AFR's Banking Crisis of '23 Brief: 3rd Edition

A cogent email of curated information on the banking crisis and the response

March 28, 2023

Regulators Speak

Today, we heard Barr, Gruenberg and Liang testifying before Senate Banking.  In an exchange with Sinema, Barr revealed – for the first time – that he has been at work reviewing Fed rules implementing S.2155. SVB was “bucketed” by categories that resulted in less “enhanced supervision” and all that entails. “I think it is important to revisit those, as I have been doing since I arrived at the Federal Reserve in July,” Barr said.

In the big picture, the criticism of S.2155 and the implementation of it is intact. There’s evidence that the government doesn’t work and regulation is all a failure. It depends on whose behalf the government works and what we ask it to do. If you design the government to work, to hold banks accountable, it can work. If the industry gets to influence the law and regulations, and have friendly officials on their side (Quarles) it can take risks and get benefits, no matter what.

Chair Brown hit hard, substantively and politically, in his statement. There was a measure of partisanship in the questioning. Republicans (Scott and Daines) talked about climate risk being a distraction. A few tried to set up the Biden administration’s skepticism about mergers for the fall (Hagerty, Scott) but Gruenberg parried that by responding there were no good offers and they did not discourage any offers. 

Tillis criticized the “regulatory red herring” that tailoring was the issue vs management and the fact that SVB was a unique bank with all those uninsured deposits. A strong ally of big Wall Street banks, Tillis tried to make the case that higher capital requirements were unnecessary, an echo of the “tailoring” argument Republicans made days before the crisis.

Some senators focused on how the Fed still had authority for “enhanced supervision” of banks between $100 and $250 billion under S.2155, Crapo especially, as the primary author. It was management and regulators/supervisors, Republicans insisted, not regulation. (Sarah Bloom Raskin memorably called this residual authority “legislative fool’s gold” in 2018 because the Fed would not be able to react quickly enough to use this authority.)

Republicans repeatedly asked why supervisors didn’t “crack down” – as did virtually all the Democrats – prompting Brown to comment, wryly, on newfound Republican support for muscular regulators. That’s one more reason why we need a strong CFPB, with independent funding, Brown said. (CFPB faces a Supreme Court case about the constitutionality of its funding.)

Barr said that the board in Washington first heard of SVB’s issues in mid-February of this year, despite Fed supervisors flagging weaknesses as early as 2021. Under the Fed stress-test rules that Quarles watered down, SVB would not have faced stress tests until 2024, Barr said.

Grueberg said the FDIC “has significant authority” to hit the banks’ CEOs with penalties if investigation uncovers wrongdoing, but they do not have the power to clawback executive compensation. A bipartisan group (Brown, Kennedy, Van Hollen, Sinema) will introduce legislation on this. Brown is planning legislation that would punch up penalties for execs at failed banks and ban them from the industry. (Implementing Dodd-Frank Section 956 on executive compensation, 15 years on, would help, as this coalition pointed out in a new letter.) Warnock spoke movingly of smallfolk who face the full weight of the law even as CEOs walk away with millions.

Gruenberg expressed confidence in the decision for the FDIC to step in and prevent what he said could have been “a contagion” among small and regional banks across the country. Gruenberg, like Barr touched on, remarked on how banks with assets of $100 billion or more can affect financial stability.

To the dismay of Warren, Liang hesitated to outrightly say whether financial regulations should be strengthened, but that “we do need to prevent these types of bank failures.” She later agreed, as did Barr and Gruenberg.

Probes and More Probes

Barr deferred a lot of matters to the internal Fed probe, due May 1. He told Cortez-Masto that the probe indicated if S.2155, the law, affected the outcomes here. He said he could not tell if the infamous “guidance on guidance” rule had an impact. He also avoided mentioning predecessor Quarles, to the point that Brown highlighted his reluctance.

Banking Committee Democrats have a unified line: they all sent a letter to the GAO asking them to “re-examine the supervisory practices of bank regulators that are responsible for ensuring depository institutions operate in a safe and sound manner.”

Bank Lobby Backtracks

A March 14 blog from the Bank Policy Institute says SVB would have still flown under the risk radar even if it had been subjected to liquidity rules under enhanced supervision.Today, they half-backtracked, coming closer to a reality that spelled failure either way according to a Yale University study .At the end of 2022 SVB would probably not have passed the LCR requirement. The bank lobby still insists there may have been a chance, given one assumption or another.