Since the failure of Silicon Valley Bank (SVB), Signature Bank, and Republic Bank, several agencies have issued reports on factors that contributed to the failures. On April 28, 2023, the Board of Governors of the Federal Reserve System (Federal Reserve), the Federal Deposit Insurance Corporation (FDIC), the United States Government Accountability Office, and the New York Department of Financial Services (NYDFS) issued reports on the SVB and Signature Bank failures. On May 8, 2023, the California Department of Financial Protection and Innovation released a report related to its supervision of SVB. On March 30, 2023, the White House issued a statement calling for increased supervision and regulation for large regional banks, and the House Committee on Oversight and Accountability is investigating the Federal Reserve Bank of San Francisco. In addition, there has been Congressional testimony by the banking agencies, with more to come.
If you have not added the recent post-mortem reports and speeches to your list of weekend or bedtime reading, you should do so. They provide an important window into the minds of bank regulators on what is to come. As we all know, the most important regulatory requirements and expectations are not found in statutes and regulations, but in speeches, Congressional testimony, reports, articles, and the like.
A number of key themes emerge from these recent reports and statements:
1. Concentrations/Diversification. While many banks were told by regulators over the past few years that banks needed to differentiate themselves and have a niche to be financially successful, that regulatory theme has done a 180. The current chorus is diversification and the avoidance of concentrations on both sides of the balance sheet.
2. Stress Testing. The regulators most certainly will re-evaluate the coverage and timing of stress testing requirements. In addition, regulatory exams will expect robust stress testing by banks of all sizes, with the results being reported to the board along with appropriate monitoring and action.
3. AOCI. Regulators are reassessing whether regulatory capital rules should take into account unrealized losses and gains on available-for-sale securities. Whether officially taken into account or not, regulators are monitoring unrealized losses and the effect on capital levels.
4. A New Uninsured Deposit Ratio. The uninsured deposit ratio has never been one of the key regulatory ratios. That has obviously changed.
5. Compensation. Bank regulators and members of Congress have all called for a renewed focus on incentive compensation.
6. Risk Management/Chief Risk Officer. Another clear theme is risk management and the role of the chief risk officer. There will be increased regulatory focus on this position in large and mid-size banks. The question is what regulatory expectations will trickle down to community banks in terms of a formal risk management process and structure.
7. Capital and Liquidity. Regulators are once again back to the basics and focused on capital and liquidity. The Federal Reserve Report as well as Federal Reserve Vice Chair for Supervision Michael Barr statements emphasize resiliency including a holistic review of the capital framework. The Vice Chair recommended additional capital or liquidity above regulatory minimum requirements for a firm with inadequate capital planning, liquidity risk management, or governance and controls. In addition, requirements may include limits on capital distributions or incentive compensation.
8. SR 09-4. This Federal Reserve SR letter is one of the more powerful regulatory tools to promote item 7 above. Banks can meet dividend statutes and regulations and get money from the bank to the holding company, only to find they cannot then use it for Subchapter S distributions, economic dividends, or redemptions without “consulting” with the Federal Reserve. Consulting essentially means obtaining approval. In the current climate, obtaining such approval is more challenging based on securities portfolio losses, GAAP tangible equity capital, liquidity, and debt to equity ratios for banking organizations subject to the Small Bank Holding Company and Savings and Loan Holding Company Policy Statement.
9. Examinations and Enforcement Actions. As with past failures, bank regulators have been faulted with not acting quickly and aggressively and giving banks too much time to correct issues. Accordingly, banks should anticipate more MRAs, MRIAs, and enforcement actions. Further, regulators will expect prompt remediation. A failure to adequately address perceived weaknesses will likely be met with another more aggressive round of enforcement actions. The Federal Reserve Report notes “the supervision of SVB did not work with sufficient force and urgency.” Also, the Office of the Comptroller of the Currency (OCC) revised its policies and procedures manual on bank enforcement actions on May 25 and described actions the OCC may take against banks that exhibit persistent weaknesses. As warranted, the OCC may require a bank to simplify or reduce its operations, including that the bank reduce its assets, divest subsidiaries or business lines, or exit from one or more markets of operation.
10. Applications. There is an interesting section in the Federal Reserve Report on SVB devoted to what applications were filed and approved by the Federal Reserve from 2018 to 2023. One of the applications SVB filed on February 24, 2021, under section 3 of the Bank Holding Company Act sought approval to merge with Boston Private Financial Holdings, Inc. The Board approved the proposal on June 10, 2021. According to the Federal Reserve Report, SVB transitioned from the Regional Banking Organization portfolio to the Large and Foreign Banking Organization (LFBO) portfolio in the first quarter of 2021, but there was no assessment of the bank’s readiness to move into the LFBO portfolio or the planned supervisory strategy. This “readiness” of an institution will most certainly be a heightened focus of applications going forward, i.e., does the banking organization have a risk management structure, the requisite management resources and expertise, and other infrastructure already in place to support increasing size, complexity, and risk profile.
In summary, there will be harsher examinations, more enforcement actions, calls for additional regulation, and proposed legislation. Capital, liquidity, examination procedures, rules and regulations, and the like are clearly important but, in my view, are not going to ensure a strong, safe and sound banking system without having management, boards, examiners, and agency leadership with the requisite skills, background, experience, and dedication. Right now, many industries, including banking, are struggling to retain and hire. As addressed at length in the FDIC Report and NYDFS Report, agency staffing was a significant contributing factor in the Signature Bank failure. Accordingly, another focus is how to retain staff and attract talent to our industry.
Finally, before knee-jerk, one-size-fits-all regulation and supervision, policymakers need to be sure they are addressing the right issues in the correct way and carefully consider unintended consequences. As one banker so aptly put it—we need more policymakers who are good chess players. As we have seen and experienced over the years, too much regulation and wrong regulation can be as detrimental as too little in terms of having a strong banking system that meets customer needs.
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