Two major California banks 鈥� Silicon Valley Bank and First Republic 鈥� have failed.
While some banking have said the immediate crisis is over, stock prices for other regional banks, including PacWest and Western Alliance,
It鈥檚 important for the financial system that people believe their money is safe, and banks failing in quick succession tends to erode confidence. So what鈥檚 a state to do?
鈥淯nfortunately, there鈥檚 not a lot that the state regulator can do that would change the risk dynamics that occurred, crippling Silicon Valley Bank,鈥� said Todd Baker, a senior fellow at the Richman Center for Business, Law, and Public Policy at Columbia University, who also testified to California lawmakers at a .
The failures of Silicon Valley Bank and First Republic alone are not cause 鈥渇or revolutionary changes in regulation,鈥� said Ross Levine, a banking and finance professor at UC Berkeley鈥檚 Haas School of Business. Shareholders profited when the banks were taking on risk and were 鈥渨iped out鈥� when interest rates went up, said Levine. But depositors at both banks saw very little disruption, Levine said.
鈥淔or example, I am a depositor at First Republic, and I have a mortgage from First Republic, and basically nothing changed from Friday to Monday,鈥� he said. 鈥淪o, at some level things worked okay.鈥�
The type of risk that led to Silicon Valley Bank鈥檚 demise is 鈥渢he most basic type of risk in banking,鈥� said Levine, and it should have been 鈥渆xtremely obvious鈥� to regulators. So, the main thing the situation calls for is not new rules but 鈥渃ompetent regulatory agencies,鈥� said Levine.
In California, the regulatory agency in question is the Department of Financial Protection and Innovation, formerly known as the Department of Business Oversight. What was it doing during all this? And should it have done more to prevent these crises?
For now, it鈥檚 not talking.
The department told CalMatters it鈥檚 too busy to make someone available to answer questions for at least 鈥渁 few weeks.鈥� The department will be issuing a report, likely by early next week, explaining its oversight and regulation of Silicon Valley Bank, including a look at how the state can 鈥渟trengthen and update鈥� its financial regulations. The department is led by Commissioner Clothilde Hewlett, who was appointed by Gov. Gavin Newsom.
Who regulates banks?
In general, state and federal regulators 鈥� either the Federal Reserve or the Federal Deposit Insurance Corporation depending on the bank 鈥� work together to supervise banks, which happens partly in the form of bank 鈥渆xams.鈥�
That鈥檚 where government workers go in and investigate a bank鈥檚 solvency, management and more. Examiners look at things like the types of loans the bank has been making, to make sure that the bank is likely to get almost all of that money back, but also things like whether the bank has good cybersecurity measures in place. If they find problems, they can take a range of actions to make the bank to resolve them 鈥� everything from a resolution that the bank鈥檚 board quietly adopts, to a public consent order or cease and desist, said Michael Stevens, president of the Graduate School of Banking at Colorado and a former bank examiner himself.
Different banks have different regulators depending on whether the bank has a state charter or a national charter 鈥� you can think of a bank charter as a kind of business license for a financial institution. Banks with a state charter are regulated by both California and the federal government. Silicon Valley Bank and First Republic both had state charters. Other banks, including Bank of America or JP Morgan Chase, have national charters and are regulated primarily by the federal government. Banks can choose which charter to seek. The different charters have pros and cons: Banks might choose to work with regulators who they believe have more expertise relevant to their business model; federal regulatory fees are more expensive.
California regulators were probably helping with examinations of First Republic and Silicon Valley Bank. 鈥淚鈥檇 be shocked if we end up learning that they were not involved,鈥� said Stevens.
State regulators also played a role in First Republic and Silicon Valley Bank鈥檚 final hours. It was the Department of Financial Protection and Innovation that had the decision-making power to , which it likely did in close coordination with federal regulators. Then, they turned the bank over to the FDIC, which provides insurance for depositors. The FDIC promptly sold the bank to JP Morgan Chase, like a game of procedural hot potato.
What can regulators do?
There are two things state regulators could do, said Columbia鈥檚 Baker. One would be to require that state-chartered banks of a certain size have one or more people with risk management experience on the risk management committee of the bank鈥檚 board. Already, banks are on their audit committee, or publicly explain why they don鈥檛.
鈥淪ilicon Valley Bank had no outside directors who had any experience, really, in the banking business, and certainly not in the risk management business,鈥� he said.
Second, California regulators could put in place new rules surrounding bank executives鈥� compensation, so that they are rewarded for prudent management, and are not incentivized to pursue risky strategies. Executive pay at Silicon Valley Bank rose as .
鈥淪ilicon Valley Bank had no outside directors who had any experience, really, in the banking business, and certainly not in the risk management business.TODD BAKER, SENIOR FELLOW AT THE RICHMAN CENTER FOR BUSINESS, LAW, AND PUBLIC POLICY AT COLUMBIA UNIVERSITY
A major federal financial regulation passed in the wake of 2008鈥檚 Great Recession, the Dodd-Frank Act, prohibiting executive compensation strategies that incentivized risky behavior, but those rules were never completed, said Baker.
States are disincentivized from putting in place rules that are drastically more restrictive or protective than federal rules because banks could theoretically sidestep those regulations by seeking a national bank charter instead.
But, said Baker, it鈥檚 hard to argue with making sure a bank鈥檚 board has expertise, and if California added new executive pay rules, it would probably need to be done in parallel with the federal government. Those moves wouldn鈥檛 be likely to drive California banks away, since the federal regulators might tighten rules at the same time, he said.
More clarity should come soon. In addition to the report coming from California鈥檚 Department of Financial Protection and Innovation, on Wednesday, May 10 the state Assembly and Senate banking committees will hold a on Silicon Valley Bank鈥檚 failure, and where regulations and supervision fell short.
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