------------------------------------------------------------
Metric 1 Metric 2 Metric 1 Metric 2
----------------------------------------------------------------------------------------------------------------
Number of Firms................................. 23 23 20 15
----------------------------------------------------------------------------------------------------------------
Table 1 presents the estimated number of not ``well managed'' firms
under both the baseline and the proposal for both metrics. As of Q4
2024, under the baseline, 23 out of 36 firms would be considered not
well managed if LFI and depository institution/FBO ratings were
considered (Metric 1), and 23 out of 36 firms would be considered not
well managed if only the LFI ratings were considered (Metric 2). Under
the proposed revisions to the LFI Framework, 20 out of 36 firms would
be not ``well managed'' under Metric 1. The number would be smaller
under Metric 2, where only 15 out of 36 firms would be classified as
not ``well managed'' when considering the LFI ratings only.
The expected effect of the proposed changes likely lies between
Metric 1 and Metric 2. On one hand, Metric 1 may underestimate the
impact of the proposal when viewed over time due to potential future
changes to ratings at the depository institution/FBO and the fact that
LFI ratings are an input to CUSO ratings.\41\ On the other hand, Metric
2 mechanically overestimates the impact by not considering any ratings
other than the LFI ratings.
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\41\ 83 FR 58724 (Nov. 21, 2018).
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Therefore, the Board expects the current proposal could result in a
decrease in not ``well managed'' firms by up to eight compared to the
baseline. To be precise, staff estimates that the proposal would
decrease the number of holding companies that are not ``well managed''
under the LFI Framework (that is, based on holding company ratings
alone) by eight, from 23 to 15. However, for a bank holding company to
qualify as a financial holding company and engage in certain financial
activities without prior Board approval, a bank holding company and
each of its depository institution subsidiaries must be ``well
capitalized'' and ``well managed;'' for an FBO, its CUSO and ROCA
ratings must also be satisfactory. As such, changes solely to the LFI
Framework would initially have a limited impact. Staff estimates that
only three of the eight firms have ``well managed'' subsidiaries (or
the FBO equivalent) as of Q4 2024.
Figure 2 illustrates the share of not ``well managed'' firms under
the baseline and the proposal, using either Metric 1 (left panel) or
Metric 2 (right panel). The share increased between Q1 2020 to Q4 2024,
with a notable and sharp increase in 2023. This increase was in
contrast with trends in regulatory capital ratios for these firms in
this period. According to the Supervision and Regulation Report of
November 2024, the share of well capitalized banks has increased over
this period, from 94 percent in 2020 to 99 percent in 2024.\42\
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\42\ Board of Governors of the Federal Reserve System,
Supervision and Regulation Report (Nov. 2024), <a href="https://www.federalreserve.gov/publications/files/202411-supervision-and-regulation-report.pdf">https://www.federalreserve.gov/publications/files/202411-supervision-and-regulation-report.pdf</a>.
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Figure 2 documents that the estimated impact, under both metrics,
is not driven by the choice of using Q4 2024 data to evaluate the
change. In fact, across the sample period, the proposed changes under
both Metric 1 and 2 would have consistently resulted in a smaller share
of firms that are not ``well managed.''
[GRAPHIC] [TIFF OMITTED] TN15JY25.015
[[Page 31649]]
C. Analysis of Benefits and Costs
This section assesses the benefits and costs of the proposal
relative to the baseline. The consequences of modifying the LFI
Framework primarily stem from allocating supervisory resources more
efficiently and from potentially altering a firm's ``well managed''
status under the BHC Act and the subsequent implications, as well as
modifying the threshold for an enforcement action. The previous section
estimated that the number of impacted firms would be between 3 and 8
out of 36, using Q4 2024 as the baseline. Therefore, the benefits and
costs of the proposed changes that are discussed below would
materialize in part through those firms and more broadly, over the long
run, through a revised ratings framework that aligns ratings more
closely with the overall condition of the supervised firms.
1. Benefits
a. Supervisory Efficiency and Efficacy
The proposal would remove the presumption in the LFI Framework that
firms with one or more Deficient-1 component rating will be subject to
an informal or formal enforcement action. It would also change the
definition of ``well managed'' to better align with other supervisory
ratings frameworks and reflect the firms' overall condition, as
described above. This alignment across frameworks and reflection of
firms' overall condition could lead to more consistent and effective
supervision.
The proposed changes could also allow supervisors to allocate
resources more efficiently, concentrating on significant risks, and
enhancing overall supervision. For instance, the removal of the
presumption in the LFI Framework that firms with one or more Deficient-
1 component ratings will be subject to an informal or formal
enforcement action could provide supervisory teams with the ability to
more efficiently allocate resources based on the severity of the issues
that are identified and the needed remediation.
b. Reduction of Compliance Costs and Other Impediments to Growth
Firms that become ``well managed'' as a result of the proposal may
experience reduced compliance costs and associated burdens on
management resulting from removing the presumption of certain
enforcement actions. This reduction in enforcement-related expenses and
efforts could enable institutions to invest more resources in core
business operations. Consequently, this reallocation of resources has
the potential to promote innovation and growth, as firms may have
increased capacity to develop new products, services, or technologies
that benefit consumers and the broader economy. It could also permit
them to focus more managerial attention on tackling business
challenges, thus supporting the financial intermediation activities of
these firms.
Between Q1 2020 and Q4 2024, following the implementation of the
LFI Framework, the loss of ``well managed'' status was associated with
slower growth in assets and loans. Figure 3 shows that the average
growth rate one year before the loss of ``well managed'' status (pre)
is about 5.6 percent, roughly in line with the yearly average growth
rate of firms that were always ``well managed'' throughout the sample
(control) of approximately 6.7 percent. By contrast, in the year after
a ratings downgrade that results in a firm becoming not ``well
managed'' (post), growth in total assets dropped by almost two thirds
to about 2.1 percent. The same qualitative findings hold true for
growth in total loans. Taken together, this analysis indicates that the
proposal has the potential to promote growth at large financial
institutions that, under the proposal, would become ``well managed.''
Moreover, as fewer firms that have sufficient financial and operational
strength and resilience to maintain safe-and-sound operations through a
range of conditions due to their overall robustness would be classified
as not ``well managed'' in the future due to the change in the LFI
ratings framework, the proposal could bolster the overall growth of
large banking organizations and thus foster economic activity.
[[Page 31650]]
[GRAPHIC] [TIFF OMITTED] TN15JY25.016
While the analysis indicates a decrease in the growth of total
assets and total loans as a firm moves to not ``well managed,'' the
observed decline may reflect multiple factors beyond just the loss of
``well managed'' status. These factors could include underlying issues
that contributed to the downgrade, such as deteriorating performance or
governance challenges. Moreover, it is possible that the remediation
efforts required to address the issues that led to the supervisory
downgrade could be a driver of the observed slower growth.
---------------------------------------------------------------------------
\43\ This figure plots the unweighted average growth in total
assets and total loans for firms which were downgraded to not ``well
managed'' between Q1 2020 and Q4 2024 in the one year before (pre)
and one year after (post) the change. For comparison, we compute the
yearly unweighted average growth rate of firms which were always
``well managed'' throughout the sample (control group). A red dashed
vertical line separates the control and treated groups.
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Under the proposal, more firms with sufficient financial and
operational strength and resilience to maintain safe-and-sound
operations through a range of conditions would be able to engage in
certain business initiatives and strategic opportunities without
obtaining prior Board approval due to the changes to the ``well
managed'' criteria, as permitted by statute. Besides the reduction in
enforcement-related compliance costs for these firms, these activities
can also promote stronger growth via economies of scale.\44\ As
institutions grow larger, they can spread fixed costs--such as
technology investments, compliance infrastructure, and branch
operations--over a broader and larger base of customers and assets,
potentially improving operational efficiency.
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\44\ See David C. Wheelock & Paul W. Wilson, ``The Evolution of
Scale Economies in US Banking,'' 33 Journal of Applied Economics 16,
16-28 (June 2017), <a href="https://doi.org/10.1002/jae.2579">https://doi.org/10.1002/jae.2579</a>.
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The proposal could also make it easier for firms that meet the
required standards of strength and resilience to expand into non-bank
financial activities, which can also generate economies of scope and
increase opportunities for innovation. By expanding into new markets
and business areas, firms could realize significant synergies from
integrating banking, investment, and technology-based services.
Encouraging firms' engagement with innovative financial sectors could
also significantly enhance consumer access to a broader range of
financial services. For example, investments in fintech could not only
foster technological advancement but also contribute to broader
financial sector resilience.\45\ Consumers and businesses might benefit
from lower costs due to these investments, along with synergies and
operational efficiencies stemming from potential investments in, or
acquisitions of, non-bank financial companies. Simultaneously, firms
could diversify revenue streams beyond traditional banking activities,
which could enhance financial stability by reducing their reliance on
particular business lines.
---------------------------------------------------------------------------
\45\ See Emma Li et al., ``Banks' investments in fintech
ventures,'' 149 Journal of Banking & Finance 106754, 106754-97
(October 2022), <a href="https://dx.doi.org/10.2139/ssrn.3979248">https://dx.doi.org/10.2139/ssrn.3979248</a>.
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2. Costs
The proposal, while enhancing supervisory efficiency, may result in
a slight increase in risk-taking by firms that have sufficient
financial and operational strength and resilience to maintain safe-and-
sound operations through a range of conditions. With the removal of the
presumption that firms with one or more Deficient-1 component ratings
will be subject to an informal or formal enforcement action,
institutions might be marginally less incentivized to immediately
address issues underlying a single Deficient-1 component rating.
However, this risk is likely to be small, as firms with a Deficient-1
rating may still receive specific supervisory findings in the form of
Matters Requiring Attention or Matters Requiring Immediate Attention,
which would outline issues that need to be remediated. Furthermore, the
possibility of becoming not ``well managed'' due to a further rating
decline to Deficient-2 could provide an incentive for institutions to
address potential deficiencies. Importantly, supervisors would continue
to monitor the remediation of supervisory issues and retain the ability
to impose enforcement actions where necessary, thus limiting this cost
and ensuring that these issues are resolved in an appropriate
timeframe.
[[Page 31651]]
D. Impact on Supervised Insurance Organizations
The proposed changes to the LFI Framework have direct implications
for the Insurance Supervisory Framework, as the latter is modeled after
the former. This section aims to assess the potential economic impact
of these changes on supervised insurance organizations.
As of Q4 2024, there were five firms subject to the Insurance
Supervisory Framework. Under the proposed changes, which would allow
firms with one ``Deficient-1'' rating and two satisfactory ratings to
be ``well managed,'' no firms would see a change in their ``well-
managed'' status.
This indicates that the proposed changes would not have meaningful
effects on the supervised insurance organizations. However, it is
important to consider the potential long-term implications of the
proposal, which could materialize for any supervised insurance
organization that is a financial holding company.
On the one hand, the proposed changes offer potential benefits for
supervised insurance organizations that are financial holding companies
such as increased flexibility to adapt to market conditions, pursue
growth opportunities, and enhance competitiveness. Supervised insurance
organizations that are not financial holding companies could also
benefit from the reduced likelihood of being designated as not ``well
managed,'' thus reducing their enforcement-related compliance costs.
On the other hand, potential costs might include a slight increase
in risk-taking as insurance firms may be marginally less incentivized
to remediate single Deficient-1 component ratings. Notwithstanding, it
is important to note that the possibility of losing ``well managed''
status due to further rating decline to Deficient-2 might provide an
incentive to address potential deficiencies promptly. Moreover,
supervisors would continue to monitor the remediation of supervisory
issues, ensuring that these issues are resolved in an appropriate
timeframe.
E. Conclusion
The proposal has the potential to alleviate constraints faced by
large financial institutions and supervised insurance organizations
that are financial holding companies arising from the current
requirements for a firm to be ``well managed.'' By enabling firms to
potentially realize economies of scale and scope, the proposal could
enhance operational efficiency and promote financial innovation.
Vigilant supervision can address a potential increase in risk-taking by
firms. Taken together, the Board expects that the benefits of this
proposal justify the costs.
Question 8: What additional benefits or costs could be relevant for
assessing the proposal?
Question 9: How would the proposed changes impact firm behavior,
including expansionary activities? What additional risks could these
changes in behavior pose to individual firms and the banking sector?
IV. Administrative Law Matters
A. Solicitation of Comments and Use of Plain Language
Section 722 of the Gramm-Leach-Bliley Act \46\ requires the Federal
banking agencies to use plain language in all proposed and final rules
published after January 1, 2000. The Board has sought to present the
proposal in a simple and straightforward manner and invite comment on
the use of plain language. For example:
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\46\ Public Law 106-102, sec. 722, 113 Stat. 1338, 1471 (1999),
12 U.S.C. 4809.
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<bullet> Has the Board organized the material to suit your needs?
If not, how could they present the proposal more clearly?
<bullet> Are the requirements in the proposal clearly stated? If
not, how could the proposal be more clearly stated?
<bullet> Do the regulations contain technical language or jargon
that is not clear? If so, which language requires clarification?
<bullet> Would a different format (grouping and order of sections,
use of headings, paragraphing) make the regulation easier to
understand? If so, what changes would achieve that?
<bullet> Would more, but shorter, sections be better? If so, which
sections should be changed?
<bullet> What other changes can the Board incorporate to make the
regulation easier to understand?
B. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') generally requires an
agency to conduct an initial regulatory flexibility analysis (``IRFA'')
and a final regulatory flexibility analysis (``FRFA'') of any rule
subject to notice-and-comment rulemaking requirements, unless the head
of the agency certifies that the rule will not, if promulgated, have a
significant economic impact on a substantial number of small
entities.\47\ This proposal would not impose any obligations on
regulated entities, and regulated entities would not need to take any
action in response to this proposal. The Board certifies that the
proposal will not have a significant economic impact on a substantial
number of small entities.\48\ The Board requests comments on this
analysis and any relevant data.
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\47\ 5 U.S.C. 601-612.
\48\ 5 U.S.C. 605(b).
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C. Riegle Community Development and Regulatory Improvement Act of 1994
Pursuant to section 302(a) of the Riegle Community Development and
Regulatory Improvement Act (``RCDRIA''),\49\ in determining the
effective date and administrative compliance requirements for new
regulations that impose additional reporting, disclosure, or other
requirements on insured depository institutions (``IDIs''), each
Federal banking agency must consider, consistent with principles of
safety and soundness and the public interest, any administrative
burdens that such regulations would place on depository institutions,
including small depository institutions, and customers of depository
institutions, as well as the benefits of such regulations. In addition,
section 302(b) of RCDRIA requires new regulations and amendments to
regulations that impose additional reporting, disclosures, or other new
requirements on IDIs generally to take effect on the first day of a
calendar quarter that begins on or after the date on which the
regulations are published in final form.\50\ The Board has determined
that the proposal would not impose additional reporting, disclosure, or
other requirements on IDIs; therefore, the requirements of the RCDRIA
do not apply. However, the Board invites comments that will further
inform its consideration of RCDRIA.
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\49\ 12 U.S.C. 4802(a).
\50\ 12 U.S.C. 4802.
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D. Providing Accountability Through Transparency Act of 2023
The Providing Accountability Through Transparency Act of 2023 (12
U.S.C. 553(b)(4)) requires that a notice of proposed rulemaking include
the internet address of a summary of not more than 100 words in length
of the proposed rule, in plain language, that shall be posted on the
internet website under section 206(d) of the E-Government Act of 2002
(44 U.S.C. 3501 note).
In summary, the Board is inviting public comment on a proposal to
revise two of its supervisory rating systems for
[[Page 31652]]
large financial institutions. The proposal would revise the rating
systems such that a firm that receives certain deficient ratings in one
of three supervisory criteria would still be considered well managed,
assuming the other two criteria are rated satisfactory.
The proposal and such a summary can be found at <a href="https://www.regulations.gov">https://www.regulations.gov</a> and <a href="https://www.federalreserve.gov/supervisionreg/reglisting.htm">https://www.federalreserve.gov/supervisionreg/reglisting.htm</a>.
This Appendix A and Appendix B will not publish in the CFR.
Appendix A--Text of Proposed Large Financial Institution Rating System
A. Overview
Each large financial institution (LFI) is expected to ensure that
the consolidated organization (or the combined U.S. operations in the
case of foreign banking organizations), including its critical
operations and banking offices, remain safe and sound and in compliance
with laws and regulations, including those related to consumer
protection.\51\ The LFI rating system provides a supervisory evaluation
of whether a covered firm possesses sufficient financial and
operational strength and resilience to maintain safe-and-sound
operations through a range of conditions, including stressful ones.\52\
The LFI rating system applies to bank holding companies with total
consolidated assets of $100 billion or more; all non-insurance, non-
commercial savings and loan holding companies with total consolidated
assets of $100 billion or more; and U.S. intermediate holding companies
of foreign banking organizations with combined U.S. assets of $50
billion or more established pursuant to the Federal Reserve's
Regulation YY.\53\
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\51\ See SR letter 12-17/CA letter 12-14, ``Consolidated
Supervisory Framework for Large Financial Institutions,'' at <a href="http://www.federalreserve.gov/bankinforeg/srletters/sr1217.htm">http://www.federalreserve.gov/bankinforeg/srletters/sr1217.htm</a>.
Hereinafter, when ``safe and sound'' or ``safety and soundness''
is used in this framework, related expectations apply to the
consolidated organization and the firm's critical operations and
banking offices.
``Critical operations'' are a firm's operations, including
associated services, functions and support, the failure or
discontinuance of which, in the view of the firm or the Federal
Reserve, would pose a threat to the financial stability of the
United States.
``Banking offices'' are defined as U.S. depository institution
subsidiaries, as well as the U.S. branches and agencies of foreign
banking organizations.
\52\ ``Financial strength and resilience'' is defined as
maintaining effective capital and liquidity governance and planning
processes, and sufficiency of related positions, to provide for the
continuity of the consolidated organization (including its critical
operations and banking offices) through a range of conditions.
``Operational strength and resilience'' is defined as
maintaining effective governance and controls to provide for the
continuity of the consolidated organization (including its critical
operations and banking offices) and to promote compliance with laws
and regulations, including those related to consumer protection,
through a range of conditions.
References to ``financial or operational'' weaknesses or
deficiencies implicate a firm's financial or operational strength
and resilience.
\53\ Total consolidated assets will be calculated based on the
average of the firm's total consolidated assets in the four most
recent quarters as reported on the firm's quarterly financial
reports filed with the Federal Reserve. A firm will continue to be
rated under the LFI rating system until it has less than $95 billion
in total consolidated assets, based on the average total
consolidated assets as reported on the firm's four most recent
quarterly financial reports filed with the Federal Reserve. As noted
in the proposal, the Federal Reserve may determine to apply the RFI
rating system or another applicable rating system in certain limited
circumstances.
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The LFI rating system is designed to:
<bullet> Fully align with the Federal Reserve's current supervisory
programs and practices, which are based upon the LFI supervision
framework's core objectives of reducing the probability of LFIs failing
or experiencing material distress and reducing the risk to U.S.
financial stability;
<bullet> Enhance the clarity and consistency of supervisory
assessments and communications of supervisory findings and
implications; and
<bullet> Provide transparency related to the supervisory
consequences of a given rating.
The LFI rating system is comprised of three components:
<bullet> Capital Planning and Positions: An evaluation of (i) the
effectiveness of a firm's governance and planning processes used to
determine the amount of capital necessary to cover risks and exposures,
and to support activities through a range of conditions and events; and
(ii) the sufficiency of a firm's capital positions to comply with
applicable regulatory requirements and to support the firm's ability to
continue to serve as a financial intermediary through a range of
conditions.
<bullet> Liquidity Risk Management and Positions: An evaluation of
(i) the effectiveness of a firm's governance and risk management
processes used to determine the amount of liquidity necessary to cover
risks and exposures, and to support activities through a range of
conditions; and (ii) the sufficiency of a firm's liquidity positions to
comply with applicable regulatory requirements and to support the
firm's ongoing obligations through a range of conditions.
Governance and Controls: An evaluation of the effectiveness of a
firm's (i) board of directors,\54\ (ii) management of business lines
and independent risk management and controls,\55\ and (iii) recovery
planning (only for domestic firms that are subject to the Board's Large
Institution Supervision Coordinating Committee (LISCC) Framework).\56\
This rating assesses a firm's effectiveness in aligning strategic
business objectives with the firm's risk appetite and risk management
capabilities; maintaining effective and independent risk management and
control functions, including internal audit; promoting compliance with
laws and regulations, including those related to consumer protection;
and otherwise planning for the ongoing resiliency of the firm.\57\
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\54\ References to ``board'' or ``board of directors'' in this
framework includes the equivalent to a board of directors, as
appropriate, as well as committees of the board of directors or the
equivalent thereof, as appropriate.
At this time, recovery planning expectations only apply to
domestic bank holding companies subject to the Federal Reserve's
LISCC supervisory framework. Should the Federal Reserve expand the
scope of recovery planning expectations to encompass additional
firms, this rating will reflect such expectations for the broader
set of firms.
\55\ The evaluation of the effectiveness of management of
business lines would include management of critical operations.
\56\ There are eight domestic firms in the LISCC portfolio: (1)
Bank of America Corporation; (2) Bank of New York Mellon
Corporation; (3) Citigroup, Inc.; (4) Goldman Sachs Group, Inc.; (5)
JP Morgan Chase & Co.; (6) Morgan Stanley; (7) State Street
Corporation; and (8) Wells Fargo & Company. In this guidance, these
eight firms may collectively be referred to as ``domestic LISCC
firms.''
\57\ ``Risk appetite'' is defined as the aggregate level and
types of risk the board and senior management are willing to assume
to achieve the firm's strategic business objectives, consistent with
applicable capital, liquidity, and other requirements and
constraints.
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B. Assignment of the LFI Component Ratings
Each LFI component rating is assigned along a four-level scale:
<bullet> Broadly Meets Expectations: A firm's practices and
capabilities broadly meet supervisory expectations, and the firm
possesses sufficient financial and operational strength and resilience
to maintain safe-and-sound operations through a range of conditions.
The firm may be subject to identified supervisory issues requiring
corrective action. These issues are unlikely to present a threat to the
firm's ability to maintain safe-and-sound operations through a range of
conditions.
<bullet> Conditionally Meets Expectations: Certain, material
financial or operational weaknesses in a firm's practices or
capabilities may place the firm's prospects for remaining safe and
sound through a range of conditions at risk if not resolved in a timely
manner during the normal course of business.
The Federal Reserve does not intend for a firm to be assigned a
``Conditionally Meets Expectations'' rating for a prolonged period, and
will
[[Page 31653]]
work with the firm to develop an appropriate timeframe to fully resolve
the issues leading to the rating assignment and merit upgrade to a
``Broadly Meets Expectations'' rating.
A firm is assigned a ``Conditionally Meets Expectations'' rating--
as opposed to a ``Deficient'' rating--when it has the ability to
resolve these issues through measures that do not require a material
change to the firm's business model or financial profile, or its
governance, risk management or internal control structures or
practices. Failure to resolve the issues in a timely manner would most
likely result in the firm's downgrade to a ``Deficient'' rating, since
the inability to resolve the issues would indicate that the firm does
not possess sufficient financial or operational capabilities to
maintain its safety and soundness through a range of conditions.
It is recognized that completion and validation of remediation
activities for select supervisory issues--such as those involving
information technology modifications--may require an extended time
horizon. In all instances, appropriate and effective risk mitigation
techniques must be utilized in the interim to maintain safe-and-sound
operations under a range of conditions until remediation activities are
completed, validated, and fully operational.
<bullet> Deficient-1: Financial or operational deficiencies in a
firm's practices or capabilities put the firm's prospects for remaining
safe and sound through a range of conditions at significant risk. The
firm is unable to remediate these deficiencies in the normal course of
business, and remediation would typically require the firm to make a
material change to its business model or financial profile, or its
practices or capabilities.
A firm's failure to resolve the issues in a timely manner that gave
rise to a ``Conditionally Meets Expectations'' rating would most likely
result in its downgrade to a ``Deficient'' rating. A firm with a
``Deficient-1'' rating is required to take timely corrective action to
correct financial or operational deficiencies and to restore and
maintain its safety and soundness and compliance with laws and
regulations, including those related to consumer protection. Firms with
one or more ``Deficient-1'' component ratings may be subject to an
informal or formal enforcement action, depending on particular facts
and circumstances. Two or more component ratings of ``Deficient-1''
could be a barrier for a firm seeking Federal Reserve approval to
engage in new or expansionary activities.
<bullet> Deficient-2: Financial or operational deficiencies in a
firm's practices or capabilities present a threat to the firm's safety
and soundness, or have already put the firm in an unsafe and unsound
condition.
A firm with a ``Deficient-2'' rating is required to immediately
implement comprehensive corrective measures, and demonstrate the
sufficiency of contingency planning in the event of further
deterioration. There is a strong presumption that a firm with a
``Deficient-2'' rating will be subject to a formal enforcement action,
and the Federal Reserve would be unlikely to approve any proposal from
a firm with this rating to engage in new or expansionary activities.
The Federal Reserve will take into account a number of individual
elements of a firm's practices, capabilities and performance when
making each component rating assignment. The weighting of an individual
element in assigning a component rating will depend on its impact on
the firm's safety, soundness and resilience as provided for in the LFI
rating system definitions. For example, for purposes of the Governance
and Controls rating, a limited number of significant deficiencies--or
even just one significant deficiency--noted for management of a single
material business line could be viewed as sufficiently important to
warrant a ``Deficient-1'' for the Governance and Controls component
rating, even if the firm meets supervisory expectations under the
Governance and Controls component in all other respects.
Under the LFI rating system, a firm must be rated ``Broadly Meets
Expectations'' or ``Conditionally Meets Expectations'' for each of the
three component ratings (Capital, Liquidity, Governance and Controls),
or rated ``Deficient-1'' in one component and ``Broadly Meets
Expectations'' or ``Conditionally Meets Expectations'' ratings for each
of the other two components, to be considered ``well managed'' in
accordance with various statutes and regulations.\58\ A firm rated
``Deficient-1'' for two or more rating components or ``Deficient-2''
for any rating component would not be considered ``well managed,''
which would subject the firm to various consequences. The Federal
Reserve would be unlikely to approve any proposal from a firm rated
``Deficient-2'' for any rating component to engage in new or
expansionary activities. A firm rated ``Deficient-1'' for two or more
rating component would not be considered ``well managed,'' which would
subject the firm to various consequences. Two or more ``Deficient-1''
ratings could be a barrier for a firm seeking Federal Reserve approval
of a proposal to engage in new or expansionary activities, unless the
firm can demonstrate that (i) it is making meaningful, sustained
progress in resolving identified deficiencies and issues; (ii) the
proposed new or expansionary activities would not present a risk of
exacerbating current deficiencies or issues or lead to new concerns;
and (iii) the proposed activities would not distract the firm from
remediating current deficiencies or issues A ``well managed'' firm has
sufficient financial and operational strength and resilience to
maintain safe-and-sound operations through a range of conditions,
including stressful ones.
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\58\ 12 U.S.C. 1841 et seq. and 12 U.S.C. 1461 et seq. See,
e.g.,12 CFR 225.4(b)(6), 225.14, 225.22(a), 225.23, 225.85, and
225.86; 12 CFR 211.9(b), 211.10(a)(14), and 211.34; and 12 CFR
223.41.
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C. LFI Rating Components
The LFI rating system is comprised of three component ratings: \59\
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\59\ There may be instances where deficiencies or supervisory
issues may be relevant to the Federal Reserve's assessment of more
than one component area. As such, the LFI rating will reflect these
deficiencies or issues within multiple rating components when
necessary to provide a comprehensive supervisory assessment.
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1. Capital Planning and Positions Component Rating
The Capital Planning and Positions component rating evaluates (i)
the effectiveness of a firm's governance and planning processes used to
determine the amount of capital necessary to cover risks and exposures,
and to support activities through a range of conditions; and (ii) the
sufficiency of a firm's capital positions to comply with applicable
regulatory requirements and to support the firm's ability to continue
to serve as a financial intermediary through a range of conditions.
In developing this rating, the Federal Reserve evaluates:
<bullet> Capital Planning: The extent to which a firm maintains
sound capital planning practices through effective governance and
oversight; effective risk management and controls; maintenance of
updated capital policies and contingency plans for addressing potential
shortfalls; and incorporation of appropriately stressful conditions
into capital planning and projections of capital positions; and
<bullet> Capital Positions: The extent to which a firm's capital is
sufficient to
[[Page 31654]]
comply with regulatory requirements, and to support its ability to meet
its obligations to depositors, creditors, and other counterparties and
continue to serve as a financial intermediary through a range of
conditions.
Definitions for the Capital Planning and Positions Component Rating
Broadly Meets Expectations
A firm's capital planning and positions broadly meet supervisory
expectations and support maintenance of safe-and-sound operations.
Specifically:
<bullet> The firm is capable of producing sound assessments of
capital adequacy through a range of conditions; and
<bullet> The firm's current and projected capital positions comply
with regulatory requirements, and support its ability to absorb current
and potential losses, to meet obligations, and to continue to serve as
a financial intermediary through a range of conditions.
A firm rated ``Broadly Meets Expectations'' may be subject to
identified supervisory issues requiring corrective action. However,
these issues are unlikely to present a threat to the firm's ability to
maintain safe-and-sound operations through a range of potentially
stressful conditions.
A firm that does not meet the capital planning and position
expectations associated with a ``Broadly Meets Expectations'' rating
will be rated ``Conditionally Meets Expectations,'' ``Deficient-1,'' or
``Deficient-2,'' and subject to potential consequences as outlined
below.
Conditionally Meets Expectations
Certain, material financial or operational weaknesses in a firm's
capital planning or positions may place the firm's prospects for
remaining safe and sound through a range of conditions at risk if not
resolved in a timely manner during the normal course of business.
Specifically, if left unresolved, these weaknesses:
<bullet> May threaten the firm's ability to produce sound
assessments of capital adequacy through a range of conditions; and/or
<bullet> May result in the firm's projected capital positions being
insufficient to absorb potential losses, comply with regulatory
requirements, and support the firm's ability to meet current and
prospective obligations and to continue to serve as a financial
intermediary through a range of conditions.
The Federal Reserve does not intend for a firm to be rated
``Conditionally Meets Expectations'' for a prolonged period. The firm
has the ability to resolve these issues through measures that do not
require a material change to the firm's business model or financial
profile, or its governance, risk management, or internal control
structures or practices. The Federal Reserve will work with the firm to
develop an appropriate timeframe during which the firm would be
required to resolve each supervisory issue leading to the
``Conditionally Meets Expectations'' rating.
The Federal Reserve will closely monitor the firm's remediation and
mitigation activities; in most instances, the firm will either:
(i) Resolve the issues in a timely manner and, if no new material
supervisory issues arise, be upgraded to a ``Broadly Meets
Expectations'' rating because the firm's capital planning practices and
related positions would broadly meet supervisory expectations; or
(ii) Fail to resolve the issues in a timely manner and be
downgraded to a ``Deficient-1'' rating, because the inability to
resolve the issues would indicate that the firm does not possess
sufficient financial or operational capabilities to maintain its safety
and soundness through a range of conditions.
It is possible that a firm may be close to completing resolution of
the supervisory issues leading to the ``Conditionally Meets
Expectations'' rating, but new issues are identified that, taken alone,
would be consistent with a ``Conditionally Meets Expectations'' rating.
In this event, the firm may continue to be rated ``Conditionally Meets
Expectations,'' provided the new issues do not reflect a pattern of
deeper or prolonged capital planning or position weaknesses consistent
with a ``Deficient'' rating.
A ``Conditionally Meets Expectations'' rating may be assigned to a
firm that meets the above definition regardless of its prior rating. A
firm previously rated ``Deficient-1'' may be upgraded to
``Conditionally Meets Expectations'' if the firm's remediation and
mitigation activities are sufficiently advanced so that the firm's
prospects for remaining safe and sound are no longer at significant
risk, even if the firm has outstanding supervisory issues or is subject
to an active enforcement action.
Deficient-1
Financial or operational deficiencies in a firm's capital planning
or positions put the firm's prospects for remaining safe and sound
through a range of conditions at significant risk. The firm is unable
to remediate these deficiencies in the normal course of business, and
remediation would typically require a material change to the firm's
business model or financial profile, or its capital planning practices.
Specifically, although the firm's current condition is not
considered to be materially threatened:
<bullet> Deficiencies in the firm's capital planning processes are
not effectively mitigated. These deficiencies limit the firm's ability
to effectively assess capital adequacy through a range of conditions;
and/or
<bullet> The firm's projected capital positions may be insufficient
to absorb potential losses and to support its ability to meet current
and prospective obligations and serve as a financial intermediary
through a range of conditions.
Supervisory issues that place the firm's safety and soundness at
significant risk, and where resolution is likely to require steps that
clearly go beyond the normal course of business--such as issues
requiring a material change to the firm's business model or financial
profile, or its governance, risk management or internal control
structures or practices--would generally warrant assignment of a
``Deficient-1'' rating.
A ``Deficient-1'' rating may be assigned to a firm regardless of
its prior rating. A firm previously rated ``Broadly Meets
Expectations'' may be downgraded to ``Deficient-1'' when supervisory
issues are identified that place the firm's prospects for maintaining
safe-and-sound operations through a range of potentially stressful
conditions at significant risk. A firm previously rated ``Conditionally
Meets Expectations'' may be downgraded to ``Deficient-1'' when the
firm's inability to resolve supervisory issues in a timely manner
indicates that the firm does not possess sufficient financial or
operational capabilities to maintain its safety and soundness through a
range of conditions.
To address these financial or operational deficiencies, the firm is
required to take timely corrective action to restore and maintain its
capital planning and positions consistent with supervisory
expectations.
Deficient-2
Financial or operational deficiencies in a firm's capital planning
or positions present a threat to the firm's safety and soundness, or
have already put the firm in an unsafe and unsound condition.
Specifically, as a result of these deficiencies:
<bullet> The firm's capital planning processes are insufficient to
effectively
[[Page 31655]]
assess the firm's capital adequacy through a range of conditions; and/
or
<bullet> The firm's current or projected capital positions are
insufficient to absorb current or potential losses, and to support the
firm's ability to meet current and prospective obligations and serve as
a financial intermediary through a range of conditions.
To address these deficiencies, the firm is required to immediately
(i) implement comprehensive corrective measures sufficient to restore
and maintain appropriate capital planning capabilities and adequate
capital positions; and (ii) demonstrate the sufficiency, credibility
and readiness of contingency planning in the event of further
deterioration of the firm's financial or operational strength or
resiliency. There is a strong presumption that a firm rated
``Deficient-2'' will be subject to a formal enforcement action by the
Federal Reserve.
2. Liquidity Risk Management and Positions Component Rating
The Liquidity Risk Management and Positions component rating
evaluates (i) the effectiveness of a firm's governance and risk
management processes used to determine the amount of liquidity
necessary to cover risks and exposures, and to support activities
through a range of conditions; and (ii) the sufficiency of a firm's
liquidity positions to comply with applicable regulatory requirements
and to support the firm's ongoing obligations through a range of
conditions.
In developing this rating, the Federal Reserve evaluates:
<bullet> Liquidity Risk Management: The extent to which a firm
maintains sound liquidity risk management practices through effective
governance and oversight; effective risk management and controls;
maintenance of updated liquidity policies and contingency plans for
addressing potential shortfalls; and incorporation of appropriately
stressful conditions into liquidity planning and projections of
liquidity positions; and
<bullet> Liquidity Positions: The extent to which a firm's
liquidity is sufficient to comply with regulatory requirements, and to
support its ability to meet current and prospective obligations to
depositors, creditors and other counterparties through a range of
conditions.
Definitions for the Liquidity Risk Management and Positions Component
Rating Broadly Meets Expectations
A firm's liquidity risk management and positions broadly meet
supervisory expectations and support maintenance of safe-and-sound
operations. Specifically:
<bullet> The firm is capable of producing sound assessments of
liquidity adequacy through a range of conditions; and
<bullet> The firm's current and projected liquidity positions
comply with regulatory requirements, and support its ability to meet
current and prospective obligations and to continue to serve as a
financial intermediary through a range of conditions.
A firm rated ``Broadly Meets Expectations'' may be subject to
identified supervisory issues requiring corrective action. However,
these issues are unlikely to present a threat to the firm's ability to
maintain safe-and-sound operations through a range of potentially
stressful conditions.
A firm that does not meet the liquidity risk management and
position expectations associated with a ``Broadly Meets Expectations''
rating will be rated ``Conditionally Meets Expectations,'' ``Deficient-
1,'' or ``Deficient-2,'' and subject to potential consequences as
outlined below.
Conditionally Meets Expectations
Certain, material financial or operational weaknesses in a firm's
liquidity risk management or positions may place the firm's prospects
for remaining safe and sound through a range of conditions at risk if
not resolved in a timely manner during the normal course of business.
Specifically, if left unresolved, these weaknesses:
<bullet> May threaten the firm's ability to produce sound
assessments of liquidity adequacy through a range of conditions; and/or
<bullet> May result in the firm's projected liquidity positions
being insufficient to comply with regulatory requirements, and support
its ability to meet current and prospective obligations and to continue
to serve as a financial intermediary through a range of conditions.
The Federal Reserve does not intend for a firm to be rated
``Conditionally Meets Expectations'' for a prolonged period. The firm
has the ability to resolve these issues through measures that do not
require a material change to the firm's business model or financial
profile, or its governance, risk management or internal control
structures or practices. The Federal Reserve will work with the firm to
develop an appropriate timeframe during which the firm would be
required to resolve each supervisory issue leading to the
``Conditionally Meets Expectations'' rating.
The Federal Reserve will closely monitor the firm's remediation and
mitigation activities; in most instances, the firm will either:
(i) Resolve the issues in a timely manner and, if no new material
supervisory issues arise, and be upgraded to a ``Broadly Meets
Expectations'' rating because the firm's liquidity risk management
practices and related positions would broadly meet supervisory
expectations; or
(ii) Fail to resolve the issues in a timely manner and be
downgraded to a ``Deficient-1'' rating, because the firm's inability to
resolve those issues would indicate that the firm does not possess
sufficient financial or operational capabilities to maintain its safety
and soundness through a range of conditions.
It is possible that a firm may be close to completing resolution of
the supervisory issues leading to the ``Conditionally Meets
Expectations'' rating, but new issues are identified that, taken alone,
would be consistent with a ``Conditionally Meets Expectations'' rating.
In this event, the firm may continue to be rated ``Conditionally Meets
Expectations,'' provided the new issues do not reflect a pattern of
deeper or prolonged capital planning or position weaknesses consistent
with a ``Deficient'' rating.
A ``Conditionally Meets Expectations'' rating may be assigned to a
firm that meets the above definition regardless of its prior rating. A
firm previously rated ``Deficient-1'' may be upgraded to
``Conditionally Meets Expectations'' if the firm's remediation and
mitigation activities are sufficiently advanced so that the firm's
prospects for remaining safe and sound are no longer at significant
risk, even if the firm has outstanding supervisory issues or is subject
to an active enforcement action.
Deficient-1
Financial or operational deficiencies in a firm's liquidity risk
management or positions put the firm's prospects for remaining safe and
sound through a range of conditions at significant risk. The firm is
unable to remediate these deficiencies in the normal course of
business, and remediation would typically require a material change to
the firm's business model or financial profile, or its liquidity risk
management practices.
Specifically, although the firm's current condition is not
considered to be materially threatened:
<bullet> Deficiencies in the firm's liquidity risk management
processes are not effectively mitigated. These deficiencies limit the
firm's ability to effectively
[[Page 31656]]
assess liquidity adequacy through a range of conditions; and/or
<bullet> The firm's projected liquidity positions may be
insufficient to support its ability to meet prospective obligations and
serve as a financial intermediary through a range of conditions.
Supervisory issues that place the firm's safety and soundness at
significant risk, and where resolution is likely to require steps that
clearly go beyond the normal course of business--such as issues
requiring a material change to the firm's business model or financial
profile, or its governance, risk management or internal control
structures or practices--would generally warrant assignment of a
``Deficient-1'' rating.
A ``Deficient-1'' rating may be assigned to a firm regardless of
its prior rating. A firm previously rated ``Broadly Meets
Expectations'' may be downgraded to ``Deficient-1'' when supervisory
issues are identified that place the firm's prospects for maintaining
safe-and-sound operations through a range of potentially stressful
conditions at significant risk. A firm previously rated ``Conditionally
Meets Expectations'' may be downgraded to ``Deficient-1'' when the
firm's inability to resolve supervisory issues in a timely manner
indicates that the firm does not possess sufficient financial or
operational capabilities to maintain its safety and soundness through a
range of conditions.
To address these financial or operational deficiencies, the firm is
required to take timely corrective action to restore and maintain its
liquidity risk management and positions consistent with supervisory
expectations.
Deficient-2
Financial or operational deficiencies in a firm's liquidity risk
management or positions present a threat to the firm's safety and
soundness, or have already put the firm in an unsafe and unsound
condition.
Specifically, as a result of these deficiencies:
<bullet> The firm's liquidity risk management processes are
insufficient to effectively assess the firm's liquidity adequacy
through a range of conditions; and/or
<bullet> The firm's current or projected liquidity positions are
insufficient to support the firm's ability to meet current and
prospective obligations and serve as a financial intermediary through a
range of conditions.
To address these deficiencies, the firm is required to immediately
(i) implement comprehensive corrective measures sufficient to restore
and maintain appropriate liquidity risk management capabilities and
adequate liquidity positions; and (ii) demonstrate the sufficiency,
credibility and readiness of contingency planning in the event of
further deterioration of the firm's financial or operational strength
or resiliency.
3. Governance and Controls Component Rating
The Governance and Controls component rating evaluates the
effectiveness of a firm's (i) board of directors, (ii) management of
business lines and independent risk management and controls, and (iii)
recovery planning (for domestic LISCC firms only). This rating assesses
a firm's effectiveness in aligning strategic business objectives with
the firm's risk appetite and risk management capabilities; maintaining
effective and independent risk management and control functions,
including internal audit; promoting compliance with laws and
regulations, including those related to consumer protection; and
otherwise providing for the ongoing resiliency of the firm.
In developing this rating, the Federal Reserve evaluates:
<bullet> Effectiveness of the Board of Directors: The extent to
which the board exhibits attributes that are consistent with those of
effective boards in carrying out its core roles and responsibilities,
including: (i) Setting a clear, aligned, and consistent direction
regarding the firm's strategy and risk appetite; (ii) directing senior
management regarding the board's information; (iii) overseeing and
holding senior management accountable, (iv) supporting the independence
and stature of independent risk management and internal audit; and (v)
maintaining a capable board composition and governance structure.
<bullet> Management of Business Lines and Independent Risk
Management and Controls
The extent to which:
[cir] Senior management effectively and prudently manages the day-
to-day operations of the firm and provides for ongoing resiliency;
implements the firm's strategy and risk appetite; maintains an
effective risk management framework and system of internal controls;
and promotes prudent risk taking behaviors and business practices,
including compliance with laws and regulations, including those related
to consumer protection.
[cir] Business line management executes business line activities
consistent with the firm's strategy and risk appetite; identifies and
manages risks; and ensures an effective system of internal controls for
its operations.
[cir] Independent risk management effectively evaluates whether the
firm's risk appetite appropriately captures material risks and is
consistent with the firm's risk management capacity; establishes and
monitors risk limits that are consistent with the firm's risk appetite;
identifies and measures the firm's risks; and aggregates, assesses and
reports on the firm's risk profile and positions. Additionally, the
firm demonstrates that its internal controls are appropriate and tested
for effectiveness. Finally, internal audit effectively and
independently assesses the firm's risk management framework and
internal control systems, and reports findings to senior management and
the firm's audit committee.
<bullet> Recovery Planning (domestic LISCC firms only): The extent
to which recovery planning processes effectively identify options that
provide a reasonable chance of a firm being able to remedy financial
weakness and restore market confidence without extraordinary official
sector support.
Definitions for the Governance and Controls Component Rating Broadly
Meets Expectations
A firm's governance and controls broadly meet supervisory
expectations and support maintenance of safe-and-sound operations.
Specifically, the firm's practices and capabilities are sufficient to
align strategic business objectives with its risk appetite and risk
management capabilities,\60\ maintain effective and independent risk
management and control functions, including internal audit; promote
compliance with laws and regulations (including those related to
consumer protection); and otherwise provide for the firm's ongoing
financial and operational resiliency through a range of conditions.
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\60\ References to risk management capabilities includes risk
management of business lines and independent risk management and
control functions, including internal audit.
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A firm rated ``Broadly Meets Expectations'' may be subject to
identified supervisory issues requiring corrective action. However,
these issues are unlikely to present a threat to the firm's ability to
maintain safe-and-sound operations through a range of potentially
stressful conditions.
A firm that does not meet supervisory expectations associated with
a ``Broadly Meets Expectations'' rating will be rated ``Conditionally
Meets Expectations,'' ``Deficient-1,'' or ``Deficient-2,'' and subject
to potential consequences, as outlined below.
[[Page 31657]]
Conditionally Meets Expectations
Certain, material financial or operational weaknesses in a firm's
governance and controls practices may place the firm's prospects for
remaining safe and sound through a range of conditions at risk if not
resolved in a timely manner during the normal course of business.
Specifically, if left unresolved, these weaknesses may threaten the
firm's ability to align strategic business objectives with the firm's
risk appetite and risk management capabilities; maintain effective and
independent risk management and control functions, including internal
audit; promote compliance with laws and regulations (including those
related to consumer protection); or otherwise provide for the firm's
ongoing resiliency through a range of conditions.
The Federal Reserve does not intend for a firm to be rated
``Conditionally Meets Expectations'' for a prolonged period. The firm
has the ability to resolve these issues through measures that do not
require a material change to the firm's business model or financial
profile, or its governance, risk management or internal control
structures or practices. The Federal Reserve will work with the firm to
develop an appropriate timeframe during which the firm would be
required to resolve each supervisory issue leading to the
``Conditionally Meets Expectations'' rating.
The Federal Reserve will closely monitor the firm's remediation and
mitigation activities; in most instances, the firm will either:
(i) Resolve the issues in a timely manner and, if no new material
supervisory issues arise, and be upgraded to a ``Broadly Meets
Expectations'' rating because the firm's governance and controls would
broadly meet supervisory expectations; or
(ii) Fail to resolve the issues in a timely manner and be
downgraded to a ``Deficient-1'' rating, because the firm's inability to
resolve those issues would indicate that the firm does not possess
sufficient financial or operational capabilities to maintain its safety
and soundness through a range of conditions.
It is possible that a firm may be close to completing resolution of
the supervisory issues leading to the ``Conditionally Meets
Expectations'' rating, but new issues are identified that, taken alone,
would be consistent with a ``Conditionally Meets Expectations'' rating.
In this event, the firm may continue to be rated ``Conditionally Meets
Expectations,'' provided the new issues do not reflect a pattern of
deeper or prolonged capital planning or position weaknesses consistent
with a ``Deficient'' rating.
A ``Conditionally Meets Expectations'' rating may be assigned to a
firm that meets the above definition regardless of its prior rating. A
firm previously rated ``Deficient'' may be upgraded to ``Conditionally
Meets Expectations'' if the firm's remediation and mitigation
activities are sufficiently advanced so that the firm's prospects for
remaining safe and sound are no longer at significant risk, even if the
firm has outstanding supervisory issues or is subject to an active
enforcement action.
Deficient-1
Financial or operational deficiencies in a firm's governance and
controls put the firm's prospects for remaining safe and sound through
a range of conditions at significant risk. The firm is unable to
remediate these deficiencies in the normal course of business, and
remediation would typically require a material change to the firm's
business model or financial profile, or its governance, risk management
or internal control structures or practices.
Specifically, although the firm's current condition is not
considered to be materially threatened, these deficiencies limit the
firm's ability to align strategic business objectives with its risk
appetite and risk management capabilities; maintain effective and
independent risk management and control functions, including internal
audit; promote compliance with laws and regulations (including those
related to consumer protection); or otherwise provide for the firm's
ongoing resiliency through a range of conditions.
A ``Deficient-1'' rating may be assigned to a firm regardless of
its prior rating. A firm previously rated ``Broadly Meets
Expectations'' may be downgraded to ``Deficient-1'' when supervisory
issues are identified that place the firm's prospects for maintaining
safe-and-sound operations through a range of potentially stressful
conditions at significant risk. A firm previously rated ``Conditionally
Meets Expectations'' may be downgraded to ``Deficient-1'' when the
firm's inability to resolve supervisory issues in a timely manner
indicates that the firm does not possess sufficient financial or
operational capabilities to maintain its safety and soundness through a
range of conditions.
To address these financial or operational deficiencies, the firm is
required to take timely corrective action to restore and maintain its
governance and controls consistent with supervisory expectations.
Deficient-2
Financial or operational deficiencies in governance or controls
present a threat to the firm's safety and soundness, or have already
put the firm in an unsafe and unsound condition. Specifically, as a
result of these deficiencies, the firm is unable to align strategic
business objectives with its risk appetite and risk management
capabilities; maintain effective and independent risk management and
control functions, including internal audit; promote compliance with
laws and regulations (including those related to consumer protection);
or otherwise provide for the firm's ongoing resiliency.
To address these deficiencies, the firm is required to immediately
(i) implement comprehensive corrective measures sufficient to restore
and maintain appropriate governance and control capabilities; and (ii)
demonstrate the sufficiency, credibility, and readiness of contingency
planning in the event of further deterioration of the firm's financial
or operational strength or resiliency.
Appendix B--Text of Proposed Insurance Supervisory Framework
Framework for the Supervision of Insurance Organizations
This framework describes the Federal Reserve's approach to
consolidated supervision of supervised insurance organizations.\61\ The
framework is designed specifically to account for the unique risks and
business profiles of these firms resulting mainly from their insurance
business. The framework consists of a risk-based approach to
establishing supervisory expectations, assigning supervisory resources,
and conducting supervisory activities; a supervisory rating system; and
a description of how Federal Reserve examiners work with the state
insurance regulators to limit supervisory duplication.
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\61\ In this framework, a ``supervised insurance organization''
is a depository institution holding company that is an insurance
underwriting company, or that has over 25 percent of its
consolidated assets held by insurance underwriting subsidiaries, or
has been otherwise designated as a supervised insurance organization
by Federal Reserve staff.
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A. Proportionality--Supervisory Activities and Expectations
Consistent with the Federal Reserve's approach to risk-based
supervision, supervisory guidance is applied, and supervisory
activities are conducted, in
[[Page 31658]]
a manner that is proportionate to each firm's individual risk profile.
This begins by classifying each supervised insurance organization
either as complex or noncomplex based on its risk profile and continues
with a risk based application of supervisory guidance and supervisory
activities driven by a periodic risk assessment. The risk assessment
drives planned supervisory activities and is communicated to the firm
along with the supervisory plan for the upcoming cycle. Supervisory
activities are focused on resolving supervisory knowledge gaps,
monitoring the safety and soundness of the firm, assessing the firm's
management of risks that could potentially impact its ability to act as
a source of managerial and financial strength for its depository
institution(s), and monitoring for potential systemic risk, if
relevant.
1. Complexity Classification and Supervised Activities
The Federal Reserve classifies each supervised insurance
organization as either complex or noncomplex based on its risk profile.
The classification serves as the basis for determining the level of
supervisory resources dedicated to each firm, as well as the frequency
and intensity of supervisory activities.
Complex
Complex firms have a higher level of risk and therefore require
more supervisory attention and resources. Federal Reserve dedicated
supervisory teams are assigned to execute approved supervisory plans
led by a dedicated Central Point of Contact. The activities listed in
the supervisory plans focus on understanding any risks that could
threaten the safety and soundness of the consolidated organization or a
firm's ability to act as a source of strength for its subsidiary
depository institution(s). These activities typically include
continuous monitoring, targeted topical examinations, coordinated
reviews, and an annual roll-up assessment resulting in ratings for the
three rating components. The relevance of certain supervisory guidance
may vary among complex firms based on each firm's risk profile.
Supervisory guidance targeted at smaller depository institution holding
companies, for example, may be more relevant for complex supervised
insurance organizations with limited inherent exposure to a certain
risk.
Noncomplex
Noncomplex firms, due to their lower risk profile, require less
supervisory oversight relative to complex firms. The supervisory
activities for these firms occur primarily during a rating examination
that occurs no less often than every other year and results in the
three component ratings. The supervision of noncomplex firms relies
more heavily on the reports and assessments of a firm's other relevant
supervisors, although these firms may also be subject to continuous
monitoring, targeted topical examinations, and coordinated reviews as
appropriate. The focus and types of supervisory activities for noncom
plex firms are also set based on the risks of each firm.
Factors considered when classifying a supervised insurance
organization as either complex or noncom plex include the absolute and
relative size of its depository institution(s), its current supervisory
and regulatory oversight (ratings and opinions of its supervisors, and
the nature and extent of any unregulated and/or unsupervised
activities), the breadth and nature of product and portfolio risks, the
nature of its organizational structure, its quality and level of
capital and liquidity, the materiality of any international exposure,
and its interconnectedness with the broader financial system.
For supervised insurance organizations that are commencing Federal
Reserve supervision, the classification as complex or noncomplex is
done and communicated during the application phase after initial
discussions with the firm. The firm's risk profile, including the
characteristics listed above, are evaluated by staff of the Board and
relevant Reserve Bank before the complexity classification is assigned
by Board staff. Large, well-established, and financially strong
supervised insurance organizations with relatively small depository
institutions can be classified as noncomplex if, in the opinion of
Board staff, the corresponding level of supervisory oversight is
sufficient to accomplish its objectives. Although the risk profile is
the primary basis for assigning a classification, a firm is
automatically classified as complex if its depository institution's
average assets exceed $100 billion. A firm may request that the Federal
Reserve review its complexity classification if it has experienced a
significant change to its risk profile.
The focus, frequency, and intensity of supervisory activities are
based on a risk assessment of the firm completed periodically by the
supervisory team and will vary among firms within the same complexity
classification. For each risk described in the Supervisory Expectations
section below, the supervisory team assesses the firm's inherent risks
and its residual risk after considering the effectiveness of its
management of the risk. The risk assessment and the supervisory
activities that follow from it take into account the assessments made
by and work performed by the firm's other regulators. In certain
instances, Federal Reserve examiners may be able to rely on a firm's
internal audit (if it is rated effective) or internal control functions
in developing the risk assessment.
2. Supervisory Expectations
Supervised insurance organizations are required to operate in a
safe and sound manner, to comply with all applicable laws and
regulations, and to possess sufficient financial and operational
strength to serve as a source of strength for their depository
institution(s) through range of stressful yet plausible conditions. The
governance and risk management practices necessary to accomplish these
objectives will vary based on a firm's specific risk profile, size, and
complexity. Guidance describing supervisory expectations for safe and
sound practices can be found in Supervision & Regulation (SR) letters
published by the Board and other supervisory material. Supervisory
guidance most relevant to a specific supervised insurance organization
is driven by the risk profile of the firm. Federal Reserve examiners
periodically reassess the firm's risk profile and inform the firm if
different supervisory guidance becomes more relevant as a result of a
material change to its risk profile.
Most supervisory guidance issued by the Board is intended
specifically for institutions that are primarily engaged in banking
activities. Examples of specific practices provided in these materials
may differ from (or not be applicable to) the nonbanking operations of
supervised insurance organizations, including for insurance operations.
The Board recognizes that practices in nonbanking business lines can be
different than those published in supervisory guidance without being
considered unsafe or unsound. When making their assessment, Federal
Reserve examiners work with supervised insurance organizations and
other involved regulators, including state insurance regulators, to
appropriately assess practices that may be different than those
typically observed for banking operations.
This section describes general safety and soundness expectations
and how the Board has adapted its supervisory expectations to reflect
the special characteristics of a supervised insurance organization. The
section is organized
[[Page 31659]]
using the three rating components--Governance and Controls, Capital
Management, and Liquidity Management.
Governance and Controls
The Governance and Controls component rating is derived from an
assessment of the effectiveness of a firm's (1) board and senior
management, and (2) independent risk management and controls. All firms
are expected to align their strategic business objectives with their
risk appetite and risk management capabilities; maintain effective and
independent risk management and control functions including internal
audit; promote compliance with laws and regulations; and remain a
source of financial and managerial strength for their depository
institution(s).
When assessing governance and controls, Federal Reserve examiners
consider a firm's risk management capabilities relative to its risk
exposure within the following areas: internal audit, credit risk, legal
and compliance risk, market risk, model risk, and operational risk,
including cybersecurity/information technology and third-party risk.
Governance & Controls Expectations
<bullet> Despite differences in their business models and the
products offered, insurance companies and banks are expected to have
effective and sustainable systems of governance and controls to manage
their respective risks. The governance and controls framework for a
supervised insurance organization should:
[cir] Clearly define roles and responsibilities throughout the
organization;
[cir] Include policies and procedures, limits, requirements for
documenting decisions, and decision-making and accountability chains of
command; and
[cir] Provide timely information about risk and corrective action
for non-compliance or weak oversight, controls, and management.
<bullet> The Board expects the sophistication of the governance and
controls framework to be commensurate with the size, complexity, and
risk profile of the firm. As such, governance and controls expectations
for complex firms will be higher than that for noncom plex firms but
will also vary based on each firm's risk profile.
<bullet> The Board expects supervised insurance organizations to
have a risk management and control framework that is commensurate with
its structure, risk profile, complexity, activities, and size. For any
chosen structure, the firm's board is expected to have the capacity,
expertise, and sufficient information to discharge risk oversight and
governance responsibilities in a safe and sound manner.
In assigning a rating for the Governance and Controls component,
Federal Reserve examiners evaluate:
Board and Senior Management Effectiveness
<bullet> The firm's board is expected to exhibit certain attributes
consistent with effectiveness, including: (i) setting a clear, aligned,
and consistent direction regarding the firm's strategy and risk
appetite; (ii) directing senior management regarding board reporting;
(iii) overseeing and holding senior management accountable; (iv)
supporting the independence and stature of independent risk management
and internal audit; and (v) maintaining a capable board and an
effective governance structure. As the consolidated supervisor, the
Board focuses on the board of the supervised insurance organization and
its committees. Complex firms are expected to take into consideration
the Board's guidance on board of directors' effectiveness.\62\ In
assessing the effectiveness of a firm's senior management, Federal
Reserve examiners consider the extent to which senior management
effectively and prudently manages the day-to-day operations of the firm
and provides for ongoing resiliency; implements the firm's strategy and
risk appetite; identifies and manages risks; maintains an effective
risk management framework and system of internal controls; and promotes
prudent risk taking behaviors and business practices, including
compliance with laws and regulations such as those related to consumer
protection and the Bank Secrecy Act/Anti-Money Laundering and Office of
Foreign Assets Control (BSA/AML and OFAC). Federal Reserve examiners
evaluate how the framework allows management to be responsible for and
manage all risk types, including emerging risks, within the business
lines. Examiners rely to the fullest extent possible on insurance and
banking supervisors' examination reports and information concerning
risk and management in specific lines of business, including relying
specifically on state insurance regulators to evaluate and assess how
firms manage the pricing, underwriting, and reserving risk of their
insurance operations.
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\62\ See SR letter 21-3, ``Supervisory Guidance on Board of
Directors' Effectiveness.''
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Independent Risk Management and Controls
<bullet> In assessing a firm's independent risk management and
controls, Federal Reserve examiners consider the extent to which
independent risk management effectively evaluates whether the firm's
risk appetite framework identifies and measures all of the firm's
material risks; establishes appropriate risk limits; and aggregates,
assesses and reports on the firm's risk profile and positions.
Additionally, the firm is expected to demonstrate that its internal
controls are appropriate and tested for effectiveness and
sustainability.
<bullet> Internal Audit is an integral part of a supervised
insurance organization's internal control system and risk management
structure. An effective internal audit function plays an essential role
by providing an independent risk assessment and objective evaluation of
all key governance, risk management, and internal control processes.
Internal audit is expected to effectively and independently assess the
firm's risk management framework and internal control systems, and
report findings to senior management and to the firm's audit committee.
Despite differences in business models, the Board expects the largest,
most complex supervised insurance organizations to have internal audit
practices in place that are similar to those at banking organizations
and as such, no modification to existing guidance is required for these
firms.\63\ At the same time, the Board recognizes that firms should
have an internal audit function that is appropriate to their size,
nature, and scope of activities. Therefore, for noncomplex firms,
Federal Reserve examiners will consider the expectations in the
insurance company's domicile state's Annual Financial Reporting
Regulation (NAIC Model Audit Rule 205), or similar state regulation, to
assess the effectiveness of a firm's internal audit function.
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\63\ Regulatory guidance provided in SR letter 03-5, ``Amended
Interagency Guidance on the Internal Audit Function and its
Outsourcing'' and SR letter 13-1, ``Supplemental Policy Statement on
the Internal Audit Function and Its Outsourcing'' are applicable to
complex supervised insurance organizations.
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The principles of sound risk management described in the previous
sections apply to the entire spectrum of risk management activities of
a supervised insurance organization, including but not limited to:
<bullet> Credit risk arises from the possibility that a borrower or
counterparty will fail to perform on an obligation. Fixed income
securities, by far the largest asset class held by many
[[Page 31660]]
insurance companies, is a large source of credit risk. This is unlike
most banking organizations, where loans generally make up the largest
portion of balance sheet assets. Life insurer investment portfolios in
particular are generally characterized by longer duration holdings
compared to those of banking organizations. Additionally, an insurance
company's reinsurance recoverables/receivables arising from the use of
third-party reinsurance and participation in regulatory required risk-
pooling arrangements expose the firm to additional counterparty credit
risk. Federal Reserve examiners scope examination work based on a
firm's level of inherent credit risk. The level of inherent risk is
determined by analyzing the composition, concentration, and quality of
the consolidated investment portfolio; the level of a firm's
reinsurance recoverables, the credit quality of the individual
reinsurers, and the amount of collateral held for reinsured risks; and
credit exposures associated with derivatives, securities lending, or
other activities that may also have off-balance sheet counterparty
credit exposures. In determining the effectiveness of a firm's
management of its credit risk, Federal Reserve examiners rely, where
possible, on the assessments made by other relevant supervisors for the
depository institution(s) and the insurance company(ies). In its own
assessment, the Federal Reserve will determine whether the board and
senior management have established an appropriate credit risk
governance framework consistent with the firm's risk appetite; whether
policies, procedures and limits are adequate and provide for ongoing
monitoring, reporting and control of credit risk; the adequacy of
management information systems as it relates to credit risk; and the
sufficiency of internal audit and independent review coverage of credit
risk exposure.
<bullet> Market risk arises from exposures to losses as a result of
underlying changes in, for example, interest rates, equity prices,
foreign exchange rates, commodity prices, or real estate prices.
Federal Reserve examiners scope examination work based on a firm's
level of inherent market risk exposure, which is normally driven by the
primary business line(s) in which the firm is engaged as well as the
structure of the investment portfolio. A firm may be exposed to
inherent market risk due to its investment portfolio or as result of
its product offerings, including variable and indexed life insurance
and annuity products, or asset/wealth management business. While
interest rate risk (IRR), a category of market risk, differs between
insurance companies and banking organizations, the degree of IRR also
differs based on the type of insurance products the firm offers. IRR is
generally a small risk for U.S. property/casualty (P/C) whereas it can
be a significant risk factor for life insurers with certain life and
annuity products that are spread-based, longer in duration, may include
embedded product guarantees, and can pose disintermediation risk.
Equity market risk can be significant for life insurers that issue
guarantees tied to equity markets, like variable annuity living
benefits, and for P/C insurers with large common equity allocations in
their investment portfolios. Generally foreign exchange and commodity
risk is low for supervised insurance organizations but could be
material for some complex firms. Firms are expected to have sound risk
management infrastructure that adequately identifies, measures,
monitors, and controls any material or significant forms of market
risks to which it is exposed.
<bullet> Model risk is the potential for adverse consequences from
decisions based on incorrect or misused model outputs and reports.
Model risk can lead to financial loss, poor business and strategic
decision-making, or damage to a firm's reputation. Supervised insurance
organizations are often heavily reliant on models for product pricing
and reserving, risk and capital management strategic planning and other
decision-making purposes. A sound model risk management framework helps
manage this risk.\64\ Federal Reserve examiners take into account the
firm's size, nature, and complexity, as well as the extent of use and
sophistication of its models when assessing its model risk management
program. Examiners focus on the governance framework, policies and
controls, and enterprise model risk management through a holistic
evaluation of the firm's practices. The Federal Reserve's review of a
firm's model risk management program complements the work of the firm's
other relevant supervisors. A sound model risk management framework
includes three main elements: (1) an accurate model inventory and an
appropriate approach to model development, implementation, and use; (2)
effective model validation and continuous model performance monitoring;
and (3) a strong governance framework that provides explicit support
and structure for model risk management through policies defining
relevant activities, procedures that implement those policies,
allocation of resources, and mechanisms for evaluating whether policies
and procedures are being carried out as specified, including internal
audit review. The Federal Reserve relies on work already conducted by
other relevant supervisors and appropriately collaborates with state
insurance regulators on their findings related to insurance models.
With respect to insurance models, the Federal Reserve recognizes the
important role played by actuaries as described in actuarial standards
of practice on model risk management. With respect to the business of
insurance, Federal Reserve examiners focus on the firm's adherence to
its own policies and procedures and the comprehensiveness of model
validation rather than technical specifications such as the
appropriateness of the model, its assumptions, or output. Federal
Reserve examiners may request that firms provide model documentation or
model validation reports for insurance and bank models when performing
transaction testing.
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\64\ SR letter 11-7, ``Guidance on Model Risk Management'' is
applicable to all supervised insurance organizations.
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<bullet> Legal risk arises from the potential that unenforceable
contracts, lawsuits, or adverse judgments can disrupt or otherwise
negatively affect the operations or financial condition of a supervised
insurance organization.
<bullet> Compliance risk is the risk of regulatory sanctions,
fines, penalties, or losses resulting from failure to comply with laws,
rules, regulations, or other supervisory requirements applicable to a
firm. By offering multiple financial service products that may include
insurance, annuity, banking, services provided by securities broker-
dealers, and asset and wealth management products, provided through a
diverse distribution network, supervised insurance organizations are
inherently exposed to a significant amount of legal and compliance
risk. As the consolidated supervisor, the Board expects firms to have
an enterprise-wide legal and compliance risk management program that
covers all business lines, legal entities, and jurisdictions of
operation. Firms are expected to have compliance risk management
governance, oversight, monitoring, testing, and reporting commensurate
with their size and complexity, and to ensure compliance with all
applicable laws and regulations. The principles-based guidance in
existing SR letters related to legal and compliance risk is applicable
to supervised insurance
[[Page 31661]]
organizations.\65\ For both complex and noncom plex firms, Federal
Reserve examiners rely on the work of the firm's other supervisors. As
described in section C, Incorporating the Work of Other Supervisors,
the assessments, examination results, ratings, supervisory issues, and
enforcement actions from other supervisors will be incorporated into a
consolidated assessment of the enterprise-wide legal and compliance
risk management framework.
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\65\ SR letter 08-8, ``Compliance Risk Management Programs and
Oversight at Large Banking Organizations with Complex Compliance
Profiles'' is applicable to complex supervised insurance
organizations. For noncomplex firms, the Federal Reserve will assess
legal and compliance risk management based on the guidance in SR
letter 16-11, ``Supervisory Guidance for Assessing Risk Management
at Supervised Institutions with Total Consolidated Assets Less than
$100 Billion.''
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[cir] Money laundering, terrorist financing and other illicit
financial activity risk is the risk of providing criminals access to
the legitimate financial system and thereby being used to facilitate
financial crime. This financial crime includes laundering criminal
proceeds, financing terrorism, and conducting other illegal activities.
Money laundering and terrorist financing risk is associated with a
financial institution's products, services, customers, and geographic
locations. This and other illicit financial activity risks can impact a
firm across business lines, legal entities, and jurisdictions. A
reasonably designed compliance program generally includes a structure
and oversight that mitigates these risks and supports regulatory
compliance with both BSA/AML OFAC requirements. Although OFAC
regulations are not part of the BSA, OFAC compliance programs are
frequently assessed in conjunction with BSA/AML. Supervised insurance
organizations are not defined as financial institutions under the BSA
and, therefore, are not required to have an AML program, unless the
firm is directly selling certain insurance products. However, certain
subsidiaries and affiliates of supervised insurance organizations, such
as insurance companies and banks, are defined as financial institutions
under 31 U.S.C. 5312(a)(2) and must develop and implement a written
BSA/AML compliance program as well as comply with other BSA regulatory
requirements. Unlike banks, insurance companies' BSA/AML obligations
are limited to certain products, referred to as covered insurance
products.\66\ The volume of covered products, which the Financial
Crimes Enforcement Network (FinCEN) has determined to be of higher
risk, is an important driver of supervisory focus. In addition, as U.S.
persons, all supervised insurance organizations (including their
subsidiaries and affiliates) are subject to OFAC regulations. Federal
Reserve examiners assess all material risks that each firm faces,
extending to whether business activities across the consolidated
organization, including within its individual subsidiaries or
affiliates, comply with the legal requirements of BSA and OFAC
regulations. In keeping with the principles of a risk-based framework
and proportionality, Federal Reserve supervision for BSA/AML and OFAC
primarily focuses on oversight of compliance programs at a consolidated
level and relies on work by other relevant supervisors to the fullest
extent possible. In the evaluation of a firm's risks and BSA/AML and
OFAC compliance program, however, it may be necessary for examiners to
review compliance with BSA/AML and OFAC requirements at individual
subsidiaries or affiliates in order to fully assess the material risks
of the supervised insurance organization.
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\66\ ``Covered products'' means: a permanent life insurance
policy, other than a group life insurance policy; an annuity
contract, other than a group annuity contract; or any other
insurance product with features of cash value or investment. 31 CFR
1025.100(b). ``Permanent life insurance policy'' means an agreement
that contains a cash value or investment element and that obligates
the insurer to indemnify or to confer a benefit upon the insured or
beneficiary to the agreement contingent upon the death of the
insured. 31 CFR 1025.100(h). ``Annuity contract'' means any
agreement between the insurer and the contract owner whereby the
insurer promises to pay out a fixed or variable income stream for a
period of time. 31 CFR 1025.100(a).
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<bullet> Operational risk is the risk of loss resulting from
inadequate or failed internal processes, people, and systems, or from
external events. Operational resilience is the ability to maintain
operations, including critical operations and core business lines,
through a disruption from any hazard. It is the outcome of effective
operational risk management combined with sufficient financial and
operational resources to prepare, adapt, withstand, and recover from
disruptions. A firm that operates in a safe and sound manner is able to
identify threats, respond and adapt to incidents, and recover and learn
from such threats and incidents so that it can prioritize and maintain
critical operations and core business lines, along with other
operations, services and functions identified by the firm, through a
disruption.
[cir] Cybersecurity/information technology risks are a subset of
operational risk and arise from operations of a firm requiring a strong
and robust internal control system and risk management oversight
structure. Information Technology (IT) and Cybersecurity (Cyber)
functions are especially critical to a firm's operations. Examiners of
financial institutions, including supervised insurance organizations,
utilize the detailed guidance on mitigating these risks in the Federal
Financial Institutions Examination Council's (FFIEC) IT Handbooks. In
assessing IT/Cyber risks, Federal Reserve examiners assess each firm's:
[ssquf] Board and senior management for effective oversight and
support of IT management;
[ssquf] Information/cyber security program for strong board and
senior management support, integration of security activities and
controls through business processes, and establishment of clear
accountability for security responsibilities;
[ssquf] IT operations for sufficient personnel, system capacity and
availability, and storage capacity adequacy to achieve strategic
objectives and appropriate solutions;
[ssquf] Development and acquisition processes' ability to identify,
acquire, develop, install, and maintain effective IT to support
business operations; and
[ssquf] Appropriate business continuity management processes to
effectively oversee and implement resilience, continuity, and response
capabilities to safeguard employees, customers, assets, products, and
services.
[ssquf] Complex and noncomplex firms are assessed in these areas.
All supervised insurance organizations are required to notify the
Federal Reserve of any computer-security notification incidents.\67\
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\67\ SR letter 22-4, ``Contact Information in Relation to
Computer-Security Incident Notification Requirements'' applies to
all supervised insurance organizations.
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[cir] Third party risk is also a subset of operational risk and
arises from a firm's use of service providers to perform operational or
service functions. These risks may be inherent to the outsourced
activity or be introduced with the involvement of the service provider.
When assessing effective third party risk management, Federal Reserve
examiners evaluate eight areas: (1) third party risk management
governance, (2) risk assessment framework, (3) due diligence in the
selection of a service provider, (4) a review of any incentive
compensation embedded in a service provider contract, (5) management of
any contract or legal issues arising from third party agreements, (6)
ongoing monitoring and reporting of third parties, (7) business
continuity and
[[Page 31662]]
contingency of the third party for any service disruptions, and (8)
effective internal audit program to assess the risk and controls of the
firm's third party risk management program.\68\
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\68\ SR letter 13-19, ``Guidance on Managing Outsourcing Risk''
applies to all supervised insurance organizations.
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Capital Management
The Capital Management rating is derived from an assessment of a
firm's current and stressed level of capitalization, and the quality of
its capital planning and internal stress testing. A capital management
program should be commensurate with a supervised insurance
organization's complexity and risk profile. In assigning this rating,
the Federal Reserve examiners evaluate the extent to which a firm
maintains sound capital planning practices through effective governance
and oversight, effective risk management and controls, maintenance of
updated capital policies and contingency plans for addressing potential
shortfalls, and incorporation of appropriately stressful conditions
into capital planning and projections of capital positions. The extent
to which a firm's capital is sufficient to comply with regulatory
requirements, to support the firm's ability to meet its obligations,
and to enable the firm to remain a source of strength to its depository
institution(s) in a range of stressful, but plausible, economic and
financial environments is also evaluated.
Insurance company balance sheets are typically quite different from
those of most banking organizations. For life insurance companies,
investment strategies may focus on cash flow matching to reduce
interest rate risk and provide liquidity to support their liabilities,
while for traditional banks, deposits (liabilities) are attracted to
support investment strategies.
Additionally, for insurers, capital provides a buffer for
policyholder claims and creditor obligations, helping the firm absorb
adverse deviations in expected claims experience, and other drivers of
economic loss. The Board recognizes that the capital needs for
insurance activities are materially different from those of banking
activities and can be different between life and property and casualty
insurers. Insurers may also face capital fungibility constraints not
faced by banking organizations.
In assessing a supervised insurance organization's capital
management, the Federal Reserve relies to the fullest extent possible
on information provided by state insurance regulators, including the
firm's own risk and solvency assessment (ORSA) and the state insurance
regulator's written assessment of the ORSA. An ORSA is an internal
process undertaken by an insurance group to assess the adequacy of its
risk management and current and prospective capital position under
normal and stress scenarios. As part of the ORSA, insurance groups are
required to analyze all reasonably foreseeable and relevant material
risks that could have an impact on their ability to meet obligations.
The Board expects supervised insurance organizations to have sound
governance over their capital planning process. A firm should establish
capital goals that are approved by the board of directors, and that
reflect the potential impact of legal and/or regulatory restrictions on
the transfer of capital between legal entities. In general, senior
management should establish the capital planning process, which should
be reviewed and approved periodically by the board. The board should
require senior management to provide clear, accurate, and timely
information on the firm's material risks and exposures to inform board
decisions on capital adequacy and actions. The capital planning process
should clearly reflect the difference between the risk profiles and
associated capital needs of the insurance and banking businesses.
A firm should have a risk management framework that appropriately
identifies, measures, and assesses material risks and provides a strong
foundation for capital planning. This framework should be supported by
comprehensive policies and procedures, clear and well established roles
and responsibilities, strong internal controls, and effective reporting
to senior management and the board. In addition, the risk management
framework should be built upon sound management information systems.
As part of capital management, a firm should have a sound internal
control framework that helps ensure that all aspects of the capital
planning process are functioning as designed and result in an accurate
assessment of the firm's capital needs. The internal control framework
should be independently evaluated periodically by the firm's internal
audit function.
The governance and oversight framework should include an assessment
of the principles and guidelines used for capital planning, issuance,
and usage, including internal post-stress capital goals and targeted
capital levels; guidelines for dividend payments and stock repurchases;
strategies for addressing capital shortfalls; and internal governance
responsibilities and procedures for the capital policy. The capital
policy should reflect the capital needs of the insurance and banking
businesses based on their risks, be approved by the firm's board of
directors or a designated committee of the board, and be re-evaluated
periodically and revised as necessary.
A strong capital management program will incorporate appropriately
stressful conditions and events that could adversely affect the firm's
capital adequacy and capital planning. As part of its capital plan, a
firm should use at least one scenario that stresses the specific
vulnerabilities of the firm's activities and associated risks,
including those related to the firm's insurance activities and its
banking activities.
Supervised insurance organizations should employ estimation
approaches to project the impact on capital positions of various types
of stressful conditions and events, and that are independently
validated. A firm should estimate losses, revenues, expenses, and
capital using sound methods that incorporate macroeconomic and other
risk drivers. The robustness of a firm's capital stress testing
processes should be commensurate with its risk profile.
Liquidity Management
The Liquidity Management rating is derived from an assessment of
the supervised insurance organization's liquidity position and the
quality of its liquidity risk management program. Each firm's liquidity
risk management program should be commensurate with its complexity and
risk profile.
The Board recognizes that supervised insurance organizations are
typically less exposed to traditional liquidity risk than banking
organizations. Instead of cash outflows being mainly the result of
discretionary withdrawals, cash outflows for many insurance products
only result from the occurrence of an insured event. Insurance
products, like annuities, that are potentially exposed to call risk
generally have product features (i.e., surrender charges, market value
surrenders, tax treatment, etc.) that help mitigate liquidity risk.
Federal Reserve examiners tailor the application of existing
supervisory guidance on liquidity risk management to reflect the
liquidity characteristics of supervised insurance organizations.\69\
For example, guidance on intra-day liquidity management would only be
applicable for supervised insurance organizations with material intra-
day
[[Page 31663]]
liquidity risks. Additionally, specific references to liquid assets may
be more broadly interpreted to include other asset classes such as
certain investment-grade corporate bonds.
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\69\ See SR letter 10-6, ``Interagency Policy Statement on
Funding and Liquidity Risk Management.''
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The scope of the Federal Reserve's supervisory activities on
liquidity risk is influenced by each firm's individual risk profile.
Traditional property and casualty insurance products are typically
short duration liabilities backed by short-duration, liquid assets.
Because of this, they typically present lower liquidity risk than
traditional banking activities. However, some nontraditional life
insurance and retirement products create liquidity risk through
features that allow payments at the request of policyholders without
the occurrence of an insured event. Risks of certain other insurance
products are often mitigated using derivatives. Any differences between
collateral requirements related to hedging and the related liability
cash flows can also create liquidity risk. The Board expects firms
significantly engaged in these types of insurance activities to have
correspondingly more sophisticated liquidity risk management programs.
A strong liquidity risk management program includes cash flow
forecasting with appropriate granularity. The firm's suite of
quantitative metrics should effectively inform senior management and
the board of directors of the firm's liquidity risk profile and
identify liquidity events or stresses that could detrimentally affect
the firm. The metrics used to measure a firm's liquidity position may
vary by type of business.
Federal Reserve examiners rely to the fullest extent possible on
each firm's ORSA, which requires all firms to include a discussion of
the risk management framework and assessment of material risks,
including liquidity risk.
Supervised insurance organizations are expected to perform
liquidity stress testing at least annually and more frequently, if
necessary, based on their risk profile. The scenarios used should
reflect the firm's specific risk profile and include both idiosyncratic
and system-wide stress events. Stress testing should inform the firm on
the amount of liquid assets necessary to meet net cash outflows over
relevant time periods, including at least a one-year time horizon.
Firms should hold a liquidity buffer comprised of highly liquid assets
to meet stressed net cash outflows. The liquidity buffer should be
measured using appropriate haircuts based on asset quality, duration,
and expected market illiquidity based on the stress scenario
assumptions. Stress testing should reflect the expected impact on
collateral requirements. For material life insurance operations,
Federal Reserve examiners will rely to the greatest extent possible on
information submitted by the firm to comply with the National
Association of Insurance Commissioners' (NAIC) liquidity stress test
framework.
The fungibility of sources of liquidity is often limited between an
insurance group's legal entities. Large insurance groups can operate
with a significant number of legal entities and many different
regulatory and operational barriers to transferring funds among them.
Regulations designed to protect policyholders of insurance operating
companies can limit the transferability of funds from an insurance
company to other legal entities within the group, including to other
insurance operating companies. Supervised insurance organizations
should carefully consider these limitations in their stress testing and
liquidity risk management framework. Effective liquidity stress testing
should include stress testing at the legal entity level with
consideration for intercompany liquidity fungibility. Furthermore, the
firm should be able to measure and provide an assessment of liquidity
at the top-tier depository institution holding company in a manner that
incorporates fungibility constraints.
The enterprise-wide governance and oversight framework should be
consistent with the firm's liquidity risk profile and include policies
and procedures on liquidity risk management. The firm's policies and
procedures should describe its liquidity risk reporting, stress
testing, and contingency funding plan.
B. Supervisory Ratings
Supervised insurance organizations are expected to operate in a
safe and sound manner, to comply with all applicable laws and
regulations, and to possess sufficient financial and operational
strength to serve as a source of strength for their depository
institution(s) through a range of stressful yet plausible conditions.
Supervisory ratings and supervisory findings are used to communicate
the assessment of a firm. Federal Reserve examiners periodically assign
one of four ratings to each of the three rating components used to
assess supervised insurance organizations. The rating components are
Capital Management, Liquidity Management, and Governance & Controls.
The four potential ratings are Broadly Meets Expectations,
Conditionally Meets Expectations, Deficient-1, and Deficient-2. To be
considered ``well managed,'' a firm must receive a rating of
Conditionally Meets Expectations or better in each of the three rating
components or a rating of Deficient-1 in one rating component and
Broadly Meets Expectations or Conditionally Meets Expectations ratings
for each of the other two rating components. A firm rated Deficient-1
for two or more rating components or Deficient-2 for any rating
component would not be considered ``well managed.'' Each rating is
defined specifically for supervised insurance organizations with
particular emphasis on the obligation that firms serve as a source of
financial and managerial strength for their depository institution(s).
High-level definitions for each rating are below, followed by more
specific rating definitions for each component.
Broadly Meets Expectations. The supervised insurance organization's
practices and capabilities broadly meet supervisory expectations. The
holding company effectively serves as a source of managerial and
financial strength for its depository institution(s) and possesses
sufficient financial and operational strength and resilience to
maintain safe-and-sound operations through a range of stressful yet
plausible conditions. The firm may have outstanding supervisory issues
requiring corrective actions, but these are unlikely to present a
threat to its ability to maintain safe-and-sound operations and
unlikely to negatively impact its ability to fulfill its obligation to
serve as a source of strength for its depository institution(s). These
issues are also expected to be corrected on a timely basis during the
normal course of business.
Conditionally Meets Expectations. The supervised insurance
organization's practices and capabilities are generally considered
sound. However, certain supervisory issues are sufficiently material
that if not resolved in a timely manner during the normal course of
business, may put the firm's prospects for remaining safe and sound,
and/or the holding company's ability to serve as a source of managerial
and financial strength for its depository institution(s), at risk. A
firm with a Conditionally Meets Expectations rating has the ability,
resources, and management capacity to resolve its issues and has
developed a sound plan to address the issue(s) in a timely manner.
Examiners will work with the firm to develop an appropriate timeframe
during which it will be required to resolve that supervisory issue(s)
leading to this rating.
[[Page 31664]]
Deficient-1. Financial or operational deficiencies in a supervised
insurance organization's practices or capabilities put its prospects
for remaining safe and sound, and/or the holding company's ability to
serve as a source of managerial and financial strength for its
depository institution(s), at significant risk. The firm is unable to
remediate these deficiencies in the normal course of business, and
remediation would typically require it to make material changes to its
business model or financial profile, or its practices or capabilities.
A firm with a Deficient-1 rating is required to take timely action to
correct financial or operational deficiencies and to restore and
maintain its safety and soundness and compliance with laws and
regulations.
Supervisory issues that place the firm's safety and soundness at
significant risk, and where resolution is likely to require steps that
clearly go beyond the normal course of business--such as issues
requiring a material change to the firm's business model or financial
profile, or its governance, risk management or internal control
structures or practices--would generally warrant assignment of a
Deficient-1 rating. Firms with one or more Deficient-1 component
ratings may be subject to an informal or formal enforcement action,
depending on particular facts and circumstances.
Deficient-2. Financial or operational deficiencies in a supervised
insurance organization's practices or capabilities present a threat to
its safety and soundness, have already put it in an unsafe and unsound
condition, and/or make it unlikely that the holding company will be
able to serve as a source of financial and managerial strength to its
depository institution(s). A firm with a Deficient-2 rating is required
to immediately implement comprehensive corrective measures and
demonstrate the sufficiency of contingency planning in the event of
further deterioration.
There is a strong presumption that a firm with a Deficient-2 rating
will be subject to a formal enforcement action.
Definitions for the Governance and Controls Component Rating
Broadly Meets Expectations. Despite the potential existence of
outstanding supervisory issues, the supervised insurance organization's
governance and controls broadly meet supervisory expectations, supports
maintenance of safe-and-sound operations, and supports the holding
company's ability to serve as a source of financial and managerial
strength for its depository institutions(s). Specifically, the firm's
practices and capabilities are sufficient to align strategic business
objectives with its risk appetite and risk management capabilities;
maintain effective and independent risk management and control
functions, including internal audit; promote compliance with laws and
regulations; and otherwise provide for the firm's ongoing financial and
operational resiliency through a range of conditions. The firm's
governance and controls clearly reflect the holding company's
obligation to act as a source of financial and managerial strength for
its depository institution(s).
Conditionally Meets Expectations. Certain material financial or
operational weaknesses in a supervised insurance organization's
governance and controls practices may place the firm's prospects for
remaining safe and sound through a range of conditions at risk if not
resolved in a timely manner during the normal course of business.
Specifically, if left unresolved, these weaknesses may threaten the
firm's ability to align strategic business objectives with its risk
appetite and risk-management capabilities; maintain effective and
independent risk management and control functions, including internal
audit; promote compliance with laws and regulations; or otherwise
provide for the firm's ongoing resiliency through a range of
conditions. Supervisory issues may exist related to the firm's internal
audit function, but internal audit is still regarded as effective.
Deficient-1. Deficiencies in a supervised insurance organization's
governance and controls put its prospects for remaining safe and sound
through a range of conditions at significant risk. The firm is unable
to remediate these deficiencies in the normal course of business, and
remediation would typically require a material change to the firm's
business model or financial profile, or its governance, risk management
or internal control structures or practices.
Examples of issues that may result in a Deficient-1 rating include,
but are not limited to:
<bullet> The firm may be currently subject to, or expected to be
subject to, informal or formal enforcement action(s) by the Federal
Reserve or another regulator tied to violations of laws and regulations
that indicate severe deficiencies in the firm's governance and
controls.
<bullet> Significant legal issues may have or be expected to impede
the holding company's ability to act as a source of financial strength
for its depository institution(s).
<bullet> The firm may have engaged in intentional misconduct.
<bullet> Deficiencies within the firm's governance and controls may
limit the credibility of the firm's financial results, limit the board
or senior management's ability to make sound decisions, or materially
increase the firm's risk of litigation.
<bullet> The firm's internal audit function may be considered
ineffective.
<bullet> Deficiencies in the firm's governance and controls may
have limited the holding company's ability to act as a source of
financial and/or managerial strength for its depository institution(s).
Deficient-2. Financial or operational deficiencies in a supervised
insurance organization's governance and controls present a threat to
its safety and soundness, a threat to the holding company's ability to
serve as a source of financial strength for its depository
institution(s), or have already put the firm in an unsafe and unsound
condition.
Examples of issues that may result in a Deficient-2 rating include,
but are not limited to:
<bullet> The firm is currently subject to, or expected to be
subject to, formal enforcement action(s) by the Federal Reserve or
another regulator tied to violations of laws and regulations that
indicate severe deficiencies in the firm's governance and controls.
<bullet> Significant legal issues may be impeding the holding
company's ability to act as a source of financial strength for its
depository institution(s).
<bullet> The firm may have engaged in intentional misconduct.
<bullet> The holding company may have failed to act as a source of
financial and/or managerial strength for its depository institution(s)
when needed.
<bullet> The firm's internal audit function is regarded as
ineffective.
Definitions for the Capital Management Component Rating
Broadly Meets Expectations. Despite the potential existence of
outstanding supervisory issues, the supervised insurance organization's
capital management broadly meets supervisory expectations, supports
maintenance of safe-and-sound operations, and supports the holding
company's ability to serve as a source of financial strength for its
depository institution(s).
Specifically:
<bullet> The firm's current and projected capital positions on a
consolidated basis and within each of its material business lines/legal
entities comply with regulatory requirements and support its ability to
absorb potential losses, meet
[[Page 31665]]
obligations, and continue to serve as a source of financial strength
for its depository institution(s);
<bullet> Capital management processes are sufficient to give
credibility to stress testing results and the firm is capable of
producing sound assessments of capital adequacy through a range of
stressful yet plausible conditions; and
<bullet> Potential capital fungibility issues are effectively
mitigated, and capital contingency plans allow the holding company to
continue to act as a source of financial strength for its depository
institution(s) through a range of stressful yet plausible conditions.
Conditionally Meets Expectations. Capital adequacy meets regulatory
minimums, both currently and on a prospective basis. Supervisory issues
exist but these do not threaten the holding company's ability to act as
a source of financial strength for its depository institution(s)
through a range of stressful yet plausible conditions. Specifically, if
left unresolved, these issues:
<bullet> May threaten the firm's ability to produce sound
assessments of capital adequacy through a range of stressful yet
plausible conditions; and/or
<bullet> May result in the firm's projected capital positions being
insufficient to absorb potential losses, comply with regulatory
requirements, and support the holding company's ability to meet current
and prospective obligations and continue to serve as a source of
financial strength to its depository institution(s).
Deficient-1. Financial or operational deficiencies in a supervised
insurance organization's capital management put its prospects for
remaining safe and sound through a range of plausible conditions at
significant risk. The firm is unable to remediate these deficiencies in
the normal course of business, and remediation would typically require
a material change to the firm's business model or financial profile, or
its capital management processes.
Examples of issues that may result in a Deficient-1 rating include,
but are not limited to:
<bullet> Capital adequacy currently meets regulatory minimums
although there may be uncertainty regarding the firm's ability to
continue meeting regulatory minimums.
<bullet> Fungibility concerns may exist that could challenge the
firm's ability to contribute capital to its depository institutions
under certain stressful yet plausible scenarios.
<bullet> Supervisory issues may exist that undermine the
credibility of the firm's current capital adequacy and/or its stress
testing results.
Deficient-2. Financial or operational deficiencies in a supervised
insurance organization's capital management present a threat to the
firm's safety and soundness, a threat to the holding company's ability
to serve a source of financial strength for its depository
institution(s), or have already put the firm in an unsafe and unsound
condition.
Examples of issues that may result in a Deficient-2 rating include,
but are not limited to:
<bullet> Capital adequacy may currently fail to meet regulatory
minimums or there is significant concern that the firm will not meet
capital adequacy minimums prospectively.
<bullet> Supervisory issues may exist that significantly undermine
the firm's capital adequacy metrics either currently or prospectively.
<bullet> Significant fungibility constraints may exist that would
prevent the holding company from contributing capital to its depository
institution(s) and fulfilling its obligation to serve as a source of
financial strength.
<bullet> The holding company may have failed to act as source of
financial strength for its depository institution when needed.
Definitions for the Liquidity Management Component Rating
Broadly Meets Expectations. Despite the potential existence of
outstanding supervisory issues, the supervised insurance organization's
liquidity management broadly meets supervisory expectations, supports
maintenance of safe-and-sound operations, and supports the holding
company's ability to serve as a source of financial strength for its
depository institutions(s). The firm generates sufficient liquidity to
meet its short-term and long-term obligations currently and under a
range of stressful yet plausible conditions. The firm's liquidity
management processes, including its liquidity contingency planning,
support its obligation to act as a source of financial strength for its
depository institution(s).
Specifically:
<bullet> The firm is capable of producing sound assessments of
liquidity adequacy through a range of stressful yet plausible
conditions; and
<bullet> The firm's current and projected liquidity positions on a
consolidated basis and within each of its material business lines/legal
entities comply with regulatory requirements and support the holding
company's ability to meet obligations and to continue to serve as a
source of financial strength for its depository institution(s).
Conditionally Meets Expectations. Certain material financial or
operational weaknesses in a supervised insurance organization's
liquidity management place its prospects for remaining safe and sound
through a range of stressful yet plausible conditions at risk if not
resolved in a timely manner during the normal course of business.
Specifically, if left unresolved, these weaknesses:
<bullet> May threaten the firm's ability to produce sound
assessments of liquidity adequacy through a range of conditions; and/or
<bullet> May result in the firm's projected liquidity positions
being insufficient to comply with regulatory requirements and support
the firm's ability to meet current and prospective obligations and to
continue to serve as a source of financial strength to its depository
institution(s).
Deficient-1. Financial or operational deficiencies in a supervised
insurance organization's liquidity management put the firm's prospects
for remaining safe and sound through a range of stressful yet plausible
conditions at significant risk. The firm is unable to remediate these
deficiencies in the normal course of business, and remediation would
typically require a material change to the firm's business model or
financial profile, or its liquidity management processes.
Examples of issues that may result in a Deficient-1 rating include,
but are not limited to:
<bullet> The firm is currently able to meet its obligations but
there may be uncertainty regarding the firm's ability to do so
prospectively.
<bullet> The holding company's liquidity contingency plan may be
insufficient to support its obligation to act as a source of financial
strength for its depository institution(s).
<bullet> Supervisory issues may exist that undermine the
credibility of the firm's liquidity metrics and stress testing results.
Deficient-2. Financial or operational deficiencies in a supervised
insurance organization's liquidity management present a threat to its
safety and soundness, a threat to the holding company's ability to
serve as a source of financial strength for its depository
institution(s), or have already put the firm in an unsafe and unsound
condition.
Examples of issues that may result in a Deficient-2 rating include,
but are not limited to:
<bullet> Liquidity shortfalls may exist within the firm that have
prevented the firm, or are expected to prevent the firm, from
fulfilling its obligations, including
[[Page 31666]]
the holding company's obligation to act as a source of financial
strength for its depository institution(s).
<bullet> Liquidity adequacy may currently fail to meet regulatory
minimums or there is significant concern that the firm will not meet
liquidity adequacy minimums prospectively for at least one of its
regulated subsidiaries.
<bullet> Supervisory issues may exist that significantly undermine
the firm's liquidity metrics either currently or prospectively.
<bullet> Significant fungibility constraints may exist that would
prevent the holding company from supporting its depository
institution(s) and fulfilling its obligation to serve as a source of
financial strength.
<bullet> The holding company may have failed to act as source of
financial strength for its depository institution when needed.
C. Incorporating the Work of Other Supervisors
Similar to the approach taken by the Federal Reserve in its
consolidated supervision of other firms, the oversight of supervised
insurance organizations relies to the fullest extent possible, on work
performed by other relevant supervisors. Federal Reserve supervisory
activities are not intended to duplicate or replace supervision by the
firm's other regulators and Federal Reserve examiners typically do not
specifically assess firms' compliance with laws outside of its
jurisdiction, including state insurance laws. The Federal Reserve
collaboratively coordinates with, communicates with, and leverages the
work of the Office of the Comptroller of the Currency (OCC), Federal
Deposit Insurance Corporation (FDIC), Securities and Exchange
Commission (SEC), Financial Crimes Enforcement Network (FinCEN),
Internal Revenue Service (IRS), applicable state insurance regulators,
and other relevant supervisors to achieve its supervisory objectives
and eliminate unnecessary burden.
Existing statutes specifically require the Board to coordinate
with, and to rely to the fullest extent possible on work performed by
the state insurance regulators. The Board and all state insurance
regulators have entered into Memorandums of Understanding (MOU)
allowing supervisors to freely exchange information relevant for the
effective supervision of supervised insurance organizations. Federal
Reserve examiners take the actions below with respect to state
insurance regulators to support accomplishing the objective of
minimizing supervisory duplication and burden, without sacrificing
effective oversight:
<bullet> Routine discussions (at least annually) with state
insurance regulatory staff with greater frequency during times of
stress;
<bullet> Discussions around the annual supervisory plan, including
how best to leverage work performed by the state and potential
participation by state insurance regulatory staff on relevant
supervisory activities;
<bullet> Consideration of the opinions and work done by the state
when scoping relevant examination activities;
<bullet> Documenting any input received from the state and
considering the assessments of and work performed by the state for
relevant supervisory activities;
<bullet> Sharing and discussing with the state the annual ratings
and relevant conclusion documents from supervisory activities;
<bullet> Collaboratively working with the states and the NAIC on
the development of policies that affect insurance depository
institution holding companies; and
<bullet> Participating in supervisory colleges.
The Federal Reserve relies on the state insurance regulators to
participate in the activities above and to share proactively their
supervisory opinions and relevant documents. These documents include
the annual ORSA,\70\ the state insurance regulator's written assessment
of the ORSA, results from its examination activities, the Corporate
Governance Annual Disclosure, financial analysis memos, risk
assessments, material risk determinations, material transaction filings
(Form D), the insurance holding company system annual registration
statement (Form B), submissions for the NAIC liquidity stress test
framework, and other state supervisory material.
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\70\ See NAIC Own Risk and Solvency Assessment (ORSA) Guidance
Manual (December 2017) at <a href="https://content.naic.org/sites/default/files/publication-orsa-guidance-manual.pdf">https://content.naic.org/sites/default/files/publication-orsa-guidance-manual.pdf</a>.
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If the Federal Reserve determines that it is necessary to perform
supervisory activities related to aspects of the supervised insurance
organization that also fall under the jurisdiction of the state
insurance regulator, it will communicate the rationale and result of
these activities to the state insurance regulator.
By order of the Board of Governors of the Federal Reserve
System.
Ann E. Misback,
Secretary of the Board.
[FR Doc. 2025-13223 Filed 7-14-25; 8:45 am]
BILLING CODE 6210-01-P
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</html>Indexed from Federal Register on July 15, 2025.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.