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September 2024

Understanding and Responding to Supervisory Messages
by J.M. Nemish, Senior Examiner, Supervision, Regulation, and Credit, Federal Reserve Bank of Richmond, and Jessica Olayvar, Senior Manager, Supervision, Regulation, and Credit, Federal Reserve Bank of Richmond

The business of banking is inherently risky. Extending credit to businesses and consumers, providing a safe place to store deposits, and generating a return to shareholders can be a tough balancing act. As a bank grows and introduces new products and services, its leadership weighs the risks against the possible outcomes. Supervisors are responsible for assessing whether the bank’s activities are in compliance with applicable statutes and regulations and whether the bank operates in a safe and sound manner. This evaluation of a bank’s safety and soundness includes an assessment of its financial condition as well as the effectiveness of its risk management practices. When risk management practices are insufficient to address a bank’s business activities and associated risks, examiners will issue supervisory findings to the bank in the report of examination. One goal of supervisory findings is to assist banks in addressing their risks and ultimately improving their safety and soundness. In most cases, banks effectively address these findings in a timely manner.

This article provides an overview of the supervisory tools that examiners use to convey messages to a bank’s board of directors and senior management. It also shares some common themes and trends driving supervisory findings and discusses practices that banks may wish to consider when responding to Federal Reserve supervisory staff.

Types of Supervisory Tools

Supervisory Findings in the Report of Examination

During the examination process, examiners evaluate a bank’s soundness and the level of risk involved in the bank’s business activities and operations. They accomplish this, in part, by analyzing the bank’s financial condition and its policies, procedures, and risk management practices. Examiners also meet with senior management to gain an understanding of the bank’s business model and risk profile. At the conclusion of the supervisory event, examiners issue a report of examination directed to the bank’s board of directors. This report of examination provides an assessment of the bank and may identify unsafe and unsound practices, supervisory findings, or violations of laws and regulations. It’s important to note that the report of examination and the findings therein are confidential and not made available to the public. The report of examination conveys key messages to the board of directors and senior management, and these messages come in a variety of forms, depending on the nature of the weakness. The following sections list these messages from least severe to most severe.

Matters Requiring Attention

Matters requiring attention (MRAs) constitute matters that are important and must be addressed by a bank to ensure safe, sound, and compliant operation, but they do not pose an immediate threat to the safety and soundness of the bank. Therefore, the bank is expected to take corrective action over a reasonable period of time, as highlighted in the report of examination.¹ If a banking organization does not adequately address an MRA in a timely manner, examiners may elevate the MRA to a matter requiring immediate attention (MRIA).

Matters Requiring Immediate Attention

MRIAs arising from an examination, or any other supervisory activity, are matters of significant importance and urgency that examiners require banks to address immediately. According to Supervision and Regulation (SR) letter 13-13/Consumer Affairs (CA) letter 13-10, “Supervisory Considerations for the Communication of Supervisory Findings,” MRIAs include:²

• matters that have the potential to pose significant risk to the safety and soundness of the banking organization;
• matters that represent significant noncompliance with applicable statutes or regulations;
• repeat criticisms that have escalated in importance because of insufficient attention or inaction by the banking organization; and
• in the case of consumer compliance examinations, matters that have the potential to cause significant consumer harm.

When an institution’s financial condition has declined to less than satisfactory or the institution has risk management weaknesses that must be addressed to improve the condition of the bank, it often results in multiple new or repeat MRAs and MRIAs. Furthermore, the nature and severity of outstanding MRAs and MRIAs are factors that may warrant consideration of ratings downgrades and escalating issues into enforcement actions.³

Enforcement Actions

This section provides a list and brief overview of the types of enforcement actions, arranged in the order of least severe to most severe.⁴

Informal Actions

Informal enforcement actions against banks are not legally enforceable and are not published or available to the public. Informal actions are generally considered when a bank is rated a composite “3” or worse and it is necessary to obtain written commitments from a bank’s board of directors to remedy the identified problems and weaknesses.⁵ Commitments, board resolutions, and memoranda of understanding (MOUs) are the most common forms of informal enforcement actions.

• Commitments: Commitments are generally used to correct minor problems or to request periodic reports addressing certain aspects of a bank’s operations. Commitments may be used when there are no significant violations of law or unsafe or unsound practices and when the bank and its officers and directors are expected to cooperate and comply. Commitments are generally obtained by the Federal Reserve by sending a letter to a bank outlining the request and asking for a response and an indication that the bank will act on the findings detailed in the letter. These informal commitments are distinct from conditions imposed in writing in connection with the grant of an application or other request by an institution, which may be enforced through the imposition of a civil money penalty.
• Board Resolutions: Board resolutions generally represent a number of commitments made by a bank’s board of directors to take corrective action and are formally voted on by the bank’s board and documented in the bank’s corporate minutes. The Federal Reserve may request board resolutions in the report of examination transmittal letter to ensure that a bank’s board of directors is aware of the severity of the supervisory findings and is committed to taking corrective action.
• Memoranda of Understanding: An MOU is a highly structured, informal agreement that is signed by an individual from the Federal Reserve and a member of a bank’s board of directors. An MOU is generally used when a bank has multiple deficiencies that the Federal Reserve believes can be corrected by present board and bank management.

Formal Actions

Formal enforcement actions are more severe actions than informal actions. Formal enforcement actions are legally enforceable and are disclosed to the public. Formal actions are generally used when an institution faces problems that are more severe in nature. For example, the condition of the institution has deteriorated and the composite bank rating is generally deficient (“4”) or critically deficient (“5”). Written agreements and cease and desist orders (C&Ds) are the most common formal enforcement actions.

• Written Agreements: Written agreements are drafted by the Federal Reserve Board staff. The provisions of written agreements may relate to any of the problems found at a bank.
• Cease and Desist Orders: The Federal Reserve issues C&Ds when a bank is engaging, has engaged, or is about to engage in (1) a violation of law, rule, or regulation; (2) a violation of a condition imposed in writing by the Federal Reserve Board in connection with the granting of any application or any written agreement; or (3) an unsafe or unsound practice in conducting the business of the institution.

Enforcement Action Themes

Enforcement actions can be narrow and specific to a particular area of a bank (e.g., Bank Secrecy Act or information technology), or they can be broad and all encompassing. Most often, banks under an enforcement action are subject to enhanced supervision, such as more frequent on-site examinations, to assess whether the bank has taken appropriate actions to address the provisions in the enforcement action.

Enforcement actions call attention to areas of weakness, unsafe and unsound practices, or significant law violations, such as poor board oversight, deficient risk management practices, insider abuse, and financial condition deterioration. Some of the common high-level issues that result in enforcement actions are noted below.

• Managing and controlling growth: History has shown that institutions lacking appropriate risk management practices and controls to support rapid and significant growth are exposed to increased risk. Institutions that pursue rapid, significant, and uncontrolled growth (either organically or through acquisitions) may have misaligned financial incentives to support the growth. In developing effective growth strategies, institutions may have to adapt their risk management practices to mitigate the risks associated with their new risk profile or business model.
• Responding to a dynamic economic environment: The prevailing business cycle and economic conditions also influence the evolution of an institution’s risk management practices that enable it to operate in a safe and sound manner. In assessing the effectiveness of a bank’s risk management practices, examiners consider management’s ability to mitigate the risk associated with the broader economic context and prevailing market conditions. For example, a previous Community Banking Connections article highlighted how the risks associated with commercial real estate concentrations in certain sectors have changed significantly since the onset of the COVID-19 pandemic.⁶
• Managing general financial risks: In certain instances, institutions fail to appropriately manage financial risks because of an inability to respond to a changing economic environment, as noted above. Weaknesses in managing traditional financial risks have appeared in multiple written agreements that have been executed among the Reserve Banks and community banking organizations over the past two years.⁷ For example, there have been several written agreements with provisions for liquidity and funds management, interest rate risk management, investment portfolio management, earnings improvement plans, and credit risk management.

Successfully Navigating a Supervisory Action

Whether a bank has supervisory findings or an enforcement action to address, there are several common sound practices that the bank’s senior management and board of directors should follow to set the bank up for success.

• Have the appropriate people in place. Arguably the most important first step of any remediation plan is designating who will be responsible for carrying it out from start to finish. Successfully addressing issues and developing a longer-term, sustainable strategy are contingent on having people in place with the ability (skills or resources) and willingness to make the necessary improvements. This may require the shifting of resources or job responsibilities, investing in training and development, hiring additional talent, and even reassigning individuals. Depending on the scope and scale of the identified issues, many banks may identify a person to manage the numerous moving parts associated with remediation plans and coordinate communications with the many stakeholders, such as senior management, the board of directors, and supervisors.
• Have a plan with clear success measures or criteria. Institutions that have been the most successful in remediating issues have understood the root causes of the deficiencies. Before implementing the remediation plan, it is also important to have the end vision in mind so that appropriate staff members can understand and agree upon the common goal they are working to achieve. To appropriately address issues, it is important to ensure that the remediation plan addresses all of the provisions in the enforcement action and has the appropriate long-term oversight from the bank’s board of directors or senior management. The plan may also consider any required resource allocation, intermediary steps, and time frames, as well as roles and responsibilities. As the bank executes its corrective action plan, it should take immediate steps to change policies, practices, and controls to avoid further deterioration.
• Maintain ongoing communications with supervisors. Open communication with supervisors throughout the remediation process will save time and resources, contributing to successful remediation of the findings or enforcement actions. Active communication may also make for a more efficient examination process, as supervisors will have a better understanding of the status and challenges associated with each issue. Finally, ongoing communications between a bank and the supervisory team can help the bank develop and implement an effective remediation plan with a realistic timeline for corrective action.

Conclusion

After a bank receives a supervisory finding or enforcement action, it is incumbent upon its board of directors and senior management team to acknowledge the issues and hold themselves and their employees accountable.⁸ Depending on the issues at hand, truly sustainable and meaningful change may require alterations to processes as well as a shift in the bank’s culture of risk management, necessitating widespread buy-in and commitment from the board of directors, management, and staff members.

• ¹ See Supervision and Regulation (SR) letter 13-13/Consumer Affairs (CA) letter 13-10, “Supervisory Considerations for the Communication of Supervisory Findings,” available at www.federalreserve.gov/supervisionreg/srletters/sr1313.htm.

• ² See SR letter 13-13/CA letter 13-10 and the relevant attachment, which is available at www.federalreserve.gov/supervisionreg/srletters/sr1313a1.pdf.

• ³ See the attachment to SR letter 13-13/CA letter 13-10.

• ⁴ For further reading on these types of enforcement actions, see the Commercial Bank Examination Manual, Section 1050.1: Formal and Informal Supervisory Actions, available at www.federalreserve.gov/publications/files/cbem.pdf.

• ⁵ For a definition of the CAMELS rating system and information about the associated ratings scale, see the May 2024 Supervision and Regulation Report, available at www.federalreserve.gov/publications/files/202405-supervision-and-regulation-report.pdf. See also SR letter 96-38, “Uniform Financial Institutions Rating System,” available at www.federalreserve.gov/boarddocs/srletters/1996/sr9638.htm.

• ⁶ See Jessica Olayvar and Mina Oldham, “Commercial Real Estate: Key Trends and Risk Management in a New Era,” Community Banking Connections, First Issue 2023, available at www.cbcfrs.org/Articles/2023/I1/CRE-Key-Trends-And-Risk-Management.

• ⁷ A searchable database of enforcement actions is available at www.federalreserve.gov/supervisionreg/enforcementactions.htm.

• ⁸ The Federal Reserve Board has developed guidelines that implement the intra-agency appeals process required by section 309 of the Riegle Community Development and Regulatory Improvement Act of 1994. See SR letter 20-28/CA letter 20-14, “Internal Appeals Process for Material Supervisory Determinations and Policy Statement Regarding the Ombudsman for the Federal Reserve System,” available at www.federalreserve.gov/supervisionreg/srletters/SR2028.htm.