The banking industry has spent the summer arguing about two words it is not allowed to define for itself. The Federal Financial Institutions Examination Council's proposed reform of the CAMELS rating system, the first major rewrite since 1996, rests on a single organizing idea: examiners should focus on issues that present material financial risk rather than on box-checking trivia. More than sixty comment letters arrived before the deadline, and the striking thing about them is how much agreement they contain. Banks, credit unions, state supervisors, and even the proposal's critics mostly accept the direction. The fight is over what material means, and underneath that, over who will decide what it means from one exam to the next.
The term is undefined in the proposal, and that is not an oversight. An undefined term is a container for someone's judgment, and every comment letter is a claim about whose judgment the container should hold. William Mellin, president of the New York Credit Union Association, put the industry's worry in its plainest form: "the undefined term risks preserving the very examiner discretion the proposal seeks to constrain." The proposal's whole purpose is to constrain discretion. A reform that leaves its central term undefined may, in the view of its own supporters, reform nothing at all.
The system being reformed was built by accretion
To see what is at stake, it helps to know what the agencies are trying to change. The Uniform Financial Institutions Rating System dates to 1979, with six components that later gave it the name CAMELS: capital, asset quality, management, earnings, liquidity, and sensitivity to market risk. The last major rewrite, in 1996, added the sensitivity component and, more consequentially, gave the management component a heavier weight than its siblings. Banks have spent the three decades since arguing that the management component became a catch-all: examiners could cite operational or governance issues with little transparency, and a management downgrade could drag down an otherwise sound rating.
The current proposal responds to that history directly. It would remove the special consideration for management issues, narrow what can be included in the management field, require quantitative justification for management downgrades, and prevent a poor management score alone from downgrading an otherwise strong bank. Comptroller of the Currency Jonathan Gould, supporting the direction, has flagged the same problem from the agency side: the management rating historically reflects deficiencies already captured in other components, a double counting that lets one set of findings weigh twice.
The comment letters are a jurisdictional map
Read together, the letters are less a debate than a map of who loses what if the term gets defined one way rather than another. The Bank Policy Institute wants the management component eliminated entirely. Tabitha Edgens, its co-head of regulatory affairs, argues that "the simplest fix would be to eliminate it," so that governance judgments affect ratings only through demonstrated material financial risk. The large banks behind that position would be perfectly comfortable with a narrow, quantified definition of material, because their lawyers can litigate a definition and cannot litigate an examiner's mood. The Flagstar Bank comment makes the legal ambition explicit: the examination process has operated out of compliance with the Administrative Procedure Act, and a codified, defined framework would finally give banks something to appeal to.
The state supervisors and the smaller institutions map the other side. David Herndon, the Kansas banking commissioner, calls management "the most important factor of the CAMELS rating," and warns that de-emphasizing it would fall hardest on small state-chartered banks, where the quality of a handful of people is most of the risk picture. The Independent Community Bankers of America wants a tiered materiality standard scaled to an institution's size and complexity, an arrangement that would keep small-bank exams closer to the current, more discretionary world. The senators watching from Congress, John Hickenlooper and Elizabeth Warren among them, warn the proposal could "hamstring bank supervisors and invite more bank failures," citing Silicon Valley Bank as proof that well-capitalized banks can die from management failures before the numbers turn.
Even among the proposal's friends, the worry runs in both directions. James Hunsanger of Michigan State University Federal Credit Union argues a focus on measurable risk makes exams backward-looking, since control functions identify governance weaknesses before financial losses occur; a framework that only counts what has already gone wrong on the income statement misses the failure while it is still a forecast. Better Markets makes the same point as an accusation, calling the direction a rearview-mirror supervision that would trade an early-warning system for an autopsy report.
Vagueness is not a drafting error; it is the resource in dispute
The pattern across all sixty letters is that nobody is confused. Everyone knows what the undefined term would mean in practice: it would mean whatever the examiner holding it says it means, in the exam room, at the moment of downgrade, with the bank's ability to respond limited to the appeals the framework provides. The disagreement is not about clarity. It is about the fact that discretion has to live somewhere, and this reform is a relocation project.
A precisely defined material financial risk transfers the last word to banks and their counsel, because a definition is a question of law, and questions of law end up before judges. A vague one keeps the last word with examiners, because a judgment call is a question of expertise, and questions of expertise end with the agency. The management-component fight is the same contest from the side: eliminate it and banks win, keep it weighted and examiners win. The community banks and state supervisors who want management emphasized are not disagreeing with the large banks about philosophy. They are disagreeing about who will hold the discretion over the banks they supervise.
The 1996 settlement produced this fight
The proposal's shape only makes sense against what the 1996 reform did. Before that rewrite, the rating system was a balance-sheet instrument: five components, each pegged to measurable financial condition. The 1996 changes added the sensitivity-to-market-risk component and, more consequentially, elevated the management component into a weighted judgment about the people running the bank. The motive was the post-crisis consensus of the early 1990s, that banks fail from governance failures before they fail from losses, and that examiners should be able to say so.
What the industry says happened next is that the management component became a dumping ground. An examiner who found a compliance lapse, a succession plan that was never written, a board slow to respond to a minor recommendation, could register the finding in the management rating without connecting it to any balance-sheet consequence. Because the component carried special weight, the finding dragged the composite rating, and because ratings drive enforcement, insurance, and strategic options, the drag was real. Banks argue the result was a supervision system that punished process failures as if they were solvency failures, with no public standard for what counted.
The current proposal is best understood as an attempt to unwind that settlement on both sides at once. It narrows the management field and removes its special weight, which satisfies the banks; it refocuses everything on material financial risk, which is supposed to satisfy the agencies by keeping supervision pointed at solvency; and it removes the references to reputation risk, which the industry has long argued invited examiners to police headlines rather than balance sheets. Every piece of the package follows from the same diagnosis: the 1996 system overreached into judgment, and this proposal walks it back. Whether the walk-back goes too far is the question the senators, the state supervisors, and Better Markets are asking, and the undefined term is the hinge the answer turns on.
The stakes below the terminology are concrete
It is worth remembering, beneath the comment-letter vocabulary, what a rating change costs a bank in practice. The composite rating is not a report card. It drives the agency's enforcement posture, the frequency and intensity of exams, restrictions on growth and dividends, deposit insurance pricing, and in the credit union system, governance itself: America's Credit Unions notes that under the Credit Union Board Modernization Act, a downgrade from a 2 to a 3 changes how often a board must meet. A finding that moves the management component can therefore change how an institution is run before any of its numbers change, which is exactly why the banks want the path from finding to rating paved with definitions.
That concrete machinery also explains the strange bedfellows among the letters. A large bank wants a narrow, quantified standard because its ratings battles are fought by lawyers over documents. A small bank wants examiner discretion preserved because its relationship with its examiner is personal: the same supervisor who knows the board by name can hear an explanation a definition would not accommodate. The community bankers and the state supervisors are not defending vagueness out of principle. They are defending the arrangement under which a conversation can still change an outcome, because for a small institution that conversation is the appeals process.
The credit union commenters add a dimension the banking letters mostly skip: regulatory change itself is a cost, and it falls hardest on institutions with one compliance officer. Every rewrite of the framework means new exam procedures to learn, new templates to fill, new interpretations to absorb, and the smaller the institution, the larger that burden is relative to everything else. The ICBA's tiered materiality proposal is the field's answer: one standard for the giants, another for the rest. Whether the agencies accept it will say as much about who they think the system is for as the definition of material ever will.
The reform's success will be measured by what it does not define
The FFIEC will now reconcile the letters into a final rule, and the final rule will be judged by the standard the commenters themselves set. A reform that defines material financial risk carefully, with examples and thresholds, will have moved the last word, and the industry's lawyers will be the first to notice. A reform that keeps the term open will have preserved examiner discretion, and Mellin's warning will have been the prophecy. Either outcome can be defended, and either can be gotten wrong. The only outcome that cannot be defended is the one the proposal currently threatens: a system rebuilt around a standard that exists nowhere but in the moment of its application.
Primary sources
- Kyle Campbell's American Banker article of August 20, 2026, for the proposal's central features, the more-than-sixty comment letters, William Mellin's warning, Tabitha Edgens's call to eliminate the management component, David Herndon's defense of it, James Hunsanger's backward-looking concern, Peter Sullivan's Administrative Procedure Act argument, the ICBA's tiered materiality proposal, and the 1979 and 1996 history of the rating system.
- The OCC's statement for Comptroller Gould's double-counting concern, and reporting on the comment letters and the senators' letter for the Hickenlooper-Warren warning and the Better Markets rearview-mirror critique.