In contrast with the White House’s position, the Vice Chairman denied that loosened Dodd-Frank rules contributed to the recent bank failures.

By Arthur S. Long, Pia Naib, and Deric Behar

On April 12, 2023, Federal Deposit Insurance Corporation (FDIC) Vice Chairman Travis Hill delivered a speech at the Bipartisan Policy Center, “Recent Bank Failures and the Path Ahead.” In it, he addressed key themes and takeaways from the March 2023 bank failures that saw the FDIC appointed as receiver for a bank with over $200 billion in consolidated assets and another with over $110 billion in consolidated assets, as well the voluntary liquidation of another bank with over $10 billion in consolidated assets. Notably, his views indicate that the US banking agencies do not agree over the regulatory lessons to be drawn from the failures.

Interest Rate Risk

According to Vice Chairman Hill, mismanagement of interest rate risk, and not other issues such as digital asset uncertainty, was the key problem underlying the bank runs. Two of the recently failed institutions had invested over half of their assets in long-dated fixed-rate US Treasuries and agency securities. As discussed in this Latham blog post, US banks have incurred heavy paper losses on their securities holdings over the past year due to the increase in interest rates (approximately $620 billion at year-end 2022, according to FDIC Chairman Martin Gruenberg). To meet heavy demands for withdrawals, some banks were compelled to raise capital by selling their securities holdings at a loss in the open market, leading to a crisis of confidence among depositors and a “stampede for the exits.”

High Concentrations of Uninsured Deposits

The nature of the liabilities at the banks that experienced the runs was unique in that the liabilities were “almost all uninsured, highly concentrated, and … remarkably quick to run.” Vice Chairman Hill described two approaches that regulators face in attempting to bring stability to the system: increased federal deposit insurance coverage versus policies intended to promote market discipline. He indicated that he was not ready to commit to either approach.

A Technology-Fueled Bank Run

The Vice Chairman viewed the history of bank runs in the US as a long one. With technological advances such as online banking and social media, what has changed, he argued, is the speed at which a bank can become insolvent once depositor confidence is compromised.

Resolution Issues

Vice Chairman Hill emphasized the need for the FDIC, in concert with the Treasury Department and Federal Reserve, to act quickly once it has determined that a bank failure is in progress. “The FDIC not only needs to be open to any and all bidders,” he said, but “it needs to act with urgency and initiative to solicit bids and make a deal happen.” He noted that in one of the recent bank failures, a key hindrance to a swifter sale of the bank’s assets was the inability to quickly populate a data room that potential bidders could use to perform adequate due diligence.

The Vice Chairman suggested that regulatory testing for this capacity, as well as requirements for more innovative financial reporting, are possibilities that the FDIC should explore. He remained skeptical, however, of requiring banks to prepare detailed descriptions of hypothetical failure and resolution scenarios: “How a regional bank is ultimately resolved and sold will be determined not by the failed bank during peacetime but by the FDIC and prospective acquirers during resolution.” At the same time, he proposed that regulators carefully consider whether regional banks should be required to issue long-term debt to absorb losses in resolution ahead of depositors and the FDIC’s Deposit Insurance Fund.

S. 2155

Vice Chairman Hill denied that S. 2155 (Economic Growth, Regulatory Relief and Consumer Protection Act), the bipartisan banking law passed in 2018 that relaxed provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, had anything to do with the recent bank failures. He noted that the changes enacted by S. 2155 did not affect the primary causes for the bank failures: capital standards for mid-size banks did not change; stress tests did not assess for rapidly rising rates; and the liquidity coverage ratio did not limit investment in government bonds.

These comments contrast with the recent White House recommendation that regulators reverse some of the 2018 deregulatory measures, on the ground that the weakening of those safeguards and supervisory requirements under the Dodd-Frank Act led to the bank failures and the resulting threat of contagion (for more information, see this Latham blog post).

Conclusion

Vice Chairman Hill concluded by echoing remarks made by other regulators at the March 2023 congressional hearings on bank failures that the FDIC should review the bank failures with an open mind and be willing to make “targeted changes” to its oversight framework. He warned, however, against a heavy-handed approach to regulation. This sentiment was shared by the Board of Governors of the Federal Reserve System’s Michelle W. Bowman, who in a separate speech said that while the bank failures have “demonstrated that some changes may be warranted,” they are not “an indictment of the broader regulatory landscape.” These views will likely be asserted more strongly if the US banking agencies determine to respond to the bank failures by moving forward with stricter capital and liquidity regulation in the months to come.

Latham & Watkins will continue to monitor developments in this area.