Collapse of major US banks prompts calls for more regulation

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Senator Elizabeth Warren (D-MA), a member of the Senate Finance Committee, questions U.S. Treasury Secretary Janet Yellen during a hearing on the Biden administration’s fiscal year 2024 federal budget proposal before the committee at the Dirksen Senate Office Building on Capitol Hill March 16 2023

When Silicon Valley and signature banks failed in early March 2023, state regulators took over rushed in to guarantee deposits and protect bank customers. However, under current banking regulations, there was no obligation for the state to intervene.

Well, both Democratic and Republican politicians make announcements on whether bipartisan-backed deregulation in 2018 led to the collapse of banks and whether the banking industry needs more government intervention.

Senator Elizabeth Warren of Massachusetts and US Rep. Katie Porter of California, both Democrats, introduced a bill on March 15, 2023, restoring the strict banking regulations they maintained would have prevented the practices that led to the recent bank failures. But some Republicans, including Kentucky Rep. Andy Barr, Let’s say lax government policies That included overspending – which Barr says has fueled inflation and long-term low interest rates – rather than the deregulation that was behind bank failures.

Requirements in 2010 are disputed Dodd-Frank Wall Street Reform and Consumer Protection Act which were reversed in 2018. Dodd-Frank introduced changes to financial regulation in response to the 2008 global financial crisis. Among other things, the legislation meant that banks with assets of 50 billion US dollars must be subject to strict standards. Some lawmakers, including Porter and Warren, say those requirements should have stayed intact.

But the Economic Growth, Regulatory Relief and Consumer Protection Act In 2018, standards were relaxed and the asset threshold raised to $250 billion, meaning fewer banks were subject to stringent controls.

The conversation asked Gerard W. Comizioa law professor, former Wall Street attorney, and former senior Treasury Department official to explain some of the problems that caused the failure of Silicon Valley Bank, Signature Bank, and another bank.

What Caused the Failure of Silicon Valley, Signature, and a Third Bank, Silvergate?

Significant Withdrawals at all three banks caused cash crises that could not be addressed by selling assets such as banknotes and bonds. For all three banks, selling their assets would have caused significant additional losses as their portfolios were worth less than they paid for them and interest rates rose.

While some aspects of each failure were different, there were common elements and a degree of Murphy’s Law – the idea that if anything can go wrong, it will. Everything went wrong at these banks.

In the last three months of 2022, Silvergate had a record loss of $1 billionbecause of heavy lending problems and failed crypto trading exchanges. And his interest-sensitive securities portfolio became the fuel for the current crisis.

Throughout 2022, Silvergate’s deposit base grew dramatically, almost Doubling his wealth to $210 billion. But the bank had neither the administrative capacity nor the market demand to lend all the money that banks normally do. So it invested the excess deposits into government bonds and mortgage investment products.

But the bond purchases became a problem Federation
Reservations started to
raise interest rates to counter inflation. As Business Insider reported, a two-year U.S. Treasury offered nearly three times the Silicon Valley Bank’s portfolio of long-dated bonds — who earned an average income of only 1.6% – was much more attractive.

Bond prices plummeted, causing billions of dollars in paper losses for the Silicon Valley bank, popularly known as SVB.

To support its cash position in the face of increasing customer withdrawals, SVB sold $21 billion worth of bonds with a loss of $1.8 billion.

What provisions of the Dodd-Frank Act 2010 were developed to prevent bank failures?

Section 165 of the Dodd-Frank Act passed so-called “enhanced prudential regulatory” rules for all banking organizations with assets in excess of US$50 billion and referred to them as “systemically important financial institutions”, which are popularly referred to as “too big to fail.” These standards are designed to be stricter than those applicable to smaller banks. Lawmakers believed that the larger institutions posed a far greater risk to US financial stability

Among other things, these stricter rules required that those banks they deemed too big were regularly updated to fail them federal reserve and the Federal Deposit Insurance Corp. a comprehensive resolution plan. Syncs the living will, this plan outlines a company’s plans for a “swift and orderly” resolution of the bank if it fails or has already failed. Additionally, these too-big-to-fail banks have had to regularly assess their risk under various market conditions, including rate hikes and risk hedging strategies. The rules also stated that certain banks had significantly higher capital requirements.

The failed banks were no longer required to comply with these key provisions of the Dodd-Frank Act. The regulations could probably have saved her.

Why weren’t the banks subject to these regulations?

Industry leaders, including Greg Becker, CEO of Silicon Valley Bank, lobbied for Congress in 2015 to reverse some of the provisions of the Dodd-Frank Act.

Arguing that the $50 billion threshold needs to be raised, Becker said the restrictions on mid-sized banks under the Dodd-Frank Act were too onerous and hampered banks’ ability to “Providing the banking services our customers need.”

In 2018, Congress passed the Economic Growth, Regulatory Relief and Consumer Protection Act. It amended the Dodd-Frank Act to significantly reduce the number of banks subject to tighter regulation, raising the threshold at which banks pose potential systemic risk from $50 billion to $250 billion.

On July 6, 2018 all bank offices issued a confirmation statement the elimination of these requirements.

If the Dodd-Frank Act had stayed intact, would the banks have failed?

There are a number of arguments as to whether these errors could have been prevented and resolved more quickly if the Dodd-Frank standards had still been in effect. These standards were arguably designed to specifically prevent and address the type of circumstances that have precipitated these recent bank failures: multiple failures and financial system contagion, market panics, deposit storms and liquidity crunches.

For example, adhering to living wills and stress testing would have caught problems much earlier, potentially forcing these banks to address a number of potential red flags that represent higher risk, such as:

• Interest rate risk in banks’ securities portfolio investments and the consequences of liquidating these investments with significant losses in the event of a liquidity crisis;

• Lack of interest rate risk hedging strategies;

• Excessive uninsured deposits that pose a risk to the bank when customers withdraw their money en masse; And

• The need to hold more money than normal to address their risks.

Ironically, by taking steps to provide unprecedented deposit insurance coverage for uninsured deposits at these banks, the The US Treasury, the Fed and the FDIC issued a joint statement on March 12 that they invoked that Exception systemic risk This allowed them to replace depositors’ money, although the law was amended in 2018 to clarify that banks of their size no longer pose systemic risk.

By V. Gerard (Jerry) Comiziolaw professor, American University

This article is republished by The conversation under a Creative Commons license. read this original article.