FIN 366 Week 5 Regulation and Recent Events Example

What Changed After the 2023 Bank Failures: Deposit Insurance, Capital and Liquidity Rules, Stress Testing and Supervision, and What a Regional Bank's Board Should Do Differently

[Student Name]

University of Phoenix

FIN/366: Financial Institutions

Week 5 Assignment

[Instructor Name]

[Date]

The regional bank is a composite written for a model paper; regulatory facts and research findings come from the sources listed and are stated generally.

Earlier weeks examined how banks price assets, respond to monetary policy, manage their balance sheets and compete with other intermediaries. Regulation is the framework around all of it, and in 2023 that framework was tested when several regional banks failed within weeks. Rules show their worth not in quiet years but in the weeks when a bank's depositors decide at once that they want their money back. This paper reviews the framework and what the failures revealed.

Why Regulate Banks

Banks are regulated because depositors cannot easily judge a bank's safety, because runs can spread from weak banks to sound ones and because bank failures can disrupt credit to the whole economy. Deposit insurance protects small depositors and reduces the incentive to run, but it can encourage risk taking, which regulation must then restrain (Mishkin, 2022).

The Post-2008 Framework

After the 2008 financial crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, reshaped regulation. It created the Financial Stability Oversight Council to identify systemic risks, required stress testing for large banks, created resolution planning and made the $250,000 deposit insurance limit permanent. Capital rules adopted under the international Basel III framework raised the quantity and quality of capital, with a focus on common equity, and introduced liquidity requirements, including the liquidity coverage ratio for the largest banks (Basel Committee on Banking Supervision, 2011).

In 2018, Congress raised the asset threshold for the strictest standards, so many regional banks between $100 billion and $250 billion in assets became subject to less frequent stress testing and were not required to apply the full liquidity coverage ratio or to include unrealized securities losses in regulatory capital.

The 2023 Failures

In March 2023, a large regional bank in California failed after depositors withdrew about $42 billion in a single day, and a New York bank failed days later. A third regional bank, also with many uninsured deposits, failed in May. The first bank had grown rapidly with deposits from technology companies, mostly uninsured, and invested heavily in long-term securities when rates were low. As rates rose, those securities lost value. When it announced a loss on securities sales and a plan to raise capital, depositors, coordinating quickly through social media and able to move money instantly online, withdrew at unprecedented speed.

Regulators invoked a systemic risk exception to protect all depositors at the two March failures, including uninsured ones, and the Federal Reserve opened a temporary facility that let banks borrow on the face value of their Treasury and agency holdings rather than their lower market value.

What the Review Found

The Federal Reserve's review of its supervision of the California bank concluded that the bank's board and management failed to manage interest rate and liquidity risk, that supervisors did not fully appreciate the vulnerabilities as the bank grew and did not act with enough force when they identified problems and that the 2018 changes and a shift in supervisory approach reduced the intensity of oversight (Board of Governors of the Federal Reserve System, 2023). The review is notable as a regulator's criticism of its own work.

Policy Responses

Regulators proposed and debated several changes: applying more stringent capital and liquidity rules to banks with more than $100 billion in assets, requiring those banks to recognize unrealized securities losses in regulatory capital, strengthening long-term debt requirements to aid resolution and revising liquidity rules to reflect how fast uninsured deposits can move. Some proposals were revised or scaled back after industry comment, and the final shape of several remained under discussion. Diamond and Dybvig's (1983) model of runs is again central: the speed of digital runs means liquidity must be available in hours, not days.

Deposit Insurance Questions

The 2023 events also reopened the question of deposit insurance limits. Protecting all depositors at the failed banks prevented further runs but raised concerns that large depositors would expect the same treatment in future failures, weakening their incentive to monitor banks. The Federal Deposit Insurance Corporation published options ranging from keeping the current limit to raising coverage for business payment accounts. Any change would need congressional action for most options and would involve higher insurance premiums paid by banks.

Supervision as Well as Rules

The review's emphasis on supervisory follow-through matters as much as the rules. Supervisors had identified problems at the California bank, but findings took time to escalate. Regulators have since emphasized acting more quickly when a fast-growing bank's risks outpace its controls, a change in practice rather than in written rules.

Trade-Offs

Stricter rules make banks safer but raise their costs, which can reduce lending or shift activity to less regulated lenders. The debate after 2023 turns on where to draw lines by bank size and how much to rely on rules versus supervisors' judgment.

What One Regional Bank's Board Did

The board of a composite regional bank with $40 billion in assets took several steps without waiting for new rules. It set a limit on uninsured deposits as a share of total deposits and required available liquidity to exceed uninsured deposits, reviewing both weekly rather than quarterly. It began tracking capital ratios including unrealized securities losses. It shortened the duration of new securities purchases. It tested the bank's ability to borrow from the Federal Reserve discount window by pledging collateral and running a practice draw. And it added a scenario of a one-day outflow of 20% of uninsured deposits to its liquidity stress test.

Conclusion

Banks are regulated because they are fragile by design and central to the economy. The post-2008 framework raised capital and liquidity standards, but thresholds and supervisory practice left gaps that the 2023 failures exposed. Interest rate risk, concentrated uninsured deposits and fast digital runs combined with supervision that did not act forcefully enough. A prudent board can close some gaps on its own while regulators debate the next set of rules.

References

Basel Committee on Banking Supervision. (2011). Basel III: A global regulatory framework for more resilient banks and banking systems (Rev. ed.). Bank for International Settlements.

Board of Governors of the Federal Reserve System. (2023). Review of the Federal Reserve's supervision and regulation of Silicon Valley Bank.

Diamond, D. W., & Dybvig, P. H. (1983). Bank runs, deposit insurance, and liquidity. Journal of Political Economy, 91(3), 401-419. https://doi.org/10.1086/261155

Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010).

Mishkin, F. S. (2022). The economics of money, banking, and financial markets (13th ed.). Pearson.