Fed’s Fault-Finding On Bank Failures Could Lead To Stronger Regulations
By Casey Quinlan
Indiana Capital Chronicle
New banking regulations proposed by federal watchdogs don’t go far enough in countering potential problems, but could help lower bank fees and calm financial markets and nerves, leading to a more stable financial system, according to some economists.
The Federal Reserve, FDIC and Government Accountability Office released reports last week blaming mismanagement of risk, including overreliance on uninsured deposits and rapid growth on problems at California-based Silicon Valley Bank and New York-based Signature Bank, which were shut down in March. The Federal Reserve report also criticized its own delay in recognizing and addressing problems at SVB, and changes in the supervision of banks resulting from the 2018 banking deregulation law.
In the Fed’s report, Michael Barr, vice chair for supervision at the Fed, said the regulator would “re-evaluate a range of rules for banks with $100 billion or more in assets.” In March, several Democratic senators called for the Fed to exercise its discretion to enforce stricter requirements for banks that have assets between $100 and $250 billion. Lawmakers are also considering options for holding bank executives accountable for their mismanagement.
Barr said the Fed’s approach to “stress testing,” or weighing how some scenarios would affect banks, and whether they have sufficient capital to absorb losses, should be “revisited.”
Aaron Klein, senior fellow in economic studies at the Brookings Institution, said the Fed report doesn’t take enough responsibility for the magnitude of its mistakes or reasons for those mistakes even though it did admit its approach was “too deliberative.”
“No stress test would have predicted COVID. Any stress test should have predicted interest rate hikes and they missed them both,” he said. “When you miss the one that no one could see coming and you miss the one that everyone should have seen coming, it ought to set off deeper alarm bells about the overreliance on the test to begin with.”
Proposed rules already having effect
Some of these changes wouldn’t go into effect for several years because federal rulemaking requires a notice and comment period and a period to phase-in these changes. But some economists say that the mere consideration of those rules is already having an effect.
Although the banking system will be more resilient as a result, there will be shorter-term economic challenges ahead as a result of these changes.
“More regulation will, in theory, prevent some of these issues from cropping up again, thus, ensuring the safety of consumers’ deposits at those particular institutions. And that, in turn, will calm financial markets and nerves,” Jennifer Lee, senior economist at BMO Capital Markets, stated in an email to States Newsroom. “… Yes, it may require all banks to hold more reserves and that would mean less credit but longer term, it would mean a more stable financial system.”
On Monday, Moody’s responded to potential regulatory changes in a report for investors that said they would affect more than just regional banks, which would be “a credit positive for US banks.” The report added that, “The potential strengthening of US bank regulation and supervision would likely help address weaker capital, interest rate risk and funding risk at some US banks.”
Rhame said that from Moody’s perspective these regulations would result in better capitalization and improve the credit rating of bonds or other investment vehicles in banks.
Congress is also looking closely at how to prevent more bank failures and incentivize better risk management by banks. A bipartisan Senate bill, proposed by U.S. Sens. Elizabeth Warren (D-MA), Catherine Cortez-Masto (D-NV), Josh Hawley (R-MO), and Mike Braun (R-IN) would force bank executives to give up some or all of their compensation, which includes bonuses, performance pay, and salaries, for the five years that led up to the failure of their bank.
On Thursday, the Senate Committee on Banking, Housing, and Urban Affairs held another hearing in a series of hearings on recent bank failures, where senators spoke to law professors and a U.S. Chamber of Commerce executive about how current law could hold bank executives accountable for their mismanagement.
Da Lin, assistant professor at law at the University of Richmond said there are limitations in federal regulators’ authority to remove bankers from office and prohibit them from continuing to work in the banking industry and that their enforcement tends to affect the rank and file workers more than executives. Executives are often shielded from knowledge of bank problems even though they have also not set up structures to prevent mismanagement of risk and other issues, law professors explained.
“Instead regulators have primarily excluded rank and file workers (from the industry) for low-level misconduct such as embezzlement that has little impact on banks’ safety or administration …,” Lin said. “… This disparity exists because the current law is not well-designed to be applied to senior bank leadership … The culpability requirement for removal and prohibition is overly demanding, requiring, as I have mentioned, personal dishonesty or a willful or continuing disregard for safety and soundness of the institution. Yet, failed management is seldom a deliberate act and is even less likely to be provable as one.”
See full article here.