BPInsights: April 15, 2023

Fact Check: What Policymakers’ SVB Statements Got Wrong

Statements this week by federal policymakers such as CFPB Director Rohit Chopra and NEC Director Lael Brainard have blamed regulatory changes for Silicon Valley Bank’s failure and asserted that the bank was not subject to requirements that would have raised alarms about its problems. Given the potential impact on the economy, it’s important to diagnose the problems at SVB correctly to ensure the remedy is appropriate and effective. SVB’s liquidity position and mix of uninsured/insured deposits were known ahead of its failure, and the tailoring law that exempted midsize banks from certain requirements would not have prevented its massive buildup of interest-rate risk and poor management.

  1. NEC Director Brainard said “liquidity stress tests would have alerted the supervisors to the fact that uninsured deposits were a huge percentage of [overall] deposits”. In fact, details on SVB’s levels of uninsured versus insured deposits were clearly listed in the publicly available quarterly call reports SVB filed with regulators. So, regulators were keenly aware of the level of uninsured deposits under existing requirements. Also, SVB was required by regulation to have a contingency funding plan addressing how the bank would source alternative funding if, say, its uninsured deposits walked in a stress event. Its examiners presumably would have reviewed that plan.
  2. Director Brainard said SVB “hadn’t undergone” and “didn’t have liquidity requirements.” But SVB was already subject to quarterly internal liquidity stress test requirements by regulation as a Category 4 bank, and the bank was actually performing them monthly, and disclosing and discussing them with its examiners.  This is disclosed in SVB’s public securities filings. SVB was also required to report comprehensive information about its liquidity profile on a monthly basis to the Federal Reserve on the Fed’s own “Complex Institution Liquidity Monitoring Report” form – commonly known as the FR 2052a.
  3. Director Chopra said “there is no question that some of the deregulation in recent history helped to contribute” to SVB’s failure. But he offered no evidence. SVB’s failure appears to stem from factors outside of regulation, such as unhedged interest rate risk, concentration among uninsured depositors and supervision failures, and the Fed had the power to impose heightened supervisory standards on the bank and chose not to do so.  To date, the evidence suggests SVB failed due to poor management and supervisory failures.
  4. Director Brainard said that SVB didn’t undergo capital stress tests, and a capital stress test that tested for interest rate increases could have made a material difference, but the suggestion that adding a scenario with increasing rates would have made a difference is a red herring because unrealized changes in securities values, such as the significant unrealized losses SVB had in its fixed income securities portfolio, would not affect earnings or regulatory capital in any such stress test.
  5. Director Brainard asserted that for banks like SVB, there was a shift in Fed supervision to a “much lighter-touch” form of oversight and that examiners were discouraged from “intrusive” oversight. There is no evidence for this assertion. The 2018 and 2021 interagency releases outlining the use of supervisory guidance for banks, presumably the subject of this criticism, do nothing to weaken bank supervision and simply clarify which actions will be taken through supervision and which will be taken through rulemaking consistent with applicable law, due process and efforts for interagency harmonization.

Bottom line: SVB’s demise was not due to a gap in regulatory requirements – regulators had a clear view into SVB’s liquidity and capital and were empowered by the law to subject it to stringent scrutiny. SVB’s failure was instead a cautionary tale about an undiversified business model and improper balance sheet risk management.

Five Key Things

1. The CFPB’s Deeply Flawed Proposal on Credit Card Late Fees

Under bedrock principles of administrative law, the crafting of regulations requires agencies to explain their rationale for the choices they make and support those choices with sound data. For credit card fees, Congress enacted the Credit Card Accountability Responsibility and Disclosure Act (CARD Act) of 2009 to govern issuers’ use of those fees. But the CFPB’s recent late fee proposal under the CARD Act, which would cap the safe harbor for credit card late fees at $8, falls far short of this standard.

What’s happening: The CFPB proposal fails to fully consider the deterrence role of late fees and the role of risk-based pricing. The CFPB:

  • Takes an overly narrow view of late fee deterrence and only considers the potential deterrence role of late fees on the actual payment due date.
    • Reality: Late fees play a role in motivating consumers’ financial choices over the longer term, not just on the day a bill is due.
  • Ignores the risk pricing aspect of late fees.
    • Reality: With risk appropriately priced, consumers can make better borrowing decisions and banks can offer a lower, baseline interest rate up front.
  • Fails to give appropriate consideration to incentive effects of late fees for consumers who may make mistakes or exhibit behavioral biases, such as overoptimism about their ability to meet debt obligations.
    • Reality: Not every consumer is the same when it comes to financial decision-making, and late fees can motivate consumers to make more proactive budgeting decisions. A consumer who is charged a late fee once may adjust their approach to payments after that instance. Late fees may also drive consumers to make healthier financial choices such as limiting excessive spending or the number of credit cards they hold.
  • Asserting, without giving evidence or details, that while the proposal may weaken deterrence, it “creates additional incentives for issuers to emphasize reminders, automatic payment, and other mechanisms that maintain similar or better payment behavior.”
    • Reality: Reminders are no substitute for late fees in terms of a deterrence effect, and automated payment plans, while convenient for many customers, may have unintended or costly side effects, such as the risk of overdraft.

To learn more, read BPI’s research note here.

2. Fed’s Bowman: Banking System on ‘Solid Regulatory Foundation’

Federal Reserve Governor Michelle Bowman said this week that the banking system remains “standing on a solid regulatory foundation” in the wake of recent bank failures. The upcoming reviews of SVB’s collapse should provide insight into lessons learned and potential areas for improvement in regulation and supervision, Bowman said in a speech on Friday. But “we should not rush to judgment with respect to these ongoing reviews,” she said. “If we identify shortcomings in supervision and regulation, we should and will address those shortcomings. While this episode has demonstrated that some changes may be warranted, I do not believe the failure of these two institutions is an indictment of the broader regulatory landscape.” Bowman’s comments come as some have blamed regulatory tailoring and other aspects of the bank regulatory landscape for SVB’s failure. Finally, Bowman offered a glimpse of what’s to come with the Fed’s review of the SVB failure, saying that Vice Chair Barr “conducting an internal review of the Federal Reserve’s oversight leading up to the failure of Silicon Valley Bank and will issue a report by May 1 that provides his conclusions” and that there “are also a number of external reviews underway, which should contribute to a robust discussion about the root causes of the two bank failures.”

3. FDIC’s Hill on SVB: Tailoring Had ‘Nothing to Do With It’

The S. 2155 tailoring law had “nothing to do with” SVB’s failure, FDIC Vice Chair Travis Hill said in remarks this week. “We have people searching under the couch cushions… under the carpets… under the mattress… in the storage closet… hoping to find something somewhere tying the SVB failure to that law and its implementing rules,” Hill said. “The rule changes did not change the stringency of capital standards for a bank of SVB’s size, the stress tests did not test for rapidly rising rates, and the exact thing that got SVB in trouble – investing in government bonds – is exactly what the liquidity coverage ratio is designed to require.  The reasons for SVB’s failure are quite straightforward and easy to explain, and those rule changes had nothing to do with them.” He said policymakers should “closely review the lessons to be learned from the recent failures, and be open to targeted changes to our framework, but we should be humble about what our rules and policies can accomplish, and avoid the temptation to overcorrect.”

4. A Liquidity Requirement Change That Could Drive More Bank Lending to Main Street

The recent SVB failure has prompted calls for banks to reserve even more space on their balance sheets for high-quality liquid assets (HQLA), which leaves less room for lending to businesses and households. Would different policies improve banks’ liquidity without imposing the cost of lower economic growth?

A better way: Allowing committed liquidity facilities, or CLFs, to count as HQLA is one way to reduce the economic costs of liquidity requirements while preserving their benefits. Like discount window loans, CLFs would be collateralized by banks’ loans to businesses and households, among other things. Under this policy change, banks would be allowed to anticipate using these CLFs to meet cash outflows under stress. That would enable banks to offer more loans to their communities.

Big-picture benefits: More room for lending on banks’ balance sheets would not only boost economic growth, but also bolster employment. Incorporating CLFs into liquidity requirements would benefit the whole economy.

To learn more, read BPI’s recent blog post here.

5. OCC Drops Enforcement Action Against Former CCO of Rabobank NA

The OCC recently scrapped a longstanding enforcement case against former Rabobank NA chief compliance officer Laura Akahoshi. The regulator, whose acting chief Michael Hsu decided “reluctantly” to terminate the case, had accused Akahoshi in 2018 of withholding information during a 2013 anti-money laundering exam.  In particular, the OCC asserts that Akahoshi waited nearly a month before taking steps to hand over a report requested by examiners that was critical of the bank’s AML compliance.  Hsu cites the length of time since the examination in question – and the attendant difficulty of determining whether Akahoshi acted with the required intent to obstruct the exam as required to satisfy the culpability requirement for an enforcement action — as a factor in the dismissal: “The delay in this action would likely make it difficult for witnesses to accurately recall the events in question and their attendant states of mind,” the decision states. “More than ten years have passed since the events that gave rise to this matter.” Acting Comptroller Hsu had declined to adopt an OCC administrative law judge’s recommendation that Akahoshi be fined $30,000 and be banned from the banking industry.

  • Raises questions: Akahoshi’s attorney called the dismissal “a transparent attempt by the OCC to avoid subjecting the agency’s own conduct and meritless enforcement action to public and judicial scrutiny in federal court.”

In Case You Missed It

SCOTUS: Constitutional Challenges to SEC/FTC Administrative Actions Can Head Straight to Federal Court

On April 14, the U.S. Supreme Court in Axon Enterprise, Inc. v FTC, et. al. and SEC, et. al. v. Cochran held that persons facing administrative action before the FTC and SEC do not need to go through administrative law judge proceedings prior to challenging the constitutionality of those proceedings in federal courts.  The decision addresses an important jurisdictional question only as the SCOTUS did not reach the merits of the constitutional questions addressed in the cases including whether in-house ALJ proceedings violated the respondents’ due process and equal protection rights and the ALJ was unconstitutionally protected from removal.  The question of whether Article III courts have legal authority to entertain constitutional law questions inherent in ALJ proceedings until the ALJ proceedings have run their course (which could at times take years) has arisen in several cases in recent years.   The claim that an agency’s structure or existence itself violates the Constitution is not the type of claim contemplated by Congress in the administrative review scheme it set out in the Securities and Exchange Act and the FTC Act, the SCOTUS said.

Waller Highlights SVB Uninsured Deposits as Key Risk

Fed Governor Christopher Waller noted in a speech on Friday that SVB’s high share of uninsured deposits concentrated in similar types of businesses formed a unique risk. “Unlike other banks, where a substantial share of deposits is insured and verifiably safe, more than 90 percent of SVB’s deposits were above the $250,000-per-account limit for deposit insurance,” Waller said. “Additionally, those deposits were largely from many of the same types of businesses, resulting in additional risk.” Waller also said that the Fed’s new Bank Term Funding Program and the discount window “appear to have been successful in providing stability to the banking system.” Deposit flows have stabilized in recent weeks, he noted, and “as a result, the combined usage of the discount window and the new program has moderated.” He said that adjustments in the banking system after the recent stress could potentially cause credit conditions to tighten. Waller noted that he voted for the Fed to invoke the systemic risk exception for SVB and Signature — which led to the guaranteeing of all SVB deposits, including uninsured — not because those banks are systemically important on their own, but “to stem the emerging crisis of confidence which could have led to additional bank runs with significant adverse effects on financial markets and the broader economy.” Waller also said “SVB seems to have done a terrible job managing its risks.”

The Crypto Ledger

“Follow the bitcoin” is becoming a viable law enforcement investigative strategy, according to a recent Wall Street Journal article. Despite crypto’s nefarious appeal as an anonymous medium of exchange, law enforcement agencies are working with crypto exchanges and blockchain analytics firms to map crypto flows across global criminal networks, the piece states. Here’s what else is new in crypto.

  • FTX: Bankrupt crypto exchange FTX has recovered more than $7.3 billion in assets, according to its attorney, who said “the dumpster fire is out.” (The full extent of that conflagration is detailed in a recent Wall Street Journal piece, which notes that multimillion-dollar expenses were “approved by emoji” at the failed firm.)
  • Wyoming: An analysis of Wyoming crypto firm Custodia’s failed attempt to seek a Fed master account suggests the firm won’t stop in its quest for banking system access. “The Wyoming blockchain plan was always delusional,” David Gerard and Amy Castor wrote in a recent post on the Attack of the 50 Foot Blockchain blog. “They thought they could use one weird trick to get around regulation — any kind of regulation. This was never going to work even before crypto screwed up as hard as it did all through 2022.”

Deposit Insurance: Views from Europe, U.K.

The European Commission’s proposed banking overhaul package would allow authorities to use deposit insurance funds to finance the wind-downs of some smaller banks, according to Bloomberg this week. A proposed change would allow deposit guarantee funds to be used in some resolutions as bridge financing to complement bank reserves that would be “bailed in” before the fund is used, according to the article.

  • Meanwhile, in the U.K.: Bank of England Governor Andrew Bailey this week said the BoE is considering improvements to its approach to depositor payouts for smaller banks without Eligible Liabilities (a form of loss-absorbing debt that can be converted to equity in crisis). “Our work has thus far focused on the speed of pay-outs,” Bailey said in a wide-ranging speech. “Going further and considering increasing deposit protection limits could have cost implications for the banking sector as a whole. As with all things relating to bank resolution, there is no free lunch.”

U.S., U.K. Sanction Russia Financial Fixers

The U.S. Treasury Department is coordinating with the U.K. to crack down on “facilitators” that enable Russia’s access to the global financial system, Treasury announced this week. The countries are targeting the facilitation network of Alisher Usmanov. Usmanov also faces sanctions from the EU. The action’s targets range from Cypriot nationals to financial facilitators in Switzerland and Liechtenstein.  The sanctions are intended to help disrupt Russia’s importation of critical technologies used in its war against Ukraine. 

A Subtle Update on CBDC

A recent New York Times article on CBDC controversy mentions a subtle but important update to the Fed’s website: the central bank recently updated its frequently asked questions to clarify it “would only proceed with the issuance of a CBDC with an authorizing law.” The update aligns with comments previously made by Chair Jerome Powell. 

U.S. Bank Announces Leadership Changes

U.S. Bank this week announced several changes to its leadership team. Kate Quinn, vice chair and chief administrative officer, and Jim Kelligrew, vice chair of corporate and commercial banking, will retire on June 30. Quinn will be succeeded by Terry Dolan; John Stern will become chief financial officer on Sept. 1; and Gunjan Kedia will assume an expanded role overseeing a combined wealth management and investment services and corporate and commercial banking organization. 

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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.