The agency that did not sign

On 27 August the OCC and the FDIC finalised a rule giving the phrase "unsafe or unsound practice" a definition and setting standards for when an examiner may issue a Matter Requiring Attention. It takes effect sixty days after Federal Register publication.

The definition has two limbs. Conduct must be contrary to generally accepted standards of prudent operation, and it must have caused or be reasonably likely to cause material financial harm to the institution, or pose material risk to the Deposit Insurance Fund. Supervisory objections must connect to material financial risk or to a violation of banking law. Examiners are directed to prioritise financial risk over policies, procedures and documentation.

That is a real change in what can be written down, and most of the commentary is about crypto and debanking. The part with a number attached is elsewhere.

The Federal Reserve is not a party to it

The Board of Governors did not join. State member banks, which the Fed supervises, are outside the rule.

That is 698 institutions holding $4.7 trillion, 16.5% of the industry by count and 17.8% by assets. The 3,533 institutions supervised by the OCC or the FDIC are covered.

This is the second time in four weeks. The CRA proposal issued on 31 July was also an OCC and FDIC action that the Federal Reserve did not join, leaving state member banks outside that framework too.

Two rules, one month, the same absent agency. A bank's supervisory standard is now materially a function of its charter in a way it was not in June, and charter choice has acquired a consequence it did not previously carry. For a state nonmember bank considering Federal Reserve membership, or the reverse, this belongs in the analysis alongside the assessment and the examination cycle.

What actually changes inside an examination

Process findings do not disappear. They lose the ability to stand on their own.

An MRA now has to connect to material financial risk or to a legal violation. A documentation weakness that an examiner previously could cite as an MRA in its own right will need to be tied to something financial, or it becomes an observation rather than a matter requiring attention.

The practical question for a bank is therefore specific and answerable from its own file: which of your open findings would survive the new test. Not as an argument to have with your examiner, and I would not recommend having it. As a way of knowing which of your outstanding items were process observations that happened to carry the weight of a formal finding, and which were always about money.

Related and separate: the agencies moved earlier this year to prohibit the use of reputation risk in supervision, a distinct rulemaking finalised in April. The two are often conflated. This rule is about what constitutes an unsafe or unsound practice; that one was about whether reputational concern alone can drive a supervisory outcome.

The argument against, which deserves stating

Process findings are frequently leading indicators, and that is the honest objection.

A weakness in credit file documentation is not material financial harm on the day it is found. It is often how a loan review failure looks two years before the charge-offs arrive. A framework that requires an examiner to demonstrate financial materiality before writing a formal finding will, by construction, produce findings later in the deterioration.

Our own work on Tioga-Franklin makes the point better than an argument can. Its liquidity scored a 1, the strongest reading available, in every one of the eight quarters we recomputed, while capital ran from 3 to 5 and the bank closed. The measure that looked fine was measured accurately. The problem was elsewhere, and it was visible for eleven quarters in the filings.

Supervision that concentrates on material financial risk is defensible. It also means fewer things get written down for you, which raises the value of measuring your own condition rather than waiting to be told.

What I would do about it

Three things, in order.

Read your open findings against the new definition and sort them into those that clearly meet it, those that clearly do not, and those that are arguable. The middle group is the one worth understanding, because those are the items where your institution and your examiner may now be reasoning differently.

If you are a state member bank, note that none of this applies to you, and that your position relative to a national bank down the street has changed twice in a month.

And do not read a narrower definition as a lighter obligation. The rule changes what an examiner must demonstrate before writing something down. It does not change what happens to a bank that gets its concentration, its funding or its credit wrong.

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Sources

• Unsafe or unsound practices, matters requiring attention · Federal Register, OCC and FDIC
• FDIC and OCC formally define unsafe and unsound practices · ABA Banking Journal
• Prohibition on the use of reputation risk by regulators · Federal Register
• Institution directory · Federal Deposit Insurance Corporation