Last month's Federal Reserve
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"In the interviews for this report, staff repeatedly mentioned changes in expectations and practices, including pressure to reduce burden on firms, meet a higher burden of proof for a supervisory conclusion, and demonstrate due process when considering supervisory actions," the report states. "There was no formal or specific policy that required this, but staff felt a shift in culture and expectations from internal discussions and observed behavior that changed how supervision was executed."
But former Fed officials, supervisory policy experts and bank lawyers say the cultural deficiencies at play in the supervision of Silicon Valley Bank are nothing new for the central bank. They say the heavy focus on gathering evidence and building "consensus" before taking decisive action on lingering issues has been endemic in the institution for years.
There are differing opinions on why this is the case. Some say it is tied to supervision being a secondary consideration for the monetary policy-focused institution. Others call it a focus on the wrong issues.
Quarles argues the Fed's long-running modus operandi has been to cast a wide net in its supervision, a practice that he said prioritizes the volume of citations over the risk they present to individual banks or financial stability broadly.
Quarles said he tried to do away with this manner of supervision, insisting that his directive was for supervisors to forgo small infractions in favor of hitting hard on major issues. He said the report on Silicon Valley Bank — which notes that 31 supervisory findings were issued to the bank — is evidence that his advice was not heeded.
"I wasn't able to do much on supervision and it's evident that I really didn't get much done on changing the culture, because the objective was to stop distracting both the institutions and ourselves with excessive attention to routine administrative matters and focus on what's really important – like interest rate and liquidity risk," he said. "I would often use the phrase, 'And if they won't do what's really important, smite them hip and thigh.'"
The 31 matters requiring attention and matters requiring immediate attention, commonly known as MRAs and MRIAs, raised with Silicon Valley Bank touched on a wide range of issues, according to the supervisory documents released alongside the report last month. These included matters that played no apparent role in the bank's collapse, including the management of third-party vendors, the granularity of its loan risk rating system and its governance around lending procedures.
Some MRAs and MRIAs focused on broad topics relevant to the bank's ultimate demise, including funding concentration, deposit segmentation, liquidity management and interest rate modeling for internal stress tests. Still, the two central factors in Silicon Valley Bank's collapse, a reliance on uninsured deposits and a lack of hedges on its long-dated bond investments, were not singled out in the materials released.
"Where's the specific MRA about SVB's excessive exposure to uninsured deposits? Where's the MRA about SVB's specific interest rate risk?" Randall Guynn, a bank regulatory lawyer with Davis Polk, said. "They had 31 supervisory findings, but they couldn't have raised those issues in the 15 months after Quarles left or eight months after Barr got on the job? Unless there's more that hasn't been disclosed, it just doesn't make any sense."
Clifford Stanford, a regulatory lawyer with Alston & Bird and a former attorney in the Federal Reserve Bank of Atlanta's supervision division, said the matter speaks to a long-running complaint by many bankers that having to address a litany of minor issues saps them of time and resources needed to remedy major concerns.
"There is a sense that when a bank's chief risk officer is looking at dedicating resources and they are inundated with dozens of MRAs, the impact of the emphasis on any one MRA could be diluted," he said.
Yet, Stanford said, supervision is largely a matter of judgment and it is difficult to know which potential threats will ultimately play out. Had another issue proved ruinous for Silicon Valley Bank, he said, the issues highlighted by the Fed could have proven more prescient.
The Silicon Valley Report report, commissioned by Quarles's successor Michael Barr, notes that it is difficult to pinpoint a specific catalyst for the culture shift. But it points to a 2018 "guidance on guidance" and a 2021 rule spelling out appropriate activities for supervisors as key moments. Others have said Quarles's focus on transparency and consistency in the supervisory process carried the implication that bank examiners would have their actions held to a higher standard.
At face value, these efforts were all aimed at making bank supervision more effective, but the report states that they "also led to slower action by supervisory staff and a reluctance to escalate issues."
Last month, a senior Fed official told reporters that Barr had undertaken efforts to change the culture of supervision in the Federal Reserve System, including meeting with supervisors and holding town halls and conferences to encourage them to be more aggressive in their oversight. But implementing changes across the entirety of the Fed's supervisory apparatus — which includes thousands of staffers spread through the 12 regional reserve banks and the Board of Governors in Washington — is no simple task.
Quarles had a similar experience when he joined the Fed. In 2018 and 2019, he held town halls at each reserve bank in hopes of spelling out his vision to every supervisor directly. Still, he said, there seems to have been a disconnect between what he wanted and what those beneath him thought he wanted.
"There are changes to supervisory culture that need to be made," he said. "My message to the supervisors was that they needed to be focused on stuff that really matters, and that they needed to draw the attention of the institutions to stuff that really matters. No doubt with the best of intentions, they clearly did the exact opposite of that here."
Supervisory culture at the Fed has been a work in progress for more than a decade. After the subprime mortgage crisis of 2008 and the passage of the Dodd-Frank Act in 2010, Fed leadership sought to consolidate supervisory standards to the board, particularly for large institutions. Previously, each reserve bank had more discretion over how they supervised the banks in their regions, leading to discrepancies from one district to another in terms of supervisory priorities and outcomes.
Brookings Institution fellow and former Treasury official Aaron Klein said the cultural issues around supervision are deeply ingrained in the institution. He has argued in favor of stripping the Fed of its regulatory mandate.
The emphasis on forming a consensus before acting stems from the Fed's approach to monetary policy, he said, noting that the Fed has had unanimity on all of its rate-setting decisions for 18 years straight. He added that while this aversion to dissent has advanced an agenda of lighter regulation in recent years, it is only the latest episode in a long-running saga.
"Did the Trump-appointed Governors promote a culture of deregulation? Yes. Did they create a culture of consensus? No," he said. "That culture stems from monetary policy which is the Fed's telos, its core objective."
Karen Petrou, managing partner of Federal Financial Analytics, has a less hardlined view on the Fed's future as a regulator, but she agrees that the primacy of monetary policy making within the organization has contributed to its supervisory weaknesses.
Petrou said supervisors are rarely blindsided by failures; it's more the case that the regulators identify critical issues that go unchecked. For Fed-supervised banks, she blames this disconnect on supervisors receiving insufficient support from leadership.
"Supervisors need to be rewarded for and given the tools, which they don't have, to cut problematic action short," she said. "What we see constantly in supervision is a negative feedback loop in which banks fail to do what they're told and sometimes even double down to try and do as much of what's making them money as fast as they can before they think they have to stop."
