Senate Banking Committee Issues Testimony From FDIC Chair Gruenberg
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I am pleased to appear at today's hearing on "Oversight of Financial Regulators: Financial Stability, Supervision, and Consumer Protection in the Wake of Recent Bank Failures," to discuss the condition of the banking industry and the
State of the Banking Industry
The banking industry has proven to be quite resilient during this period of stress. Early reports from first quarter 2023 indicate that first quarter aggregate bank net income was roughly unchanged compared to the fourth quarter, excluding the effects on acquirers' incomes of their acquisitions of failing banks. In addition, asset quality metrics remain favorable, and the industry remains well capitalized. Recent declines in medium- and long-term rates have reduced somewhat the volume of unrealized losses on securities.
Risks to the outlook include the potential for weakening credit quality and profitability that could result in further tightening of loan underwriting, slower loan growth and higher provision expenses. Commercial real estate (CRE) loan portfolios, particularly loans backed by office properties, face challenges should demand for office space remain weak and property values continue to soften. Higher interest rates and reduced property values may contribute to increased financing costs and make refinancing CRE loans more difficult.
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1 12 U.S.C. Sec. 1823(c)(4)(G)(ii).
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Notably, the recent banking turmoil exacerbated deposit movement to other deposit accounts or non-deposit alternatives outside of the banking system2 and accelerated an already developing trend of increasing deposit costs seen in the 46 basis point increase between the third and fourth quarters of 2022. While the FDIC Quarterly Banking Profile data will not be available until later this month, early reports from first quarter 2023 indicate that deposit costs have risen more than asset yields, which may result in a tightening of net interest margin for some banks.
Securities and other assets with longer maturities and lower yields may hinder earnings and adversely affect bank balance sheets in coming quarters, further limiting the ability of banks to lend, raise capital, or restructure. Banks with high levels of mortgages may be particularly impacted, as these loans, even commercial mortgages, tend to have at least certain periods where payments are made based on fixed rates. As noted above, recent declines in medium and long-term rates have reduced somewhat the volume of unrealized losses on securities.
The economy slowed in recent months in part from higher interest rates and inflation, and the outlook for 2023 weakened in March. Stress in the banking system may reduce credit availability and slow economic growth. Credit tightening is likely to be most prominent in banks that experienced the largest deposit outflows during the banking turmoil, although the banking industry in aggregate could tighten lending as a reaction to general liquidity concerns. Early reports from first quarter 2023 indicate some slowdown in quarterly loan growth as deposit outflows have continued. Banks have already begun to tighten underwriting standards over the past year across a range of household and business loans, and they tightened further in the first quarter of this year.3 The
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2 Balances at institutional
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Liquidity Monitoring
Over the past two months, the
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8 to nearly
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Condition of the
As of
On
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4 The BTFP provides qualified institutions with eligible securities the ability to access longer term (one year) funding at par, which should alleviate the need to sell those securities at a loss in times of stress, as happened at
5 Federal Reserve Statistical Release, H.4.1 Factors Affecting Reserve Balances,
6 The reserve ratio is calculated as the ratio of the net worth of the DIF (fund balance) to the value of the aggregate estimated insured deposits at the end of a given quarter. See 12 U.S.C. 1813(
7 Section 7(b)(3)(E) of the Federal Deposit Insurance Act, 12
8 2020 FDIC Restoration Plan, 85 FR 59306 (
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The
The remaining estimated loss from the failures of
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9 2022 FDIC Amended Restoration Plan, 87 FR 39518 (
10 See FDIC: PR-21-2023
11 The cost estimate for the sale of the
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As required under the Restoration Plan, the
Recent Bank Failures
On
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12 See SVB Financial Group Form 8-K (
13 See Silvergate Capital Corporation Press Release, Silvergate Capital Corporation Announces Intent to
14 See New York Times, "
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Contagion effects from SVB's failure began to spread through traditional media, social media, and short sellers to other banks with perceived similar risk characteristics, notably, those with high levels of uninsured deposits, concentrations of customers in the venture capital and tech industries, and high levels of unrealized losses on securities. Contagion effects initially manifested in large declines in stock prices and then in deposit outflows at certain other banks. For two of these banks -
Consolidated Reports of Condition and Income (Call Report).16 In accordance with
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16 See Call Report Schedule RC-B, Securities.
17 The Financial Accounting Standards Board Accounting Standards Codification (ASC) addresses fair value. ASC Topic 820, Fair Value Measurement, defines fair value, establishes a framework for measuring fair value, and addresses financial statement disclosures about fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the asset's or liability's principal (or most advantageous) market at the measurement date. This value is often referred to as an "exit" price.
18 The amortized cost basis, net of allowances for credit losses, exceeded the fair value by
19 See "Monetary Tightening and
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First Republic Bank Closing
On the day the run on SVB began,
On
On
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20 JPMorgan Chase & Co., Citigroup Inc., Bank of America Corp., and Wells Fargo & Co. each made a
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On
During the week of
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21
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As part of the transaction, the
The
Silicon Valley Bank Receivership
On
As of
At SVB, for which 88 percent of domestic deposits were uninsured at the point of failure, the portion of the total estimated loss of
The
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22 See FDIC Announces Retention of Financial Advisor to Assist with the Liquidation of Securities of the
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Signature Bank Receivership
On
As of
The
As with the securities retained from the SVB receivership, the
The
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23 See FDIC Announces Retention of Financial Advisor to Assist with the Liquidation of Securities of the
24 See FDIC Announces Upcoming Sale of the Loan Portfolio from the
25 12 U.S.C. Sec. 1823(d)(3)(D)(v).
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The
Internal Review of the
Following the failure of
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26 See FDIC Releases Report Detailing Supervision of the
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Causes of Failure and Material Loss
The report of the
The
While the report of the
Additionally, the report found that the
From 2017 to 2023, the
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27 Bank examiners review and evaluate an institution's condition using the Uniform Financial Institutions Rating System, also known as CAMELS (Capital, Asset quality, Management, Earnings, Liquidity, and Sensitivity to market risk). CAMELS ratings are scored on a scale of "1" (best) to "5" (worst). Examiners assign a rating for each CAMELS component and an overall Composite rating.
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The report of the
Proposed Special Assessment
The failures of
On
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28 12 U.S.C. 1823(c)(4)(G).
29 See Notice of Proposed Rulemaking on Special Assessments Pursuant to Systemic Risk Determination, available at https://www.fdic.gov/news/board-matters/2023/2023-05-11-notice-dis-a-fr.pdf.
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Defining the assessment base in this way would effectively exclude most small banks from the special assessment. In implementing the special assessment, the law requires the
Based on data reported as of
The
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30 12 U.S.C. 1823(c)(4)(G)(ii)(III).
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As proposed, the
Consistent with generally accepted accounting principles, it is assumed that the effects of the special assessment on capital and income would be recognized in one quarter only. Given the estimated loss amount, the
Comments on the proposal are due 60 days from the date of publication in the
Review of the Deposit Insurance System
The
The failures of
At its peak in 2021, the proportion of uninsured deposits in the banking system was 46.6 percent, higher than at any time since 1949. Uninsured deposits are held in a small share of accounts but can be a large proportion of banks' aggregate funding, particularly among the largest ten percent and largest one percent of banks by asset size. Large concentrations of uninsured deposits, or other short-term demandable liabilities, increase the potential for bank runs and can threaten financial stability.
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31 The current deposit insurance requirements may be found in the FDI Act, 12 U.S.C.
32 See FDIC Releases Comprehensive Overview of Deposit Insurance System, Including Options for Deposit Insurance Reform,
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The ubiquity of social media and mobile banking may mean that bank runs, when they occur, happen much faster than they have in the past. Technological advances in the financial sector allow for large financial transactions to occur with unprecedented ease. Depositors can easily set in motion the transfer of millions of dollars, open and close accounts, link bank accounts with other financial accounts, and move funds across asset classes. In addition, the role of social media in the SVB depositor run illustrates the dynamics that can arise. Social media posts advised depositors to withdraw funds from SVB, and uninsured depositors did so all at once. The concentration of these large deposits in technology industry firms and individuals who appear to have been part of closely overlapping virtual communities may have contributed to the synchronized nature of the deposit outflows.
The effectiveness of deposit insurance depends upon how it is used with other policy tools. Regulation and supervision play important roles in constraining moral hazard and supporting financial stability. Tools such as capital requirements and supervision of bank growth can reduce moral hazard that arises from deposit insurance, and regulation and supervision of liquidity can help reduce run risk.
This report evaluates three options to reform the deposit insurance system: (1) Limited Coverage, which maintains the current structure of deposit insurance in which there is a finite deposit insurance limit (possibly higher than the current
Because losses on uninsured deposits associated with business payments are most likely to create spillovers, providing higher coverage on these deposits increases financial stability without expanding the safety net more broadly. Relative to savings and investment accounts, business payment accounts are less likely to seek yield and are more difficult to diversify across banks in the current system to obtain full deposit insurance. However, there are significant unresolved practical challenges to Targeted Coverage, including defining accounts for additional coverage and preventing depositors and banks from circumventing differences in coverage.
It should also be noted that all of the options for expanding deposit insurance coverage examined in the study would require Congressional action. The
Update on the
Strengthening and Modernizing the Community Reinvestment Act
On
Finalizing the Basel III Capital Rules
After the global financial crisis of 2008, the
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33 See Joint Notice of Proposed Rulemaking: Community Reinvestment Act, 87 FR 33884 (published
34 Comment submission closed on
35 See Basel III, International Framework for Banks, available at https://www.bis.org/bcbs/basel3.htm.
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In
The agencies plan to seek public input on the new capital standards for large banking organizations and are currently developing a joint proposed rule for issuance as soon as possible. Community banks, which are subject to different capital requirements, would not be impacted by the proposal, given their limited overall size and trading activities.
Resolution-Related Long-Term Debt Requirement for Large Banking Organizations
In
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36 See Agencies Reaffirm Commitment to Basel III Standards, FDIC PR-65-2022, (
37 Resolution-Related Resource Requirements for Large Banking Organizations, 87 Fed. Reg. 64170 (
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The comment period for the ANPR closed on
Reviewing the Bank Merger Process
The Bank Merger Act of 1960 (BMA) established a framework that requires, in general, approval by the
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38 Bank Merger Act, Pub. L. 86-463, 72 Stat. 129 (1960); Bank Merger Act Amendments of 1966, Pub. L. 89-356, (codified as amended at 12 U.S.C. 1828(c)(2018)), available at https://www.fdic.gov/regulations/laws/rules/1000-2000.html#1000sec.18c.
39 12 U.S.C. Sec. 1828(c)(1) and (2).
40 12 U.S.C. Sec. 1828(c)(5).
41 12 CFR part 303, available at https://www.fdic.gov/regulations/laws/rules/2000-250.html and 63 FR 44762,
42 Request for Information and Comment on Rules, Regulations, Guidance, and Statements of Policy Regarding Bank Merger Transactions, 87 Fed. Reg. 18740 (published
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Although there has been a significant amount of consolidation in the banking sector over the last thirty years, facilitated in part by mergers and acquisitions, there has not been a significant review of the implementation of the BMA by the agencies in that time. Additionally, the prospect for continued consolidation among both large and small banks remains significant. Particularly in light of recent events, a review of the regulatory framework implementing the BMA is both timely and appropriate.
The comment period closed on
Conclusion
The banking industry has proven to be quite resilient during this period of stress. Early reports from first quarter 2023 indicate that first quarter aggregate bank net income was roughly unchanged compared to the fourth quarter, excluding the effects on acquirers' incomes of their acquisitions of failing banks. In addition, asset quality metrics remain favorable, and the industry remains well capitalized. Recent declines in medium- and long-term rates have reduced somewhat the volume of unrealized losses on securities.
Nevertheless, there are significant downside risks to the outlook. These include the potential for weakening credit quality and profitability that could result in further tightening of loan underwriting, slower loan growth, and higher provision expenses. CRE loan portfolios, particularly loans backed by office properties, face challenges should demand for office space remain weak and property values continue to soften.
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43 Comments received are available at https://www.fdic.gov/resources/regulations/federal-register-publications/2022/2022-rfi-rules-regulations-statements-of-policy-regarding-bank-merger-transactions-3064-za31.html.
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Given these risks, the
Finally, the failures of
The
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Original text here: https://www.banking.senate.gov/download/gruenberg-testimony-5-18-23
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