Editor’s Note: The NYU School of Law Program on Corporate Compliance and Enforcement (PCCE) is watching the recent banking crisis and failures of Silicon Valley Bank, Signature Bank, and First Republic Bank. In this post, lawyers at Cleary Gottlieb Steen & Hamilton LLP analyze the reports released by the Federal Reserve, the FDIC, and GAO, and the NYDFS.

by Derek Bush, Hugh C. Conroy, Jr., Patrick Fuller, Lauren E. Semrad, Julia A. Knight, Megan Lindgren, Rishi Kumar, and Abby Shamray

In late April, several banking regulators and the Government Accountability Office released reports analyzing factors that contributed to the failures of Silicon Valley Bank and Signature Bank, while at the same time suggesting areas of forthcoming supervisory focus and regulatory change.[1] The “FRB Report,” led by Federal Reserve Board (“FRB”) Vice Chair for Supervision Michael Barr, analyzes the supervision and failure of SVB Financial Group and Silicon Valley Bank (together, “SVB”).[2] The “FDIC Report,” led by the Federal Deposit Insurance Corporation’s (“FDIC”) Chief Risk Officer, and the “NYDFS Report,” led by the New York Department of Financial Services (“NYDFS”) Office of General Counsel, examine the supervision and failure of Signature Bank.[3] The “GAO Report” focuses on how the responsible bank regulatory agencies regulated and supervised SVB and Signature Bank, and how the agencies responded to the March 2023 turmoil.[4]

These reports offer a detailed look into the bank supervisory process and provide important insights into regulatory and supervisory changes that may be on the horizon. In this post, we summarize our expectations for potential regulatory and supervisory developments.

Executive Summary of Key Takeaways

• The Reports provide a detailed regulatory self-assessment. The FRB, FDIC, and NYDFS each identify a number of ways in which supervision fell short and could be improved. In particular, supervisors at times failed to identify or escalate issues in a timely manner, and bank management was often slow to remediate important issues identified by supervisors. The FRB Report releases a large amount of confidential supervisory information in an effort to increase transparency of the events leading up to SVB’s failure.
• Supervisory staff will more quickly escalate and take action on identified issues and will more aggressively scrutinize firms that are growing rapidly. Each Report faults a lack of urgency of supervisory action, particularly considering the rapid growth of the banks. We expect that supervisory staff will more quickly escalate and act on supervisory concerns going forward, which is likely to lead to higher numbers of exam findings and more frequent (and quicker) enforcement actions.
• Regulatory focus on interest rate risk, liquidity requirements, capital and resolution-related requirements will increase. Possible measures under consideration include applying standardized liquidity requirements to more firms; changing the treatment of uninsured deposits; strengthening capital requirements; and applying long-term debt and other enhanced resolution-related requirements to more firms.
• The “tailoring framework” implemented in response to the 2018 Economic Growth, Regulatory Relief and Consumer Protection Act (“EGRRCPA”) will be revisited.[5] The FRB Report characterizes the tailoring approach and related supervisory developments as having combined to create a weaker regulatory framework for a firm like SVB.
• There will be a more acute supervisory focus on uninsured deposits and a new appreciation for the possible speed of deposit runs considering new technology. The Reports observe that the pace of deposit runoff at SVB and Signature was unprecedented and attribute it to a combination of factors, including high levels of uninsured deposits as well as new technology. A May 1 FDIC report on options for insurance reform also concludes these factors have increased the risk of bank runs and analyzes options for reform to the U.S. deposit insurance system.[6]
• There will be stronger emphasis on oversight by bank boards and management, as well as increased scrutiny with respect to incentive compensation. Each of the Reports find considerable fault with the boards and management of the failed banks.
• There will be increased supervisory pressure on operational readiness. The Reports characterize SVB and Signature as being insufficiently prepared to access sources of liquidity in their final days.

Regulatory and Supervisory Implications of Recent Reports

The Reports provide important indicators of possible changes to the supervision and regulation of insured depository institutions (“IDIs”) and bank holding companies (“BHCs”) that could be implemented or proposed in the near term.

Banking supervisors will focus on improvements to their own supervisory processes and cultures.

The Reports assess the ways in which supervisory processes may have contributed to the failure of SVB and Signature Bank. A common theme that emerges is that supervisors often identified pertinent issues but did not escalate and compel the resolution of these issues quickly enough. In his letter accompanying the FRB Report, Vice Chair Barr suggested that supervisors could be given new tools to incentivize banks to remediate supervisory and regulatory issues.[7] For example, inadequate risk controls could trigger “[higher] capital or liquidity requirements” or “limits on capital distributions or incentive compensation,” a significant change to current practice.

The FRB Report points to EGRRCPA and the tenure of the former Vice Chair for Supervision, Randal Quarles, as sources of a shift in supervisory culture that contributed to delays. Former Vice Chair Quarles has since firmly pushed back on the idea that there was a “shift in the stance of supervisory policy” during his tenure.[8]

The FRB will revisit the “tailoring framework.”

EGRRCPA’s changes to the thresholds for applying enhanced prudential standards under the Dodd-Frank Act and the resultant tailoring framework receive close attention in the FRB Report. Vice Chair Barr suggests that the FRB will revisit the enhanced prudential standards that apply to BHCs that have between $100 billion and $250 billion in assets. EGRRCPA raised the threshold for the application of enhanced prudential standards from $50 billion to $250 billion. However, it gave the FRB the discretion to impose enhanced prudential standards on BHCs with $100 billion to $250 billion in total assets. Therefore, the FRB should not need Congressional approval to modify requirements or impose additional standards on BHCs in this range. There are by no means consensus views on how or if the tailoring framework should be recalibrated, and political dynamics are highly likely to affect the debate over additional tailoring.

Regulators will re-emphasize bank liquidity requirements.

Vice Chair Barr asserted that the FRB would “consider applying standardized liquidity requirements to a broader set of firms.” The standardized liquidity requirements include the liquidity coverage ratio (“LCR”) and the net stable funding ratio (“NSFR”), and thresholds for their applicability were calibrated in connection with EGRRCPA. Currently, only some BHCs with total assets between $100 billion and $250 billion must comply with the LCR and NSFR (and reduced versions of those metrics at that). Regulators could propose that all BHCs with over $100 billion in total assets become subject to heightened LCR and NSFR requirements.

The Reports emphasize the rapidity of deposit outflows. For example, the outflows from SVB corresponded to approximately 85 percent of SVB’s deposit base. Therefore, regulators are also likely to revisit the components and assumptions in the LCR, particularly with regard to standardized outflow rates for uninsured deposits and whether held-to-maturity securities should be part of the required liquidity pool under these rules. The NYDFS Report suggests that just as the LCR’s assumptions were based in part on data from the 2008 financial crisis, the current turmoil could inform revised assumptions.

Prudential and supervisory (non-standardized) liquidity requirements are likely to receive renewed attention too, particularly as examiners may have new-found confidence to dig into and criticize both the processes and outcomes of banks’ internal liquidity policies. The FRB Report notes that when SVB initially became subject to the FRB’s enhanced prudential standards in July 2022, it repeatedly failed its own internal liquidity stress testing. The FDIC and NYDFS also raised concerns about Signature Bank’s liquidity risk management.

Recent developments in the banking sector have renewed regulators’ priorities on capital and resolution-related initiatives.

Existing regulatory (and resolution-related) capital requirements were under scrutiny even prior to the SVB and Signature Bank failures. Vice Chair Barr suggests that the FRB will continue to emphasize completing the Basel III “End Game” and the “holistic review of capital standards” as he had announced in December 2022, as well as review whether multiple stress testing scenarios should be used and whether resolution-related requirements for large banks should be modified. The FRB and FDIC’s recent advance notice of proposed rulemaking seeking comment on enhancements to the resolvability of large banking organizations focused on non-“GSIB” “Category II” and “Category III” BHCs. However, SVB’s recent experience raises the question of whether “Category IV” BHCs also will be addressed in a forthcoming proposed rule.

We also expect to see discussion of the effectiveness and proper role of resolution planning. SVB would have submitted its first BHC resolution plan in July 2024, and it submitted its first IDI resolution plan in December of 2022. While review was ongoing, initial review by the FDIC indicated that the plan would not have met the FDIC’s standards. As for Signature (which did not have a BHC), its IDI resolution plan would have been due in June 2023. The recent failures have generated both questions about the utility of resolution planning as well as calls for renewed emphasis on resolution planning.

Regulators are likely to place greater emphasis on banks’ contingency and emergency planning.

The more operational aspects of liquidity management and contingency planning are in the spotlight because of the recent failures. The FRB Report presents an extensive list of actions that SVB did not take to prepare for a liquidity crisis, including pledging enough collateral to the Federal Reserve’s discount window. Similarly, Signature Bank had not arranged to be able to pledge collateral directly to FRBNY to access the discount window, and in its final hours before failure, even attempted to include loans it knew were not acceptable collateral in its collateral calculations. We expect supervisors to place immediate emphasis on emergency access to liquidity as well as more general operational planning for crises.

The practices of boards of directors and senior management—as well as incentive compensation—are likely to draw additional regulatory, supervisory and enforcement attention.

The FRB, FDIC and NYDFS Reports unequivocally place responsibility on the leadership of the failed banks. President Biden and legislators have called for increased accountability for the leaders of failed banks, so additional guidance or rules on incentive compensation may be forthcoming. Incentive compensation rules required by the Dodd-Frank Act were never finalized by the six regulatory agencies tasked with implementing them, and the recent turmoil in the banking sector may provide renewed momentum.

This is an important moment for banks to assess and, as needed, strengthen their leadership and governance. It is also a good time for banks to specifically assess incentive compensation arrangements (SVB’s program was found to have major weaknesses).

There is likely to be close attention to a firm’s rate of growth as an indicator of risk and to the length of “transition periods” for the application of regulatory and supervisory standards.

Both SVB and Signature Bank grew rapidly in the period between 2019 and 2022 and significantly faster than their peers. A concern clearly expressed by the Reports is that a bank’s growth may outpace a supervisor’s ability to provide sufficient oversight or for bank management to maintain appropriate risk management practices. In light of recent events, the FRB may work to shorten the time that BHCs are given to transition to higher levels of supervision and regulation. Under the tailoring framework, BHCs that move from one “category” to a higher category typically are given a transition period to comply with this more stringent level of regulation. The FRB Report places strong and repeated emphasis on the transition time and delays associated with SVB’s graduation from the Regional Banking Organization portfolio to the Large and Foreign Banking Organization portfolio, leaving little doubt that the transition of supervisory portfolios will be an area of FRB focus.

Conclusion

There is substantial momentum around regulatory change related to the banking turmoil, but much of this will take time to effectuate. A change in presidential administration as of 2025 could slow this process, though an impending election may create additional impetus for rules to be finalized expeditiously. In contrast, there are fewer barriers to changing supervisory and examination practices, and we expect a change in the tone of supervision reflecting the regulators’ experiences with SVB and Signature Bank to become apparent in the very near term.

Footnotes

[1] See also the Cleary Gottlieb Alert Memo on the released reports for additional insights and references, available here.

[2] FRB, Review of the Federal Reserve’s  Supervision and Regulation of Silicon Valley Bank (Apr. 2023).

[3] GAO, Preliminary Review of Agency Actions Related to March 2023 Bank Failures (Apr. 2023).

[4] FDIC, FDIC’s Supervision of Signature Bank (Apr. 2023); NYDFS, Internal Review of the Supervision and Closure of Signature Bank (Apr. 2023).

[5] Economic Growth, Regulatory Relief, and Consumer Protection Act, Pub. L. No. 115-174, § 401, 132 Stat. 1296, 1356 (2018).

[6] FDIC, Options for Deposit Insurance Reform (May 1, 2023).

[7] Vice Chair for Supervision Michael S. Barr, Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley Bank (Apr. 28, 2023).

[8] Randal Quarles, “Statement of Randal Quarles Regarding the Federal Reserve Report on the Failure of Silicon Valley Bank” (Apr. 28, 2023).

Derek Bush and Hugh C. Conroy, Jr. are Partners, Patrick Fuller is Counsel, Lauren E. Semrad, Julia A. Knight, Megan Lindgren, and Rishi Kumar are Associates, and Abby Shamray was a Summer Associate at Cleary Gottlieb Steen & Hamilton LLP. 

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