Most Open Bank Exam Criticisms Are Going Away. Small Banks Win.

As of Monday, a bank examiner can no longer write a bank up just for messy paperwork. A new OCC and FDIC rule took effect on Nov. 2 that requires a likely material hit to a bank's capital, earnings, liquidity or asset quality, or an actual violation of law, before an examiner issues a Matter Requiring Attention.¹ Most coverage stopped at the definition. The bigger news is in an FDIC statement: the agency has already reviewed every open criticism and concluded that "a large majority" do not meet the new standard.² That is a backlog being wiped, not a slower pace of new write-ups. And the banks that carry the heaviest relative burden are the small ones.

Key Highlights

• The rule: An "unsafe or unsound practice" now requires conduct contrary to prudent operation that has materially harmed, or is likely to materially harm, a bank's financial condition or the Deposit Insurance Fund. It took effect Nov. 2, 2026.³
• The backlog: The FDIC says "a large majority" of outstanding supervisory criticisms fail the new test and "will be (or in some cases already have been) closed out".⁴
• The money: The OCC expects direct savings "will likely exceed $100 million" a year from fewer MRAs, and cites consultant rates of $150 to $1,200 an hour.⁵
• The reach: The OCC supervises 986 institutions and the FDIC 2,700, and 1,978 of the FDIC's are small entities.⁶
• The idea: The First Trust NASDAQ ABA Community Bank Index Fund (QABA), which excludes the 50 largest banks, traded at $67.86 on Tuesday, up 19.8% this year against 10.8% for the S&P 500 ETF.⁷

What The Rule Actually Does

"Unsafe or unsound practice" is one of the most powerful phrases in banking law. It is the hook for enforcement actions under Section 8 of the Federal Deposit Insurance Act, and until now it had no binding definition. The OCC and FDIC adopted one on Aug. 27, published it on Sept. 1 and made it effective Nov. 2.⁸

Under the new definition, a practice is unsafe or unsound only if it is contrary to generally accepted standards of prudent operation and it either has already materially harmed the bank's financial condition, or, if continued, is likely to materially harm it or present a material risk of loss to the Deposit Insurance Fund.³

"Financial condition" is spelled out. It means losses or other negative effects on capital, asset quality, earnings, liquidity or sensitivity to market risk.⁹ Process, documentation and policy gaps don't count by themselves.

The rule then applies a similar test to Matters Requiring Attention. An MRA is the formal write-up that goes to the board and requires corrective action. Now an examiner can issue one only if an imprudent practice "could reasonably be expected" to cause material financial harm under current or reasonably foreseeable conditions, has already caused it, or is an actual violation of a banking law.³ The FDIC adds that the risk must be "more than speculative or merely possible".⁴

Anything below that line becomes a "supervisory observation." The rule says an observation creates no expectation that the bank will brief its board or take corrective action.¹⁰

The Backlog Is Already Being Cleared

Here's what I think the market has underweighted, and why you should care even if you never read a bank exam report.

Most rule changes work prospectively. They change what happens at the next exam. This one also reaches back. The FDIC says it "completed a lookback review of all outstanding" board-attention matters and supervisory recommendations to decide which meet the new MRA standard. Its conclusion: "a large majority" do not, and they will be, or already have been, closed out. The rest get converted into MRAs.⁴

The agency did not publish a count. I won't guess one. But "a large majority" of every open FDIC criticism is a lot of board agendas, consultant engagements and remediation projects that end without being finished.

The OCC moved the same day the rule took effect. It revised its enforcement and MRA manuals so that examiners "will only issue an MRA for practices, acts, or failures to act that meet the standard," and MRAs "must be tailored based on financial risk-related factors".^{11, 12}

One more line in the rule matters for banks with old write-ups. "Mere failure to remediate an MRA does not constitute an unsafe or unsound practice".¹³ That takes away one path from an old write-up to an enforcement action. If you own small bank stocks, that is the sentence to reread.

The Numbers That Matter

The reach is broad. The OCC supervises 986 institutions, about 602 of them small. The FDIC supervises 2,700 insured institutions, and 1,978 of them are small entities.⁶ The FDIC estimates it runs between 1,319 and 1,978 exams a year on its small banks alone.¹⁴

The OCC says its savings estimate is hard to pin down. It still expects direct savings to "likely exceed $100 million" a year from fewer MRAs. It points to consultant bills of $300 to $1,200 an hour at top-tier firms, $150 to $300 at lower-tier firms, and $250 to $550 at financial advisory firms.⁵ The FDIC said it lacked the data to quantify its side.¹⁵

Only 36 comments came in on the proposal.¹⁶ For a rule that touches roughly 3,700 banks, that is a quiet record.

Now the market side. QABA tracks community banks and excludes the 50 largest banks by assets. It holds 158 stocks with a median market value of $863 million, at 12.5 times earnings and 1.27 times book.¹⁷ It is up 19.8% this year, against 13.5% for the broader regional bank fund KRE and 10.8% for the S&P 500 ETF.^{18, 19}

The Free-Market Read

The case for the old system deserves a fair hearing first.

Bank failures rarely start with a capital ratio. They start with weak controls: a risk committee that never meets, a model nobody checks, a deposit base nobody stress-tested. Process failures come before financial ones. An examiner who sees a bad process and has to wait until it is "likely" to cause material harm may be waiting until it is too late. Critics of this rule will say regulators are tying their own hands, right as bank stocks are rallying and risk appetite is rising.

I take that seriously. I still think the rule gets the economics right.

A Matter Requiring Attention is not free. It goes to the board. It usually means a remediation plan, outside consultants and months of staff time. And the agencies themselves admit they have "often kept MRAs outstanding for a prolonged period of time after an institution has fully completed its remediation" while examiners waited to see it stick.²⁰ That is a tax with no clear benefit.

The tax is regressive. Say you run a bank and the remediation work costs $100,000. At a $500 billion bank, you won't notice it. For a $1 billion community bank, it can be a meaningful share of a year's earnings. When compliance costs are fixed and assets are not, the burden falls hardest on the smallest banks. That pushes them toward selling out, which concentrates the industry in the very banks regulators worry about most.

Here's the part that makes me comfortable: the rule doesn't stop examiners from acting early. They can still issue an MRA for a practice that "could reasonably be expected" to cause material harm under foreseeable conditions. They just have to explain how it connects to capital, earnings, liquidity or asset quality. Asking a regulator to show the link between a criticism and a balance sheet is not deregulation for its own sake. It's accountability.

Winners And Losers

Community banks. They gain the most, because fixed compliance costs weigh heaviest on small balance sheets, and they make up most of the supervised universe.

Bank boards and management. Less time on process write-ups means more time on lending, pricing and deposits. That is the real return, and it doesn't show up in the $100 million estimate.

Compliance consultants and outside counsel. Their remediation business shrinks. The OCC's own savings math is built on their hourly rates.

Examiners. They lose discretion and gain a clearer standard. Their work shifts from checking documents to judging financial risk.

The Bear Case

First, the rule can be reversed. A definition adopted by two agencies can be rewritten by the next leadership of those agencies, and the Federal Reserve is not a party to it. Banks supervised by the Fed don't get the same standard from this rule.

Second, the next stress could make this look premature. If a bank fails in the next two years and its exam file shows a process problem that was downgraded to an "observation," the political response will be swift and the rule will be the first target.

Third, the market may already have priced it. QABA is up 19.8% this year and sits about 4% below its 52-week high of $70.66.⁷ Some of the deregulation story is in the price.

Fourth, the bigger lever hasn't moved yet. The agencies declined to change CAMELS ratings in this rule, calling it "premature" while an FFIEC proposal from May 19, 2026 is pending.²¹ Ratings are the bigger lever in bank supervision, and that lever hasn't moved.

The Idea: First Trust NASDAQ ABA Community Bank Index Fund (QABA)

QABA holds Nasdaq-listed community banks and thrifts and excludes the 50 largest banks by assets, as well as credit-card and international specialists.²²

Why it fits this rule. The benefit of fewer MRAs scales with how much of a bank's cost base is fixed compliance. That share is largest at small banks, and small banks are what this fund owns. Its median holding is worth $863 million, and its largest is about $9.6 billion. Its top holdings as of Oct. 30 were Wintrust Financial at 4.32%, Central Bancompany at 3.62% and Commerce Bancshares at 3.32%.²³

The data. At $67.86 on Tuesday⁷, the fund trades at 12.5 times earnings and 1.27 times book. Its 30-day SEC yield was 2.14% on Oct. 30. It has a 0.60% net expense ratio, capped through April 30, 2027.¹⁷

What the market may be missing. The $100 million savings estimate is the visible number, and it is small. The value I care about is the backlog. Closing "a large majority" of open FDIC criticisms at once frees management time that was locked up in remediation, and the earnings effect of that shows up gradually, in lending and deposit pricing, not in one quarter.

The risks. The fund is small, about $86 million in net assets as of Oct. 30¹⁷, so trading can be thin. Community banks carry concentrated commercial real estate and deposit-cost risk that no supervision rule changes. And a recession would swamp any compliance savings.

What would prove me wrong. If QABA gives back its lead over KRE by the end of the first quarter of 2027, or if a bank failure in that window prompts the agencies to revisit the rule, I'd call the thesis broken. I track every idea, good and bad, on the FMR Idea Scorecard.

What To Watch Next

I track dated catalysts on the Deregulation Investor's Catalyst Calendar. Three things matter from here.

• The CAMELS rewrite. The FFIEC's May 19, 2026 proposal to revise bank ratings is still pending.²¹ FDIC Chairman Hill called it "forthcoming".⁴
• The Fed. Whether the Federal Reserve adopts a matching standard for the banks it supervises.
• Disclosure. Whether the FDIC or OCC publishes a count of closed criticisms. That number would tell us how big the backlog really was.

For more on the bank rules I've been tracking, read why the FDIC is taking back a job it handed 31 big banks, how the FDIC closed a 30-year gap in interstate banking, and why the OCC left one door open on stablecoin yield.

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Know someone who runs or invests in a community bank? Forward this one along.

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