In the spring of last year,
Indeed, some have said modern bank regulation attempts to boil the ocean or, in effect, manage the bank soup to nuts. If we do not change our focus, in how we address modern information and payments technology on the one hand and our bank regulatory framework on the other, we will face even more destructive runs. And we may well lose a disproportionate part of our community and regional bank system to the detriment of smaller communities and small businesses.
In the first installment of this two-part series, I will dissect the anatomy of these events, unpacking the precise interplay of technological manipulation and regulatory blind spots that fueled the flames. In the second, I will incorporate learnings from the 2023 difficulties so that we can best avoid a repeat, outlining concrete steps for a more dynamic and adaptable regulatory framework.
Prior to the troubles that occurred last spring, all three of the banks that failed enjoyed strong reputations among bank analysts, the business community and many regulators. Each served targeted areas of the American economy in unique ways and with specialized skills. All three were pioneers in their respective fields, recognizing emerging markets that benefited from unique banking service approaches. And all three demonstrated that hands-on, personalized service coupled with specialized expertise is often best delivered by smaller financial institutions. Indeed, the entities that failed in the spring of 2023 had been well rated by regulators during the months, weeks and even days prior to their failures.
In reality, these three institutions, along with many other reputable banks, were caught up in a kind of internet wildfire, unprecedented in its speed and destructive nature. The internet allowed, if not fomented, rumors, half-truths and some distorted facts to spread almost instantaneously and create a panic. This panic, with the use of the internet and other modern banking techniques, including a much-faster payments system, allowed frantic deposit holders to withdraw funds in unprecedented amounts and at unprecedented speed. Importantly too, individuals with their own vested interests can leverage the internet to create or exaggerate rumors of failure to manipulate stock prices. To add heat to any modern conflagration, self-styled pundits spread their "wisdom" on the internet to gain attention. Moreover, competitors and malcontents often take advantage of online platforms to create chaos and unrest. The contours of the 21st century internet-induced panic have brought such a significant change in circumstances that it warrants the lion's share of attention and regulatory change.
Clearly, what our regulatory community and banks need today are tools to allow for a time-out to ensure what is said about a bank and its financial condition is truthful and/or to alert the public of steps the regulators are taking to
Furthermore, the bank regulatory mechanism should take steps to avoid complicating and misdirecting regulation and supervision that banks and regulators take their eyes off the core issues that can cause a bank to fail, for example: (1) lack of liquidity; (2) an asset and liability mismatch; (3) overly risky trading, investments or a weak loan book; (4) excessive financial concentrations; (5) weak provisioning or capital. And bank regulators should not force banks to take steps, or themselves take steps, particularly public steps, in a time of financial vulnerability that gives the public reason to panic and start a run.
After California was hit hard by the banking crisis of 2023, tens of thousands of commercial and consumer customers turned to East West, helping the company achieve record full-year revenue, its CEO says.
Indeed, public actions in times of institutional vulnerability have become a particularly important issue in a modern supervisory approach. If our regulatory framework is to support banks, especially during crises — and it should — we will need to avoid taking steps that will cause or exacerbate a run. Given sufficient time, the greatest share of regulated banks can, with supervisory support, work their way out of a financial hole. The goal of supervision in moments of crisis should be saving the bank, first and foremost. Putting out the financial fire, eliminating (or minimizing) panic runs and policing the misuse of social media should be the first order of business. Overreacting by way of forced write-downs that are excessive, issuing public orders when private orders will accomplish the same goals, dividend cuts and other public steps can give rise to the very public panic we should want to avoid. After all, confidential supervisory information is deemed confidential for important reasons.
While focusing on the basics of bank safety and soundness is critical, merely applying the nostrums of the past, and particularly when applied with an overly heavy hand, is unlikely, as a regulatory matter, to prevent future panic runs of the type we witnessed last year, and indeed can do the opposite. To the extent we rely solely — and double down — on using regulatory tools in the same, old-fashioned way, the banking system will become less adaptable and effective in fighting the real fires of the future. For example, strong capital is important. But it is only one tool in the safety and soundness toolkit. I fear that today we are looking too much at capital as a cure-all, which it is not. In the 2023 crisis, all the affected entities had adequate capital and it can be persuasively argued that even a much stronger capital stack would not have made a difference in the outcome.
We also must not be so tied up in regulatory administrivia that supporting a diverse and dynamic economy will take a back seat. This is of particular concern for smaller financial institutions that possess expertise in serving small businesses and low- and moderate-income communities. But at the same time, they don't have the bandwidth to deal with additional regulatory complications — and to the degree that those complications are only marginally impactful, the effort they're forced to expend to comply can make them much less viable.
To date, Congress and the regulators have made a "down payment" on recognizing that smaller institutions need less intrusive regulation, but what has been done to date is much, much less than is needed to have a robust regional and community bank framework. While it is important to test systems and controls, we have to be careful not to exalt form over substance — to focus so much on the process that the product is neglected. Bank supervision history has shown that process addicts almost always miss the forest for the trees.
So, what more can the government do, beyond doing a better job of policing the internet and focusing on the basics of financial risk while rightsizing regulatory responses and creating a mechanism for a time-out when a run starts? Protecting Main Street requires more than post-mortem analysis. Unfolding in part two, we'll map a clearer path toward solutions for building a regulatory system that protects not just financial institutions but the communities they serve.
