Experts, banks are looking for ideas to stop the next bank failure


WASHINGTON — The warning signs were all there. Silicon Valley Bank expanded at breakneck speed, pursuing wildly risky investments in the bond market. The vast majority of its deposits were uninsured by the federal government, leaving its customers in crisis.

None of this was a secret. But banking regulators at the Federal Reserve Bank of San Francisco and the state of California did nothing when the bank rolled over the cliff.

“Your job is to ensure that the bank is run in a safe and sound manner and does not pose a threat,” said Dennis Kelleher, president of Better Markets, a non-profit organization that advocates stricter financial regulations. “The big mystery here is why the regulator at Silicon Valley Bank was AWOL.”

The search for causes and culprits — and solutions — draws attention back to a 2018 federal law that reversed harsh banking regulations imposed after the 2008-2009 financial crisis and, perhaps even more so, to the ways in which how regulators have written the rules for law in place.

The collapse of Silicon Valley Bank — the second largest bank failure in US history — also raises difficult questions about whether the FDIC needs to provide more protection for deposits.

On Friday, regulators shut down and seized the Santa Clara, California-based bank. She had bet for months that interest rates would stay low. They rose instead – as the Federal Reserve repeatedly raised interest rates to combat inflation – and the bank’s bond portfolio fell in value. As the problems became public, concerned depositors began withdrawing their money in an old-fashioned bank run.

And over the weekend, the federal government, determined to restore public confidence in the banking system, decided to protect all of the bank’s deposits, even those that exceeded the FDIC’s $250,000 limit.

The demise of Silicon Valley Bank on Friday and New York-based Signature Bank two days later revived bad memories of the financial crisis that plunged the United States into the Great Recession of 2007-2009.

As a result of this disaster, which was triggered by reckless lending in the US housing market, Congress passed the so-called Dodd-Frank Act in 2010, tightening financial regulation. Dodd-Frank particularly focused on “systemically important” institutions with assets of $50 billion or more – so large and connected to other banks that their failure could bring down the entire system.

These institutions had to maintain a larger capital buffer against losses, hold more cash or other liquid assets on hand to deal with a bank run, undergo annual Federal Reserve “stress tests” and write a “living will” to arrange things in an orderly manner, when they fail.

However, with the crisis in the past and more and more banks grumbling about the burden of complying with the new rules, Congress decided to exonerate the Dodd-Frank legislation. Among other things, the $50 billion asset limit for the strictest supervision was abandoned and raised to $250 billion. This freed many large lenders, including Silicon Valley Bank, from the strictest regulatory scrutiny.

Critics including Democratic Sen. Elizabeth Warren of Massachusetts, a leading critic of the banking industry, condemned the law at the time, saying it would encourage banks to take more risks.

The law gave Federal Reserve officials the power to re-impose tougher regulations on banks with assets between $100 billion and $250 billion if they deemed it necessary.

But they chose not to be harsh on these banks. For example, they only required a stress test every two years, not annually. So the Silicon Valley Bank didn’t have to undergo a stress test in 2022 and didn’t have to do so until later this year.

Todd Phillips, a fellow at the left-leaning Roosevelt Institute and a former FDIC attorney, said Congress’ push for deregulation during the Trump years sparked a “sentiment shift.”

“It basically gave regulators permission to turn their backs on lenders like Silicon Valley Bank,” he said. “Regulators drove with it.”

Warren and other lawmakers introduced legislation Tuesday to reverse the 2018 law and restore the stricter Dodd-Frank regulations.

But Better Markets’ Kelleher said US banking regulators “do not have to wait for a divided Congress to act in the best interests of the American public.”

You could rewrite 20 bank-friendly rules introduced by the Fed and other banking authorities during the Trump years. For banks with assets of $100 billion or more, Phillips wrote in a report on Wednesday, among other things, regulators should reintroduce annual stress tests and increase capital requirements.

“When we reverse regulations so bank executives can use these banks to increase their profits, increase their own salaries and get big bonuses, they do it by taking more risks,” Warren told reporters Wednesday. “Banking should be boring. And we have a chance here in Congress to make banking boring again.”

The sudden collapse of Silicon Valley Bank has also drawn attention to federal deposit insurance.

The FDIC only covers up to $250,000. But Silicon Valley Bank, the go-to place for tech entrepreneurs, kept cash ready for many startups: 94% of their deposits — including money companies need to pay their paychecks — were above the $250,000 threshold and vulnerable to losses when the bank collapsed.

The idea that so many savers would lose their savings threatened to shake public confidence in the banking system. Therefore, the Biden administration announced Sunday night that the FDIC would cover 100% of deposits at Silicon Valley Bank and also at Signature Bank

Now some are calling for a permanent increase in the deposit insurance limit.

“I hope that they will not now treat this increase in guaranteed deposits as a one-off response … but will go ahead with it,” said Barney Frank, former chairman of the Financial Services Committee and director of the House of Representatives for the failed signature bank. He also proposed an increase for companies to meet their payrolls.

But Phillips of the Roosevelt Institute said the problem is complicated. If you cover company payslips, should you cover the deposits they earmarked to pay rent or suppliers? And unlimited deposit insurance would mean that even the wealthiest and most financially savvy would not have to take responsibility for overseeing the financial health of their banks.

To cover all deposits, the FDIC would also have to charge banks more for the additional insurance, a prospect the industry has not been receptive to in the past. The industry has campaigned unsuccessfully for the past year to reduce FDIC insurance ratings.

However, fully comprehensive insurance can be a competitive advantage.

A group of small Massachusetts banks created their own private deposit insurance fund in the 1990s, allowing depositors to insure themselves beyond the $250,000 limit through this government program. While it costs more for small banks to participate than just being insured by the FDIC, Massachusetts bankers said they have been attracting customers since the collapse of Silicon Valley Bank.

“Maybe our rates aren’t as competitive as the largest banks, but customers like this we insure 100% of their funds,” said Catherine Dillon, chief operating officer of Bank Five in Fall River, Massachusetts. ___ Sweet reports from New York.

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