Center for American Progress

4 Things Bank Regulators Can Do to Help Prevent Bank Failures

4 Things Bank Regulators Can Do to Help Prevent Bank Failures

In addressing the recent instability within the U.S. financial system, regulators must confront continuing risk and bank fragility.

The SVB Private logo is displayed outside of a Silicon Valley Bank branch in Santa Monica, California.
The SVB Private logo is displayed outside of a Silicon Valley Bank branch in Santa Monica, California on March 20, 2023. (Photo by Patrick T. Fallon / AFP) (Photo by PATRICK T. FALLON/AFP via Getty Images)

In the wake of the recent bank failures, the Federal Reserve and Federal Deposit Insurance Corporation (FDIC) are conducting investigations to understand what can be learned and what actions they might take to help prevent more failures. Both regulators have committed to releasing analyses of the crisis by May 1, 2023.

The Fed report will focus on “the supervision and regulation of Silicon Valley Bank, in light of its failure.” The FDIC “will undertake a comprehensive review of the deposit insurance system” and its report “will include policy options for consideration related to deposit insurance coverage levels, excess deposit insurance, and the implications for risk-based pricing and deposit insurance fund adequacy.”

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Emergency actions taken by the Fed, FDIC, and Treasury Department were central to containing the worst effects of the recent failures and preventing their spread throughout the financial system. Many have called for further actions, including reversing the 2018 regulatory rollbacks that lifted certain prudential requirements for firms like the ones that recently failed. While these reforms should certainly be considered, there is a larger problem of continuing unacceptable risk in the financial system and bank fragility. This is a concern because, as banks face increasing economic shocks like those from climate disasters, the pandemic, and the war in Ukraine, they must be stronger than ever. The 2010 Dodd-Frank reforms have helped a great deal, especially for the largest banks, but there is more work to be done.

A closer look at the recent bank failures and the latest academic research suggests that the elephant in the room is inadequate equity. That is, the owners of banks are not putting in enough of their own money and are instead relying too heavily on debt to finance their operations. While there are various calculations that banks must do to determine the appropriate level of equity—some of which were weakened by the 2018 rollbacks, especially for midsize banks—the ratios and calculations themselves fail to reflect all the risks that they should. A look at banks’ balance sheets provides insight into this risk.

Balance sheet basics

Banks make commercial loans, provide mortgages, and administer accounts on behalf of their customers. They charge interest and fees for these services—resulting in profits—and, eventually, the loans and mortgage principals are repaid. They also buy securities and other assets on which they hope to earn a profit.

Banks get the money to lend and buy other assets from contributions that bank owners make—called equity—and from various forms of debt. The debt includes deposits that customers make into accounts held by the bank, which must be repaid on demand (known as “callable debt”); long-term bonds issued to investors (essentially an interest bearing loan to the bank that the bank will pay back in a specified number of years); and short-term debt (such as commercial paper, which is essentially a promise to repay in a specified number of months, and repo markets, which are overnight loans that banks make to one another).

A critical aspect of good bank management involves managing the risks created by their portfolios of assets and liabilities. In highly simplified form, the balance sheet looks like this:


  • Loans: Commercial and industrial, real estate, and consumer loans
  • Mortgages: These could be commercial or residential
  • Securities: These could include many types of investments such as stocks, bonds, notes, and other companies’ bonds that a bank purchases (i.e., invests in). Thus, these could be debt securities or equity securities. A common debt security held by banks is long-term fixed income investments, like Treasury bonds
  • Reserves: Cash minimums the bank must have on hand to meet any large, unexpected demand for withdrawals


  • Equity:
    • Value of shareholders’ residual claim on the bank’s assets after deducting debts the bank owes to others
  • Debt:
    • Callable debt: Deposits (some are insured, some are not)
    • Long term: Bank issues preferred stock or bonds
    • Short term: Bank issues commercial paper (promises to repay, usually in one or more months) or bank gets overnight loans from the repo markets

Two of the risks that are evident from the recent bank failures can be found on either side of the balance sheet: unrealized losses on securities assets and uninsured deposits.

On the liability side, banks take in deposits, but the FDIC only insures deposits up to $250,000 per account. Silicon Valley Bank (SVB) had deposits far in excess of these amounts—93.8 percent of the total dollar value of its deposits—and should have managed that increased level of risk. Fortunately for their uninsured depositors, the FDIC used its emergency authority to backstop all deposits to quell depositor anxieties and prevent further bank runs. But backstopping uninsured deposits should not be necessary if banks are well-managed.

On the asset side, the accounting rules that govern banks permit them to list long-term securities—such as long-term Treasury bonds—at their face or “par” value if the bank classifies them as “held to maturity”—that is, held until their scheduled repayment date. But this is a fiction. Long-term bond securities are nearly always among the assets a bank will sell to pay off depositors in a mass withdrawal, or run on the bank. And, when market interest rates rise, the market value of the long-term bonds will decline below par value. In other words, an asset that it reflected on the balance sheet at its face or par value can only be sold for less and, if sold, will result in a loss on the asset side of the balance sheet. Assets that have declined in value but are not yet sold constitute “unrealized” losses.

According to FDIC data, there are large unrealized losses for securities on bank balance sheets,  about $620 billion in the fourth quarter of 2022. That amounts to more than 10 percent of the value of all securities held on depository balance sheets.

Moreover, recent academic research shows that unrealized losses on securities and commercial and residential mortgages, taken together, amount to as much as $2 trillion. That is to say, the market value of assets on bank balance sheets is approximately $2 trillion less than the book or accounting value of those assets. If banks were forced to sell these securities or mortgages at current market prices, they could do so only at a discount to their nominal (or face) value; in other words, at a loss.

Depending on where these losses are located, there may be other banks like SVB that could be insolvent—that is, they have liabilities greater than the market value of their assets. The recent coordinated effort to shore up First Republic Bank—by having large banks make an infusion of deposits in First Republic to show confidence in the bank—is one indication that SVB was not an isolated case.

Banks that have both large unrealized losses, signaling a potential drop on the assets side of the ledger, and large amounts of uninsured deposits—a risk on the liabilities side of the ledger since there is no insurance for these amounts if depositors demand their money—may be in an even more precarious position.

The academic research cited above suggests that, currently, many banks that rely heavily on uninsured deposits to fund their business are fragile. Under certain reasonable assumptions, many banks would be insolvent and unable to pay insured depositors if a sufficient fraction of uninsured deposits were withdrawn. For example, the study’s authors estimate that if half of all uninsured deposits were withdrawn from each bank, 190 banks would be insolvent and unable to repay their insured depositors. The shortfall would be an estimated $300 billion. As the share of uninsured deposits withdrawn rises to 100 percent, the number of insolvent banks would rise more than proportionately, and losses would be more than $1.6 trillion.

What the banking regulators can do to help

Looking at the balance sheet above, it becomes clear that shoring up banks’ equity is an effective way to address these risks. Here are some steps regulators could take.

1.     The Fed generally should require all banks to have more equity than is currently required

The financial regulators can raise the equity requirements for banks. Currently a bank the size of SVB is “well capitalized” if it has equity equal to at least 5 percent of its assets. However, this threshold is clearly too low. SVB had a leverage ratio of 7.96 percent at the end of 2022 and still failed. By raising the threshold, banks would be required to shoulder a greater fraction of any losses in asset value or any runs on uninsured deposits. This would increase “self-insurance” against loss, change bank incentives, and reduce the likelihood of depositor runs by strengthening the balance sheet. While leverage limits become marginally higher for the very largest banks, all banks would be less fragile if they financed more of their assets with their own funds. Higher equity requirements of course should be phased in over a reasonable time.

2.     Minimum equity requirements should not be based on the “held-to-maturity” fiction

As was seen in the recent bank failures, the classification of assets as “held to maturity” can lead to inflated equity calculations and allow excessive risk taking.

Banks use a variety of ratios to assess how much they rely on debt versus equity to finance their operations. These ratios can show the bank’s ability to pay off liabilities as they become due. One ratio that helps determine if a bank is healthy is the equity to asset ratio. In most circumstances, a decline in the market value of assets would be deducted from bank equity. However, for purposes of calculating a bank’s equity to asset ratio, this deduction is not made so long as the securities are listed on its balance sheet as “held to maturity.” Although financial regulators and other experts can determine the level of unrealized losses by scrutinizing the underlying accounting data, the accounting maneuver of classifying those assets as “held to maturity” on the balance sheet can allow the bank to appear solvent and above the regulatory threshold to most observers when, in fact, they are at risk.

3.     The FDIC should consider factoring in the level of uninsured deposits and the amount of assets booked as “held to maturity” in assessing banks’ deposit insurance fund fees

The recent failures have reignited the debate over the appropriate level of deposit insurance. There are serious reasons to be skeptical of proposals to raise bank deposit insurance, including the moral hazard that doing so might increase bank managers’ incentives to take more risks. At the same time, given that federal regulators are increasingly covering uninsured deposits to avoid potential contagion and other systemic risks, it makes sense that they should increase the cost of bank insurance for banks with exceptionally large uninsured deposits or unrealized losses.

4.     Regulators should follow through on the Dodd-Frank mandate that they promulgate a rule on clawback of incentive-based executive compensation

Finally, regulators can reduce the financial gains for bank executives who game the system, earn large bonuses, and raise risks to financial stability. Executives at SVB, who had to know they had taken their bank to the precipice of failure, nonetheless were rewarded handsomely before the bank was taken over by regulators. Clawback of excessive executive compensation when banks face insolvency due to their own mismanagement would better align incentives for bank managers and would fulfill the Dodd-Frank mandate on this point.


Of the two means that bank owners have for financing their business—their own money (equity) or borrowed money (debt)—there is no question that banks prefer to use debt. It goes without saying that bank owners have a greater incentive to see that their operations are managed well when they have more skin in the game. Regulators should take steps to ensure that banks have adequate levels of equity; are fully transparent about unrealized losses; consider both unrealized losses and large amounts of uninsured deposits when calculating leverage ratios; and are prepared to forfeit excessive executive compensation when gamesmanship contributes to bank insolvency.

The positions of American Progress, and our policy experts, are independent, and the findings and conclusions presented are those of American Progress alone. A full list of supporters is available here. American Progress would like to acknowledge the many generous supporters who make our work possible.


Marc Jarsulic

Senior Fellow; Chief Economist

Alexandra Thornton

Senior Director, Financial Regulation

Lilith Fellowes-Granda

Associate Director, Financial Regulation


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