On March 28, 2023 the US Senate Committee on Banking, Housing, and Urban Affairs held a hearing on the topic of ‘Recent Bank Failures and the Federal Regulatory Response’. Given both the unique and shared characteristics of recent bank failures, the US banking industry must move swiftly to determine an optimal path forward for the evaluation and implementation of future legislation, rulemaking, policy changes, and supervision.
Witnesses at the hearing included Martin Gruenberg, Chairman of the Federal Deposit Insurance Corporation (FDIC); Michael Barr, Vice Chairman for Supervision, Board of Governors of the Federal Reserve System; and Nellie Liang, Undersecretary for Domestic Finance at the US Department of the Treasury. The hearing provided perspectives for policymakers to consider regarding how these bank failures should affect the interests of regulators in future rulemaking and policy changes.
Topics explored included the events that led up to the failures, impacts on the banking sector, risks to the broader banking system and lessons learned. Future approaches to addressing any gaps in the supervision and examination of the banking sector were also discussed. Our analysis below focuses specifically on expected actions by the Federal Reserve, given the Vice Chairman for Supervision’s unique position in developing policy recommendations for the Federal Reserve and the supervision and regulation of the banks it supervises.
In prepared testimony to the committee, the Vice Chairman for Supervision (Vice-Chair) made the case for the strength and resilience of the US banking system. He outlined how regulators will take steps to ensure deposits are protected, that the public remains confident in the banking system, and that depositors are protected throughout banking system. “[We are] prepared to use all of our tools for any size institution,” he noted1.
The Vice-Chair indicated that there would be a detailed review of what went wrong and why, including a public report expected to be released on May 1. The report will be closely scrutinized for indications that the Federal Reserve, and potentially the FDIC and the Office of the Comptroller of Currency (OCC), will propose enhanced prudential standards for banks with assets between $100 billion and $250 billion.
Regulators are also expected to consider what supervision frameworks and regulations need to be enhanced, including the following capital, liquidity, and stress testing areas:
- Basel III
- Capital Planning
- Risk-Based Capital Ratios
- Countercyclical Capital Buffer (CCyB)
- Liquidity Standards
- High-Quality Liquid Assets (HQLA)
- Liquidity Coverage Ratio (LCR)
- Liquidity Risk Management
- Liquidity Stress Tests
- Resolution Planning & Living Wills
- Stress Tests
- Comprehensive Capital Analysis and Review (CCAR)
- Dodd-Frank Act Stress Test (DFAST).
A recent letter from Sen. Elizabeth Warren (D-MA), Sen. Chris Van Hollen (D-MD), Sen. Tammy Duckworth (D-IL), Sen. Richard Blumenthal (D-CT), Sen. Bernie Sanders (I-VT), Sen. Jack Reed (D-RI), Sen. Mazie Hirono (D-HI), Sen. Ed Markey (D-MA), Sen. Angus King (I-ME), Sen. Sheldon Whitehouse (D-RI), Sen. Tina Smith (D-MN), and Sen. Brian Schatz (D-Hawaii)2 asked for the Federal Reserve to consider adjustments to the current discretion under the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA). The letter also asked for an increase capital and liquidity requirements, as well as a strengthening of the hypothetical scenarios under which banks would need to be sufficiently capitalized to absorb losses in stressful market conditions.
The banking sector will be closely watching whether the Federal Reserve intends to address the areas identified in the letters from the Senators, given the Vice-Chair stated that these proposed changes “are in the scope of our review”. In his testimony, the Vice-Chair also indicated that other areas of alignment in terms of potential modification – and which he would address in the upcoming report – included:
- How effective is the supervisory approach in identifying these risks?
- Once risks are identified, can supervisors distinguish risks that pose a material threat to a bank’s safety and soundness?
- Do supervisors have the tools to mitigate threats to safety and soundness?
- Do the culture, policies, and practices of the Board and Reserve Banks support supervisors in effectively using these tools?
In addition to these considerations, the Vice-Chair identified the need to finalize required rulemaking under Basel III reforms, explicitly focusing on trading and operational risks for a bank’s capital. He indicated that the Federal Reserve plans to further address long-term debt requirements for large banks to ensure they “do not pose systemic risk” – and, to that end, expand stress testing scenarios, better identify potential channels for contagion, and implement changes to liquidity rules. These measures would be focused on “ensuring that the Federal Reserve fully accounts for any supervisory or regulatory failings, and that we fully address what went wrong”.
Stresses in the banking system from interest rate risk (IRR) and continued concerns over poor liquidity risk management may additionally lead to changes in supervisory approaches based on asset size thresholds. According to the Vice-Chair’s testimony, “size is not always a good proxy for risk”.
The Federal Reserve’s testimony also highlighted its efforts to strengthen the overall resilience of the banking sector – which included ongoing efforts to address emerging risks from social media, customer behaviors, and novel business models – in a manner consistent with its recent efforts to mitigate these risks under the auspices of its “dedicated novel activity supervisory group, with a team of experts focused on risks of novel activities”.
Financial institutions do not need to wait for specific regulatory action to prepare for the priorities discussed at the March 28 hearing. Specifically, banks can refresh their regulatory roadmaps to include preparation for a likely expanded regulatory agenda over the coming years. Specific considerations include:
- Return to mandatory stress testing for banks between $100bn and $250bn of assets
- Enhanced supervisory monitoring of and expedited/more forceful action regarding financial risk metrics (e.g., liquidity ratios and interest rate risk)
- Final rules for FRTB and FRTB-CVA within 2023, including potentially increased requirements for intra-day risk from prior expectations
- Increased prioritization on quality of Recovery and Resolution Planning, specifically focusing on unwind scenarios
- Progress on centralized data lakes, multi-purpose taxonomies, and other strategic enhancements to increase quality and consistency of metrics.
As the regulatory and supervision landscape continues to shift, Capco’s Center of Regulatory Intelligence (CRI) continues to monitor and analyze, keeping your institution proactively informed.
- Barr, Michael S. (2023). Statement by Michael S. Barr, Vice Chair for Supervision, Board of Governors of the Federal Reserve System before the Committee on Banking, Housing, and Urban Affairs U.S. Senate. https://www.banking.senate.gov/imo/media/doc/Barr%20Testimony%203-28-231.pdf
- US Senate. March 22, 2023. Van Hollen, Warren, Senators Call on Fed to Strengthen Rules for Banks with Assets Over $100b.https://www.vanhollen.senate.gov/news/press-releases/van-hollen-warren-senators-call-on-fed-to-strengthen-rules-for-banks-with-assets-over-100b