Internal crisis threatens to derail FDIC regulatory crackdown

Mark Taylor

Mark Taylor

Senior Editorial Manager

A sweeping overhaul of how US banks are regulated is up in the air following an internal crisis at the Federal Deposit Insurance Corporation (FDIC). 

A damning Wall Street Journal report detailing a toxic work environment at the Washington, DC agency has plunged the regulator into turmoil and cast doubt on plans to force banks to put more capital aside. 

The FDIC, Federal Reserve, and Office of the Comptroller of the Currency presented the case for bigger bank capital buffers last July, amongst a swathe of other proposals. 

The rules would increase capital requirements for banks by an aggregate of 16% and broaden the scope of the new rules to include banks with as low as $100bn in assets. 

Regulatory officials said the changes were necessary to avoid a repeat of the regional bank shocks that occurred earlier this year when the failures of Silicon Valley Bank, Signature Bank, and First Republic triggered deposit withdrawals. 

However, findings from an investigation by the Wall Street Journal into the agency’s problematic work environment have triggered pressure from senators and other figures for the FDIC’s chairman Martin Gruenberg, the man leading the reforms, to stand down. 

Based on interviews with more than 100 current and former FDIC employees, the report detailed episodes of sexual harassment and discrimination over a decade that went largely unpunished, prompting women to leave the agency. 

Gruenberg faced questions from Congress after denying knowledge of workplace problems but later recanted his testimony. He is now battling calls to resign. 

The inappropriate behavior was said to have “festered” over the years because of weak leadership at the agency.  

What does the FDIC uncertainty mean for financial institutions? 

The FDIC has proposed a series of new rules that financial institutions (FIs) say would cost them billions of dollars, prompting strong lobbying efforts in opposition. 

After the March bank collapses, US regulators sought to protect against future crises by raising capital requirements.  

The agency has also recently finalized tougher ESG measurement and reporting requirements; updated fair lending laws to include online lending requirements; and made banks with more than $5bn in assets cover a share of March’s banking crisis. 

Ongoing investigations and Gruenberg’s uncertain tenure have implications for the impending rule changes. Should he reign, it may torpedo the agency’s agenda with a partisan split board, half of which oppose the tougher capital requirements. 

Pending plans for other regulatory measures, like tougher capital requirements, may be stalled as a result of the impact.  

A split in the FDIC board would halt decision-making, which could lead to a period of inactivity at the agency. 

The regulator has said it will launch a “special inquiry” into how leadership handled allegations of sexual harassment and other inappropriate workplace conduct. 

The new inquiry will “report on the leadership climate at the FDIC with regard to all forms of harassment and inappropriate behavior,” a spokesperson said. 

What FDIC proposals are impacted? 

Rules currently awaiting approval include a requirement that banks with at least $100bn in assets issue around $70bn long-term debt to help absorb losses if they are at risk of becoming insolvent. This often happens when depositors worry their bank does not have enough money on hand, and their funds may be wiped out if they do not quickly withdraw.   

A new requirement would prevent banks from tapping the FDIC’s Deposit Insurance Fund (DIF), which is used to back depositors’ money at failed FDIC-insured banks. 

The DIF covers up to $250,000 per depositor for each account ownership category. However, the FDIC-backed deposits exceeded that limit when Silicon Valley Bank and Signature Bank failed earlier this year. 

The fund was also used to help soften some of the losses of the failed First Republic Bank and allow the sale to JPMorgan Chase in May. 

In total, the three bank failures drained $31.5bn from the DIF, according to FDIC estimates. Had the proposed rule been in place prior to the three bank failures, it could have prevented many uninsured depositors from causing a bank run, the agencies said. 

If the new rule on long-term debt is approved after the agencies review comments, banks would have three years to transition to the new compliance requirements.  

Additional proposals include a rule that would force banks to disclose more details on how they could safely be managed should they fail. 

It could make it easier for the FDIC to seize and sell a failed bank, which it failed to do in a timely manner with SVB and Signature Bank. 

CUBE comment 

Uncertainty at the top of a major banking regulator could have significant implications for banks. The fallout from the scandal has already damaged the agency’s reputation, led to confusion in the market, and has led to questions from the sector about the regulatory initiatives in the pipeline. 

The legislative direction of travel may shift dramatically depending on the outcome of the FDIC’s internal investigation, making it imperative for compliance professionals to stay alert to any changes.  

Financial institutions can leverage CUBE’s horizon-scanning solutions to proactively adapt to regulatory changes and protect themselves from developing risks that can emerge during periods of market turbulence.