Update 774 — A Meltdown Retrospective:
Lessons Learned from the 2023 Bank Crisis
With a year’s perspective, we can look back now at the worst banking crisis in the U.S. since the 2008 financial crisis — and appreciate how and why the failures of that episode were not replicated in 2023. While the frailties of SVB, Signature Bank, and First Republic were novel and circumstantial, we can take away some lessons from the crisis and the policy response to it, well before the next one.
First and foremost, regulators who had missed signs of trouble, moved quickly to stem a tide of withdrawals that threatened a metastatic run on regional banks across the country. But the rush to respond involved improvisations that leave open policy questions. What steps are still needed to ensure financial stability in a crisis going forward?
Best,
Dana
It’s been almost a full year since the bank failures of Spring 2023. Between last March and early May, a series of banks with combined assets over $500 billion collapsed. The American banking sector faced its most significant period of stress since the 2008 financial crisis.
The banks failed due to their uniquely high concentrations of uninsured deposits, sectoral concentration among their depositors, and extremely fast depositor flight enabled by technology. Since then, regulators and legislators have begun to address issues that could have prevented these failures, including undercapitalization, the exclusion of unrealized losses on banks’ “available for sale” securities holdings in their regulatory capital disclosures, and bank executive compensation agreements that incentivized inappropriate risk-taking.
Backward Glance: the Banking Stress of Spring 2023
After Silvergate Bank was voluntarily liquidated in early March, Silicon Valley Bank (SVB), then Signature Bank, collapsed. At the end of 2022, SVB was the nation’s sixteenth largest bank with over $200 billion in assets, while Signature was the twenty-ninth largest, with over $110 billion in assets.
The Treasury Department and banking regulators took extraordinary measures to stem contagion to the broader financial system by invoking a systemic risk exemption to make the depositors of both SVB and Signature whole. The Fed also created a temporary funding lifeline, the Bank Term Funding Program, to help banks meet the needs of depositors.
Tens of billions in emergency loans and a cash infusion from the nation’s largest banks during this period weren’t enough to save First Republic Bank. At the end of March 2023, First Republic was the nation’s fourteenth-largest bank with over $230 billion in total assets. The bank was seized by the FDIC on May 1. But the steps taken by regulators successfully stabilized the financial system and protected the overall economy.
Banking Reforms We Support and Their Status
Since then, regulators and legislators have moved to address issues that underpinned these dangerous failures. As we approach the one-year anniversary of First Republic’s collapse, we look at a series of reforms that we believe would integrate the lessons we’ve learned to make our banking sector and financial system safer and stronger.
The Basel III Endgame Proposal
Capital functions as a bank’s cushion against losses. The Fed, FDIC, and OCC’s Basel III Endgame joint proposal would implement stricter capital requirements on banking firms with $100 billion or more in total assets and firms that engage in significant trading activities. The proposal would strengthen banks’ resilience during periods of stress like the one seen last Spring. It would increase common equity tier 1 capital requirements by an average of 16 basis points across the largest banks. The proposed rule would implement the final components of the Basel III or “Basel Endgame” regulatory capital framework, the final set of reforms published by the Basel Committee on Banking Supervision in 2017.
The capital increase required by the proposal is relatively small and U.S. banks could easily increase their capital levels by retaining more of their earnings, rather than engaging in stock buybacks or paying dividends. Additionally, the proposal would only have a small impact on lending. As Fed Vice Chair of Supervision Michael Barr has explained, the increased requirement is expected to increase the cost to banks for funding the average lending portfolio by just 0.03 basis points. We continue to support the finalization of the proposal in a way that maintains its key elements. The comment period for the proposal has ended and regulators are reviewing comments received by the public.
H.R. 4206, the Bank Safety Act of 2023, led by Representative Brad Sherman (D-FL), would implement one key element of the proposal. SVB and Signature exploited a loophole to exclude unrealized losses on their “available for sale” securities holdings in their regulatory capital disclosures. As interest rates rose, their unrealized losses went up, they weren’t accurately reflected leading up to the banks’ collapses. The bill would close the loophole by requiring banks with $100 billion to $250 billion in total assets to use the actual value of securities for sale when calculating capital for purposes of meeting capital requirements, bringing regional banks more in line with large banks. The bill was favorably reported out of the House Committee on Financial Services last Wednesday and 20/20 Vision supports it moving forward.
Compensation Clawback from Failed Bank Chiefs
SVB, Signature, and First Republic executives loaded up on risk, prioritizing short-term personal returns over the long-term health of the banks they were charged with leading. They made millions in compensation in the years leading up to their banks’ failures. Eleven days before SVB went into receivership, then-CEO Greg Becker sold over $3.5 million in stock, and the bank’s former CFO sold just over $575,000 in shares. Becker said after his bank’s failure that he deserved the millions he raked in, despite the fact that his failed leadership almost took down the stability of the financial system alongside his bank.
S.2190, the Recovering Executive Compensation from Unaccountable Practices (RECOUP) Act, led by Senate Banking, Housing, and Urban Affairs Committee Chair Sherrod Brown (D-OH) and Ranking Member Tim Scott (R-SC), strengthens regulators’ ability to impose penalties against a senior executive who not just “knowingly,” but “recklessly,” commits violations of law, engages in unsafe and unsound practices, or breaches any fiduciary duty. It also increases the maximum penalty for violations laid out in the Federal Deposit Insurance Act from one to three million dollars. The bill was favorably reported out of the Committee with overwhelming bipartisan support last year, passing with a 21-2 margin.
H.R. 4208, the Failed Bank Executives Accountability and Consequences Act, led by House Committee on Financial Services Ranking Member Maxine Waters (D-CA), would similarly expand bank regulators’ authority with respect to clawing back compensation, imposing fines, and banning future work in the industry for bank executives that negligently contribute to their bank’s failure.
The bills would hold the executives of failed banks accountable for the consequences of their greed and recklessness. We continue to support the passage of both pieces of legislation.
New Moves to Finalize Dodd-Frank Section 956
Congress recognized the need to remove the incentive for inappropriate risk-taking from bank executives’ compensation agreements following the financial crisis in 2008. Section 956 of the Dodd-Frank Act required that six agencies — the Federal Reserve, Federal Housing Finance Agency, Federal Deposit Insurance Corporation, Securities and Exchange Commission, Office of the Comptroller of the Currency, and National Credit Union Administration — finalize a rule to ban incentive-based executive compensation that encourages “inappropriate” risk-taking. The May 2011 deadline set by Congress passed roughly twelve years ago, and still, a final rule has yet to be finalized.
Last week, the Wall Street Journal reported that several agencies may propose such a rule soon, though the proposal may not include the Fed. Finalization of a rule is critical and we continue to call for a strong rule to be finalized as quickly as possible.
Work Ahead: Bolste Banks’ Safety and Soundness
The measures outlined above would make our financial system far more resilient, but additional steps could go further. In May, the FDIC issued a report, Options for Deposit Reform, which suggested several options, including a move toward a system of targeted coverage in which consumer and business accounts are covered at different thresholds. Though Congress may lack the appetite to propose serious substantive reform to deposit insurance right now, many options are on the table. Some are also pressing to reinstate the Transaction Account Guarantee (TAG) program that was implemented by the FDIC during the 2008 financial crisis.
Additionally, the bank failures have brought new scrutiny of the Fed’s discount window. Legislators considered how we may better prepare depository banks to access Fed emergency lending under unexpected circumstances at a hearing in February. During the hearing, MIT Professor Simon Johnson suggested that this could be achieved by ensuring that private sector information technology systems are set up to interface effectively and immediately with official systems.
One year on, it is important to recall the anxiety depositors faced in the interim after SVB’s collapse but before regulators announced that deposits of all sizes would be covered. Over those few days, companies with funds trapped at the bank worried that they would not be able to distribute millions of dollars in payment to their employees. Some had considered furloughs or even layoffs. Customers knocked on locked doors looking for answers and called regulators, at times, with no answer. Bank failures and the financial instability they can bring have real consequences, often borne most heavily by the most economically vulnerable. The U.S. banking sector has been comfortable for too long with the privatization of its gains while taxpayers and workers are forced to subsidize the consequences of their failures.
The measures we highlight above address issues that persist. For example, many banks continue to exclude unrealized losses from the value of “available for sale” securities in their regulatory capital disclosures. The measures we discuss today are strong first steps towards a safer financial system for all. Regulators and legislators must move swiftly to make substantive changes to prevent the next such period of stress.