New regulatory requirements are coming for banks—how and why they should prepare now

The crisis at Silicon Valley Bank has the industry speculating on how a collapse of a bank could have taken place under today’s regulatory environment. The question then quickly becomes: How are the regulators going to respond and what is this going to mean for banks going forward?  

In the aftermath of the financial crisis of 2008, Congress passed the Dodd-Frank Act in 2010, imposing stricter regulations on banks with $50 billion or more in assets. A hallmark of the legislations was the  implementation of stress testing related to credit losses, coupled with tougher capital requirements.   But aspects of Dodd-Frank were rolled back in 2018 via The Economic Growth, Regulatory Relief, and Consumer Protection Act ("EGRRCPA")—which effectively relieved banks under $250 billion in assets of stricter stress-testing requirements. Fast forward to March 2023: two midsize banks collapsed in the span of three days. 

From what we’ve seen historically and what we are hearing in industry, the following outlines what we believe is headed banks’ way—and fast.  

1. A push to repeal the 2018 Senate Bill which eased several regulatory requirements for banks with less than $250 BILLION of assets. The repeal of this bill would reinstate requirements like the following for banks with greater than $50 billion in assets:  

• Annual DFA stress testing 
• Capital requirements that would have the sustainability to absorb losses  
• Liquidity requirements to be able to quickly meet cash obligations 
• Filing of “living will” plans for the bank’s quick and orderly dissolution if it were to fail   

2. Heightened requirements and stress testing—specifically around liquidity  

Historically, stress testing has largely been credit-oriented—these tests were designed to address the credit-related problems in prior banking crises. However, the Fed’s severe stress test, which involves a hypothetical widespread recession, likely would not have captured the current rising interest rate scenario (one of the primary drivers of the SVB collapse). Going forward, it’s likely that the Fed will design required stress testing for scenarios impacting liquidity and addressing interest rate risk sensitivity to a higher degree. Reporting will also require banks to model what will happen if a large liquidity run were to occur.  

3. More sophisticated and modeled approach to a run-off of deposits and interest rate sensitivity of HQLA (high quality liquid assets)  

We speculate that the future of regulation will not only require banks to have enough liquid assets to cover deposits but also require the skillset for robust modeling around forecasting their balance sheets among a variety of interest rate scenarios and liquidity events—with the ability to act fast in executing a plan if these scenarios were to occur. 

4. Tighter capital requirements or further disclosure around capital against long-term assets like US Treasury bonds  

Following the 2008 crisis, regulators deemed seemingly safe assets such as sovereign bonds of various durations as preferred assets to hold for capital requirements. SVB’s overweighted concentration of investment in these “safe” assets ultimately created liquidity issues as rates changed and forced the bank to take a significant loss in the sale of the assets—signaling major balance sheet management issues. We expect the Fed may re-evaluate what they deem as “safe” assets for capital requirements, concentrations around certain long-term assets, and further disclosure around how unrealized securities losses may impact capital ratios.  

5. More thorough exams and less tolerance from regulators  

Silicon Valley Bank was on the Fed’s radar for more than a year, beginning in 2021 when a Fed review issued several MRAs—those of which were never remediated and led to the bank being in full supervisory review by 2022. The Fed has begun an investigation into the oversight of SVB and anticipates findings to be publicly released by May 1. We expect the outcome of this investigation to lead to more public scrutiny against the regulators and a tightening of the regulatory review environment—with less tolerance when weaknesses are identified.  

What banks can do to prepare for new regulations 

Even if only a few of the suspected changes come to fruition, midsize banks still need to be preparing for a different regulatory environment in the near future and should be taking the following actions to prepare:  

• Ensure your data is accessible. Banks need to proactively identify potential weaknesses or runoffs while also responding to regulatory inquiries and exams faster than is expected in today’s environment. Speed, in addition to accuracy, will be key. 
• Evaluate existing practices and methodologies in place for liquidity testing and balance sheet forecasting. Are these in line with best and leading practices? Even more, are they scalable?   
• Prepare for Dodd-Frank Act Stress Testing. Given the push to repeal the 2018 Senate Bill (“EGRRCPA”), it’s all but assumed annual stress testing will yet again become a requirement for midsize banks. Start planning today.   
• Ensure your modeling capabilities are ready for robust requirements. What’s more, do you have the talent and team behind the models who understand them? Our expectation is that  regulators will push harder on the “why” to ensure banks are understanding the implications and taking action as needed. 
• Consider upskilling talent in finance and treasury functions. Does your firm have the right talent in place to adhere to future expectations of regulation and communicate implications of complex modeling scenarios? Going forward, regulators will expect more than “check-the-box” modeling—the people managing the models will need to be able to speak to why the models accurately reflect the bank’s predicted behavior.  
• Fortify your governance framework. Assume that regulators will be more interested in your firm’s overall risk management practices; can your governance framework stand up to scrutiny?  
• Assess your firm’s exposure to non-traditional financial products. Does your firm service the crypto industry, and if so, to what extent? What portion of your customer base is made up of non-traditional financial products? 
• Expedite the remediation of any outstanding regulatory findings. As we expect heightened scrutiny and less tolerance from regulators. Any outstanding regulatory findings will likely be scrutinized more heavily and any remediation activities that do not meet timelines will likely be penalized. 

While we don’t know exactly what changes are coming by way of regulation, we do know these best practices will help you prepare—and will be crucial in the new environment. It’s equally as important to note that upskilling talent, models, and governance practices won’t mean anything unless the implications are well understood by top-of-the-house executives who have the power to make decisions for the health of the bank.