Fed Proposes Changes to Rating System for Large Financial Institutions

The Federal Reserve ("Fed") proposed changes to how it determines whether large financial institutions ("LFI") and insurance-focused holding companies are "well managed," a status that affects their ability to expand or engage in certain business activities.

In the proposed rulemaking, the Fed explained that under the Bank Holding Company Act, only firms that are both "well capitalized" and "well managed" are allowed to elect financial holding company ("FHC") status. FHCs are permitted to engage in a broader range of nonbanking activities, including securities dealing, insurance underwriting and certain investments, without needing prior approval from the Fed. Firms that lose "well managed" status may be restricted from making acquisitions, entering new business lines, or taking advantage of streamlined application procedures.

The Fed proposed allowing firms with only one "Deficient-1" supervisory rating and two higher ratings (either "Broadly Meets Expectations" or "Conditionally Meets Expectations") to still be considered "well managed." Currently, a single "Deficient-1" rating in any of the three core components—capital, liquidity, or governance and controls—automatically disqualified a firm from receiving the "well managed" designation. The proposed rule also affected insurance organizations supervised by the Fed. These companies would follow the same revised criteria under the Insurance Supervisory Framework, which is modeled after the LFI Framework.

In addition to adjusting the rating criteria, the Fed proposed removing the automatic presumption that a "Deficient-1" rating would trigger an enforcement action. Instead, enforcement would depend on the specific facts and circumstances. Firms with any "Deficient-2" rating would still face a presumption of formal enforcement.

The Fed explained that the change reflects lessons learned since the introduction of the LFI rating system in 2018. It stated that many firms currently rated as not "well managed" still demonstrated financial strength and resilience. As of the end of 2024, 23 out of 36 large financial firms under the LFI Framework were considered not "well managed," often due to a single "Deficient-1" rating.

The proposal did not change the definitions of the component ratings, or the standards used to assign them.

Comments are due within 30 days following its publication in the Federal Register.

Statements

Vice Chair for Supervision Michelle W. Bowman said that the proposal is the "first step in pursuing a broader goal, which is to ensure that supervisory activities, and the accompanying ratings, are aligned with a renewed supervisory focus on core, material financial risks."

Governor Michael S. Barr Governor dissented, arguing it would allow large financial firms with serious management deficiencies to be labeled "well managed," weakening oversight and increasing systemic risk. He criticized the proposal for removing the presumption of supervisory action when such a rating is assigned, warning it would reduce firms' urgency to fix shortcomings. He stated the proposal was inconsistent with the legal definition of "well managed" established under the Gramm-Leach-Bliley Act.

Governor Lisa D. Cook called the proposal "an important step in pursuing an open and transparent rulemaking process." While she acknowledged that the proposal would appropriately reduce the weight of a single "Deficient-1" rating, she noted that a better approach might be to add a composite score (discussed in the rule's preamble). Ms. Cook said a composite rating would allow for a more nuanced and accurate assessment of a firm's overall condition.

Governor Adriana D. Kugler raised concern that the proposed changes may overcorrect problems in the current system. While she agreed that it is problematic for a firm to be considered not "well managed" due to a single, isolated deficiency, she warned that the proposal could allow firms with multiple issues within one rating category to still qualify as "well managed"—a result that fails to reflect a true assessment. Ms. Kugler stated she would prefer adding a composite rating to the framework.