FDIC Says "Meaningful Action" Might Have Saved First Republic
Commentary by Steven Lofchie
In a report based on an internal review of its supervision over First Republic Bank, the FDIC concluded that "meaningful action to mitigate interest rate risk and address funding concentrations would have made First Republic more resilient and less vulnerable to the March 2023 contagion event."
Causes of Failure
The FDIC stated that the primary driver of First Republic Bank's failure was a loss of market and depositor confidence which caused a bank run after the failures of Silicon Valley Bank ("SVB") and Signature Bank. The FDIC identified "several attributes" of First Republic that made the bank susceptible to inflation and contagion risk, including (i) "rapid growth and loan and funding concentrations," (ii) an "overreliance" on uninsured deposits and depositor loyalty and (iii) failing to address interest rate risk. The FDIC said that First Republic experienced "immediate liquidity stress due to significant uninsured deposit outflow" following the SVB and Signature Bank failures, which in turn prompted a significant decline in First Republic’s stock price and more significant deposit outflows.
Supervision
The FDIC said that it would be hindsight to conclude that earlier supervisory action would have prevented First Republic's failure, but the FDIC said that "meaningful action" to address interest rate risk and funding concentrations may have improved First Republic's resiliency. In reviewing its supervisory practices, the FDIC found that the Risk Management Supervision ("RMS") staff could have (i) been "more forward-looking" when considering how increasing interest rates could negatively impact the bank and (ii) encouraged First Republic's management to develop strategies to mitigate interest rate risk.
The FDIC noted that based on the FDIC's Uniform Financial Institutions Rating System (a/k/a CAMELS), First Republic generally received "satisfactory" or "strong" examination ratings regarding its overall condition, asset quality and management and liquidity levels and funds management practices. However, the FDIC determined that rating First Republic's liquidity levels as "strong" was "too generous" due to the high level of the bank's funding concentration of uninsured deposits.
Commentary
This report appears to be the result of a meaningful self-examination by the FDIC. In contrast to what would have been a predictable call for more legislation, this report seems to place the blame where it more appropriately belongs: on the managers of the bank who made bad business decisions and on the bank's regulators who were aware of risks that the bank was taking but did not adequately respond to them.
Of course, identifying the causes of failure does not mean that they would be easy to solve. Human failure is not going away. But at least the response in this case was not to join the chorus that all would be right if only there were more legislation. (See also "FRB Concludes SVB Failure Was "Textbook Case" of Mismanagement, Slow Regulatory Response"; "FDIC Finds Poor Management and Lack of Oversight Causes of Signature Bank Failure.")
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The Federal Reserve Board concluded that the failure of Silicon Valley Bank was due to a “textbook case” of mismanagement of basic interest rate and liquidity risk, in addition to insufficient supervision from the bank’s board of directors and Federal Reserve supervisors.
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The FDIC concluded that the root cause of Signature Bank’s failure was poor management and illiquidity, exacerbated by contagion effects from Silvergate Bank's and Silicon Valley Bank's closings.