Body contemplates supervisory overhaul
The Federal Deposit Insurance Corp. (FDIC) admitted on Friday that its oversight of First Republic Bank could have been more stringent.
In a statement, the FDIC said it didn’t appropriately factor in the bank’s high levels of uninsured deposits or vulnerability to changes in interest rates. This oversight becomes even more glaring when considering that the time examiners dedicated to the bank decreased, even as First Republic underwent significant expansion.
The San Francisco-based bank’s collapse on May 1 was the second biggest bank failure in US history. JPMorgan Chase & Co. purchased First Republic through a government-mediated transaction, sealing an agreement with the FDIC to share potential losses.
First Republic, like several distressed regional lenders, found itself in turbulent waters when the Federal Reserve escalated interest rates to combat inflation. This move adversely affected the value of bonds and loans that First Republic had acquired during a period of lower rates. The subsequent fallout saw depositors withdrawing in search of better returns and, later, out of growing concerns about the bank’s stability.
“Given the size and scale of First Republic’s operations, we concluded there were opportunities for the FDIC to take a more holistic approach to supervising the bank,” the FDIC said in its report.
The agency also added that its decision to give the bank a strong liquidity rating in 2021 was “too generous and was inconsistent with First Republic’s high level of uninsured deposits.”
“Greater criticism of First Republic’s vulnerability to interest rate risk and reliance on a high level of uninsured deposits may have also prompted a downgrade to the bank’s management component rating in the 2021 roll-up ROE,” the FDIC said.
Another striking revelation was the 11% decline in the FDIC’s examination hours dedicated to First Republic from 2018 to 2023, during which the bank’s size doubled. Addressing this anomaly, the FDIC observed that such a trend “appears counterintuitive and may have warranted greater explanation in annual Supervisory Plans.”
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The report further suggested that with a more comprehensive supervisory framework, the FDIC’s Large Bank Supervision branch could have played a more significant role in challenging the bank management’s strategies, offering a broader perspective on industry risks.
“We cannot say whether taking earlier supervisory action, such as criticizing interest rate risk or liquidity risk management, would have prevented First Republic from failing given the significance and speed of deposit withdrawals,” the FDIC said. “However, meaningful action to mitigate interest rate risk and address funding concentrations would have made the bank more resilient and less vulnerable to the March 2023 contagion event.”
In light of this review, the FDIC is mulling over a revamp of its supervisory paradigm, including enhanced contingency planning and more capital buffers.
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