- In 2025 the Fed, OCC, and FDIC shifted supervision toward material financial risks and codified more changes via rulemaking, including limiting the use of reputation risk.
- The Fed’s revised LFI Framework broadens “well-managed” status by allowing up to one Deficient-1 rating if at least two other components meet expectations.
- For community banks, the OCC is replacing fixed, policy-driven exam schedules and procedures with more risk-based examiner discretion, reducing requirements like routine transaction testing and annual model validations.
- The Fed is flattening supervision by cutting about 30% of board-level staff by end-2026 and de-emphasizing process compliance in favor of capital, liquidity, earnings, and market-risk focus.
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The regulatory environment for U.S. banking institutions underwent a marked reorientation in 2025. The Federal Reserve, OCC, and FDIC jointly and separately advanced a deregulatory agenda centered around distinguishing material financial risk from compliance or reputational risks that historically have consumed significant supervisory attention. These changes reflect the Trump Administration’s priorities, aligned with pressure from Treasury Secretary Scott Bessent, to streamline oversight and enhance growth capacity without compromising safety and soundness.
In the Large Financial Institution (LFI) space, the Federal Reserve’s final rule, adopted November 5, 2025, relaxed what constituted “well-managed” status. Under prior rules, a single “Deficient-1” rating in any critical component disqualified an institution; the new rule allows up to one such rating provided the other two components meet expectations. This change, viewed by industry as enhancing flexibility, drew criticism from dissenters like Governor Michael Barr for potentially weakening oversight and accountability, especially in areas like governance and controls. The impact is quantifiable: estimates suggest that seven out of 36 LFIs will newly qualify as well-managed; however, only three are projected to recover the full set of privileges (like FHC status) due to corresponding challenges at subsidiary levels.
Community banks are benefiting from multiple deregulatory reforms. Effective January 1, 2026, OCC Bulletin 2025-24 removes fixed, policy-based examination requirements for community banks and replaces them with risk-based tailoring of both frequency and scope. Similarly, OCC Bulletins 2025-25 and 2025-26 free community banks from rigid RNDIP (retail nondeposit investment products) assessment requirements and annual model validation demands; examiners may now rely more on internal reports and limited sampling. Additionally, the OCC’s Bulletin 2025-37 simplifies BSA/AML procedures for community banks, allowing prior cycle results and reduced transaction testing based on risk profile.
The Federal Reserve is also restructuring its supervision apparatus. Vice Chair for Supervision Michelle Bowman aims to reduce its Washington-board level staff by approximately 30% by end-2026, shifting toward flatter organizational structure with fewer management tiers and divesting process compliance tasks in favor of focusing on material financial risks. New internal operating principles reinforce that examiners should give more weight to issues impacting capital, liquidity, earnings, market sensitivity rather than documentation or managerial shortcomings alone.
Strategic implications are significant. LFIs acquiring or considering expansionary moves may find fewer regulatory barriers if previously constrained by component rating deficiencies. Community banks are likely to see reduced compliance costs and reporting burdens, freeing up capital and management bandwidth for business growth. However, these changes increase the need for institutions to clearly document risk profile, internal controls, and financial strength to secure favorable supervisor ratings. Conversely, there are risks: subjective interpretations remain around “materiality,” and the reduction in supervisory workforce and procedural oversight may undermine early detection of emerging risks.
Open questions remain—how “material financial risk” will be defined operationally across agencies, whether the shifts will lead to lower long-term stability or increased risk of failures, how supervisory appeals will function in practice, and how future administrations may reverse or refine these rules. Also, coordination among agencies (Fed, OCC, FDIC) will be tested, given different implementation styles and rule vs guidance variations.
Supporting Notes
- The LFI Framework final rule allows an institution to be “well managed” if it has at least two component ratings of Broadly Meets Expectations or Conditionally Meets Expectations and no more than one Deficient-1 rating, replacing the earlier presumption disqualifying any Deficient-1 rating.
- The Federal Reserve’s LFI revisions remove the presumption that one or more Deficient-1 ratings lead automatically to formal enforcement action; instead such actions will depend on specific facts and circumstances.
- OCC Bulletin 2025-24, effective January 1, 2026, eliminates policy-based examination requirements for community banks and directs examiners to tailor examinations based on the bank’s size, complexity, and risk profile; examples include ceasing mandatory flood insurance transaction testing and fair-lending assessments every cycle if risk is low.
- OCC Bulletin 2025-26 clarifies that community banks are not required to perform annual model validation; validation frequency and scope should depend on model complexity and risk exposure.
- BSA/AML examination procedures for community banks (Bulletin 2025-37) will allow examiner discretion to use prior cycle conclusions in certain areas and limit transaction testing or shift toward analytical reviews when appropriate.
- The Fed’s Washington Board’s supervision division staff will shrink from about 500 to ~350 employees by end-2026, mainly via attrition, voluntary departures, and retirements; structure will be flatter with fewer management layers.
- Reputation risk removed from OCC/FDIC supervisory rulemaking: proposed rule would bar examiners from taking adverse action on banks solely due to reputation risk, including pressure to de-bank entities for political, social or religious views.