News Alert: Examiners to Focus on Banks’ Ability to Manage COVID-19 Risks

CEOs take note: Bank examiners will be looking at how well your management team has assessed risks from the COVID-19 environment, whether and how you have changed your business practices, and if you have addressed these changes in your long-term strategic planning, according to an 11-page document outlining supervisory guidance that was released on Tuesday.

The document, which guides examiners from every regulatory body as they conduct safety and soundness exams, notes that some banks should expect downgrades, especially if they have weak risk management.

“In conducting their supervisory assessment, examiners will consider whether institution management has managed risk appropriately, including taking appropriate actions in response to stresses caused by COVID-19 impacts,” the regulators wrote.

As we have written since March, the best way for banks to seize control of the risks facing them in the COVID-19 environment is through stress testing. There is no other tool that can identify risks, show banks how to pivot from them, and adjust their long-term plans to take account of changes in the marketplace. Stress tests are instrumental in identifying how much capital a bank needs to operate safely in the COVID-19 economy.

Federal Reserve Vice Chair for Supervision Randal K. Quarles said in a speech last week that “stress tests remain a valuable tool, even in this time of extreme uncertainty.”

Regulators said Tuesday that they will be focusing on banks’ capital planning efforts in upcoming exams. “Examiners will evaluate the institution’s capital projections and whether institution management appropriately assesses the institution’s capital needs and vulnerabilities related to the pandemic and consistent with the institution’s risks,” they wrote. “If an institution’s risk profile is not supported appropriately by its capital levels, examiners should determine whether management has a satisfactory plan to maintain capital adequacy and, if needed, build capital.”

Regulators also said that they expect banks to be adjusting their assessments as the market changes, a point Invictus CEO Adam Mustafa made in April when he urged banks in a webinar that they need to repeat stress tests if the results are to be meaningful. “As additional information becomes available, examiners expect management to update risk assessments, measure the effectiveness of its response, and adjust, as necessary,” the regulators wrote.

While the guidance instructs examiners to be flexible, it also suggests a return to an era of stricter enforcement, similar to what happened after the 2008 financial crisis. “When considering whether to take a formal or informal enforcement action in response to issues related to the pandemic, the agencies will consider whether an institution’s management has appropriately planned for financial resiliency and continuity of operations; implemented prudent policies; and is pursuing realistic resolution of the issues confronting the institution,” the joint interagency guidance noted.