FT: Bair on Protecting Smaller Banks from Investor Nerves

Today, the Financial Times published Sheila Bair’s Opinion piece “Congress must act to protect smaller banks from investor nerves. Measures to shield operational business accounts, introduced during Covid, should be triggered urgently.”

While she does not believe that universal coverage for all accounts is the answer, she does advocate for using the Transaction Account Guarantee (or TAG programme). “To promote banking competition and mitigate concentrations of power, we need to help them protect their core business accounts. Congress needs to reinstate TAG.”

We look forward to any comments you might have.

To view the full article:
https://www.ft.com/content/caae5e89-4f6f-4ec8-94c7-0c15ed4592fa

Sheila Bair is a former chair of the US Federal Deposit Insurance Corporation and a senior fellow and Advisory Board member at the Center for Financial Stability.

US regulators are setting a dangerous precedent on Silicon Valley Bank

Former FDIC Chair and CFS senior fellow Sheila Bair penned “US regulators are setting a dangerous precedent on Silicon Valley Bank” in the Financial Times (FT).  The piece covers:

– Systemic risk determination,
– Use of FDIC insurance,
– Fed policy.

To view the piece:
https://www.ft.com/content/b860ebb6-f202-4ec6-a80c-8b1527c949f4

U.S. Government Announces Uninsured SVB/Signature Depositors to Be Made Whole

In a joint statement, the U.S. Treasury, the FDIC and the Federal Reserve Board announced that all depositors, both insured and uninsured, of Silicon Valley Bank and Signature Bank, would be made whole for their deposits. Each bank had been closed this past Friday, SVB by the FDIC and Signature Bank by the New York State banking authorities.

The regulators described the protection of the depositors as not requiring funding from taxpayers as the funding would come from a special assessment on banks that will be paid into the Deposit Insurance Fund.

The regulators had previously said that shareholders and other unsecured creditors of the bank would not be protected (and thus could be wiped out) and that management of the two banks had been removed.

President Joseph R. Biden issued a statement to assure depositors and call on Congress and the banking regulators to “strengthen the rules for banks to make it less likely that this kind of bank failure will happen again.” Numerous other statements have been issued (see primary sources below).

LOFCHIE COMMENTARY

First, the statement that none of the bailout will be borne by taxpayers is somewhat misleading. The bailout is not being financed by other banks buying a business that had positive going forward value. Rather, it is being financed by government-imposed regulatory fees that must be passed through and eaten by shareholders or paid by customers in higher fees or lower interest rates on deposits.  

Second, the statement raises many questions. Are all bank deposits from now on implicitly insured? Where will the no-bailout line be drawn in the future? What is the justification? That is not to say that the bailout was not reasonable under the circumstances. Had there not been one, we almost certainly would have seen additional runs on other banks and financial institutions. Depositors were very much poised to move their money from small banks to larger ones. But it will be interesting to see whether depositors begin assessing bank risk more closely going forward, just as institutional investors began to assess broker-dealer risk more carefully after 2008.

Third, the best explanation of the 2008 financial crisis was a 1986 book by Hyman Minsky called “Stabilizing an Unstable Economy.” (See The Future of Financial Regulation.) Minsky argued that periods of financial calm create a lack of focus on real risks, which in turn leads to speculation and thus to instability. The book came briefly into vogue during the 2008 financial crisis, in a period referred to as the “Minsky Moment.” 

One could reasonably argue that that the last few years have seen rampant speculation, but by the regulators, not market participants. Rather than focus on the ordinary risks inherent to our economy – money supply, inflation, price volatility – the financial regulators have become distracted by speculative risks that are of high political import, such as climate change, an issue as to which they have neither sufficient knowledge nor actionable data, nor any meaningful ability to influence events. 

The FSOC’s 2022 Annual Report (see related coverage) makes 16 references to inflation (many of them about global inflation and very little about the impact of inflation and the attempts to control it on bank risk). By contrast, there are 112 references to climate (not historically regarded as a threat to financial stability). The FSOC 2021 Annual Report managed 41 references to inflation versus 86 references to climate, a lack of attention to actual risk in 2021 that only became more pronounced in 2022. (It also is notable that SVB was particularly focused on ESG lending, not limited to climate.)  So while the regulators may have been right that climate risk is a material risk to the financial system, they were likely wrong about the reasons. The risk was that climate change distracted the financial regulators from the relative boring work of financial regulation.  

Financial regulators need to devote their attention to the ordinary and mundane matters of financial risk. Attending to mundane matters does not mean adopting a slew of new and burdensome regulations, imposing new weights on the markets to compensate for past regulatory distractions.  When the next FSOC Annual Report is published, there should be more references to ordinary risks such as inflation, interest rates, maturity mismatches and failures to diversify risk, than there are to references to climate.  

Primary Sources

  1. White House: Remarks by President Biden on Maintaining a Resilient Banking System and Protecting our Historic Economic Recovery
  2. Joint Statement by the Department of the Treasury, Federal Reserve, and FDIC
  3. House Financial Services Committee Press Release: McHenry Statement on Regulator Actions Regarding Silicon Valley Bank
  4. Senate Banking, Housing and Urban Affairs Committee Press Release: Scott Statement on Government Response to Failures of Silicon Valley Bank and Signature Bank
  5. NYS Department of Financial Services: Superintendent Adrienne A. Harris Announces New York Department of Financial Services Takes Possession of Signature Bank
  6. FRB Press Release: Federal Reserve Board announces it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors
  7. Press Release: Joint Statement by Treasury, Federal Reserve, and FDIC
  8. SEC Statement: Chair Gary Gensler on Current Market Events
  9. FDIC Establishes Signature Bridge Bank, N.A., as Successor to Signature Bank, New York, NY
  10. FDIC Acts to Protect All Depositors of the former Silicon Valley Bank, Santa Clara, California
  11. FDIC Creates a Deposit Insurance National Bank of Santa Clara to Protect Insured Depositors of Silicon Valley Bank, Santa Clara, California
  12. Financial Stability Oversight Council Meeting on March 12, 2023
  13. House Financial Services Committee: Ranking Member Waters’ Statement Following the Closure of Silicon Valley Bank

On China’s Financial System and Property Markets: Aliber and Walter

We are delighted to share work presented in recent days by two good friends of the CFS: Robert Z. Aliber and Carl E. Walter.

Carl discussed his forthcoming book The Red Dream: the Chinese Communist Party and the financial deterioration of China. Red Dream analyzes 1) the build-up of leverage throughout the system, 2) how regulators have worked to generate strong performance metrics while sloughing off unwanted assets, 3) the health of the financial system, as well as 4) the present within the context of prior financial stressors in the U.S., Japan and China itself.

Bob offers his latest thoughts on China’s property market, Evergrande, and future economic prospects more broadly. He first discussed these dynamics in the epilogue of the seventh edition of Manias, Panics and Crashes: A History of Financial Crises.

Carl recently served as an independent director of a major Chinese bank. For many years, Carl worked in China, where he last served as JP Morgan’s China COO and CEO of its banking subsidiary. He is now a visiting scholar at the Stanford Shorenstein Asia Pacific Research Center.

Bob is professor emeritus of International Economics and Finance at the University of Chicago. He has written extensively about the prices of currencies, international investment flows, banking issues, the multinational firm, international monetary arrangements, and financial crises.

To view Carl’s slides on China’s financial system:
http://www.centerforfinancialstability.org/research/Walter_China_Feb_2022.pdf

To view Bob’s “The Ponzi Bubble in China’s Property Market is Deflating”:
http://www.centerforfinancialstability.org/research/Aliber_China_031122.pdf

As these topics are complex and challenging, we look forward to any comments you might have.

New Papers on Lessons for the Future from the Global Financial Crisis

The Center for Financial Stability (CFS) was delighted to co-host a conference with the Central Bank of Iceland and the University of Iceland.

Leaders in academia, government, and finance from around the world joined together to present and discuss notable and pointed papers.  Held on the tenth anniversary of the Global Financial Crisis, discussions delved into crisis causes, the regulatory response, and lessons for the future.

Agenda and working papers can be found here
http://centerforfinancialstability.org/iceland.php

A conference volume published by Palgrave Macmillan will be forthcoming.

Agencies Propose Changes to Volcker Proprietary Trading and Name-Sharing Restrictions

The FDIC, the Federal Reserve Board, the Office of the Comptroller of the Currency, the SEC and the CFTC (collectively, the “agencies”) proposed excluding certain community banks from the Volcker Rule. In addition, the proposal would permit a banking entity to share a name with a covered fund that it organizes and offers under certain circumstances. The proposal would amend the regulations implementing the Volcker Rule, consistent with the statutory amendments made pursuant to Sections 203 and 204 of the Economic Growth, Regulatory Relief and Consumer Protection Act (“EGRRCPA”).

Pursuant to Section 203 of the EGRRCPA, the proposal would exclude a community bank from the restrictions of the Volcker Rule if both of the following conditions are met: (i) it has total consolidated assets equal to or less than $10 billion, and (ii) its trading assets and liabilities are equal to or less than five percent of its total consolidated assets.

In addition, pursuant to Section 204 of the EGRRCPA, the proposal would allow a covered fund to share “the same name or a variation of the same name with . . . an investment adviser to the fund, subject to the conditions” that (i) the investment adviser is not, and does not share the same name as, “an insured depository institution, a company that controls an insured depository institution, or a company that is treated as a bank holding company”; and (ii) the name does not contain the word “bank.”

Comments on the proposal must be received no more than 30 days following its publication in the Federal Register.

Crisis Detection and Prevention

I discuss crisis detection and prevention based on experiences chairing an inter-agency crisis prevention group (while at the U.S. Treasury), working as a strategist on Wall Street, and advising a global macro hedge fund. The paper was published as a chapter in “The 10 Years After” the financial crisis volume published by the Reinventing Bretton Woods Committee.

My views differ from many recently offered.

I conclude with eight actionable ideas to improve crisis detection for investors and officials.

For full remarks:
www.CenterforFinancialStability.org/research/10YearsAfter_Goodman_Chapter.pdf

Bank Regulators Testify on Bank Deregulation Act

Federal banking regulators testified before the U.S. Senate Committee on Banking, Housing and Urban Affairs on progress toward implementing the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Act”). As previously covered, the Act makes targeted changes to key areas of Dodd-Frank, which will primarily benefit smaller banking organizations with simpler business models. Testimony was provided by Comptroller of the Currency Joseph M. Otting; Federal Reserve Board (“FRB”) Vice Chair for Supervision Randal K. Quarles; FDIC Chair Jelena McWilliams; and National Credit Union Administration (“NCUA”) Chair J. Mark McWatters.

Mr. Otting, Mr. Quarles and Ms. McWilliams described various agency initiatives, including (i) the issuance of a notice of proposed rulemaking (“NPR”) that grants federal savings associations greater flexibility to exercise national bank powers without changing their charters, (ii) the issuance of a joint NPR to revise the statutory definition of a high-volatility commercial real estate exposure acquisition, development and construction loan, (iii) the adoption of interim final rules modifying the liquidity coverage ratio rule and (iv) the issuance of a joint agency proposal to raise the total asset threshold from $1 billion to $3 billion to allow well-capitalized insured depository institutions to be eligible for an 18-month examination cycle.

Mr. Otting noted that the Office of the Comptroller of the Currency also intends to:

  • implement an exemption from appraisal requirements for certain rural real estate transactions;
  • reduce the regulatory burden on banks for calculating and reporting regulatory capital;
  • reduce reporting requirements on Call Reports;
  • increase the required frequency of stress testing and reduce the required number of scenarios; and
  • revise the leverage ratio requirements for the largest U.S. banking organizations.

Mr. Quarles stated that the FRB prioritized:

  • issuing a proposed rule tailoring enhanced prudential standards for banks with assets between $100 billion and $250 billion;
  • reviewing requirements for firms with assets between $250 billion and the globally systemic important bank threshold; and
  • revisiting the threshold for the application of enhanced prudential standards to foreign banks.

Ms. McWilliams outlined the FDIC’s plans, which include:

  • rule amendments to reflect the exemption for certain loans secured by real property;
  • a proposed rule as to the community bank leverage ratio;
  • updates to Call Report Instructions to reflect the reporting change from brokered to non-brokered treatment of specified reciprocal deposits; and
  • reductions in reporting requirements for “covered depository institutions” with less than $5 billion total assets in the first and third quarter Call Reports.

Mr. McWatters discussed the NCUA’s recent actions and noted that the agency began to (i) update its examiner guidance and examination procedures, (ii) review credit union compliance in line with its risk-focused examination program and (iii) work with state supervisory authorities and other federal regulators to implement regulatory amendments.

Senator Sanders Proposes Big Bank Breakup

Senator Bernie Sanders (D-VT) introduced legislation that would break up the biggest U.S. banking and financial institutions. The bill is sponsored in the U.S. House of Representatives by Representative Brad Sherman (D-CA).

The bill, titled the Too Big to Fail, Too Big to Exist Act, would, among other things, require:

  • the restructuring of certain covered financial institutions (including banking organizations, insurance firms, broker-dealers and investment advisers) with a total exposure greater than three percent of the GDP of the U.S.;
  • insurance companies with more than $50 billion in assets to report total exposure to federal financial regulators; and
  • the Federal Reserve Board Vice Chair of Supervision and the Financial Stability Oversight Council to submit written reports on the status of financially significant institutions.

Entities that exceed the three percent cap (i.e., “too big to fail” institutions) would be given two years to restructure. According to the bill, these “too big to exist” institutions would not be eligible for a taxpayer bailout from the Federal Reserve Board and could not use customers’ bank deposits to engage in “risky financial activities.”

Lofchie Comment: Like some Cabinet newsletters, nice title, not much substance.

CFS Financial Crisis Timeline

As the 10-year anniversary of the global financial crisis approaches, assessment of key events before, during, and since is essential for understanding varying dimensions of the crisis.

The CFS Financial Timeline, created and managed by senior fellow Yubo Wang, seamlessly links financial markets, financial institutions, and public policies. It:

  • Covers more than 1,100 international events from early 2007 to the present.
  • Provides an actively maintained, free, and easy-to-use resource to help track developments in markets, the financial system, and forces that impact financial stability.
  • Curates essential inputs on a real time basis from established public sources.

Since 2010, the Timeline has become an integral part of the work done by scholars, students, government officials, and market analysts. View the Timeline.

We hope you find it of use and interest.