The Silicon Valley Bank collapse changed the way Washington works with small and mid-sized banks

Matthew Zeitlin

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Typically, when you think about power the financial system has over Washington, it’s the JPMorgans, Goldman Sachs, Citis and Banks of America that first come to mind. And when you think about community banks, it might be the “penny-ante Building and Loan” run by George Bailey in “It’s A Wonderful Life” instead.

But when it comes to getting the most out of Congress, it’s sometimes best to be somewhere in the middle. The biggest banks don’t always get the kindest treatment due to the lasting harm done to their reputations by the 2008 financial crisis. Instead, the best path for combining scale, profitability and political favoritism consists of convincing lawmakers your bank and similarly situated ones are just a series of Bailey Building and Loans — all the while operating large enough institutions such that the chief executive can pull $10 million in annual compensation.

For a while, Silicon Valley Bank (SVB) and its peer institutions were able to pull it off. When SVB and other “mid-size” banks successfully removed some of the strictures of the Dodd-Frank Act in 2018, the headline in Reuters was: “Small banks trump Wall Street on Dodd-Frank rewrite.”

While the term of art in the banking industry for banks like Silicon Valley Bank or Signature Bank is “mid-size” or sometimes “regional,” that label can sometimes belie their impact — and the risks they pose to the financial system. The failures of these two banks has echoed far beyond Northern California or New York City, where they were respectively based: On Wednesday, the Swiss bank Credit Suisse was teetering on the edge.

SVB was the 16th-largest bank in the country — a $200 billion bank that was able to get hundreds of millions of dollars worth of deposits from single companies and even became the go-to banker for the Northern California wine industry. And yet this still left it, along with the $100 billion Signature Bank, well out of the league of the country’s megabanks, which have trillions of dollars of assets.

“The argument these banks made was that ‘we’re just little banks, just like community banks, we pose no risk,’” Sen. Elizabeth Warren (D-Mass.) told CNBC, referring to the successful effort made to roll back parts of Dodd-Frank. “I think we’ve seen that’s not the case.”

The industry and the elected officials who oversaw the 2018 deregulation that favored just about every non-mega-bank — including mid-size and substantially smaller community banks — aren’t standing by and taking the blame. They are instead scrambling to argue that the failure of Signature Bank and Silicon Valley Bank shouldn’t reflect poorly on them — or result in new rules or taxes that would impinge on bank profits.

Why small banks don’t want you to think Silicon Valley Bank is one of them

While any individual community bank may only have a few branches and a balance sheet a fraction of the size of even a “mid-size” bank, the community banks as a whole have a lot of sway in Washington. That’s because they are more locally rooted and tend to serve institutions dear to elected officials, like local businesses and nonprofits. This reputational advantage tends to extend to the general public as well for the same reasons.

In the wake of SVB’s failures, the community banks are trying to draw a clear line separating them from Silicon Valley Bank. “Silicon Valley Bank and the Nation’s Largest Banks Are Not Community Banks,” the community bank trade group Independent Community Bankers of America (ICBA) said in a statement Monday.

“To ensure the nation appropriately understands the Silicon Valley Bank closure, policymakers must distinguish large, risky financial institutions from the Main Street community banks that serve local consumers and small businesses,” the group’s Chief Executive Rebeca Romero Rainey said in another statement.

One of the concerns of community banks is that following SVB’s collapse, as Federal Deposit Insurance Corp. members, they would all have to contribute to the FDIC’s Deposit Insurance Fund, which is now potentially on the hook for all the deposits that were at SVB and Signature Bank, including those over the $250,000 deposit insurance cap.

In a statement, the trade association made the case that its members should not have to bail depositors out of the mess that SVB and Signature Bank made — and should not have to be on the hook to refund the FDIC: “ICBA will also vehemently oppose community banks bearing any financial responsibility for potential losses to the deposit insurance fund,” Romero Rainey said in a statement.

This is not the first time community banks have opposed higher payments to the Deposit Insurance Fund following a banking crisis. After the 2008 financial crisis, Congress increased the deposit insurance limit from $100,000 to $250,000, thus requiring higher payments into the fund. The ICBA unsuccessfully objected, with its then-CEO describing the subsequent fee increase as “a heavy burden on Main Street banks to indirectly pay for the economic wreckage caused by the incompetence and greed on Wall Street.” Even outside of crises, increased payments into the Deposit Insurance Fund can be controversial — last year, essentially the entire banking industry objected to a proposed increase in payments, describing them as a “preemptive strike against a nonexistent threat.”

Who’s really paying?

The White House has been very clear that the money to make depositors whole will not come from taxpayers, instead pointing to the Deposit Insurance Fund. But some lawmakers, especially Republicans, doubt this distinction between putting the burden on the taxpayers and the banks can be drawn so cleanly.

“They’ve got now a situation where taxpayers are not on the hook for this, but every bank in America is going to get an increased fee based on the amount of [deposits] that [have] to be covered. And last time I checked, banks in America pay taxes too,” Tennessee Republican Sen. Bill Hagerty told Bloomberg Radio.

Missouri Sen. Josh Hawley, who stands out among Republican lawmakers for his willingness to criticize and perhaps even regulate the largest financial institutions, has said he would put forward legislation that “will exempt responsible community banks from the ‘special fees’ to bail out the California billionaires” as well as prevent any bank from passing on payments to the FDIC to customers.

A new political reality for mid-size banks

And while Silicon Valley Bank may have been the local bank of the venture-backed technology industry, as far as some in Washington are concerned, its former peers may be back to being big enough to warrant stricter oversight.

“We would not be surprised if regulators create rules that crack down harder on those banks,” referring to large regional banks, Eric Compton, a strategist at Morningstar, wrote in a note.

In 2018, Democrats and Republicans in Congress voted to roll back some provisions of Dodd-Frank for small and mid-size banks. And while the current divided Congress is unlikely to pass legislation to undo the Dodd-Frank rollback, regulators still have some discretion about how they treat large regional banks. While Trump-appointed regulators took advantage of the 2018 bill to relieve banks like SVB from some of Dodd-Frank’s mandates, Biden-appointed regulators could take a different tack.

“We now have evidence of what happens when you ease up on the regulations for banks of that size, we just need to put those tougher constraints back in place and tell the regulators to toughen up against banks of that size,” Warren told CNBC on Wednesday.

Michael Barr, the Federal Reserve’s vice chair of supervision, is already reviewing rules relating to bank capital, which limit how much banks fund their operations through borrowing, and the Wall Street Journal reported Tuesday that the Fed is considering bringing a megabank-level of regulation and supervision onto smaller banks using its existing regulatory powers.

“If there was any question about whether banks in the $100 billion to $250 billion range would be affected, there is no doubt now, those banks are going to see substantive increases in regulation,” said Todd Phillips, a fellow at the progressive Roosevelt Institute and a former FDIC lawyer.

But the regulatory relief passed on a bipartisan basis in 2018 may survive, as even Democrats who supported it are not exactly eager to revisit their work.

What about the regulators?

While new rules and laws are being considered in the White House, Congress and the regulatory agencies, others in Washington are asking if regulators are making effective use of their existing powers. There’s been something of an unlikely alliance on this point between financial reform advocates who generally support tougher rules and then bank trade groups and lawmakers who support the 2018 Dodd-Frank rollback on the question of whether regulators were using their existing powers aggressively enough. For the latter two groups, what they see a failures by the Federal Reserve and other regulators is evidence that new rules aren’t needed.

For example, the Bank Policy Institute, an industry group, argued that rules Silicon Valley Bank was exempted from that require banks to hold a certain amount of assets that are easy to sell when depositors are demanding their money would not have been enough, if followed, to prevent its failure. “The failure of SVB appears to reflect primarily a failure of management and supervision rather than regulation,” the group said.

Sen. Michael Crapo, the Idaho Republican who helped lead efforts to modify Dodd-Frank, described the failure of SVB as not related to the capital rules that changed, instead telling Fox Business “the bank leaders didn’t adequately protect the liquidity of their assets, and the supervisors did not pick up on that quickly enough.”