04/26/2023
More than a month after Silicon Valley Bank collapsed, the Federal Reserve is considering expanding oversight to prevent some mid-sized banks from covering up losses on their securities holdings.
The sudden collapse of Silicon Valley Bank and Signature Bank last month sent shockwaves through the global financial industry before regulators began considering changes. If passed, it would reverse the Fed's decision to loosen regulatory rules in 2019 and apply restrictions currently applied only to the largest and most complex financial institutions to manage mid-sized banks.
In total, regulators are considering extending the tougher restrictions to about 30 banks with assets between $100 billion and $700 billion. Specific proposals could be announced as early as this summer, with changes to be phased in over the next few years.
Regional banks such as U.S. Bancorp and PNC Financial Services Group could be affected and forced to raise capital. They may respond to regulatory changes by cutting back on buybacks, retaining more earnings or raising capital from investors.
The aforementioned Federal Reserve Vice Chairman Barr once hinted after the collapse of Silicon Valley Bank that a series of stricter regulatory rules will be introduced, which will enhance the resilience of the financial system. He has said, for example, that SVB's capital levels don't necessarily reflect unrealized losses on certain securities.
Under regulations introduced after the 2008 financial crisis, banks with more than $250 billion in assets must factor unrealized gains and losses on "available-for-sale" securities into their capital ratios. But smaller regional banks would not have to, arguing that such a move would introduce excessive volatility to their capital metrics. Larger regional banks were also exempted in 2019.
Changes being considered by the Fed could reverse that, meaning that unrealized losses would also reduce banks' capital levels.
"Available-for-sale" securities played a major role in the collapse of Silicon Valley banks. On March 9, Silicon Valley Bank announced that it had sold a large number of securities, resulting in a loss of nearly $2 billion, and said it would sell shares to raise funds. That has sparked shareholder concerns about dilution and possible unrealized losses in the bank's books.
Silicon Valley Bank shares plummeted, depositors withdrew $42 billion in deposits the next day, and regulators had to take control of the bank. The bank has larger unrealized losses in another class of securities that the bank has said it will hold to maturity. These losses were neither reflected in the bank's financial statements nor recognized by regulatory capital.
Proponents of changing the capital rules on unrealized losses on banks’ “available-for-sale” securities say it would force Silicon Valley Bank to address the problem earlier when interest rates start to rise and the value of the securities it holds falls.
But banks say the change could lead to higher government borrowing costs and mortgage rates. The rule would require banks to hold more capital, which, combined with possible restrictions on the securities they plan to hold to maturity, could instead prompt banks to stop buying long-term Treasury and mortgage-backed securities, they said.
