The failures of Silicon Valley Bank and Signature Bank have shed light on the need for a major overhaul of the United States’ banking laws. For a century, the government has increased federal backing, regulation, and micromanagement of the financial sector. The approach has repeatedly failed. Yet, when several regulated banks recently collapsed, Congress immediately began flirting with even more federal backing, regulation, and micromanagement. Is there any way out of this vicious cycle?

Join us for a conversation with Jeb Hensarling, former chairman of the House Financial Services Committee, and Jelena McWilliams, former chairman of the Federal Deposit Insurance Corporation, as they discuss the recent bank failures, the federal government’s response, and a path forward for banking regulation.

Luncheon to follow

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Financial Stability and Systemic Risk: What Recent Bank Failures Say about the U.S. Regulatory Frame

The collapse of large financial institutions can have catastrophic consequences for both the national and global economy. As witnessed during the 2008 financial crisis, the failure of major banks can lead to a severe economic downturn, mass unemployment, and the erosion of public confidence. Therefore, maintaining financial stability and mitigating systemic risk are essential goals for any regulatory framework. In the United States, recent bank failures have raised concerns about the effectiveness of the country’s regulatory structure in achieving these objectives.

One of the primary weaknesses exposed by recent bank failures is the lack of stringent regulatory oversight. As banks become increasingly complex and interconnected, the potential for risks and vulnerabilities to spread throughout the financial system intensifies. Yet, several large banks were able to engage in risky activities without appropriate regulatory intervention, leading to their eventual collapse. This lack of regulatory vigilance enabled certain financial institutions to take on excessive leverage, engage in speculative trading, and pressure weak risk controls, ultimately endangering the stability of the entire financial system.

Another area of concern is the perceived inadequacy of capital requirements imposed on banks. Capital acts as a buffer against potential losses and enhances the ability of banks to absorb shocks. However, many argue that the existing capital requirements are insufficient to protect against a severe economic downturn or another financial crisis. This insufficiency was evident in the aftermath of the 2008 crisis, as several banks lacked the necessary capital to weather the storm, leading to their failure and subsequent taxpayer-funded bailouts. Consequently, there is a pressing need to reassess and strengthen capital requirements to ensure banks are adequately prepared to withstand future shocks.

Moreover, recent bank failures have highlighted the need for stronger risk management practices. Financial institutions must have robust risk management systems in place to detect, assess, and mitigate risks effectively. Weak risk management and internal control mechanisms were primary contributors to bank failures during the financial crisis. Despite subsequent efforts to enhance risk management practices, allegations of inadequate risk controls have resurfaced in recent bank failures. This calls for greater scrutiny, oversight, and accountability to ensure banks are implementing and adhering to sound risk management practices consistently.

Furthermore, the interconnectedness between banks and other financial institutions poses a significant systemic risk. The failure of a major institution can quickly spread its contagion effects throughout the financial system, potentially triggering a domino-like chain reaction. Recent bank failures have demonstrated the need for regulators to prioritize monitoring and regulating these interconnected relationships effectively. Stricter oversight and stress testing of these interconnections are necessary to identify and address any potential risks before they can escalate into a systemic crisis.

While the U.S. regulatory landscape has made some progress since the 2008 financial crisis, recent bank failures underscore the continued vulnerabilities and weaknesses that persist in the system. Strengthening regulatory oversight, revising capital requirements, enforcing robust risk management practices, and closely monitoring interconnections are vital steps to enhance financial stability and mitigate systemic risk.

The lessons from recent bank failures should serve as a wake-up call for regulators and policymakers to revisit and reinforce the regulatory framework. Only through proactive and diligent efforts can the U.S. regulatory system effectively safeguard financial stability and protect the economy from the potentially devastating consequences of future bank failures.