What is Risky In Life - Zero Reserve or Full Reserve Banking?

Since the inception of the Federal Reserve System, our fractional reserve banking system has steadily degraded reserve ratio requirements until they finally just did away with them altogether and ushered in our brave new era of zero reserve banking. Banks are not tasked with maintaining any specific thresholds of reserves and now manage liquidity by buying and selling debt instruments as necessary.

It works great - until it doesn't. As the Federal Reserve embarked on QE and lowered interest rates towards zero several years ago, banks loaded up their balance sheets with low interest bearing debt. When the Fed reversed course with QT and raising rates to combat inflation, many banks were caught with balance sheets full of upside down investments. Unable to keep pace with the yields offered by Money Market Funds (MMFs), they are facing deposit redemptions as money is pulled from the banks to chase yields in MMFs. The situation is leading to fears of a systemic crisis as half of America's banks are reportedly already insolvent.

The Fed Knows Best? They Certainly Know Irony​

Consider the saga of Custodia Bank:

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So a few years ago, Wyoming, the state, created a blockchain task force to figure out how to modernize their state law to be more friendly to financial technology, bitcoin, and blockchain technology. And one of the measures that the legislature passed was a law creating special purpose depository institutions. They say, "Look, what we're going to allow with…" they call it the SPDI Charter, and perhaps it's inaptly named because they're not getting started really speedily. "But what we hope to do with this SPDI charter is let banks get a charter that allows them custody cryptocurrency, provide US dollar payments to be an on-ramp and an off-ramp to cryptocurrency, but would not let them lend. Instead, all of their deposits would have to be stored in safe, relatively liquid assets." And so Custodia applies for this SPDI charter, they get it. They want to custody cryptocurrency for institutional investors, family offices.
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Custodia Bank applied for both membership in the Federal Reserve System and for a Fed Master Account. Custodia Bank planned to use a full reserve banking model to satisfy risk requirements of Wyoming where it got it's charter, except it planned to serve the crypto industry. So, with America's War on Crypto (and Operation Choke Point 2.0) in full swing, the Fed denied Custodia's applications with the justification that:

... Custodia had insufficient risk management and controls, “particularly with respect to overall risk management; compliance with the Bank Secrecy Act and U.S. sanctions … financial projections, and liquidity risk management practices.”

The board also argued that Custodia’s revenue model, which “relies almost solely upon the existence of an active and vibrant market for crypto assets” makes it vulnerable to market volatility, even though the board admitted that “Custodia appears to have sufficient capital and resources to sustain initial operations.”

Great job fellas! You certainly understand risk management controls and liquidity risk management practices and know a solid bank when you see one. The last decade is replete with examples (see graph above).

Narrow Thinking​

Now consider the saga of the Narrow Bank:

... the Narrow Bank is a Connecticut chartered bank, and they want to accept deposits, big deposits from institutional investors and just hold them in a Federal Reserve account. These big institutional investors have deposits that are so large that they can't be covered by deposit insurance, which caps out at $250,000. And so when these businesses take money and put it at a bank, they're subject to some risk, the credit risk, the liquidity risk of the underlying bank. And TNB, The Narrow Bank says that they can make a safer place for these institutional investors because instead of lending out the money, subjecting the depositor to credit and liquidity risk, they're just going to take the money and put it in an account at the Fed. And TNB thinks that it could make money because the Federal Reserve pays interest on excess reserves. And so they could earn the money from the Federal Reserve, pass a little bit of it on to their own depositors and pocket the difference, making for profitable business model.

So they got a charter from Connecticut, life seemed to be good, and they asked the Federal Reserve Bank of New York for a master account and then nothing happened. They hear that the board’s become concerned about their business model, that it might impact the Fed's ability to conduct monetary policy. One of the things that they're very worried about is that during times of economic uncertainty, everyone would decide TNB is safer, and so they'd withdraw their money from traditional banks and put it in TNB. And they say that that would be problematic. Another thing that they're worried about is that because TNB wouldn't be constrained by the same sorts of capital rules, that it would just grow bigger and bigger and bigger. And that might make it hard for the Fed to have the same impact in their efforts to control the money supply.

So TNB gets sick of waiting after 18 months or so, and they sue. And the Fed's argument in the suit is, look, we haven't made a decision yet. And the court considers it and says, well, it's right. The Federal Reserve hasn't made a decision, so it's not right for us to consider it. Part of the court's decision there too was, I think, this possibility that the Fed might be able to deny the account on some technical ground. The court thought maybe that the Connecticut charter had expired. It hadn't, Connecticut had given them another 18 months to get the bank off the ground, and Connecticut has extended it a number of times since then. But the Narrow Bank has been waiting now for more than five years for the Fed to decide whether or not they can open an account.
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The issue that led to the current wave of regional bank failures was deposit draw downs and then, in SVB's case, a run on deposits from customers holding large, uninsured deposits - the very customers that the Narrow Bank sought (seeks) to service.

Great job fellas! Another triumph of risk management for masses.

 

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The Federal Reserve Board on Wednesday announced that the Bank Term Funding Program (BTFP) will cease making new loans as scheduled on March 11. The program will continue to make loans until that time and is available as an additional source of liquidity for eligible institutions.

During a period of stress last spring, the Bank Term Funding Program helped assure the stability of the banking system and provide support for the economy. After March 11, banks and other depository institutions will continue to have ready access to the discount window to meet liquidity needs.

As the program ends, the interest rate applicable to new BTFP loans has been adjusted such that the rate on new loans extended from now through program expiration will be no lower than the interest rate on reserve balances in effect on the day the loan is made. This rate adjustment ensures that the BTFP continues to support the goals of the program in the current interest rate environment. This change is effective immediately. All other terms of the program are unchanged.
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Federal Reserve Board announces the Bank Term Funding Program (BTFP) will cease making new loans as scheduled on March 11

The Federal Reserve Board on Wednesday announced that the Bank Term Funding Program (BTFP) will cease making new loans as scheduled on March 11. The program wi

www.federalreserve.gov

BTFP arbitrage has ended.

 

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This new policy is reminiscent of the Fed’s actions during the 2007 financial crisis, where financial authorities encouraged large banks to tap into the discount window, taking loans directly from the Federal Reserve, to make it easier for distressed banks to do the same. The hesitancy from financial institutions to tap into this source of liquidity is justified. If the public believes a bank needs support from the Fed, it is rational for depositors to flee the bank. The Fed’s explicit aim is to provide cover from at-risk banks, trying to hold off bank runs that are an inherent risk in our modern fractional reserve banking system.

By strong-arming healthy banks to comply, the Fed is escalating moral hazard and leaving customers more vulnerable. They are deliberately trying to remove a signal of institutional risk.
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The Fed Prepares for a Bank Crisis While Telling Americans the Economy is Strong | Tho Bishop

Last Thursday, Bloomberg reported that federal regulators are preparing a proposal to force US banks to utilize the Federal Reserve’s discount window in preparation for future bank crises.

mises.org

 

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Seeking to uphold its right to approve and regulate state-chartered banks, particularly special purpose depository institutions, the Wyoming Attorney General’s Office has filed an amicus brief in support of Custodia Bank’s motion for summary judgment in its lawsuit against the Federal Reserve Board of Governors and the Federal Reserve Bank of Kansas City.

Custodia, a Wyoming-chartered SPDI, filed a motion for summary judgment Dec. 22 in U.S. District Court in its lawsuit against the Fed and Kansas City Fed over the denial a year ago of the bank’s application for a master account. The master account denial followed nearly a two-year delay from its application. If the summary judgment is granted, Custodia would be granted a master account.

State of Wyoming defends right to create state-chartered special purpose depository institutions

CHEYENNE — Seeking to uphold its right to approve and regulate state-chartered banks, particularly special purpose depository institutions, the Wyoming Attorney General’s Office has filed an amicus brief in support

www.wyomingnews.com

 

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New York Community Bank on Wednesday promoted its chairman to help stabilize the company's operations, hours after Moody's Investors Service downgraded the bank's credit ratings two notches to junk.

NYCB made Alessandro DiNello executive chairman effective immediately, promoting him from nonexecutive chairman, to work with CEO Thomas Cangemi "to improve all aspects of the Bank's operations," according to a statement.

The regional bank has been in free fall, shedding almost 60% of its market value across a punishing series of trading sessions, since reporting a surprise fourth-quarter loss last week, along with mounting losses on commercial real estate and the need to slash its dividend by 71% to shore up capital levels.

The moves reignited concerns that some small and medium-sized banks could be squeezed by declines in profitability and losses on real estate holdings.
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NYCB: Moody's downgrades bank's credit rating to junk

NYCB appears to be in serious trouble. What's the over/under on how long before the FDIC steps in and allows JPM to swallow it at pennies on the dollar?

 

[Peter89]

The Federal Reserve has removed the sentence “The U.S. banking system is sound and resilient” from the FOMC Policy Statement released on January 31st.

... because they knew that ...

Bad property debt exceeds reserves at largest U.S. banks​

Bad commercial real estate loans have overtaken loss reserves at the biggest U.S. banks after a sharp increase in late payments linked to offices, shopping centers, and other properties.

The average reserves at JPMorgan Chase, Bank of America, Wells Fargo, Citigroup, Goldman Sachs, and Morgan Stanley have fallen from $1.60 to 90 cents for every dollar of commercial real estate debt on which a borrower is at least 30 days late, according to filings to the Federal Deposit Insurance Corp.

The sharp deterioration took place in the last year after delinquent commercial property debt for the six big banks nearly tripled to $9.3 billion

Bad property debt exceeds reserves at largest U.S. banks | Gold Anti-Trust Action Committee | Exposing the long-term manipulation of the gold market

www.gata.org

 

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If one of the G-SIBs goes down, it might be too much to be absorbed by the others. Maybe we see the first big bail-in in action.

 

[Peter89]

The Federal Reserve has removed the sentence “The U.S. banking system is sound and resilient” from the FOMC Policy Statement released on January 31st.

Fed Fears "Notable" Financial System Vulnerability As Renowned CRE Investor Tells Team 'Stop All NYC Underwriting'​

Furthermore, in the Federal Reserve's last meeting, the minutes from the session, published on Wednesday, showed the CRE downturn is only gaining steam:

CRE prices continued to decline, especially in the multifamily and office sectors, and low levels of transactions in the office sector likely indicated that prices had not yet fully reflected the sector’s weaker fundamentals.

The minutes noted:

Leverage in the financial sector was characterized as notable. In the banking sector, regulatory risk-based capital ratios continued to increase and indicated ample loss-bearing capacity in the banking system.

And also this:

The staff provided an update on its assessment of the stability of the U.S. financial system and, on balance, characterized the system’s financial vulnerabilities as notable. The staff judged that asset valuation pressures remained notable, as valuations across a range of markets appeared high relative to fundamentals

 

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Tomorrow is Friday. FDIC receivership on tap?

 

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Seems like a convergence of bad news for regional banks right before the Fed's BTFP ends.

 

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I have not vetted any claims in this tweet. Could be legit. Could be nonsense...

 

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Somehow NYCB survived last Friday. Will they survive this Friday?

New York Community Bancorp Inc.’s exposure to stressed loans for rent-controlled multifamily apartments and office space continue to weigh on the outlook for the bank, leading to its second debt downgrade in about a month from Moody’s Investors Service.

“The possibility of rising provisions for credit losses and higher funding costs will complicate the bank’s ability to organically raise capital,” Moody’s said late Friday.

Moody’s downgraded all long-term and some short-term ratings and assessments of New York Community Bancorp NYCB, -25.89% further into junk territory, after the bank said it had “material weaknesses” in its accounting protocols and said it would delay its financial filings.

Flagstar Bank, NA, the operating business of holding company New York Community Bancorp, was downgraded to Ba3 from Baa2, lowering it from investment-grade to speculative-grade, or junk, status.
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NYCB’s stressed multifamily loans cloud its outlook, Moody’s says in downgrade

As interest rates remain high, the bank’s exposure to NY’s multifamily housing weighs

www.marketwatch.com

 

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Bank failures​

In the FDIC’s data going back to 1936, there were only five years without failures of FDIC-insured banks. During the two free-money years of the pandemic – 2021 and 2022 – no bank failed. In 2018, no bank failed. In 2006 and 2005, no bank failed. And that was it.

In each of the remaining 88 years, some banks failed. In 1989, at the peak of the S&L Crisis and following the oil bust, 531 banks failed – and people actually went to jail over it. In 2010, during the Financial Crisis, 155 banks failed. But by then, the banks were far larger than in 1989. And in an insidious turn of events, no one went to jail; instead, bankers at the banks that got bailed out made record bonuses.

In 2023, six banks collapsed: Silicon Valley Bank, Signature Bank, First Republic, plus two very small banks in Iowa and in Kansas were taken over by the FDIC. And Silvergate Bank, with regulators breathing down its neck, agreed to self-liquidate, but since it had enough assets to cover its deposits without FDIC involvement, the FDIC doesn’t count it as a “failed bank.” So officially, there were five “failed banks” and one self-liquidation.

In 2024, some banks will fail. We pretty much know that; we just don’t know how many. If eight banks fail, that would be on par with 2015 and 2017.

Commercial banks continue to vanish. In 2023, mergers took out 100 banks; bank failures and a self-liquidation took out 6 banks; but 6 new banks were started. At the end of 2023, the bank count was down to 4,026 commercial banks, from over 14,000 in the 1980s.

The Banks: “Unrealized Losses” in Q4, Securities Held by Banks, Bank Failures, and the Dropping Bank Count | Wolf Street

 

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Speculation abounds regarding the onset of the upcoming week, as Monday marks the conclusion of the U.S. central bank’s BTFP. Anticipations of renewed chaos in the banking sector are high, harking back to the U.S. banking crisis witnessed in March 2023. ...

Speculation Intensifies Over US Banking Sector's Fate as Fed's BTFP Closure Looms – Economics Bitcoin News

This weekend, many are intrigued by the potential outcomes following the cessation of the U.S. Federal Reserve's BTFP.

news.bitcoin.com

This could end up being a very turbulent week for banking, stocks, gold and cryptos!

 

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Kraken has entered the full reserve banking chat:

https://www.pmbug.com/threads/federal-reserve-is-an-exclusive-club.5032/post-96923

 

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S&P Global has issued a negative outlook on five U.S. regional banks facing an increased challenge from higher office vacancies as well as an increasing number of loan maturities on the horizon.

First Commonwealth Financial Corp. M&T Bank Corp., Synovus Financial Corp. Trustmark Corp. and Valley National Bancorp were downgraded to a negative outlook, from stable.
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The rating of BBB- is the lowest rating for investment-grade debt.

S&P stuck to a BBB issuer credit rating for Trustmark and a BBB+ issuer credit rating for M&T Bank.

Including the five debt outlook downgrades on Tuesday by S&P, the debt rating firm now has nine U.S. banks with negative outlooks, for a total of about 18% of U.S. banks that it covers.
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https://www.msn.com/en-us/money/per...anks-due-to-office-space-exposure/ar-BB1kCGsO

 

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Revised liquidity standards are the key to preventing future bank runs like the one that toppled Silicon Valley Bank last year, according to a paper by former Federal Reserve officials.

Former Fed Govs. Dan Tarullo and Jeremy Stein are among the co-authors of a paper released late Wednesday that explores last year's bank failures and the evolution of the banking sector in recent decades.

In it, they call for lowering the asset threshold at which banks are subject to the full liquidity coverage ratio — which requires banks to maintain enough high-quality liquid assets to withstand 30 days of significant deposit outflows — from $250 billion to $100 billion. They also say banks should be required to have enough assets pledged as collateral to the Fed's last-resort lending facility to offset uninsured deposits.

"The concept is that the liquidity situation of the bank would be substantially enhanced, precisely because it had ready access to the discount window, collateral that was pre-positioned, and thus the Fed was in a position to provide the liquidity immediately to a bank, should it suffer a run on its deposits," said Tarullo, who served as the Fed's top regulatory official after the subprime lending crisis and through the implementation of the Dodd-Frank Act.

The suggestion comes as regulators in Washington prepare to put forth their own liquidity reforms at some point this year.
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Former Fed officials: Liquidity tweaks needed to prevent next SVB

Harmonizing standards for liquidity coverage ratios and discount window pledges could prevent the type of strains that led to last year's bank failures, according to a new paper whose authors include former Federal Reserve Govs. Dan Tarullo and Jeremy Stein.

www.nationalmortgagenews.com

 

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A recent letter from the International Swaps and Derivatives Association Inc. (ISDA) to the Board of Governors of the Federal Reserve System highlights a larger risk in the United States and international banking sector than what is commonly perceived by the market.

The letter, dated March 5, emphasizes the urgent need for reform in the supplementary leverage ratio (SLR) and enhanced supplementary leverage ratio (eSLR) framework.

Specifically, it calls for the exclusion of on-balance sheet U.S. Treasuries from the total leverage exposure used in calculating the SLR for global systemically important bank holding companies (GSIB surcharge). This reform is seen as crucial to preserve the resilience of the U.S. Treasury markets, the U.S. economy, and the international financial system at large.

Though this issue may not be in the forefront of public attention, the arguments put forth in the letter are indeed alarming. Banks are advocating for U.S. Treasuries to be excluded from their supplementary leverage ratio calculation for several key reasons.

First, U.S. Treasuries are traditionally regarded as the “risk-free asset” due to being backed by the full faith and credit of the U.S. government. Excluding them from leverage ratio calculations implies that banks perceive them as risky, which could undermine confidence in U.S. government debt.

Second, the supplementary leverage ratio serves as a critical backstop to risk-based capital requirements, ensuring that banks do not become overleveraged even with assets considered to be safe. The proposal to carve out Treasuries from this calculation weakens the protection against excessive leverage.

Furthermore, if Treasuries are excluded, banks might be inclined to accumulate significant amounts of Treasury debt without it impacting their SLR. This concentration of risk heightens the interconnectedness between the banking system and government debt, posing systemic risks.

The request for this exclusion also hints at banks' concerns regarding the size of their Treasury holdings compared to their capital base. This could signal broader anxieties about the U.S. fiscal situation and government debt levels.

Any perception that banks require special exemptions for holding U.S. government debt could shake global confidence in Treasuries as a safe-haven asset and could impact the status of the U.S. dollar. ...

Calls to exclude U.S. Treasuries from leverage ratio imply fear of their rising risk | Gold Anti-Trust Action Committee | Exposing the long-term manipulation of the gold market

gata.org

 

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This was a fun read:

In December, the CEOs of the eight largest banks in the United States participated in a three-hour posturing session before the Senate Banking Committee. It was a disheartening display that showcased the toxic blend of politics and asinine rhetoric that often characterizes discussions about banking.

Much of the hearing focused on proposed banking regulations known as the “Basel 3 Endgame.” Claiming to “translate” the potential implications of this complex topic “for the average American,” Republican Senator Tim Scott stated that the proposed rules would lead to “fewer dollars to lend to Americans.” Bankers and several senators, including Scott, argued that by keeping a portion of the banks’ money “on the sidelines,” these regulations would prevent poor people from achieving the American Dream.

But these threats often originate from falsehoods, such as Scott’s suggestion that capital is something banks cannot use. In reality, as Democratic Senator Sherrod Brown noted, “Absolutely nothing in these rules would stop banks from making loans.” Instead, they would simply require banks to rely more on their own equity and less on borrowing to finance loans and investments. As the late US Federal Reserve Chair Paul Volcker famously observed, there is a lot of “bullshit” in the debate about capital requirements.
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More:

Nonsense and Bad Rules Persist in Banking | by Anat R. Admati - Project Syndicate

Anat R. Admati debunks the misconceptions propagated by financial executives and economists opposed to regulatory reforms.

www.project-syndicate.org

 

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Fulton Bank, N.A. of Lancaster, Pennsylvania Assumes Substantially All Deposits of Republic First Bank, Philadelphia

WASHINGTON — Philadelphia-based Republic First Bank (doing business as Republic Bank) was closed today by the Pennsylvania Department of Banking and Securities, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. To protect depositors, the FDIC entered into an agreement with Fulton Bank, National Association of Lancaster, Pennsylvania to assume substantially all of the deposits and purchase substantially all of the assets of Republic Bank.

Republic Bank’s 32 branches in New Jersey, Pennsylvania and New York will reopen as branches of Fulton Bank on Saturday (for branches with normal Saturday hours) or on Monday during normal business hours. This evening and over the weekend, depositors of Republic Bank can access their money by writing checks or using ATM or debit cards. Checks drawn on Republic Bank will continue to be processed and loan customers should continue to make their payments as usual.

Depositors of Republic Bank will become depositors of Fulton Bank so customers do not need to change their banking relationship in order to retain their deposit insurance coverage. Customers of Republic Bank should continue to use their existing branches until they receive notice from Fulton Bank that it has completed systems changes that will allow its branch offices to process their accounts as well.

Customers with questions about Fulton Bank’s acquisition of Republic Bank may call the FDIC toll-free at 1-877-467-0178. The FDIC’s Call Center will be open this evening until 9 p.m. Eastern Time (ET); on Saturday from 9:00 a.m. to 6:00 p.m. ET; on Sunday from noon to 6:00 p.m. ET; on Monday from 8:00 a.m. to 8:00 p.m. ET; and thereafter from 9:00 a.m. to 5:00 p.m. ET. Interested parties may also visit the FDIC’s website.

As of January 31, 2024, Republic Bank had approximately $6 billion in total assets and $4 billion in total deposits. The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) related to the failure of Republic Bank will be $667 million. The FDIC determined that compared to other alternatives, Fulton Bank’s acquisition of Republic Bank is the least costly resolution for the DIF, an insurance fund created by Congress in 1933 and managed by the FDIC to protect the deposits at the nation’s banks. Republic Bank is the first U.S. bank failure this year; the last failure was Citizens Bank, Sac City, Iowa on November 3, 2023.

PRESS RELEASE: Fulton Bank, N.A. of Lancaster, Pennsylvania Assumes Substantially All Deposits of Republic First Bank, Philadelphia

content.govdelivery.com

First to fail in 2024. Very likely won't be the last.

 

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Regarding the Republic First Bank Failure:

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The bank attempted to raise $125 million in additional capital from investors last year — an effort that launched on the same day that Silicon Valley Bank failed — but the deal fell apart only months later.

A subsequent capital infusion came together last fall amid reports that the FDIC was seeking a buyer for the troubled bank. But that capital raise also ultimately fell apart.
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Republic First fails; Fulton Bank acquires assets, branches

The Philadelphia-based bank's parent company, Republic First Bancshares, had been roiled by a yearslong proxy battle involving activist investors groups and its former CEO.

www.americanbanker.com

Zombies limp along until they are dismembered I guess.

 

[searcher]

Update on Fulton / Republic

Regional bank has abruptly shut 18 branches across three states - here's the full list​

Fulton Financial is set to close 18 bank branches after its acquisition of Republic First earlier this year.

The closures will encompass five Republic First locations and thirteen of its own. Scroll down to see the full list and locations.

Most of the branches are in greater Philadelphia and southern New Jersey.

However, both Republic First branches in New York city will also be shuttered.

Furthermore, Fulton Financial, the parent company of Fulton Bank, will not reopen its branch in Philadelphia that was temporarily closed after a water main break.

More:

MSN

www.msn.com

 

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Regional/branch banks really should be front line warriors against the "war on cash" or "cashless society". Without a robust cash economy, they will eventually become irrelevant dinosaurs as lending/financing moves to decentralized/tokenized on chain smart contracts and middlemen are no longer required nor desired. It's a ways down the road of course, but Pandora's box has already been opened.

 

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Small bank fails, uninsured deposits may not be made whole (unlike with SVB):

First Bank & Trust Co., Duncan, OK, Acquires Insured Deposits of The First National Bank of Lindsay, Lindsay, OK | FDIC

WASHINGTON – The First National Bank of Lindsay, Lindsay, Okla., was closed today by the Office of the Comptroller of the Currency (OCC), which then appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. To protect depositors, the FDIC entered into a purchase and assumption...

fdic.gov