Need To Strengthen Regulation Of Financial Institutions After US Bank Failures: Fed Chair Jerome Powell

US Fed Chair also said that tougher regulations put in place after the 2007-2008 financial crisis have made large multinational banks much more resilient to widespread loan defaults

Jerome Powell said that one reason regulators missed the threats to the three banks was the natural human tendency to fight the last war.

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The US Federal Reserve Chair Jerome Powell said on Thursday that there is a need to strengthen supervision and regulation of financial institutions in the wake of the failure of three large US banks earlier this year. Speaking at the Banco de Espana Fourth Conference on Financial Stability in Madrid, Powell said that the bank runs and failures in 2023 were painful reminders that we cannot predict all of the stresses that will inevitably come with time and chance.

"We therefore must not grow complacent about the financial system's resilience," Powell said. Adding that the collapse of Silicon Valley Bank, Signature Bank and First Republic Bank exposed different vulnerabilities that the Fed will likely address through new proposals.  However, He did not provide details. US Fed Chair also said that tougher regulations put in place after the 2007-2008 financial crisis have made large multinational banks much more resilient to widespread loan defaults, such as the bursting of the housing bubble that led to that crisis.

Powell said that one reason regulators missed the threats to the three banks was the natural human tendency to fight the last war. "In 2008 we saw banks come under stress from outsized credit losses and insufficient liquidity. SVB's vulnerability came not from credit risk, but from excessive interest rate risk exposure and a business model that was vulnerable in ways its management did not fully appreciate, including a heavy reliance on uninsured deposits."

These events suggest a need to strengthen our supervision and regulation of institutions of the size of SVB, Powell said.

"Notably, bank runs were no longer a matter of days or weeks—they could now be nearly instantaneous," he further added. 

In a question and answer session, the Fed chief highlighted the need for updated rules to address the speed of bank runs, citing the shift from physical queues to instant digital transactions. He said that Fed supervisors identified vulnerabilities but were constrained by a slow-moving system, prompting an ongoing review for more agile and forceful supervision, as per an Associated Press report. 

"An ongoing review of Fed supervision would try to find ways to be more agile and, where appropriate, more forceful," he further said.

According to the AP report, US Fed officials have said that banks should be required to hold more capital in reserve to guard against loan losses. However, any such proposals are likely to face resistance from the banking industry and some congressional Republicans. The US GOP argue that the Fed had the necessary tools to prevent the bank collapses but failed to use them, the report said. Adding that legislation passed by Congress and rules set by the Fed in 2018 provided regulatory relief to banks with assets ranging from $100 billion to $250 billion, which encompassed the three banks that experienced failures.

During recent House and Senate hearings, as per the report, Jerome Powell encountered significant opposition from Republicans regarding the potential implementation of stricter regulations. The Fed's top regulator, Michael Barr, suggested that larger banks may be required to hold higher capital reserves. However, GOP members of Congress argue that such requirements could hinder lending and slow down the economy.

During the hearing Powell mentioned the possibility of issuing a proposal next month but reiterated that any new rules would undergo a public comment process and be phased in gradually, potentially taking several years to come into effect.

Powell also emphasised that the bank runs and failures in 2023 served as reminders of the unpredictability of future stresses, emphasising the need to remain vigilant and not become complacent about the resilience of the financial system, the report said.