The Federal Reserve’s post-mortem following the Silicon Valley Bank failure stressed the “need to evaluate how we supervise and regulate a bank’s management of interest rate risk.” Other bank regulators have noted similar concerns. It’s now 16 months since SVB’s failure. What actions have regulators taken (or not taken) to address interest rate risk?
SVB failed due to an unprecedented deposit run, but excessive IRR made its resolution more costly. The same goes for Signature Bank. IRR played the primary role in the First Republic Bank failure and in this year’s failure of Republic First. Reviews of each of the 2023 bank failures showed that regulators’ efforts to rein in IRR at these banks were at best, ineffective, at worst, nonexistent. It’s reasonable to expect regulators to make adjustments. Have they?
Regulation & Supervision
Banking agencies have two distinct but related functions: regulation and supervision. Regulation covers the rulemaking process and can include specific regulations, policies, and guidance. Supervision applies these rules to individual banks, with a healthy dose of examiner judgment thrown in.
Little has changed on the regulatory front. The banking agencies have not proposed any new regulations or guidance specifically addressing interest rate risk. The Basel Endgame proposal would expand the number of firms that would need to reflect in capital unrealized losses on their available-for-sale (AFS) investment portfolios. Those unrealized losses primarily result from interest rate risk. This change would recognize economic reality. However, as I noted in an earlier post it could also encourage banks to move more investments into held-to-maturity rather than addressing their interest rate exposure.
And that’s about it. The only regulation that specifically addresses interest rate risk is 12 CFR § 163.176 . That reg only applies to 248 federal savings associations, or a little more than 5% of all financial institutions in the United States. Current safety and soundness standards (12 CFR 30 for national banks) merely indicate that banks “should manage interest rate risk in a manner that is appropriate to the size of the institution and the complexity of its assets and liabilities” and periodically report IRR to management and the board.
There is more in the way of guidance. The 2010 Interagency Advisory on Interest Rate Risk identifies better practices in IRR management. Each agency also includes sections on IRR in their examiner handbooks. The handbooks were last updated in 2020. While the guidance is generally adequate, the 2023 experience exposed some gaps. For example, neither the Interagency Advisory nor the handbook define “excessive” IRR, except to reiterate Basel guidance for the largest internationally active banks.
How About Supervision?
The dearth of regulations specifically dealing with IRR means leaving that task primarily with Supervision. Unfortunately, bank supervision operates outside of the public view. We can, however, try to make some inferences from what we do know.
Let’s start with examination ratings. The number of institutions on the FDIC’s Problem Bank List increased from 43 in Q1 2023 to 63 by Q1 2024. That list covers banks with composite CAMELS ratings of “4” or “5.” The Problem Bank List excludes component ratings, so it remains unclear whether Sensitivity to Market Risk ratings are driving adverse overall ratings. The Federal Reserve Supervision and Regulation Report Supervision and Regulation Report provides more granular data that show an increase in adverse ratings for large financial institutions. The Federal Reserve’s list lumps together liquidity and sensitivity. (More than 90% of regional and community banks have a Satisfactory rating, however.)
Trends in matters requiring attention (MRAs) provide another data point. While there is not always a direct, linear relationship between MRA counts and a supervisor’s level of concern, they are broadly indicative. Moreover, supervisors need to provide justification when downgrading a bank’s component rating. The biggest element we look for is the supervisory record. It’s hard to adversely rate a risk area without an MRA or two calling out the concern.
The Federal Reserve provides overall MRA counts for banks and holding companies under its supervision. It further breaks this down by category, but again lumps together liquidity and interest rate risk. The FDIC’s 2023 Annual Report includes matters requiring board attention by category. MRBAs attributable to sensitivity increased from 30 in 2022 to 60 in 2023. The OCC’s Semiannual Risk Perspective provided the percentage of MRAs by categories, showing just 2% attributable to IRR as of Fall 2023. OCC only provided percentages and not MRA totals. MRA statistics disappeared entirely from the Spring 2024 Risk Perspective.
Enforcement Actions
That leaves enforcement actions. Regulators set a high bar for public enforcement actions. Supervisors can take plenty of steps to rein in interest rate risk without resorting to enforcement actions. But we can still look at trends. One advantage of public enforcement actions is that they are, well, public. Unlike problem bank or MRA counts, we don’t need to infer. The concerns are right there in the enforcement documents, which are conveniently available online.
The table below shows, by agency, the number of IRR-related enforcement actions since the SVB failure and for the preceding 16 months.
The contrast is quite stark. IRR-related enforcement actions have more than tripled overall. Enforcement actions usually cover other risk areas as well. We can’t necessarily say whether IRR drove of the enforcement action. The OCC totals also include instances where IRR is one of a litany of risks. For example, the Consent Order for City National requires development of a strategic plan that considers interest rate risk, along with seven other risk stripes. Nine of the OCC’s 18 post-SVB enforcement actions only discussed IRR among a litany of risks. Each of OCC’s three pre-SVB enforcement actions took the litany approach.
Conclusions and Recommendations
IRR-related enforcement actions have sharply increased over the past 15 months. The experience with SVB and other failed banks clearly appears to have had an impact. However, none of the enforcement actions relate to banks with more than $100Bn in assets. There was long a perception that IRR was less of an issue at the largest banks, with the perception strongest among those furthest away from the action. Some regulators presumed that large banks were sufficiently diversified and that they possessed the sophistication and resources to manage IRR prudently. Recent experience shows that banks with significant concentrations can grow quite large and big doesn’t necessarily mean prudent and sophisticated.
Regulators could do more. Ideally, that would include codifying the Interagency Advisory and adding some discussion of what constitutes “excessive” IRR. At a minimum, regulators could beef up the IRR section of the safety and soundness regulations with more specificity. More transparency would also help. Regulators could provide breakdowns of component as well as composite ratings. The FDIC reports MRBA counts by category. The other banking regulators should follow suit.