The Federal Regulators’ Response to Recent Bank Failures – House Financial Services

House Committee on Financial Services 

The Federal Regulators’ Response to Recent Bank Failures 

Wednesday, March 29, 2023  

Topline 

• Rep. Ann Wagner (R-Mo.) questioned Barr on trading risk and his justification for increasing capital requirements. 
• Republicans highlighted capital and the need for the Fed to examine their supervisory role before adding new requirements on banks, defended the 2018 Dodd Frank rollbacks, and questioned why regulators did not address the issues at SVB earlier. 
• Democrats discussed Silicon Valley Bank’s (SVB) management and the need for enhanced bank regulations around capital and liquidity. 

Witnesses 

• The Honorable Martin Gruenberg, Chairman, Federal Deposit Insurance Corporation 
• The Honorable Michael Barr, Vice Chairman for Supervision, Board of Governors of the Federal Reserve System 
• The Honorable Nellie Liang, Undersecretary for Domestic Finance, U.S. Department of the Treasury 

Opening Statements 

Chairman Patrick McHenry (R-N.C.) 

In his opening statement, McHenry said the Committee needs to establish facts before drawing conclusions on regulations or changes to law. He noted that leading up to its failure, SVB experienced rapid growth, relying on an undiversified deposit base and investments made risky by high inflation. He added that it is important to have insight into federal regulators’ decision-making during that period. McHenry continued by stating that Vice Chair Barr made time to start a review of climate risk and capital standards for larger banks but made no mention of changes to bank supervision or liquidity provisions. He said that neither Dodd Frank nor the technical corrections law from 2018 dealt with issues from March. Finally, McHenry listed key questions for the hearing, including: 

• What were regulators thinking in the key hours of the first week of March?  
• Was there adequate planning for a large-scale bank run?  
• Did the Chief Supervisor follow the playbook? 

• How did examiners miss the hole in the bank’s balance sheet? 
• Did the FDIC chair use all tools available to resolve the banks that weekend? 
• Was there a viable private sector solution? Why was a potential buyer not accepted sooner? 

Ranking Member Maxine Waters (D-Calif.) 

In her opening statement, Waters asserted that 2023 is not 2008 because of the Dodd Frank reforms that Democrats passed and stressed the need to uncover how management, regulatory, and supervisory failures contributed to the banking failures and explore solutions. She also stated that community banks and minority depository institutions should not have to pay for the mismanagement at SVB or Signature Bank. Waters highlighted how Democrats are working on legislation to enhance claw backs and other penalties, and she asked Republicans to join the minority in working to strengthen compliance through bank rules and transparency. 

Testimony 

Martin Gruenberg, Chair, Federal Deposit Insurance Corporation 

In his testimony, Gruenberg discussed how the failure of SVB signaled the possibility of a contagion effect on other banks. He said it is worth noting that these two institutions were allowed to fail. Gruenberg explained that shareholders lost their investment, unsecured creditors took losses, and the Boards and the most senior executives were removed. He noted the FDIC has authority to investigate and hold accountable the directors, officers, professional service providers, and other institution-affiliated parties of the banks for the losses they caused to the banks and for their misconduct in the management of the banks. Gruenberg added that the FDIC has already commenced these investigations. He also explained that any losses to the FDIC’s Deposit Insurance Fund (DIF) as a result of uninsured deposit insurance coverage will be repaid by a special assessment on banks as required by law.   

Gruenberg noted that the FDIC completed the sale of both bridge banks to acquiring institutions and emphasized that the financial system remains sound despite these recent events. He said the FDIC will undertake a comprehensive review of the deposit insurance system and release a report by May 1, 2023. Gruenberg noted that the FDIC will issue a proposed rulemaking for the special assessment for public comment in May.  

Gruenberg discussed how the two bank failures demonstrate the implications that banks with assets over $100 billion can have for financial stability. He said the prudential regulation of these institutions merits serious attention, particularly for capital, liquidity, and interest rate risk. Gruenberg explained this would include the capital treatment associated with unrealized losses in banks’ securities portfolios. He added resolution plan requirements for these institutions also merit review, including a long-term debt requirement to facilitate orderly resolution.  

Michael Barr, Vice Chair for Supervision, Board of Governors of the Federal Reserve System 

In his testimony, Barr emphasized that the U.S. banking system is sound and resilient, with strong capital and liquidity. He said the events of the last few weeks raise questions about what more can be done to ensure isolated banking problems do not undermine confidence in healthy banks and threaten the stability of the banking system as a whole. Barr emphasized how important he believes it is to maintain the strength and diversity of banks of all sizes that serve communities across the country. 

Barr said SVB had inadequate risk management and internal controls that struggled to keep pace with the growth of the bank. He explained how in 2021, as SVB grew rapidly in size, the bank moved into the large and foreign banking organization (LFBO) portfolio to reflect its larger risk profile and was assigned a new team of supervisors. Barr noted LFBO firms between $100 billion and $250 billion are subject to some enhanced prudential standards but not at the level of larger banks or global systemically important banks (G-SIBs), and that the Fed is evaluating whether the application of more stringent standards would have prompted the bank to better manage the risks that led to its failure. He said the Fed is also assessing whether SVB would have had higher levels of capital and liquidity under those standards, and whether such higher levels of capital and liquidity would have forestalled the bank’s failure or provided further resilience to the bank.  

Barr said the failure of SVB illustrates the need to move forward with the Fed’s work to improve the resilience of the banking system, adding it is critical that the regulators propose and implement the Basel III endgame reforms, which will better reflect trading and operational risks in the measure of banks’ capital needs. He said following the Fed’s prior advance notice of proposed rulemaking, the Fed plans to propose a long-term debt requirement for large banks that are not G-SIBs, so that they have a cushion of loss-absorbing resources to support their stabilization and allow for resolution in a manner that does not pose systemic risk. Barr called for the enhancement of stress testing with multiple scenarios so that it captures a wider range of risk and uncovers channels for contagion. He concluded regulators must explore changes to liquidity rules and other reforms to improve the resiliency of the financial system. 

Nellie Liang, Undersecretary for Domestic Finance, U.S. Department of the Treasury 

In her testimony, Liang noted the American economy relies on a healthy banking system – one that includes large, small and mid-size banks and provides for the financial needs of families, businesses, and local communities. She said the federal government took decisive actions to strengthen public confidence in the U.S. banking system and protect the American economy, including the Federal Reserve’s creation of the Bank Term Lending Program. Liang explained how this program, along with its pre-existing discount window, helped banks meet depositor demands and bolstered liquidity in the banking system.  

Liang noted that on March 16th, 11 banks deposited $30 billion into First Republic Bank. She said these actions represent a vote of confidence in the banking system and demonstrate the importance of banks of all sizes working to keep our economy strong.  Liang emphasized that while we do not have all the details about the failures of the two banks, it is clear that the recent developments are very different from those of the global financial crisis. She explained that while in 2008, many financial institutions came under stress because they held low credit quality assets, this was not at all the catalyst for recent events.   

Liang emphasized that our financial system is significantly stronger than it was 15 years ago, in large part due to post-crisis reforms for stronger capital and liquidity requirements.  

Question & Answer 

Capital Requirements and Liquidity 

Rep. Ann Wagner (R-Mo.) strongly disagreed with Barr’s testimony stating, “The failure of SVB illustrates the need to move forward with our work to improve the resilience of the banking system. For example, it is critical that we propose and implement the Basel III endgame reforms, which will better reflect trading and operational risks in our measure of banks’ capital needs.” She added that these reforms will result in additional costs for consumers and businesses and asked if trading risk was the reason SVB had almost 94 percent of its deposits uninsured. Barr said no. Wagner then asked if trading risk the reason SVB did not have a risk officer for nearly 9 months last year and had 51 percent of its deposits in the technology industry. Barr said he did not believe it was. She also asked Barr to show how trading risk directly resulted in SVB failure or if he was just looking for a reason, correlated or not, to increase capital. Barr said it is important to strengthen capital and liquidity requirements in the system and that the rule the Fed doing will make the system stronger. 

Rep. Bill Foster (D-Ill.) asked if the Fed will finally consider contingent capital requirements as part of its review. Barr noted that the Fed and FDIC have issued a notice of advanced rulemaking on a different type of contingent instrument that would be required for large banks, but he added that it makes sense to consider alternative options as well.  

Rep. Juan Vargas (D-Calif.) asked about the steps that need to be taken to mitigate the potential for future bank failures. Gruenberg recommended starting with supervising liquidity risk. He noted that in the past some regional banks have been treated more lightly than the largest institutions, and he said it is important to take a close look at that in light of this event. 

Rep. Steven Horsford (D-Nev.) encouraged Barr to consider the effects of increased capital requirements on the lending of healthy banks. Barr stated that the capital review does not apply to community banks, which seem to be well capitalized and stable. He said the review is looking at larger institutions, and will do so through a notice and comment.  

Timeline of Bank Collapse 

McHenry asked the regulators when they first became aware of SVB’s financial distress. Barr said Thursday morning and Gruenberg said Thursday evening. The chair also asked Barr what he did between the February staff presentation that included risks at SVB and the week of March 6. Barr replied that the staff presented on the interest rate risk and indicated that they were completing their review of the bank. He said he was aware of the difficulty in raising capital on Wednesday night, but the bank reported Thursday morning that deposits were stable. Thursday afternoon Barr became aware of deposit flows, and Thursday evening there was a bank run. McHenry also asked when the FDIC became aware that it would receive the bank. Gruenberg said they were informed Thursday evening by staff that the bank would fail and the FDIC needed to make provision to take over. He said they opened an auction Sunday afternoon. McHenry argued that the lack of pronouncements until Sunday afternoon, when they mentioned the systemic risk designation, is what shook the market.  

The Role of Regulators  

Waters asked if the Fed failed to supervise the bank. Barr replied that any time a bank fails like this, bank management, supervisors, and the regulatory system have all failed. Waters asked about how the Fed is responding. Barr explained that the review is focusing on ways they could have done better as supervisors and how the Fed’s regulatory structure might have played a role. He also stated that the May report will include confidential supervisory information such as exam reports.  

Rep. French Hill (R-Ark.) said that there was a lack of supervisory urgency. Barr said that it is a fair question about whether supervisors could have been more aggressive in responding to the risk. 

Rep. Nydia Velazquez (D-N.Y.) asked if Barr agrees with her that category three and four banks should face the same rules as megabanks. Barr said the Fed is looking at capital and liquidity standards for all large banks, including firms of $100 billion and above. He added that a tiering approach still makes sense, but stronger rules for firms of this size are needed. Velazquez argued that without appropriate regulations that account for the systemic risk profile of a bank, bankers will be incentivized to search for yield and it will invite moral hazard. She also asked if the Fed will rewrite rules to require all banks to account for interest rate risk. Barr said that this is something they are looking at, and he anticipated a notice and comment rulemaking on capital rules with appropriate transitions.  

Rep. Pete Sessions (R-Texas) asked the regulators for inward thinking about how they were part of the problem. Barr said that the Fed needs to examine its supervision and regulation, and it will be unflinching in its review. Gruenberg said that the FDIC shares responsibility and will conduct internal reviews.  

Rep. Blaine Luetkemeyer (R-Mo.) said more rules are not needed until it is apparent which rules were not being enforced and which messages were not being delivered to the bank. 

Rep. David Scott (D-Ga.) asked if the San Francisco Fed sent multiple warnings to the bank management about its risk. Barr said that it pointed out interest rate and liquidity risk. He added that the particular issue with SVB did not rise to the level of the Board of Governors until mid-February of this year. Scott also asked why the bank doubling in size was not a red flag. Barr replied that they are looking at how the Fed’s regulations set up the structure for supervision of firms in the $50-100 billion range with lower levels of requirements, and how it had a phase in period for firms above the $100 billion line, which meant their transition to those higher standards took a long time.  

Wagner asked why the Fed did not consider escalating these issues into more formal enforcement actions to require the bank to remediate its deficiencies. Barr said he would look into it. Wagner said that the additional reforms proposed in the wake of this will result in additional costs for businesses, consumers, and investors.  

Rep. Andy Barr (R-Ky.) argued that the Fed could have applied enhanced prudential standards before the bank reached the size it did in February 2023. He said that it does not seem appropriate to change the tailoring rules for all banks to account for a lapse in supervision by the Fed and its inability to employ enhanced prudential standards when it can do so under existing law. He concluded by stating that the Fed had all the tools it needed.  

Rep. Young Kim (R-Calif.) asked who decided to put SVB under the horizontal review process, and how the Fed confirmed that the firm did not warrant actions beyond that. Barr said that supervisors on the ground saw this risk and required the firm to make changes. He added that the firm did not make them in time, so the concerns of the supervisors grew. Kim said the Fed should have considered enforcement actions or downgrading.  

Rep. Mike Lawler (R-N.Y.) asked if the regulators had the tools to prevent this. Barr said he did not have information to answer, but Gruenberg said that from a supervisory basis there was an opportunity. 

Bank Mismanagement 

Rep. Rashida Tlaib (D-Mich.) said that SVB is the bad actor here, and Barr agreed that the basic problem is the mismanagement of the bank. Tlaib added that she thinks SVB misled regulators and probably made fraudulent actions. 

Rep. Ritchie Torres (D-N.Y.) said that SVB had a uniquely unstable, uninsured deposit base, and asked if a bank like that should be subject to a higher standard of regulation than a bank with a stable, insured deposit base. Barr agreed.  

Rep. Wiley Nickel (D-N.C.) asked who was asleep at the wheel. Barr said that bank management failed in basic measures of interest rate and liquidity risk. He said that they had many outstanding matters requiring immediate attention, were deficient in governance and controls, and were rated a three overall, meaning not well managed.  

2018 Dodd Frank Rollbacks (S. 2155) 

Hill noted that in S. 2155’s rule of construction, it says nothing in the bill shall be construed to limit the supervisory authorities for safety and soundness. Barr said that the Fed has substantial authority under existing law to regulate firms in a way that is appropriate for their risk, size, and complexity.  

Velazquez asked if the rules passed under S. 2155 need to be rewritten. Barr replied that the Fed is going to look at the regulatory structure the Fed put in place in 2019, including the size thresholds and standards.  

Rep. Josh Gottheimer (D-N.J.) said that under the 2018 amendment to Dodd Frank, the Fed could and should have applied annual stress tests to banks like SVB, but it chose not to.  

Rep. Ayanna Pressley (D-Mass.) argued that the 2018 deregulation bill stripped away crucial requirements, got rid of enhanced prudential standards, and made it easy for SVB and Signature bank to engage in risky management practices with little to no oversight. She asked Bar if the Bill reduced supervision requirements by the Fed for small and medium-sized banks. The Vice Chair replied that the overall effect of the law was to reduce the regulatory burden for the smallest banks. He explained that for banks with $50-100 billion, it limited the Fed’s discretion, but for institutions over $100 billion, the Fed retained discretion, and chose in 2019 to put in place a set of rules that had the overall effect of reducing supervision and regulation. Pressley said that this is the story of a Republican administration in cahoots with the banking industry to weaken our financial regulations. 

Rep. Warren Davidson (R-Ohio) said that S.2155 is not the reason these banks failed. Barr replied that the Fed’s rules issued in wake of the 2018 legislation did have the effect of lowering the regulatory standard for firms, but the Fed retains the discretion for different rules. He said that it is his job going forward to put in place rules that are appropriate for that size institution. 

Deposit Insurance 

Rep. Brad Sherman (D-Calif.) said that he hopes the FDIC will consider $3 million of coverage, but only of non-interest bearing accounts. 

Rep. Joyce Beatty (D-Ohio) asked Gruenberg for his thoughts on proposals to modify the $250,000 cap. The chair said the coverage is statutorily set at $250,000 so adjusting it would require legislative change.  

Rep. Barry Loudermilk (R-Ga.) asked about Treasury’s position regarding deposit insurance. Liang replied that the agency used its tools to prevent contagion in the banking system, and has reflected a commitment to ensure all deposits are safe. She said they would use the tools again if there was a threat to the broader system. 

Rep. Nikema Williams (D-Ga.) asked if risk-priced deposit insurance should be maintained, even as deposit insurance reforms are considered. Gruenberg agreed, and noted that it is important to think about liquidity risks and concentrations of uninsured deposits. 

Interest Rate Risk 

Luetkemeyer said that Fed Chair Jerome Powell has made his intentions very clear, and no bank should have been caught off guard by rate increases. He also asked if an economic analysis is done every time the Fed raises rates. Barr replied that they have staff forecasts of the expected impact of rate decisions on the economy.  

Regional/Community Banking 

Rep. Roger Williams (R-Texas) said that community banks should not be required to bail out larger banks that take risky bets. Gruenberg replied that under the law, the FDIC is required to impose a special assessment on the banking industry to recover any costs to the Deposit Insurance Fund from covering uninsured deposits.  

Rep. Frank Lucas (R-Okla.) asked if community bankers will end up paying for the mistakes of the biggest institutions in the country. Gruenberg explained that the FDIC has to use a notice and comment rulemaking, but added that they have discretion and will be keenly aware of the impact on community banks. Rep. John Rose (R-Tenn.) also said that Tennessee bankers should not be paying for the mistakes of coastal banks. 

Rep. Dan Meuser (R-Pa.) asked if FDIC rates will go up on community and regional banks. Gruenberg repeated the same response that he gave to Lucas. 

The Impact on Housing and Real Estate 

Waters asked if First Citizens will continue implementation of the former bank’s community benefits plan. Gruenberg said that the agreement between community organizations and SVB was between those two parties, but there will be an opportunity for community organizations in California to engage with First Citizens, who is also subject to supervision under the CRA. 

Rep. Stephen Lynch (D-Mass.) said that there are 18 affordable housing developments in and around his district that depend on the fulfilment of outstanding debt and equity commitments made by SVB. He noted that the First Citizens assumption agreement is silent on the status of these low-income victims. 

Torres said that the rise of work from home during COVID has driven down office property values and the rapid rise of interest rates has driven up financing costs, creating a perfect storm. He added that $2.5 trillion in commercial real estate is coming due over the next five years, a substantial share of which is office debt. Gruenberg said that the office loan portfolio presents a risk, and is one the FDCI has identified publicly. 

The Role of Technology and Social Media 

Luetkemeyer expressed concern about the $42 billion rolling off the book as a result of Twitter information. Barr agreed that these are critical questions about the role of social media and depositor networks. Luetkemeyer added that the Fed’s real-time payment system will be ripe for a problem like this.  

Gottheimer also asked if social media and online banking tools have the potential to increase the intensity of future runs. Liang said the runs at SVB were unprecedented in speed and size and aided by social media and technology. She added that these new risks need to be considered, and said that Treasury is working on how to think about payment systems, fintech, and digital assets. 

Executive Compensation 

Rep. Al Green (D-Texas) asked about the power to claw back bonuses. Barr said that the Fed can pursue actions for individuals who violated the law, but does not have generalized claw back authority. Gruenberg said that the FDIC does not have claw back authority under the Federal Deposit Insurance Act, but does under Dodd Frank in regard to failures under Title II. 

Tlaib asked if there will be a rulemaking on Section 956 of Dodd Frank. Gruenberg said that they should complete that rulemaking to provide explicit claw back authority on compensation. 

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