Where will regulators turn following SVB, Signature Bank failures?

The time to prepare is now.

“The pendulum will swing to a much more aggressive, hyper-focused review by exam teams at individual banks,” said Patrick Hanchey, partner at law firm Alston & Bird. Banks should “take the bull by the horns and be proactive,” he said.

SVB was closed and placed into receivership by California’s banking regulator and the Federal Deposit Insurance Corporation (FDIC) on March 10 after investors and depositors tried to withdraw $42 billion in one day. Signature Bank was similarly shuttered Sunday by the New York State Department of Financial Services and the FDIC.

Federal regulators announced all $264 billion in combined deposits at both banks would be fully protected, albeit with bank assets and not with taxpayer money.

The Department of Justice and Securities and Exchange Commission launched investigations into SVB’s collapse, according to multiple reports. The Federal Reserve Board on Monday announced it would initiate a review of what happened regarding supervision of SVB, with the results due to be published May 1.

While those reviews progress, regulators will be examining individual banks’ balance sheet structures even more closely than usual, Hanchey said, looking for risks posed by depositor concentrations in particular industries or sectors, which were the driving factor in the failures of SVB and Signature Bank.

“The FDIC has always been uncomfortable with banks that have concentrated customer bases,” said Matthew Bisanz, partner at law firm Mayer Brown. “Those concerns will only become more prominent.”

Bisanz said banks should expect more supervisory pressure in this area and more resistance from regulators when seeking to expand in sectors where they already have an overly concentrated presence.

Regulators might also discourage banks from having a large percentage of customer deposits in accounts with more than $250,000, the limit at which the FDIC insures deposits, Bisanz said. Media outlets reported as much as 90 percent of deposits at SVB and Signature Bank were in high-value accounts and thus uninsured.

Bank examiners will also be seeking information about contingency planning, internal stress testing, and whether banks have undertaken resolution planning that adequately assesses the challenges their structure and business activities pose to the financial system if they fail or become distressed, Hanchey said.

“The FDIC has always been uncomfortable with banks that have concentrated customer bases. Those concerns will only become more prominent.”

Matthew Bisanz, Partner, Mayer Brown

Both SVB and Signature Bank invested heavily in U.S. Treasury bonds and mortgage-backed securities whose values declined because of raising interest rates. When customers began withdrawing deposits all at once, the banks lacked available funds and were forced to sell off these assets at a loss.

As a result, another area of focus for regulators will be interest rate risk, Bisanz said. Banks should be able to explain to regulators how they would react to a similar set of circumstances.

Regulators might also seek to impose higher and more explicit market capital requirements on mid-sized banks, Bisanz said.

Some pundits and politicians claim a loosening of regulatory requirements imposed by the Dodd-Frank Act for mid-sized banks under the Trump administration—something SVB lobbied for—allowed SVB’s deposit concentration and liquidity risks to grow undetected. Legal experts said that’s too simplistic.

“Washington has started taking sides, with the Democrats saying there needs to be more regulation and that rolling back Dodd-Frank was a mistake and Republicans saying regulators need to do the job they were tasked to do,” Hanchey said. “It’s unfortunate that will come to be the narrative.”

The Bank Policy Institute (BPI), a nonpartisan public policy, research, and advocacy group, said the failures of SVB and Signature Bank “appear to reflect primarily a failure of management and supervision rather than regulation.”

“The weaknesses at both banks—management of interest rate risk and asset liability management—are traditionally a key focus of bank management and examination,” the BPI wrote in a statement. “Unlike credit risk and liquidity risk, interest rate risk is not susceptible to being reduced to a formula; it is more art than science. For that reason, it has always been a core function of corporate CFOs and treasurers and of bank examiners and not subject to prescribed regulatory formulas.”