Crawl. Walk. (Bank) Run: The 2023 Banking Panic and the Federal Regulatory Response - O'Melveny (2024)

SVB and Signature Bank were subject to receivership by the FDIC under the Federal Deposit Insurance Act (the “FDI Act”).3Among other things, the FDI Act gives the FDIC authority to act as a receiver of failed banks.4

FDIC receivership allows for the resolution of a failed bank’s assets and liabilities, with the aim of protecting insured depositors and creditors, minimizing disruption to the failed bank’s customers and counterparties, and maintaining confidence in the financial system. Banks themselves generally cannot file for relief under US bankruptcy law,5though bank holding companies can.6

Upon appointment, the FDIC has broad administrative authority under the FDI Act and holds all the powers of the shareholders, directors, and officers of the insolvent bank. Generally, the FDIC will remove and replace senior management and the board of directors—while also eliminating shareholders’ rights and powers.7Compared with other insolvency regimes, creditors of banks in FDIC receivership do not have the same ability to influence, vote on, or object to the FDIC’s decisions as receiver.8

FDICreceivership only applies to US banking entities insured by the FDIC, not to international bank affiliates or non-bank affiliate subsidiaries of FDIC-insured banks. For example, SVB’s parent bank holding company, SVBFG, also owned private banking and securities affiliates. Some of these entities have remained independent of SVBFG’s chapter 11 bankruptcy case. SVB also operated foreign branches in the UK and the Cayman Islands, which were beyond the scope of the receivership. Though HSBC has purchased the UK branch of SVB, the status of SVB’s Cayman branch remains unclear.

Claims Process

The FDIC notifies creditors (other than known depositors) of a deadline to submit claims that must be no less than 90 days from the notice.9The FDIC will distribute the proceeds of the failed bank’s assets among the claimants in accordance with statutory priority.10Under the FDI Act, after secured claims are paid,11administrative expenses of the receiver are paid first, followed by deposit liability claims (including insured and uninsured deposits), other general or senior liabilities of the insolvent bank, subordinated obligations, and then shareholder claims.12

Insured depositors are paid in full “as soon as possible” up to the statutory limit of US$250,000 per depositor, while uninsured depositors are subordinated in priority and may need to wait for an interim distribution.13The FDI Act permits the FDIC as receiver to withhold distribution of deposits on account of a depositor’s unpaid liability (unless such liability is otherwise offset by the depositor).14In the cases of SVB and Signature Bank, the “systemic risk exception” invoked by the US government obviated the need for interim distributions to uninsured depositors, who otherwise would have received an “advance dividend” based on the receiver’s conservative estimate of the bank’s remaining assets.15

In circumstances where deposits are not fully backstopped, the FDIC typically provides “receivership certificates” to uninsured depositors, and payments are made as the failed bank’s assets are monetized. The level of recoveries that holders of receivership certificates will receive or the timing of the distributions are each based on the facts and circumstances of the bank failure.

Avoidance Actions

The FDIC can avoid certain transfers of interest of an institution-affiliated party (or any person whom the FDIC determines is a debtor of the institution in receivership) that were made within five years of the FDIC’s appointment as receiver. But unlike typical avoidance actions under bankruptcy law, the transfers must have been made with the intent to hinder, delay, or defraud the insolvent bank in receivership, the FDIC, or any other federal banking agency. If avoided, the FDIC can recover the property transferred or the value of the property from either the initial transferee or any immediate transferee of the initial transferee. The FDIC cannot recover from any transferee that takes for value, including satisfaction or securing of a present or prior debt, in good faith or any immediate good faith transferee of such transferee.16There is no analogue in the FDI Act to bankruptcy law that allows the recovery of preferences and constructive fraudulent transfers.

Setoff and Loan Covenants

The FDIC has indicated a general willingness to allow for setoff by a creditor or depositor of its mutual obligations with a failed bank—typically for a setoff of uninsured deposits against loans outstanding with the institution—so long as the setoff is otherwise allowable under applicable law.17But the FDIC usually requests that parties make a formal request, as it did in its public notices regarding the SVB and Signature Bank receiverships. If a depositor is a net creditor and sets off its deposits against other unpaid liabilities, the FDI Act does not permit the FDIC as receiver to withhold payment of insured deposits on account of any of the depositor’s unpaid liabilities.18

The D’Oench Duhme doctrine, codified in 12 USC. § 1823(e), may also impact setoff rights in certain unique circumstances. This doctrine is both a common-law and statutory doctrine that is available to certain federal regulatory agencies and their assignees when dealing with the loans of a failed lender. The doctrine operates like a “Statute of Frauds” applied to banking that precludes affirmative claims and defenses seeking to enforce oral credit agreements (or raised against the enforcement of a loan). The Seventh Circuit once applied the doctrine in Federal Deposit Ins. Corp. v. State Bank of Virden, barring setoff because it relied on contradicting the loan documents with oral statements.19To the extent any setoff is in respect of a written agreement properly executed and recorded by the bank, the doctrine is generally inapplicable.

Many loan documents contain customary provisions requiring ongoing payments notwithstanding any setoff. Borrowers who are also creditors or depositors should normally continue to honor their existing contractual relationships with a failed bank in receivership except in certain circumstances and only after consulting legal counsel. The FDIC as receiver can enforce contracts notwithstanding so-called “ipso facto” contractual provisions providing for termination, default, acceleration, or exercise of rights upon insolvency or appointment of a receiver.20

The FDI Act also provides for a temporary 90-day stay on certain actions against a bank in receivership or its property, preventing contract parties from terminating, accelerating, or declaring a default under any contract that involves the failed institution or taking possession of or control over any of the failed institution’s property or affecting its contractual rights.21However, this provision does not apply to property or contracts transferred to a bridge bank, and it is unclear whether this provision would prevent the application of setoff generally. As a result, caution is warranted.22The FDI Act provides explicit protection for setoff or netting of qualified financial contracts (e.g., swaps, forward contracts) and for setoff of certain lease obligations where the depository institution is the lessor.23

III. What Is a Bridge Bank?

Bridge banks are national depository institutions chartered by the Office of the Comptroller of the Currency and controlled by the FDIC in connection with its takeover of a failed bank. The bridge bank gives the FDIC the opportunity to determine how best to liquidate the bank’s assets, whether as a sale to a single buyer or the piecemeal sale of assets. Sales may be to an existing bank or non-bank purchasers. Bridge banks are exempt from certain provisions of the FDI Act applicable to banks in receivership.24

The FDIC can transfer any assets or liabilities of a failed institution to a bridge bank without further approval under federal or state law, even if there are assignment or consent right restrictions.25Congress mandates that the FDIC continue to honor commitments made by the failed institution to creditworthy customers and not interrupt adequately secured loans transferred to a bridge bank.26

A bridge bank’s status is terminated as soon as any of several specific conditions is met, such as the sale of a majority of its capital stock to an entity other than the FDIC or another bridge bank. A bridge bank’s status can also expire after two years, with the possibility of three one-year extensions.27

IV. What Is the Bank Term Funding Program?

The Federal Reserve established the BTFP on March 12, 2023, under Section 13(3) of the Federal Reserve Act, as a source of emergency liquidity provided against high‑quality, pledged securities. The principal function of the BTFP is to eliminate a bank’s need to liquidate those securities under stress, with the broader goal of supporting US households and businesses and increasing confidence in the financial system.

The BTFP provided for advances of up to one year to most US banks pledging collateral eligible for purchase by the Federal Reserve Banks in open market operations, including US government securities.28

In contrast with regulatory discount-window lending, the BTFP values eligible collateral at face value, not market value, which strikes at the heart of the stress faced by SVB and Signature Bank: Both institutions held securities whose market value was significantly lower than face value because of recent interest-rate increases. The loans under the BTFP have recourse beyond the pledged collateral to the borrower.

The Federal Reserve has indicated that eligible banks’ use of the BTFP will not raise supervisory concerns.29

The Federal Reserve has also indicated its intent to publicly disclose information concerning the BTFP one year after its closure, currently scheduled for March 11, 2024. That information will include identifying details of participants in the facility along with the amount borrowed, interest rate paid, and collateral type pledged.30

V. What’s Next?

This crisis could have several knock-on effects, including changes to standard banking practices and new or adjusted rules for bank supervision.

  • CashManagement Practices. Large depositors may begin to more critically examine where they hold cash deposits—uninsured deposits in particular—and whether they should implement risk-mitigation strategies such as sweep accounts or diversification of deposit accounts.
  • Deposit Insurance.Continued calls to reform the FDIC’s national deposit insurance program are likely, particularly to increase or even eliminate insurance limits that many now claim were illusory.
  • Regulatoryand Legislative Responses.Calls for increased supervision over regional banks are expected to grow louder. Senator Elizabeth Warren and Rep. Katie Porter have introduced companion bills to re-impose heightened regulations on small- and medium-sized banks. Regulators have already announced inquiries into the recent bank failures. And the Senate Banking Committee and the House Financial Services Committee are holding hearings with FDIC Chairman, Martin Gruenberg; Federal Reserve Vice Chairman for Supervision, Michael Barr; and Department of Treasury Undersecretary for Domestic Finance, Nellie Liang.
  • GovernmentEnforcement Investigations. Multiple reports have suggested that the SEC and Department of Justice have opened investigations into events surrounding SVB’s failure, and Massachusetts regulators have announced a formal investigation into stock trading by SVBFG executives.
  • Bankruptcy Cases.
    • Inaddition to SVBFG’s bankruptcy filing—the first major bank holding company Chapter 11 filing since the global financial crisis—other bank holding companies may seek bankruptcy protection in connection with the failure of their depository institutions.
    • Inits Chapter 11 case, SVBFG has already previewed disputes with the FDIC over access to more than US$2 billion in cash held at SVBB. The FDIC has allegedly declined to honor requests to transfer the accounts and to allow access to certain books and records that were held at SVB, and it has allegedly attempted to claw back certain payments to the debtor’s bankruptcy professionals.
    • One major issue that will arise in Chapter 11 cases of bank holding companies is the application of section 365(o) of the Bankruptcy Code, which requires a Chapter 11 debtor to assume any commitment to a regulator to maintain capital at an insured depository institution. The provision also affords priority to claims of the regulator arising from a breach of this capital maintenance commitment. Section 365(o) is, therefore, a stark departure from the otherwise wide discretion that the Bankruptcy Code grants a Chapter 11 debtor to reject burdensome agreements and choose not to perform under agreements during the pendency of the bankruptcy.
  • Sourceof Strength. US banking law has long imposed a “source of strength” doctrine on bank holding companies, which generally requires that a bank holding company be a sufficient source of financial and managerial strength to its subsidiary bank. Questions remain as to how the doctrine, which Congress clarified and strengthened in the Dodd-Frank Act, would apply to bank holding companies by way of section 365(o).

[1] 12 U.S.C. § 5383 et seq.; Fed. Deposit Insur. Corp., PR-17-2023, Joint Statement by the Dep’t of the Treasury, Fed. Rsrv., and FDIC (2023), https://www.fdic.gov/news/press-releases/2023/pr23017.html.

[2] Bd. Of Governors of the Fed. Rsrv. Sys., Federal Reserve Board announces it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors (2023), https://www.federalreserve.gov/newsevents/pressreleases/monetary20230312a.htm.

[3] 12 U.S.C. §§ 1821(c)(2)(A)(ii), (c)(2)(B); see also Fed. Deposit Insur. Corp., Crisis & Response: An FDIC History, 2008-2013 at 17677 (2017).

[4] The FDI Act also provides the FDIC with the authority to insure bank deposits and supervise and regulate state-chartered banks that are not members of the Federal Reserve System, with the purpose of promoting stability and confidence in the banking system of the United States and promoting safe and sound banking practices.

[5] 11 U.S.C. §§ 109(b)(2), (d).

[6] Id. §§ 101(41); 109(d).

[7] 12 U.S.C. § 1821(d)(2).

[8] In contrast, under U.S. bankruptcy law, a debtor’s estate is administered by a debtor-in-possession or trustee in a legal proceeding overseen by a federal bankruptcy court. Though court approval is often necessary for taking actions outside of the ordinary course of business, often management is retained and both creditors and the debtor’s management often have significant control over decisions. Affected creditors generally can vote on a plan of reorganization of a debtor.

[9] 12 U.S.C. § 1821(d)(3)(B)(i).

[10] See Id.§ 1811(b).

[11] Secured claims can be disallowed if not proved to the satisfaction of the FDIC as receiver, and, with very limited exceptions, the FDIC may treat as unsecured any claim amounts in excess of the fair market value of the security. 12 U.S.C. § 1821(d)(5)(D).

[12] 12 U.S.C. § 1821(d)(11).

[13] Id. §§ 1821(a)(1)(C), (E); (f)(1).

[14] Id. §1822(d).

[15] Id.. § 1821(d)(4)(B); Fed. Deposit Insur. Corp., Glossary, Resolutions Handbook, https://www.fdic.gov/bank/historical/reshandbook/glossary.pdf (last visited Mar. 11, 2023).

[16] 12 U.S.C. § 1821(d)(17).

[17] See, e.g., Fed. Deposit Insur. Corp., Fin. Inst. Emp.’s Guide to Deposit Insur. (2023), https://www.fdic.gov/resources/deposit-insurance/diguidebankers/insurance-basics/index.html.

[18] 12 U.S.C. §1822(d) (permitting the FDIC as receiver to withhold distribution of insured deposits on account of a depositor’s unpaid liability except if the liability is “offset against a claim due from such depository institution”).

[19] 893 F.2d 139, 143-44 (7th Cir. 1990).

[20] 12 U.S.C. § 1821(e)(13)(A).

[21] Id. §1821(e)(13)(C).

[22] Notably, not a single published court opinion cites to 12 U.S.C. §1821(e)(13)(C).

[23] 12 U.S.C. §§1821(e)(5), (8). “Walkaway” clauses, which are expressly distinguished from netting/set off rights under qualified financial contracts, are unenforceable. Id.

[24] See, e.g., 12 U.S.C. §1821(e)(10)(c)(i).

[25] Id. §1821(n)(3)(a)(iv).

[26] Id. §1821(n)(3)(B).

[27] Id. §1821(n)(9)-(12).

[28] 12 C.F.R. § 201.108.

[29] Bd. Of Governors of the Fed. Rsrv. Sys., Bank Term Funding Program (FAQs) (2023), https://www.federalreserve.gov/monetarypolicy/files/bank-term-funding-program-faqs.pdf.

[30] Id.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Jarryd E. Anderson, an O’Melveny partner licensed to practice law in the District of Columbia, New Jersey, New York, and Pennsylvania, Peter Friedman, an O’Melveny partner licensed to practice law in the District of Columbia, Jordan Weber, an O'Melveny counsel licensed to practice law in California and New York, and Damilola G. Arowolaju, an O'Melveny associate licensed to practice law in the District of Columbia, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

© 2023 O’Melveny & Myers LLP. All Rights Reserved. Portions of this communication may contain attorney advertising. Prior results do not guarantee a similar outcome. Please direct all inquiries regarding New York’s Rules of Professional Conduct to O’Melveny & Myers LLP, Times Square Tower, 7 Times Square, New York, NY, 10036, T: +1 212 326 2000.

I am a seasoned expert in the field of banking and financial regulations, with a deep understanding of the Federal Deposit Insurance Act (FDI Act) and the processes involved in the receivership of failed banks. My expertise is demonstrated through a comprehensive understanding of the concepts and intricacies involved in the FDIC receivership process, including the protection of insured depositors and creditors, the distribution of assets, the claims process, avoidance actions, setoff and loan covenants, bridge banks, and the Bank Term Funding Program.

FDIC Receivership Process

The Federal Deposit Insurance Act (FDI Act) grants the FDIC the authority to act as a receiver of failed banks, allowing for the resolution of a failed bank’s assets and liabilities to protect insured depositors and creditors, minimize disruption to customers, and maintain confidence in the financial system [[3]].

Claims Process

The FDIC notifies creditors of a failed bank of a deadline to submit claims, with insured depositors being paid in full up to the statutory limit of US$250,000 per depositor, while uninsured depositors may need to wait for an interim distribution [[9]].

Avoidance Actions

The FDIC can avoid certain transfers made within five years of its appointment as receiver if they were made with the intent to hinder, delay, or defraud the insolvent bank. However, unlike typical avoidance actions under bankruptcy law, the FDIC's ability to recover property transferred is limited [[16]].

Setoff and Loan Covenants

The FDIC generally allows for setoff by a creditor or depositor of its mutual obligations with a failed bank, subject to formal requests. The D’Oench Duhme doctrine and the FDI Act impact setoff rights in certain circumstances [[17]].

Bridge Banks

Bridge banks are national depository institutions controlled by the FDIC in connection with the takeover of a failed bank, allowing the FDIC to determine how best to liquidate the bank’s assets [[III]].

Bank Term Funding Program (BTFP)

The BTFP, established by the Federal Reserve, provides emergency liquidity against high‑quality, pledged securities to support US households and businesses. It allows for advances of up to one year to most US banks pledging eligible collateral, with recourse beyond the pledged collateral to the borrower [[IV]].

Potential Impacts and Responses

The crisis could lead to changes in banking practices, calls for reform of the FDIC’s national deposit insurance program, increased supervision over regional banks, government enforcement investigations, and bankruptcy cases [[V]].

My expertise in these areas allows me to provide comprehensive insights into the complex processes and regulations involved in the FDIC receivership of failed banks. If you have further questions or need more detailed information on any of these topics, feel free to ask!

Crawl. Walk. (Bank) Run: The 2023 Banking Panic and the Federal Regulatory Response - O'Melveny (2024)
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