Regulators Increase Scrutiny of Wall Street Lending

Federal bank regulatory agencies are significantly increasing their scrutiny of Wall Street bank lending, moving from annual reviews to a system of monthly audits in a major effort to curtail aggressive underwriting practices.

Until recently, the Federal Reserve, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency (OCC) have monitored banks’ behavior annually in Shared National Credit (SNC) reviews, meaning that banks had to wait up to a year to receive feedback from regulators. With a move toward monthly audits — focused on whether banks are adhering to guidelines released by the regulatory agencies in March of last year — there will be ongoing feedback from regulators, and regulators will be able to provide more specific guidance. The audits, for example, are understood to be broader than the SNC reviews, looking beyond just loans that the banks have made to deals that the banks turned down, how the banks rate and classify each loan, and the process the banks go through to approve credit.

Despite the increased scrutiny, bankers are generally welcoming the news because of concerns over disparate treatment between banks watched by the Federal Reserve and the OCC, and because there remains uncertainty over how to interpret the guidelines related to last year. The change also comes on the heels of significant regulatory concern over Credit Suisse’s failure to heed warnings to stop making loans seen as risky, and similar concerns over JP Morgan’s recent collaboration with unregulated lenders to underwrite a highly leveraged financing for the $4.3 billion acquisition of business software maker Tibco.

While generally applauded, the increased supervision by regulators also poses a risk of accelerating shadow banking by non-bank financial intermediaries, with alternative capital providers filling the gap left by banks now unable or unwilling to provide capital in compliance with regulatory guidelines.