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After SVB is there still such a thing as a non-systemic bank?

Author: ICAEW Insights

Published: 06 Apr 2023

The collapse of Silicon Valley Bank has raised some interesting questions as to the future of regulating banks. Are there lessons to be learned from the US as the Prudential Regulation Authority consults on its “Strong and Simple” regime?

These are interesting times for policymakers. For several years smaller banks and building societies have been calling for more proportionate, prudential regulation. After the horrors of the 2007-08 financial crisis the rules brought in to ensure there was not a repeat, were designed to address the failures of very large and systemically important banks. 

These rules stretch across the way in which banks must calculate, hold and report capital and liquidity. Smaller banks have pointed to these rules in the past as complex, costly and overly burdensome. 

The argument goes that if there are “systemic” banks, then there must also be those that are not and so to afford the same rule book to both would not be fair. Especially where the “costs of operationalising” those rules are disproportionately higher. 

Up until now these claims have held some merit, hence the Prudential Regulation Authority’s recent initiative on the “Strong and Simple” regime. 

The regulator’s proposals “seek to simplify the prudential framework for non-systemic domestic banks and building societies, while maintaining their resilience”. In effect this would introduce a two-tier prudential regime in the UK with a different set of rules applying to those with less than £20bn in assets (alongside additional risk-based criteria). 

The US approach 

In recent weeks you may have come across other examples of tiering in the context of the US bank failure of Silicon Valley Bank (SVB). 

In January 2019 the Federal Reserve Board introduced changes to the “Enhanced Prudential Standards” originally implemented as part of the Dodd-Frank Act. 

The changes were thought to support growth by introducing, what the Chair of the Federal Reserve, Jay Powell, then described as “…materially less stringent requirements on firms with less risk, while maintaining the most stringent requirements for firms that pose the greatest risks to the financial system and our economy”. 

For smaller banks, such as SVB, this meant a relaxation of capital and liquidity requirements coupled with reduced regulatory oversight. 

One of the more consequential rules was relaxed via an exemption from including movements in Accumulated Other Comprehensive Income in regulatory capital. In simple terms, SVB was able to flatter its capital position as it did not have to write down regulatory capital to reflect unrealised losses relating to Available-for-Sale bonds. 

Erroneously, the bank was also not held to the same stress testing standards of large banks. An exercise that may have highlighted the fatal flaws within its business model and which ultimately led to its downfall. 

As with any bank failure there are lessons to be learned for policy makers. While there were a number of factors that played into SVB’s downfall, it is clear that the relaxation of rules – at the very least – played a supporting role.

What is perhaps more interesting is how the failure and subsequent crisis, albeit now contained, informs our understanding of what constitutes systemic. 

The repercussions of SVB

In the days following SVB’s collapse, mid-sized and smaller regional banks across the US experienced sharp deposit outflows. 

Depositors took the (arguably logical) view that, were a full-scale banking crisis to emerge, history would show that state intervention would prioritise the very large over the very small, playing on the theme of “too big to fail”. Consequently, very large US banks experienced unprecedented inflows to their savings and deposit products. 

Thankfully US regulators recognised early that, while SVB was not particularly large, its failure had acted as a catalyst for greater instability across banks. 

ICAEW Deputy President Mark Rhys says: “The lesson learned is that any bank failure irrespective of size or relative importance can, given the wrong set of circumstances, have broader systemic implications.” 

And so, in many ways SVB provides helpful context for UK regulators as they develop “Strong and Simple” and a bulwark against those voices across the sector that would like to see greater deregulation. 

Rhys says: “We might conclude that for smaller banks to survive the entirety of a business cycle – where at some point there is likely to be vulnerability in the system – then we need to give depositors a compelling reason to stick around. A proportionate regime in this context might be one that is as robust as, not less than, that applied to larger peers.” 

The other side of this debate is of course that the UK banking sector does not operate as a zero-failure regime. Rhys says: “Banks allowed to fail should do so in such a way as to not create wider disruption. The question being in moments of market panic, irrespective of how well banks have managed their risks, can we always expect failure to be orderly?” 

We are yet to see the entirety of the “Strong and Simple” proposals and are still waiting on the most consequential aspects, including how capital is calculated. However, details to date include removal of certain reporting requirements, simpler templates, replacement of complex measures as to whether sufficient liquidity was on hand, fewer add-ons to minimum levels of liquidity held (also known as Pillar 2) and reduced market disclosures.

By design, none of these changes amounts to a regime that is significantly less robust. They certainly do not add up to the kind of tiering introduced by regulators in the US and £20bn as a threshold is also a far cry from the $250bn limit set in the US. 

Nonetheless, recent events will no doubt push regulators to reconsider what is systemic and where the line is more appropriately drawn. Arguably, the failure of SVB supports any reticence UK regulators may have to water down requirements and in doing so reinforces the initial premise of a regime that is “strong” as much as it is “simple”.

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