The banking crisis of 2023 has claimed its largest US victim to date: First Republic Bank. The deal regulators orchestrated in the early hours of Monday for JPMorgan Chase to acquire the California lender’s assets and deposits is perhaps the best outcome that might have been expected in the circumstances. Sharing First Republic’s loan losses with JPMorgan will limit the costs to the Federal Deposit Insurance Corporation to $13bn. Yet the failure of a bank that was, on the surface, highly successful and not engaged in obviously risky activities is alarming. It underlines the need for all stakeholders in the banking system — investors, managers, boards and regulators — to find more flexible and imaginative ways to spot risks that may bubble up suddenly from changes in the trading environment.
What First Republic shared with Silicon Valley Bank and Signature Bank, which failed in March, was a business model that did not adapt well to rising interest rates. Yet while SVB’s problem was its stock of mortgage bonds and Treasuries, First Republic’s issues were more in its loan portfolio, where its model of providing cheap mortgages to wealthy customers left it sitting on large paper losses on its mortgage book when rates rapidly climbed. On the funding side, customers also began demanding higher deposit rates to keep their money at the bank. First Republic was more diversified than SVB’s heavily tech sector-dominated client base. The bank was facing a couple of years of poor earnings, but might well have survived had it not suffered a run on its deposits.
That highlights the need for a rethink of rules on liquidity requirements and making stress testing more rigorous and imaginative. The withdrawal of $40bn from SVB in one day in March had already demonstrated the dizzying speed at which deposits can be taken out in the digital banking age, and how social media can amplify a panic. First Republic’s fate was in effect sealed last week when it revealed customers had pulled out $100bn of deposits in the first quarter.
There is a strong argument for partially rolling back changes introduced by bipartisan banking legislation in 2018 that eased restrictions and oversight for banks with less than $250bn in assets, and once again applying higher standards to midsized banks. A report last week by Michael Barr, the Federal Reserve’s vice chair for supervision, pinned much of the blame for SVB’s failure on the Trump-era weakening of regulations, as well as mis-steps by internal supervisors. In a multi-tiered system, regulators also need to address “cliff edges” that occur as lenders cross asset-size thresholds and move from one regulatory regime to another. Banks should face increased scrutiny as they approach thresholds, not just after they cross them.
The deal with JPMorgan is positive for the short-term stability of the banking sector, though the weeks-long bleeding out of First Republic that took place first probably increased losses to the FDIC. America has too many banks and consolidation is needed, though it would be better for midsized lenders to consolidate among themselves. Another acquisition by JPMorgan — which, after it acquired Washington Mutual in 2008, has now been the buyer in the two largest bank collapses in US history — raises awkward questions. Waiving limits that would otherwise bar the biggest US lender from making the acquisition could both be detrimental to competition and makes it even more of a too-big-to-fail institution.
Opening up such situations to banks beyond the very top tier is tricky since the mandate of the FDIC is to minimise losses to its insurance fund. But the best way to avoid further concentration with big lenders stepping in is to ensure smaller and midsized banks are more effectively managed and regulated — and not likely to fail in the first place.