In 2023, the largest US bank failure to date occurred with the collapse of First Republic Bank. Regulators arranged for JPMorgan Chase to acquire First Republic’s assets and deposits, limiting the cost to the Federal Deposit Insurance Corporation to $13 billion. The failure of a seemingly successful bank that was not engaged in obviously risky activities highlights the need for all stakeholders in the banking system to find more flexible and imaginative ways to spot risks that may bubble up suddenly from changes in the trading environment.
First Republic, Silicon Valley Bank, and Signature Bank had a business model that did not adapt well to rising interest rates. First Republic’s model of providing cheap mortgages to wealthy customers left it sitting on large paper losses on its mortgage book when rates rapidly climbed. Customers also demanded higher deposit rates to keep their money at the bank. While First Republic was more diversified than SVB’s heavily tech sector-dominated client base, it was still facing a couple of years of poor earnings. First Republic’s fate was sealed when it revealed customers had pulled out $100 billion of deposits in the first quarter.
The withdrawal of $40 billion from SVB in one day in March demonstrated the speed at which deposits can be taken out in the digital banking age and how social media can amplify panic. There is a strong argument for partially rolling back changes introduced by bipartisan banking legislation in 2018 that eased restrictions and oversight for banks with less than $250 billion in assets and once again applying higher standards to midsized banks. Regulators need to address “cliff edges” that occur as lenders cross asset-size thresholds and move from one regulatory regime to another. Banks should face increased scrutiny as they approach thresholds, not just after they cross them.
Consolidation is needed in the banking sector, though it would be better for midsized lenders to consolidate among themselves. Another acquisition by JPMorgan raises awkward questions and could be detrimental to competition. The best way to avoid further concentration with big lenders stepping in is to ensure smaller and midsized banks are more effectively managed and regulated, and not likely to fail in the first place