Federal Reserve Proposes Changes to Rating System for Large Financial Institutions
On July 10, 2025, the Board of Governors of the Federal Reserve System (“Board”) proposed changes to its supervisory rating systems for large financial institutions (“LFIs”) and supervised insurance organizations (the “Proposal”). The changes address the meaning of “well managed” and are intended to more accurately reflect the strength of large Board-supervised financial institutions and the banking system as a whole.
Five members of the Board voted to issue the Proposal, while one voted against its issuance (Governor Michael Barr), and one abstained (Governor Adriana Kugler). Only four votes are needed to finalize it in the current form.
Comments on the Proposal are due by August 14, 2025. In this Legal Update, we provide background on the rating systems for large Board-supervised financial institutions and discuss the changes in the Proposal.
Background
The Board supervises and regulates bank holding companies (“BHCs”), as well as companies that control savings associations (known as “savings and loan holding companies” or “SLHCs”) and US intermediate holding companies (“IHCs”) of foreign banking organizations. As part of this supervision, the Board assesses the financial and operational strength of a BHC, SLHC, or IHC (collectively, a “firm”) through a supervisory rating system.
From 2004 to 2020, the Board used a single rating system to assess all BHCs and most SLHCs, known as the RFI/C(D) rating system.1 Starting in 2020, the Board adopted a new rating system, known as the LFI rating system, for BHCs with total consolidated assets of $100 billion or more; non-insurance, non-commercial SLHCs with total consolidated assets of $100 billion or more; and IHCs with combined US assets of $50 billion or more. Starting in 2022, the Board established a rating system for SLHCs significantly engaged in insurance activities (also known as supervised insurance organizations) that is modeled on the LFI rating system. Smaller BHCs and other SLHCs remain subject to the RFI/C(D) rating system.
The LFI rating system evaluates firms based on three components: (i) capital planning and positions; (ii) liquidity risk management and positions; and (iii) governance and controls. Each component is rated based on a four-point non-numeric scale: Broadly Meets Expectations, Conditionally Meets Expectations, Deficient-1, and Deficient-2.
A firm that receives a rating of Deficient-1 or Deficient-2 in any component rating is considered to be not well managed. A firm that is not well managed faces limitations on certain acquisitions and new activities. For example, the Bank Holding Company Act restricts a BHC that is not well managed from engaging in expansionary activities and pursuing investments in certain nonbank financial companies without obtaining prior Board approval. More importantly, the LFI rating system establishes a presumption that the Board will impose an informal or formal enforcement action on any firm that is not well managed. As noted in the preamble to the Proposal, over half of the firms that are subject to the LFI rating system are not well managed.
Proposal
The Proposal would revise the LFI rating system such that a firm with at least two Broadly Meets Expectations or Conditionally Meets Expectations component ratings and no more than one Deficient-1 component rating would be well managed. A firm would not be well managed if it receives a Deficient-2 for any of the component ratings.
The Proposal would also remove the presumption in the LFI rating system that the Board will bring an informal or formal enforcement action against firms with one or more Deficient-1 ratings. Instead, decisions to issue enforcement actions to those firms would be made based on the particular facts and circumstances of the firm. The LFI rating system would continue to contain a presumption of an enforcement action for a firm that receives a Deficient-2 rating for any component.
The Proposal would make the same changes to the rating system for supervised insurance organizations, which already is modeled on the LFI rating system.
The Proposal states that, of the 23 firms that were not well managed (out of 36 firms considered) under the LFI rating system as of Q4 2024, eight would become well managed as a result of the proposed changes. However, only three of those eight firms would be able to fully benefit from the changes, because a BHC must also be well managed at each of its depository institution subsidiaries to be considered well managed at the BHC level.2
Further, the Proposal discusses how the rating systems for other banking organizations do not determine a firm’s composite rating based solely on any one of its component ratings. For example, the Uniform Financial Institutions Rating System (also known as “CAMELS”) incorporates a composite score, which is relevant to a firm’s “well managed” status. Similarly, the RFI/C(D) rating system includes a composite rating based on an evaluation of several component ratings, including the firm’s managerial and financial condition and an assessment of future potential risk to its subsidiary depository institutions. Therefore, the changes in the Proposal would better align the LFI rating system with the supervisory rating systems used for other banking organizations.
Concluding Thoughts
The Proposal is the latest reform by Vice Chair for Supervision Miki Bowman as part of her efforts to streamline and enhance the Board’s supervisory practices. It seeks to address the dichotomy between the Board’s view that “the banking system remains sound and resilient overall” and the fact that, under the current LFI rating system, approximately 64% of large firms are not well managed, even though they may be well capitalized, have strong liquidity risk management, and have performed well during recent stress tests and stress events, according to the Board’s Supervision and Regulation Report. This outcome indicates that the current approach is unduly punitive and may arise from subjective assessments of operational control matters. As a result, the current system creates an inaccurate and overly broad group of not-well-managed firms that may also mask which firms need the most supervisory attention.
The Proposal seeks to remedy these problems by making ratings more reflective of the actual financial condition of large firms. These changes, though, will not have a profound effect, as the Board indicated that only three firms would become “well managed” under the BHC Act if the Proposal was currently in effect. The other firms that would become “well managed” under the FLI rating system do not also have depository institution subsidiaries rated as “well managed,” as required under the BHC Act.
The Proposal also does not make other changes to the LFI rating system, such as the Board’s standard for evaluating the individual component ratings and the Board’s expectation that a firm with a Deficient-1 component rating would take timely corrective action. It does include questions asking whether the Board should make changes to the rating systems for other banking organizations, as well as whether other changes to the LFI rating system should be considered to ensure that a firm’s “well managed” status is appropriately calibrated. For example, as set forth in Question 5 and reiterated in statements from members of the Board, an alternative approach would be to add a composite score to the LFI framework and use that score to determine “well managed” status.
1 From 1979 to 2004, the Board used the BOPEC/F-M rating system for BHCs.
2 The Proposal states that none of the 5 SLHCs significantly engaged in insurance activities would see a change in their well managed status, but does not indicate how many of them currently are not well managed.
