The U.S. Court of Appeals for the Seventh Circuit recently issued a rare decision on a bank’s ability to challenge its supervisory ratings—in this case, its Federal Deposit Insurance Company (“FDIC”) Capital, Assets, Management, Earnings, Liquidity and Sensitivity (“CAMELS”) rating—in court.  See Builders Bank v. FDIC, — F.3d —, 2017 WL 237585 (7th Cir. 2017) (Easterbrook, J.).  The ruling affirmed that, while certain components of supervisory ratings may be committed to agency discretion and therefore not subject to judicial review in the normal course, other components may be reviewable under standard principles of administrative law.

Lower bank supervisory ratings, including supervisory ratings for compliance with the Community Reinvestment Act, carry significant consequences for a Bank’s ability to, among other things, pay dividends, expand or re-align branch networks, and engage in corporate acquisitions.  Low ratings may also expose banks to informal or formal supervisory actions, which can become increasingly severe if the bank’s ratings do not improve.  Despite these consequences, however, banks have only rarely challenged their supervisory ratings in court—perhaps due to concerns that such challenges could prejudice a bank’s long-term relationships with its regulators and are, in any event, unlikely to succeed because of the deference courts would likely accord to bank regulators.

The Seventh Circuit’s decision confirms that, on some subjects, courts are exceptionally unlikely to interfere with the technical expertise of bank regulators.  The Capital component of the CAMELS rating, for example, may be committed to agency discretion by section 3907 of the International Lending Supervision Act, which provides each Federal banking agencies with the authority to “establish such minimum level of capital for a banking institution as the appropriate Federal banking agency, in its discretion, deems to be necessary or appropriate.”  12 U.S.C. § 3907(a)(2) (emphasis added); see Builders Bank at *3; Frontier State Bank Oklahoma City, Okla. v. FDIC, 702 F.3d 588, 595-597 (10th Cir. 2012).

But, as the Seventh Circuit explained, the discretion conferred by section 3907 cannot automatically be extended to other areas of supervision, including assessments of “asset quality, management, earnings, liquidity, and sensitivity.”  Builders Bank at *4.  The court declined to decide whether any other component of the CAMELS rating was committed to agency discretion by statute, noting that the parties had not briefed the issue.  But it made clear that, absent a statutory provision specifically depriving courts of the ability to review bank supervisory determinations, courts should apply the same standards to bank supervisors as they do to other regulatory agencies—i.e., they should review their final agency actions under the “arbitrary and capricious” standard of the Administrative Procedure Act, 12 U.S.C. § 701 et seq.

The court also affirmed that, even where a determination is committed to agency discretion by statute, courts retain some power of review.  In cases challenging capital adequacy determinations, for examples, courts may not set aside the banking agency’s judgment as to the minimum amount of capital required by a bank but it may, for example, review “the agency’s math”:

Suppose the FDIC were to decide that Builders Bank needs $5 million in net capital in order to operate safely but has only $4 million. Section 3907(a)(2) puts the $5 million floor beyond judicial questioning. But the statute does not insulate the agency’s math. If the Bank were to contend that the examiners found that it fell short of $5 million because they had mistakenly treated a $1 million asset as a $1 million liability, turning $6 million of net capital into $4 million by error, a court would not impinge on the statutory discretion by insisting that assets go in one column of the balance sheet and liabilities in the other.

Builders Bank at *4.

Taken as a whole, the Seventh Circuit’s decision leaves open a narrow path for banks to challenge supervisory ratings, as well as other supervisory determinations.  Banks will likely make use of this path only in rare circumstances and they will have to jump through multiple procedural hoops, including internal agency appeals processes, in order to secure their day in court.  Nevertheless, the decision is an important reminder that bank supervisory determinations are not categorically different from regulatory determinations in other industries and that bank regulators will not be accorded automatic deference by the courts.