Next Week's Big Week of Congressional Hearings
A (sort of) preview
Next week both the House Financial Services Committee and the Senate Banking Committee are set to continue their inquiries into the recent banking turmoil. On the agenda:
Tuesday, May 16
Federal Reserve Board Vice Chair for Supervision Michael Barr, FDIC Chair Martin Gruenberg, Acting Comptroller of the Currency Michael Hsu, and NCUA Chair Todd Harper appear before the HFSC.
Former Silicon Valley Bank CEO Greg Becker, former Signature Bank Chairman and Co-Founder Scott Shay, and former Signature Bank President Eric Howell (who succeeded to the role just a few weeks before Signature’s failure) appear before the SBC.
Wednesday, May 17
The HFSC holds a two-part hearing. Part I features Mr. Becker and Mr. Shay, while Part II features NYDFS Superintendent Adrienne Harris and CA DFPI Commissioner Clothilde Hewlett.
The SBC holds a hearing on strengthening Federal Reserve Board accountability. Witnesses are set to include Mark Bialek, who serves as Inspector General for the Board and the CFPB, as well as Peter Conti-Brown, Paul Kupiec and Mayra Rodríguez Valladares.
Thursday, May 18
After visiting the House earlier in the week, VCS Barr, Chair Gruenberg, Acting Comptroller Hsu, Chair Harper, Superintendent Harris and Commissioner Hewlett appear before the SBC.
With the typical disclaimer that these are just things I am interested in and not necessarily of the greatest importance, here are a few things I am looking out for.
Seeking More Specificity From the Board’s SVB Report
I realize I have gone on about it at probably too great of length already, but I continue to find the Federal Reserve Board’s report into SVB1 most interesting for its conclusion that part of the blame can be traced back to a change in supervisory tone and approach. I cannot say that conclusion is wrong, but the work done to support that conclusion in the text of the Board’s report is a little incomplete. So, given that these are Vice Chair for Supervision Barr’s first appearances before Congress since the report was released, I hope we get answers on questions like the below.
In interviews with them, what specific examples did examiners give of situations in which they wanted to take supervisory action, or wanted to escalate issues, but felt they could not do so?
The report notes a few instances where certain supervisors wanted to, or could have done, one thing, but ultimately decided to do another. The report often does a poor job explaining why this was the case. For example:
Staff wanted to subject SVBFG to an informal enforcement action, an MOU, in 2021 relating to information technology, but “subsequently dropped the matter because they felt it would not be pursued by policymakers at that time.” What specific things did staff point to that made them feel this way? Did they do anything to press their point? Who or what does “policymakers” refer to in this context? The Board of Governors? Senior Board staff?
SVBFG “could” have been subject to an MRIA relating to its lack of a Chief Risk Officer but “[i]n consultation with Board staff,” supervisors decided not to take that step because the firm was “actively searching” for a CRO. Unless the Board staff knew something about the status of the CRO search that the Reserve Bank did not, this seems like sort of a weird outcome, as presumably the Reserve Bank staff would have known as well as or better than the Board staff that SVBFG was actively searching for a CRO. So what points specifically did Board staff make in these consultations that led to the ultimate conclusion not to issue an MRIA?
It is true, as the report says, that if SVBFG had been subject to the full LCR it would have come up badly short. But according to the report SVBFG failed the regulatorily-mandated internal liquidity stress test to which it was subject. Were there discussions about using this as the basis for a formal or informal enforcement action? Is it the report’s conclusion that, absent the shift in supervisory tone and approach referenced in the report, this sort of violation would have resulted in enforcement action or at least more forceful escalation? I understand one part of the staff’s concern with the Quarles-era changes was an undue need to produce significant documentation to support supervisory conclusions, but this does not seem a like an instance where this would have been the case. Isn’t whether an institution has a sufficient Reg YY liquidity buffer more of a bright line analysis? Without naming the specific firms, are there pre-2018 examples where a bank similarly failed an ILST and was subject to more immediate action?
The report says that both the bank’s supervisory central point of contact and an LFBO analyst at the Board level recommended that the Board not permit SVB under Regulation K to make a $1.8 billion investment in a UK entity in 2022. But ultimately, “staff decided that there were not sufficient grounds to object to the notice.” What specifically led staff to this decision? Is it the report’s conclusion that this is an area where, absent the late 2010s supervisory changes, more forceful action would have been taken? If not, what explains it?
In remarks last week, CFPB Director Chopra said that too many of the current rules are “so complicated with weird formulas, dizzying methodologies, and endless loopholes and carveouts” and that simpler rules are necessary “to prevent future disasters.” Does the Federal Reserve Board agree with Director Chopra? The Board’s SVB report included a sentence saying “reduced complexity of the regulatory structure” could be beneficial as it would allow for the shifting of some bandwidth “away from the supervisory process and more toward understanding and effectively managing the fundamental risk itself.” What specifically did the report have in mind with this passage? What does the Board intend to do to make the regulatory structure less complex?
Last week an EU institution called the European Court of Auditors released a report on the EU supervision of banks’ credit risk. While the report’s focus was different than the Board’s SVB report, some of its conclusions were familiar. The European Central Bank was faulted, for example, for failing to “escalate its supervisory measures for some banks even in the presence of high and sustained credit risk and persistent control weaknesses.” The report also observes that a “lengthy dialogue and approval phase” resulted in final determinations not being made promptly, and as a result those determinations “do not reflect banks’ actual risk profiles.” Should the similarity of these conclusions to those reflected in the postmortem reports by a number of U.S. federal and state regulators lead us to ask whether there is something more fundamentally broken about the current approach to bank supervision that cannot be explained by reference to the actions of a few U.S. regulators in the late 2010s? If so, how do we fix it?
Vice Chair for Supervision Barr has now been in his role for just under a year, and former Vice Chair for Supervision Quarles has not been at the Board since the end of 2021. How has the Board’s supervisory approach changed in that time? What specifically has been done to address changes in approach to supervision under VCS Quarles that the Board now believes were inappropriate? Most importantly, given the confidential nature of much of bank supervision, what is the best way for the public to judge whether the Board’s efforts at re-empowering supervisors have been successful?
Finally, to sneak in a question not directly related to the SVB report: in a speech last Friday, Governor Bowman warned against a “broad-based imposition of new capital requirements on all banks with more than $50 billion in assets.” Understanding that no final decisions have been made, is it true that the Board is actively considering using $50 billion as the cut-off for the imposition of the new rules? This is lower than some were expecting, but maybe I am overreading Governor Bowman.2
Bank Mergers
U.S. federal regulatory policy toward ordinary-course bank M&A has risen back towards the top of the discussion agenda following the May 4 announcement by TD and First Horizon that in light of “uncertainty as to when and if … regulatory approvals can be obtained” the parties would terminate the merger agreement they first signed in February 2022.
First Horizon’s stock has reacted predictably to the news, and though the WSJ has since reported that (unspecified) money laundering issues were the reason for the delay, there have been questions over whether, in the current environment, this sort of thing should really have been allowed to scupper the deal.
Taking things a step further, former Acting Comptroller of the Currency Keith Noreika and former OCC Deputy Comptroller for Public Affairs Bryan Hubbard wrote in the American Banker this week that the TD situation reflects a broken bank merger review process and that current policy amounts to a “de facto ban” on bank mergers.
They would know better than I would, but I am not yet ready to go that far given the large mergers (US Bank-MUFG Union Bank; BMO-Bank of the West) that have gained approval not all that long ago. Even so, the appearance of Acting Comptroller of the Currency Hsu before Congress next week presents an excellent opportunity to get more details on the current federal thinking on bank M&A. Some of these questions will likely be batted away by saying he cannot talk about individual banks, but for instance:
Is it the case that anti-money laundering issues were in fact the hang up in the OCC’s review of the TD Bank-First Horizon deal? Can you say more about what the specific issues were?
Why in your view did these issues rise to the level of something that meant the OCC needed to delay a decision on the merger? This seems especially odd in this case given that no public enforcement actions have been taken against TD Bank recently on AML-related grounds, and that by public appearances the supervisory ratings of TD Bank as of a couple months ago seem to have been satisfactory.3
Another weird thing about this is that the issue has been described not so much as TD being told that the merger would definitely not be approved, but more as TD and First Horizon being unable to get clarity from the regulators as to when a decision would be made either way. Do you agree with this characterization? If so, even if the OCC had legitimate concerns about AML, why was it unable to articulate what it would need to see, and by when, to allow the merger to proceed?
Just this past week, in your capacity as an FDIC board member you issued a statement in support of an FDIC proposed rule because, among other things, the proposal was “intuitive, simple, and fair.” Also, you believed the proposed rule “establishes a healthy precedent” regulators could follow in the future.
Do you believe these statements can fairly be made about the OCC’s approach to bank mergers?
Since you became Acting Comptroller the OCC has (1) approved an acquisition by a large regional bank in a public order without conditions or detailed financial stability analysis; (2) approved a facially similar acquisition by a different large regional bank in a public order that did include certain conditions and a detailed financial stability analysis; (3) approved an acquisition by the U.S. subsidiary of a large Canadian bank in a public order that fell somewhere in between the approach taken in the first two orders; (4) approved a transaction that the FDIC had apparently declined to approve; and (5) now declined to approve (or at least provide a timeline for decision on) a transaction that looks pretty similar to transactions (1), (2), and (3).
To be clear, my contention here is not that all of these transactions were in fact the same and should have been dealt with the same way. It could well be true that bank-specific factors more than justify the approach taken by the OCC in each case. But if the OCC won’t explain why it took the actions it did, how is the public supposed to evaluate whether its actions were in fact justified?
Of course it is also possible Acting Comptroller Hsu gets equally pointed criticism next week from the other direction. As we’ve talked about before, Senator Warren in particular is unimpressed with the OCC’s approach to bank mergers, including the OCC’s recent decision to approve JPMorgan Chase’s acquisition of First Republic Bank. You could easily see a situation next week where the Acting Comptroller faces five minutes of criticism from one side of the dais painting him as a de facto banner of bank M&A, only to turn to the other side of the dais to face five minutes of characterization as someone who waves through every merger he sees.
I should say, I do not think either of these characterizations are particularly fair, and on the substance of all this I am pretty sympathetic to Acting Comptroller Hsu. Either way, he hardly needs or cares about my support or lack thereof.
But if you are going to consistently talk about the need for the OCC to “provide greater transparency and predictability,” and about how regulatory actions should be “intuitive, simple, and fair,” while producing merger review outcomes (to say nothing of charter application outcomes) that are not all that predictable and certainly are not transparent, I do not know what someone who is inclined to be favorable to the Acting Comptroller is supposed to do.4
Executives of Failed Banks
If truth serum existed, responses to the questions asked during the appearances of the former SVB and Signature Bank executives could be the most informative of any at the hearings next week. For example, did the executives themselves notice a shift in the tone or approach of supervision? How did they react to it? Is there any merit to the argument some have made that management found itself distracted by a focus on side issues, rather than core issues relating to liquidity and interest rate risk? What was the deal with those stock sales?
In reality, while I find these questions interesting,5 I expect the answers would unavoidably be colored by self-interest and so would not be very reliable. So other than catharsis and public shaming (both of which have their place), I am not sure I expect the hearings with the executives to produce much.
What could be notable though is the prepared written testimony of the witnesses. This is the executives’ first real chance to publicly explain what they think went wrong. If they take it,6 I am curious to see how their explanations line up with what is already in the public record.
Also, in the category of could be something, could be nothing, I am not sure what to make of the fact that currently Mr. Becker and Mr. Shay are scheduled to testify in front of both the Senate and the House, while Mr. Howell is currently scheduled to appear only before the Senate. Mr. Howell (according to his LinkedIn profile at least) continues to have an active role at a bank, having come over to Flagstar Bank as part of Flagstar’s acquisition from the FDIC of certain assets and assumption of certain liabilities of Signature Bridge Bank. I am not sure if this explains it or if the reason is something more pedestrian like scheduling conflicts.
What Is Fair to Expect From State Bank Supervision?
Most of the federal regulators testifying next week have already appeared before Congress at least once to respond to questions about the current situation. In contrast, next week will mark the first appearances by the New York and California regulators before Congress since the turmoil began.
As previously discussed, the CA DFPI report on SVB emphasizes repeatedly that the Federal Reserve Bank of San Francisco took the lead in the supervision of SVB, with the DFPI deferring to the FRBSF in particular in areas like liquidity, interest rate risk, and market risk in light of the FRBSF’s greater “expertise” in these areas.
So how should we be thinking about this? If the role of state regulators with respect to large banks under their supervision is always going to be ancillary to the role of their federal counterparts, should we make that explicit in some way, so that there is better accountability in terms of who is responsible for what? Or, if you believe as the CA DFPI does that state supervisors sometimes play an important role by “offer[ing] a unique ‘local’ perspective because they may be more familiar with the regional environment, economy, and other financial issues that impact the state,” what needs to be done to make sure that state supervisors are appropriately able to convey those views to their federal counterparts and follow up to make sure they are taken seriously?
Also, the framing here is maybe unfair but I do think the question needs to be asked: At the start of 2023, there were thirteen California-chartered banks with more than $10 billion in total assets. Three of them have now failed or announced plans to liquidate, notwithstanding the unique local perspective the DFPI brought to their supervision. The DFPI's SVB report is a reasonable first step, but is there any plan to look at the DFPI's approach more systematically, given that banks representing around 47% of the total assets of all California state-chartered banks at the start of 2023 have now gone out of business?7
To be super clear, I think a reasonable answer to this sort of question could well be that California is mostly blameless here and that the DFPI’s supervision of California chartered banks, once they become relatively large, truly is a matter primarily handled at the federal level. But if that is true, doesn’t that get us back to the fundamental question of what modern day state supervision of large banks should be for? I feel state regulators sometimes try to have it both ways here, saying that state supervision is very important but also cautioning that we should not expect it to do very much.
General, Inspect Thyself
The subject of the Senate Banking Committee hearing at which he will appear is Federal Reserve Board accountability generally, but one sort of meta area of possible questions for Inspector General Bialek concerns his own accountability.
In late March, Senator Elizabeth Warren and Senator Rick Scott reintroduced a bill that would require the Board/CFPB Inspector General to be appointed by the President and confirmed by the Senate. This would be a change from current law which says the IG is to be appointed by the Chair of the Federal Reserve Board. Senators Scott, Warren and their co-sponsors believe this prevents the IG from being “truly independent” and thus able to fully hold to account the Board and CFPB.
I do not know enough to have a strong view on this, but bring it up because in late April Inspector General Bialek wrote a letter to Senator Scott disagreeing with the assertion that the current setup is insufficient, and offering to “better inform” Senator Scott on the matter.
Inspector General Bialek’s argument is that as a practical matter the Board/CFPB IG is just as independent as Presidentially-appointed inspectors general.
The argument is that a PAS [Presidentially appointed and Senate confirmed] IG for the Board and the CFPB would be a more independent IG. I disagree, and I want to provide you with information about our authorities and operations as a designated federal entity (DFE) IG to better inform you on this matter.
As a DFE IG, we currently have the exact same authorities as PAS IGs to audit and investigate the Board and the CFPB without interference from our agency heads. Specifically, we have unfettered access to all agency records and documents; subpoena authority to require the production of records from nonfederal entities; law enforcement powers, such as executing arrest and search warrants; and the ability to hire our own staff and control our own resources. We also have the same reporting mechanisms at our disposal if attempts are made to resist or object to oversight activities conducted by our office or to significantly delay our access to information. Converting us into a PAS IG would in no way enhance our independence or existing authorities.
Moreover, Inspector General Bialek says, having a Presidentially appointed IG could make the role harder to fill, including because the IG would make less than some of his or her subordinates.8
Converting our office into a PAS IG could also lead to an extended vacancy and difficulty in attracting quality candidates for the position. There are over 1,200 positions that require Senate confirmation in the federal government. The number and length of IG vacancies over the years have raised questions about the effect such vacancies have on the ability of offices of inspector general to carry out their statutory duties and responsibilities. A 2018 study conducted by the U.S. Government Accountability Office found that over a 10-year period, PAS IGs had more and longer IG vacancies than DFE IGs. As of April 2023, there are 13 IG vacancies, 7 of which are PAS IG positions.
Additionally, converting us into a PAS IG would set the position's compensation at level III of the Executive Schedule (plus 3 percent), which is lower than the pay scale the Board has determined is necessary to compete with the private sector and other federal financial regulators and attract and retain talent. Thus, directors of other Board divisions and even subordinate IG staff would earn significantly more than the IG, a dilemma that PAS IGs are now facing and which deters experienced, high-quality candidates from seeking the position.
Again I don’t have a strong view on who is right here, but the suggestion that the Senators supporting this bill could stand to be “better inform[ed]” on this issue seems like something with which they may take issue.
Thanks for reading! Thoughts, challenges, criticisms are always welcome at bankregblog@gmail.com.
As in previous posts, I refer to the report here as the Board’s report, but that itself may become a point of contention during next week’s hearings — see Governor Bowman’s speech on Friday calling the report a “self-assessment prepared and reviewed by a single member of the Board of Governors.” I thought about going with “Barr report” in this post rather than Board report, but that seems a little contentious for a blog that of course always remains studiously neutral. And anyway Chair Powell has said he “agree[s] with and support[s]” Barr’s recommendations, so while not necessarily supported by the full Board, I think for now it is fair to regard the report as reflecting, at least at a general level, the majority view of the Board.
As Victoria Guida of Politico pointed out on Twitter, this could also be a clever effort by Governor Bowman to leave room to categorize a rule that ultimately sets the bar at $100 billion as a win.
As mentioned in a previous post, in early March 2023 TD closed a non-banking acquisition without prior Federal Reserve Board approval. As a general matter, the ability to do so would only have been available to TD if, among other things, its U.S. depository institution subsidiaries were well managed.
So long as I am complaining about the OCC’s lack of clarity in bank merger policy, I should acknowledge that the FDIC has perhaps been an even more difficult regulator to get a read on. The WSJ reported this week that the FDIC “discouraged” State Street’s acquisition of a unit of Brown Brothers Harriman last year, and as the OCC acknowledged in its order approving NYCB-Flagstar, the only reason the transaction was before it in the first place was because “the initial application did not result in Federal Deposit Insurance Corporation (FDIC) approval.” The largest merger approved by FDIC of late, Columbia Bank-Umpqua Bank, got approval from the FDIC in January 2023, more than 13 months after the merger application was first filed and, unusually, more than two months after the Federal Reserve Board had approved the holding company transaction.
Of course the FDIC has not said anything publicly about any of this, and its approach to the recent failed bank auctions has also been accused of sending mixed messages. Liz Hoffman at Semafor reported that in the first attempt at an SVB auction the largest U.S. banks “were initially excluded from the sales process by the Federal Deposit Insurance Corp. and ran out of time as a result” although the FDIC has said this is not true. And of course in more recent auctions large banks have been able to bid, sometimes successfully.
Except maybe the one about the stock sales. I expect that most of the answer here as to why these sales occurred is the boring one: the stock had gone up a lot, so the executives sold some of it. This would be an issue if the executives did so on the basis of confidential information that their banks were not as well run as they may have looked, but I am not sure that is going to turn out to be the case. For SVB, for example, rather famously at this point, the problems that brought down the bank were public.
Of course certain legal and other considerations may argue in favor of keeping any prepared testimony brief.
I am just using dumb simple math here and this shouldn’t be taken too seriously: the FDIC’s data shows that at 12/31/22 there were 103 California state-chartered banks with aggregate total assets of $922,621,327,000. The same data source shows aggregate total assets of SVB, First Republic and Silvergate, again as of 12/31/22, were $433,018,248,000.
This would not make the IG role unique among the federal financial regulatory agencies —SEC Commissioners generally make less than career staff; a bunch of people at the FDIC make more than Chair Gruenberg, etc. But I suppose the (sort of grubby, but almost certainly true) unstated aspect of this argument is that the post-government opportunities for remuneration are probably worse for Inspectors General than they are for agency principals.