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Lessons Learned from the U.S. Regional Bank Failures of 2023

Chairman Martin J. Gruenberg
 Speech, Florence School of Banking and Finance  
May 17, 2024

Introduction

Thank you for the invitation to speak today at this conference celebrating the 10th anniversary of the launching of the Banking Union.  I am deeply grateful to the Florence School of Banking and Finance, and in particular to Ignazio Angeloni, for the privilege of participating in this program.

The establishment of the European Banking Union was a landmark event not just for Europe but for the global financial system. In particular, the establishment of the Single Supervisory Mechanism within the European Central Bank, and the Single Resolution Board, in my view, significantly enhanced financial stability globally. I only hope Europe is able to implement the third leg of the Banking Union and advance the European Deposit Insurance Scheme. Perhaps that would be the subject of another speech.

Today however, I would like to focus on the U.S. experience with the failures of three large regional banks last year and the lessons we have drawn from that experience for both supervision and resolution.

The Regional Bank Failures of 2023

As many of you probably know, on March 10, 2023, SVB, with $209 billion in assets at year-end 2022, was closed by the state banking authority, who appointed the FDIC as receiver. Stress at the firm had become apparent a few days earlier, on Wednesday, March 8, when Silicon Valley Bank (SVB) announced a $1.8 billion loss on sale of securities, experiencing the consequences of unrealized losses on those securities, and a concurrent plan to raise $2 billion in capital to shore up its balance sheet. Then, on Thursday, March 9, shares of SVB fell 60 percent, and it experienced a run by uninsured depositors.

By that evening, $42 billion in deposits had left the bank with an additional $100 billion staged to be withdrawn the next day. To put this in perspective, nearly 30 percent of deposits left the bank in a matter of hours, and another 50 percent were set to leave. Of great relevance, over 90 percent of SVB’s deposits were uninsured.

When SVB failed that Friday, the FDIC initially established a Deposit Insurance National Bank (DINB), which is a self-liquidating vehicle under FDIC control.1

We announced that insured depositors would have full access to their funds on Monday, and that uninsured depositors would have access to a portion of their funds shortly thereafter. A portion of the uninsured deposits would be held back in the receivership and would experience losses depending on the losses to the Deposit Insurance Fund.

The prospect that uninsured depositors at SVB would experience losses alarmed uninsured depositors at several other regional banks, and depositors began to withdraw funds. Signature Bank of New York with over $100 billion in assets, in particular, experienced heavy withdrawals. A contagion effect became apparent, and there was clear evidence that the failure of a regional bank in which uninsured depositors faced losses could cause systemic disruption.

On Sunday March 12, just two days after the failure of SVB, the New York State bank regulator closed Signature Bank and appointed the FDIC as receiver.2  Like SVB, Signature had experienced a run on deposits and was ultimately unable to meet its obligations. Also like SVB, over 90 percent of Signature Bank’s deposits were uninsured.

Faced with growing contagion in the system, the Boards of Directors of the FDIC and Federal Reserve voted to recommend that the Secretary of the Treasury, in consultation with the President, make a systemic risk determination under the Federal Deposit Insurance Act with regard to the resolutions of SVB and Signature Bank.3

The systemic risk determination enabled the FDIC to extend deposit insurance protection to all of the depositors of SVB and Signature Bank, including uninsured depositors. The FDIC as receiver organized two bridge banks4 to carry this out and to start the process of finding potential buyers for the bridge banks. This process allows for the sale of the entire bank to an acquirer or major pieces of it to separate buyers.

A regional bank, New York Community Bank’s subsidiary Flagstar Bank, purchased Signature a week after it was placed in receivership.5  Another regional bank, First Citizens Bank of North Carolina, purchased SVB two weeks after its failure.6

Although the FDIC was authorized to proceed under the systemic risk exception in these cases, it is important to recognize that both institutions were allowed to fail. Shareholders lost their investment. Unsecured creditors took losses. The boards and the most senior executives were removed. The FDIC is conducting investigations, as it is legally required to do, to hold directors, officers, and executives accountable for losses and misconduct.7

Less than two months later, on May 1, 2023, First Republic Bank of California, with $213 billion in assets at year-end 2022, was closed by the state regulator, and again the FDIC was appointed receiver.8  First Republic had a nearly 70 percent reliance on uninsured deposits and had been clearly impacted by the contagion effect of the previous two failures.

First Republic was resolved via a purchase and assumption agreement with JPMorgan Chase Bank, which assumed all of the failed bank's deposits and substantially all of the assets. This transaction was done under the least-cost test, without a systemic risk exception.

Lessons and Response

This experience has focused our 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. In light of our experience, we are taking important steps to make reliance on the systemic risk exception much less likely.  They include better aligning capital requirements with changes in the value of securities, building loss-absorbing capacity with long-term debt requirements, improving resolution planning at the bank level, and strengthening bank supervision. The FDIC also released a paper on options for reforming deposit insurance.   Let me provide more detail on these efforts.

Capital Treatment of Unrealized Losses

In late July 2023, the three federal banking agencies issued a Notice of Proposed Rulemaking (NPR) to implement the Basel III capital rule.9 There are many aspects to this proposal, but one in particular is a step toward addressing 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.  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.

It is worth noting that, although Silicon Valley Bank’s failure was caused by a liquidity run, the loss of market confidence that precipitated the run was prompted by the sale of available for sale securities at a substantial loss that raised questions about the capital adequacy of the bank. Had Silicon Valley Bank been required to include unrealized losses on its available for sale securities in regulatory capital, as the proposed Basel III framework would require, the bank might have averted the loss of market confidence and the liquidity run. That is because there would have been more capital held against these assets.

Long-Term Debt Requirement

Going back to the 2008 Global Financial Crisis, we have been able to see the benefits of banks holding long-term debt to help absorb losses.10 During 2008, we experienced the largest bank failure in U.S. history – Washington Mutual Bank, a $300 billion thrift institution. Yet it was resolved at no cost to the Deposit Insurance Fund, and uninsured depositors suffered no losses. That’s because the bank had sufficient unsecured debt to absorb all of the losses.

In October 2022, the FDIC and Federal Reserve jointly issued an Advance Notice of Proposed Rulemaking (ANPR) on Resolution-Related Resource Requirements for Large Banking Organizations.11  The ANPR was followed by a Notice of Proposed Rulemaking by the agencies, joined by the OCC, in August 2023.12

The agencies proposed that large banks with assets of $100 billion or more be required to issue long-term debt sufficient to recapitalize the bank in resolution.  Such a long-term debt requirement bolsters financial stability in several ways.  First, it absorbs losses before the depositor class – the FDIC and uninsured depositors – take losses.  This lowers the incentive for uninsured depositors to run.  Even if the institution fails, the buffer of long-term debt reduces cost to the Deposit Insurance Fund and the need for a systemic risk exception. Further, it creates 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, as an alternative to a merger with another large institution.

Since this debt is long-term, it will not be a source of liquidity pressure when problems become apparent.  Unlike uninsured depositors, investors in this debt know that they will not be able to run if the firm is under stress.  This gives them a greater incentive to monitor risk in these banks and exert pressure on management to better manage risk.  Finally, because these instruments are publicly traded, their prices serve as a signal of the market’s view of risk in these banks.

Resolution Plans for Insured Depository Institutions (IDI Plans)

In addition to our work on requirements for resolution resources, we are also working to enhance the existing resolution plan requirements for large banks.  There is currently a requirement for large regional banks to file plans that address the resolution of the insured depository institution under the FDI Act.13 This requirement for Insured Depository Institution Plans (IDI Plans) is separate from the Dodd-Frank Act Title I resolution plans that apply to large bank holding companies.14

The IDI Plan Rule, first adopted in 2011, requires certain large banks to periodically submit resolution plans to provide the FDIC with information about the bank that is essential to effective resolution planning, and to support the execution of a resolution if necessary.

Since that time, the FDIC has continued to consider ways to improve the effectiveness of these resolution plans and to set clear expectations for the banks with respect to the content of these plans. On August 29, 2023, the FDIC proposed changes to the IDI plan requirements that would make them significantly more effective.15

Our proposed rule emphasizes elements that would have been helpful last spring, like the 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. It also calls for maintenance of information necessary for operational continuity of the bank, including a more thorough description of key personnel and retention plans, critical third party and shared services, and payments and trading activities.

While each of the three bank failures last spring ultimately concluded in a sale to a single acquirer, it is also clear that a sale to a single acquirer may not always be possible.  Therefore the proposed rule will seek to expand the options available to the FDIC. For example, the proposed rule would require a bank to provide a resolution strategy that is not dependent on an over-the-weekend sale.  It would also require banks to 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.

A stronger resolution-planning requirement for large regional banks, combined with a long-term debt requirement, would provide a much stronger foundation for the orderly resolution of these institutions.

Supervision to Address the Liquidity Risks of Uninsured Deposits

Finally, the regional bank failures of 2023 highlighted the vulnerabilities that can result when banks have a heavy reliance on uninsured deposits for funding. The significant proportion of uninsured deposit balances makes the banks more vulnerable to bank runs.

For the banking industry as a whole, reliance on uninsured deposit funding has been increasing.   In the aggregate, uninsured deposits rose from about 18 percent of domestic deposits in 1991 to nearly 47 percent at their peak in 2021, higher than at any time since 1949.  The aggregate concentration of uninsured deposit funding has since come down slightly from 2021 but still remains high.16

More forward-looking supervision of large regional banks is certainly a key lesson from the 2023 bank failures.  In particular, the FDIC is 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.  We are also 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.

In addition, we are renewing our supervisory efforts to ensure that banks have access to appropriate sources of contingent liquidity, including the Federal Reserve’s Discount Window.  Recent supervisory work has focused on assessing discount window operational readiness by ensuring that legal and operational documents are current, responsibilities are well-defined, and testing is performed as appropriate.  Additionally, supervisors are reviewing the sufficiency of pre-pledged collateral and the ability to move additional collateral to the Discount Window given potential funding needs during stress.

In addition, we regularly monitor 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

Beyond supervision, the FDIC also issued a report on Options for Deposit Insurance Reform.17 The report considered three main options.

The first is to raise the level of deposit insurance coverage. This could provide more protection for savers, but it would likely do little to address the financial stability and contagion risks experienced last year. That is because uninsured deposits are held by relatively few depositors.

A second option would be to provide unlimited coverage. This would effectively remove run risks as insurance backed by the federal government provides a strong deterrent to bank runs. However, it also would exacerbate moral hazard by removing depositor discipline and may have broader, unintended effects on financial markets.

The third option would be targeted coverage with different levels of deposit insurance coverage for different types of accounts. In particular, it would focus on higher coverage levels for business payment accounts. Business payment accounts may pose a lower risk of moral hazard because those account holders are less likely to view their deposits using a risk-return tradeoff than a depositor using the account for savings and investment purposes. At the same time, business payment accounts may pose greater financial stability concerns than other accounts given that the inability to access these accounts can result in broader economic effects.

However, there are challenges to establishing a practical definition for transaction accounts that merit higher coverage while limiting the ability of depositors and banks to circumvent those distinctions.

It is also worth noting that any change in deposit insurance coverage in the United States would require legislation by the Congress.


Conclusion

In conclusion, the United States has learned a number of important lessons from the regional bank failures of last year.

From a supervisory standpoint, we saw the critical importance of monitoring and managing interest rate risk, unrealized losses, concentrations of uninsured deposits, and operational preparedness for discount window access, as well as compelling compliance when an institution is unresponsive to reasonable supervisory guidance.

From a regulatory standpoint, we are moving forward with rulemakings related to capital requirements for unrealized losses, a long-term debt requirement, and improved resolution planning at the bank level.

If we can follow through on these initiatives, we can make significant progress in lowering the likelihood of the kind of regional bank failures we experienced in the United States last year, with the serious final stability risks they pose.

Last Updated: May 17, 2024