Home Banking Regulatory Changes Are on the Horizon Following the Banking Sector’s Turmoil

Regulatory Changes Are on the Horizon Following the Banking Sector’s Turmoil

by internationalbanker

By Stuart Plesser, Financial Institutions Managing Director, S&P Global Ratings





Triggering a period of disquiet in the US financial system, the rapid collapse of US regional lenders, such as Silicon Valley Bank (SVB), First Republic and Signature Bank, as well as the distressed sale of the much larger Zürich-based Credit Suisse, sent shockwaves throughout the banking sector in March 2023. Prompted partly by these events, policymakersare reassessing the financial system’s regulatory landscape to reinforce its resiliency while also allaying risks and fears of another crisis.

Liquidity mismatches exposed

SVB’s collapse came after the Federal Reserve’s (the Fed’s) sharp increase in interest rates led to significant unrealized losses on its securities, earnings pressures and declining deposits. Those factors ultimately led to a loss of confidence among itsdepositors. Because roughly 90 percent of SVB’s deposits exceeded the limit insured by the Federal Deposit Insurance Corporation (FDIC), it may have been more vulnerable than most to a bank run.

Quickly shifting sentiment can leave banks vulnerable

Banks have always been susceptible to quickly shifting sentiment among investors and depositors. If left unchecked, fearsamong stakeholders that result in sudden and sharp deposit outflows (even if not a full-on run on a bank) can disrupt money flows, fuel market volatility, hurt bank profitability and, on a macroeconomic level, curb consumer confidence and spending.

Social media’s role

The incident also sheds light on the potentially destabilizing role of social media, as issues raised on these platforms can amplifymarket and client concerns, especially if there’s some credence to them. Liquidity runs likely reflect underlying concerns about a lender’s perceived flaws. Fundamentally, the banking volatility of March 2023 likely occurred after a sharp rise in interest rates exposed some of traditional banking’s risks, sparking heightened contagion risks.

Contagion risks

In the United States, the banks that failed had similar weaknesses, most notably high dependencies on uninsured deposits and unrealized losses on their assets, to various degrees. The market turmoil that followed and contagion threats to other banks suggest the failed banks turned out to be more systemically important than anticipated. As a result, extraordinary measureswere implemented to allay concerns, including the FDIC paying out on the uninsured deposits of the failed banks and theFederal Reserve launching a bank-funding program.

Credit Suisse’s troubles were more self-contained rather than systemic, given the bank’s specific business model and pre-existing confidence problems—which, granted, were likely exacerbated by the loss of confidence in the US. Regulators stepped in and allowed the takeover of Credit Suisse by larger rival UBS without the need for shareholder approval of either bank and at a price (roughly $3 billion) that was a fraction of the value of Credit Suisse’s assets.

Supervisory and regulatory changes

Regulators appear to believe that culpability for the failure of these banks lies in large part with management—although theyhave also been self-critical about the need for better regulatory oversight. After a period of reflection, changes are afoot—in supervision and regulation. We don’t expect the sweeping changes to the policy framework that were implemented in the wake of the Global Financial Crisis (GFC) of 2007-08, but the US market could see substantial changes to bank regulation andsupervision, particularly for large regional banks with greater than $100 billion of assets. Elsewhere, policymakers have highlighted areas of potential finetuning, reinforcing crisis management and ensuring full implementation of existing standards.

We see inevitable changes in regulatory standards and bank supervision (how those standards are enforced). Supervisorychange could be greatest in the US and Switzerland, although policymakers beyond their borders will doubtless reflect on whether they have anything to learn.

Notably, we see policy likely to evolve in several areas, including:

  • the calibration of liquidity coverage ratios (LCRs),
  • interest-rate risk,
  • supervisory and regulatory

Specifically, the Fed and other agencies could make further changes in the coming months—for example, around liquidity-outflow assumptions, tougher liquidity rules for category III and IV banks, and the operational preparedness for banks to access contingent liquidity—perhaps even requiring them to routinely borrow fromthe central bank’s “discount window”, which provides short-term funding for lenders, and a change to how held-to-maturity securities are counted in liquidity requirements.

All told, S&P Global Ratings views tougher regulation and supervision as a net positive for creditors. Tighter oversight ofcapital, liquidity, interest-rate risk and other factors support creditworthiness.

On the downside, stricter regulatory requirements carry costs and can potentially affect banks’ appetites to lend. If banksbecome more selective in lending to preserve their balance sheets and look to comply with more stringent proposed regulations, entities such as small and medium-sized businesses, as well as households, could conceivably find it incrementally harder to gain funding. That may also open further room for nonbanks to compete.

Separately, US policymakers have put forth proposals that modify capital requirements for large banks and detail how regulators plan to implement the capital standards that the Basel Committee on Banking Supervision (BCBS) finalized in 2017 and 2019.Known as the Basel III endgame, it aims to increase the banking system’s strength and resilience. However, based on themultitude of comments that regulators received, there may be significant changes in the final rule compared to the proposal.

All told, tighter regulation of the banking sector won’t resolve all systemic risks. As we’ve seen since the GFC, this could lead to more financing outside the regulated financial sector, with less transparency and possible contagion risks for the economy. Asalways, regulators will have to strive for a balancing act.


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