US regulators should take a leaf out of Europe’s rule book
Bank controls have proven far more useful on one side of the Atlantic than the other this year and any regulatory overhaul stemming from the recent debacle in the sector should keep this in mind
It has been a traumatic few months for the banking industry. The US has taken the brunt of the pain, while banks in the EU have fared better, so far.
Regardless, the rules set in place since 2008 were supposed to prevent the sort of shambles that took down Silicon Valley Bank, Signature Bank, Credit Suisse and First Republic Bank. Surely a regulatory overhaul is coming. When it does rule makers in the US should take a close look at what has worked on the other side of the Atlantic Ocean.
JP Morgan may feel it got a who got a pretty good deal on taking over First Republic Bank but the fact that the latter was able to get into the position where it needed rescuing in the first place shows a systemic problem in the US regulatory system.
So many firms either capitulating or needing bail outs in the space of two months is a stinging indictment of US banking protection. If another tumbles after First Republic there will be no excuses.
JP Morgan has paid $182.6bn in cash and assumed liabilities to rescue First Republic and the Federal Deposit Insurance Corporation has been wading into provide guarantees across the sector. Cynics might be forgiven for thinking that any lender outside the top 10 is at risk of failure. The country's banking giants and the FDIC may have deep pockets but there are surely only so many bailouts they can do before the country's banking industry loses serious credibility.
This is not a particularly brave opinion to take. The US prudential banking regulators, including the Federal Reserve, have made it clear that they intend to rethink the rules for mid-sized banks. Stress testing, liquidity and capital buffer requirements are all on the cinder block and those banks free of that sort of scrutiny are very unlikely to be in the same situation in due course.
As GlobalCapital's sister title Euromoney wrote on Tuesday, the deposit insurance system in the country — which has also been under intense scrutiny since March — could use a serious overhaul as well. Confidence is low and less vague oversight from the Fed would go some way to helping restore it.
On Friday, the Federal Reserve announced the results of its review on the supervision and regulation of SVB and the part it played in its downfall. The report laid much of the blame on the board of directors and management of the bank itself, but also on the rule changes enacted during Donald Trump's presidency, when his administration eased the rules for banks of SVB's size, and the Fed’s own supervisory failings. "Following Silicon Valley Bank's failure, we must strengthen the Federal Reserve's supervision and regulation based on what we have learned," said the Fed's vice-chair for supervision Michael Barr, who was echoed by chair Jerome Powell.
It is apparent that something needs to change. The rules set out in the Dodd-Frank Act and tweaked by the Economic Growth, Regulatory Relief, and Consumer Protection Act are no longer fit for purpose.
The EU should provide some inspiration for how to improve the system in the US. First Republic has been teetering on the edge for weeks now, but when Deutsche Bank made nerves fray on March 24 after its share price slid rapidly following a spike in credit default swap spreads, the drama was short lived, and the German outfit emerged unscathed the following week.
That day there were murmurs of contagion around Europe, people questioning the strength of Societe Generale or Monte dei Paschi di Siena and the collapse of several European banks at this point could have been cataclysmic for the global economy. But, as GlobalCapital wrote at the time, the differences in banking regulations between the regions have led to EU banks being better capitalised than those in the US. As a result, market participants believe the eurozone banking sector will be insulated from recent problems originating across the pond.
The European Central Bank declares a bank to be “significant” if it holds more than €30bn of assets, much less than in the US under existing or prior rules. Such banks come under the ECB’s direct supervision and are subject to its stress testing regime, while similar sized banks in the US have very limited oversight by comparison.
Eurozone banks, on average, are also not as reliant on deposits for overall funding as SVB was. Deposits made up 82% of SVB’s total assets, compared to an average of 54% for EU banks, according to ABN Amro.
US banks often outperform their European counterparts in the capital markets and when it comes to earnings. They should have greater reserves in place to protect themselves.
The US authorities have been quick to step in and prevent a more severe crisis from spreading throughout US banking and beyond to the world. That is to their credit. But they should not have been in this situation in the first place. When the emergency fixes are done, the US needs to take a long look at its system of banking governance to prevent another episode like this.