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What to Watch as the Fed Releases Its Look Into Silicon Valley Bank Fed Slams Its Own Oversight of Silicon Valley Bank in Post-Mortem
(about 5 hours later)
WASHINGTON — The Federal Reserve is set to release a highly anticipated report on Friday examining what went wrong with its oversight of Silicon Valley Bank, which collapsed in mid-March, in the largest bank failure since the 2008 financial crisis. WASHINGTON — The Federal Reserve released a sweeping and highly critical report on Friday examining why its own supervision and regulation of Silicon Valley Bank failed to address risks that ultimately led to its collapse in mid-March, a crash that was the largest bank failure since the 2008 financial crisis.
The post-mortem comes as the aftershocks of Silicon Valley Bank’s collapse continue to shake the American financial system: First Republic, which required a cash infusion from other large banks as nervous customers pulled their deposits and fled, remains imperiled. The review — conducted by Michael S. Barr, the Fed’s vice chair for supervision — blamed Fed overseers for failing to “take forceful enough action.” Mr. Barr also stated that the bank’s failure demonstrated “weaknesses in regulation and supervision that must be addressed.”
The Fed’s investigation into what went wrong at Silicon Valley Bank has been overseen by Michael S. Barr, the central bank’s head of supervision and one of the architects of the 2010 Dodd-Frank law, which aimed to prevent a repeat of the 2008 crisis. The review was announced on March 13, just after S.V.B.’s failure and the government’s sweeping announcement on March 12 that it would protect the bank’s large depositors, among other measures to shore up the banking system. He added that “regulatory standards for SVB were too low, the supervision of SVB did not work with sufficient force and urgency, and contagion from the firm’s failure posed systemic consequences not contemplated by the Federal Reserve’s tailoring framework.”
That same weekend, the federal government also shuttered a second institution, Signature Bank. The Federal Deposit Insurance Corporation, which was the primary supervisor for Signature, will release its own report Friday. The review spanned hundreds of pages and painted a picture of a bank that grew rapidly in size and risk with limited intervention from supervisors who missed obvious problems and moved slowly to address the ones they did recognize. And it outlined a range of changes to bank oversight and regulation — from stronger deterrents against risk-taking to possible curbs on incentive compensation for executives at poorly managed banks — that the Fed will consider in response to the disaster.
Still, most of the attention has focused on S.V.B., in part because significant weaknesses at the bank appear to have started and grown progressively worse in plain sight in the years leading up to its demise. The bank had a large share of deposits above the government’s $250,000 insurance limit. That is a potential risk, given that uninsured depositors are more likely to pull their money at the first sign of trouble to prevent losing their savings. The post-mortem is a rare instance of overt self criticism from the Fed, and it comes as the aftershocks of Silicon Valley Bank’s collapse continue to shake the American financial system. First Republic Bank, a regional lender that required a cash infusion from other large banks as nervous customers pulled their deposits and fled, remains imperiled.
The bank’s leaders also made a big bet on interest rates staying low. That became a problem as the Fed, trying to control rapid inflation, carried out its most aggressive rate increase campaign since the 1980s. The bank held longer-term bonds that dropped in value as interest rates rose, because newer debt issued at the higher rates became more attractive for investors. Mr. Barr’s review was announced on March 13, just after Silicon Valley Bank’s failure and the government’s sweeping announcement on March 12 that it would protect the bank’s large depositors, among other measures to shore up the banking system. That same weekend, the federal government also shuttered a second institution, Signature Bank. The Federal Deposit Insurance Corporation, which was the primary supervisor for Signature, will release its own report later on Friday.
Supervisors at the Fed were aware of many of the bank’s problems and had flagged and tried to follow up on some of them. Yet the issues were not resolved quickly enough to save the bank. Yet attention has focused heavily on Silicon Valley Bank, both because it failed earlier and because significant weaknesses at the bank appear to have started and grown progressively worse in plain sight in the years leading up to its demise.
The questions that the review could answer center on what went wrong. Was it a problem at the Federal Reserve Bank of San Francisco, which supervised the bank, or did the fault rest with the Federal Reserve Board, which has ultimate responsibility for bank oversight? It is also unclear whether there was an issue with the Fed’s culture around — and approach to — supervision, or whether the existing rules were lacking. The bank had a large share of deposits above the government’s $250,000 insurance limit. Uninsured depositors are more likely to pull their money at the first sign of trouble to prevent losing their savings, making that a major vulnerability for Silicon Valley Bank. The bank’s leaders also made a big bet on interest rates staying low, which turned out to be a bad one as the Fed raised rates rapidly in a bid to control inflation. That left the bank facing big losses and helped to bring it to its knees — leading to a rapid failure that spooked depositors at other banks across the country.
“It’s a little bit of a mystery” what the report will hold, said Steven Kelly, a researcher at the Yale Program on Financial Stability, explaining that he had little expectation that the release would point fingers. “In some sense, they really need a head on a pike — and they’re not going to do that in this report.” “Contagion from the failure of S.V.B. threatened the ability of a broader range of banks to provide financial services and access to credit for individuals, families, and businesses,” Mr. Barr said.
Jeff Hauser, director of the Revolving Door Project, said he was interested to see how the report would deal with the tone around bank supervision at the Fed, and the reality that Gregory Becker, S.V.B.’s chief executive, sat on the board of the Federal Reserve Bank of San Francisco. That role gave Mr. Becker no official influence over bank oversight, but Mr. Hauser thinks that such positions might offer banks the advantage of more prestige. Mr. Barr was a major architect of intensified bank regulations in the wake of the 2008 crisis. He was nominated to his job by President Biden and took office in July 2022 — toward the end of Silicon Valley Bank’s life. Given that, much of his review reflected on supervision under his predecessor, Randal K. Quarles, the Trump-appointed vice chair for supervision in that office from 2017 to October 2021.
Mr. Hauser said he also thinks an independent review is needed in addition to the Fed’s internal probe and whatever its inspector general — who is also looking into the matter — eventually releases. Mr. Barr will still have to work with his colleagues in the future, Mr. Hauser pointed out, and the central bank’s inspector general is appointed by the Fed chair. The report itself was produced by regulatory and financial experts within the Fed system who were not involved in the bank’s oversight. They had full access to supervisory documents and internal communications, and had the ability to interview relevant Fed staff, according to the release.
“We need someone with some independence to dig in,” Mr. Hauser said. The findings suggested that supervisors failed to fully understand how much risk Silicon Valley Bank was taking. Fed supervisors flagged issues at the bank, but it did not catch them all or follow up on them intensively enough. The bank’s management was rated satisfactory from 2017 through 2021, despite repeated observations of risk taking, the report found.
Silicon Valley Bank had 31 open supervisory findings when it failed in March 2023, about three times the number at its peers, based on the Fed’s report.
It was hard to identify precisely what caused the foot-dragging, the review said, but it pointed to both a culture that focused on consensus and to supervisory changes that happened under Mr. Quarles and during the Trump administration. Mr. Quarles suggested in speeches that bank oversight should be more transparent and predictable.
“Staff felt a shift in culture and expectations from internal discussions and observed behavior that changed how supervision was executed,” the report said.