SR 19-3 / CA 19-2: Large Financial Institution (LFI) Rating System

SR 19-3 / CA 19-2: Large Financial Institution (LFI) Rating System

BOARD OF GOVERNORS
OF THE FEDERAL RESERVE SYSTEM
WASHINGTON, D.C. 20551

DIVISION OF
SUPERVISION AND REGULATION

DIVISION OF CONSUMER
AND COMMUNITY AFFAIRS

SR 19-3 / CA 19-2
February 26, 2019

TO THE OFFICER IN CHARGE OF SUPERVISION AT EACH FEDERAL RESERVE BANK AND TO LARGE FINANCIAL INSTITUTIONS

SUBJECT:

Large Financial Institution (LFI) Rating System

Applicability: This guidance applies to bank holding companies with total consolidated assets of $100 billion or more; all non-insurance, non-commercial savings and loan holding companies with total consolidated assets of $100 billion or more; and U.S. intermediate holding companies of foreign banking organizations with combined U.S. assets of $50 billion or more established pursuant to the Federal Reserve’s Regulation YY.

Introduction

This letter provides an overview of the new rating system for the supervision of large financial institutions (LFIs).1 This "LFI rating system" would replace the current bank holding company rating system (referred to as the "RFI rating system") for these firms.2 See Attachment, Large Financial Institution Rating System.

The LFI rating system is designed to: (i) align with the Federal Reserve’s current supervisory programs and practices for LFIs; (ii) enhance the clarity and consistency of supervisory assessments and communications of supervisory findings and implications; and (iii) provide greater transparency to firms regarding the supervisory consequences of a given rating. The LFI rating system supports the Federal Reserve’s supervisory program for all LFIs, including the largest firms that pose the greatest risk to U.S. financial stability.3

Applicability and Implementation

The LFI rating system is used to evaluate and communicate the supervisory condition of bank holding companies with total consolidated assets of $100 billion or more; all non-insurance, non-commercial savings and loan holding companies with total consolidated assets of $100 billion or more;4 and U.S. intermediate holding companies of foreign banking organizations with combined U.S. assets of $50 billion or more established pursuant to the Federal Reserve’s Regulation YY.5 The Federal Reserve will assign initial LFI ratings to firms in the LISCC portfolio in early 2019. For all other firms subject to the LFI rating system, the Federal Reserve will assign initial LFI ratings in early 2020.

Federal Reserve supervision staff will continue to use the RFI rating system in assessing bank holding companies with total consolidated assets less than $100 billion.6 For noncomplex holding companies with total consolidated assets less than $3 billion, Reserve Bank supervisory staff will assign only a composite RFI rating and risk management rating to the firm following an inspection.7

Summary of LFI Rating System

The LFI rating system represents a supervisory evaluation of whether a firm possesses sufficient financial and operational strength and resilience to maintain safe-and-sound operations and comply with laws and regulations, including those related to consumer protection, through a range of conditions. The LFI rating system is composed of the following three components, which are described in greater detail in the attachment to this letter:

1. Capital Planning and Positions
2. Liquidity Risk Management and Positions
3. Governance and Controls

Each LFI component is rated based on the following four-point non-numeric scale, which are described in greater detail in the attachment to this letter:

• Broadly Meets Expectations
• Conditionally Meets Expectations
• Deficient-1
• Deficient-2

A firm is considered to be in satisfactory condition if all of its component ratings are either "Broadly Meets Expectations" or "Conditionally Meets Expectations." Under the LFI rating system, a firm must be rated "Broadly Meets Expectations" or "Conditionally Meets Expectations" for each of the three components (Capital Planning and Positions, Liquidity Risk Management and Positions, and Governance and Controls) to be considered "well managed" in accordance with various statutes and regulations.8 Unlike the RFI rating system, the Federal Reserve will neither assign a standalone composite rating nor subcomponent ratings under the LFI rating system.

Communication of Ratings

In accordance with the Federal Reserve’s regulations governing confidential supervisory information, ratings assigned under the LFI rating system will be communicated by the Federal Reserve to the firm, but individual ratings are not disclosed publicly. The Federal Reserve will assign LFI ratings and communicate ratings to large firms on an annual basis and more frequently as warranted. Under the LFI rating system, the Federal Reserve will continue to rely to the fullest extent possible on the information and assessments developed by other relevant supervisors and functional regulators.

Questions

Reserve Banks should distribute this letter to LFIs in their districts, as well as to their own supervisory and examination staff. Questions regarding the LFI rating system should be directed to Richard Naylor, Associate Director, (202) 728-5854, Vaishali Sack, Assistant Director, (202) 452-5221, or Christine Graham, Manager, (202) 452-3005, Division of Supervision and Regulation, and Phyllis Harwell, Associate Director, (202) 452-3658 or Mayank Patel, Manager, (202) 452-2316, Division of Consumer and Community Affairs. In addition, questions may be sent via the Board’s public website.9

signed by
Arthur W. Lindo
Deputy Director
Division of
Supervision and Regulation

signed by
Eric S. Belsky
Director
Division of Consumer and Community Affairs

Attachments:

• Large Financial Institution Rating System

Cross References:

• SR letter 13-21, "Inspection Frequency and Scope Requirements for Bank Holding Companies and Savings and Loan Holding Companies with Total Consolidated Assets of $10 Billion or Less"
• SR letter 12-17 / CA letter 12-14, "Consolidated Supervision Framework for Large Financial Institutions"

Notes:

1. See 83 Fed. Reg. 58724 (November 21, 2018) and 84 Fed. Reg. 4309 (February 15, 2019) for more information. Return to text
2. See 69 Fed. Reg. 70444 (December 6, 2004) for more information. Return to text
3. The Federal Reserve’s Large Institution Supervision Coordinating Committee (LISCC) coordinates the supervisory oversight for the systemically important firms that pose the greatest risk to U.S. financial stability. Refer to the Board’s website for a list of these firms at https://www.federalreserve.gov/bankinforeg/large-institution-supervision.htm. Return to text
4. SLHCs are considered to be engaged in significant commercial activities if they derive 50 percent or more of their total consolidated assets or total revenues from activities that are not financial in nature under section 4(k) of the Bank Holding Company Act of 1956, as amended (12 U.S.C. 1843(k)). SLHCs are considered to be engaged in significant insurance underwriting activities if they are either insurance companies or hold 25 percent or more of their total consolidated assets in subsidiaries that are insurance companies. SLHCs that meet these criteria are excluded from the definition of "covered savings and loan holding company" in section 217.2 of the Board’s Regulation Q. See 12 CFR 217.2. Return to text
5. Consistent with the Board’s proposal on tailoring its supervisory expectations for domestic institutions, see 83 Fed. Reg. 61408 (November 29, 2018), the Board continues to consider tailoring for foreign banking organizations. Return to text
6. The Federal Reserve has adopted a final rule to begin applying the RFI rating system on February 1, 2019 on a fully implemented basis to savings and loan holding companies with total consolidated assets less than $100 billion, excluding savings and loan holding companies engaged in significant insurance or commercial activities. See 83 Fed. Reg. 56081 (November 7, 2018). Non-insurance, non-commercial savings and loan holding companies with total consolidated assets of $100 billion or more will receive supervisory ratings under the RFI rating system in 2019, and under the LFI rating system beginning in 2020. If an SLHC engaged in significant insurance or commercial activities has total consolidated assets of $100 billion or more, the Federal Reserve will continue to assign an indicative RFI rating to the firm as it considers the appropriate manner to assign supervisory ratings to such firms on a permanent basis. Return to text
7. See SR letter 13-21, "Inspection Frequency and Scope Requirements for Bank Holding Companies and Savings and Loan Holding Companies with Total Consolidated Assets of $10 Billion or Less." Return to text
8. 12 U.S.C. 1841 et. seq. and 12 U.S.C. 1461 et seq. See, for example, 12 CFR 225.4(b)(6), 225.14, 225.22(a), 225.23, 225.85, and 225.86; 12 CFR 211.9(b), 211.10(a)(14), and 211.34; and 12 CFR 223.41. Return to text
9. See https://www.federalreserve.gov/apps/contactus/feedback.aspx. Return to text

PDF

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Large Financial Institution Rating System

Attachment SR 19-3 / CA letter 19-2
Large Financial Institution Rating System
February 2019 [Fotne1

• See 83 Fed. Reg. 58724 (November 21, 2018) and 84 Fed. Reg. 4309 (February 15, 2019) for more information.
  See also the Board’s press release dated November 2, 2018 available at https://www.federalreserve.gov/newsevents/pressreleases/bcreg20181102a.htm. EndofFte 1.] A. Overview Each large financial institution (LFI) is expected to ensure that the consolidated organization (or the combined U.S. operations in the case of foreign banking organizations), including its critical operations and banking offices, remain safe and sound and in compliance with laws and regulations, including those related to consumer protection. [Fotne2
• See SR letter 12-17/CA letter 12-14, “Consolidated Supervisory Framework for Large Financial Institutions,” at
  http://www.federalreserve.gov/bankinforeg/srletters/sr1217.htm.
  Hereinafter, when “safe and sound” or “safety and soundness” is used in this framework, related expectations apply to the consolidated organization and the firm’s critical operations and banking offices. “Critical operations” are a firm’s operations, including associated services, functions and support, the failure or discontinuance of which, in the view of the firm or the Federal Reserve, would pose a threat to the financial stability of the United States. “Banking offices” are defined as U.S. depository institution subsidiaries, as well as the U.S. branches and agencies of foreign banking organizations. EndofFte 2.] The LFI rating system provides a supervisory evaluation of whether a covered firm possesses sufficient financial and operational strength and resilience to maintain safe-and-sound operations through a range of conditions, including stressful ones. [Fotne3
• “Financial strength and resilience” is defined as maintaining effective capital and liquidity governance and
  planning processes, and sufficiency of related positions, to provide for the continuity of the consolidated organization (including its critical operations and banking offices) through a range of conditions. “Operational strength and resilience” is defined as maintaining effective governance and controls to provide for the continuity of the consolidated organization (including its critical operations and banking offices) and to promote compliance with laws and regulations, including those related to consumer protection, through a range of conditions. References to “financial or operational” weaknesses or deficiencies implicate a firm’s financial or operational strength and resilience. EndofFte 3.] The LFI rating system applies to bank holding companies with total consolidated assets of $100 billion or more; all non-insurance, non-commercial savings and loan holding companies with total consolidated assets of $100 billion or more; and U.S. intermediate holding companies of foreign banking organizations with combined U.S. assets of $50 billion or more established pursuant to the Federal Reserve’s Regulation YY. [Fotne4
• Total consolidated assets will be calculated based on the average of the firm’s total consolidated assets in the four
  most recent quarters as reported on the firm’s quarterly financial reports filed with the Federal Reserve. A firm will continue to be rated under the LFI rating system until it has less than $95 billion in total consolidated assets, based on the average total consolidated assets as reported on the firm’s four most recent quarterly financial reports filed with the Federal Reserve. The Federal Reserve may determine to apply the RFI rating system or another applicable rating system in certain limited circumstances. EndofFte 4.]

The LFI rating system is designed to:

• Fully align with the Federal Reserve’s current supervisory programs and practices, which
  are based upon the LFI supervision framework’s core objectives of reducing the probability of LFIs failing or experiencing material distress and reducing the risk to U.S. financial stability;
• Enhance the clarity and consistency of supervisory assessments and communications of
  supervisory findings and implications; and
• Provide transparency related to the supervisory consequences of a given rating.
  The LFI rating system is comprised of three components:
• Capital Planning and Positions: an evaluation of (i) the effectiveness of a firm’s
  governance and planning processes used to determine the amount of capital necessary to cover risks and exposures, and to support activities through a range of conditions and events; and (ii) the sufficiency of a firm’s capital positions to comply with applicable regulatory requirements and to support the firm’s ability to continue to serve as a financial intermediary through a range of conditions.
• Liquidity Risk Management and Positions : an evaluation of (i) the effectiveness of a
  firm’s governance and risk management processes used to determine the amount of liquidity necessary to cover risks and exposures, and to support activities through a range of conditions; and (ii) the sufficiency of a firm’s liquidity positions to comply with applicable regulatory requirements and to support the firm’s ongoing obligations through a range of conditions.
• Governance and Controls: an evaluation of the effectiveness of a firm’s (i) board of
  directors, [Fotne5
• References to “board” or “board of directors” in this framework includes the equivalent to a board of directors, as
  appropriate, as well as committees of the board of directors or the equivalent thereof, as appropriate. At this time, recovery planning expectations only apply to domestic bank holding companies subject to the Federal Reserve’s LISCC supervisory framework. Should the Federal Reserve expand the scope of recovery planning expectations to encompass additional firms, this rating will reflect such expectations for the broader set of firms. EndofFte 5.] (ii) management of business lines and independent risk management and controls, [Fotne6
• The evaluation of the effectiveness of management of business lines would include management of critical
  operations. EndofFte 6.] and (iii) recovery planning (only for domestic firms that are subject to the Board’s Large Institution Supervision Coordinating Committee (LISCC) Framework). [Fotne7
• There are eight domestic firms in the LISCC portfolio: (1) Bank of America Corporation; (2) Bank of New York
  Mellon Corporation; (3) Citigroup, Inc.; (4) Goldman Sachs Group, Inc.; (5) JP Morgan Chase & Co.; (6) Morgan Stanley; (7) State Street Corporation; and (8) Wells Fargo & Company. In this guidance, these eight firms may collectively be referred to as “domestic LISCC firms.” EndofFte 7.] This rating assesses a firm’s effectiveness in aligning strategic business objectives with the firm’s risk appetite and risk management capabilities; maintaining effective and independent risk management and control functions, including internal audit; promoting

compliance with laws and regulations, including those related to consumer protection; and otherwise planning for the ongoing resiliency of the firm. [Fotne8

• “Risk appetite” is defined as the aggregate level and types of risk the board and senior management are willing to
  assume to achieve the firm’s strategic business objectives, consistent with applicable capital, liquidity, and other requirements and constraints. EndofFte 8.] B. Assignment of the LFI Component Ratings Each LFI component rating is assigned along a four-level scale:
• Broadly Meets Expectations: A firm’s practices and capabilities broadly meet
  supervisory expectations, and the firm possesses sufficient financial and operational strength and resilience to maintain safe-and-sound operations through a range of conditions. The firm may be subject to identified supervisory issues requiring corrective action. These issues are unlikely to present a threat to the firm’s ability to maintain safe￾and-sound operations through a range of conditions.
• Conditionally Meets Expectations: Certain, material financial or operational weaknesses
  in a firm’s practices or capabilities may place the firm’s prospects for remaining safe and sound through a range of conditions at risk if not resolved in a timely manner during the normal course of business. The Federal Reserve does not intend for a firm to be assigned a “Conditionally Meets Expectations” rating for a prolonged period, and will work with the firm to develop an appropriate timeframe to fully resolve the issues leading to the rating assignment and merit upgrade to a “Broadly Meets Expectations” rating. A firm is assigned a “Conditionally Meets Expectations” rating - as opposed to a “Deficient” rating - when it has the ability to resolve these issues through measures that do not require a material change to the firm’s business model or financial profile, or its governance, risk management or internal control structures or practices. Failure to resolve the issues in a timely manner would most likely result in the firm’s downgrade to a “Deficient” rating, since the inability to resolve the issues would indicate that the firm does not possess sufficient financial or operational capabilities to maintain its safety and soundness through a range of conditions. It is recognized that completion and validation of remediation activities for select supervisory issues - such as those involving information technology modifications - may require an extended time horizon. In all instances, appropriate and effective risk mitigation techniques must be utilized in the interim to maintain safe-and-sound operations under a range of conditions until remediation activities are completed, validated, and fully operational.
• Deficient-1: Financial or operational deficiencies in a firm’s practices or capabilities put
  the firm’s prospects for remaining safe and sound through a range of conditions at significant risk. The firm is unable to remediate these deficiencies in the normal course of business, and remediation would typically require the firm to make a material change to its business model or financial profile, or its practices or capabilities.

A firm’s failure to resolve the issues in a timely manner that gave rise to a “Conditionally Meets Expectations” rating would most likely result in its downgrade to a “Deficient” rating. A firm with a “Deficient-1” rating is required to take timely corrective action to correct financial or operational deficiencies and to restore and maintain its safety and soundness and compliance with laws and regulations, including those related to consumer protection. There is a strong presumption that a firm with a “Deficient-1” rating will be subject to an informal or formal enforcement action, and this rating assignment could be a barrier for a firm seeking Federal Reserve approval to engage in new or expansionary activities.

• Deficient-2: Financial or operational deficiencies in a firm’s practices or capabilities
  present a threat to the firm’s safety and soundness, or have already put the firm in an unsafe and unsound condition. A firm with a “Deficient-2” rating is required to immediately implement comprehensive corrective measures, and demonstrate the sufficiency of contingency planning in the event of further deterioration. There is a strong presumption that a firm with a “Deficient-2” rating will be subject to a formal enforcement action, and the Federal Reserve would be unlikely to approve any proposal from a firm with this rating to engage in new or expansionary activities. The Federal Reserve will take into account a number of individual elements of a firm’s practices, capabilities and performance when making each component rating assignment. The weighting of an individual element in assigning a component rating will depend on its impact on the firm’s safety, soundness and resilience as provided for in the LFI rating system definitions. For example, for purposes of the Governance and Controls rating, a limited number of significant deficiencies - or even just one significant deficiency - noted for management of a single material business line could be viewed as sufficiently important to warrant a “Deficient-1” for the Governance and Controls component rating, even if the firm meets supervisory expectations under the Governance and Controls component in all other respects. Under the LFI rating system, a firm must be rated “Broadly Meets Expectations” or “Conditionally Meets Expectations” for each of the three component ratings (Capital, Liquidity, Governance and Controls) to be considered “well managed” in accordance with various statutes and regulations. [Fotne9
• 12 U.S.C. § 1841 et. seq. and 12 U.S.C. § 1461 et seq. See, eg., 12 CFR 225.4(b)(6), 225.14, 225.22(a), 225.23,
  225.85, and 225.86; 12 CFR 211.9(b), 211.10(a)(14), and 211.34; and 12 CFR 223.41. EndofFte 9.] A “well managed” firm has sufficient financial and operational strength and resilience to maintain safe-and-sound operations through a range of conditions, including stressful ones.

C. LFI Rating Components
The LFI rating system is comprised of three component ratings: [Fotne10

• There may be instances where deficiencies or supervisory issues may be relevant to the Federal Reserve’s
  assessment of more than one component area. As such, the LFI rating will reflect these deficiencies or issues within multiple rating components when necessary to provide a comprehensive supervisory assessment. EndofFte 10.]

1. Capital Planning and Positions Component Rating
   The Capital Planning and Positions component rating evaluates (i) the effectiveness of a firm’s governance and planning processes used to determine the amount of capital necessary to cover risks and exposures, and to support activities through a range of conditions; and (ii) the sufficiency of a firm’s capital positions to comply with applicable regulatory requirements and to support the firm’s ability to continue to serve as a financial intermediary through a range of conditions. In developing this rating, the Federal Reserve evaluates:

• Capital Planning: The extent to which a firm maintains sound capital planning practices
  through effective governance and oversight; effective risk management and controls; maintenance of updated capital policies and contingency plans for addressing potential shortfalls; and incorporation of appropriately stressful conditions into capital planning and projections of capital positions; and
• Capital Positions: The extent to which a firm’s capital is sufficient to comply with
  regulatory requirements, and to support its ability to meet its obligations to depositors, creditors, and other counterparties and continue to serve as a financial intermediary through a range of conditions. Definitions for the Capital Planning and Positions Component Rating Broadly Meets Expectations A firm’s capital planning and positions broadly meet supervisory expectations and support maintenance of safe-and-sound operations. Specifically:
• The firm is capable of producing sound assessments of capital adequacy through a range
  of conditions; and
• The firm’s current and projected capital positions comply with regulatory requirements,
  and support its ability to absorb current and potential losses, to meet obligations, and to continue to serve as a financial intermediary through a range of conditions. A firm rated “Broadly Meets Expectations” may be subject to identified supervisory issues requiring corrective action. However, these issues are unlikely to present a threat to the firm’s ability to maintain safe-and-sound operations through a range of potentially stressful conditions.

A firm that does not meet the capital planning and position expectations associated with a “Broadly Meets Expectations” rating will be rated “Conditionally Meets Expectations,” “Deficient-1,” or “Deficient-2,” and subject to potential consequences as outlined below. Conditionally Meets Expectations Certain, material financial or operational weaknesses in a firm’s capital planning or positions may place the firm’s prospects for remaining safe and sound through a range of conditions at risk if not resolved in a timely manner during the normal course of business. Specifically, if left unresolved, these weaknesses:

• May threaten the firm’s ability to produce sound assessments of capital adequacy through
  a range of conditions; and/or
• May result in the firm’s projected capital positions being insufficient to absorb potential
  losses, comply with regulatory requirements, and support the firm’s ability to meet current and prospective obligations and to continue to serve as a financial intermediary through a range of conditions. The Federal Reserve does not intend for a firm to be rated “Conditionally Meets Expectations” for a prolonged period. The firm has the ability to resolve these issues through measures that do not require a material change to the firm’s business model or financial profile, or its governance, risk management, or internal control structures or practices. The Federal Reserve will work with the firm to develop an appropriate timeframe during which the firm would be required to resolve each supervisory issue leading to the “Conditionally Meets Expectations” rating. The Federal Reserve will closely monitor the firm’s remediation and mitigation activities; in most instances, the firm will either:
  (i) Resolve the issues in a timely manner and, if no new material supervisory issues arise, be upgraded to a “Broadly Meets Expectations” rating because the firm’s capital planning practices and related positions would broadly meet supervisory expectations; or (ii) Fail to resolve the issues in a timely manner and be downgraded to a “Deficient￾1” rating, because the inability to resolve the issues would indicate that the firm does not possess sufficient financial or operational capabilities to maintain its safety and soundness through a range of conditions. It is possible that a firm may be close to completing resolution of the supervisory issues leading to the “Conditionally Meets Expectations” rating, but new issues are identified that, taken alone, would be consistent with a “Conditionally Meets Expectations” rating. In this event, the firm may continue to be rated “Conditionally Meets Expectations,” provided the new issues do not reflect a pattern of deeper or prolonged capital planning or position weaknesses consistent with a “Deficient” rating. A “Conditionally Meets Expectations” rating may be assigned to a firm that meets the above definition regardless of its prior rating. A firm previously rated “Deficient-1” may be

upgraded to “Conditionally Meets Expectations” if the firm’s remediation and mitigation activities are sufficiently advanced so that the firm’s prospects for remaining safe and sound are no longer at significant risk, even if the firm has outstanding supervisory issues or is subject to an active enforcement action. Deficient-1 Financial or operational deficiencies in a firm’s capital planning or positions put the firm’s prospects for remaining safe and sound through a range of conditions at significant risk. The firm is unable to remediate these deficiencies in the normal course of business, and remediation would typically require a material change to the firm’s business model or financial profile, or its capital planning practices. Specifically, although the firm’s current condition is not considered to be materially threatened:

• Deficiencies in the firm’s capital planning processes are not effectively mitigated. These
  deficiencies limit the firm’s ability to effectively assess capital adequacy through a range of conditions; and/or
• The firm’s projected capital positions may be insufficient to absorb potential losses and
  to support its ability to meet current and prospective obligations and serve as a financial intermediary through a range of conditions. Supervisory issues that place the firm’s safety and soundness at significant risk, and where resolution is likely to require steps that clearly go beyond the normal course of business - such as issues requiring a material change to the firm’s business model or financial profile, or its governance, risk management or internal control structures or practices - would generally warrant assignment of a “Deficient-1” rating. A “Deficient-1” rating may be assigned to a firm regardless of its prior rating. A firm previously rated “Broadly Meets Expectations” may be downgraded to “Deficient-1” when supervisory issues are identified that place the firm’s prospects for maintaining safe-and-sound operations through a range of potentially stressful conditions at significant risk. A firm previously rated “Conditionally Meets Expectations” may be downgraded to “Deficient-1” when the firm’s inability to resolve supervisory issues in a timely manner indicates that the firm does not possess sufficient financial or operational capabilities to maintain its safety and soundness through a range of conditions. To address these financial or operational deficiencies, the firm is required to take timely corrective action to restore and maintain its capital planning and positions consistent with supervisory expectations. There is a strong presumption that a firm rated “Deficient-1” will be subject to an informal or formal enforcement action by the Federal Reserve. A firm rated “Deficient-1” for any rating component would not be considered “well managed,” which would subject the firm to various consequences. A “Deficient-1” rating could be a barrier for a firm seeking Federal Reserve approval of a proposal to engage in new or expansionary activities, unless the firm can demonstrate that (i) it is making meaningful, sustained progress in resolving identified deficiencies and issues; (ii) the proposed new or

expansionary activities would not present a risk of exacerbating current deficiencies or issues or lead to new concerns; and (iii) the proposed activities would not distract the firm from remediating current deficiencies or issues. Deficient-2 Financial or operational deficiencies in a firm’s capital planning or positions present a threat to the firm’s safety and soundness, or have already put the firm in an unsafe and unsound condition. Specifically, as a result of these deficiencies:

• The firm’s capital planning processes are insufficient to effectively assess the firm’s
  capital adequacy through a range of conditions; and/or
• The firm’s current or projected capital positions are insufficient to absorb current or
  potential losses, and to support the firm’s ability to meet current and prospective obligations and serve as a financial intermediary through a range of conditions. To address these deficiencies, the firm is required to immediately (i) implement comprehensive corrective measures sufficient to restore and maintain appropriate capital planning capabilities and adequate capital positions; and (ii) demonstrate the sufficiency, credibility and readiness of contingency planning in the event of further deterioration of the firm’s financial or operational strength or resiliency. There is a strong presumption that a firm rated “Deficient-2” will be subject to a formal enforcement action by the Federal Reserve. A firm rated “Deficient-2” for any rating component would not be considered “well managed,” which would subject the firm to various consequences. The Federal Reserve would be unlikely to approve any proposal from a firm rated “Deficient-2” to engage in new or expansionary activities.

2. Liquidity Risk Management and Positions Component Rating
   The Liquidity Risk Management and Positions component rating evaluates (i) the effectiveness of a firm’s governance and risk management processes used to determine the amount of liquidity necessary to cover risks and exposures, and to support activities through a range of conditions; and (ii) the sufficiency of a firm’s liquidity positions to comply with applicable regulatory requirements and to support the firm’s ongoing obligations through a range of conditions. In developing this rating, the Federal Reserve evaluates:

• Liquidity Risk Management: The extent to which a firm maintains sound liquidity risk
  management practices through effective governance and oversight; effective risk management and controls; maintenance of updated liquidity policies and contingency plans for addressing potential shortfalls; and incorporation of appropriately stressful conditions into liquidity planning and projections of liquidity positions; and
• Liquidity Positions: The extent to which a firm’s liquidity is sufficient to comply with
  regulatory requirements, and to support its ability to meet current and prospective

obligations to depositors, creditors and other counterparties through a range of conditions. Definitions for the Liquidity Risk Management and Positions Component Rating Broadly Meets Expectations A firm’s liquidity risk management and positions broadly meet supervisory expectations and support maintenance of safe-and-sound operations. Specifically:

• The firm is capable of producing sound assessments of liquidity adequacy through a
  range of conditions; and
• The firm’s current and projected liquidity positions comply with regulatory requirements,
  and support its ability to meet current and prospective obligations and to continue to serve as a financial intermediary through a range of conditions. A firm rated “Broadly Meets Expectations” may be subject to identified supervisory issues requiring corrective action. However, these issues are unlikely to present a threat to the firm’s ability to maintain safe-and-sound operations through a range of potentially stressful conditions. A firm that does not meet the liquidity risk management and position expectations associated with a “Broadly Meets Expectations” rating will be rated “Conditionally Meets Expectations,” “Deficient-1,” or “Deficient-2,” and subject to potential consequences as outlined below. Conditionally Meets Expectations Certain, material financial or operational weaknesses in a firm’s liquidity risk management or positions may place the firm’s prospects for remaining safe and sound through a range of conditions at risk if not resolved in a timely manner during the normal course of business. Specifically, if left unresolved, these weaknesses:
• May threaten the firm’s ability to produce sound assessments of liquidity adequacy
  through a range of conditions; and/or
• May result in the firm’s projected liquidity positions being insufficient to comply with
  regulatory requirements, and support its ability to meet current and prospective obligations and to continue to serve as a financial intermediary through a range of conditions. The Federal Reserve does not intend for a firm to be rated “Conditionally Meets Expectations” for a prolonged period. The firm has the ability to resolve these issues through measures that do not require a material change to the firm’s business model or financial profile, or its governance, risk management or internal control structures or practices. The Federal Reserve will work with the firm to develop an appropriate timeframe during which the firm would be required to resolve each supervisory issue leading to the “Conditionally Meets Expectations” rating.

The Federal Reserve will closely monitor the firm’s remediation and mitigation activities; in most instances, the firm will either:
(i) Resolve the issues in a timely manner and, if no new material supervisory issues arise, and be upgraded to a “Broadly Meets Expectations” rating because the firm’s liquidity risk management practices and related positions would broadly meet supervisory expectations; or (ii) Fail to resolve the issues in a timely manner and be downgraded to a “Deficient￾1” rating, because the firm’s inability to resolve those issues would indicate that the firm does not possess sufficient financial or operational capabilities to maintain its safety and soundness through a range of conditions. It is possible that a firm may be close to completing resolution of the supervisory issues leading to the “Conditionally Meets Expectations” rating, but new issues are identified that, taken alone, would be consistent with a “Conditionally Meets Expectations” rating. In this event, the firm may continue to be rated “Conditionally Meets Expectations,” provided the new issues do not reflect a pattern of deeper or prolonged liquidity risk management and positions weaknesses consistent with a “Deficient” rating. A “Conditionally Meets Expectations” rating may be assigned to a firm that meets the above definition regardless of its prior rating. A firm previously rated “Deficient-1” may be upgraded to “Conditionally Meets Expectations” if the firm’s remediation and mitigation activities are sufficiently advanced so that the firm’s prospects for remaining safe and sound are no longer at significant risk, even if the firm has outstanding supervisory issues or is subject to an active enforcement action. Deficient-1 Financial or operational deficiencies in a firm’s liquidity risk management or positions put the firm’s prospects for remaining safe and sound through a range of conditions at significant risk. The firm is unable to remediate these deficiencies in the normal course of business, and remediation would typically require a material change to the firm’s business model or financial profile, or its liquidity risk management practices. Specifically, although the firm’s current condition is not considered to be materially threatened:

• Deficiencies in the firm’s liquidity risk management processes are not effectively
  mitigated. These deficiencies limit the firm’s ability to effectively assess liquidity adequacy through a range of conditions; and/or
• The firm’s projected liquidity positions may be insufficient to support its ability to meet
  prospective obligations and serve as a financial intermediary through a range of conditions. Supervisory issues that place the firm’s safety and soundness at significant risk, and where resolution is likely to require steps that clearly go beyond the normal course of business - such as issues requiring a material change to the firm’s business model or financial profile, or its

governance, risk management or internal control structures or practices - would generally warrant assignment of a “Deficient-1” rating. A “Deficient-1” rating may be assigned to a firm regardless of its prior rating. A firm previously rated “Broadly Meets Expectations” may be downgraded to “Deficient-1” when supervisory issues are identified that place the firm’s prospects for maintaining safe-and-sound operations through a range of potentially stressful conditions at significant risk. A firm previously rated “Conditionally Meets Expectations” may be downgraded to “Deficient-1” when the firm’s inability to resolve supervisory issues in a timely manner indicates that the firm does not possess sufficient financial or operational capabilities to maintain its safety and soundness through a range of conditions. To address these financial or operational deficiencies, the firm is required to take timely corrective action to restore and maintain its liquidity risk management and positions consistent with supervisory expectations. There is a strong presumption that a firm rated “Deficient-1” will be subject to an informal or formal enforcement action by the Federal Reserve. A firm rated “Deficient-1” for any rating component would not be considered “well managed,” which would subject the firm to various consequences. A “Deficient-1” rating could be a barrier for a firm seeking Federal Reserve approval of a proposal to engage in new or expansionary activities, unless the firm can demonstrate that (i) it is making meaningful, sustained progress in resolving identified deficiencies and issues; (ii) the proposed new or expansionary activities would not present a risk of exacerbating current deficiencies or issues or lead to new concerns; and (iii) the proposed activities would not distract the firm from remediating current deficiencies or issues. Deficient-2 Financial or operational deficiencies in a firm’s liquidity risk management or positions present a threat to the firm’s safety and soundness, or have already put the firm in an unsafe and unsound condition. Specifically, as a result of these deficiencies:

• The firm’s liquidity risk management processes are insufficient to effectively assess the
  firm’s liquidity adequacy through a range of conditions; and/or
• The firm’s current or projected liquidity positions are insufficient to support the firm’s
  ability to meet current and prospective obligations and serve as a financial intermediary through a range of conditions. To address these deficiencies, the firm is required to immediately (i) implement comprehensive corrective measures sufficient to restore and maintain appropriate liquidity risk management capabilities and adequate liquidity positions; and (ii) demonstrate the sufficiency, credibility and readiness of contingency planning in the event of further deterioration of the firm’s financial or operational strength or resiliency. There is a strong presumption that a firm rated “Deficient-2” will be subject to a formal enforcement action by the Federal Reserve. A firm rated “Deficient-2” for any rating component would not be considered “well managed,” which would subject the firm to various consequences. The Federal Reserve would

be unlikely to approve any proposal from a firm rated “Deficient-2” to engage in new or expansionary activities.
3. Governance and Controls Component Rating
The Governance and Controls component rating evaluates the effectiveness of a firm’s (i) board of directors, (ii) management of business lines and independent risk management and controls, and (iii) recovery planning (for domestic LISCC firms only). This rating assesses a firm’s effectiveness in aligning strategic business objectives with the firm’s risk appetite and risk management capabilities; maintaining effective and independent risk management and control functions, including internal audit; promoting compliance with laws and regulations, including those related to consumer protection; and otherwise providing for the ongoing resiliency of the firm. In developing this rating, the Federal Reserve evaluates:

• Effectiveness of the Board of Directors : The extent to which the board exhibits attributes
  that are consistent with those of effective boards in carrying out its core roles and responsibilities, including: (i) setting a clear, aligned, and consistent direction regarding the firm’s strategy and risk appetite; (ii) directing senior management regarding the board’s information; (iii) overseeing and holding senior management accountable, (iv) supporting the independence and stature of independent risk management and internal audit; and (v) maintaining a capable board composition and governance structure.
• Management of Business Lines and Independent Risk Management and Controls
  The extent to which:
  o Senior management effectively and prudently manages the day-to-day operations of the firm and provides for ongoing resiliency; implements the firm’s strategy and risk appetite; maintains an effective risk management framework and system of internal controls; and promotes prudent risk taking behaviors and business practices, including compliance with laws and regulations, including those related to consumer protection. o Business line management executes business line activities consistent with the firm’s strategy and risk appetite; identifies and manages risks; and ensures an effective system of internal controls for its operations. o Independent risk management effectively evaluates whether the firm’s risk appetite appropriately captures material risks and is consistent with the firm’s risk management capacity; establishes and monitors risk limits that are consistent with the firm’s risk appetite; identifies and measures the firm’s risks; and aggregates, assesses and reports on the firm’s risk profile and positions. Additionally, the firm demonstrates that its internal controls are appropriate and tested for effectiveness. Finally, internal audit effectively and independently assesses the firm’s risk management framework and internal control systems, and reports findings to senior management and the firm’s audit committee.
• Recovery Planning (domestic LISCC firms only): The extent to which recovery planning
  processes effectively identify options that provide a reasonable chance of a firm being

able to remedy financial weakness and restore market confidence without extraordinary official sector support. Definitions for the Governance and Controls Component Rating Broadly Meets Expectations A firm’s governance and controls broadly meet supervisory expectations and support maintenance of safe-and-sound operations. Specifically, the firm’s practices and capabilities are sufficient to align strategic business objectives with its risk appetite and risk management capabilities, [Fotne11

• References to risk management capabilities includes risk management of business lines and independent risk
  management and control functions, including internal audit. EndofFte 1.] maintain effective and independent risk management and control functions, including internal audit; promote compliance with laws and regulations (including those related to consumer protection); and otherwise provide for the firm’s ongoing financial and operational resiliency through a range of conditions. A firm rated “Broadly Meets Expectations” may be subject to identified supervisory issues requiring corrective action. However, these issues are unlikely to present a threat to the firm’s ability to maintain safe-and-sound operations through a range of potentially stressful conditions. A firm that does not meet supervisory expectations associated with a “Broadly Meets Expectations” rating will be rated “Conditionally Meets Expectations,” “Deficient-1,” or “Deficient-2,” and subject to potential consequences, as outlined below. Conditionally Meets Expectations Certain, material financial or operational weaknesses in a firm’s governance and controls practices may place the firm’s prospects for remaining safe and sound through a range of conditions at risk if not resolved in a timely manner during the normal course of business. Specifically, if left unresolved, these weaknesses may threaten the firm’s ability to align strategic business objectives with the firm’s risk appetite and risk management capabilities; maintain effective and independent risk management and control functions, including internal audit; promote compliance with laws and regulations (including those related to consumer protection); or otherwise provide for the firm’s ongoing resiliency through a range of conditions. The Federal Reserve does not intend for a firm to be rated “Conditionally Meets Expectations” for a prolonged period. The firm has the ability to resolve these issues through measures that do not require a material change to the firm’s business model or financial profile, or its governance, risk management or internal control structures or practices. The Federal Reserve will work with the firm to develop an appropriate timeframe during which the firm would be required to resolve each supervisory issue leading to the “Conditionally Meets Expectations” rating.

The Federal Reserve will closely monitor the firm’s remediation and mitigation activities; in most instances, the firm will either:
(i) Resolve the issues in a timely manner and, if no new material supervisory issues arise, be upgraded to a “Broadly Meets Expectations” rating because the firm’s governance and controls would broadly meet supervisory expectations; or (ii) Fail to resolve the issues in a timely manner and be downgraded to a “Deficient￾1” rating, because the firm’s inability to resolve those issues would indicate that the firm does not possess sufficient financial or operational capabilities to maintain its safety and soundness through a range of conditions. It is possible that a firm may be close to completing resolution of the supervisory issues leading to the “Conditionally Meets Expectations” rating, but new issues are identified that, taken alone, would be consistent with a “Conditionally Meets Expectations” rating. In this event, the firm may continue to be rated “Conditionally Meets Expectations,” provided the new issues do not reflect a pattern of deeper or prolonged governance and controls weaknesses consistent with a “Deficient” rating. A “Conditionally Meets Expectations” rating may be assigned to a firm that meets the above definition regardless of its prior rating. A firm previously rated “Deficient” may be upgraded to “Conditionally Meets Expectations” if the firm’s remediation and mitigation activities are sufficiently advanced so that the firm’s prospects for remaining safe and sound are no longer at significant risk, even if the firm has outstanding supervisory issues or is subject to an active enforcement action. Deficient-1 Financial or operational deficiencies in a firm’s governance and controls put the firm’s prospects for remaining safe and sound through a range of conditions at significant risk. The firm is unable to remediate these deficiencies in the normal course of business, and remediation would typically require a material change to the firm’s business model or financial profile, or its governance, risk management or internal control structures or practices. Specifically, although the firm’s current condition is not considered to be materially threatened, these deficiencies limit the firm’s ability to align strategic business objectives with its risk appetite and risk management capabilities; maintain effective and independent risk management and control functions, including internal audit; promote compliance with laws and regulations (including those related to consumer protection); or otherwise provide for the firm’s ongoing resiliency through a range of conditions. A “Deficient-1” rating may be assigned to a firm regardless of its prior rating. A firm previously rated “Broadly Meets Expectations” may be downgraded to “Deficient-1” when supervisory issues are identified that place the firm’s prospects for maintaining safe-and-sound operations through a range of potentially stressful conditions at significant risk. A firm previously rated “Conditionally Meets Expectations” may be downgraded to “Deficient-1” when the firm’s inability
to resolve supervisory issues in a timely manner indicates that the firm does not possess sufficient financial or operational capabilities to maintain its safety and soundness through a range of conditions.

To address these financial or operational deficiencies, the firm is required to take timely corrective action to restore and maintain its governance and controls consistent with supervisory expectations. There is a strong presumption that a firm rated “Deficient-1” will be subject to an informal or formal enforcement action by the Federal Reserve. A firm rated “Deficient-1” for any rating component would not be considered “well managed,” which would subject the firm to various consequences. A “Deficient-1” rating could be a barrier for a firm seeking Federal Reserve approval of a proposal to engage in new or expansionary activities, unless the firm can demonstrate that (i) it is making meaningful, sustained progress in resolving identified deficiencies and issues; (ii) the proposed new or expansionary activities would not present a risk of exacerbating current deficiencies or issues or lead to new concerns; and (iii) the proposed activities would not distract the firm from remediating current deficiencies or issues. Deficient-2 Financial or operational deficiencies in governance or controls present a threat to the firm’s safety and soundness, or have already put the firm in an unsafe and unsound condition. Specifically, as a result of these deficiencies, the firm is unable to align strategic business objectives with its risk appetite and risk management capabilities; maintain effective and independent risk management and control functions, including internal audit; promote compliance with laws and regulations (including those related to consumer protection); or otherwise provide for the firm’s ongoing resiliency. To address these deficiencies, the firm is required to immediately (i) implement comprehensive corrective measures sufficient to restore and maintain appropriate governance and control capabilities; and (ii) demonstrate the sufficiency, credibility, and readiness of contingency planning in the event of further deterioration of the firm’s financial or operational strength or resiliency. There is a strong presumption that a firm rated “Deficient-2” will be subject to a formal enforcement action by the Federal Reserve. A firm rated “Deficient-2” for any rating component would not be considered “well managed,” which would subject the firm to various consequences. The Federal Reserve would be unlikely to approve any proposal from a firm rated “Deficient-2” to engage in new or expansionary activities.