Banking Groups React To Barr's Proposed Regulations

Fed Vice Chair for Supervision Michael Barr said Tuesday that he plans to pursue multiple regulatory initiatives that would direct larger banks with more than $100 billion in assets to hold more in reserve, saying the recent bank failures underlined the need for regulators to bolster resilience in the system.

Barr introduced his proposals in an April review after the collapse of Silicon Valley Bank.

"Following Silicon Valley Bank's failure, we must strengthen the Federal Reserve's supervision and regulation based on what we have learned," said Vice Chair for Supervision Barr. "This review represents a first step in that process—a self-assessment that takes an unflinching look at the conditions that led to the bank's failure, including the role of Federal Reserve supervision and regulation."

Industry professionals praised Barr accepting responsibility for some of the Fed’s shortcomings, and addressing their own supervisory failings that contributed to the demise of the bank. But special interest groups argue the policy recommendations included in the 114-page report are misguided, particularly those relating to regulatory changes.

Assigning Responsibility

Kevin Fromer, president and CEO of the Financial Services Forum, a trade group that represents the eight largest banks in the country, took issue with Barr's calls for heightened capital requirements for all large banks in the wake of the failure.

He argued that Barr is using the unique circumstances surrounding Silicon Valley Bank — a fast-growing bank with a distinct business model and distinctively poor risk management capabilities — to justify industry-wide changes.

Similarly, Greg Baer, president and CEO of the lobbying group Bank Policy Institute, pushed back against Barr's assessment that regulatory changes ushered in by the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018, also known as S. 2155, played a role in the bank's failure.

Instead, Baer said, the issue was that Fed supervisors — from both the Board of Governors in Washington and the Federal Reserve Bank of San Francisco — failed to act on clear signs that the bank was in trouble, including the fact that it failed its own internal stress tests and that it had insufficient hedges on its interest rate risk exposures.

"Put simply, there is no provision of S. 2155 that requires examiners to misjudge interest rate risk," Baer said in a written statement, "the examination materials make clear that nothing in S. 2155 prevented them from properly examining it."

Rob Nichols, president and CEO of the American Bankers Association, took a less hard-lined stance against the Fed.

"We take any bank failure seriously, and we will review the findings and proposed policy changes in these reports carefully, including where the conclusions may differ," he said in a written statement.

"At the same time, we urge policymakers to refrain from pushing forward new and unrelated regulatory requirements that could limit the availability of credit and the ability of banks of all sizes to meet the needs of their customers and communities when these reports suggest that existing rules were sufficient," closed Nichols.

Alexa Philo, a senior policy analyst for banking at American for Financial Reform and a former examiner for the Federal Reserve Bank of New York, said Barr's report was "notably light" on the role changes by current and past Fed leaders contributed to the situation at Silicon Valley Bank.

"Powell supported a light-touch approach to banking regulation and supervision before he even became chair, and Quarles handled these matters directly," Philo said. "Yet the report gives us only vague impressions of lower-level officials about leadership, not concrete evidence."

“Holistic Review”

In a speech to the Bipartisan Policy Center on Wednesday, Barr introduced his framework for a “holistic review” of bank regulation practices.

“The holistic review began well before [SVB], of course, and the steps proposed here address shortcomings in capital standards that did not begin in March of 2023,” he said. “But in an obvious way, the failures of SVB and other banks this spring were a warning that banks need to be more resilient.”

The plan proposes banks with more than $100 billion in assets adhere to a higher reserve capital requirement. The banks which would qualify, according to Fed data, include Citizens Financial Group, Fifth Third, Huntington and Regions.

Most banks already have enough capital to meet the new standards Barr has envisioned, and firms that must raise capital would likely be able to do so in less than two years of retained earnings, while maintaining their investor dividends.

“With respect to stress testing, I believe that the stress capital buffer framework is sound. At the same time, I believe that the stress test should continue to evolve to better capture risk,” he added.

Regulators are likely to continue to change the Supervisory Stress Test to meet the requirements of any new framework.

Basel III Endgame

Commenting on the nearly finalized regulatory framework known as Basel III Endgame, Barr noted that there was a consensus among the Basel jurisdictions that banks should be required to hold a higher minimum capital requirement.

Multiple reviews, beginning in 2017, found that banks are likely to underestimate their credit risk, a finding that may be confirmed later this year as many commercial real estate backed loans approach maturity or their refinancing deadlines.

“Currently, large banks use their own internal models to estimate certain types of credit risk. These internal models for credit risk suffer from several deficiencies. Experience suggests that banks tend to underestimate their credit risk because they have a strong incentive to lower their capital requirements,” Barr noted.

“Standardized credit risk approaches—meaning we apply the same requirements to each bank and not let each bank develop their own requirements—appear to do a reasonably good job of approximating risks,” he added.

A related proposal to the Basel Endgame could impose a long-term debt issuance requirement for all major banks. Currently, there is no such requirement. Regulators believe long-term debt improves the chances of recovery should a bank collapse given the convertible nature of such securities, and would also reduce the burden on the FDIC, which currently absorbs the majority of losses should a bank collapse.