Recent Bank Failures Show More Oversight of Midsize Lenders Needed, Fed’s Powell Says

Federal Reserve Board Chairman Jerome Powell testifies before a House Financial Services Committee hearing on the Federal Reserve's Semi-Annual Monetary Policy Report, on Capitol Hill in Washington on June 21, 2023. Stefani Reynolds/AFP via Getty Images

The collapses of Silicon Valley Bank (SVB) and Signature Bank in March show that more oversight of midsize lenders is needed, Federal Reserve (Fed) Chair Jerome Powell told lawmakers in his semi-annual testimony.

While banking stress occurred in the fallout of the SVB and Signature failures, the Fed chair said that “the U.S. banking system is sound and resilient.” At the same time, the turmoil that unfolded earlier this year highlights the importance of maintaining a set of “appropriate rules and supervisory practices” for banks similar in size to SVB and Signature.

“The recent bank failures, including the failure of Silicon Valley Bank, and the resulting banking stress have highlighted the importance of ensuring we have the appropriate rules and supervisory practices for banks of this size,” Powell said.

It’s still critical to refrain from overregulating small and midsized banks that would weigh on operations and prevent them from lending to clients, Powell told the House Financial Services Committee on June 21.

After hearing statements from Powell, Fed Vice Chair Michael S. Barr, and other U.S. officials who have assured everyone that the financial system is well-capitalized and highly liquid, Republican lawmakers sought clarity as to why there would need to be additional regulation and supervision.

When asked whether an increase in capital requirements for SVB or other banks that had gotten into trouble would have prevented the turmoil from happening, Powell responded that “it’s a hypothetical, unknowable question.”

A security guard at the failed Silicon Valley Bank monitors a line of people outside the office in Santa Clara, Calif., on March 13, 2023. Justin Sullivan/Getty Images

“I think it might have helped,” he said. “Clearly, the main issue there was a failure of management to follow up, and a failure of supervision to require them to follow up. Really, the liquidity regulation was not appropriate. We needed to have stronger regulation around liquidity and uninsured deposits.”

But Powell purported that public officials need to understand that there is a trade-off between higher capital standards and economic growth.

In a separate exchange, Powell explained that one of the issues was that SVB’s management failed to manage the company’s interest-rate risk. Most U.S. financial institutions accurately handled the central bank’s quantitative tightening cycle, he noted. Supervisors pointed out to SVB managers that they faced risks, and the California-based bank should have acted more quickly.

“You can say that it was interest rate hikes that caused portfolio losses, but it was management that failed to hedge against those losses and failed to hold appropriate liquidity,” Powell stated.

Is the Banking Crisis Over?

Three of the four largest bank failures in U.S. history occurred this year and it’s unclear if the banking crisis is over.

The Office of the Comptroller of the Currency (OCC) recently published its semi-annual risk report, reaffirming that the banking system is “sound” after conducting the spring stress test. The report confirmed that banks are increasing their cash holdings and borrowing capacity to offset possible depositor drawdowns.

Michael Hsu, acting head of the OCC, revealed on June 14 that banks had strengthened their liquidity positions but that they must remain on guard for potential challenges. Financial institutions must take another look at their exposures, institute strong risk management practices, and preserve capital, according to the OCC review.

“Hope for the best, prepare for the worst,” Hsu told reporters. “We hope [the stability] continues, but we are prepared and preparing for volatility to return.”

In a panel discussion at the New York Fed Bank on June 20, Barr said the central bank is considering strategies to fasten the process of bank oversight and stress tests after regulators identify issues.

“We’re not an institution that moves quickly on supervisory issues,” Barr said. “We tend to have a culture that makes it difficult for the institution to act quickly with respect to supervision.”

Barr also acknowledged that the Fed needs to explore a widespread “reverse stress test” to help envision various situations that might force a bank to fail.

“Instead of thinking of a stressful scenario and then seeing how it would play through on, say, the balance sheet of a firm, you look at a bank, and you say, well, what would it take to break this institution? What are the different ways this institution could die, or a piece of it, a significant piece of it?” he said. “We’re beginning to do that kind of thinking. I’d say we’re pretty nascent in it.”

Michael Barr testifies at the Senate Banking, Housing, and Urban Affairs at the U.S. Capitol on May 19, 2022. Tasos Katopodis/Getty Images

Although the meltdown this past spring hasn’t devastated the economy as some had initially worried, fears of a credit crunch persist.

The National Federation of Independent Business’s Small Business Optimism Survey found that future credit conditions are expected to weaken. Nearly 54 percent of households believe that credit will be harder to obtain one year from now, according to the New York Fed’s Survey of Consumer Expectations.

In its latest Global Economic Prospects report, the World Bank warned that restrictive credit conditions and tighter monetary policy will weigh on the international economy in the second half of 2023, “with weakness persisting into 2024.”

“Several large banks in advanced economies have failed this year. More—and more disorderly—bank failures represent a key risk,” the World Bank wrote. “The negative effects would be greatest if banking turmoil were to escalate into a systemic crisis, transmitted around the world via cross-border financial linkages. This would result in a severe downturn in the global economy in 2024—global growth could decline to just 0.3 percent. A severe credit crunch confined mostly to advanced economies would do lesser though still serious damage, reducing global growth in 2024 to 1.3 percent.”

Meanwhile, commercial bank deposits have yet to recover from the sharp withdrawals that took place in March, although there had been a steady downward trend going back to July 2022. For the week ending June 7, all commercial bank deposits were down by nearly 5 percent from the same time a year ago, totaling $17.203 trillion, according to the Fed’s H.8 data.

Bank credit has also been on a downward trajectory since March, falling by close to 2 percent.