Fed report asserts supervisors ‘redoubling efforts’ to address rising risks within banking

Banking supervisors are “redoubling their efforts” to assess banks’ preparedness for emerging credit, liquidity, and interest rate risks in the wake of rising interest rates, declining securities values and the recent failure of three large, regional banks, the Federal Reserve said in a report Tuesday.

In its semi-annual Supervision and Regulation Report, issued in conjunction with testimony before Congress by the agency’s top supervisor, Federal Reserve Board Vice Chair Michael Barr, the Fed said the banking system is sound and resilient, with strong capital and liquidity. However, the Fed also noted that “recent stress” in the banking system “shows the need for us to be vigilant as we assess and respond to risks.”

The report covers the period of late 2022 through this month. The Fed said that in 2022, its supervisors began preparing for a more challenging economic environment for banks.

“In view of unprecedented growth of deposits during the pandemic and questions about how depositors would react to more adverse conditions, supervisors focused on assessing firms’ ability to manage risks related to liquidity,” the report stated. “Supervisors also undertook additional examination work to evaluate interest rate risks and the impact on firms’ funding options. Declines in the fair value of investment securities have led to pressures on liquidity and capital at some banks, necessitating updates to contingency funding plans.”

The Fed report also asserted that its supervisors have increased efforts to gauge banks’ credit risk exposure, paying attention to regional and community banks’ commercial real estate lending.

Other key points made in the report:

  • The recent failures of three large U.S. banks (Silicon Valley Bank, or SVB, of Santa Clara, Calif.; Signature Bank of New York, N.Y.; and First Republic Bank of San Francisco) “have also demonstrated the risks of concentrated funding sources and poor management of interest rate risks.”
  • As interest rates have risen, fair values of investment securities have declined significantly.
  • Deposit costs have also increased from low levels, and firms are turning to wholesale borrowings to address emerging funding needs.
  • Delinquency rates for some loan segments have started to increase from the low levels seen over the past several years.
  • Banks have increased provisions for credit losses in anticipation of asset quality deterioration.

Supervision and Regulation Report, May 2023