Reflecting on ‘lessons learned’ from ’23 bank failures, Hsu urges ‘better brakes’ for easing system risk

Addressing the lessons from the failures of large regional banks last spring will take a targeted regulatory approach, along with “better brakes” for mitigating systemic risk, the regulator of national banks said Thursday.

Speaking at the Columbia University Law School in New York, N.Y., Acting Comptroller of the Currency Michael J. Hsu said with the upcoming one-year anniversary of the failures last year of Silicon Valley Bank (SVB) of Santa Clara, Calif., and Signature Bank of New York, N.Y., it’s “a good time to reflect on lessons learned and to discuss how best to ensure the safety and soundness of the banking system going forward.”

Hsu said there were three lessons resulting from the failure of the banks:

  • Uninsured deposits can be withdrawn quickly en masse.
  • Having liquid assets is necessary but not sufficient for banks to endure acute liquidity stress. “Banks also need to be adequately prepared and have the operational capacity to monetize those assets quickly,” Hsu said.
  • Contagion to healthy banks does not require interconnectedness and direct exposure to a failing bank. “Systemic threats can occur via ‘guilt by association,’ i.e., shared uncertainty with regards to seemingly similar risk profiles, such as high reliance on uninsured deposits for funding,” the acting comptroller said.

Hsu said a new targeted, regulatory requirement “warrants serious consideration” that would have midsize and large banks hold sufficient liquidity to cover stress outflows over a five-day period.

The denominator for the formula of that requirement, he said, “should consider the potential speed and severity of uninsured deposit outflows, while the numerator should consider the liquidity value of pre-positioned discount window collateral, in addition to reserve.”

He said the rule should also clarify operational preparedness expectations related to the discount window, perhaps even including a requirement to do periodic test draws.

Regarding “brakes,” Hsu noted that the payments system of today is round-the-clock (rather than proceeding in “daily increments” as has been the historic norm). “The time increments are shrinking towards ‘always on,’ 24/7/365,” Hsu asserted. “Instant payments systems are becoming the norm abroad, for instance in the UK, Brazil, India, Singapore, Thailand, and others, as well as domestically.”

He noted that the Fed’s own “round the clock” system (FedNow), now operational, allows banks and credit unions to settle payment transactions any time, including nights, weekends, and holidays. “In addition, to the extent tokenization reduces settlement frictions, it will also accelerate the velocity of banking and finance,” he said.

However, he added, the future of faster, always on, real-time money flows creates new risks. “Faster payments can lead to faster fraud and limit the ability to remediate erroneous transactions,” he said. “The instantaneous nature of real-time payments necessitates enhanced liquidity risk management, third-party risk management, and fraud and compliance risk management.”

Hsu maintained that, as the payments speeds increase, “we need to think carefully about the associated risks and controls. Banks and regulators should start working now on building the right brakes for a more real-time financial system.”

Acting Comptroller of the Currency Michael J. Hsu: “Building Better Brakes for a Faster Financial World”