The Federal Reserve’s supervisors are taking a closer look at bank funding and interest rate risk management in the wake of three large bank failures this year.
The Fed’s spring report on supervision and regulation, released Monday afternoon, said the banking sector was “strong and resilient,” with high levels of capital and liquidity. But the central bank also highlighted several pockets of growing distress, including rising costs of deposits, higher rates of delinquency on some types of loans and mounting losses in securities portfolios.
“Overall, banks have strong capital and liquidity, enabling them to lend and provide financial services to households and businesses,” Fed Vice Chair for Supervision Michael Barr said in written remarks issued Monday. “At the same time, recent stress in the banking system shows the need for us to be vigilant as we assess and respond to risks.”
Barr is set to discuss the report’s findings in Congress this week. He is set to testify in front of the House Financial Services Committee on Tuesday and the Senate Banking Committee on Thursday.
After increasing by $2.4 trillion between the start of the COVID-19 pandemic and the third quarter of 2021, liquid assets at banks — including cash and government-backed securities — have decreased by $1 trillion since then, the report noted. Although these assets, as a share of total holdings, remain above their 10-year average, the Fed said it is still watching the decline as a potential driver of instability.
The report noted that most banks also reported declines in their levels of common equity tier 1, which is meant to absorb losses during periods of distress. Capital levels remain above their statutory minimums, the report found, but below their five-year average as of the end of 2022.
Rising interest rates, a slowing of the economy and uncertainty in the banking system were all cited as causes for rising uncertainties in the banking sector, the report noted.
As a result, Fed supervisors have increased the “frequency and depth of their monitoring of the funding positions of potentially vulnerable banks,” the report states, including deposit trends, the diversity of funding sources, performance of investment securities and the “adequacy of contingency funding plans.”
In particular, examiners are looking to see if banks need to raise more capital or liquidity to deal with potential periods of stress. They also want banks to position themselves to take advantage of emergency lending facilities, including the discount window and the Bank Term Funding Program — a super discount window launched after the failures of Silicon Valley Bank and Signature Bank to provide one-year loans in exchange for government-backed bonds taken at par value.
The report also pointed to growing structural weaknesses in the commercial property sector — specifically the declining usage of city center office and retail space amid a rise in remote work — as a top concern for bank examiners, who are keyed in on the health of bank’s commercial real estate loan books.
Community and regional banks, those below $10 billion of assets and between $10 billion and $100 billion of assets, respectively, hold the highest concentration of commercial real estate loans, the report noted. As a result, Fed supervisors have been conducting more frequent examinations for banks within these categories that have large real estate exposures.
The report also noted that the Fed is still keeping a close eye on risks in the crypto sector. It reiterated the guidance issued earlier this year and noted that banks should check with their primary regulator before pursuing business lines that deal with digital assets.
The report said the Fed is creating a special team of supervisors to oversee novel activities in the banking sector. The group will focus its efforts on crypto assets.