Analysis: Fixing oversight culture may be biggest challenge in averting future bank crises

Signature Bank

20/09/2023 11:00

By Douglas Gillison
       Sept 20 (Reuters) - As U.S. regulators start to overhaul
the way they police lenders after three banks failed this year,
they will have to address examiners' hesitancy to raise red
flags, a deep-seated problem that has plagued the system for
years.
    The Federal Deposit Insurance Corporation (FDIC) this month
released its review into the demise of First Republic Bank, the
third official postmortem into the crisis which also felled
Silicon Valley Bank (SVB) and New York's Signature Bank. 
    Each failed following depositor runs. The postmortems on why
bank managers and regulators were not able to avert disaster
reveal a common theme: Federal Reserve and FDIC examiners tasked
with ensuring banks follow rules and remain sound spotted major
problems but acted too slowly.
    Federal Reserve examiners spotted "foundational" issues with
SVB's liquidity risk management in 2021 but were still drafting
a disciplinary action the day it died, the Fed report found.
Likewise, a 2019 FDIC notice warning Signature Bank's board
about liquidity planning problems "remained outstanding" when it
failed, according to the FDIC's review.
    The FDIC has blamed staffing challenges and examiners' lack
of urgency. The Fed has cited deregulatory zeal under former
Republican President Donald Trump's administration and excessive
efforts at consensus building, as well as examiner hesitancy,
for delaying action. Both agencies have pledged to improve the
speed and forcefulness of supervision.
    However, five former bank examiners and regulatory officials
told Reuters that cultural problems and structural obstacles
have been embedded in the supervisory system for decades and are
unlikely to be solved easily. Chiefly, examiners worry that
confronting bank management with problems will spark blowback
and that their bosses may not support them when that happens. 
    "Once you've detected the information; do you have the
courage to do something?" said Charles Calomiris, a professor at
Columbia Business School and former official at the Office of
the Comptroller of the Currency (OCC), noting examiners worry
that raising red flags will "make everybody angry."
        The OCC, a third U.S. bank regulator, did not respond to
a request for comment. 
    
    'PUSHBACK'
    Signature Bank's management was "generally dismissive" of
examiners' findings, the FDIC said. First Republic's examiners
could have done more to challenge management in 2021 but "would
have likely encountered pushback" because growth was strong and
interest rates were low at the time, the regulator also found.
   "It can be challenging to take action on banks that are
seemingly healthy," said Michael Clements, a director at the
Government Accountability Office (GAO), which has been calling
for more timely and assertive action by bank supervisors for
decades. "Managers will push back on examiners." 
        The Fed declined to comment. An FDIC spokesman referred
to Chair Martin Gruenberg's previous comments that the problems
identified at Signature Bank are "an area of urgent focus."
    Examiners monitor banks and perform onsite supervision. They
rate their health on a range of metrics and can instruct them to
correct problems. But the work is with the rarest of exceptions
strictly confidential. That means there is often little public
accountability, even after something blows up.
    One former supervisor in the Fed system who spoke on the
condition of anonymity said examiners need, more than anything,
to feel that their superiors back them. Under former Fed Vice
Chair for Supervision Randal Quarles, however, the committees
overseeing supervisory work raised the threshold for evidence
required to support examiners' concerns, the former supervisor
said. 
    According to the SVB report, staff said that under Quarles,
a Trump appointee, they felt pressured to go easier on banks
while meeting "a higher burden of proof for a supervisory
conclusion." 
        Quarles said that this is not true and that supervisors
have "always been fully supported" by Fed leadership. "I
expressly encouraged examiners to focus on liquidity risk and
concentration of deposit risk," he said in an email to Reuters.
    Fed decision-making can be further slowed because lines of
authority are decentralized and encourage excessive
consensus-building, the former supervisor who spoke anonymously
added, a point also supported by the SVB review. It found that
the need for consensus between regional Fed banks and staff in
Washington often slowed processes.
    "The problem with supervision at the Fed is that it is too
obsessed with process and not enough with actual risk," said
Quarles.

    TRIP WIRES
        Michael Barr, Quarles' successor, publicly said in June
that it can be hard for examiners to confront bank management in
good times, and that Fed culture makes it difficult to act
quickly. In May testimony, he called for a "culture that
empowers supervisors to act in the face of uncertainty." 
        But how to get there remains an open question. Barr has
floated imposing additional capital requirements when
supervisors detect weak risk controls, providing an incentive
for banks to act quickly.
    Others say it may be more effective to take the problem of
bearing bad news out of the hands of supervisors by setting
automatic thresholds for enforcement action.
    The GAO, for example, has in the past suggested supervisory
"trip wires" or "triggers" that would require banks to take
"prompt corrective action" based on factors other than capital,
such as asset quality or concentration.
        "If you get to that point, you simply take more forceful
action, taking a little bit of discretion away," said Clements.

 (Reporting by Douglas Gillison and Pete Schroeder; editing by
Michelle Price and Aurora Ellis)