In the summer of 2016, Builders Bank of Chicago, Illinois was informed that its Camels rating—a risk-profile metric assigned by banking regulators—had reached a 4. This is the threshold at which a financial institution is considered a “problem bank” by regulators and has a significant impact on the insurance premium paid by the financial institution. But Builders Bank did not accept its Camels rating and took the unusual action of filing suit against the Federal Deposit Insurance Corporation (“FDIC”) claiming that the FDIC’s risk profile determination for the bank was flawed. In a surprising result, Builders Bank won an appeal that could set a precedent for other financial institutions that feel that they have been unfairly graded by their regulators.
Court’s typically refuse to hear cases regarding regulatory ratings and find that ratings are completely within the discretion of bank regulatory agencies. However, in overturning a lower court’s dismissal of Builders Bank’s lawsuit, the Seventh Circuit found that even though bank regulators are at liberty to determine capital adequacy—one component of the Camels rating—their ratings can face legal challenges because they are calculated based on other variables. Indeed, Camels ratings are based on (1) Capital Adequacy, (2) Asset Quality, (3) Management, (4) Earnings, (5) Liquidity and (6) Sensitivity. The Seventh Circuit found that a district court can analyze the factors outside of capital adequacy to determine whether a final rating is arbitrary or supported by substantial evidence, without making any inroad on a regulatory agency’s discretion to evaluate a bank’s capital adequacy.
Notwithstanding its ruling, the Seventh Circuit did not find that the FDIC’s Camels rating was arbitrary. Instead, it ruled that if certain facts were present, then the lower court had jurisdiction to hear the complaint against the FDIC and should not have dismissed Builders Bank’s complaint for lack of jurisdiction. The Seventh Circuit instructed the lower court to explore: (1) Whether the FDIC’s assignment of a 4 rating was a final agency action which could be challenged in court and (2) Whether Builders Bank exhausted its remedies at the agency level such that it could challenge its Camels rating in court.
Regardless of the ultimate outcome, Builders Bank’s win should embolden other financial institutions to fight their Camels ratings in court and open an avenue to challenge CAMELS ratings which previously appeared unavailable.