Banks should prepare for harsher exams and demands for quicker remediation as regulators step up supervision following recent bank failures.
Regulatory agencies have started intensifying their supervision of banks following the collapses of Silicon Valley Bank, Signature Bank and First Republic Bank, which rank as the third-, fourth-, and second-largest bank failures in US history, respectively. Deposits, liquidity and capital levels will be closely scrutinized, and regulators will have less tolerance for companies that are slow to fix their issues.
"Regulators will be more skeptical of how banks are complying with legal requirements [rather] than good-faith efforts," said Matthew Bisanz, a partner with Mayer Brown's financial services regulatory and enforcement practice. Promises of improvement or even some progress will be greeted with a reply of "you need to get it done," he said.
Banks will soon have much less time to address problem areas, according to Bisanz.
"We're going to see 90 days become 30 days," Bisanz said. "We're going to see 180 days become 60 days."
Regulators are revisiting previously issued Matters Requiring Attention (MRAs) and Matters Requiring Immediate Attention (MRIAs) and scrutinizing the responses to make sure banks are doing what needs to be done to mitigate risks to the banking system, said Peter Dugas, who heads the Center for Regulatory Intelligence at financial consulting firm Capco.
Concentrating on deposit concentrations
Federal regulators said they will enact stricter rules in the wake of the recent bank failures, but such changes could take several years to take effect. In the meantime, they are expected to leverage tools already in their toolbox to step up supervision.
"One issue that I have never really heard regulators focus on before, but have been hearing focus on lately, is the composition of banks' deposits, both in terms of concentrations to depositors and to industries," said James Stevens, co-leader of the financial services industry practice at Troutman Pepper. "They're also focusing, in a way that I hadn't really seen before, on levels of uninsured deposits."
The Federal Deposit Insurance Corp. indicated that it will step up oversight of deposits when it released a report April 28 saying it will consider the need for "enhanced examination guidance" for banks that are overly reliant on uninsured deposit funding or have concentrations in uninsured deposits. The report came after regulators had to cover all the deposits at Silicon Valley Bank, where uninsured deposits comprised 93.8% of its deposit base, and at Signature Bank, where they totaled 89.3%.
The intense focus on deposits could lead to call report changes.
"I think that [reports] will be more focused, similar to the way that you see loan information in greater detail on all reports. You'll see deposits migrating to more detailed reporting," Bisanz said.
Looking at liquidity
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Regulators are also concentrating on liquidity after their fear that banks could have to sell securities at a loss in the event of a liquidity crunch came true with Silicon Valley Bank, which sold $21 billion in securities for a loss of $1.8 billion. That disclosure spurred a run on its deposits, with customers pulling $42 billion in deposits on March 9, according to the California Department of Financial Protection and Innovation's order taking possession of the bank.
Regulators are now stepping up their oversight of banks' funding sources, investment strategies and levels of unrealized losses, Stevens said.
"Regulators may require banks that have higher liquidity risks, paired with large unrealized losses, to raise capital to some extent against those losses," he said.
The regulatory agencies are honing in on two specific metrics as part of this effort: accumulated other comprehensive income (AOCI) and tangible common equity (TCE) ratios.
AOCI captures changes in the value of banks' available-for-sale securities portfolios. As the Federal Reserve ratcheted up interest rates to fight inflation, securities books were pushed underwater. Many US banks ended up recording surges in AOCI losses.
"In a fast-growth business, the AOCI can get out of control pretty fast, especially if you haven't been able to make loans as fast as you're making deposits, and that was certainly the case with SVB," Stevens said.
Reduced Treasury yields and improved pricing on government bonds have led to sequential improvements in AOCI for most public US banks in both the fourth quarter of 2022 and the first quarter of 2023.
Total AOCI at US public banks improved to a loss of $186.78 billion in the first quarter from losses of $206.88 billion and $214.73 billion in the fourth and third quarters of 2022, respectively. Among the top 20 largest US banks, all but one posted a sequential improvement in AOCI in the first quarter.
Regulators are also starting to pay more attention to the TCE ratio, which is TCE divided by tangible assets. The ratio, which can be used to evaluate a bank's ability to absorb potential losses, is not a regulatory ratio, but regulators are keying in on it because AOCI is not included in banks' regulatory ratios — except at global systemically important banks.
"They'll be looking at that, obviously, but there's a tradeoff between capital and profitability, too," Stevens said. "SVB had plenty of capital, it just didn't have enough liquidity to absorb a massive run on the bank."
Like AOCI, most public US banks posted sequential improvements in adjusted TCE in the first quarter.
Other focus areas
Regulators are also looking at other areas they consider potentially risky, such as commercial real estate, and are also taking a fresh look at banks' underwriting and hedging activities.
"Commercial real estate is not going to hit the same everywhere. For example, states like New York and California are probably not as well situated as states like Florida, where the commercial real estate market is doing much better," Dugas said.
