BY KEVIN STEIN
FDIC Chairman Marty Gruenberg’s recent speech at the Brookings Institution Center for Regulation and Markets had some important smoke signals for banks and the fintechs that depend on them. Using the IndyMac and WAMU failures as historical context and the recent trio of bank failures as inspiration, he outlined five key areas of likely coming regulatory reform for which banks should prepare:
Capital treatment of unrealized losses: The Notice of Proposed Rulemaking on Basel III issued in late July by the three federal banking agencies would require unrealized losses on available for-sale securities to flow through regulatory capital for all banks with more than $100 billion in assets - meaning that in order to maintain their capital levels, these banks would “need to retain or raise more capital as these unrealized losses occur.” Had SVB been required to do this, Gruenberg noted, the bank might have prevented the loss of market confidence that precipitated the bank run that took it down.
Long-term debt requirements: Gruenberg predicted the banking agencies will “in the near future” propose a long-term debt requirement for banks with $100 billion or more in assets, which will likely require banks to issue new debt. Such debt “creates additional options in resolution, such as recapitalizing the failed bank under new ownership or breaking up the bank and selling portions of it to different acquirers, as an alternative to a merger with another large institution.” This would probably be a good step for the industry as it was clearly missed by public policymakers post-GFC, although I’d note that while unsecured debt can certainly play a safety and soundness role, Chairman Gruenberg could have addressed the topic of the Federal Home Loan Bank System in the context of bank failures including risk-based FHLB borrowing metrics, limiting use of FHLB borrowings by large banks with capital markets access and waiving of FHLB fees and penalties in a bank failure.
Resolution plans for Insured Depository Institutions (IDI Plans): All banks with assets under $100 billion, but particularly those between $50 billion and $100 billion, should plan to prepare much more detailed resolution plans than they have historically been required to have, in part to support resolution options beyond a weekend sale to a single acquirer. The devil, of course, is in the details (which are yet to be revealed), but clearly well-run banks should have their house in order such that they will be able to meet any new requirements and be prepared for costs should technology investment be required to comply.
Reliance on uninsured deposits: Uninsured deposits rose from 18 percent of domestic deposits in 1991 to 47 percent at their 2021 peak and remain high - and are concentrated at banks with more than $50 billion in assets. Gruenberg noted, “More forward-leaning supervision of large regional banks is certainly a key lesson from the events earlier this year. In particular, the FDIC is reviewing whether its supervisory instructions on funding concentrations should be bolstered to better capture risks related to high levels of uninsured deposits generally or types of deposits, more specifically, such as business operating account deposits. For example, FDIC examiner instructions could establish a specific threshold for concentrations of uninsured deposits, which would require examiners to devote supervisory attention to the concentration. Regulators and other stakeholders may also benefit from more granular and more frequent reporting of deposits. These are matters of priority attention for the FDIC.” I don’t disagree, but I’d add that the FDIC should be thinking about tiering the insurance system to allow for insurance above and below the $250K limit. Despite the higher assessments paid by large banks, these banks are currently getting a free ride on uninsured deposits.
Deposit insurance pricing: While this is a potentially useful tool, Gruenberg noted that “calibrating precisely the risk of uninsured deposits is a challenge” and therefore, deposit insurance pricing “is best seen as a complement to other tools that mitigate the risk of over-reliance on uninsured deposits.” Stay tuned here.
Clearly, there are things that banking regulators can do to soften the blow of what happened the past spring, but necessary structural fixes to the deposit system require congressional approval, meaning the timing on all this is uncertain, as is what will happen first. But Gruenberg’s speech, particularly his conclusion, made it clear that changes are coming, and banks should prepare: “These are perhaps lessons we should have learned from the 2008 financial crisis. The events of earlier this year provide us with another opportunity. This time I don’t think we’ll miss.”
Photo by Etienne Martin on Unsplash