New FDIC and OCC Rule Defining Safety and Soundness: No “Free Pass” for

The FDIC and OCC recently finalized a rule designed to give banks clarity as to what constitutes “unsafe or unsound” banking practices and focus examiners on practices that are likely to materially harm an institution’s financial condition.

• For covered institutions, the final rule defines an unsafe or unsound practice as a practice, act, or failure to act that is contrary to generally accepted standards of prudent operation and that, if continued, is likely to materially harm the institution’s financial condition or present a material risk of loss to the Deposit Insurance Fund—or that has already materially harmed the institution’s financial condition.
• The rule also permits examiners to issue an MRA (Matter Requiring Attention) under a lower, forward-looking standard: An MRA may address such imprudent conduct if, under current or reasonably foreseeable conditions, its continuation could reasonably be expected to materially harm the institution’s financial condition or present a material risk of loss to the Deposit Insurance Fund, or if the conduct has already materially harmed the institution’s financial condition.
• Examiners may also issue an MRA for an actual violation of a banking or banking-related law or regulation.

At first blush, the rule appears to change examiners’ focus away from meta-compliance and technical violations and toward the most serious risks facing banks. But banks as institutions, on the one hand, and the individuals that work at and for them, on the other, should note the separate standards involved.

Key Highlights

• A generally positive development for banks as institutions. The OCC and FDIC finalized a joint rule that narrows the definition of “safety and soundness” to focus on material risks to banks and their customers. Supervisory priorities will shift toward this narrower definition.
• The final rule does not apply to individuals. A bank employee or board member might still be held personally liable for a safety-and-soundness violation even if it is not material. Whether that actually happens is something to watch.
• Compliance still matters. Banks and individuals can still be subject to supervisory or enforcement actions for violations of banking and related laws. Though the OCC proposed a rule to limit supervisory actions, it is not clear how much protection that will give banks or individuals.
• Policies, procedures, and controls can still help. Banks—and individuals working at and for banks—should consider reviewing policies, procedures, and controls with an eye toward the human side of the examination process.

Safety and Soundness Background

A key concept of federal banking law is safety and soundness. Though the concept was undefined and malleable, the underlying idea is that federally insured banks should not set themselves up for failure.

The operative definition for decades was a statement made by John Horne, then Chairman of the Federal Home Loan Bank…