After three bank failures in less than two months, some regulatory observers say the government’s response to such distress is little changed from 2008, raising questions about the reform efforts undertaken during the past 15 years.
The legislative response to the last banking crisis, the Dodd-Frank Act of 2010, sought to create a new playbook for handling bank failures, one that would allow regulators — or, ideally, banks themselves — to wind down troubled institutions in a controlled manner. The hope was that doing so would prevent government bailouts and brokered sales that make ‘too big to fail” banks even larger.
Instead, the crisis of 2023 has seen regulators make two systemic risk declarations, absorb significant losses and sell failed depositories to other banks, including the biggest bank in the country, JPMorgan Chase.
“What is damning is there appears to have been no playbook,” Karen Petrou, managing partner of Federal Financial Analytics, said. “If there was, it didn’t work.”
The latest failed institution to be put through this process was San Francisco-based First Republic Bank, which was seized by the Federal Deposit Insurance Corp. and sold to JPMorgan in the early hours of Monday morning, allowing the bank’s 80-plus branches to open as scheduled at the start of the workweek.
Unlike the prior two failures — Silicon Valley Bank and Signature Bank, which were shuttered within two days of one another in March — the resolution of First Republic did not necessitate a systemic risk declaration. Yet, it still came at significant cost to the FDIC’s Deposit Insurance Fund — roughly $13 billion.
Kathryn Judge, a professor at Columbia Law School and expert in financial regulation, said the outcome was “disheartening” for those who spent years devising a new tool set for bank regulators in the wake of the subprime mortgage crisis, only to see them return to bailouts and “shotgun weddings” that circumvent the traditional merger review process.
“What we’ve seen suggests that the government is unlikely to allow losses to fall where they will, and is far more likely to take an interventionist approach to facilitating a smooth resolution,” Judge said, “even if that means absorbing some losses or failing to honor its playbook.”
Dodd-Frank rewrote many of the rules on bank regulation, but two provisions of the legislation have proved particularly futile in the current crisis, policy experts say. The first is a requirement that all banks with at least $50 billion of assets — which was increased to $100 billion under a 2019 rule change — have resolution plans for a controlled wind-down, and the second is a granting of power to the FDIC to orchestrate an orderly liquidation of banks assets.
FDIC board member Jonathan McKernan said the three failures are proof — each of which involved banks with more than $100 billion of assets — that the reforms enacted by Dodd-Frank were unsuccessful, noting that the banking system remains susceptible to failures while bank investors “do not always bear the consequences” of poor risk management.
“More work remains to be done. We should avoid the temptation to pile on yet more prescriptive regulation or otherwise push responsible risk taking out of the banking system,” McKernan said in a written statement following the sale of First Republic. “Instead, we should acknowledge that bank failures are inevitable in a dynamic and innovative financial system. We should plan for those bank failures by focusing on strong capital requirements and an effective resolution framework as our best hope for eventually ending our country’s bailout culture that privatizes gains while socializing losses.”
Dan Tarullo, the onetime Federal Reserve governor who oversaw the central bank’s implementation of Dodd-Frank, said he does not blame the FDIC for not invoking its liquidation authority under Title II of the law.
Tarullo said Silicon Valley Bank is the only failure that could have gone through the Title II process, but doing so would have only made sense if the issues were unique to the bank. Instead, he said, because interest rate changes were a central problem for Silicon Valley, invoking Title II could have had systemic implications.
Still, Tarullo said, the episode reinforces his view that the Dodd-Frank playbook is not viable in periods of widespread stress. If regulators were unwilling to let large regional banks go through the resolution process without intervening, he said, he doubts they would allow a systemically important bank to do so.
“It’s not so much that they aren’t using Title II, it’s more that we’re seeing the reluctance to move forward with the resolution of even moderately large institutions under stressed circumstances without making accommodations for the systemic risks involved,” he said.
Dennis Kelleher, head of the consumer advocacy group Better Markets, called the sale of First Republic to JPMorgan “time-pressured, panicky-looking and biased.” He noted that regulators were acting in accordance with the law in their handling of the failed bank, but the outcome “starkly illustrates the total failure of the resolution process required by” Dodd-Frank.
“After the collapses of Silicon Valley Bank and Signature Bank, this latest bank seizure and sale makes clear that regulators have utterly failed to implement the Dodd-Frank law as written, designed and intended,” Kelleher said in a written statement. “That must change and change fast, or the current egregiously flawed process for resolving banks will continue, which will continue consolidation in the banking industry, make the ‘too big to fail’ problem much worse, and reduce lending to communities and small businesses.”
Others see the government’s handling of the current crisis as evidence that the Dodd-Frank reforms are inadequate and need to be replaced with a new system for dealing with faltering banks.
Jenna Burke, senior vice president and regulatory council for the Independent Community Bankers of America, a small-bank trade group, said the past two months have proved the current system inadequate and biased toward larger depositories.
“Each of the recent failures confirms that the FDIC’s solutions for resolving large bank failures is either through a government bailout or by allowing large banks to become even bigger banks,” Burke said. “More thought needs to be placed on holding large banks accountable for their outsized risk — and this starts with bank regulators stepping up their oversight of large banks long before signs of stress emerge.”
Joseph Lynyak, a regulatory lawyer and partner at the law firm Dorsey & Whitney, said rather than attempting to craft tools that prevent bank crises from ever arising, regulators’ efforts would be better directed toward making sure banks are prepared to deal with them when they arise.
“Historically, every 10 to 20 years we have a bank crisis,” Lynyak said. “It is probably a better use of effort to determine as a policy matter that the prudential regulators perform their roles as the guardians against systemic risk by forcefully and aggressively imposing capital, liquidity and other rules that avoid the reoccurrence of another bank crisis.”
Tarullo agreed that the focus should be on improving bank resilience and making sure the government response to failures — particularly the provision of liquidity by the Fed — does not lead to moral hazard.
“The two things need to be tied together,” he said. “That’s tricky to accomplish institutionally.”
Even before the crisis, regulators were mulling steps to improve bank supervision and regulation in normal times as well as initiatives that could enhance resolution efforts moving forward.
Fed Vice Chair for Supervision Michael Barr has said the recent bank failures will inform ongoing efforts to review capital and liquidity standards, finalize regulatory guidelines related to the Basel III international standards, and revitalize the Fed’s supervisory culture.
Last year, the Fed and FDIC began exploring options for ratcheting up resolution-planning requirements for large regional banks. Potential changes include long-term debt and so-called total loss-absorbing capacity, or TLAC, requirements aimed at improving banks’ abilities to be wound down in an orderly fashion. Currently, such requirements are limited to the largest banks in the country. Barr has said those efforts will get a closer look in the wake of recent bank failures, too.
David Zaring, a professor of legal studies at the University of Pennsylvania’s Wharton School of Business, said he’s skeptical that such measures would ultimately be relied upon at times of crisis. He noted that the Swiss bank Credit Suisse faced TLAC requirements — which call for banks to have creditors poised to “bail-in” an institution in a period of severe distress — but that structure proved ineffective. Credit Suisse’s additional tier 1, or AT1, bondholders were wiped out as part of the bank’s government-brokered sale to rival UBS.
Ultimately, Zaring said, resolution plans can be a helpful exercise for banks, but the current crisis demonstrates their limited applicability in an actual failure.
“Living wills are a third order solution to safety and soundness,” he said. “They work as a memento mori for banks, and they are an outsourced, and thus inexpensive form of regulation, but it seems like they don’t make much of a difference in a crisis.”
—Ebrima Santos Sanneh contributed to this report