The rapid and disorderly failures of Silicon Valley, Signature, and Silvergate banks last month quickly unleashed calls for more bank regulation, before there was time to even begin an assessment of what had taken place. Hopefully, informed policymakers will let careful review of the facts and issues be the basis for any targeted recommendations that the public can consider and debate.
During this period, the strength of the largest U.S. banks – which are subject to the most stringent regulation and supervision – has never been in doubt. In fact, as they did during the pandemic, the nation’s largest banks have acted as a source of strength and supported the broader banking sector to avoid further turmoil and cost to the economy.
Recent bank failures have been characterized by a classic “bank run” dynamic in which a lack of liquidity was the key source of vulnerability. In the case of Silicon Valley Bank (SVB), the first line of defense was the management itself, followed by supervisory oversight, to ensure that as the bank grew rapidly, its management had the information and judgment to manage its unique deposit profile and customer base, it had adequate liquidity, and eventually, access to capital.
Only thorough reviews by authorities, independent arms like the GAO, and oversight committees of Congress will help reveal if additional requirements might have prevented these bank runs. A clear focus will be on liquidity risk – or the need to manage the duration and liquidity profile of a bank’s assets and liabilities – which is the most fundamental risk in banking. Such risk is addressed by a set of requirements that are designed to regulate and inform bank management’s assessment of its ability to meet its liquidity needs. But liquidity risk is wholly unrelated to the risk that is targeted by capital regulation – credit risk. The largest U.S. banks meet the most stringent liquidity and capital requirements. They are also subject to the strictest and most stringent supervisory program on an ongoing basis.
Even though the collapse of SVB and Signature Bank had nothing to do with the existing capital regime for large banks, there are some who simply respond by saying that more capital solves any problem. However, the capital standards that apply to the largest U.S. banks never applied to these or similarly sized banks. Notably, when the Biden administration called for changes to the bank regulatory regime, none was suggested for the largest banks.
Despite this, U.S. regulators are considering changes to large bank regulation, including the final elements of the Basel capital reforms, on top of an already robust capital framework to which the largest U.S. banks fully adhere. Final Basel reforms were first contemplated before our nation’s largest banks had been tested through a real-life stress test of the pandemic, and more recently, a period of significant uncertainty in the banking sector. Throughout it all, the nation’s largest banks have been a source of strength and proven their resilience. Consequently, the onus should be on regulators to prove an increase in capital is necessary or wise for the largest U.S. banks, given the inevitable negative impact on the costs of lending and the real economy, and the continued migration of risk to the less regulated non-bank sector. Over the next several months, making the right choices for borrowers, savers and the economy will be critical.
The Difference Between Capital and Liquidity
Importantly, requirements for liquidity and capital are distinct. Liquidity is the cash and other assets banks have available to quickly meet short-term business and financial obligations. Capital encompasses the resources banks maintain to absorb losses in times of stress and continue to serve customers, clients, and communities. Learn more.