WASHINGTON — First Republic Bank's May failure followed the dramatic failures of Silicon Valley Bank and Signature Bank in the preceding weeks, and a new report from the the Federal Deposit Insurance Corp.'s inspector general suggests the FDIC may have missed some opportunities to more effectively address risks leading up to the firm's collapse.
A material-loss review commissioned by the FDIC’s Office of Inspector General shed light on the circumstances leading to the failure of First Republic Bank. The comprehensive examination, conducted by Cotton & Company Assurance and Advisory, said the FDIC could have implemented more timely supervisory actions, including downgrading the firm's component ratings and reassessing guidance concerning the substantial quantity of uninsured deposits that ultimately fled from the bank.
The report emphasizes the need for the agency to take a hard look at some of the triggers the agency uses to define bank health, saying the agency’s current capital measures classified the bank as well-capitalized up until its failure.
"The bank’s failure may warrant changes to the guidelines establishing standards for safety and soundness, including the adoption of noncapital triggers requiring regulatory actions," the report notes.
The Inspector General of the FDIC is required to conduct material loss reviews following the failure of a financial institution to determine the causes that led to the institution's downfall and resulted in a material loss to the deposit insurance fund.
The material-loss review attributed the demise of San Francisco-based First Republic to contagion effects stemming from the failure of other major financial institutions like Silicon Valley Bank and Signature Bank months prior. The review noted a run on deposits severely impacted the bank's liquidity, revealing vulnerabilities in its business strategy.
The review also pointed to the bank's reliance on attracting high-net-worth customers with competitive loan terms and funding growth through low-cost deposits, which heightened the concentration of uninsured deposits and increased the bank’s sensitivity to interest rate risk.
“This strategy ultimately led to a significant asset/liability mismatch for the bank, and fair value declines on its portfolio of low-yielding, long-duration loans, which limited its ability to obtain sufficient liquidity and prevented its recovery,” the review noted.
The report proposed 11 recommendations to improve the FDIC's supervision processes including reviewing examination guidance, establishing communication protocols for large banks, updating examination instructions, conducting reviews on contagion risk factors and the supervisory approach to contagion risk, exploring processes for monitoring large bank liquidity risk, adding institutions to the supplemental offsite review list, assessing fair value for long-term loans and engaging with other regulators to evaluate potential changes to regulations under Section 39 of the FDI Act, which empowers the agencies to establish safety and soundness standards.
FDIC agreed with all 11 recommendations and will complete the actions by the summer of next year.
“The FDIC concurs with this recommendation and will engage with the other regulators to evaluate why the changes to the regulations promulgated under Section 39 of the FDI Act may be warranted to address noncapital triggers to take actions related to unsafe and unsound practices,” the FDIC wrote in its response letter to the report. “The FDIC will document the results of that engagement and evaluation with the other regulators by March 31 2024.”
