Having closed the books for the quarter, bank managers remain wary but optimistic. Asset quality metrics have risen from historic lows seen during the COVID-19 pandemic and the height of the Federal stimulus, but this trend is not a new story and remains well within the range of normal. Moreover, commercial real estate lending has remained healthy so far; the feared refi Armageddon in the office building and multi-family residential space has not materialized. At least so far. They are also optimistic that bank supervision will ease up, perhaps by redefining the thresholds for what constitutes a large institution last set in October 2019. The Fed released the results of its stress tests it conducted on 22 of the large banks on June 27th after markets closed and concluded that all 22 “are well positioned to weather a severe recession, while staying above minimum capital requirements and continuing to lend to households and businesses.”

Bank managers remain hopeful that the Fed will still cut rates this year and still believe that the yield curve will eventually steepen at the front end, which would help net interest margins and net interest income. The Fed continues to encourage these hopes with its dot plot projections, even though its projections about inflation trending back to 2% have yet to pan out. Moreover, and highly unusually, except for a brief couple of weeks at the beginning of the year, the yield spread between the 3-month Treasury Bill and the 5-year Treasury Note has remained negative, as it has since November 2022.

Bank treasurers continue to hold their balance sheets neutral to short-term changes in rates, and hedging activity is up. Eris Innovations, one of the newsletter’s corporate sponsors, told the newsletter that it continued again this month to see a surge in use of the Eris SOFR swap futures contract which mimics the economics of an interest rate swap and can be used as a qualifying hedge for accounting purposes for both fair value and cash flow hedging, but for a lower cost bank would incur using a traditional swap to hedge.

Balance sheet mix remains stable. The Fed’s H.8 small bank peer group’s level of total deposits this month reached a record $5.5 trillion, up $0.5 trillion since Q2 2023, following the failures of Silicon Valley Bank, Signature Bank, and First Republic. Loan growth kept pace with deposit growth, as the ratio of loans to deposits for small banks, at 83%, has remained unchanged for the last 24 months. The ratio of loans to deposits for small banks was as low as 60% in the late 1980s and early 1990s and reached over 100% on the eve of the Global Financial Crisis. Three years ago, when the Fed first began raising rates, the ratio of the small bank peer group’s loans to deposits was 70%.

A combination of the Fed’s rapid rate increases from 2022 to 2023 and the bank failures in 2023 put enormous pressure on the funding and liquidity of regional and community banks. However, those pressures have long since abated, as the memory of the regional bank crisis fades with nervous depositors and the Fed’s rate cuts take effect, rolling through resetting time deposits. The mix of deposits, between interest-bearing and non-interest-bearing, remains stable. At 22% in Q1 2025, the industry’s aggregate ratio of noninterest-bearing deposits to total deposits is just over its historic 20% 40-year average (based on FDIC data).

Through Q1 2025, bank treasurers continued to reduce brokered deposits and FHLB advances as these funding stresses continued to recede. Bank treasurers expect to retain over 80%-85% of their time deposits that are coming up for reset before the end of 2025. R&T Deposit Solutions, one of the newsletter’s corporate sponsors offering products and services to banks, trust companies, broker-dealers, credit unions, and other financial institutions around cash sweep, deposit funding, and balance sheet management, told the newsletter that it saw a bump up in brokered CDs rates in Q2 2025 which could be bank treasurers looking to cover in the brokered CD market some of the expected run off in time deposits.

Bank reserve deposits totaled $3.3 trillion, unchanged since the Fed initiated quantitative tightening (QT) 36 months ago, with the ostensible purpose of draining excess liquidity from the financial system. Texas Senator Ted Cruz floated the idea, during an interview on CNBC this month, that Congress may vote to ban the Fed from paying interest on reserve deposits to help reduce the deficit. The industry earned $38 billion from interest on reserves in Q1 2025, as reported by the Fed, compared to the sector's total quarterly interest income of $305 billion. Bank treasurers continue to value reserve deposits over all other classes of high-quality liquid assets. Still, if the Fed could no longer pay interest on bank reserve deposits, bank treasurers would likely shift at least some of their deposits at the Fed into the short-term Treasury market. Indeed, this trend has already begun, as domestic banks have reduced their reserve deposits while foreign branches and agencies have increased theirs (see Slides 3 and 4 in this month's chart deck).

Fed Governor Michelle Bowman, the new Vice Chair of Supervision, laid out her new vision for bank supervision in a speech this month at Georgetown University, outlining her goal to promote more balance, accountability, and transparency in bank examinations and in the interaction between examiners and bank management. Meanwhile, bank supervisors, including the Federal Reserve (Fed), the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC), have all committed to a 10% reduction in staffing. The National Credit Union Administration (NCUA) plans for a 20% cut.

The House Banking Committee voted 29 to 23 in favor of the HUMPS (Halting Uncertain Methods and Practices in Supervision) Act, which committee members believe is necessary to rein in perceived bias in bank examiner ratings that impact exam composite CAMELS (Capital, Asset Quality, Management, Earnings, Liquidity, and Market Sensitivity) scores. This month, the Fed announced that it would no longer formally include reputational risk in its assessment of management. It also announced plans to roll back the enhanced supplementary leverage ratio for large banks, without addressing the weighting for Treasurys.

The Senate passed the Genius (Guiding and Establishing National Innovation for U.S. Stablecoins) Act this month, which will need to be reconciled with the House’s version to pass into law. Both pieces of legislation would allow banks and nonbanks to issue stablecoins backed dollar for dollar by U.S. Treasurys. They would be able to reduce expenses related to cross-border payments that pass through the Society for Worldwide Interbank Financial Telecommunication (SWIFT) system. In general, the tokenization of financial instruments promises to improve market efficiency and transparency in collateral-based markets such as repo. Digital payments over the new FedNow service have surged since the Fed launched it in July 2023. Still, stablecoins would enable participants to move much larger blocks of money than the Fed currently permits over the service.

The Bank Treasury Newsletter

Dear Bank Treasury Subscribers,

Carter, the fictional bank examiner in Frank Capra's 1946 movie, "It's A Wonderful Life," (not Kotter, the fictional teacher in the 1975 television series, "Welcome Back, Kotter") meets George Bailey, the owner of the Bailey Brothers Building and Loan, for the first time, about halfway through the movie. His scene is approximately one minute in length, a walk-on, essentially (compared to the movie's 2-hour, 10-minute run time), and adding to his fictional obscurity, the writers did not even give him a first name. He is just Carter, or Mr. Carter as George called him.

Consequently, he does not have a particularly rich backstory that one needs to know. He could be anyone, but not really. We know his family lived in Elmira, New York. Elmira is only 60 miles from Seneca Falls, the small town in upstate New York that Frank Capra used as inspiration for Bedford Falls, where the movie takes place around Christmas, and which also happens to be the birthplace of the women’s suffrage movement.

We know he dressed well, judging by his picture, was a bit of a tightwad about money, and a stiff with those Pince Nez glasses he wore. Probably nothing much impressed him; he must have been a stickler on rules, and maybe never heard a joke he thought was funny. We can also imagine that he liked to work alone, which would not have been so unusual considering the likely size of the balance sheet of the building and loan he came to examine. In 1946, building and loans like Bailey Brothers would not have had more than $40,000-$50,000 in total assets, if that much. A lot of credit unions today are like the Bailey Brothers, most of them with small balance sheets.

Building and loans were typically small, well-established institutions. They were a fixture on the main streets of small-town USA 100 years ago, and just like the Community Development Financial Institutions today, they focused on the low-income, affordable housing market. They promoted saving money to buy a home, like a sou-sou, an informal savings club. They were very popular at one time, unlike today, when they are just an obscure footnote in this nation’s banking history, and are only known to have existed thanks to the movie.

Set up as cooperatives, like credit unions, their depositors were technically shareholders, as building and loan associations by law could not offer deposit accounts to the public. Their depositor-shareholders agreed to pay for their “shares” through a subscription over time. In return, shareholders had the right to borrow money from the building and loan to buy a home, but no right to withdraw funds on demand. To withdraw what they had paid into the building and loan and cash out, they had to give advance notice. In the case of the Bailey Brothers Building and Loan, that notice was 60 days.

Theoretically, this feature made them less susceptible to a run, although as the famous bank run scene in the movie suggests, in times of stress and panic, all bets are off. FDIC insurance was initially not available to depositor-shareholders in a building and loan association, if any were still around in 1946. Most had already wound up when all their “sou-sou” members had borrowed the money they were entitled to and paid off their share subscriptions.

If not, by 1946, they had merged into Federal Savings and Loan, or disbanded because people like Henry Potter, the villain in the movie, and the Bailey Brothers’ principal investor, decided to cash out and sell the assets to a bank at a fraction of their value. Ultimately, they all merged into commercial bank charters after the global financial crisis when the government merged the Office of Thrift Supervision with the OCC.

Bank Examiners: A Cut Above

Building and loans were also typically state-chartered and thus examined by a state bank examiner, which means that Carter worked for the New York State Banking Department. For the record, the New York State legislature established the Banking Department in 1851, making it the oldest state banking regulator in the country. Working there was prestigious, like working for the Ministry of Finance in Japan, prestigious, or it should have been.

The Banking Department, however, became a victim of modernization. As bank treasurers working in the state of New York are aware, immediately following the Global Financial Crisis (GFC), the department consolidated with the New York State Insurance Department (established in 1860), and the combined departments officially became known as the Department of Finance. The Department of Finance today is still staffed with exceptionally smart and dedicated examiners, which is just as remarkable today as it was in Carter’s time, considering the recruiting challenges it faced then and now.

Working as an examiner for the Banking Department in 1946 was no small feat. Carter must have been knowledgeable and a person of high integrity, because not just anyone worked there. As Leffert Holz, the Superintendent of the New York State Banking Department, wrote in the Banking Department’s 1955 annual report,

“Examiners must be men of the highest integrity. They must possess. unusually good judgment which they can apply not only fairly and impartially, but in such a manner as will leave no hint of improper invasion of management's rights and prerogatives.”

In other words, they had to know how to thread needles with the bank managers whose cooperation they needed, how to walk and draw fine lines at the same time, and when to use sticks and when to use carrots. They had to establish the business of risk intermediation, which involves determining what is safe and sound asset-liability management, as well as what is reckless and imprudent. They would have to know that not everything in the movie is black and white, that sometimes borrowers can be late, but still be good with their money, and that generally, everything is not what it seems. Know when errors in the details are just details and nothing to worry about, or when they are a sign of something more that could be a problem or could develop into one. You had to have a nose for risk to be a bank examiner.

A bank examiner like Carter focused on the details. He came prepared to review each loan George had made and determine whether the pricing on it was appropriate for the risk, as well as whether any unknown losses lurked in the loan portfolio. He was ready to review all the procedures and protocols and weigh risk exposures against the building and loan’s capital and liquidity resources. However, Carter also had to go beyond the numbers, as a safe and sound assessment is as much a quantitative judgment as it is a qualitative one. Part of the qualitative assessment was determining whether management, specifically George Bailey, could maintain it that way.

Leffert Holz appreciated the difficulties that bank examiners such as Carter faced every day in their line of work, as he wrote,

“The examiner's task is not simply one of checking records, verifying assets, or criticizing certain practices that violate laws, important as these detailed duties are. His responsibility is to safeguard the greatest volume of deposits ever entrusted to any state banking system, and to encourage bank management to make them useful to our growing economy.”

Overworked and Underpaid

Carter must have been a rare hire for the Banking Department, as every one of its bank examiners must have been from Leffert Holz’s description. However, to add to its HR department’s recruitment challenges, finding someone like Carter meant finding someone willing to put up with being overworked and underpaid. Recruiting meant finding candidates willing to spend years of their lives schlepping around the whole state of New York, from Niagara Falls, the Finger Lakes, the Thousand Islands, and the Adirondacks down to Long Island and Staten Island; put up with being away from their family, and spending their time examining what are supposed to be boring, low risk, small building and loans for the rest of their careers.

Bank exams may not be all about number crunching and checklists; it can be an interesting line of work. However, whether it is 1946 or 2025, there are not many college-educated, intelligent students who want to pursue a career as a bank supervisor to begin with, and even fewer after they read the job description. No wonder the Banking Department was understaffed in 1955, as Holz went on,

“The difficulty experienced in recruiting a sufficient number of capable new members for the examining staff is a matter of grave concern. At the present time there are twenty-three vacancies and indications are that an examination for bank examiner held June 27 this year will result in barely fifty eligibles. Judging by experience with the last list of eligibles, at least one-third will not accept an appointment mainly because of insufficient compensation and a lack of opportunity for promotion.”

Bank examination staffing challenges are just as acute a problem today as they were in Holz’s day. The FDIC’s inspector general blamed Signature Bank’s failure, if only indirectly, on the agency’s chronic understaffing in bank examinations. There are over 7,200 bank examiners in the field today working at the Fed, the OCC, or the FDIC, who are responsible for covering 4,460 commercial banks operating in the U.S. today. Some small banks could be covered by one or two examiners, but generally, the larger the bank, the larger the team needed to examine it. On the other hand, each of these agencies are in the process of implementing a 10% reduction in force.

Judging by the numbers, the NCUA also appears to have an understaffing issue. There are 4,489 credit unions in the U.S. today. The NCUA has less than 1,200 examiners to cover them, and it plans a 20% reduction in force. The state banking departments have an additional 4,890 examiners, but in addition to banks and credit unions, they are responsible for covering 5,978 domestic insurance companies across the country.

The bottom line is that the bank examination force in the U.S., encompassing federal agencies and state-level departments, is understaffed. Thus, the people who vote for political representatives to push cuts on bank supervisors should not be surprised the next time a big bank gets into trouble seemingly out of the blue, the way Silicon Valley Bank did two years ago. It should come as no surprise to them to discover that understaffing in bank exams was partly to blame for the regional bank failures in 2023, as both the Fed and the FDIC readily acknowledged in their post-mortems.

Perhaps, with all the AI and technology available today, bank exam teams no longer require the exact headcount and hours needed to complete an exam as they once did. Unfortunately, it is one thing to discuss using technology to improve efficiencies in bank examinations; it is another to procure it and then utilize it effectively to drive those efficiencies. It takes knowing what problem the technology will solve to procure the right technology. And then it takes knowledgeable, adaptable, and determined individuals to learn to use it.

Good luck finding those people who also want to work for a place where they will have numerous responsibilities, a high workload, and relatively low pay compared to what the private sector would offer for their talents. Salaries at the Fed, for example, range in 2025 from $36,000 for a lowly grade FR-16 to a maximum of $295,000 for a grade FR-31. The base pay for an entry position at the OCC is $58,000, and the average salary for a bank examiner is in the mid-$100,000s, according to the Bureau of Labor Statistics.

Throw in the business with a rotten workplace culture as detailed in the third-party review of the FDIC last year, lack of management accountability, sexual harassment, bullying, a culture that frowned on trouble-makers, and a long list of other workplace dysfunction, and it is not hard to understand why working as a bank examiner is not much of a desirable career choice. How many intelligent, knowledgeable, capable, highly educated people show up to interview for a job like that?

Seriously?

Second-Guessing CAMELS

That is just the B.S. (baseless stupidity) that bank examiners put up with internally. Then there are the external issues, the client base that can be less than cooperative, dismissive, and resistant to guidance. The lack of board accountability or the sheer incompetence of the people they hire. How much job satisfaction does the public think bank examiners have when, after attempting to work with management to implement improvements in governance, these individuals turn around and file appeals alleging examiner bias?

What the heck is that all about? Does Carter seem like someone who is biased, overly critical, makes unwarranted demands on management, or assigns busy work? Is it fair to criticize management decisions, such as George Bailey's, who lets his Uncle Billy, with early dementia, take $8,000 in cash to deposit in Potter's bank across the street, and in the process nearly causes the Building and Loan to fail? Gee whiz, is that just some minutia, focus on form over substance? It must be so much fun to be the villain when you're the bank examiner and are always assumed to be coming down too hard on the little community bank.

Bank examiners assign banks a "CAMELS" score, which evaluates their capital, asset quality, management, earnings, liquidity, and interest rate sensitivity. The score they assign ranges from "1" (strong) to "5" (unsatisfactory), with separate scores assigned to each component, which examiners use to calculate a composite score. Bank examiners probably rate all but 1%-2% of the banks in the U.S. with total assets below $10 billion as at least a "2" (satisfactory), if not a "1." Above that threshold is another story, especially for banks with total assets over $100 billion, where bank supervisors rated all but one-third as unsatisfactory last year.

The capital, asset quality, earnings, liquidity, and interest rate sensitivity components are determined based on qualitative and quantitative factors. Then there is the "M" in CAMELS, which is based solely on a qualitative assessment, requiring bank examiners to exercise their subjective judgment. And while the composite rating is a weighted average of the six components, not all the components are weighted equally. Sometimes, the separate management component can outweigh all the other elements combined and drag down a bank's composite rating for what management believes are unfair criticisms of form over substance

Theoretically, and sometimes not so theoretically, a bank can score a "1" or a "2" on capital, asset quality, earnings, liquidity, and market sensitivity and still get so badly dinged on management that it turns into a composite "4" (weak) or "5." On the other hand, a bank could be rated a composite "2," but still rate less on some of its key metrics, such as earnings or liquidity. Bank examiners refer to those banks as "dirty 2s."

Finally, adding to the challenges that bank examiners face in their job, the ratings process is not publicly available information, and the lack of transparency can fuel disagreement and misunderstanding between examiners and bank management, especially in qualitative assessments.

How many people want to sign up for a job where your work gets criticized in a Congressional committee which then votes out a bill called the HUMPS act last month, standing for “Halting Uncertain Methods and Practices in Supervision” which will further constrain bank examiners from just doing their job who will be spending time trying to explain why a bank with 20% regulatory capital, pristine asset quality, solid earnings, enough liquidity to survive a run, and completely, ideally interest rate neutral could still be rated anything less than a “2.” There must be bank examiner candidates out there who, Congress should hope, are eager for the additional paperwork they will be filing, documenting every step in reaching their decision!

Because if he were reading the plain text of the bill passed by a vote of 29 to 23 last month in the House Banking committee, it is hard not to see Carter rolling his eyes,

“Congress finds that (1) CAMELS ratings (Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity to market risk) are a critical tool for evaluating the safety and soundness of financial institutions, and the basis for determining significant regulatory matters such as the evaluation for mergers and acquisitions and a bank’s deposit insurance premiums; (2) the CAMELS rating system relies heavily on examiner judgment, which can lead to subjective and inconsistent ratings across similar institutions; (3) establishing clear, objective measures for each CAMELS component and their relative weighting in determining composite ratings will promote fairness, consistency, and accountability in supervisory assessments; and (4) examination and supervision, as well as the CAMELS rating system, should focus on a financial institution’s core financial condition or solvency.”

Of course, it is possible that Carter was sometimes unfair in his work, made mistakes, or was biased at times. Bank examiners are human beings and can make mistakes, which is excusable given the amount of work they typically have on their plates, with more than enough banks for them to examine. But when the public expects bank examiners to be responsible for the safety and soundness of the nation’s savings accounts, to look beyond checklists, then bank examiners erring on the side of caution does not seem unreasonable. The bank examiner deserves the benefit of the doubt.

Back to Basics On Supervision

Even if a bank has consistently scored well on its exams, there is nothing wrong with a new examiner coming in and taking a fresh look, perhaps finding problems not uncovered or practices not criticized in prior exams. It is okay for Carter to include criticisms in his write-up of the Bailey Brothers Building and Loan for entrusting forgetful Uncle Billy to make a cash deposit at Potter’s bank, even though he had done it before, and bank examiners had not brought it up in their prior reviews. Or maybe in the case of Silicon Valley Bank and Signature Bank, their contingency funding plans were outdated and woefully inadequate.

Quality of management is as much about an institution’s antiquated systems as about simple checklist procedures. There are no fine lines in the real world. Yet, the House Banking Committee voted in favor of establishing,

“…clear and objective criteria for assessing each CAMELS component, (2) revise the weighting of each CAMELS component to derive a composite rating that more accurately reflects the financial condition and risk profile of the financial institutions being rated, (3) either (A) eliminate the management component of the CAMELS rating system; or “(B) revise the management component of the CAMELS rating system to limit the assessment under such component to objective measures of the governance and controls used to manage an institution’s risk profile; and (4) ensure that composite ratings are determined based on a transparent methodology that is limited to the objective criteria established for each CAMELS component.”

Fed governor Michelle Bowman, the new Vice-chair of Supervision, seemed to advocate just that, more second-guessing of bank examiners, saying in a speech this month titled, “Taking a Fresh Look at Supervision and Regulation,”

“We must also consider the appropriateness of the broader ratings framework which applies to smaller institutions, including the CAMELS framework. Are these frameworks appropriately tailored to capture material financial risks, particularly for elements that rely on subjective examiner judgment? While judgment is a legitimate and necessary tool in supervision, it must always be grounded in the materiality of the identified issues as they relate to the financial health of each institution and the banking system as a whole.”

Broken windows is a policing concept where small, petty crimes and minor infractions, much like broken windows, are tracked down and dealt with to prevent more serious crimes from occurring. Maybe fining George Bailey for keeping Uncle Billy on the payroll when he was clearly in the early stages of dementia would have been harsh. Still, it might also have saved Bedford Falls from a worse catastrophe if, one day, Uncle Billy had lost all their money. Form over substance is not always wrong. The Vice-chair of Supervision, however, seemed to question the theory,

“A random sample of examination reports demonstrates that supervisory focus has shifted away from core financial risks (credit risk, interest rate risk, and liquidity risk, for example), to process-related concerns. While process is important for effective management, there is a risk that overemphasis on process and supervisory box-checking can be a distraction from the core purpose of supervision, which is to probe financial condition and financial risk. Checklists should not distract examiners from the central purpose of examinations.”

The Vice-chair of Supervision was only echoing what bank treasurers say all the time about their interaction with bank examiners, how they can miss the forest for the trees. She went on to say,

“Supervision focused on material financial risks that threaten a bank's safety and soundness is inherently more effective and efficient. We should be cautious about the temptation to overemphasize or become distracted by relatively less important procedural and documentation shortcomings.”

It is a lot to ask of a bank examiner to deal with people who may think they are doing a fantastic job but are as dumb as a post. How do you excuse stupidity? Carter had no choice but to criticize George Bailey’s governance structure. The Vice-chair believes there is too much emphasis on management shortcomings in the ratings process,

“Ratings must reflect risk, and yet we have seen gradual changes in supervisory approaches that have eroded the link between ratings and financial condition. Federal Reserve supervisory statistics show that that two-thirds of the largest financial institutions in the U.S. were rated unsatisfactory in the first half of 2024. At the same time, the majority of these same institutions met all supervisory expectations for capital and liquidity. This odd mismatch between financial condition and supervisory ratings requires careful review and appropriate revisions to our current approach.”

Bank Exam First Day Meeting

George Bailey meets Carter the bank examiner right about now, just before Uncle Billy drops a bomb shell and tells George all about how he screwed up the deposit he was supposed to make at Mr. Potter’s bank. Here is the script from the movie: George Bailey greets Mr. Carter just outside his office. Action!

Carter: Carter—bank examiner.
George: Merry Christmas.
Carter: Merry Christman.
George: We're all excited around here. My brother just got the Congressional Medal of Honor. The President just decorated him.
Carter: Well, I guess they do those things. Well, I trust you had a good year.
George: Good year? Well, between you and me, Mr. Carter, we're broke.
Carter: Yeah, very funny.

George Bailey leads Mr. Carter into his office, saying to him as they walk in:

George: Well now, come right in here, Mr. Carter.
Carter: Although I shouldn't wonder when you okay reverse charges on personal long-distance calls. Now, if you'll cooperate, I'd like to finish with you by tonight. I want to spend Christmas in Elmira with my family.
George: I don't blame you at all, Mr. Carter, Just step right in here. We'll fix you up.

Carter probably never made it to Elmira that night. Right after he sat down in George's office, George was pulled away to talk urgently with Uncle Billy and never came back to answer Carter's questions. Carter ended up staying all day in his office, waiting for him to return. Uncle Billy then tells George the news.

He took the money to the bank to deposit it, just as George had told him to do. He did not stop on the way and did not speak to anyone. He had the deposit slip all made out and walked up to the teller, but suddenly, he realized he didn't have the money. Of course, he would not have known that the reason he lost the money was that he folded it up in his paper and left the money and the paper absentmindedly in Mr. Potter's lap when he saw him at the bank..

Good Governance Matters

There are basic governance rules that banks should follow to prevent avoidable mistakes from happening. Maybe it would have been better if it were so important to keep Uncle Billy on the payroll, to send two people instead of one to deposit the money in Potter’s bank, even if it was just across the street. Governance is about details, following checklists, and preventing Uncle Billy messes, such as wiring nearly $1 billion to the wrong corporate account or employing a London whale to lose $6 billion on credit derivatives.

A survey conducted by the Bank Policy Institute last year found that a typical regional, community bank allocates approximately 5 percent of its workforce to compliance functions. Senior managers report spending 42 percent of their time on compliance tasks or examiner mandates. The board of directors spends an equal share of time on those tasks. Compliance or meeting examiner mandates accounted for 13 percent of an average bank’s technology budget last year.

Training the Next Gen of Bank Examiners

Let’s say the Fed, OCC, FDIC, NCUA, and the banking departments covering all the state chartered banks in the U.S. find the next Carter out of a pool of candidates who apply for a job as a bank examiner, many of who renege on their offers once they learn about all of the challenges working as a bank examiner, the culture, the long hours, the impossible expectations, the abuse internally and externally, the fact that you always are on the defensive, and the fact that when all is said and done, you do not get paid as much as you could in the private sector. Let’s say they find that perfect candidate to succeed Carter as bank examiner.

Even if after you hire them and they even show up on day 1, they will still not be ready to take on Carter’s work when he retires (which, if he is still working today, would be imminent). First, they need to get trained. Carter would have undergone extensive training to achieve his career success when he examined the Bailey Brothers Building and Loan in the movie. The Vice-chair of Supervision continued,

“Examiners must engage in a challenging course of study and pass rigorous tests before qualifying to become a commissioned bank examiner. Those who have obtained this license have a strong foundation that they can rely on to conduct appropriate examinations. The commission demonstrates an elevated level of expertise, judgment, and fairness that these examiners bring to their work.”

The new hires will need training, and this task is more urgent today than it might have been in Carter's time because the juniors who might have worked under him as a senior examiner 79 years ago are long gone, as are the people who replaced those juniors. That's a significant amount of institutional memory loss. Plus, the demographics are not working in favor of finding a large pool of replacements for Carter. The Vice-chair is a big believer in training, as she went on to say,

“The Fed will prioritize…training…as…we face an aging workforce across the Federal banking agencies that will require our new examination staff to ensure the safety and soundness of the banking system into the future. Failure to invest in and plan for examiner training today will result in much less effective supervision in years to come.”

A significant amount of training, both for new hires and ongoing education, will be necessary to prepare the next generation of Carters for the complexities of the future financial system. The Genius Act, which the Senate passed this month, will establish a framework for regulating stablecoins that are backed one-to-one with the U.S. dollar. If the bill passes into law, (and who knows how that will turn out, given that the House of Representatives has its version of the Genius Act called the Stable Act), the introduction of cryptocurrencies into the banking system will require a significant number of competent bank examiners to monitor the risks that they might pose. Even if the U.S. dollar backs a stablecoin, there is always a risk of a run on the dollar to think about.

Regulatory High Hopes

Regardless of which version becomes law, both banks and nonbanks will be able to issue the coins, and the FDIC will not insure investors. The latter must be a relief to bank treasurers who worry that stablecoins could lead to their disintermediation by nonbanks, which the law would nonetheless put on a stronger competitive footing with banks than they already are.

Bank treasurers are very enthusiastic about the new Vice Chair of Supervision and have high hopes. When asked what they want from bank regulators on crypto, the number one request is that they design smart regulations that do not hinder financial innovation. As the CFO of a large regional bank based in the Midwest told participants at an industry analyst conference this month,

“The regulations need to be made significantly clearer. There's a lot to be done still…Crypto is going to be part of the financial ecosystem in the future…though there are significant questions around anti-money laundering and bank secrecy act, so we are looking for more clarity on that.”

There are a lot of opportunities in the crypto space if Carter’s employers can get the regulations right, as he continued,

“We think that there's some interesting places where stablecoin can really create some efficiencies in the commerce space. Think about international payments today. Being able to settle activity 24/7 in an instantaneous and cost-efficient way, it would be a significant advancement from the existing correspondent banking system and coordination through the SWIFT reporting…Another use case we're thinking about is the ability to really focus on collateral optimization, the ability to move collateral from market to market around the globe instantaneously as the markets move is an awesome opportunity when you think about people that are trying to deal with global markets 24/7”

The chairman, CEO, and president of one of the global banks welcomed clarity on the stablecoin front, explaining that the industry needs to have crypto capabilities or it faces extinction, insisting to analysts that,

“We have to have it. The industry has to have it. We've not been quite sure how big it will be, but we have to be ready because the of the day, if people use as a transactional account, we have to be ready to have those transactional deposits stay within our franchise basically or else you'll see a major migration of deposits outside the industry. If they get the GENIUS Act or the Stable Act or anything like that past and then you get the markets infrastructure enablement piece, that clarity will allow us to figure out whether there's really a business proposition. At the end of the day, if the customers need it, customers can make use of it app.”

However, bank treasurers are primarily seeking a relationship with bank supervisors who focus on the real risks that the industry faces. As the CFO from a regional bank in the northeast told analysts this month, he watched the new Vice Chair of Supervision speak and said her passion was striking,

“Yeah. I actually watched it…she's very passionate about doing the right thing for our industry, and focusing on the real risk that you need to be focused on, whether it's credit risk, interest rate risk, liquidity risk, capital…And getting and training and the supervision side.”

They just want a little more balance in the relationship with their supervisors. In the last few years, the pendulum has swung too far against the industry, as her predecessor pushed to implement the Basel 3 Endgame, and it needs to swing back to the middle, as the CEO of a regional bank from the southeast told analysts. He wanted to see an improvement in the tone,

“Just generally the regulatory tone, which again I think there'll be more transparency around. And a little more clarity…It's been 15 years since the regulatory regime has appeared as favorable as it looks today. Now that's not to say that I expect we're going to get everything we want. The reality is the industry has improved tremendously over the last 15 years in terms of the way that we're structured, the way we're organized, the amount of capital liquidity that we carry, our processes, our controls so much better than we were 15 years ago. And so, I welcome the balance which is what I think we're going to get just a little better balance between.”

Bank managers would like to see bank supervisors raise the asset caps used to distinguish between small and large banks. Size categories make a difference. Theoretically, small institutions such as George Bailey’s Building and Loan would likely receive a warning from Carter to ensure that Uncle Billy never handles any more money or is ever again trusted to handle anything bank-related. Larger institutions might get fined for their infractions. But yesterday’s large bank is today’s regional bank and tomorrow’s community bank. The CFO of a large bank based in the Midwest was optimistic that supervisors would raise the $100 billion threshold defining a Category IV institution,

“I think one of the outcomes will be a moving of the cap. I don't know exactly what could happen to the $100 billion cap. I do believe it will go higher, whether it's inflationary or an arbitrary number that is chosen, I don't know, but I do believe that it will move higher.”

The new Vice-chair is open to suggestions from bank managers, which is yet another thing they appreciate about her style. She is a bank supervisor who gets the business of banking, as she spoke this month,

“Both regulators and legislators should consider whether the bank regulatory framework includes appropriate thresholds for defining distinct categories of institutions, and whether simple fixes—for example the indexing of thresholds to inflation or growth—could better ensure a sound, tailored approach that remains durable over time. It is clear that the current $10 billion threshold defining the upper bounds of a "community bank" leaves many institutions that pursue this business model—of community and relationship-based banking—subject to heightened requirements more suitable for larger and more complex firms. To further these objectives, later this year I will host a conference.”

The House has just the bill that the Vice-chair was describing, at least the beginning of one. The 'Financial Institution Regulatory Tailoring Enhancement Act' would raise thresholds impacting the scope of the Volcker Rule, the Consumer Financial Protection Bureau, mortgage lending, and capital rules. Asset inflation is a real thing. In October 2019, when the Fed finalized rules categorizing large banks (Category I, II, III, or IV), the total assets of these banks (as shown in Figure 1) equaled $11 trillion. Today, the total assets held by those two dozen domestic institutions in the large bank peer group equal $14 trillion based on the Fed’s H.8 data.

**Figure 1:Total Assets: Large Domestic Banks**

Natural organic growth could lead a bank to choose between incurring regulatory compliance costs as a Category IV bank or turning away business, because a bank that would not have met the $100 billion threshold for a Category IV when bank supervisors set the threshold in October 2019, through normal economic expansion of the economy would cross the threshold today. How to account for size inflation is an urgent issue for bank supervisors.

Follow Up Questions

We can imagine that if the story had continued and Frank Capra had kept filming, Carter would have returned to Bedford Falls after the holidays to finish his examination of the Bailey Brothers Building and Loan. Assuming he had finally gotten George to sit down and cooperate in the exam, he would have had some questions that would seem familiar to bank treasurers who talk to examiners today. Perhaps he would have begun by asking questions about risk and avoidance.

Bank treasurers today remain wary of deviating from their current balance sheet strategy, maintaining a more liquid balance sheet than they would have in October 2019. Their asset-liability management strategy is to maintain a neutral position. As the chairman and CEO of a regional bank based in the southeast said,

“I think one of the really key strengths of our balance sheet is that we have a interest rate neutral balance sheet.”

The stress in the system following the bank failures two years ago and the Fed’s rapid increase in Fed funds between 2022 and 2023 are in the past. Deposits are higher at regional and community banks compared to where balances had fallen by H1 2023. Bank treasurers are not clamoring for funding, and checking balances are no longer flowing into time deposits like they once were. Deposits that people took out of banks and moved to the money markets are unlikely to return should the Fed lower rates again. However, what they have left in their checking accounts is likely to stay put.

The prospect of rate cuts likely means that the upward pressure on deposit funding costs that bank treasurers were dealing with last year is also a thing of the past, now that the Fed is biased towards rate cuts, whenever they happen in the remaining four meetings of the Federal Open Market Committee. As always, regardless of what happens with rates, bank treasurers just want to be neutral. They do not need to be more asset-sensitive, that is for sure, as the CFO of a regional bank on the West Coast told analysts,

“The bias would seem to be towards a downward momentum in Fed funds over some horizon, so we probably don't need to become more asset sensitive.”

The CFO at another regional bank based in the west said he wanted to be less asset sensitive,

“We'll continue to dial back our asset sensitivity modestly in the current environment.”

As markets have become more volatile and uncertain, bank treasurers have increased their hedging activity and taken advantage of more accommodating hedge accounting rules than existed a few years ago, before the Financial Accounting Standards Board (FASB) revised fair value hedge accounting in 2022. (The FASB has an ongoing project to revise cashflow hedge accounting, too.) The notional principal of interest rate contracts not used for trading, based on call reports, increased in Q1 2025 to $5.4 trillion, up from $5.1 trillion in Q4 2024, the highest notional level since Q2 2023, when the notional principal surged to $6.2 trillion.

Eris Innovations, one of the newsletter’s corporate sponsors, saw a surge in open interest in its Eris SOFR swap futures contracts, which mimic the economics of an interest rate swap and can satisfy hedge accounting requirements for fair value and cash flow hedging. The trend might reflect the financial market catching on to the arbitrage opportunity, given that the margin costs for a futures contract are one-third of the price for a swap contract.

But the surge in open interest on the contract most likely also reflects new hedging activity, too. As an Eris spokesperson told the newsletter this month, the surge in its futures contract reflected an increase in hedging activity, as well as some substitutions of futures contracts for swaps,

“Cleared swap positions are being converted to swap futures in single transactions or via Exchange for Risk.”

Bank treasurers are beginning to recognize the value proposition of utilizing the Eris SOFR Swap futures contract to hedge their interest rate risk, rather than relying on interest rate swaps. Smaller institutions can work with nonbank futures commission merchants such as R.J. O’Brien, another valued corporate sponsor of the newsletter, and not even have to go through the hassle of setting up an ISDA. The Eris spokesperson continued,

“We continue to get good traction with banks. For example, there’s a $1-2bn asset institution in New England using swap futures to synthetically fix the variability in their brokered deposits. They’re did the execution with RJ O’Brien (Non-bank FCM) and are handling the cashflow hedge accounting themselves.”

Carter’s next question for George would have been around market volatility and uncertainty. How was all that affecting the bank, he would ask. And it would not have been an idle question, as markets were very volatile in 1946. There was a massive stock market crash in September 1946, during which prices fell by 25% from May 1946 to May 1947. The chairman and CEO of a large regional bank on the East Coast had a ready response to the question, telling analysts this month that,

“So there is volatility in markets. There actually wasn't volatility in activity. The hard data remains strong. The soft data scares everybody. But what we see inside of our book in terms of credit, client activity, all remains pretty solid. Consumer spending look solid. We don't have any change in our guidance.”

And, for the record, bank treasurers stay close to their customers, internal and external, as a former treasurer and current CFO of a regional bank in the Midwest told analysts,

“Our Treasury team is heavily involved in the balance sheet strategy across the businesses. They meet regularly with the business leaders, so they're involved in both commercial and consumer deposit strategies and understanding where the loan growth activity, where we're expecting to see it, and that gives us a good line of sight to really focus on optimization.”

And what their customers are telling them is that they do not need to worry as much as they did a year ago about hitting the bottom of the range for their net interest margin and net interest income guidance. There might even be a risk on the upside, where income increases and margins widen. With the Fed still biased to cut rates in the remaining six months, at least based on its latest dot plot, term deposits coming due to reset, set a year ago before the Fed’s first rate cut in September 2024, are going to price something close to 100 basis points lower. And that is a good thing, even if they do not retain every deposit dollar from heading to the money markets instead.

Carter would have had more questions for George, and to start, how much of the time deposits coming due written last year does he expect to retain when they reset? How has technology changed the relationship with his depositors might be another follow-up, as, unlike in 1946, depositors can move their money in the blink of an eye and with a click on a phone app. Just since the new year, money market deposit balances grew by $174 billion, to a record $7.4 trillion. The CFO of a regional bank based in the Midwest believed his bank would retain most of the deposits coming up against their reset dates,

“In the second quarter, we've got retail CDs maturing at a weighted average cost of 4.8%. So we will get a natural benefit from those maturing and resetting lower. And typically, we've been retaining 80% to 85% of CDs that have been maturing and then replacing that small runoff with new CDs.”

The latest FDIC quarterly data tends to confirm these observations by the CFOs quoted above, as the industry has paid down a considerable chunk of the advances and brokered CDs it held at the end of Q4 2023, when advances totaled $584 billion and brokered CDs totaled $1.4 trillion. At the end of the last quarter, advances totaled $446 billion, and brokered CDs reached $1.2 trillion.

However, as bank treasurers know — and as Carter might have reminded George —during volatile and uncertain times, a strong deposit market today can turn sour quickly. A spokesperson for R&T Deposit Solutions, one of the newsletter’s corporate sponsors, observed an uptick in brokered deposit rates since the end of Q1 2025. The data point could be a blip, but may indicate that at least some bank treasurers want to hedge against the chance that their retention estimates were too optimistic. Some bank treasurers may also be using SOFR swap futures contracts paired with those brokered deposits,

“In the second quarter, shifting market dynamics and growing uncertainty drove funding costs higher compared to the first quarter. Still, banks remained active in adding wholesale funding to their balance sheets. We saw this trend reflected across the industry—including a significant uptick in brokered CD activity—and within our own network, where bank balances (as of 6/11/25) grew over 10% quarter over quarter. In this environment, R&T continues to stand out as a reliable, efficient source of funding that helps institutions manage liquidity with confidence.”

Carter probably would have had more questions for George Bailey, most of which would sound familiar to a bank treasurer today. He would have wanted to ask him what he was seeing in terms of loan demand and competition from non-banks, given how insurance companies were expanding their footprint in the home mortgage market in 1946. He would have liked to hear his plans if the Fed does not cut the range on the Fed funds rate at all this year.

What if the term structure of the yield curve remains permanently inverted between the 3-month Treasury Bill and the 5-year Treasury note, which has averaged a negative 30-40 basis points spread since the new year? What if tariffs lead to stagflation? What is the effect on business of uncertainty? What if the Fed were barred by Congress from paying interest on bank reserve deposits, reversing a law passed under the Dodd-Frank Act, an idea that U.S. Texas Senator Ted Cruz floated in an interview this month?

But as much as he would have liked to stay and talk, Carter would have been under time pressure to wrap up his exam, get back in his car, and get to his next assignment. With the kind of schedule the state put bank examiners through, no doubt he needed to be onsite in Lake Placid tomorrow, and that meant he needed to get an early start in the morning. Given the distance between Bedford Falls (Seneca Falls) and Elmira, and then the distance from Elmira to Lake Placid, he would be driving through the night. That is what dedication means.

The Bank Treasury Newsletter is an independent publication that welcomes comments, suggestions, and constructive criticisms from our readers in lieu of payment. Please refer this letter to members of your staff or your peers who would benefit from receiving it, and if you haven’t yet, subscribe here.

Ethan M. Heisler, CFA

Editor-in-Chief

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This Month’s Chart Deck

U.S. Senator Ted Cruz of Texas made an off-hand remark during an interview this month with CNBC, where he floated the idea that Congress should ban the Fed from paying interest on reserve balances (IORB) to banks to help the U.S. pare down its deficit. Congress initially granted the Fed the ability to pay IORB in the Financial Services Regulatory Relief Act of 2006. This tool is a critical element of the Fed’s control over rates while also maintaining an abundant reserve policy.

The Federal Reserve earns interest primarily on its System Open Market Account (SOMA) portfolio of Treasury and Mortgage-backed securities, which totaled $6.4 trillion this month. It earns interest on $3.3 trillion in reserves and $0.5 trillion in reverse repos (RRPs), which account for 60% of the portfolio. The rate it pays out (4.4% for IORB and 4.3% for RRP) continues to exceed the rate it earns on SOMA, and the net difference accumulates on its balance sheet as a negative Treasury remittance balance, a liability of the Fed that it owes to the Treasury (Slide 1). Since 2022, IORB has become a significant contributor to the industry’s interest income (Slide 2). However, as the Fed began lowering rates last September, domestic banks reduced their reserve balances (Slide 3), which were subsequently picked up by foreign branches and agencies (Slide 4).

Money market funds grew to a record $7.4 trillion this month, which equals 29% of total U.S. savings, counting money market funds and commercial bank deposits (Slide 5). The increase reflects considerable disintermediation of the banking industry since 2017.

The Fed’s restrictive monetary policy during this rate cycle dampened demand for residential mortgage loans, especially among first-time homebuyers. Still, until the last couple of months (Slide 6), high rates have done little to cool soaring home prices. Meanwhile, the spread between 30-year mortgage rates and the 10-year Treasury widened in Q2 2025, with the rates market gripped by heightened uncertainty and market volatility (Slide 7).

Monetary policy may also be leading the surge in asset-backed securities issuance this year (Slide 8). Growing awareness of the opportunities to optimize credit risk through synthetic risk transfer transactions may also be driving the growing trend in ABS issuance. Meanwhile, poor returns on capital continue to encourage the banking industry to shift its loan mix out of residential mortgage loans (Slide 9). Bank treasurers are increasing their hedging activity to help maintain interest rate neutrality (Slide 10).