FDIC acknowledges ‘too generous’ view of First Republic’s liquidity

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US regulators in charge of supervising First Republic bank were “too generous” and “could have done more to effectively challenge” management on its plans for dealing with rising interest rates and liquidity risk before its failure this year, the Federal Deposit Insurance Corporation said on Friday.

The FDIC’s first in-depth report into California-based First Republic’s collapse put the blame squarely on “a loss of market and depositor confidence” that had been triggered by the demise of Silicon Valley Bank in March.

But the financial watchdog acknowledged that its supervisors could have done more to address specific factors that made First Republic especially vulnerable to “dramatic and severe contagion effects”, including a bank run. These included the bank’s rapid growth, reliance on uninsured deposits and failure to mitigate interest rate risk.

Before the FDIC shut First Republic down in May and sold most of its assets and liabilities to JPMorgan Chase, the bank was suffering from a sharp share price fall, paper losses on its large mortgage book and rapid deposit outflows.

The report noted that First Republic’s main strategy for coping with rising interest rates assumed that it would grow its way out of trouble. Starting in late 2021, when it became clear that interest rates were likely to rise, FDIC supervisors “could have done more to effectively challenge and encourage bank management to implement strategies to mitigate interest rate risk”.

In retrospect, the report said, “for an institution of its size, sophistication, and risk profile, the bank should have taken additional proactive measures to mitigate interest rate risk” such as selling off loans, raising prices on its loans and buying interest rate hedges.

The report also said the decision to give First Republic top ratings on liquidity risk management in 2021 — one of the problems that ultimately brought it down — was “too generous and was inconsistent with First Republic’s high level of uninsured deposits”.

The report also noted that supervisory attention did not keep up with First Republic’s rapid growth: while its assets more than doubled to $233bn between 2018 to 2023, actual supervisory hours declined by 11 per cent.

However, unlike a Federal Reserve report into its supervision of SVB, the FDIC assessment of its actions on First Republic did not find significant regulatory concerns had gone unaddressed.

The FDIC report said it could not determine whether earlier supervisory action would have saved First Republic, but “meaningful action to mitigate interest rate risk and address funding concentrations would have made the bank more resilient and less vulnerable to the March 2023 contagion event”.