By Lalita Clozel 

WASHINGTON -- After years of acrimony, the nation's top banking regulators are seeking a detente with the firms they oversee.

Two Trump-appointed officials have spent several months touring the country, visiting bank examiners in regional offices and asking examiners to adopt a less-aggressive tone when flagging risky practices and pressing firms to change their behavior.

The officials -- the Federal Reserve's Randal Quarles and the Federal Deposit Insurance Corp.'s Jelena McWilliams -- aim to change regulation in a small but significant way and reshape regulators' relationship with banks, which officials have said was too contentious during the Obama years that followed the financial crisis.

Changing the supervision culture "will be the least visible thing I do and it will be the most consequential thing I do," Mr. Quarles, the Fed's vice chairman for supervision and regulatory point person, said in an interview. "The banks should feel that their supervisor is going to be firm but fair."

Critics say friendlier examiners could blunt the effect of postcrisis rules, giving banks more freedom to engage in riskier practices.

"We have this constant cycle of crisis, regulation, deregulation, crisis, " said Jeremy Kress, a professor at the University of Michigan's Ross School of Business and a former Fed lawyer. "It's in that deregulatory time period that risks start to build."

The 2008 financial crisis stung regulators, who missed risks building across the banking sector. In the years following, examiners tightened the leash on banks, handing out more citations over issues such as credit risk and governance controls. They sat in on board committee meetings, downgraded many banks' supervisory ratings and pressured them to avoid activities deemed risky.

The Fed also created annual "stress tests" and publicly embarrassed banks who didn't pass -- most prominently with Citigroup Inc.'s startling failure in 2014, which put CEO Michael Corbat's job in jeopardy. When banks began boosting leveraged lending to highly indebted companies, regulators instructed them to tighten underwriting standards and enforced them aggressively.

That is changing. In the past, "you would meet with the bank regulators and it felt like it was us versus them," said American Bankers Associations executive vice president Wayne Abernathy. Now, "they're really listening."

In September, the Fed, FDIC and three other financial regulators issued a statement affirming that supervisory guidance -- informal documents that serve as yardsticks for examiners to evaluate banks -- can't be used to punish a firm unless it has broken a specific law or rule. The Fed is also developing a new rating system for large banks that could expand the ability of firms to address deficiencies identified by examiners before they are formally punished.

If bankers feel examiners are overstepping their authority, "let us know, " Ms. McWilliams, the FDIC chairman, said in an interview. During a recent North Carolina trip, a banker told her he kept the two-page joint statement from September laminated by his desk. "If that works for you," Ms. McWilliams responded, "all of you should print and keep it."

For their part, bankers have long complained that regulators enforce guidance improperly, holding them accountable for standards that are supposed to be voluntary. With regard to leveraged loans, regulators in 2013 instructed banks to apply higher underwriting standards for leveraged loans, pushing banks away from such lending.

But in the Trump era, regulators have distanced themselves from that guidance. Mr. Quarles in January said it "is not something that is cited in supervisory actions." Banking regulators have said that they were monitoring banks' exposure to that market.

The internal effort to change the culture among examiners has included specific directives from Trump-appointed officials. Mr. Quarles told Fed examiners to include positive feedback in their reports instead of focusing only on deficiencies, according to the Fed.

"The coach is demanding as much as ever from the sidelines -- it's just that every now and then he's throwing some 'Good job!'s and 'Way to go!, '" said Michael Silva, a former big-bank supervisor at the Fed and partner at law firm DLA Piper.

Comptroller of the Currency Joseph Otting has also changed the tone from the top at his agency, calling banks his "customers." Mr. Otting said in a written statement he has "empowered examiners to use their expert judgment in the ongoing supervision of banks," while working "to reduce unnecessary burden of specific regulations and requirements."

Supervision has become a particularly salient issue for large banks, which have received limited relief under the Trump administration compared with smaller peers. In multiple meetings over the past year, they have urged regulators to address what they view as a capricious attitude from examiners.

The topic was discussed in a series of October meetings between the CEOs of Bank of America Corp., JPMorgan Chase & Co. and several other large banks, and their regulators, including Messrs. Quarles and Otting, according to people familiar with the matter.

Meanwhile, by easing capital, stress-test and other requirements, regulators are putting more onus on examiners to identify emerging risks at the banks. The Fed plans to remove a key liquidity requirement for midsize banks with $100 billion to $250 billion in assets, making evaluations the primary tool in determining whether these banks have enough assets that could be converted into cash in a credit crunch.

There are exceptions. Wells Fargo & Co. remains very much in the regulatory spotlight and continues to have its assets capped, and growth curtailed, under an unprecedented sanction imposed by the Fed earlier this year.

And some bankers say they have yet to see significant changes in the supervisory process. In November, two banking trade groups publicly pressed regulators to add muscle to the September guidance directive by turning it into a formal rule.

Banks are suffering from "examiner criticisms that do not deal with any violation of law," said Greg Baer, CEO of the Bank Policy Institute, one of the two groups behind the request.

Trump-appointed leaders acknowledge that changing the culture of the agencies -- each of which has hundreds of examiners stationed in offices across the country -- will take time. "All of this will be difficult to quantify except by air miles," Mr. Quarles said.

Ryan Tracy contributed to this article.

Write to Lalita Clozel at Lalita.Clozel@wsj.com

(END) Dow Jones Newswires

December 12, 2018 13:26 ET (18:26 GMT)