Print ArticleA Message from Governor Bowman*
by Governor Michelle W. Bowman
The recent failures of three large banks continue to be a focal point in the news and of interest to community bankers. Therefore, I would like to focus my Community Banking Connections message on the events leading up to and following the failures of Silicon Valley Bank, Signature Bank, and First Republic. At the time of their failures, Silicon Valley Bank had approximately $218 billion in assets, Signature Bank held approximately $110 billion, and First Republic had approximately $229 billion in assets. The Federal Deposit Insurance Corporation (FDIC) estimates that the failure of Silicon Valley Bank will cost the Deposit Insurance Fund approximately $20 billion and that the failure of Signature Bank will cost $2.5 billion.1 The FDIC estimates the cost to the Deposit Insurance Fund of the First Republic failure to be $13billion.2 Ultimately, the failures of Silicon Valley Bank and Signature Bank were largely due to their inability to fund the rapid outflow of deposits. More precisely, customers with deposits above the FDIC-insured amount of $250,000 per depositor, per account type, withdrew or tried to withdraw their deposits over the course of a few days, resulting in these banks having insufficient liquidity to meet their deposit outflows.
In March 2023, the U.S. Treasury, the Federal Reserve, and the FDIC announced that all depositors at Silicon Valley Bank and Signature Bank will be made whole.3 On May 1, 2023, the FDIC entered into a purchase and assumption agreement with JPMorgan Chase Bank, N.A. to assume all of the deposits (including uninsured deposits) and substantially all of the assets of First Republic Bank.
The Federal Reserve Board created the Bank Term Funding Program (BTFP) to provide additional funding support to financial institutions beyond the Fed’s discount window.4 The BTFP, which expires on March 11, 2024, offers one-year loans to institutions that are collateralized by U.S. Treasury securities, agency debt and mortgage-backed securities, and other qualifying assets.5
It is imperative that we understand these bank failures and market events, and the lessons we can draw from them.6 Such information will help to guide discussions among policymakers about the gaps in current bank supervision and regulation, and the potential for effective improvements to both.
These events also highlight the importance of supervisors’ continued focus on assessing core banking risks. I believe that the U.S. banking system remains resilient and is on a solid foundation. The relationship banking model employed by the vast majority of community banks represents a source of strength and resilience for the banking system. I am concerned that the disparate treatment of larger firms in comparison with the treatment of smaller firms in times of crisis can itself be a source of instability in the banking system, by reinforcing the notion that certain institutions are too big to fail.
Community Bank Resilience
After the recent bank failures, the deposits held by community banks were generally more stable than those at larger regional banks. In comparison with larger banks, traditional community banks generally hold fewer uninsured deposits and often leverage private sources of supplemental deposit insurance to protect their uninsured deposits. Community bank deposits remained relatively stable because their deposit base is closely tied to established customer relationships in their communities.
As we saw over the past three years, community banks continue to play an important economic function in their communities by using deposits to extend credit and financial support to families and small businesses. Small banks have a deep commitment to their communities and understand their unique customers. In turn, community bank customers, even those with uninsured deposits, are more closely tied to the institution.
Unintended Effects of the Disparate Treatment of Depositors at Large Banks Versus Smaller Banks
The follow-on effects of these recent bank failures have had broader financial stability implications for the banking system. A question many are now asking is whether uninsured depositors at a future failed bank will be afforded the same treatment as depositors at Silicon Valley, Signature, and First Republic banks. Under federal law, deposit insurance is capped at the FDIC-insured account limit of $250,000. However, some depositors and market participants believe that deposits at the largest banks have an implicit government guarantee, including those deposits above the $250,000 cap. Affording larger and systemically important banks with this implicit government guarantee could harm the ability of community banks to compete for depositors. Further, uncertainty in the treatment of uninsured depositors contributed to the contagion risk in the banking system and resulted in uninsured depositors withdrawing their funds from regional banks and placing them at larger or systemically important banks.
In addition to implementing appropriate changes to the supervisory and regulatory framework to mitigate future bank runs, policymakers need to consider the competitive environment for community banks. At the heart of this work, policymakers need to address whether an implicit government guarantee on uninsured depositors will be afforded only to large banks that are viewed to be too big to fail. I support a level playing field.
There are certainly other areas of supervision that warrant further study about our supervisory approach for assessing the liquidity risk associated with uninsured deposits. These include refining the analysis of depositor and asset concentration risks, determining the risks associated with a bank’s growth strategy, and understanding the effect of social media on depositor behavior.
As we take this opportunity to learn from the recent bank failures, the Federal Reserve will continue to promote a safe and sound banking system and safeguard the stability of the U.S. financial system. To attain these goals, the Federal Reserve will continue to hold supervised institutions to high regulatory standards, commensurate with their asset size and risks.
In determining a way forward, I expect to support regulatory and supervisory changes that are efficient.7 In other words, any incremental changes to regulation should consider the costs to comply with a rule and the risks to the bank’s safety and soundness. We need to tailor any new regulatory requirements and changes to our supervisory approach based on the size, complexity, risk profile, and business activities of banks. Furthermore, changes to regulations promoting a safe and sound financial system need to be consistent, transparent, and fair.
Focus on Key Banking Risks
In my previous Community Banking Connections message about economic conditions and the Federal Reserve’s supervisory posture under a rising interest rate environment, I highlighted the liquidity risks associated with declining tangible common equity and unrealized securities losses. This very issue played out, in part, at Silicon Valley Bank. Between 2019 and 2022, Silicon Valley Bank experienced significant deposit growth, and the bank invested these deposits in longer-term securities to boost yield and increase its profits. The rising interest rate environment presented challenges in managing Silicon Valley Bank’s unrealized losses and the associated risks to liquidity.
Starting in the summer of 2022, the Federal Reserve began closely monitoring banks with less than $100 billion in assets for unrealized losses in their available-for-sale securities portfolios and for a reduction in their tangible common equity ratios. As part of this effort, the Federal Reserve provided examiners with supplemental instructions and training to assist them in supervising community and regional banks with large unrealized losses relative to capital.
The Federal Reserve expects bank management to engage in proactive risk management to mitigate potential risks, including interest rate risks. In general, examiners will criticize banks with ineffective interest rate risk management practices and, in a letter or report of examination, communicate their supervisory findings and required corrective actions. Further, bankers should expect that examiners will base the assignment of a bank’s supervisory ratings on the bank’s current condition, considering the impact of unrealized losses on securities.
A Resilient Path Forward
The effects of the recent bank failures will not soon be forgotten. These bank failures highlight the interconnectivity of the banking system and that bank runs are not a relic of the past. As a result, there will undoubtedly be changes to regulation, policies, and supervisory practices. I will endeavor to work toward clear and appropriate changes for all supervised institutions based on lessons learned. Fortunately, most community banks are weathering the recent events. This is no accident. The community bank business model helps to mitigate the deposit-flight risks of the recent bank failures because the relationship banking model offers deposit stability. Furthermore, proactive supervision of community banks, focusing on the risks associated with unrealized losses and negative tangible equity, has elevated the importance of appropriate risk management processes for liquidity and interest rate risk.
In my industry outreach activities and meetings with bankers, I ask that you continue to provide me with your feedback on Federal Reserve supervision and your views on the risks faced by community banks and the broader economy. Your thoughtful comments will help in advancing an effective supervisory program and any potential policy changes.
- 1 See the FDIC’s press releases at www.fdic.gov/news/press-releases/2023/pr23023.html and www.fdic.gov/news/press-releases/2023/pr23021.html.
- 2 See the FDIC’s press release at www.fdic.gov/news/press-releases/2023/pr23034.html.
- 3 See the joint press release at www.federalreserve.gov/newsevents/pressreleases/monetary20230312b.htm.
- 4 The Federal Reserve presented an Ask the Fed webinar on this topic: The Bank Term Funding Program — Overview and Important Details for Depository Institutions; see https://bsr.stlouisfed.org/askthefed/Home/ArchiveCall/340.
- 5 See www.federalreserve.gov/monetarypolicy/bank-term-funding-program.htm.
- 6 For more information, see the April 28, 2023, report Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley Bank, available at www.federalreserve.gov/publications/files/svb-review-20230428.pdf, and its accompanying press release, available at www.federalreserve.gov/newsevents/pressreleases/bcreg20230428a.htm.
- 7 See Governor Michelle W. Bowman's May 12, 2023, speech, titled “The Evolving Nature of Banking, Bank Culture, and Bank Runs,” at the 21st Annual Symposium on Building the Financial System of the 21st Century: An Agenda for Europe and the United States, European Central Bank, Frankfurt, Germany, available at www.federalreserve.gov/newsevents/speech/bowman20230512a.htm.
*The views expressed here are my own and not necessarily those of my colleagues on the Federal Open Market Committee or the Board of Governors.
