Transcription:
Chana Schoenberger (00:01):
When the spring 2023 banking crisis was in five alarm fire mode, bankers were focused on making sure the failures didn't happen to them. Now that the emergency phase is over, they're asking what next American banker's Federal Reserve reporter Kyle Campbell covers Central banking and regulation. In this episode of Bank Shot, he takes a closer look at how regulators are overseeing banks and how that will change. Now
CNN (00:28):
Silicon Valley Bank, Santa Clara was closed today by the California Department of Financial Protection and Innovation, which appointed the FDIC, the Federal Deposit Insurance Corporation as the receiver.
Fox 10 (00:39):
It collapsed today as depositors rushed to withdraw their money after the bank revealed a big loss on its bond withholdings.
CBS NY (00:47):
Another bank just shut down regulators today abruptly closed Signature Bank. It has offices throughout New York and Connecticut.
Bloomberg (00:55):
It is a giant collapse. The third biggest in the history of US banking.
NBC News (00:59):
First Republic Bank has been taken over by federal regulators and sold to JPMorgan Chase. This comes after regulators spent the weekend trying to find a buyer for the bank.
ABC News (01:08):
One big question, what did the Fed know and when?
Se. Tim Scott (01:12):
By all accounts, our regulators appear to have been asleep at the wheel.
Kyle Campbell (01:19):
Federal regulators have had some soul searching to do this year, two large banks failed in a span of three days in March, and then a third went down less than two months later. That abrupt episode raised a lot of questions about bank capital, liquidity stability, and uninsured deposits, but it also begs some explanation of why bank supervisors, particularly those from the Federal Reserve, didn't see this coming, or if they did, why they were unable to stop it. A few things have come from that self-reflection, including calls for additional staffing and sweeping proposals to change the regulatory framework around banks with between a hundred billion dollars and 250 billion of assets. There's also been a focus on something that's a bit harder to quantify culture,
Michael Barr (02:01):
So we need to have a way to make sure that our supervisors feel empowered to take action promptly. We need to give them the tools to do that, and we need to change the supervisory culture.
Kyle Campbell (02:12):
That was Federal Reserve Vice Chair for supervision, Michael Barr. He testified in front of the Senate Banking Committee in May about the failures, and during that hearing, he noted that supervisors were able to identify her issues at the bank, but they did not quickly enough or forcefully enough to make executives change course. In short, examiners spent too much time gathering evidence of risk and not enough time working to address it. One of Barr's most striking conclusions was that this sort of thing was not unique to SVB supervisors, but rather something endemic in the Fed's supervisory apparatus.
Michael Barr (02:47):
One of the first things I did when taking this job was to go talk to supervisors around the system, telling them I wanted to make sure that they were asking the hard questions, being tough, that they were standing true and that they were agile, looking for new risks in the system. I think we have to keep at that and change the culture.
Kyle Campbell (03:04):
The Fed's supervisory culture, therefore is a critical part of this post-crisis reckoning, but defining culture much less changing. It isn't something with which policy makers have a great deal of success or even experience, but whether by design or by accident. What is clear is that the Fed's approach to supervision has evolved over time, both from policy choices made by politically appointed leaders and by necessity as the central bank prepares to usher in this next wave of supervisory reforms, it's worth examining as best we can, what its supervisory culture looks like today, how it got this way and what changes are worth revisiting from American Banker. I'm Kyle Campbell and this is Bank Shot Podcast about banks, finance and the world we live in.
Sarah Bloom Raskin (03:58):
Bank supervision is most importantly the eyes and ears of bank supervisors on the ground, and these are people who I think are really the unsung heroes in a lot of the work that goes on on behalf of banks and on behalf of the public.
Kyle Campbell (04:19):
That's Sarah Bloom Raskin, a Duke University law professor whose resume includes stints as the Deputy Secretary of the Treasury Department and as governor of the Federal Reserve Board. She also served as Maryland's Commissioner of Financial Regulation in the aftermath of the subprime mortgage crisis, a position that put her in direct contact with bank supervisors on a daily basis.
Sarah Bloom Raskin (04:39):
This is a group of individuals who have been highly trained, have excellent judgment. I have good communication skills. They can write, they can illuminate issues. They really are the canaries in the mind, so to speak. They are ignored really at the public's peril,
Kyle Campbell (04:59):
But as much as supervisors are tasked with rooting out bad actors and dangerous activities, they also must ensure the banks and their remit are sound, or in other words, profitable
David Zaring (05:10):
Supervision is this sort of strange being that sometimes has the supervisor sort of serving as consultants for the bank. Here's your business plan, we like it. We think it could be improved in this way. We're worried that this exposes you to too much risk. Sometimes supervision looks a little bit like an enforcement action. You've done something that we think is inconsistent with our regulations, and so we're going to punish you.
Kyle Campbell (05:33):
That's David Zaring.
David Zaring (05:35):
My name is David Zaring and I'm the Elizabeth F. Putzel Professor at the Wharton School.
Kyle Campbell (05:40):
Zaring says supervisory culture is largely a reflection of where an agency, in this case, the Federal Reserve falls on that spectrum between ally and adversary.
David Zaring (05:49):
It's a real tight rope to walk to sort of have both relationships at once, and yet supervisors need both kinds of relationships for sure.
Kyle Campbell (05:57):
Yet, because banking touches so many things and takes so many forms, supervision is not binary. Supervisory culture contains multitudes and an individual supervisor may lean more permissive or restrictive depending on the issue, the bank or the activities in question.
Sean Vanatta (06:13):
There are a number of different avenues that supervision can go down, and that means the supervision necessarily involves trade-offs. I'm Sean Vanatta. I teach economic history at the University of Glasgow, and I'm a senior fellow at the Wharton Initiative for Financial Policy and Regulation.
Kyle Campbell (06:30):
Vanatta is also working on a book chronicling 150 years of financial supervision in the Fed's early days. He says supervisors were focused solely on credit quality. Essentially, they just wanted to ensure banks had good assets to use as collateral should they need to borrow from the Fed in a pinch over time. And in response to political pressures and legislative mandates, the fed's list of supervisory concerns grew to include consumer protection, discrimination, money laundering, and cybersecurity among others. This has meant having to make choices.
Sean Vanatta (07:00):
Government actors have to decide what to prioritize, what given the kind of limited interaction that they can have with bank managers. Given the limited attention bank managers can give to these specific concerns within the larger business of banking, there is this sort of question of how do you set priorities? Is the priority, safety and soundness of particular financial institutions is the priority sort of macro prudential stability, so making sure that the entire financial system remains stable and productive. Is the priority consumer protection or something more narrow like ensuring that bank IT systems aren't subject to interference from foreign hackers or something, right? You can imagine all of these different roles that have been assigned to supervision. And then the culture question is how do supervisors understand those roles and how do they prioritize?
Kyle Campbell (07:59):
While the Fed's supervisory mandates have been expanding over the past century, recent decades have seen a consolidation of those various oversight responsibilities. As banks have grown bigger and more complex, the Federal Reserve Board in Washington has by necessity taken a more dominant role in the supervisory process that has made supervision more uniform across the Federal Reserve system. But some say it has also stripped away autonomy and accountability from the fed's 12 regional reserve banks and their presidents
Tom Hoenig (08:27):
Culture is a sense of number one, what your role is, a clear understanding of what your role is as a supervisor at a reserve bank and at the Board of Governors and at the Federal Reserve and how you conduct your role in supervision. And that has changed over the years from being more immediately responsible at the Reserve Bank level to one of where you still responsible, but in a reporting way to the Board of Governors or to the centralized part of the supervision function.
Kyle Campbell (09:05):
This is Tom Hoenig.
Tom Hoenig (09:06):
I'm Tom Hoenig. I'm currently a distinguished senior fellow at the Mercatus Center. I'm formerly vice chair of the FDIC and formerly president of the Federal Reserve Bank of Kansas City. And before I was president, I was head of supervision at the Federal Reserve Bank of Kansas City.
Kyle Campbell (09:24):
Early in his career when Paul Volcker was chair of the Fed, Hoenig said supervision, particularly for large banks, involved more of a dialogue between reserve banks and the Board of Governor's staff.
Tom Hoenig (09:34):
There was a conference of presidents, a committee on supervision of the presidents, and there was a committee of supervision at the Board of Governors and if there was a policy issue, the perennial issue of say of capital, what's enough capital, the presidents would actually present studies or policy papers that would then go to the Board of Governors for discussion and resolution as to how we would go forward. So there was what I call a vested interest in the topic of supervision and in the policy of supervision, both at the Reserve Bank president level and at the board of governor's level. So it became more and more centralized and therefore the Reserve Bank became less and less directly involved. And how much involved really kind of depended on personalities. A reserve bank president who had a lot of interest in it would inquire, would be briefed on it, those who were less involved, and it would leave it at the board of governor's level. So with that, the culture changed.
Kyle Campbell (10:42):
Hoenig said that paradigm shift, like so many paradigm shifts in bank regulation began in earnest after the passage of the Dodd-Frank Act in 2010. The law did many things, but the most culturally impactful change was the creation of the vice chair for supervision, a move that solidified a more centralized approach to large bank oversight
Tom Hoenig (11:02):
When the law said there's a vice chair for supervision that kind of invites things into that direction. So I don't blame anyone other than that's the way the statute was written. That's the way it was designed, and therefore that's what followed. And the Reserve Bank presidents became less involved
Kyle Campbell (11:20):
By the letter of the law. Supervision has always been under the purview of the Board of Governors, but has at different times been delegated to a greater or lesser degree to the reserve banks as banks became more national and in some instances global in their pursuits. Some say the move toward a centralized oversight regime is a logical evolution, but there are still risks in having supervisory policy and decision-making as centralized as it has become, namely taking important supervisory questions out of the hands of banks and supervisors on the ground.
Sarah Bloom Raskin (11:51):
The notion that power gets shifted into Washington is not to me necessarily a great solution. I mean, I do think that policymakers need to understand bank supervision better. People in Washington do need to understand what is going on in the supervisory context. I'm afraid though that sometimes when they intervene, they intervene too late or they intervene in a way that casts blame on the activity of supervisors who have really been doing an extraordinary job and have uncovered things and have been able to look at things but didn't have the support that they needed from the DC Home office, so to speak. So I think that shifting things into Washington is not always necessarily the best approach. I mean, I think that really empowering supervisors to be able to have a good channel of communication regarding what they're seeing and supporting their observations, whatever that takes, whatever that takes I think is really important.
Kyle Campbell (12:57):
There's also the question of how much power bank regulators truly want to assert. As Vanatta put it, the more directly an agency can influence a bank's actions, the more it owns the outcome of those actions in an environment in which regulatory bodies and their supervisors on the ground have so many types of risks to monitor. You said it makes sense that they would want to ensure banks themselves are accountable for their own risk management.
Sean Vanatta (13:21):
Some would say, well, bank supervisors need to focus on safety and soundness. They need to focus on the most important issues and leave the rest to bank managers. And others would say, well, Congress has given bank supervisors 15 different jobs and they need to do all those jobs effectively. A way that bank supervisors recently have been trying to deal with these political challenges is to try to push as much responsibility as possible onto banks. I think you see that in the recent SVB report and the other kind of post-ops of the failures where supervisors are saying what managers need to do is take more responsibility for issues. One way to think about supervision is supervisors are identifying problems for managers to deal with because otherwise it becomes the government deciding what government's saying, you must implement the following risk management policies or you must implement the following IT policies. And government really doesn't want to do that because of the political ramifications, because of the political risks that if the government tells a bank to do certain things and then there are bad consequences, then that's going to have political ramifications. But if the government tells bank managers to address these problems, then it still enables management to make the ultimate decisions. It limits the political risk to supervisors for making a decision for banks to do one thing or another.
Kyle Campbell (14:58):
Trying to determine which way the Fed's cultural pendulum is swinging at any given moment is challenging if for no other reason than because much of its supervisory work takes place behind the scenes shielded from the general public
David Zaring (15:10):
Figuring out exactly what happens in the supervisory relationship between banks and supervisors is always a little hard to do for us outsiders. And that's because one of the features of the supervisory culture that's out there is a real commitment to confidentiality. Banks and supervisors interact all the time and outsiders just can't observe what those interactions are, including the outsiders who might be particularly interested in the interactions like the shareholders of the bank
Kyle Campbell (15:41):
Reports on this spring's Bank failures and the policy proposals that followed provide a rare glimpse into where the Fed stands in relation to the banks it supervises and where that relationship might be heading.
David Zaring (15:52):
The new proposed final capital adequacy rules, those heightened requirements on banks, especially relatively large banks. Supervisors can't sort of depart from those because they like their regulator, and that means that supervisors are going to come to banks and tell them, this is something you have to do and it's going to hurt. It may hurt your share price, it may hurt your ability to issue dividends and you're doing it. That's pretty adversarial. On the other hand, with the bar report on the collapse of Silicon Valley Bank suggests that the day-to-day relationship there was, if anything, exhibiting sort of a cautious timidity that turned out to be not what the bank or its shareholders really needed.
Kyle Campbell (16:38):
When it failed. SVB had more than 30 outstanding citations known as matters requiring attention or MRIs. Raskin says this is evidence that supervisors on the ground were doing their job. If the culture failed, she said it was further up the chain of command.
Sarah Bloom Raskin (16:52):
I do not blame for the first moment the examiners on the ground for that it was not their fault that for whatever reason this escalation process didn't occur fast enough and effectively enough to get the issues addressed. And I do believe that these issues could have been addressed. Many of them could have been addressed with more prompt escalation
Kyle Campbell (17:15):
Barr Silicon Valley reports as the cultural shift began under his predecessor, Randall Quarles, who served as vice chair for supervision from 2017 to 2021. It cites a perceived shift in culture and expectations based on internal discussions and observed behavior. Some Democrats in Congress seized on these findings and the reports criticism of the economic growth, regulatory Relief and Consumer Protection Act of 2018 as proof that blame for the failure lies with Trump era policy changes to bank supervision and regulation. Here's what Senate Banking Committee chair, Sherrod Brown, had to say it in May,
Sherrod Brown (17:50):
We're all friends here. That was the mentality. It was the weaker rules on the books and it was the culture they created in the top and allowed to fester.
Kyle Campbell (17:58):
Republicans like Senator John Kennedy of Louisiana called the focus on Trump era policies a cop out.
John Kennedy (18:05):
I hear you saying, my people and I screwed up. But even though we're adults with free will and responsibility, it wasn't our fault because Trump ate our homework. I mean, I looked at your report and to be more specific, Randy Quarles ate our homework
Kyle Campbell (18:26):
During his time as vice chair for supervision. Quarles emphasized the need for due process in both regulation and supervision. His argument was that if expectations were set explicitly and transparently, banks would be better able to meet them.
David Zaring (18:40):
I think it's fair to say that neither Vice Chair Quarles nor Vice-Chair Barr have engaged in sort of a root and branch reorganization of supervision from the way their predecessors did it. But that said, I think the vice chair Quarles really wanted to create a sort of fundamentally different relationship between banks and supervisors with his concerns about tailoring transparency and due process. Those were efforts to make this supervisory process a little bit less confidential, a little bit less unobservable, and that was a different initiative. And it'll be interesting to see if Vice Chair Barr tries to build on that or tries to go in a different direction.
Kyle Campbell (19:22):
And the speech at the Hoover Institution in May quarrels described his supervisory philosophy as one in which supervisors had broad latitude to address serious issues, but were told not to sweat the small stuff.
Randal Quarles (19:33):
My message to the supervisors was not that they were to be less assertive, but that they were to be more focused on the things that really mattered and more assertive on those things. The phrase I would often use is that if they won't do what really matters, smite them hip and thigh. Second, if somehow the supervisors thought I was saying to be less assertive, they obviously didn't listen because there were over 30 matters requiring attention and matters requiring immediate attention at the end of 2022. And the great bulk of them were about routine administrative matters like third party vendor management and audit management, very little on the core financial issues facing the bank, and no suggestion that there was any prioritization among them
Kyle Campbell (20:15):
Based on comments from quarrels and bar, neither side of the political divide is happy with the state of the Fed's supervisory culture. There is a debate about how much blame for that state of affairs belongs to the supervisors on the ground versus policymakers in Washington versus politicians on Capitol Hill. There is also the question of what can and should be done about it. For Raskin, the answer is to find a holistic solution without getting hung up on whose fault it is that banks failed this spring, particularly for those supervisors who are lowest on the organizational ladder.
Sarah Bloom Raskin (20:46):
Again, when we talk about culture, we talk about the entire ecosystem of regulation and supervision, which is an ecosystem that includes people obviously on the ground, writing the reports, setting the exam schedules, going in and doing the hard work of determining the bank's condition. And part of that system is also people who take those reports, who read those reports, who figure out what to do with those reports, who figure out whether this is a matter that should be escalated. So if you're going to talk culture, don't just talk about the people on the ground, talk about the entire apparatus, and the entire apparatus goes from the people who walk in to the front door of that bank all the way to the very top of the regulatory system.
Kyle Campbell (21:39):
Some believe the answer could be in distributing more authority and accountability throughout the Federal Reserve system.
Tom Hoenig (21:46):
You can't keep an eye on everything among 12 districts and do it well. And I think there has been a cost to that that we have seen now, we still had crisis in the eighties. I can't deny that. So it's hard to judge whether you would've had better outcomes with a more distributed oversight and accountability. I mean, I can't say that a Reserve Bank president is accountable. Now, I could say when I was a head of supervision, our president felt the pressure of it directly because these things were going on in the region and they had certain responsibilities there and they had some accountability. So I think there is a loss there, whether it's enough to make a difference time and history, and studies will have to show that in the future.
Kyle Campbell (22:34):
Others, including Vanatta, see further consolidation of supervisory oversight as the ideal trajectory. But he says the key to maintaining a sound supervisory culture is to keep it out of the shadows.
Sean Vanatta (22:46):
I think it's really important to have a conversation about bank supervision. Bank supervisors want to be behind the scenes. They want to nudge banks one way or another to provide bank managers with information, but to generally not be in the spotlight. And I think we want to be having productive conversations about bank supervision when there are not crises, so that we can have competence in our supervisory agencies when there are crises. Because what often happens is we talk about bank supervision when a big bank has failed or when the financial system has failed, and then we stop talking. But it's in those moments when we're not talking and thinking about supervision that the problems build up. And so that would be my ultimate call to action would be to keep supervision in the conversation.
Chana Schoenberger (23:45):
This episode of Bankshot was reported and written by Kyle Campbell and edited by John Heltman. Our audio producer is Kelly Malone Yee. Special thanks to Duke University, the University of Pennsylvania's Wharton School, the University of Glasgow, the Mercatus Center, C-Span, CNBC, Fox 10 Phoenix, CBS, New York, Bloomberg, NBC News and ABC News. For more news and analysis of the banking world, go to american banker.com/subscribe. From American Banker, I'm editor-in-Chief Chana Schoenberger, and thanks for listening.