In the wake of three bank collapses, Signature Bank, crypto-focused Silvergate, and the high-profile implosion of Silicon Valley Bank, many business owners are wondering — where were the fail-safe banking regulations when we needed them? Aren’t the banking regulations put into place following the 2008 banking collapse meant to prevent struggles and stumbles like these?
In this article, we’ll look at two banking regulations designed to stop banks from overleveraging themselves and taking on too much risk — and why these fail-safes missed the mark in 2023.
Banking regulation #1: the Dodd-Frank Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act is a comprehensive set of regulations that apply to both banks and public companies. The act, which was approved in 2010, increases the level of corporate governance these organizations are subjected to, limits how much their executive team can earn, and sets stricter rules for credit rating agencies.
In the banking sector specifically, Dodd-Frank created a 10-member Financial Stability Oversight Council and the Consumer Financial Protection Bureau. These independent groups were formed to help identify significant financial risks, guide the market and respond to banking threats quickly while minimizing depositor panic.
Unfortunately, in the case of Silicon Valley Bank in particular, the Dodd-Frank act, and resulting oversight councils, failed to recognize (or respond to) the growing crisis before depositors were put at increased risk.
For banking regulators, the signs were clear.
Long before SVB’s collapse, regulators understood that rising federal interest rates could put a strain on banks. And as SVB’s liabilities increased month after month, the regulators who oversaw the bank failed to warn the government or depositors.
According to some reports, it was SVB’s own poor management and mishandling of risk that triggered the bank’s insolvency. The right regulations were in place, but SVB failed to follow them carefully. An example of the deep level of mismanagement is how the bank struggled to pull together the basic data potential bank buyers were looking for as SVB prepared for purchase. No banking regulations can compensate for disorganized data — one sign of a company growing faster than it’s prepared to.
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Data aside, some argue that better oversight through every interest rate hike could have prevented the bank from becoming so overleveraged. SVB, like all banks of this size, was required to submit periodic reports to bank supervisors. As interest rates increased, supervisors should have been closely watching for early signs of distress, like the ballooning growth of uninsured deposits and the declining value of the bank’s investments in mortgage-backed securities.
Banking regulation #2: FDIC-backed deposits
In 2010, as part of the Emergency Economic Stabilization Act, the FDIC raised the level of insured bank deposits from $100,000 to $250,000. While the vast majority of individual bank account holders won’t hit the upper limit of the new cap, millions of small businesses hit — and exceed it — many times over.
This low limit on backed deposits causes bank customers with more than $250,000 in their accounts to immediately withdraw their deposits the moment they sense market turbulence. And that bank run scenario is exactly what happened at SVB and banks like it. Even banks unaffected by SVB’s insolvency saw depositors pull out millions in cash, fearful their bank would be next.
Now, some lawmakers and regulators are calling for a higher limit — or no cap at all — to prevent future bank runs.
While the FDIC technically only backs deposits up to $250,000, no one has lost their deposits.
The FDIC regulation states that the government can step in to cover both FDIC-insured and uninsured deposits by invoking the “systemic risk exception”. If allowing a group of large depositors to lose their cash would trigger a systemic risk, these bigger deposits can be backed at the government’s discretion. And since the 1980s, that exception has been leveraged in every collapse.
If this unspoken best practice becomes explicit, bank customers (and especially small businesses) would have the peace of mind that comes from knowing no matter what happens to their bank, their deposits are safe. By raising or removing the FDIC cap, we may see the end — or a significant decline — in bank run situations.
Are the post-2008 crisis banking regulations working?
According to Peter Conti-Brown, professor of financial regulation at the Wharton School of Business, the collapse of three banks earlier in 2023 suggests that the regulations put into place serve a valuable function, but may be underenforced.
SVB was one mid-sized bank with a comparatively small list of customers. While many of these customers were influential tech companies, the full collapse of a bank this size shouldn’t have had the global impact it did. If our banking sector is truly sturdy, resilient and insulated from crises, the stumble of one shouldn’t take down others with it. Conti-Brown suggests the fallout triggered by SVB’s collapse could be either an overreaction or exposes just how fragile the banking system is in times of volatility.
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This material has been prepared for informational purposes only. Escalon and its affiliates are not providing tax, legal or accounting advice in this article. If you would like to engage with Escalon, please contact us here.
