The following article was posted on Bloomberg Opinion on January 4, 2024. It points out the massive gaps in regulations and lack of transparency with banks’ supervisory issues, among other industry failings, that led to the SVB failure and will continue to plague the banking industry without regulatory action. This is just one example of how IDC Financial Publishing’s bank ratings are critical to bank investors and managers, and remain so in 2024.
If Only We Knew the Problems Facing America's Banks1
Almost a year after Silicon Valley Bank's failure, the Federal Reserve is still keeping the public in the dark about the deficiencies it finds at US lenders.
The US has yet to fully address one of the greatest weaknesses revealed by last year’s failure of Silicon Valley Bank and other regional lenders: Supervisors saw the problems, but they failed to compel action before it was too late.
Some well-placed transparency could go a long way toward creating a much-needed sense of urgency.
Before its demise in March 2023, SVB had accumulated more than 30 supervisory warnings, noting problems such as the interest-rate risks that contributed to its failure. These included “matters requiring immediate attention,” or MRIAs, which tend to demand a board-level response and a timeline for remedial action. As of June 2023, the 18 large banks overseen by the Federal Reserve — those with more than $100 billion in assets, but not among the eight global systemically important institutions — had 221 supervisory findings outstanding, up from 157 a year earlier. About half failed to achieve a satisfactory rating from the Fed, largely due to risk-management deficiencies in areas including cybersecurity and anti-money-laundering compliance.
Banks’ supervisory issues can be highly relevant to investors, given the risks they reveal and the costs they can entail. US securities law typically requires companies to disclose such material information. Yet bank regulators treat it as confidential, providing only an aggregate overview in semi-annual reports. This keeps markets in the dark and reduces pressure on managers to address problems quickly.
The opacity extends even to the most severe situations, in which the Fed concludes that a bank’s operations are so deficient that it’s in danger of losing its financial holding company status. Under such 4(m) agreements, banks typically can’t do acquisitions or enter new lines of business. The logic is that if the bank can’t manage its existing business well, expansion would be imprudent. This has occasionally led to mergers being mysteriously called off, with no mention of the underlying reason.
Better disclosure is amply warranted. This would presumably include MRIAs that are costly to remediate or have a material impact on the bank’s profitability and viability, as well as 4(m) agreements that limit acquisitions or expansions. It might also encompass downgrades (and upgrades) of supervisory ratings (though these might be less useful, as they can’t always be tied back directly to specific issues). In any case, the added transparency would provide a powerful nudge to bank managers and directors: If their response wasn’t credible, shareholders would flee and the share price would plummet.
Immediate disclosure, however, could unduly restrain supervisors: They might be hesitant to issue negative findings for fear of provoking deposit outflows or customer defections that would make things even worse. Hence, it would make sense to build in a short delay — say, six months. This would give bank management enough time to fix simpler deficiencies, and to develop plans to address more complex issues — and to begin implementation — before disclosure was required.
If such a regime had been in place a few years ago, the SVB crisis might never have happened. If the bank had acted more promptly on supervisors’ warnings — by raising capital and reducing its exposure to long-term interest rates — it could still be in business today.
If regulators don’t like how bankers behave, they should change the incentives. Disclosing supervisors’ material findings, with a prudent lag, would encourage everyone to act in the broader financial system’s best interests.
IDCFP’s Reduction in Bank Ranks from Three Risk Ratios
IDC Financial Publishing (IDCFP) has included the following three risk ratios with our longstanding rank evaluation of a bank to better reflect the changing risks to a financial institution.
- Risk to Tier I Capital: Risk associated with the Tier I capital ratio reported below 5%, excluding unrealized losses on securities held for sale (AOCI).
- Negative BSCF: Negative continuous quarter-to-quarter change in Balance Sheet Cash Flow (BSCF) over 4 or more quarters, results in a decrease in the rank equal to the negative BSCF calculated over the last year period.
- Liquidity Risk: Liquidity risk is further identified by the uninsured deposits and borrowings greater than the assets available for liquidation. This percentage is multiplied by the ratio of unrealized losses on securities, held to maturity, to tangible equity capital.
Based on fourth quarter 2022 data, the Liquidity Risk ratio would have reduced the IDCFP rank for Silicon Valley Bank by 158.
1 - If Only We Knew the Problems Facing America's Banks, Bloomberg, 01/04/2024
John E Rickmeier, CFA