Regulators collect and produce information about banks. This information helps regulators monitor the safety and soundness of the banking system, and it also helps policymakers preserve financial stability. A key issue is whether this information should be made public and, if so, to what extent. In this article, we will explore some of the tradeoffs involved.
What information do regulators collect? Banks are required to file comprehensive quarterly reports, such as balance sheets, income statements, and derivative and off-balance-sheet items. Regulators also maintain large examination staffs that function as external auditors, while large banks are subject to continuous on-site examinations. These examinations are a key input into banks’ so-called CAMELS scores.1 Another way that regulators assess the soundness of banks is to conduct stress tests to evaluate how banks would fare under extreme scenarios. Stress tests are mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act as part of the regulatory reform following the financial crisis. Currently, CAMELS ratings are released only to the top management of the bank, not to the public. When the Federal Reserve conducted stress tests in 2009, it disclosed bank-level results, such as projected losses under an extreme stress scenario. But when the Fed conducted stress tests two years later, it disclosed less detail.2
An important question is whether revealing more of the information regulators collect on banks would help regulators come closer to meeting their goal of preserving the safety and soundness of the financial system.
This article appeared in the Third Quarter 2014 edition of Business Review. Download and read the full issue.
CAMELS stands for capital adequacy, asset quality, management, earnings, liquidity, and sensitivity to market risk. Banks receive CAMELS ratings of 1 to 5, with 1 being the strongest. In addition to the bank’s overall rating, ratings are assigned for each component. Banks rated 3 or lower are subject to closer scrutiny, and those rated 4 or 5 may be required to impose stronger controls on loan quality or to raise new capital.
For more details about stress tests conducted in the U.S. and Europe and what was disclosed, read the article by Til Schuermann.