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Critics say the U.S. banking system needs major adjustments. What do they propose?

Jamie Cameron
4. 4. 2023
6 min read

I guess no one expected that three banks could fail in a short period of time recently. This collapse has highlighted certain cracks in the banking system and its shortcomings. Where are these weaknesses, and how can they be addressed? Let's take a look.

Silicon Valley Bank $SIVB, a key institution in the tech startup funding ecosystem, collapsed in just 48 hours, raising fears of contagion and serious questions about the effectiveness of Federal Reserve (Fed) banking supervision. Critics say bank supervision needs an overhaul to make it more nimble, transparent and decisive.

The Fed's vice chairman for supervision, Michael Barr, said supervisors have repeatedly identified risks to SVB since 2021 and have taken steps to limit its growth in 2022. Yet the bank's slide into crisis has had a dramatic impact on the market and has called into question the Fed's approach to supervising financial institutions.

The current problems

Bank supervision typically takes place behind closed doors, which can lead to banks being shielded from disclosing unflattering information and make it difficult to assess the quality of supervision. Supervisors issue "Matters Requiring Attention" (MRAs) and "Matters Requiring Immediate Attention" (MRIAs), which are not public and do not prescribe specific solutions. If the matter is serious, supervisors can issue a "consent order," which is a public enforcement action between the regulator and the bank.

Lawmakers accuse the Fed of not escalating the problem quickly enough and question the transparency of the process. The key question for lawmakers is whether the Fed could have escalated the problem faster to force the bank to fix its problems. During the hearing, Michael Barr was asked why supervisors didn't force the bank to correct identified deficiencies, such as mismanaged interest rate risk and liquidity problems.

Some experts point out that the fact that the Fed supervisors began punishing SVB at the lower end of the rankings and issuing MRAs suggests that they did not foresee a problem that would cause the firm to fail. This reveals a possible weakness in the current supervisory system, which may be overly cautious when confronted with banks that are facing serious problems.

SVB's rapid growth was a factor for Fed supervisors, who took over day-to-day oversight of the bank in the second half of the year. This growth should have caused increased attention from the Fed, but the regulator seems unable to adapt quickly enough to prevent the bank from collapsing.

SVB's collapse also highlights a potential lack of transparency in bank supervision. If MRAs and MRIAs were issued regarding serious problems at a bank, the public should have the right to know about those problems and how they were addressed. Otherwise, consumers and investors may be exposed to unexpected risks.

Possible solutions?

In response to the collapse of the SVB, a number of measures should be considered that could improve the effectiveness and transparency of banking supervision.

  • One possible step is the introduction of rules for the disclosure of information on serious bank problems that could affect financial stability. This would strengthen bank supervision and increase public confidence in regulators.
  • In addition, consideration should be given to introducing rules for escalation of problems between supervisors and banks. This could ensure that in the event of serious problems, supervisors act more quickly and decisively to prevent the collapse of other financial institutions.
  • Finally, the capacity and knowledge of supervisors needs to be strengthened so that they can effectively monitor the rapidly changing financial landscape. This could include increasing staff, improving training programmes and strengthening cooperation between different regulators at international level.

The collapse of Silicon Valley Bank exposed serious problems in the world of Federal Reserve bank supervision. This event should serve as a warning to regulators and legislators to rethink current practices and improve the transparency and effectiveness of supervision of financial institutions.

One of the main challenges is adapting to a rapidly changing financial environment that includes technological innovation and new business models. Regulators should be able to quickly identify and respond to new risks in order to protect financial stability and consumer interests.

In addition, it is important that regulators establish clear rules and guidelines for escalating problems between banks and supervisors. This would ensure that banks have clear guidelines for resolution and that supervisors have the tools they need to act quickly and decisively.

It is also crucial to improve cooperation between regulators at international level. In a world of globalisation and interconnected financial markets, it is important that regulators share information and coordinate their activities to better monitor and manage risks.

The collapse of the JGBs provides an opportunity to reflect on the current state of banking supervision and to look for ways to improve its effectiveness and transparency. It is up to legislators and regulators to learn from this experience and take the necessary measures to ensure that a similar situation does not occur again. This will help to protect financial stability and public confidence in the banking sector.

In future, banking supervision should be more nimble, transparent and decisive, with clear rules and procedures for escalating problems and cooperation between regulators. Only in this way will it be possible to prevent further collapses, such as the Silicon Valley Bank case, and to ensure stability and confidence in the financial system.

In conclusion, it should be stressed that the current crisis over the collapse of Silicon Valley Bank is not just a problem of one financial institution, but represents a broader issue of the effectiveness of banking supervision and regulation in the Federal Reserve System. It is imperative that important lessons be learned from this incident that will lead to sustainable and robust regulatory mechanisms for the future.

  • One possible solution is the introduction of independent audits of regulators, which could provide an impartial assessment of their performance and help improve banking supervision practices. This could increase public confidence in the integrity and capabilities of regulators.
  • In addition, there is a need to ensure that regulators have sufficient resources and expertise to deal with complex and rapidly changing financial markets. This includes not only ensuring adequate funding and staffing, but also ongoing training and exchange of experience between regulators globally.
  • In addition, it is important to increase the accountability of the banking sector for its actions and to establish stronger and more effective mechanisms for the enforcement of sanctions. This could include introducing tougher fines and penalties for banks that fail to comply with regulatory rules and ensuring that bank officials are held personally accountable for poor decisions and mistakes.

The collapse of Silicon Valley Bank is a serious reminder that the current system of bank supervision has shortcomings that need to be addressed. Regulators, legislators and the banking industry must work together to create a stronger, more transparent and effective supervisory system that can protect financial stability and public confidence over the long term. Only such an approach can help prevent further collapses like the one that hit Silicon Valley Bank and ensure that the financial system remains robust and resilient to future challenges and crises.

WARNING: I am not a financial advisor, and this material does not serve as a financial or investment recommendation. The content of this material is purely informational.


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