How to boost confidence in the US banking system

W hen Silicon Valley Bank and Signature Bank failed in March and a panic set in among bankers and their customers about whether the US financial system was on the precipice of a major crisis, federal officials quickly reassured the public that there wasn’t much evidence of serious trouble ahead. “Our banking system is sound,” Treasury Secretary Janet Yellen told Congress at the time.

And yet, just over a month later, a third bank failed. After First Republic Bank disclosed in late April that its customers withdrew more than $100 billion of their deposits in the aftermath of SVB’s and Signature’s collapse, its stock price plummeted to $3.51 — down from $115 in early March. Regulators subsequently seized the bank and sold it off to JPMorgan Chase. Still, federal officials are again telling Americans not to worry. “The US banking system is sound and resilient,” Federal Reserve Chair Jerome Powell said in a speech on Thursday.

That could well be a true assessment of the current landscape, but it’s unfortunately not enough to reassure Americans that everything is OK. After all, the three recently failed banks had assets that totaled more than the value of the 25 banks that failed in 2008 combined, and they all seemingly failed because of bad risk management. More than that, recently released postmortems by the Fed, the Federal Deposit Insurance Corporation, and the US Government Accountability Office blame the collapse of SVB and Signature Bank at least in part to shoddy supervision by regulators.

According to the report by the Fed, for example, its supervisory staff noticed some, though not all, warning signs that SVB was vulnerable, but regulators were slow to push the bank to make necessary changes to address its risky bets. That was a result of both Congress and the Fed scaling back regulatory standards for midsize banks, which ultimately contributed to a “shift in culture” among the Fed’s staff that made supervisors more cautious, the report said. Surely that culture shift was not limited to the staff supervising SVB. And if those supervisors missed some of SVB’s red flags and failed to act with any urgency on the ones they did notice, then how certain can the Fed actually be that there aren’t similar problems at other banks?

The reality is that the health of the US banking system heavily relies on people’s confidence in it. That was made clear by the bank runs in March: When depositors panic, they’ll instantly grab their money and go. Federal officials can’t expect to quell bank customers’ concerns by simply saying there’s nothing to worry about, especially after their own regulators were caught enabling banks to take on more risks because of poor and ineffective oversight. That’s why the federal government must couple its officials’ statements about the soundness of the banking system with swift confidence-building action that strengthens regulators’ ability to identify problem banks and compel change that improves those banks’ risk management.

The good news is that this isn’t 2008, and there is good reason to believe that the banking system is indeed as resilient as Yellen and Powell say. Despite the rollback of some banking regulations during the

Trump administration — like Congress’s 2018 law that exempted midsize banks from certain provisions under the Dodd-Frank Act and the Fed’s 2019 rule changes — the financial system is still far more strictly regulated than it was before the Great Recession. But that doesn’t mean that lawmakers should be complacent. As the Fed’s report on SVB’s failure points out, the recent rollbacks created a “weaker regulatory framework,” and had they not taken effect, an institution like SVB would have likely been more resilient. That’s why Congress should reinstate the Dodd-Frank provisions it rolled back, including subjecting midsize banks to regular stress tests that would identify risks earlier on. Capitol Hill should also consider other measures, including raising the FDIC’s deposit insurance cap, as this editorial board has previously argued — an idea that has garnered bipartisan support among lawmakers and for which the FDIC expressed support on Monday.

But what’s made clear by the recent reports is that Congress’s actions, whatever they may be, will not be enough on their own — that is, if lawmakers in a divided Congress manage to pass legislation at all. The agencies responsible for supervising banks had tools at their disposal but failed to use them. Supervisors at the Fed, for example, had identified that SVB had problematic interest rate risks as early as 2020, but they didn’t issue any supervisory findings on the matter until late 2022, and they ultimately failed to downgrade the bank’s rating on interest rate risk before it collapsed. Had they acted sooner, they could have compelled the bank to make changes before it was too late. And in its report, the FDIC, which was responsible for supervising Signature Bank, suggested that it was too understaffed to provide proper oversight. These are problems that the Fed and the FDIC can and should address as soon as possible, without waiting for Congress.

So far, Powell has said that he agrees with the Fed report’s recommendations to reverse some of its rule changes that relaxed supervision, saying, “I am confident [the recommendations would] lead to a stronger and more resilient banking system.” But the Fed must also go further and ensure that its regulatory failures are thoroughly investigated in order to signal to its own supervisors that the recent shift in culture outlined in the report will no longer be tolerated — that supervisors must be more forceful and less complacent. That means encouraging and cooperating with independent reviews of its supervision of SVB, and being as transparent as possible with lawmakers and the public.

The faster that lawmakers and regulators act, the more reassured the public will be that US banks are not going to fall like dominos. Otherwise, their words about the strength of the US banking system will start to sound less like scientific assessments and more like the comic strip of a dog sipping coffee in a burning house saying, “This is fine” — especially if, or when, the next bank fails.

The reality is that the health of the US banking system heavily relies on people’s confidence in it.