Professor Brock Kannan
State banking officials can leverage lessons from the 2023 bank failures to become more aware of their pivotal role in protecting the integrity of the U.S. banking system.
Bank regulation ensures the financial system’s stability by protecting consumers and preventing the actions of bad actors. We trust the system because numerous state and federal regulators are dedicated to providing unwavering oversight. With such a trustworthy system in place, the failures of Silicon Valley Bank (“SVB”)[1], Signature Bank[2], and First Republic Bank[3] must have been an anomaly- right?
Several agency accountability reports highlighted the strengths and weaknesses of existing bank regulatory frameworks and supervisory programs at the state[4] and federal[5] levels. While the reports list a myriad of root causes for the bank failures, they all indicate that, in some instances[6], regulators failed to note critical issues[7]. Arguably, the report published by the Federal Reserve[8] even sought to shift blame to social media, claiming that sites, such as Twitter, should be held more accountable in light of the current lax regulatory regime.
The U.S. “dual banking system”—a system whereby banks can freely decide to charter under federal or state laws—was conceived with the passing of the National Bank Act of 1863. Debates surrounding this system date back nearly 200 years[9] to historic arguments between Hamilton and Jefferson as they voiced their opinions on the power struggles between the federal government and states over control of the financial sector. The competitive nature of the dual chartering banking system[10] has prompted numerous states to respond to the needs of their constituent financial services providers, resulting in new products and powers[11]. Banks’ ability to choose their regulators pits federal and state agencies against one another, forcing them to alter regulatory practices and procedures to enhance their ability to attract and retain charters.[12] In some instances, this bifurcation has prompted the concept of “regulator shopping[13],” where a bank selects the supervisory government agency positioned to provide them with the most favorable treatment.
Knowing this practice exists, it is not surprising that regulators are asking for public commentary to better understand the trust consumers have in the banking system[14]. Although well-intentioned, these results will prove to be fruitless in our dual chartering system as they lack the necessary mechanism to hold state legislatures responsible for their pivotal role in protecting the integrity of the U.S. banking system. Using the shifting oversight of the assets of SVB to the North Carolina Office of Commissioner of Banks[15] as an example, the State Banking Commission[16] is in a prime position to emphasize “the importance of guarding against complacency and having strong risk management policies and practices in place[17]” for the agency it oversees. Yet, the North Carolina legislature has neglected to hold the Commissioner accountable for determining if enhancements are needed to the supervision process at the State level.
While their federal counterparts have a path forward, California and New York are the only states with plans for enhancement. This should come as a surprise given the partnerships between States and the federal government to regulate the safety and soundness of the nation’s banks[18]. Represented by the State Liaison Committee (“SLC”),[19] on the Federal Financial Institutions Examination Council (“FFIEC”),[20] they are held to the same standard as their federal peers, which is to “promote uniformity in the supervision of financial institutions[21].” Given recent industry events, perhaps the powers granted to the FFIEC— pursuant to Title X of the Financial Institutions Regulatory and Interest Rate Control Act of 1978 (“FIRA”)—should be expanded to create a self-regulatory organization tasked with ensuring uniformity among supervisors – in this case, the states.
[1] See Telis Demos, What Happened with Silicon Valley Bank?, Wall St. J. (March 14, 2023, 3:00 PM), https://www.wsj.com/articles/silicon-valley-bank-svb-financial-what-is-happening-299e9b65?mod=article_inline (“Last week, Silicon Valley Bank failed and was taken over by regulators. On Sunday, another bank, Signature Bank, was also closed. That day, the government stepped in to protect all of those banks’ deposits and create a way for other banks to get access to more cash.”).
[2] See Mathew Goldstein & Emily Flitter, Risky Bet on Crypto and a Run on Deposits Tank Signature Bank, N.Y. Times (March 12, 2023) https://www.nytimes.com/2023/03/12/business/signature-bank-collapse.html (“Regulators said keeping open the 24-year-old institution, which held deposits from law firms and real estate companies, could threaten the financial system’s stability.).
[3] See Maureen Farrell, Jeanna Smialek & Lauren Hirsch, First Republic Bank is Seized by Regulators and Sold to JPMorgan Chase, N.Y. Times (May 1, 2023), https://www.nytimes.com/2023/05/01/business/first-republic-bank-jpmorgan.html. (“Regulators seized control of First Republic Bank and sold it to JPMorgan Chase on Monday, a dramatic move aimed at curbing a two-month banking crisis that has rattled the financial system.”).
[4] Cal. Dept. of Fin. Prot. and Innovation, Review of DFPI’s Oversight and Regulation of Silicon Valley Bank (May 8, 2023), https://dfpi.ca.gov/wp-content/uploads/sites/337/2023/05/Review-of-DFPIs-Oversight-and-Regulation-of-Silicon-Valley-Bank.pdf; N.Y. State Dept. of Fin. Services, Internal Review of the Supervision and Closure of Signature Bank (April 28, 2023), https://www.dfs.ny.gov/system/files/documents/2023/04/nydfs_internal_review_rpt_signature_bank_20230428.pdf.
[5] U.S. Govt. Accountability Office, Bank Regulation: Preliminary Review of Agency Actions Related to March 2023 Bank Failures (May 11, 2023), https://www.gao.gov/products/gao-23-106834.; Bd. of Governors of the Fed. Rsrv. Sys., Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley Bank (April 28, 2023), https://www.federalreserve.gov/publications/files/svb-review-20230428.pdf; Fed. Deposit Ins. Corp., FDIC’s Supervision of Signature Bank (April 28, 2023), https://www.fdic.gov/news/press-releases/2023/pr23033a.pdf.
[6] Overall, the supervisory approach at Silicon Valley Bank was too deliberative and focused on the continued accumulation of supporting evidence in a consensus-driven environment. Further, the rating assigned to Silicon Valley Bank as a smaller firm set the default view of the bank as a well-managed firm when a new supervisory team was assigned in 2021 after the firm’s rapid growth. This made downgrades more difficult in practice.
[7] Id.
[8] Bd. of Governors of the Fed. Rsrv. Sys., Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley Bank (April 28, 2023), https://www.federalreserve.gov/publications/files/svb-review-20230428.pdf (“This report represents the first step in that process—a self-assessment that takes an unflinching look at the conditions that led to the bank’s failure, including the role of Federal Reserve supervision and regulation.”).
[9] See Office of the Comptroller of the Currency, National Banks and the Dual Chartering System (Sept. 2003), https://www.occ.treas.gov/publications-and-resources/publications/banker-education/files/pub-national-banks-and-the-dual-banking-system.pdf.
[10] See Watters v. Wachovia Bank, N.A., 550 U.S. 1, 15 n.7 (2007).
[11] See The Dual Chartering System and the Benefits of the State Charter, California Dep’t of Fin. Protection & Innovation, https://dfpi.ca.gov/the-dual-chartering-system-and-the-benefits-of-the-state-charter/.
[12] Kenneth E Scott, The Dual Banking System: A Model of Competition in Regulation, 30 Stan L. Rev. 1, 30-32 (1977).
[13] See John Mullin, Shopping for Regulators, Fed. Reserve Bank of Richmond (2019), https://www.richmondfed.org/publications/research/econ_focus/2019/q4/federal_reserve.
[14] See Request for Information on Annual Consumer Trust in Banking Survey, 88 Fed. Reg. 37917 (June 9, 2023) (The OCC is gathering information and comments to inform the development of an annual survey to understand consumer trust in banking and bank supervision.).
[15] As a result of the 2023 failures, First Citizens Bank (“FCB”) acquired all SVB’s deposits, loans, and branches at an 87.12% discount. Like the previous regulatory regime of SVB, FCB is a state-chartered bank holding company subject to joint federal supervision by the Federal Reserve and Federal Deposit Insurance Corporation (“FDIC”) coupled with disconnected oversight by a state agency.
[16] State Banking Comission, Off. of the Comm’r of Banks, https://nccob.nc.gov/about-us/state-banking-commission.
[17] See Statement of Michael J. Hsu, Acting Controller of the Currency, to the House Committee on Financial Services (May 16, 2023), https://occ.gov/news-issuances/congressional-testimony/2023/ct-occ-2023-44-written.pdf (“Acting Comptroller of the Currency Michael J. Hsu today testified before the U.S. House of Representatives’ Committee on Financial Services on the agency’s actions and responses to recent market stress and how the agency is ensuring that national banks and federal savings associations operate in a safe, sound, and fair manner.”).
[18] See Watters, 550 US at 15 n.7.
[19] See FFIEC State Liaison Committee (SLC), Fed. Fin. Inst. Examination Council, https://www.ffiec.gov/slc.htm (“The members of the SLC serve as an important conduit to their state colleagues and represent state supervisory interests before the Council. The SLC comprises five representatives from state regulatory agencies that supervise financial institutions. The representatives are appointed for two-year terms.”).
[20] See About the FFIEC, Fed. Fin. Inst. Examination Council, https://www.ffiec.gov/about.htm (“The Council is a formal interagency body empowered to prescribe uniform principles, standards, and report forms for the federal examination of financial institutions by the Board of Governors of the Federal Reserve System (FRB), the Federal Deposit Insurance Corporation (FDIC), the National Credit Union Administration (NCUA), the Office of the Comptroller of the Currency (OCC), and the Consumer Financial Protection Bureau (CFPB) and to make recommendations to promote uniformity in the supervision of financial institutions. Formed pursuant to title X of the Financial Institutions Regulatory and Interest Rate Control Act of 1978 (FIRA).”).
[21] Id.