Tougher Regulations Expected in the Financial Sector

It’s no surprise that tougher regulatory oversight is “knocking on the door” for financial institutions.

The unfortunate failure of Silicon Valley Bank (SVB) and Signature Bank raised questions about what some have referred to as “laxed regulatory oversight.” The latest casualty, First Republic Bank, may have sealed the fate for tougher regulatory oversight by the Federal Deposit Insurance Corporation (FDIC), Comptroller of the Currency (OCC), Federal Reserve System, and even the National Credit Union Administration and Office of Thrift Supervision.

The Federal Reserve’s assessment of the cause of SVB failure was described as a “textbook case of mismanagement.” But Michael S. Barr (Barr), the Fed’s Vice Chair for Supervision, also acknowledged fault with his office for failing to “take forceful enough action.” Barr went on to say, “weaknesses in regulation and supervision…must be addressed.” In addition, the FDIC acknowledged its own shortcomings in communicating with Signature Bank’s management about examination results as outlined in the FDIC's Supervision of Signature Bank report.

Although there has been no lack of scrutiny of what caused these bank failures (e.g. board of directors’ mismanagement, reliance on crypto industry deposits, deregulation to the Dodd-Frank Act, lack of diversified capital base, etc.) one aspect remains stronghold – tougher regulation is coming.

Yesterday, May 16, the House Financial Services Committee held a hearing, entitled Oversight of Prudential Regulators, to discuss the bank failures and to include regulatory developments and rulemaking. Top regulators from the Federal Reserve Board of Governors, FDIC, OCC, and the NCUA were in attendance.

The following are the regulators’ summaries who attended the hearing.

‍Michael S. Barr, Vice Chair for Supervision of the Federal Reserve Board of Governors:

• Deposits in the banking system are safe.
• Recent stress in the banking system shows a need for vigilance to assess and respond to risks.
• There are weaknesses in regulations and supervision that need to be addressed.

Supervision and Regulation Report (Assessment) identified key takeaways:

•   SVB Board of Directors and management failed to manage the bank’s risks.
•   Federal Reserve supervisors did not fully appreciate the extent of the vulnerabilities as SVB was growing in size and complexity.
•   When supervisors identified vulnerabilities, they did not take sufficient steps to ensure the bank fixed the problems.
•   The board's (SVB) tailoring approach impeded effective supervision by reducing standards, increasing complexity, and promoting a less assertive supervisory approach.

• Stronger capital will guard against risks and reduce cost of bank failures.
• Improve the force, speed, and agility of supervision.

Martin J. Gruenberg, Chairman of the FDIC Board of Governors:  

• The U.S. banking industry has proven to be resilient during the recent period of stress.
• The FDIC Board of Directors approved a notice of proposed rulemaking providing for the special assessment  provided by law to recover the loss to the Deposit Insurance Fund (DIF) attributable to the uninsured depositors of SVB and Signature Bank.
• The sale of First Republic Bank to JPMorgan Chase will cost the DIF approximately $13 billion.
• FDIC’s Supervision of Signature Bank (report) found that the root cause of Signature Bank failure was poor management, but also identified areas where the FDIC’s supervisory efforts could have been more timely, forward looking, and forceful.

Michael Hsu, Acting Comptroller, Office of the Comptroller of the Currency:

• Despite the market stress, the federal banking system has remained resilient.
• None of the latest bank failures were regulated by the OCC.
• Consistently emphasized to bankers the importance of guarding against complacency and having strong risk management policies and practices in place.
• Observations to restore full confidence in the banking system:

• Supervisors need support to act in a timely and effective manner. Clear support to empower supervisors to exercise discretion and act when needed will help keep the banking system safe and sound.
• Regulations regarding the resilience and resolvability of large banks need to be strong.
• Deposit insurance coverage needs to be updated.
• The diversity of the banking system must be preserved as the industry evolves. OCC has been working to update the bank merger guidelines consistent with the Bank Merger Act.

Todd M. Harper, NCUA Chairman:

• Overall, the performance of federally insured credit unions remains stable.
• 91% of total shared deposits within the system are insured.
• With increased concentration, intensifying cyber threats, and greater outsourcing of core businesses’ functions, the Government Accountability Office, the Financial Stability Oversight Council, and the NCUA’s Inspector General have all recommended congressional action to restore the NUCA’s statutory examination authority over third-party vendors. Congress should close this regulatory blind-spot.
• Consumers should remain confident that their insured shared deposits at federally insured credit unions are safe.

Capital and liquidity were mentioned, in some form, by all four regulators. In simple terms, capital is a measure of the resources banks have to absorb losses; and liquidity is a measure of the cash and other assets banks have available to quickly pay bills and meet short-term business and financial obligations. Capital is needed to allow a bank to cover any losses with its own funds.

A bank can keep its liabilities fully covered by assets as long as its aggregate losses do not deplete its capital. Banks hold capital in excess of the minimum capital requirement to ensure that unexpected losses do not lead to non-compliance with minimum capital requirement.

A liquidity risk is a decline in deposits or rise in withdrawals, as a result the bank is unable to generate enough cash to meet obligations. With Silicon Valley Bank, a bank run and a capital crisis led to a liquidity crisis. With Signature Bank, the bank’s liquidity problems and risky liabilities caused it to collapse. Both banks experienced deposit runs. First Republic Bank carried a significant amount of uninsured deposits and struggled with liquidity.  Financial institutions should expect increased capital rules for banks and increased supervisory oversight with more aggressive policies.

Capital and liquidity rules will be overhauled to assist regulators in their examination process. Examiners will be more judicious with financial institutions after their failures with Silicon Valley Bank, Signature Bank, and First Republic Bank. Issues identified by examiners will need to be addressed immediately by financial institutions to avoid hefty fines.

In addition to capital and liquidity requirements, there is no doubt financial institution examinations will be in-depth, extensive, require additional due diligence, and risk management assessments in every area of a financial institutions’ business. The dependence on spreadsheets, regulatory news alerts stored in electronic folders, following regulatory agency websites to determine changes applicable to your bank, and other ill-equipped methods to track regulatory changes is rapidly coming to an end.

Unfortunately, many financial institutions still use these mundane methods for complex business functions like tracking regulatory changes. Financial institutions should explore an AI-powered platform for regulatory change management and compliance that provides laws and regulations applicable to their specific needs. The platform should efficiently track multiple sources of  regulatory changes, removing the burden of having to manually track all of this information. AI technology is changing the regulatory compliance landscape in terms of how industries keep up with the enormous amount of information.

AI in financial institutions is maturing and provides ROI (Return on Investment) by keeping risk management departments up to date with relevant information, diminishing legal or regulatory sanctions, financial losses, and reputational damage, among other benefits. The Federal Reserve informed the House Financial Services Committee its plan to aggressively supervise financial institutions this year.

It is imperative for financial institutions to have a reliable platform to ensure regulatory compliance, today and in the future, because there will be more regulatory changes and that is unquestionable.  

You may also be interested in:

What Happens When a Bank Fails: Understanding the FDIC’s Role in the Case of Silicon Valley Bank (SVB)

‍Compliance Leaders’ Q&A Series: Banking

‍A Video Overview of Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD)