The failures of Silicon Valley Bank (SVB) and Signature Bank and the self-liquidation of Silvergate Bank in March 2023 served as wake-up calls for banking regulators and lawmakers. Although industry experts agree that steps must be taken to avoid similar failures in the future, they disagree over whether the solution is to implement stricter banking regulations or simply to improve oversight under existing regulations. Whatever the answer, banks can expect regulators to watch them more closely, particularly regarding capital, liquidity, and interest rate risks.
What’s your level of risk?
The good news for community banks is that their approach to banking is typically different than the niche banks that recently failed. So they’re generally not as susceptible to the types of risks to which those banks were exposed. For example, all three banks that failed had high percentages of uninsured deposits and dangerously high deposit concentrations. (Silvergate and Signature were heavily concentrated in cryptocurrency, and SVB’s deposit base was largely made up of uninsured tech start-up venture capital.)
Nevertheless, community banks should review their deposit mixes. They need to evaluate their risk management policies and procedures to prepare for heightened regulatory scrutiny.
What happened?
Major contributors to recent bank failures included the rapid increase in interest rates during 2022 and early 2023, as well as the collapse of the FTX crypto exchange. Rising interest rates exposed dormant interest rate risks at many banks that had invested heavily in long-term assets in a quest for higher yields when interest rates had reached rock bottom. As interest rates increased, the value of these banks’ bond portfolios plummeted, resulting in significant unrealized losses.
As FDIC Chair Martin Gruenberg explained in a statement to the Senate Banking Committee, “When Silvergate Bank and SVB experienced rapidly accelerating liquidity demands, they sold securities at a loss. The now realized losses created both liquidity and capital risk for those firms, resulting in a self-liquidation and failure.” SVB, for example, announced that it was raising capital and sold $21 billion in underwater securities at a $1.8 billion loss. This triggered a run on deposits, and in a matter of days, $42 billion in deposits were withdrawn.
What’s next?
Government officials are considering several initiatives to address the underlying issues that contributed to recent bank collapses. Their objective is to strengthen capital and liquidity standards for banks with more than $100 billion in assets. Among other things, banking regulators and lawmakers are considering:
- Imposing more rigorous stress-testing requirements on midsize banks,
- Tightening liquidity rules,
- Expanding FDIC deposit insurance coverage, which is currently limited to $250,000 per depositor, per bank, in each account ownership category,
- Increasing capital requirements,
- Reversing a 2018 law that relaxed regulation of midsize banks by increasing the “too big to fail” threshold from $50 billion in assets to $250 billion in assets, and
- Reevaluating regulatory oversight of banks’ deposit mixes, deposit concentration and percentage of uninsured deposits.
Regulatory, legislative and oversight changes will target midsize and large institutions. However, stricter scrutiny of banking risks may trickle down to community banks.
How should community banks respond?
In light of recent events, community banks need to review their risk management policies and procedures. The policies should meet regulators’ expectations and help the bank withstand any further turmoil in the financial industry. Specifically, community banks should:
- Monitor deposit trends to ensure that deposit bases are diversified and that there aren’t high concentrations of deposits in specific industries or groups of related customers,
- Review customers’ average deposit sizes and avoid a high percentage of uninsured deposits,
- Evaluate their liquidity position and, if necessary, take steps to increase liquidity and build liquidity buffers,
- Watch out for accumulated losses in their securities portfolios, and
- Conduct periodic stress tests to evaluate their exposure to interest rate risk and other risks.
Your bank also should communicate with customers to be sure they understand why community banks aren’t exposed to the same level of risk as the institutions that failed. (See “Communication is key for community banks” below.)
Stay tuned
In the coming weeks and months, community banks will need to monitor the regulatory and legislative response to this year’s bank failures and the conditions that caused them. Although new laws or regulations likely won’t affect your bank directly, they may serve as a guide to best practices that can help your bank satisfy regulators and reassure customers.
Sidebar: Communication is key for community banks
Recent bank failures have created fear among many depositors, so it’s critical for banks to assure them that their money is safe. For community banks, that means educating customers about how their approach to banking differentiates them from the institutions that collapsed in March. They should emphasize their commitments to managing liquidity and interest rate risk and maintaining a diverse deposit base from the communities they serve — rather than concentrating deposits in risky industries or customer segments. Community banks also tend to have low percentages of uninsured deposits.
Now is also a good time to remind customers of the other advantages that community banks have over their larger competitors. Examples include their ability to offer face-to-face engagement and personalized services.
© 2023