US Can Tighten Regional Bank Rules Even If Congress Doesn’t Act

Federal banking regulators can accelerate tougher rules and tighten supervision for regional banks following Silicon Valley Bank’s collapse, even if Congress doesn’t act.

A 2018 law that rolled back capital, liquidity, and stress-testing requirements for smaller banks also had a provision that empowered the regulators to bring back the rules for banks with assets between $100 billion and $250 billion, if they deem it necessary.

The banking industry turmoil that erupted in the past few days—which also included the collapses of Signature Bank and Silvergate Bank—creates a pressing scenario for the Federal Reserve, the Federal Deposit Insurance Corp., and the Office of the Comptroller to exercise the provision. Doing so would raise capital and liquidity requirements or banks with $100 billion or more in assets, and have them be subject to more regular stress testing.

Regulators could also eliminate a rule that allowed banks to stop reporting unrealized losses on securities, potentially forcing banks to raise billions of dollars in capital to protect against runs. Just as importantly, the Fed, FDIC, and OCC also can subject all the banks they oversee, regardless of asset size, to more stringent examinations from supervisors without changing any rules.

The federal agencies can also empower their bank supervisors to ramp up their examinations of large regional financial institutions.

“Regulators have a lot of leeway to figure out how strenuously they want to go,” said Todd Phillips, an independent financial regulatory consultant and a former FDIC official.

Lowering Thresholds

The 2018 law—championed by Sen. Mike Crapo (R-Idaho), the former chairman of the Senate Banking Committee, and co-sponsored by 10 Senate Democrats—eliminated a Dodd-Frank Act provision that subjected all banks with $50 billion or more in assets to heightened capital, liquidity and other prudential standards.

Instead, only banks with $250 billion in assets would be subject to those standards.

The banking industry chaos this week led to progressive lawmakers’ calls to repeal the 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA). Sen. Elizabeth Warren (D-Mass.) and Rep. Katie Porter (D-Calif.) introduced legislation to do that.

But the law also gave bank regulators the option to lower the threshold for tighter rules to force banks with $100 billion in assets to the same standards as the larger banks.

The Fed, the FDIC, and the OCC were already looking at increasing capital levels for regional banks. The Fed, led by Vice Chair of Supervision Michael Barr, also had already begun a comprehensive review of capital requirements for smaller banks.

Barr is now leading a review of regulatory and supervisory failures that may have contributed to SVB’s fall.

“We need to have humility, and conduct a careful and thorough review of how we supervised and regulated this firm, and what we should learn from this experience,” Barr said in a March 13 statement.

Following the tumult in the banking system, the chances of those reviews leading to tighter rules went up significantly.

“It’s now almost certain US banking regulators will respond with tougher prudential standards for banks above $100 billion in assets,” Nathan Dean, a Bloomberg Intelligence analyst, wrote in a March 15 note.

Removing Options

While SVB’s capital positions were strong at the time of its failure, its liquidity wasn’t. And because it was under $250 billion in assets, it wasn’t subject to regular, annual stress testing that could’ve caught the interest rate risks in its long-term assets that contributed to SVB’s demise, Phillips added.

Beyond dealing with capital and liquidity, the Fed, the FDIC, and the OCC can also move to eliminate a 2013 provision that allowed banks with under $250 billion in assets to opt out of reporting losses on investment securities.

Such a move would give regulators and investors a better view into potential losses banks face if they are forced to sell securities to raise cash, said Keith Noreika, executive vice president at Patomak Global Partners and the former acting comptroller of the currency during the Trump administration. Better visibility into banks’ potential losses could drive regulators to force banks to raise more capital, he said.

The 2013 provision, known as the AOCI Opt-Out, gave banks under $250 billion a one-time option, as they calculate their capital needs, to not report gains or losses on securities they planned to hold to maturity. AOCI is short for Accumulated Other Comprehensive Income, which includes securities and other sources of income outside of interest income and fees.

“There’s going to have to be a better review of balance sheets in light of these kinds of risks,” Noreika said.

Tougher Exams

Even if the regulators decide to exercise the 2018 law’s provision to craft rules to change requirements—rather than waiting for Congress—the regulatory changes still can drag on from the proposal stage to a finished rule.

The banking industry is pushing back on calls for tighter rules. The Bank Policy Institute said in a March 13 statement that regulatory tailoring under the 2018 regulatory reform law “does not appear to have been a major factor in SVB’s or Signature Bank’s failure.”

So if regulators want to accelerate changes for regional banks, they can turn to their bank supervisors, said Mayra Rodriguez Valladares, the managing principal of consultancy MRV Associates and a former Federal Reserve Bank of New York staffer.

“Banks are terrified that more is coming. This is the time for supervisors to pounce,” she said.

Supervision wouldn’t change what banks are required to do. But examiners can require banks to produce information about interest rate risks, deposit concentrations—including how many of their deposits come from the reeling tech sector—as well as highlight swift deposit growth and other risks that could lead to a run, Rodriguez Valladares said.

If supervisors determine that there’s a problem in a bank’s balance sheets, they can push for swift changes, Noreika added.

“There’s great discretion under the statute to order corrective action based on unsafe or unsound practices,” he said.