Fed and FDIC release reports on supervision of failed banks
On April 28, 2023, the Federal Reserve (Fed) board and the Federal Deposit Insurance Corp. (FDIC) both issued reports on the failures three days apart in March of two banks under their respective supervisions.
The Fed’s lengthy report on the failure of Silicon Valley Bank (SVB) details the Fed’s findings after a review of its own supervision of the bank leading up to the failure on March 10, 2023. Fed Vice Chair for Supervision Michael Barr led the review.
The Fed largely blamed SVB’s failure on bank mismanagement and leadership’s failure to manage basic interest-rate and liquidity risk. The report also highlights the board of directors’ failure to oversee senior leadership and hold it accountable. Lastly, the report says that Fed supervision of SVB did not work with sufficient force and urgency and that supervisors did not fully appreciate the extent of the vulnerabilities as SVB rapidly grew in asset size and complexity.
The Fed report touches on the influence of social media; the highly networked, concentrated depositor base; and the technology enabling large withdrawals over a very short period of time. The report notes that the Fed must continue to evaluate its supervisory and regulatory framework, including conducting a holistic review of the capital framework, implementing Basel III, bolstering stress-test scenarios, and improving the resiliency and resolvability of large banks through a long-term debt rule.
According to the report, the Fed will focus on improving the speed, force, and agility of supervision to ensure that supervision stays up to speed as a firm grows in size or complexity. The Fed already has begun to form a dedicated novel activity supervisory group as a complement to existing supervisory teams. The group will focus on the risks of novel activities (such as fintech or crypto activities). The Fed will identify other risk factors such as high growth or concentrations that deserve additional supervisory attention and will evaluate whether to apply standardized liquidity requirements to a broader set of firms.
The FDIC issued a report on its supervision of Signature Bank of New York (SBNY), which failed on March 12, 2023. It cited the root cause of the failure as poor management, saying the bank “pursued rapid, unrestricted growth without developing and maintaining adequate risk management practices and controls appropriate for the size, complexity, and risk profile of the institution.” According to the FDIC, SBNY “funded its rapid growth through an overreliance on uninsured deposits without implementing fundamental liquidity risk management practices and controls.” Additionally, the report notes, SBNY “failed to understand the risk of its association with and reliance on crypto industry deposits or its vulnerability to contagion from crypto industry turmoil that occurred in late 2022 and into 2023.”
Similar to the Fed, the FDIC report notes that the FDIC could have acted sooner to take supervisory actions, consistent with the forward-looking supervision concept of the Division of Risk Management Supervision. In addition, the FDIC could have produced timelier exam work products and more effective communication with SBNY’s board and management.
The FDIC report identifies matters for further study, including consideration of the need for more examiner guidance on supervising banks that are overly reliant on uninsured deposits.
FDIC proposes special deposit insurance assessment
On May 11, 2023, the FDIC board approved a proposed rule, “Special Assessments Pursuant to Systemic Risk Determination,” that would implement a special assessment to recover the cost associated with protecting uninsured depositors following the closures of SVB and SBNY. The Federal Deposit Insurance Act requires the FDIC to recover any losses to the deposit insurance fund as a result of the systemic risk determination, announced on March 12, 2023, to protect uninsured depositors of the two failed banks.
The base for the special assessment would be equal to an insured depository institution’s (IDI) estimated uninsured deposits reported as of Dec. 31, 2022, adjusted to exclude the first $5 billion in estimated uninsured deposits from the IDI. For IDIs that are part of a holding company, the $5 billion deduction would be apportioned based on its estimated uninsured deposits as a percentage of total estimated uninsured deposits held by all IDI affiliates. The FDIC is proposing to collect the special assessment at an annual rate of approximately 12.5 basis points over eight quarterly assessment periods. The FDIC would begin collecting the special assessment beginning with the first quarterly assessment period of 2024 (Jan. 1 through March 31, 2024), with an invoice payment date of June 28, 2024. The special assessment rate is subject to change depending on any adjustments to the loss estimate, mergers or failures, or amendments to reported estimates of uninsured deposits.
The FDIC estimates that 113 banks would be subject to special assessments – 48 with more than $50 billion in total assets and 65 with total assets between $5 billion and $50 billion. No banks with less than $5 billion in assets are expected to pay special assessments. The FDIC estimates banks with greater than $50 billion in assets will pay more than 95% of the special assessment.
Comments are due 60 days following publication in the Federal Register.
FDIC outlines options for deposit insurance reform
The FDIC on May 1, 2023, issued a comprehensive report on its review of the deposit insurance system, which was prompted by recent bank failures. The report evaluates three options for reforming deposit insurance: the limited coverage option that currently exists, an unlimited coverage system that would cover all deposits, and a targeted system that would allow for different levels of deposit insurance coverage across different types of accounts and provides greater coverage for business payment accounts.
The FDIC’s report presents the three options, including some advantages and disadvantages of each, along with complementary supervision tools for consideration. According to the report, the current limited coverage system does not address the risk of bank runs associated with high concentrations of uninsured deposits, even with an increase in the insurance limit. An unlimited system in which all deposits are fully insured would mostly eliminate bank runs but also would eliminate depositor discipline and might induce banks to take excessive risks.
The best option for balancing financial stability and depositor protection, according to the report, is a targeted coverage deposit insurance system in which additional coverage would be extended to business payment accounts. The FDIC suggests the targeted approach is the most promising option but acknowledges it has “significant, unresolved practical challenges” to implementation. Any modification to the deposit insurance coverage level must be approved by Congress.
The FDIC report does not address a possible special assessment fee to make up for the impact to the Deposit Insurance Fund resulting from the FDIC’s systemic risk exemption and unlimited coverage associated with the SVB and SBNY failures. An FDIC proposal on the special assessment is expected in May 2023.
OCC and FDIC issue guidance on overdraft fee program risks, CFPB citations
The Office of the Comptroller of the Currency (OCC) and FDIC on April 26, 2023, issued separate guidance addressing the risks associated with certain bank overdraft protection programs. Both agencies provide some background information on overdraft programs and address certain practices that might result in heightened risk exposure and violating Section 5 of the Federal Trade Commission Act, which prohibits unfair or deceptive acts or practices.
The OCC bulletin and FDIC financial institution letter (FIL) specifically highlight overdraft fees charged on transactions authorized against a positive balance but settled on a negative balance, often referred to as “authorize positive, settle negative” (APSN).
The OCC and FDIC also describe certain risk mitigation practices that might assist banks in managing risks associated with overdraft programs. The OCC bulletin mentions assisting customers in avoiding unduly high costs and implementing fees and practices that bear a reasonable relationship to the risks and costs of providing overdraft services. The FDIC FIL emphasizes the role third parties play in processing transactions and encourages institutions to review their third-party relationships to verify appropriate quality control over third-party arrangements and to review and understand the risks presented by third-party system settings for overdraft-related fees.
In its March 2023 “Supervisory Highlights,” the Consumer Financial Protection Bureau (CFPB) says the CFPB has cited institutions for unfairness in charging consumers APSN overdraft fees. These citations followed a circular the CFPB issued in October 2022 saying that overdraft fees assessed by financial institutions on transactions that a consumer “would not reasonably anticipate,” including APSN overdraft fees, are “likely unfair.”
FDIC issues reminder of shorter settlement cycle for broker-dealer transactions
The FDIC on April 27, 2023, issued an FIL to remind FDIC-supervised institutions of the Securities and Exchange Commission (SEC) rule implementing a shortened settlement date from two days (T+2) to one day (T+1) for most broker-dealer transactions. The SEC rule was effective May 5, 2023, with a compliance date of May 28, 2024, and the FDIC advised institutions to update their systems, operations, and processes to facilitate an orderly transition.
