Raising the threshold for tougher bank regs may not have paid off after all

Bloomberg News

A few weeks ago, we all learned that New York Community Bank — which had acquired roughly $38 billion of assets from Signature Bank, one of the casualties of last year's midsize bank crisis — was having some problems. During their fourth quarter earnings call Jan. 31, NYCB executives charged off a couple of loans, increased its loan loss reserves and cut its dividend significantly, which in turn caused its stock price to plummet.

There are many, many takes out there about what went wrong at NYCB and what it means for the rest of the banking industry and the economy at large, but the aspect of this episode that may be worthy of deeper consideration is whether enhanced regulatory obligations brought about by rapid growth had the effect of destabilizing the bank. 

NYCB CEO and President Thomas Cangemi said the acquisition of Signature's assets last year spurred the bank to pass the $100 billion asset mark "sooner than anticipated" and as a result the bank "pivoted quickly and accelerated some necessary enhancements," namely in the form of additional loan loss reserves. Keep in mind that one of the faults found in the Silicon Valley Bank experience was that regulators — and the bank itself — were unable to keep pace with the bank's dramatic growth, so perhaps regulators overlearned the lesson and cracked down extra hard on NYCB as its asset portfolio grew. 

Of course there are important differences between NYCB and SVB, not the least of which is that NYCB is still a going concern and SVB is not, and that itself is at least in part attributable to the fact that only about 28% of NYCB's deposits are uninsured compared to 90ish% of the late SVB's. But rapid growth is something that they have in common, as are the enhanced prudential standards that kicked in when both banks reached an asset threshold of $100 billion. 

That $100 billion number itself has a bit of history. When Dodd-Frank was being drafted, there were a great number of regulatory and supervisory innovations that were being bandied about to keep a disaster like 2008 from happening again — higher capital and liquidity, but also living wills, stress testing and all kinds of other things designed to allow large banks to fail without compelling the government to choose between rewarding bad behavior on the one hand and allowing the global economy to collapse on the other. But all parties agreed that the kind of systemic risk that might force such a choice was present at the largest banks and absent at the smallest ones, and somewhere in the middle a line would be drawn distinguishing the two. That initial line was drawn at $50 billion. 

Many years later, after the dust had settled from 2008 and with the benefit of hindsight, lived experience and a new administration, lawmakers decided that the $50 billion threshold was too low — too many banks were staying below the $50 billion mark to avoid incurring the considerable compliance costs of being over that mark without the benefits of large enough economies of scale to offset those costs. They passed a bill in 2018 that raised the threshold for a systemically important financial institution, or SIFI, from $50 billion to $100 billion, and further gave the Federal Reserve discretion as to how to regulate banks between $100 and $250 billion of assets — rules that introduced the Category I-IV framework that banks live by today.

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The purpose of those rules was to gradually ratchet up enhanced prudential regulations as a bank got larger and more systemically important, replacing the hard $50 billion barrier with a more incremental regime. But it seems that what that law and those rules may have done in practice is move the kink in the bank growth hose from $50 billion to $100 billion — and as we have seen, banks in that range can pose systemic risks after all. So all that has effectively happened is that banks are facing the same abrupt regulatory cliff, but the fall is twice as deep as it was before. 

I'm not necessarily advocating for a return to the $50 billion threshold. That's partly because doing so would require an act of Congress — something that of late has become something of a contradiction in terms — but also because asset size may not actually be the one true metric by which to assess a bank's systemic risk.

Instead, there ought to be a reconsideration of the assumptions that underpin the regulatory apparatus for banks and their potential to disrupt the financial system when they have bad luck or make bad choices. In SVB's case, the overreliance on insured deposits seems to have been the root of its downfall, whereas NYCB's concentration in commercial real estate or Silvergate's dalliances with crypto created their own headaches. 

But if asset thresholds are the tools that regulators have, then they should be applied in ways that minimize the suddenness with which those rules might be applied or enforced — both before a bank crosses the line in the sand and after.