Here's our situation. Couple getting divorced. Wife got the house. Husband got the debt. Wife wants to downsize and get a different house. Loan officer wants to substitute the collateral on the original note. Is this a "bank" decision and or a compliance issue? Please advise.

"wife got the house. Husband got the debt"
Is that according to divorce court, or did your bank actually release her from liability, and transfer his interest in the real estate to her? I'm assuming divorce court. In that case, it's totally up to the bank what you allow, because both pledge the existing home as collateral, and both are still liable.
I have a problem with 'substituting collateral on the original note' in either case.

The bank has not done anything yet. This was the court ruling.

If she sells the house the loan gets paid off at closing - how the husband and wife want to comply with the court order is between them. If the husband wants to "assume" the debt. Have him apply for a loan and put up the necessary collateral and use the proceeds to pay off the loan. You are not involved or obligated by anything in the court agreement nor are you obligated to faciliate the process.