- Fed supervision chief Michelle Bowman is moving to streamline bank ratings and oversight to focus on “material financial risk” and reduce burden.
- The Fed will relax the LFI “well managed” test so one Deficient-1 rating no longer automatically blocks banks from activities like mergers if there are no Deficient-2 scores.
- Regulators are weighing raising and indexing key asset thresholds (e.g., $500 million, $10 billion, $100 billion) to inflation or GDP so banks don’t trip stricter rules solely from growth.
- Industry says the changes better match bank condition and efficiency, while critics warn looser governance-and-controls standards could increase systemic risk.
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Recent regulatory developments unveiled by the Federal Reserve under Michelle Bowman indicate a strong policy shift toward easing oversight in favor of greater flexibility and efficiency. The outcomes center around an overhaul of both the rating framework for large banks, and the thresholds that determine which institutions face more intense regulatory burdens.
Revising “well-managed” constructs for large banks. Under the Large Financial Institution (LFI) Rating System, banks are judged on three components—capital adequacy, liquidity, and governance and controls—with four grading levels: broadly meets expectations; conditionally meets expectations; deficient-1; and deficient-2. Currently, a single deficient-1 rating in any one of those components disqualifies a bank from being deemed “well managed,” triggering restrictions on activities like mergers and acquisitions. Bowman’s revisions, finalized November 2025 and effective January 16, 2026, allow a bank to remain “well managed” if it has at most one deficient-1 rating and no deficient-2 ratings, reducing the automatic harsh penalties for single, less severe weaknesses. The Fed estimates this change will move 7 large bank‐holding companies from “not well managed” to “well managed”.
Adjusting regulatory thresholds. Bowman is also pushing to reset asset and regulatory thresholds that have remained static despite economic growth and inflation. For example, the Fed is considering indexing thresholds (e.g., the $500 million, $10 billion, $100 billion brackets) to nominal GDP growth or another metric so that banks can grow without tripping new regulatory requirements merely due to inflation or size. Community banks would benefit from easing in compliance and control burdens tied to smaller-threshold rules. Moreover, agencies proposed lowering the Community Bank Leverage Ratio (CBLR) minimum from 9% to 8%, and extending noncompliance grace periods—a direct example of tailoring rules to smaller banks’ operating models.
Strategic implications. For large banks, these changes could unlock acquisition and expansion opportunities by removing previous automatic disqualifications. The financial sector is likely to see shifts in capital allocation—banks may need less capital against certain low-risk assets like U.S. Treasuries under relaxed enhanced supplementary leverage ratio (eSLR) standards. For community banks, adjusting thresholds and easing leverage and rating burdens could reduce compliance costs and support growth. Regulatory alignment with economic growth may provide predictability.
Risks and open questions. Critics argue that easing standards for governance, compliance, and controls may expose systemic vulnerabilities—issues that may not immediately show up in capital or liquidity but can have outsized consequences (e.g., operational failures, financial fraud, risk culture weaknesses). The decision to index thresholds also raises questions about which metrics to use and how to set them so as not to dilute regulatory effectiveness. Legal and statutory constraints exist, including the Gramm-Leach-Bliley Act, governing what status like “well-managed” allows under law. How the definitions of “material financial risk” get operationalized will be key to how effective and safe the new regime is. Bowman has said these reforms are not intended to weaken safeguard foundations, but implementation will be watched closely.
Supporting Notes
- Bowman said upcoming rating changes are part of broader reforms to refocus supervision on material financial risk and move away from procedural or non-financial metrics.
- Under the current supervisory framework, any “deficient-1” rating disqualifies a large bank from the “well managed” status; the revised framework allows one deficient-1 but no deficient-2 across the three components.
- Of the 36 bank holding companies subject to the LFI Rating System in Q4 2024, 23 were then not considered “well managed” under the old framework; with changes, about eight would newly qualify (but only three fully, because of requirements for subsidiary institutions to also be rated well managed).
- Thresholds under review include the $500 million level for certain internal control and audit committee requirements, $10 billion for community bank rules, and higher thresholds generally for M&A and supervisory categories; Bowman and other regulators suggested indexing these to inflation or GDP growth.
- A proposed change to the Community Bank Leverage Ratio would lower its minimum from 9% to 8%, and allow a longer grace period for banks falling below threshold to regain compliance.
- Critics like former vice chair Michael Barr argue that relaxing governance and controls in private ratings could allow banks with serious management or operational issues to merge or expand, increasing system risk.