By Candice Nonas
In light of recent US bank failures, regulators are scrambling to come up with new strategies to regulate and supervise banks with the goal of ensuring safety and soundness in the banking system, and financial stability.
Congress is to hold hearings, and likely push for more regulation.
But is the answer to do more of the same manual surveillance and review? Can technology have prevented the most recent bank failures, and can it be used to strengthen bank regulation and surveillance in the future?
The regulators reviewed the most recent bank failures and identified human error in the form of poor management and lack of board oversight while in some cases the bank examiners were slow to act, as the root causes of failure.
JP Morgan sounded the alarm about commercial real estate and warned that the current disruption in the regulated bank space is not over yet. Even though this wave of bank failures lies at the feet of human judgement, regulators should explore the bevy of technology tools on the market in order to address current and impending issues in the US financial system.
Human error at the root of bank failures
The Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve Board (FRB) recently published autopsy reports on two of the largest bank failures since the great recession. The FDIC conducted a forensic review of New York-based Signature Bank while the FRB reviewed California’s Silicon Valley Bank. In both cases, the regulators pointed out a failure of leadership and management as the root cause of failure.
Looking across the landscape of bank failures reveals some common themes: each bank set out to grow the business and did it very rapidly. In the pursuit of growth, banks targeted specific customer segments. Silvergate Bank (CA) had a large exposure to the cryptocurrency market, and self-liquidated (FDIC does not list Silvergate as a bank failure) in first quarter of 2023 following the failure of the FTX crypto exchange.
Founded in 2001, Signature Bank (NY) decided to go long on private equity and digital asset banking which doubled its size between 2020 and 2021, and increased its uninsured deposits – large deposits that exceed the $250 000 (R4.6 million) deposit insurance cap – to 92% of total deposit. Rising interest rates coupled with volatility in the digital asset space led to a rapid and crippling outflow of digital asset customers’ deposits.
First Republic (CA) had a 38-year storied history and the bank offered concierge, high-touch customer service to ultra-wealthy clients. By their nature, uninsured deposits are opportunistic and not sensitive to the safety and protection of deposit insurance. When depositors saw the collapse of SVB and Signature they got spooked and moved $100 billion out of the bank in just one quarter.
The FRB vice chair of Supervision Barr offered a very succinct explanation of Silicon Valley Bank’s failure by describing it as suffering from, “… (a) highly concentrated business model, interest rate risk, and high level of reliance on uninsured deposits…” But what Barr goes on to say is at the heart of the issue when he admits that SVB’s failure exposed weaknesses in regulation and supervision that must be addressed.
Banks and regulators should double down on technology
Be it proptech, fintech or regtech, banks and financial institutions use technology to make business decisions and manage risk. Proptech is a tool used in the real estate space and the most familiar forms like Zillow, Redfin, and Air B&B are consumer-facing. However, there are tools like Risk Footprint, which has integrated live data from FEMA to help users avoid climate risk and drive their environmental, social and governance agenda.
Commercial real estate lenders, which includes banks, can use this tool during the due diligence phase of the underwriting process to gauge the probability of a natural disaster and calculate its attendant potential future exposure. This helps to inform risk-based pricing, loan terms, and the size and scope of required disaster recovery insurance.
Banks and fintech companies have been partnering on various business strategies for a while, including customer acquisition. The buy-now-pay-later also known as marketplace lending business depends in large part on relationships between banks and non-bank technology companies.
A fintech company like Affirm or After Pay offer customers financing at the point of sale in the form of a loan that is financed by a bank behind the scenes. Cross River Bank, which has recently come under scrutiny for its third-party risk management, dominates this space. Once the loan is originated, the borrower becomes a de facto credit customer of the underwriting bank; the loans are packaged and securitised; and the bank’s captive broker deal can sell the securities into the capital markets.
Deloitte took a look across 485 products in the Regtech landscape and grouped them into the following five categories:
∎ Regulatory reporting tools are intended to enable automated data distribution and regulatory reporting through big data analytics, real-time reporting and cloud computing.
∎ Risk management tech is used to detect compliance and regulatory risks, assess risk exposure and anticipate future threats.
∎ Identity management and control facilitate counter-party due diligence and know your customer procedures as well as anti-money laundering and anti-fraud screening and detection.
∎ Compliance promises to provide real-time monitoring and tracking of the current state of compliance and upcoming regulations.
∎ Transaction-monitoring solutions facilitate real time transaction monitoring and auditing.
The FDIC insures nearly $10 trillion in deposits at more than 4 700 banks, supervises over 3 200 banks, and oversees the $125 billion Deposit Insurance Fund (DIF) that protects bank depositor accounts and resolves failing banks. The FRB has the dual mandate of monetary policy as well as bank supervision and regulation. Both of these agencies have an awesome and daunting task.
Even though the goal is not to prevent bank failures, both of these agencies would do well to explore and adopt the latest tools and technology in order to keep pace with the fast paced, ever-changing banking sector.
Candice Nonas is a banking and financial services subject matter expert and former bank regulator
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