US banking crisis: Building resilience in the face of rising challenges

The collapse of Silicon Valley Bank (SVB) in March 2023 swiftly impacted other regionally concentrated mid-sized banks, prompting more runs, such as those witnessed at Signature Bank and First Republic Bank.

The collapse of SVB was triggered by a substantial mark-to-market loss from a securities-portfolio sale, a failed capital-raising attempt, and subsequent negative rating actions, leading to loss of confidence and significant withdrawal of uninsured deposits. SVB and Signature Bank witnessed the highest one-day withdrawal rates of 20% of pre-run deposits, compared with 2% during the failure of Washington Mutual (WaMu) in 2008 - the largest failure of an insured depository institution by inflation-adjusted total assets.

The rapid and substantial withdrawals of deposits raised concerns about the resilience of U.S. banks, with a large concentration of uninsured deposits and notable declines in the fair values of fixed-rate assets in a rising-rate environment, prompting decisive actions by the U.S. Federal Reserve (Fed) and other agencies.

Swift regulatory response

While the systemic liquidity crisis subsided due to robust regulatory interventions, the remarkable speed of the runs on SVB and Signature Bank - fuelled by electronic withdrawals and social media communication - distinguished them from the past banking crises, underscoring the imperative for enhanced regulatory measures. The U.S. banking crisis this year also spotlighted vulnerabilities in the regulatory framework, particularly in addressing significant asset/liability mismatches, deposit concentration/outflow risks, and regulatory oversights, especially among regionally focused small-to-mid-sized and community banks. These institutions, which enjoy comparatively less stringent regulation than their larger counterparts, faced the consequences of lower resilience and heightened susceptibility to abrupt shocks. In response, the U.S. regulators were swift in taking actions to fortify the banking system through tighter supervision, refining the regulatory framework and bolstering compliance standards across the sector. Apart from other regulatory and supervisory announcements, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) came up with supervisory announcements and consultation papers, specifically focused on mid-sized and regional banks.

Regulatory developments in the right direction

These proposed regulations and supervisory priorities collectively aim to enhance risk governance and monitoring practices at banks to better withstand the ongoing economic challenges. They also focus on strengthening compliance across the banking system, irrespective of size. Accordingly, regulators have increased their scrutiny of supervised institutions.

Notably, in November 2023, regulators took enforcement actions against three banks (asset size of less than $10bn): Vast Bank, National Association (Tulsa, Oklahoma), Heritage Bank, National Association (Spicer, Minnesota), and United Fidelity Bank, FSB (Evansville, Indiana) for gaps in credit underwriting, credit review, credit monitoring, liquidity management, interest-rate risk  management, and governance - highlighting the regulators’ focus on ensuring sound risk-management practices, even at the community banks.

External challenges warrant close monitoring and governance

In addition to the regulatory headwinds, the banking system is also facing rising credit risks from higher-for-longer interest rates and the expectations of a slower economic growth. On top of this, the emerging strain in commercial real estate (CRE) has been a credit concern for U.S. banks, driven in large part by structural changes in the patterns of office utilization and tighter lending standards.  The risk is especially prominent for small and mid-sized US banks, which are more CRE-concentrated and are significantly lending more to late-cycle CRE than their larger counterparts.

Implementation a challenge?

While most large banks, in lieu of their extensive risk-management frameworks, are well equipped to handle the enhanced regulatory requirements, small and community banks remain on the radar. These small-sized banks, which until now were not subject to stringent regulatory reporting, are required to develop extensive data reporting and risk-monitoring systems as well as governance frameworks that will help monitor risks on an ongoing basis. This imposes a substantial financial and regulatory burden on the affected banks, which will require onboarding-specific skillsets to meet the enhanced regulatory demand.

However, limited financial flexibility and the potential challenges of recruiting skilled personnel, particularly for banks situated outside the major metropolitan areas, will necessitate a reliance on external consultants. These experts can assist in establishing robust risk frameworks and streamlined processes to address the evolving regulatory landscape as well as save costs, which would have been higher had the bank onboarded skilled personnel to run transformation programmes.

With more banks coming under the regulatory radar, how they adapt to the new regulatory asks in a stipulated timeframe bears watching.