Federal Reserve Board Proposes Revisions to Large Financial Institution Rating System

The Fed's proposal is expected to free more financial institutions to engage in mergers as well as expanded and novel activities

On July 15, 2025, the Federal Reserve Board released a proposed rule to revise the Large Financial Institution rating system or "LFI Framework." The proposal would change how the Fed evaluates the financial and managerial health of large bank holding companies and large U.S. intermediate holding companies of foreign banking organizations and allow large financial institutions to obtain or retain regulatory approval even if they receive a low rating in one component rating. Taken together, the proposal is expected to provide regulatory relief to many of these types of entities. Comments on the proposal are due by August 14, 2025.

At the end of 2024, the Fed released a report asserting that only one-third of large financial institutions were deemed to be "well managed" under the current LFI Framework, despite the strong financial health of a vast majority of large financial institutions. The disconnect between the LFI Framework and market reality brought the credibility of the LFI Framework into question.

Key Takeaways

• The proposal would increase the number of institutions that are considered "well managed" and free more institutions to engage in new or expanded activities and acquisitions, including through streamlined filing obligations.
• The LFI Framework generally applies to (1) bank holding companies and savings and loan holding companies with total consolidated assets of $100 billion or more, and (2) U.S. intermediate holding companies of foreign banking organizations with total consolidated assets of $50 billion or more.
• Under the current LFI Framework, a financial institution that receives a rating of Deficient-1 or Deficient-2 in any component rating is not considered "well managed." The proposal would change the LFI Framework so that a financial institution with at least two component ratings of Conditionally Meets Expectations or better and no more than one Deficient-1 component rating is considered "well managed."
• The proposal would also eliminate the current presumption for an enforcement action in the LFI Framework and subject a financial institution with one or more Deficient-1 component ratings to an informal or formal enforcement action, depending on particular facts and circumstances.
• While the proposal only considers the LFI Framework, it may be a prelude to a broader reconsideration by the federal banking agencies of the "Management" component of the CAMELS rating system that applies to banks.
• In short, the proposal would amount to a significant transformation of "examination risk." There appears momentum for examinations to focus more on a financial institution's objective financial condition and to deemphasize issues that center principally on process. As a result, institutions could avoid having their ratings lowered simply because of an exercise of an examiner's subjective judgment.

The Current Framework

The Fed issued the LFI Framework in 2018 to set forth its criteria for grading the financial and operational strength and resilience of large financial institutions. The LFI Framework includes three components: (1) capital planning and positions; (2) liquidity risk management and positions; and (3) governance and controls. Each component is rated based on a four-point non-numeric scale (in descending order): Broadly Meets Expectations, Conditionally Meets Expectations, Deficient-1, and Deficient-2.[1] When determining whether a financial institution is considered "well managed" for purposes of the Bank Holding Company Act (BHCA) and related regulations—such as for financial holding company eligibility, expediting filings, etc.—the Fed considers the three component ratings, taken together, to be equivalent to assigning a standalone composite rating.

Under the current LFI Framework, a financial institution that receives a rating of Deficient-1 or Deficient-2 in any component rating won't qualify as "well managed," will become subject to limitations on certain new activities and acquisitions, and may face an informal or formal enforcement action.

Notably, in 2022, the Fed found that governance and controls findings (including deficiencies related to operational resilience, information technology, third party risk management and compliance) represented over 75% of the outstanding issues at large financial institutions. Clearly, the LFI Framework had come to emphasize process over financial strength, robust liquidity management, and effective capital planning.

The Proposed Framework

The proposed LFI Framework would not change the Fed's criteria for assessing a financial institution's component ratings but would recalibrate the institution's "well managed" status based on the totality of the component ratings. The Fed proposes to revise the LFI Framework so that financial institutions would obtain or retain their "well managed" status even if they receive a Deficient-1 rating in any one of the three components. A financial institution would still be considered not "well managed" if it receives a rating of Deficient-1 for two or more component ratings or a rating of Deficient-2 for any of the component ratings.

The proposal would also eliminate the presumption in the LFI Framework that the Fed will impose an enforcement action on financial institutions with one or more Deficient-1 ratings. Instead, under the proposal, institutions with one or more Deficient-1 ratings may be subject to an informal or formal enforcement action, depending on particular facts and circumstances. However, the proposal would keep the strong presumption that the Fed will initiate a formal enforcement action against an institution with a Deficient-2 rating for any of the component ratings.

The Fed's revisions, if adopted as proposed, would ease compliance costs for large financial institutions and make it easier for institutions to pursue new activities and acquisitions. The BHCA permits "well managed" institutions to engage in certain expansionary activities and to pursue investments in and acquisitions of certain nonbank financial companies without obtaining prior Fed approval. "Well managed" institutions also benefit from expedited review by Fed staff of proposed bank acquisitions and mergers or consolidations between bank holding companies, among other considerations.

Michael Barr's Dissent

Governor Barr dissented from the Fed's approval of the proposal on the basis that the proposal would undermine the Fed's supervision of large financial institutions and allow institutions that are not in satisfactory condition to undertake activities that could increase risks to consumers and the financial system. Governor Barr asserted that the proposal would allow "badly managed firms to be labeled as well managed."

Governor Barr also argued that the proposal is inconsistent with the statutory requirements established under the Gramm-Leach-Bliley Act (GLBA) for the Fed's rating system. In his view, the GLBA amended the BHCA to define "well managed" as a composite rating of 1 or 2 under the Uniform Financial Institutions Rating System, or an equivalent rating, and at least a rating of 2 for management, if such rating is given. Governor Barr asserted that the governance and controls rating in the LFI Framework is the Fed's primary means of evaluating the management of large financial institutions, and by treating an institution with a Deficient-1 rating in governance and controls as "well managed," the Fed's proposed revisions run afoul of this express statutory definition. In doing so, he may have sowed the seeds for a legal challenge in the post-Chevron environment, where agencies are not afforded deference as they were before. Any such challenge could delay implementation of the revised LFI Framework.

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