BPInsights: April 1, 2023

All Eyes on SVB on Capitol Hill

The Senate Banking Committee and House Financial Services Committee held hearings this week on the regulatory response to recent bank failures. The hearings included Vice Chair for Supervision Michael Barr, FDIC Chair Martin Gruenberg and Treasury Under Secretary for Domestic Finance Nellie Liang. Here are some key takeaways.

  • Tailoring: The S.2155 tailoring legislation and subsequent tailoring regulation faced scrutiny. Although some have blamed it for SVB’s failure, Rep. Andy Barr (R-KY) and Sen. Mike Crapo (R-ID) noted that the law enables the Fed to ramp up prudential standards on certain banks. “It doesn’t seem appropriate to change the tailoring rules for all banks to account for a lapse in supervision by the Fed and the inability of the Fed to deploy enhanced prudential standards to firms when it’s currently able to do so under existing law,” Rep. Barr said. In response to Crapo, Vice Chair Barr implied that applying enhanced standards beyond those enshrined in the 2019 tailoring regulation would require notice-and-comment rulemaking.  Pushing back on this notion, Rep. Andy Barr cited the provision of S.2155 providing the Fed with the authority to, by order, apply enhanced prudential standards to certain banks on a one-off basis. Vice Chair Barr said the central bank is considering whether there should be “appropriate changes” to the regulatory tailoring framework. “I still think a tiering approach makes some sense, it doesn’t have to be the same rules for all banks, but we do need stronger rules for firms of this size—stronger rules on capital and liquidity, I think, are going to be really important.”
  • Supervision: Several lawmakers raised alarms over the Fed’s supervision of SVB. The central bank’s supervisory record has already drawn bipartisan scrutiny from several members of Congress in letters probing its practices, and it was a central topic at the hearings. Sen. Thom Tillis (R-NC) requested that Vice Chair Barr provide more detail on SVB’s MRAs and MRIAs. One key theme resonated throughout: The Fed had supervisory and regulatory tools at its disposal to address issues at problem banks.
  • Basel: Vice Chair Barr said “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 [requirement] needs.” This notion drew pushback from Rep. Ann Wagner (R-MO) who asked Barr if trading risk drove SVB’s failure. She pointed instead to its heavy reliance on uninsured deposits, concentration in the tech sector and lack of a chief risk officer as significant weaknesses. Raising capital requirements would impose costs for businesses and consumers, Wagner said.
  • Deposit insurance: Some lawmakers pressed Gruenberg on how the costs of the special assessment on banks to replenish the deposit insurance fund post-SVB would be divided. Sen. Cynthia Lummis (R-WY) asked if community banks could be exempted. “I’m suggesting we have some discretion there and we’re going to consider that issue carefully,” Gruenberg. Sen. Bill Hagerty (R-TN) said: “That fund’s going to be replenished by banks across the nation that had nothing to do with the mismanagement of Silicon Valley Bank or the failure of supervision here.” 
  • Resolution: Senators questioned Gruenberg about the FDIC’s resolution process for SVB and the failure to find a buyer in the immediate wake of its collapse. “We received one offer that was frankly more expensive than the cost of liquidation,” Gruenberg said. He also said that banks did not have time to conduct due diligence on a potential acquisition during the “compressed timeframe over that initial weekend.” Quicker intervention by the private sector could have avoided some of the chaos surrounding SVB’s failure, Senate Banking Committee Ranking Member Tim Scott (R-SC) said. Noting that he was “inundated with phone calls that legitimate bidders were being waived off of the process,” Sen. Hagerty suggested that the FDIC discouraged some banks from buying SVB, which Gruenberg denied. “In spite of all the preparation and tools at your disposal, the FDIC failed to do its job,” Hagerty said.

Other Perspectives

  • Europe: SVB had an outlier business model concentrated in the tech industry and serving “almost exclusively uninsured large-ticket depositors,” ECB top banking supervisor Andrea Enria said in a speech this week. “There was also a bit of groupthink between the depositors, borrowers and bank management, so they went out very fast,” he said. “[M]y impression is that, in those cases, it is supervision that needs to look at the business model and – if anything – maybe tailor requirements for that specific business model rather than revise the global standard because of an outlier bank.” In the speech, Enria also disputed the view that “in Europe, we are more burdensome with regards to our capital requirements than in other jurisdictions.”
  • Former Fed supervision chief: Former Fed Vice Chair for Supervision Randal Quarles offered views on the SVB failure in a Wall Street Journal op-ed this week. “Several politicians have called for rolling back the carefully calibrated regulatory changes stemming from the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018—a banking-reform law enacted by strong bipartisan majorities,” Quarles wrote. “As Wolfgang Pauli once said of a fellow physicist’s hypothesis, that’s so nonsensical, it isn’t even wrong.” SVB did not have a capital shortage, but instead succumbed to a bank run, he noted, and “even applying to SVB the full-strength liquidity rules governing our largest banks wouldn’t have changed its fate.” He also dismissed the notion that changes in stress tests might have obscured the bank’s problems. He also disputed the claim that the “guidance on guidance” codification limited supervisors’ power to intervene: “In a world where courts are increasingly ready to invalidate agency action that doesn’t comply with the Administrative Procedure Act, this clarification strengthens bank supervision rather than weakens it.” Instead, Quarles suggested, policymakers should consider the treatment of uninsured deposits, why the FDIC didn’t find a buyer the night before it failed, and the role of fiscal policy in entrenching inflation into the economy.

Next Steps

Congress is not alone in seeking answers on regulators’ handling of SVB. The Fed inspector general is probing the central bank’s SVB supervision, separate from the internal review led by Michael Barr. The FDIC will propose rules to impose a special assessment on banks to cover the Deposit Insurance Fund shortfall and has promised a report on the deposit insurance system by May 1. Fed Chair Powell suggested that Congress review how deposit insurance works after the bank failures. The Biden Administration called for new rules for midsize banks.

All this is happening as the banking agencies prepare to propose rules to implement Basel Finalization.

Five Key Things

1. BPI Responds to White House Bank Regulatory Proposals

BPI this week released a statement in response to the White House’s proposed bank regulatory changes: “It would be unfortunate if the response to bad management and delinquent supervision at SVB were additional regulation on all banks that would impose meaningful costs on the U.S. economy going forward. The Fed has barely begun its promised review. This has a strong feeling of ready, fire, aim.” 

  • Yellen: Treasury Secretary Janet Yellen said in a recent speech that COVID and the recent bank failures “remind us of the urgent need to complete unfinished business: to finalize post-crisis reforms, consider whether deregulation may have gone too far, and repair the cracks in the regulatory perimeter that the recent shocks have revealed.” Yellen observed that the banking system is “significantly stronger than it was heading into the Global Financial Crisis,” as demonstrated by the stability in the overall banking sector despite concerns about specific firms. But she asserted that “regulatory requirements have been loosened in recent years” and said it is appropriate to assess the impact of “deregulatory decisions” and “take any necessary actions in response.”

2. The Deposit Black Hole

The Federal Reserve borrows money every day from money market mutual funds and other nonbanks at its overnight reverse repurchase agreement (ON RRP) facility. This facility subsidizes money market funds as an attractive alternative for uninsured bank depositors. Why does the Fed continue to operate it at its $2.2 trillion size?

  • Background: The Fed created the ON RRP facility 10 years ago to ensure that it could lift the effective fed funds rate above zero when it decided to do so. The facility helped it accomplish that task by broadening the set of institutions to which the Fed pays interest for deposits. After years of lying dormant, the facility surged in the last two years as the Fed expanded its balance sheet. The central bank needed to borrow from money funds to prevent the fed funds rate from falling below the FOMC’s target range.
  • What’s happening now: Now the Fed is shrinking its balance sheet. It would be understandable if the ON RRP facility, once described as a temporary tool, was shrinking, too – but that hasn’t happened. Instead, it sits at a massive $2.2 trillion – bigger than the GDP of South Korea.
  • Black hole: Money market funds drawing money away from bank deposits is nothing new, but the money normally ends up funding economic activity in some way. The ON RRP, by contrast, is a black hole for bank deposits. It uses the money to fund the government rather than private economic activity. Forty percent of money market mutual fund investments (44 percent for government funds) are overnight RRPs with the Fed – a deep black hole.

To learn more about the problem and the solution, read the post here.
Digging deeper: Concern is growing about the surge in money market funds, and the massive size of the ON RRP facility is part of the bigger picture.

3. A Deeper Dive Into SVB’s Liquidity Coverage Ratio

A BPI blog post provides an updated analysis of what Silicon Valley Bank’s liquidity coverage ratio would have been at the end of last year. The previous estimate is available here.

  • The updates: The latest note draws insights from SVB’s regulatory reports, such as 10-Ks and call reports, and its earnings presentations, and makes adjustments to the previous estimate of SVB’s LCR. The analysis includes two updates to the calculations:
    1. Assuming that if there had been no tailoring rule, SVB would have been subject to the full LCR, rather than the modified one, due to its foreign exposures.
    2. Refining the estimate of the cash outflows from deposits – a component of the LCR – by drawing on additional data.
  • Revised estimate: Taking these adjustments into account, the updated estimate of the bank’s LCR would have been 101 or 75, depending on the assumptions used to derive the estimate of projected deposit outflows. If SVB had reduced its foreign exposures to qualify for the modified LCR – a likely scenario – its estimated LCR would have been 144 or 107.
  • Bottom line: Regardless of whether SVB would have passed the LCR or its modified version, the LCR would not have prevented SVB from taking on excessive interest rate risk, a primary reason for its failure.

4. Why Regulators Should Consider Banks’ Borrowing Capacity from the Fed in Liquidity Assessments

A recent Wall Street Journal article revealed an important reason behind the disorderly cadence of Silicon Valley Bank’s failure: Trouble getting SVB’s collateral transferred from the San Francisco Federal Home Loan Bank to the Federal Reserve Bank of San Francisco. If the San Francisco Fed had received the collateral, it could have lent SVB an additional $20 billion, and the bank may have made it to the end of the business day. This would have given the government a better chance of working out the situation in an orderly way without taking emergency measures.

BPI’s take:

  • The challenge: Banks must work out collateral claims between a Federal Reserve Bank and FHLB in advance. But there is no regulatory or supervisory incentive to establish borrowing capacity at the Fed. A key problem centers on banks’ internal liquidity stress tests, which do not provide credit for discount window borrowing capacity or use of the Fed’s standing repo facility.
  • Unappealing: The standing repo facility is an unappealing option for banks, partly because of the negative regulatory treatment. One factor: Banks can’t assume in their internal liquidity stress tests that they can tap the SRF to convert securities into cash.
  • Bottom line: Liquidity regulations and tests should take into account banks’ capacity to borrow from the Fed, for many reasons. The SVB failure serves as a stark reminder that a bank with such borrowing capacity is more liquid than one without it – taking the capacity into consideration makes the assessments more accurate.

5. Shifting Into the Shadows

Regulatory constraints on banks’ balance sheets are driving a shift of financing away from regulated banks into asset management firms with less oversight, William Cohan wrote in a recent Financial Times op-ed. Major buyouts used to be a core specialty of large banks, he wrote. “But these days, the big Wall Street banks are increasingly groaning under the weight of close regulatory scrutiny and facing more restraints on how far they can stretch their balance sheets after a rough 2022. In a market they had previously dominated, they must now compete with rivals with funds swollen from an era of cheap money.” The op-ed suggests that regulators train their sights on Blackstone, Apollo and other similar firms.

In Case You Missed It

Treasury to Update Beneficial Ownership Reporting Form

The Treasury Department is working to issue an updated reporting form for its planned beneficial ownership database and make clear that reporting companies must submit complete, accurate information about their owners, the Wall Street Journal reported this week. These recent indications from Treasury’s FinCEN suggest that the bureau will take steps to assure that companies can not simply opt out of providing their ownership information to FinCEN, the WSJ article says. BPI had urged FinCEN to ensure that the information to be included in the database be reliable and useful for banks, law enforcement authorities and other authorized entities using it to help weed out shell companies. In particular, BPI expressed concern that FinCEN’s proposal would allow reporting companies to omit information as “unknown” or “unable to identify” without requiring them to clarify why the information could not be provided. 

CFPB Unveils Final Small Business Lending Data Rule

The CFPB this week released its final rule on small business lending data, based on the Section 1071 provision of the Dodd-Frank Act. The rule, which aims to promote fair access to credit for small businesses, applies to lenders making over 100 covered small business loans per year. Not only will banks and credit unions be required to provide data, but also nonbank financial institutions, according to the CFPB. The rule defines a small business as one with gross revenue under $5 million in its last fiscal year. 

  • BPI’s take: In a previous blog post, BPI called for the CFPB to collect small business lending data from all kinds of financial institutions — both banks and nonbanks.
  • The rule provides a phased-in compliance timeline, going into effect earliest for the largest lenders (those that originate at least 2,500 small business loans a year), failing to provide for a longer compliance period for those lenders as BPI had requested.
  • Small businesses will be able to identify themselves as women-, minority- or LGBTQI+-owned. The latter status is a new addition compared to the proposal. Importantly, lenders will be able to rely on the financial and other information provided by the business, and loan officers will not be required to determine an applicant’s demographic information themselves.
  • The CFPB provides that it intends to “further engage with stakeholders on the issue of data publication” before it determines what approach it will take to protecting privacy interests through modifications and deletions, but does not explicitly refer to a notice and comment process.

The Crypto Ledger

Binance and its CEO Changpeng Zhao face a lawsuit from the Commodity Futures Trading Commission. Read the lawsuit here. The CFTC accused Binance of violating U.S. derivatives rules, failing to register with the agency and failing to implement an effective AML program. Here’s what’s new in crypto.

  • Ties to China: Binance hid major ties with China for years, according to the Financial Times, which cites internal documents. Zhao and other senior executives repeatedly directed employees to hide the firm’s Chinese presence, the FT reported. The CFTC lawsuit describes Binance’s evasiveness about the location of its company headquarters as “a deliberate approach to attempt to avoid regulation.” The revelations come as Binance’s U.S. arm is attempting to buy bankrupt crypto firm Voyager’s assets, and China links would likely trigger national-security scrutiny from CFIUS.
  • FTX: China connections also came up in the case against FTX’s Sam Bankman-Fried, who was charged with conspiring to bribe Chinese officials to regain access to frozen cryptocurrency.

Ermotti Returns to UBS Helm

Former UBS CEO Sergio Ermotti will lead the bank once again as it navigates its impending acquisition of Credit Suisse, the bank announced this week. Ermotti will become CEO effective April 5, 2023.

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The views expressed do not necessarily reflect those of the Bank Policy Institute’s member banks, and are not intended to be, and should not be construed as, legal advice of any kind.