FDIC Chair Highlights "Lessons Learned" from 2023 Bank Failures

FDIC Chair Martin J. Gruenberg highlighted lessons drawn from the failures of Silicon Valley Bank ("SVB"), Signature Bank and First Republic Bank of California in 2023 as well as the steps the FDIC has taken since to avoid further bank failures. 

Chair Gruenberg said that the bank failures "focused [the FDIC's] attention on the need for meaningful action to improve the likelihood of an orderly resolution of a large regional bank under the FDI Act without the expectation of invoking the systemic risk exception." He said the FDIC is taking important steps to reduce reliance on the systemic risk exception. He highlighted the following efforts:

• Capital Treatment of Unrealized Losses. Chair Gruenberg asserted that the Basel III capital rule proposal addresses one of the key vulnerabilities of the recent failures. Under the proposal, unrealized losses on "available for sale securities" would flow through regulatory capital for all banks with more than $100 billion in assets. (See related coverage.) According to Chair Gruenberg, "this means that these banks, in order to maintain their capital levels, would need to retain or raise more capital as these unrealized losses occur." He argued that, had SVB been required to include unrealized losses on its available for sale securities in regulatory capital, SVB might have averted the loss of market confidence and the liquidity run. 
• Long-Term Debt Requirement. Chair Gruenberg pointed to an FDIC, Fed and OCC joint proposal that would require large banks with assets of $100 billion or more "to issue long-term debt sufficient to recapitalize the bank in resolution." (See related coverage.) A long-term debt requirement would bolster financial stability by: (i) ensuring that banks absorb losses before the depositor class which, would lower "the incentive for uninsured depositors to run," (ii)  creating "additional options in resolution under the "least-cost test," such as recapitalizing the failed bank under new ownership or breaking up the bank and selling portions of it to different acquirers," and (iii) allowing investor "prices to serve as a signal of the market's view of risk in these banks" because these instruments are publicly traded.
• Resolution Plans for Insured Depository Institutions ("IDI Plans"). Chair Gruenberg said the FDIC is working to enhance resolution plan requirements for large banks. (See related coverage.) He highlighted proposed changes to the IDI plan requirements that (i) emphasize a "bank's capability to promptly establish a virtual due diligence data room, and populate it with enough information for interested parties to bid on the bank or its assets or operations," (ii) call "for maintenance of information necessary for operational continuity of the bank" and (iii) "require a bank to provide a resolution strategy that is not dependent on an over-the-weekend sale [and] identify franchise components, such as asset portfolios or lines of business that could be separated and sold, in order to provide additional options for exiting from resolution by disposing of parts of the bank to reduce the size of a remaining bank and expand the universe of possible acquirers."
• Supervision to Address the Liquidity Risks of Uninsured Deposits. Chair Gruenberg said that "the bank failures... highlighted the vulnerabilities that can result when banks have a heavy reliance on uninsured deposits for funding." He said that the FDIC is responding to these vulnerabilities by: (i) "reviewing whether its supervisory instructions on funding concentrations should be bolstered to better capture risks related to high levels of uninsured deposits generally or types of deposits more specifically, such as business operating account deposits," (ii) "focusing supervisory attention on the management of interest rate risk, concentrations of unrealized losses, rapid growth, and the need to compel compliance if a bank is unresponsive to reasonable supervisory direction," (iii) renewing "supervisory efforts to ensure that banks have access to appropriate sources of contingent liquidity, including the Federal Reserve's Discount Window" and (iv) regularly monitoring "Discount Window trends related to collateral pledged, available capacity, and utilization to understand risk trends and identify potential emerging concerns."
• Options for Deposit Insurance Reform. Chair Gruenberg cited an FDIC report on Options for Deposit Insurance Reform which considered, (i) "rais[ing] the level of deposit insurance coverage," (ii) providing "unlimited coverage" and (iii) "target[ing] coverage with different levels of deposit insurance coverage for different types of accounts." Chair Gruenberg noted that "there are challenges to establishing a practical definition for transaction accounts" and "any change in deposit insurance coverage in the [U.S.] would require legislation by the Congress."