The Federal Deposit Insurance Corporation (FDIC) has proposed new regulations for regional banks with the goal of reducing costs to the FDIC insurance fund and mitigating the risk of sector-wide contagion in the event of bank failures.
Less Reliance on Deposits
Under the new rules, banks with $100 billion in assets will be required to rely more on long-term debt as a source of funding. This move aims to reduce their dependence on deposits, both insured and uninsured by the FDIC, as a primary source of funding.
While deposit funding is generally cheaper than debt financing, it comes with inherent risks. Deposits can be unstable, as savers may withdraw their funds when they believe they can earn higher interest elsewhere or when they have concerns about the stability of their bank. These factors contributed to the downfall of Silicon Valley Bank, Signature Bank, and First Republic earlier this year.
Addressing the FDIC Insurance Fund’s Balance
At the end of the first quarter, the balance of the FDIC insurance fund stood at $116 billion, reflecting a decrease of $12 billion compared to the previous quarter. Although updated figures will be released next month, banks are already expected to contribute in order to replenish the funds.
By easing potential future costs to the FDIC insurance fund, other parts of the financial system will bear the burden. During an FDIC board meeting, regulators acknowledged that the new rule would slightly increase funding costs for banks and compress their net interest margin by three basis points. A three-year phase-in period will be implemented for this new standard.
These proposed regulations aim to strike a balance between reducing costs and minimizing risks for regional banks. By encouraging greater reliance on long-term debt as funding sources, banks will become less vulnerable to fluctuations in deposits. Ultimately, this will enhance the stability and resilience of the financial system as a whole.
Banking Sector Faces Multiple Challenges
While the banking sector is currently dealing with various challenges, one significant concern revolves around the potential weakening of the economy. As a result, lenders are experiencing slower loan growth, and there are early indications of consumer stress with an increase in delinquencies.
“Living Wills” for Banks with $50 Billion in Assets
In addition to these challenges, the FDIC has introduced a new rule that requires banks with at least $50 billion in assets to develop “living wills.” These plans serve as a strategy for the orderly dissolution of a bank in the case of failure. The intention behind this requirement is to avoid hasty and disorderly bank sales that typically occur over a weekend following a failure.
This approach promotes a more organized process, reducing the likelihood of a chain reaction leading to the failure of multiple banks within the industry. The collapse of Silicon Valley Bank, for example, caused significant drops in stocks of regional banks as investors worried about the possibility of similar bank failures.
Banking Sector’s Reaction to Increased Regulations
While the banking sector generally opposes increased regulation and associated costs, it has responded positively to this news. The proposed rules will undergo a comment period until November 30th. Many of these regulations have been long-anticipated by Wall Street, and bank stocks have already experienced considerable declines this year. Credit downgrades by ratings agencies in recent weeks have further contributed to these losses.
In midday trading on Tuesday, the SPDR S&P Regional Banking ETF (KRE) rose by 1.5%, while the S&P 500 saw a 1.3% increase.
