The Federal Reserve's top regulator said the central bank failed in various stages of its supervision of Silicon Valley Bank in the run-up to the bank's failure last month.
In a highly anticipated report on the matter, which the agency released Friday morning, Vice Chair for Supervision Michael Barr said Fed supervisors noted clear instances of mismanagement at Silicon Valley Bank months before its collapse but did not appreciate how critical the risks had become or take sufficient steps to address them.
The episode, Barr concluded, provides evidence that the Fed needs to revise both its regulatory framework for banks the size of Silicon Valley as well as its overall approach to supervision.
"Following Silicon Valley Bank's failure, we must strengthen the Federal Reserve's supervision and regulation based on what we have learned," Barr said in a written statement. "This review represents a first step in that process — a self-assessment that takes an unflinching look at the conditions that led to the bank's failure, including the role of Federal Reserve supervision and regulation."
The report provides little in the way of fresh regulatory proposals but notes that the findings will inform ongoing considerations and rulemaking efforts. Those include the final implementation of the Basel III international regulatory standards, long-term debt requirements for large regional banks and Barr's holistic review of capital and liquidity.
In a call with reporters, a senior Fed official said the agency's top priorities will be creating supervisory mechanisms that quickly put restraints on banks with serious capital and liquidity issues, and completing the Basel III rulemaking process.
Other changes, such as tweaking the accounting standard for accumulated other comprehensive income, or AOCI, would likely require a brand-new rulemaking process. While the Fed does not need congressional approval for any of its considered changes, the senior official said, it expects the process of fully addressing the shortcomings exposed by the Silicon Valley Bank failure to take several years.
Fed Chair Jerome Powell, who was not involved in the review process, issued a statement of support for the report's findings and said he would back the changes called for.
"I welcome this thorough and self-critical report on Federal Reserve supervision from Vice Chair Barr," Powell said. "I agree with and support his recommendations to address our rules and supervisory practices, and I am confident they will lead to a stronger and more resilient banking system."
The report comes seven weeks after Silicon Valley Bank was shuttered by California state regulators amid an unprecedented run on deposits. More than $40 billion left the bank's coffers on March 9, and another $100 billion of digital requests were pending by the time it failed the next morning. In total, the outflows and requests totaled roughly 85% of the bank's deposit base.
Barr said the proximate cause of the Silicon Valley Bank's collapse was a failure to adequately account for and hedge its interest rate risk and a seeming disregard for the solvency problems highlighted by the bank's own internal models. Management likewise did not make the severity of those risks apparent to members of the bank's board of directors.
Silicon Valley Bank had 31 unaddressed safety-and-soundness supervisory warnings at the time of its failures. That's triple the average number of similar banks, according to the Barr report.
"The bank failed its own internal liquidity stress tests and did not have workable plans to access liquidity in times of stress," the report reads. "Silicon Valley Bank managed interest rate risks with a focus on short-run profits and protection from potential rate decreases, and removed interest rate hedges, rather than managing long-run risks and the risk of rising rates."
Cultural issues
But Barr also noted that the Federal Reserve examiners themselves did not act aggressively enough to flag the risks building up at Silicon Valley Bank for the Federal Reserve Board, which could have demanded the bank take prudential action to mitigate its interest rate risk. Those "weaknesses in supervision and regulation must be fixed," Barr said.
"We need to develop a culture that empowers supervisors to act in the face of uncertainty," Barr said. "In the case of SVB, supervisors delayed action to gather more evidence even as weaknesses were clear and growing. This meant that supervisors did not force SVB to fix its problems, even as those problems worsened."
Barr's report also laid some of the blame for Silicon Valley Bank's failure on the Fed's implementation rule for the Economic Growth, Regulatory Relief, and Consumer Protection Act — also known as S. 2155, which raised the threshold for systemically important banks from $50 billion to $100 billion and gave the Fed wide discretion on how to regulate banks with assets between $100 billion and $250 billion.
That
The Fed also altered its approach to firm-by-firm supervision with an eye toward reducing the burden on banks. While no explicit policies arose from this change, it resulted in "a shift in culture and expectations from internal discussions and observed behavior that changed how supervision was executed," the report notes.
"Overall, the supervisory approach at Silicon Valley Bank was too deliberative and focused on the continued accumulation of supporting evidence in a consensus-driven environment," the report notes. "Further, the rating assigned to Silicon Valley Bank as a smaller firm set the default view of the bank as a well-managed firm when a new supervisory team was assigned in 2021 after the firm's rapid growth. This made downgrades more difficult in practice."
The senior official said the 2019 changes likely exacerbated cultural deficiencies in the supervisory division. Barr has made efforts to address these shortcomings since joining the Fed last summer, the official said, but work remains to be done.
A reluctance to change
Barr's report, which the agency said would be produced by May 1
"Supervisors identified interest rate risk deficiencies in the 2020, 2021, and 2022 CAMELS exams but did not issue supervisory findings," the report reads. "The deficiencies were only communicated as written advisories or verbal observations. The supervisory team … planned to downgrade the Sensitivity to Market Risk rating in the CAMELS framework [in November 2022, but] the firm failed before that downgrade was finalized."
One key disconnect in the report was Silicon Valley Bank's transition from the regional banking organization, or RBO, supervision group to the more scrupulous large and foreign banking organization, or LFBO, regime. In the RBO, the bank was overseen by supervisors with less experience dealing with large, complicated banks, yet when it moved into the LFBO portfolio, supervisors there were reluctant to quickly downgrade its regulatory ratings.
The speed of Silicon Valley Bank's growth, from $71 billion of assets in 2019 to more than $211 billion in 2021, exacerbated the issue. The report notes that Fed supervisors were slow to prepare the bank for its transition into the more stringent supervisory category.
Outside reviews
Barr's report came out on the same day as a review by the Government Accountability Office on the two institutions that failed last month as well as a review from the Federal Deposit Insurance Corp. on its role in overseeing Signature Bank.
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Staff at the San Francisco Fed also "generally accepted" Silicon Valley Bank's plans to correct deficiencies identified and said that the remediation was time-consuming due to the scope of the issues, according to the GAO.
As for why the central bank didn't act swiftly enough, the Fed report chalks it up to the San Francisco Fed's oversight taking a "too deliberative" approach.
In the call with reporters, the Fed official noted that supervision of large banks is ultimately the responsibility of the Board of Governors in Washington, not individual regional banks.
The Fed has come under political scrutiny, particularly from congressional Republicans, of its role in the failure of Silicon Valley Bank. Rep. Patrick McHenry, R-N.C., the chairman of the House Financial Services Committee, dismissed many of the findings of the Fed report, calling it "frankly self-serving."
"While there are areas identified by Vice Chair Barr on which we agree—including enhancing attention to liquidity issues, especially when a firm is rapidly growing—the bulk of the report appears to be a justification of Democrats' long-held priorities," McHenry said in a statement. "Specifically, the section on tailoring is a thinly veiled attempt to validate the Biden administration and congressional Democrats' calls for more regulation."
