The Office of Inspector General (OIG) of the Federal Deposit Insurance Corporation (FDIC) has issued a Material Loss Review of First Republic Bank.
On May 1, 2023, the California Department of Financial Protection and Innovation closed First Republic Bank and appointed the FDIC as receiver. On June 5, 2023, the FDIC recorded a final estimated loss to the Deposit Insurance Fund of $15.6 billion.
Under a contract overseen by the OIG, Cotton & Company Assurance and Advisory, LLC (Cotton) performed the Material Loss Review. The objectives of the engagement were to (1) determine why the bank’s problems resulted in a material loss to the Deposit Insurance Fund, and (2) evaluate the FDIC’s supervision of the bank, including the FDIC’s implementation of the Prompt Corrective Action requirements of Section 38 of the Federal Deposit Insurance Act, and make recommendations for preventing any such loss in the future.
First Republic Bank’s failure was caused by contagion effects stemming from the failure of other prominent financial institutions, which led to a run on deposits, significantly reducing its liquidity and exposing vulnerabilities in its business strategy. Specifically, First Republic Bank’s strategy of attracting high net-worth customers with competitive loan terms, and funding growth through low-cost deposits, resulted in a concentration of uninsured deposits while increasing the bank’s sensitivity to interest rate risk. This strategy ultimately led to a significant asset/liability mismatch for the bank, and fair value declines on its portfolio of low-yielding, long-duration loans, which limited its ability to obtain sufficient liquidity and prevented its recovery.
Cotton determined that:
- The FDIC missed opportunities to take earlier supervisory actions and downgrade First Republic Bank component ratings consistent with the FDIC’s forward-looking supervisory approach;
- The FDIC assessed First Republic Bank’s uninsured deposits consistent with FDIC policies, but the magnitude and velocity of uninsured deposit outflows warrants the FDIC’s re-evaluation of assumptions and guidance pertaining to uninsured deposits; and
- First Republic Bank was well-capitalized throughout each examination cycle based on defined capital measures, but that the bank’s failure may warrant changes to the guidelines establishing standards for safety and soundness, including the adoption of noncapital triggers requiring regulatory actions.
Cotton made 11 recommendations intended to improve the FDIC’s supervision processes and its ability to apply effective forward-looking supervision in a changing banking environment. The FDIC concurred with all of the recommendations and plans to complete corrective actions by July 31, 2024.