One year later: 5 areas of regulatory focus since 2023 bank failures

REAL ECONOMY BLOG | March 27, 2024

Authored by RSM US LLP

In the aftermath of the liquidity-related bank failures in March 2023, regulatory agencies and leaders have released numerous statements, including reviews of the failures, updates on supervisory expectations and calls for additional regulation.

A few common threads emerged in these statements in the past year, including the risk of uninsured deposits and the speed at which technology allows for deposit outflows. Bankers should consider how they are accounting for these factors in their liquidity risk management framework.

Looking back over a year after the bank failures, here are five key statements or updates from regulators in response to the failures:

1. Fed vice chair’s Silicon Valley Bank post-mortem

In an April 2023 report on SVB’s failure, Federal Reserve Board of Governors Vice Chair for Supervision Michael Barr identified areas where he thought the bank’s risk management fell short. He highlighted the bank’s rapid growth and risky business model, which involved “a highly concentrated deposit base and a reliance on uninsured deposits.”

“At the time of its failure, the bank had 31 unaddressed safe and soundness supervisory warnings—triple the average number of peer banks,” the report said.

Barr also said specific regulatory rules should be modified or re-evaluated. Specifically, he said the Federal Reserve plans to revisit the tailoring framework for banks with $100 billion or more in assets, with the goal of raising the baseline expectation for their resilience and ensuring that stress testing occurs with adequate coverage and timeliness. Additionally, he noted that regulators will evaluate how uninsured deposits are captured in liquidity models used by banks and regulators, and how unrealized losses on available-for-sale securities are evaluated relative to capital requirements.

2. Supervisory update on liquidity

During a May 2023 webcast on supervisory liquidity risk management expectations, the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. emphasized the importance of well-supported stress testing assumptions and contingency funding plans that incorporate diverse, easily accessible funding sources. Regulators also noted that banks should account for the speed at which deposits can be withdrawn due to the impacts of social media and mobile banking. Find a more detailed summary of the webcast here.

3. More on contingency funding plans

In July 2023, updated liquidity guidance from the FDIC again highlighted the importance of contingency funding plans, further underscoring the level and speed of deposit outflows during the bank failures.

The statement advised institutions to maintain a broad range of funding sources that can be accessed in adverse circumstances, as during times of stress certain sources of funding may become unavailable. The FDIC also emphasized the importance of maintaining operational readiness to liquidity sources such as the Federal Reserve discount window.

4. OCC statement on liquidity rules

In a January 2024 Columbia Law School speech on bank liquidity risk, Acting Comptroller of the Currency Michael J. Hsu proposed a targeted liquidity rule for midsize and large banks, given the heightened risks involved with the banking system’s operational speed. The rule would require such banks to have sufficient liquidity to cover stress outflows over an “ultra-short-term” of approximately five days.

Hsu elaborated that the rule should measure the bank’s discount window collateral and reserves against the speed and severity of uninsured deposit outflows. The rule, he stated, should also clarify expectations regarding banks’ readiness to access the discount window, and could include a requirement for periodic test draws.

5. FHFA’s review of FHLB system

In a November 2023 review, the Federal Housing Finance Agency found that the Federal Home Loan Bank system— which provides low-cost and readily accessible funding to financial institutions–experienced significant lending demand during the banking sector volatility which began in March 2023.

Per the FHFA review, this demand demonstrated the need for a clearer distinction between the FHLB system, which is designed to support member banks’ liquidity needs across the economic cycle, and the Federal Reserve System, which is designed to provide liquidity for troubled institutions with immediate emergency needs. The report elaborated that the FHLB system cannot functionally serve as the lender of last resort, and that the FHL Banks should engage in a thorough credit evaluation of their member banks to avoid encouraging excessive risk taking.

Broader implications

Some of the findings and proposals noted above have yet to become formal regulations. Still, bankers should ensure they are developing their stress testing and contingency funding plans with a broad range of funding sources in mind, particularly in light of the FHFA’s comments on the FHLB system’s status as a lender of last resort. Financial institutions may also want to reassess their liquidity risk management framework with an eye on how they factor in uninsured deposits and the speed at which deposit withdrawals may occur.

RSM senior associate Ethon Koehler contributed to this article.