Unsafe or Unsound Practices and Matters Requiring Attention: Final Rule

Summary

The Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (collectively, the agencies) issued a joint final rule to define the term “unsafe or unsound practice” for purposes of section 8 of the Federal Deposit Insurance Act (12 USC 1818) and revise the supervisory framework for the issuance of matters requiring attention (MRA) and other supervisory communications. The final rule is intended to promote greater clarity and certainty regarding certain enforcement and supervision standards applicable to national banks, federal savings associations, and federal branches and agencies (collectively, banks), and to ensure that these standards prioritize material financial risks.

Highlights

• The final rule establishes the definitions and standards for certain supervisory activities and enforcement actions against banks.
• The final rule defines the term “unsafe or unsound practice” for purposes of the agencies’ enforcement actions under 12 USC 1818 and supervisory activities as a practice, act, or failure to act, alone or together with other practices, acts, or failures to act, that (1) is contrary to generally accepted standards of prudent operation; and (2) (i) if continued, is likely to (A) materially harm the financial condition of the bank; or (B) present a material risk of loss to the Deposit Insurance Fund (DIF); or (2)(ii) materially harmed the financial condition of the bank.
• The final rule also establishes that the agencies may only issue an MRA for a practice, act, or failure to act, alone or together with one or more other practices, acts, or failures to act, that (1) (i) is contrary to generally accepted standards of prudent operation; and (ii) (A) if continued, could reasonably be expected to, under current or reasonably foreseeable conditions; (1) materially harm the financial condition of the bank; or (2) present a material risk of loss to the DIF; or (B) has already caused material harm to the financial condition of the bank; or (2) is an actual violation of a banking or banking-related law or regulation.
• The final rule clarifies how the agencies will tailor their supervisory activities and enforcement actions based on unsafe or unsound practices under 12 USC 1818 and their issuance of MRAs based on relevant risk factors.
• The final rule authorizes the agencies to communicate to banks “other violations” and informal “supervisory observations.”

Background

The agencies exercise their enforcement and supervision authority to ensure that supervised banks refrain from engaging in unsafe or unsound practices. To that effect, the agencies believe it is important to promote greater clarity and certainty regarding certain enforcement and supervision standards by defining them by regulation. Moreover, the agencies believe it is critical that examiners and banks prioritize material financial risks over concerns related to policies, process, documentation, and other nonfinancial risks and that their enforcement and supervision standards further that prioritization. Accordingly, the agencies issued a final rule to establish definitions and standards for certain supervisory activities and enforcement actions, which will apply to all banks.

Unsafe or Unsound Practice

The final rule defines the term “unsafe or unsound practice” for purposes of both enforcement actions under 12 USC 1818 and supervisory activities as a practice, act, or failure to act, alone or together with other practices, acts, or failures to act, that (1) is contrary to generally accepted standards of prudent operation; and (2) (i) if continued, is likely to (A) materially harm the financial condition of the bank; or (B) present a material risk of loss to the DIF; or (2)(ii) materially harmed the financial condition of the bank.

To qualify as an unsafe or unsound practice under the final rule, it would have to be likely—as opposed to, for example, merely possible—that the practice, act, or failure to act, if continued, would materially harm the financial condition of the bank or present a material risk of loss to the DIF. The definition focuses on material harm to financial condition, i.e., financial losses or other negative impacts to a bank’s capital, asset quality, earnings, liquidity, or sensitivity to market risk. The definition would not include risks to the bank’s reputation unrelated to financial condition.

An unsafe or unsound practice would also include a practice, act, or failure to act that, if continued, is likely to negatively affect a bank’s ability to avoid FDIC receivership and present a material risk of loss to the DIF as a result of the failure.

MRAs and Other Supervisory Communications

The final rule creates a uniform standard for the issuance of an MRA to supervised banks. Specifically, the final rule provides that the agencies may only issue an MRA for a practice, act, or failure to act, alone or together with one or more other practices, acts, or failures to act, that (1) (i) is contrary to generally accepted standards of prudent operation; and (ii) (A) if continued, could reasonably be expected to, under current or reasonably foreseeable conditions; (1) materially harm the financial condition of the bank; or (2) present a material risk of loss to the DIF; or (B) has already caused material harm to the financial condition of the bank; or (2) is an actual violation of a banking or banking-related law or regulation. This uniform standard narrows the scope of practices that would support the issuance of an MRA while permitting the agencies to proactively identify risks.

The final rule clarifies how and when the agencies may communicate informal observations called “supervisory observations” for weaknesses that do not rise to the level of an MRA. Unlike MRAs, a supervisory observation does not create a requirement or supervisory expectation that it will be presented to a bank’s board of directors. This framework would allow examiners to share their expertise with management and the board of directors about potential enhancements while leaving decisions regarding the implementation of any enhancements to the bank.

The final rule also addresses “other violations,” which are violations for which the agencies do not take an enforcement action or issue an MRA. For other violations, the agencies may require a bank to remediate such violations and take other actions as are required by law. The agencies will not direct a bank to take any action other than to remediate the violation, unless such other actions are required by law.

Tailoring

The final rule requires the agencies to tailor their supervisory activities and enforcement actions based on unsafe or unsound practices under 12 USC 1818 and their issuance of MRAs based on the risks associated with a bank’s capital structure, complexity, activities, asset size, and any other financial risk-related factor that the agencies deem appropriate. The agencies revised the proposed tailoring standard to further clarify how the agencies will tailor relevant supervisory activities and enforcement actions. Specifically, the tailoring standard of the final rule requires tailoring with respect to the requirements or expectations set forth in enforcement actions based on unsafe or unsound practices under 12 USC 1818 and in MRAs as well as whether, and the extent to which, such actions and matters are taken or issued. As the risk associated with the factors identified in the tailoring provision increases (1) the threshold for materiality of the harm to the financial condition of a bank that constitutes an unsafe or unsound practice or warrants an MRA decreases; (2) the assessment of the harm to the financial condition of a bank becomes more granular; and (3) the requirements under an enforcement action or MRA relating to remediation, and the expectations regarding prudent operation, increase.

Basis for Determinations

The final rule explains that the agencies will use objective facts and sound reasoning to determine whether they may take an enforcement action based on an unsafe or unsound practice under 12 USC 1818 or issue an MRA. Examiners must share with a bank the basis for their identification of an unsafe or unsound practice or the issuance of an MRA. Examiners’ use of objective facts and sound reasoning will promote objective and consistent application of the final rule’s supervisory and enforcement standards.

Further Information

Please contact the Chief Counsel’s Office at (202) 649-5490.

Adam J. Cohen
Senior Deputy Comptroller and Chief Counsel

Related Link

• Final Rule: Unsafe or Unsound Practices, Matters Requiring Attention (PDF)