The collapse of SVB has left consumers and investors shaken, but how can US regulators regain confidence in their oversight of the banking system?
U.S. bank regulators can take numerous steps to address the many perceived supervisory weaknesses exposed by the collapse of Silicon Valley Bank (SVB); however, there are some actions that will require the U.S. Congress to weigh in — most importantly on deposit insurance reform.
The International Monetary Fund (IMF) has warned that the fundamental question confronting market participants and policymakers is whether recent banking turmoil, sparked by SVB’s recent failure, is a “harbinger of more systemic stress, as previously hidden losses are exposed, or simply the isolated manifestation of challenges from tighter monetary and financial conditions after more than a decade of ample liquidity.”
One of the major factors behind the collapse of SVB and Signature Bank in New York was unrealized losses on their balance sheets. The losses stemmed largely from investments such as U.S. Treasury securities, which on paper were under water due to interest rate increases. Such paper losses are widespread across the industry. The Federal Deposit Insurance Corporation (FDIC) has estimated there are more than $600 billion of such losses sitting on U.S. bank balance sheets, a figure some say is conservative.
What appears to have caught regulators and investors off-guard is the broader market and industry impact from the SVB and Signature Bank failures. Neither bank was considered systemically important. And Congress even approved a rollback of financial regulations in 2018 on banks of this size.
“Even events at smaller banks can have systemic implications by triggering widespread loss of confidence and rapidly spreading across the financial system, amplified by technology and social media,” the IMF stated in its semi-annual Global Financial Stability Report, issued on April 11. “Because regional and smaller banks in the United States account for more than one-third of total bank lending, a retrenchment from credit provision could have a material impact on economic growth and financial stability.”
Tobias Adrian, IMF monetary and capital markets director, agreed this was a concern. “Even if you think that, on average, banks have a lot of capital and liquidity, there could be these weak institutions that then spill back into the system as a whole.”
Reverse 2018 ‘tailoring’ of bank rules
Additional bank failures, along the lines of an SVB, may well dictate the overall response by U.S. regulators and Congress. Upcoming bank earnings for the first quarter will give investors a glimpse into any further signs of weakness and possible contagion.
For the moment, however, with deposit flows having become stable, and investors slightly more confident, the next steps taken by regulators in response to SVB’s failure are likely to focus on several areas. At the end of March, top regulators from the Federal Reserve and FDIC appeared before Congress, and the discussions focused on several areas:
- Re-examination of regulatory tailoring — In his opening statement, Federal Reserve vice chair for supervision Michael Barr indicated that the central bank’s SVB collapse review will include the impact of reformed stress-testing, capital-planning, and liquidity risk management requirements implemented in 2018. At the time, the Fed decided that banks roughly the size of SVB did not require the strict regulatory standards imposed on systemically important banks, such as JPMorgan and Citibank. Both Barr and FDIC Chair Martin Gruenberg said that they will likely increase regulatory requirements for banks with between $100 billion and $250 billion in total assets. This might also include increased capital requirements.
- Stress testing — There was a lot of discussion around stress testing for banks similar in size to SVB. According to the Fed, SVB was not tested for a rising rate scenario — which ultimately prompted the crisis. Barr said he will make changes to stress testing to capture a wider range of risks and channels for contagion.
- Supervision issues — Numerous observers criticized how the Fed had highlighted liquidity and interest-rate modeling weaknesses at SVB as early as November 2021. The bank’s management, however, failed to address those concerns. The Fed is reviewing what went wrong in its supervision of SVB and will issue a report on May 1.
“Banks with between $100 billion and $250 billion in total assets can expect changes around capital adequacy, total loss-absorbing capacity, liquidity requirements, resolution planning, and the impact of accounting for unrealized gains or losses in securities portfolios,” consulting firm PwC wrote in a note to clients. “The starring role that stress testing played in the hearings demonstrates that the Fed is likely to not just reassess the frequency of tests but will look to expand their scope to capture a wider range of risks.”
Expanding deposit insurance
Then there is the thorny question of FDIC deposit insurance. In SVB’s case, more than 90% of its deposits were uninsured, held largely by venture capital firms and other businesses. That level of uninsured deposits is high in comparison to other U.S. banks, but FDIC data shows that many banks have deposits above the current $250,000 insurance threshold.
At the end of 2022, about 43% of all bank deposits were uninsured, according to the FDIC. Some of the country’s largest banks have above-average uninsured deposit levels. For example, 59% of JPMorgan’s deposits are uninsured, FDIC data shows, and at Citibank, that number reaches 85%.
Following SVB’s failure, regulators, lawmakers, and industry groups questioned whether the deposit insurance cap should be raised from the current $250,000 per depositor. A coalition of midsize banks has asked regulators to extend insurance to all deposits for the next two years.
Regulators have the authority to make changes to most of the areas described in recent Capitol Hill hearings, but raising the FDIC insurance cap would require bipartisan agreement in Congress.
With bipartisanship in short supply on many issues, however, an agreement on what to do with FDIC deposit insurance is unlikely to happen any time soon.