Federal Reserve Finalizes Rule on Role of Supervisory Guidance and Issues Consolidated Regulatory FAQs

The Federal Reserve’s Final Rule is based on the Interagency Statement, which was jointly released in 2018 by the Federal Reserve, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation (FDIC), National Credit Union Administration, and Consumer Financial Protection Bureau. The Interagency Statement, colloquially referred to as the “guidance on guidance,” sought to distinguish between regulatory issuances that have the force and effect of law and those that do not. While agencies issue various types of supervisory guidance, generally it is only statutes and regulations promulgated through notice-and-comment rulemaking that are legally binding. Therefore, only statutes and regulations should typically form the basis for agency action against a regulated party.

However, prior to the Interagency Statement, banking regulators had sometimes sought to enforce requirements set forth solely in guidance. A prominent example of this was Operation Choke Point. As part of Operation Choke Point, the FDIC allegedly used its broad supervisory authority to require corrective action where financial institutions transacted with merchants engaged in higher-risk activities, such as payday lenders, pawnbrokers, and tobacco retailers, among others. This allegedly included — particularly with respect to payday lenders — taking a supervisory approach based in part on guidance documents, which resulted in institutions’ withdrawing banking services from particular clients. The Interagency Statement sought to limit these guidance-based regulatory approaches and refocus the relevant agencies to rely on appropriate legal authority. However, this did result in an obvious paradox in that the restrictions on agencies relying on guidance were themselves set forth in guidance.

The Final Rule resolves this paradox by largely adopting the Interagency Statement as a regulation, with the Federal Reserve being the final agency of those that issued the Interagency Statement to do so. It includes a number of key clarifications that will help financial institutions manage their business activities. As a baseline, the Final Rule reiterates the above-described distinction between statutes and regulations, which have the force and effect of law, and supervisory guidance, which does not. The Final Rule further provides, among other things, that agencies will limit the use of numerical thresholds in describing expectations through guidance and that examiners will not use “violations” of guidance as a basis for formal criticism of a financial institution. Importantly, regarding the latter issue, the Final Rule clarifies that the agencies will not base matters requiring attention/MRAs on noncompliance with guidance. Guidance may, however, be used to provide examples of appropriate conduct as relates to violations properly based on binding legal authority (statutes, regulations, or legally enforceable agency orders). The Final Rule also requires any such resulting criticism to be specific to “practices, operations, financial conditions, or other matters” that could adversely affect an institution’s safety and soundness, cause consumer harm, or cause violation of binding legal authority.

The Federal Reserve also released a set of FAQs primarily composed of existing legal interpretations relating to Regulations H, K, L, O, W, and Y. The FAQs are for the most part agency guidance. While, in accordance with the Final Rule, the FAQs themselves do not generally have legal force and effect, they do provide a useful tool for better understanding Federal Reserve intent in promulgating the underlying regulations. The FAQs present information in a standardized format, organized by topic or regulatory provision, as appropriate, and link to underlying primary source documents (some of which are binding legal authority), where possible. By collecting this information in one place and organizing it in an easy-to-digest manner, these FAQs help set stable regulatory expectations and reduce the burden of compliance on financial institutions that are subject to Federal Reserve supervision.

Over the past few years, both members of the Federal Reserve Board and members of the Federal Reserve legal staff have voiced concerns that Federal Reserve requirements are too complex and opaque. Encouragingly, the Federal Reserve has backed discussion of these concerns with formal remedial action. For example, the Federal Reserve’s new version of Regulation Y consolidates, organizes, and simplifies the maze of Federal Reserve decisions and interpretations through which control determinations were previously made. The Final Rule and FAQs similarly help clarify expectations for regulated entities and clarify the legal requirements with which they must comply. As such, we are hopeful that the Federal Reserve’s adoption of the Final Rule and efforts to update and consolidate existing guidance in FAQs are indicative of the Federal Reserve’s planned approach moving forward.