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


WASHINGTON – The warning signs were all there. Silicon Valley Bank expanded at a breakneck pace and pursued hugely risky investments in the bond market. The vast majority of his deposits were uninsured by the federal government, exposing his clients to 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 as the bank tumbled over the cliff.

“It’s their job to make sure the bank is run in a safe and sound manner and poses no threat,” said Dennis Kelleher, president of Better Markets, a nonprofit organization that advocates for tighter financial regulation. “The big mystery here is why supervision was AWOL at Silicon Valley Bank.”

The search for causes and culprits — and solutions — refocuses attention on a 2018 federal law that reversed harsh banking regulations in place after the 2008-2009 financial crisis and, perhaps even more so, on how regulators wrote the rules who put that law in place.

The collapse of the Silicon Valley Bank – the second largest bank failure in US history – also raises tough questions about whether the FDIC should provide more protection for deposits.

On Friday, regulators closed and seized the bank in Santa Clara, California. For months it had lost the bet that interest rates would stay low. Instead, they rose – as the Federal Reserve repeatedly raised its benchmark interest rate to fight inflation – and the bank’s bond portfolio plummeted in value. When the troubles became public, worried depositors began withdrawing their money in an old-fashioned bank run.

And over the weekend, determined to restore public confidence in the banking system, the federal government 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 Friday and of New York-based Signature Bank two days later has rekindled bad memories of the financial crisis that plunged the United States into the Great Recession of 2007-2009.

In the wake of that catastrophe caused by reckless lending in the US housing market, Congress passed the so-called Dodd-Frank Act in 2010, tightening financial regulation. Dodd-Frank focused mainly on “systemically important” institutions with assets of $50 billion or more – so large and connected to other banks that their collapse could bring down the entire system.

Those institutions had to maintain a larger capital buffer against losses, keep 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 keep their affairs in a orderly manner if they fail.

But as the crisis faded into the past and more and more banks grumbled about the burden of complying with the new rules, Congress decided to ease the Dodd-Frank legislation. Among other things, it removed the $50 billion asset threshold for the strictest supervision, raising it to $250 billion. It freed many major lenders, including Silicon Valley Bank, from the strictest regulatory scrutiny.

Critics such as Democratic Senator Elizabeth Warren of Massachusetts, a leading critic of the banking industry, denounced the bill at the time, saying it would encourage banks to take more risk.

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

But they chose not to be harsh on those banks. For example, they only required a stress test every two years, not annually. So Silicon Valley Bank did not have to undergo a stress test in 2022 and would not get one until later this year.

Todd Phillips, a fellow at the leftist Roosevelt Institute and former FDIC attorney, said Congressional deregulatory pressures during the Trump years created a “vibe shift.”

“It basically gave regulators permission to take their eyes off” lenders like Silicon Valley Bank, he said. “The supervisors went along with that.”

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

But Better Markets’ Kelleher said U.S. banking regulators “don’t have to wait for a divided Congress to act in the best interest of the American public.”

They could rewrite 20 bank-friendly rules that the Fed and other banking agencies put in place during the Trump years. For instance, for banks with $100 billion or more in assets, Phillips wrote in a report Wednesday, regulators would need to reinstate annual stress tests and raise capital requirements, among other things.

“If we roll back regulations so that bank executives can use these banks to increase their profits, increase their own salaries, to get big bonuses, they do it by taking more risks,” Warren told reporters Wednesday. “Banking should be boring. And we have an opportunity 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 institution for tech entrepreneurs, held cash for many startups: 94% of deposits — including money companies need to pay their payroll — were above the $250,000 threshold and were vulnerable to losses if the bank failed.

The idea that so many depositors would lose their savings threatened to shake public confidence in the banking system. So the Biden administration announced on Sunday evening 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 in the future they will not treat this increase in guaranteed deposits as a one-off response… but continue,” said Barney Frank, former chairman of the House Financial Services Committee and director of the failed Signature Bank. He also proposed a raise for businesses so they can meet payroll.

But Phillips of the Roosevelt Institute said the issue is complicated. If you cover corporate payrolls, do you need to cover deposits they have set aside to pay rent or suppliers? And unlimited deposit coverage would mean that even the wealthiest and most financially advanced people 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 extra insurance, a prospect the industry has historically been unreceptive to. The industry lobbied unsuccessfully last year to reduce FDIC insurance ratings.

However, having full 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 be insured above the $250,000 limit through this state-based program. While it costs more for the small banks to get involved than just being insured through the FDIC, Massachusetts bankers said they’ve attracted customers since the bankruptcy of Silicon Valley Bank.

“Our rates may not be as competitive as the biggest banks, but customers like that we insure 100% of their money,” said Catherine Dillon, chief operating officer of Bank Five in Fall River, Massachusetts. ___ Sweet reported from New York.

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