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Federal Responses to Recent Bank Failures – House Financial Services

House Financial Services Subcommittee on Financial Institutions and Monetary Policy

Federal Responses to Recent Bank Failures

Wednesday, May 10, 2023

Topline

  • Republicans questioned the role of regulators in the recent failures of Silicon Valley Bank (SVB) and Signature Bank, and they argued against additional regulations in response to the events.
  • Democrats mentioned the role of the banks in addition to regulators, and they discussed potential changes to FDIC insurance or capital requirements to prevent future runs.

Witnesses

Opening Statements

Subcommittee Chairman Andy Barr (R-Ky.)

In his opening statement, Barr said that skyrocketing inflation caused by the American Rescue Plan resulted in interest rates being raised at one of the fastest rates in modern history. He said that the precipitous interest rate increases put heightened interest rate risk into the system, and supervisors at the Fed were late to react. He added that risks were recognized by depositors, which led to bank runs and systemic stress. As a result of these failures, Barr said that the US now faces increased odds of a credit crunch, as banks of all sizes anticipate more onerous regulations and market scrutiny, as well as an increased risk of ending up with a banking system with a small number of too big to fail banks and a scattering of very small banks.

Barr also said that the Fed’s Vice Chair for Supervision Michael Barr continues to signal his desire to increase capital charges and impose more stringent regulations on already well-capitalized banks that are not to blame for recent stresses in the system. He bashed the Vice Chair’s review of the SVB failure as self-serving. He also expressed a desire to change emergency authorities for the Fed, FDIC, and Treasury, and ensure that the full boards at the Fed and FDIC are adequately consulted in important decision making so a single actor cannot act unilaterally to inject political preferences into regulations.

Finally, Barr said that the bills noticed for the hearing get at the heart of increasing accountability and transparency.

Subcommittee Ranking Member Bill Foster (D-Ill.)

In his opening, Foster said that new and old factors played a role in these events. He said that the new factors are internet-driven runs that increased withdrawal speed. He added that Congress needs to understand emergency liquidity support that will be needed to defend against these runs. He also said that he sees value in the internal and external reviews. Finally, Foster said that the committee can learn from the failure of Credit Suisse, which was truly too big to fail, but failed gracefully, without contagion, and without leaving the Swiss taxpayer on the hook. He said that was due to contingent capital, which allowed a mechanism to have a mandatory capital injection that made the bank something worth buying.

Question & Answer

FDIC and Fed Reviews of Recent Bank Failures

Barr asked if self-reviews provide impartial accountability for the Fed and FDIC to Congress. Tahyar said no. He also asked about the consequences of having opaque bank regulators that block the information flow to Congress. Tahyar said that over time, Congress needs to get a lot more information and transparency, and the consequences are failures of supervision and management and a banking panic.

FDIC Insurance

Foster asked Judge to discuss the pros and cons of fully insuring transaction/operating accounts. She replied that when it comes to small businesses, it is important that they have peace of mind that their transaction accounts at least are safe, and the FDIC did a nice job of laying out the different options and showing segmentation. She said that thinking about how to institute a system of segmentation could be helpful in promoting the health of community and small banks and promoting the stability of the clients they serve.

Foster also said that using differential FDIC insurance premiums strikes him as a big bank tax and a redistribution of wealth if not based on actuarial risks. Michaud said that there is an implicit guarantee in this too big to fail position that banks are in, so they get the benefit of paying less for deposits because of the tradeoff for safety. He said the question is if they can pay more for deposit insurance in return for the value they get for being too big to fail.

Rep. Brad Sherman (D-Calif.) asked if the proposal to expand FDIC insurance of operating accounts is limited to non-interest-bearing checking accounts. Michaud said it would be the operating accounts that businesses and nonprofits use for daily business and noted that the FDIC report has a definition. Sherman also expressed concern about a proposal to have temporary system wide unlimited insurance.

Rep. Joyce Beatty (D-Ohio) noted how the FDIC outlined three options for reforming deposit insurance: unlimited, targeted, or limited coverage. She asked the witnesses if any of these resonated with them. Judge said she thought the report was well done, and she said having more targeted approaches to insurance makes sense. Michaud said targeted is the right approach. Gould said that Congress should look at what the levels have been historically, what they are trying to fix, and what other mechanisms are available to reduce the risk of runs. Tahyar said that deposit insurance reform is something Congress must look at, but said she is hesitant about unlimited insurance.

The Cause for Recent Bank Failures

Barr also asked if SVB was subject to enhanced prudential standards in February/March of 2021. Gould said it was subject to certain enhanced prudential standards, but some of those, such as the internal liquidity stress testing requirement, were not actually enforced by the Federal Reserve.

Rep. Bill Posey (R-Fla.) asked if capital was the problem. Tahyar said it was not, as the banks were well capitalized upon failure. Posey asked if there is any reasonable capital level that would have protected against the interest risk of SVB’s asset base after Fed rate hikes began. Gould said no. Finally, Posey asked to what extent FSOC anticipated interest rate impacts when preparing a strategy to address risk. Judge said that the FOMC has a dual mandate focused on employment and price stability. She noted that in a period where inflation was rising rapidly around the world, their primary focus was price stability. She also stated that because of this, it has never been more important to have sufficiently robust regulatory structures in place and supervisory structures that are responsive to a rapidly changing environment going forward.

Rep. Roger Williams (R-Texas) asked how interest rate hikes caused these bank failures. Gould replied that the rising interest risk caused the bond portfolio of banks like SVB to decrease, and they accrued unrealized losses, which investors picked up on. He said that this phenomenon was well understood and well known. Williams said it should raise concerns that the Federal Reserve knew about SVB’s risky practice and had identified vulnerabilities for more than a year.

Barr also asked Gould about a statement that the proliferation of regulation since 2008 may have reduced risk management and supervision. Gould said that sometimes regulation provides the illusion of addressing risks, which can be a problem. He said that supervision is what matters.

Dodd Frank

Rep. Juan Vargas (D-Calif.) asked if Dodd Frank was a good law. Judge said it was a reasonable move at the time, but over time it has become clear that it should have gone farther. Gould said that expectations of what proponents said Dodd Frank would accomplish were overstated, as it did not end the era of boom and bust and there are still banks that can fail and have systemic impact. Tahyar replied that there are good parts of Dodd Frank and parts that were overstated and said there is a need for adjustments over time. Michaud said that it succeeded in bringing more capital and liquidity regulation to the industry, but parts may have gone too far.

Changes to Prevent Future Bank Runs

Barr asked if it would be wise to impose a one size fits all regulatory capital liquidity requirements on smaller banks right now. Michaud replied that it would permanently change the dynamics of banking forever, and result in midsized banks being absorbed into the bigger banks.

Rep. Nydia Velazquez (D-N.Y.) said that she recently wrote a letter with Sen. Chris Van Hollen (D-Md.) to federal realtors encouraging them to finalize their rulemaking on Section 956 of Dodd Frank, which is supposed to prohibit incentive-based compensation structures that encourage excessive risk taking. She also asked what additional measures Congress could consider to hold bad actors accountable. Judge said that a more robust set of clawback tools would be appropriate.

Velazquez also asked how to address the issue of deregulation. Judge said that Congress gave the Fed discretion over what to do with banks over a certain threshold, with the idea that the Fed was closer to the ground and might have better information over how risky banks were. She noted that they did not actually use that discretion in a manner commensurate with the risk that those banks were assuming. She suggested reversing that discretion, understanding that there may be a tendency towards deregulation.

Rep. Blaine Luetkemeyer (R-Mo.) said that he is concerned about real time payments and how they could impact future runs on banks. He floated an idea to place a 60-day ability for the FDIC to protect transactional accounts and deposits at institutions across the country. Tahyar said that social media and bad state actors in this panic are a new thing that the US has to grapple with. She said providing the FDIC with the power to temporarily guarantee deposits up to a certain level is an important tool that Congress should put back in place. Michaud said the tool could create a more orderly moment to address the bigger picture and take important corrections. Gould said it is important to understand the costs and incentives that such a mechanism would set going forward. He noted that part of that comes from increased transparency at the Fed and FDIC about what actually happened during that three-day time period.

Rep. Barry Loudermilk (R-Ga.) said that one recommendation in Vice Chair Barr’s report is to change supervisory behavior and promote faster, more decisive supervisory action. He asked how to guarantee that unbridled supervision would not create an environment where supervisors dictate management decisions unrelated to safety and soundness. Gould replied that, internally, a strong management culture is needed. He noted that unlike regulation, examiners have training on the ground over years of experience, and making sure regulators are focused on the risks that matter versus check the box exercises is tough.

Rep. Will Timmons (R-S.C.) said that the federal government should not have bailed out banks that made poor decisions. He said that those banks would have made their customers 90% whole and shareholders would have lost everything, which is what needs to happen when banks lose.

Rep. Maxine Waters (D-Calif.) asked which prudential standards should be improved. Tahyar replied that the long transition period of moving from one category to another ought to be looked at, and not passing through OCI in capital should be revisited. Waters also asked if regulators should look to strengthen the stress testing and liquidity requirements among other prudential standards. Tahyar said that there are some improvements that could be made, but she would be reluctant to put the same amount of LCR or HQLA requirements on regional banks as G-SIBs.

Consolidation

Barr asked if it is important to avoid more industry consolidation and have regulators give regional banks the opportunity to merge with future failing institutions. Michaud said that he supports congressional limits, as banks with more than 10% of the deposits in the country should not be acquiring other banks.

For more information on this meeting, please click here.

For an archive of past SIFMA hearing coverage, please click here.